-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AjnXWOo4l+93Inz9V/hTppqnrt67keAu6pe46RvGdZv17Kl8IESQTDlZqUUV41t6 W51KnvRcWuMncy6T9nTfsg== 0000891020-99-001578.txt : 19990922 0000891020-99-001578.hdr.sgml : 19990922 ACCESSION NUMBER: 0000891020-99-001578 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 19990921 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FREESHOP COM INC CENTRAL INDEX KEY: 0001087277 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 911809146 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-81151 FILM NUMBER: 99714795 BUSINESS ADDRESS: STREET 1: 95 SOUTH JACKSON STREET 2: STE 300 CITY: SEATTLE STATE: WA ZIP: 98104 BUSINESS PHONE: 2064419100 MAIL ADDRESS: STREET 1: 95 SOUTH JACKSON STREET 2: STE 300 CITY: SEATTLE STATE: WA ZIP: 98104 S-1/A 1 AMENDMENT NO. 3 TO FORM S-1 1 As filed with the Securities and Exchange Commission on September 21, 1999. File No. 333-81151 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 3 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ FREESHOP.COM, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) WASHINGTON 7310 91-1809146 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
JOHN WADE CHIEF FINANCIAL OFFICER FREESHOP.COM, INC. 95 SOUTH JACKSON STREET 95 SOUTH JACKSON STREET SUITE 300 SUITE 300 SEATTLE, WASHINGTON 98104 SEATTLE, WASHINGTON 98104 (206) 441-9100 (206) 441-9100 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE (NAME, ADDRESS, INCLUDING ZIP CODE, AND NUMBER, TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL FOR SERVICE) EXECUTIVE OFFICES)
COPIES TO: CHRISTOPHER J. BARRY STEPHEN M. GRAHAM BRYCE L. HOLLAND, JR. PERKINS COIE LLP DORSEY & WHITNEY LLP 1201 THIRD AVENUE, 48TH FLOOR U.S. BANK CENTRE, SUITE 4200 SEATTLE, WASHINGTON 98101 1420 FIFTH AVENUE (206) 583-8888 SEATTLE, WASHINGTON 98101 (206) 903-8800
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] - --------------- If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] - --------------- If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] - --------------- If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. SUBJECT TO COMPLETION, DATED SEPTEMBER 21, 1999 FREESHOP LOGO 3,200,000 SHARES COMMON STOCK This is the initial public offering of FreeShop.com, Inc. and we are offering 3,200,000 shares of our common stock. We anticipate that the initial public offering price will be between $9.00 and $11.00 per share. Our common stock has been approved for quotation on the Nasdaq National Market under the symbol "FSHP," subject to official notice of issuance. INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE RISK FACTORS BEGINNING ON PAGE 8. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
UNDERWRITING PUBLIC OFFERING DISCOUNTS AND PROCEEDS TO PRICE COMMISSIONS FREESHOP Per Share $ $ $ Total $ $ $
We have granted the underwriters the right to purchase up to 480,000 additional shares to cover any over-allotments. DEUTSCHE BANC ALEX. BROWN DAIN RAUSCHER WESSELS a division of Dain Rauscher Incorporated VOLPE BROWN WHELAN & COMPANY E*OFFERING The date of this prospectus is , 1999 3 [ON INSIDE COVER] [At the top center of the page is the FreeShop logo with the phrase "PUTTING CONSUMERS IN CONTROL OF THE DIRECT MARKETING PROCESS" set forth underneath the logo. In the middle of the page is a color depiction of the home page from the FreeShop.com Web site. Beneath the picture of the home page is the following text: "The traditional world of direct marketing is based on contacting a broad range of consumers through mail, telephone, and other solicitations in the hope of generating responses from a small percentage of those consumers. Unlike the traditional direct marketing process, FreeShop aggregates over a thousand free, trial, and promotional offers from marketers in a single place where consumers can easily choose the offers that meet their specific needs."] [ON FOLD OUT FLAP INSIDE THE FRONT COVER] [The phrase "Putting consumers in control of the direct marketing process" appears across the top of the two pages. Underneath the heading, three blocks of text appear across the page. The left block states "OVER SIX MILLION ORDERS TO DATE FreeShop connects millions of consumers with over a thousand offers covering major consumer interest areas. To date, FreeShop has generated more than six million orders." The center block states "OUR BUSINESS MODEL FreeShop generates revenue in multiple ways. Our core business is lead generation, where marketers pay us a fee per lead, or customer request for an offer. In addition, we generate revenue through advertising on our site and in our Club FreeShop newsletters." The right block states "CLUB FREESHOP: OVER 1.5 MILLION EMAIL MEMBERS Club FreeShop is a free membership program through which we communicate with our most valued customers. Members regularly receive email newsletters informing them of special offers, exclusive contests and other promotional opportunities." In the middle of the page is a picture of the FreeShop logo with rectangle banners labeled "SHOPPERS" and "MARKETERS" on either side of the logo, with arrows pointing from the banners toward the FreeShop logo. At the bottom left of the page, three color pictures of category screens from the FreeShop.com Web site appear descending diagonally from left to right. A fourth category screen appears to the right of the top category screen. The caption next to the screens reads "FreeShop is organized by category to make the site easy for customers to find what they want." centered on the bottom of the page are three graphics from the FreeShop.com Web site arranged vertically depicting graphics representing the themes of "Got kids?" "Live Longer" and "Back to School!" The "Got Kids?" graphic includes the text "100% free laughs, puzzles, pets, advice . . . and more!" The "Live Longer" graphic includes the text "100% free for a healthier glow, super wellness, tips and secrets . . . and more!" The "Back to School" graphic includes the text "100% free for high school, college, grad students . . . and more!" The caption next to the graphics reads "Offers are also organized using seasonal and interest-oriented themes." On the bottom right side of the page, three color pictures of screens from the FreeShop.com Web site appear descending diagonally from left to right, including the home page, magazine category page and Join Club FreeShop page. FreeShop's Privacy Pledge screen appears to the right of the home page screen. The caption next to the screens reads "The FreeShop site is designed to make it easy for customers to get comfortable shopping on the Internet."] 4 PROSPECTUS SUMMARY You should read the following summary together with the more detailed information and financial statements and accompanying notes appearing in this prospectus. FREESHOP.COM, INC. FreeShop provides online direct marketing services, giving consumers access to over 1,000 free, trial and promotional offers through our Web site and email newsletters. Consumers seeking to discover, learn about or try new products can choose from a collection of offers from over 100 companies. FreeShop enables consumers to seek out new products of specific interest to them, unlike the traditional direct marketing model, in which marketers communicate to broad audiences in search of new customers. FreeShop currently has more than 1,000 offers from over 100 companies for items such as catalogs, magazines, product samples, software, coupons and consumer goods. To assist consumers in locating offers that interest them most, we arrange offers by category, such as travel, personal finance, entertainment and sports. Our primary source of revenue is lead generation, for which marketers pay us fees based on the number of customer requests for the marketers' offers. We also receive revenue from advertisements placed on our Web site and in our Club FreeShop email newsletters. We believe our Internet-based, consumer-directed process creates a highly effective method of direct marketing in terms of cost, targeting, efficiency and consumer satisfaction. We have received and transmitted to marketer clients more than 6.0 million orders, which are requests by consumers for various offers. According to Media Metrix, Inc., in July 1999, FreeShop was among the top ten online shopping sites based on the estimated number of different visitors to our Web site that month. Our customer database has grown from approximately 850,000 customers in January 1998 to more than 2.0 million customers as of August 1999. In addition, our email newsletters are regularly received by the over 1.5 million members of Club FreeShop, informing them of special offers, exclusive contests and other opportunities. In December 1998, Fingerhut Companies, Inc. became a FreeShop shareholder and currently holds 34.6% of our capital stock. Fingerhut is the eighth largest cataloger and the second largest general merchandise cataloger in the United States. We have recently initiated a noncontractual direct marketing relationship with Fingerhut under which we have established Web site links and are advertising and including inserts in some of Fingerhut's catalogs and order delivery packages. As part of our strategy to increase the number and types of offers on our Web site and increase our visitor and client bases, in May 1999, we acquired the Catalog Site and the Worldwide Brochures Web sites, which greatly expanded our catalog and travel-related offerings. OUR OBJECTIVE Our objective is to be the dominant provider of online direct marketing services. We intend to achieve this objective through the following key strategies: - increase visitor traffic and transactions through both online and traditional marketing programs; - increase our client base by expanding our sales staff and the services we offer and by broadening our relationships with advertising agencies and companies with national consumer brands; - enhance FreeShop's brand name recognition through aggressive marketing; - expand the number of categories and increase the number of offers within each category; - continue to develop and use technology to serve our marketer clients and to make our Web site faster, easier to use and more personalized; and 3 5 - further develop our marketing relationship with Fingerhut and initiate a similar relationship with Federated. RISK FACTORS We have a history of significant losses and have accumulated losses of over $9.6 million since we began operations. The online direct marketing industry is highly competitive and we anticipate incurring substantial losses in the foreseeable future. OUR HISTORY FreeShop began as a division of Online Interactive, Inc., a Washington corporation that was incorporated in June 1994. On June 30, 1997, Online Interactive contributed the FreeShop division to its wholly owned subsidiary, FreeShop International, Inc., a Washington corporation incorporated on June 23, 1997, which then began operating as a separate entity. On February 19, 1999, FreeShop International, Inc. changed its name to FreeShop.com, Inc. Our offices are located at 95 South Jackson Street, Suite 300, Seattle, Washington 98104. Our telephone number is (206) 441-9100. THE OFFERING Common stock offered by FreeShop............................ 3,200,000 shares Common stock to be outstanding after the offering........... 14,955,155 shares Use of proceeds............................................. For marketing, working capital and general corporate purposes. See "Use of Proceeds." Proposed Nasdaq National Market symbol...................... FSHP
The number of shares of common stock to be outstanding after the offering as set forth above is based on the number of shares actually outstanding as of July 31, 1999 and includes: - 1,890,432 shares of common stock issuable upon conversion of 472,608 shares of series B convertible preferred stock, which conversion will occur not later than the completion of this offering; - 1,586,156 shares of common stock issuable upon conversion of 396,539 shares of series B convertible preferred stock, which stock will be acquired pursuant to the exercise of warrants and converted not later than the completion of this offering; and - 35,280 shares of common stock issuable upon conversion of 8,820 shares of series B convertible preferred stock, which stock will be issued and converted not later than the completion of this offering. The number excludes, as of July 31, 1999, a total of 953,289 shares of common stock issuable upon exercise of outstanding stock options at a weighted average exercise price of $1.50 per share, and 27,700 shares of common stock issuable upon exercise of warrants at a weighted average exercise price of $1.19 per share. --------------- The terms "FreeShop," "we," "us" and "our" as used in this prospectus refer to FreeShop.com, Inc. Information throughout this prospectus reflects a 1-for-2.5 reverse split of the outstanding shares of common stock effected on September 15, 1999. Unless otherwise specifically stated, information throughout this prospectus also assumes that: - the underwriters' over-allotment option is not exercised; and 4 6 - Fingerhut will exercise warrants to purchase 396,539 shares of series B convertible preferred stock and will purchase an additional 8,820 shares of series B convertible preferred stock prior to the completion of this offering, and all shares of series B convertible preferred stock will convert into 3,511,868 shares of common stock not later than the completion of this offering. "Free Shop" is a registered trademark of FreeShop.com, Inc. "Find It! Try It! Buy It!," "The starting point for smart online shopping," "Powered by FreeShop" and "FreeShop by Email" are service marks of FreeShop. We may apply for certain other trademarks and service marks, including Club FreeShop, FreeShop Savings Club, Savings Central, FreeShop shopping assistant, Catalog Site, Catalog Channel, The Catalog Site and Worldwide Brochures. All other trademarks and service marks that we refer to in this prospectus are the property of their respective owners. The information on our Web sites is not a part of this prospectus. 5 7 SUMMARY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) Set forth below is our actual statement of operations data. See Note 2 to FreeShop's audited financial statements for a description of how we calculated the number of shares used to compute basic and diluted net loss per share of common stock. The following unaudited pro forma statement of operations data gives effect to the acquisitions of the Catalog Site and Worldwide Brochures Web sites and related assets as if they had occurred on January 1, 1998, but does not reflect the issuance and conversion of the series B convertible preferred stock, which will have occurred not later than the completion of this offering. See Note 7 to our unaudited pro forma combined financial information for a description of the method we used to compute basic and diluted net loss per share of common stock and the number of shares used in that computation. The following balance sheet data provides a summary at June 30, 1999, - on an actual basis; - on a pro forma basis to reflect (1) the issuance of series B convertible preferred stock upon the exercise of warrants, (2) the sale of 8,820 additional shares of series B convertible preferred stock, and (3) the conversion of all series B convertible preferred stock into shares of common stock not later than the completion of this offering; and - on a pro forma as-adjusted basis to reflect the estimated net proceeds from the sale of 3,200,000 shares of common stock in this offering at an assumed initial offering price of $10.00 per share, after deducting underwriting discounts and commissions and estimated offering expenses. See "Selected Unaudited Pro Forma Financial Data," "Selected Actual Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
THREE MONTHS ENDED (UNAUDITED) YEAR ENDED ------------------------------------------------------------------ DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, 1998 1998 1998 1998 1998 1999 1999 ---------- --------- -------- --------- -------- --------- -------- STATEMENT OF OPERATIONS DATA: ACTUAL Revenues....................... $ 1,251 $ 220 $ 209 $ 321 $ 501 $ 667 $ 1,480 Gross profit................... 1,034 181 172 256 425 584 1,373 Operating loss................. (3,136) (573) (641) (970) (952) (1,378) (2,472) Net loss....................... $ (3,199) $ (585) $ (658) $ (992) $ (964) $(1,366) $(2,420) Basic and diluted net loss per common share................. $ (0.51) $ (0.10) $ (0.11) $ (0.16) $ (0.14) $ (0.17) $ (0.29) Shares used to compute basic and diluted net loss per common share................. 6,224 5,688 5,955 6,367 6,871 8,151 8,214
6 8
SIX MONTHS YEAR ENDED ENDED DEC. 31, JUNE 30, 1998 1999 ---------- ----------- PRO FORMA (UNAUDITED) Revenues.................................................. $ 1,893 $ 2,381 Gross profit.............................................. 1,455 2,135 Operating loss............................................ (4,233) (4,155) Net loss.................................................. $ (4,296) $(4,092) Basic and diluted net loss per common share............... (0.68) (0.46) Shares used to compute pro forma basic and diluted net loss per common share................................... 6,277 8,858
AS OF JUNE 30, 1999 (UNAUDITED) ----------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED ------- --------- ----------- BALANCE SHEET DATA: Cash and cash equivalents................................. $ 4,330 $13,209 $42,219 Working capital........................................... 5,190 14,069 43,079 Total assets.............................................. 10,613 19,492 48,502 Long-term obligations, less current portion............... 81 81 81 Total shareholders' equity................................ 8,507 17,386 46,396
7 9 RISK FACTORS This offering involves a high degree of risk. You should carefully consider the risks described below and the other information in this prospectus before deciding to invest in shares of our common stock. Any of these risk factors could materially and adversely affect our business, financial condition or operating results. In that case, the trading price of our common stock could decline, and you could lose all or part of your investment. RISKS RELATED TO OUR BUSINESS WE HAVE A LIMITED OPERATING HISTORY, WHICH MAKES IT DIFFICULT TO PREDICT OUR FUTURE PERFORMANCE. Our limited operating history makes predicting our future performance difficult and does not provide investors with a meaningful basis for evaluating an investment in our common stock. From our inception in June 1994 through June 1997, we existed as a division of Online Interactive, Inc. We began operations as an independent company in June 1997. In the first half of 1998, we began offering advertising opportunities on our Web site and in our email newsletters, in addition to our primary business of lead generation. As a result, our performance since the end of the first quarter of 1998 is not comparable to prior periods. Moreover, we have never operated during a general economic downturn in the United States, which typically adversely affects advertising and marketing expenditures. WE WILL FACE RISKS ENCOUNTERED BY EARLY-STAGE COMPANIES IN INTERNET-RELATED BUSINESSES AND MAY BE UNSUCCESSFUL IN ADDRESSING THESE RISKS. We face risks frequently encountered by early-stage companies in new and rapidly evolving markets, including the market for online direct marketing. We may not succeed in addressing these risks, and our business strategy may not be successful. These risks include uncertainties about our ability to: - attract a larger number of consumers to our Web site; - sign up new marketing clients and add new and compelling content to our Web site; - manage our expanding operations; - adapt to potential decreases in online advertising rates; - successfully introduce new products and services; - continue to develop and upgrade our technology and to minimize technical difficulties and system downtime; - create and maintain the loyalty of our customers and clients; - maintain our current, and develop new, strategic relationships and alliances; and - attract, retain and motivate qualified personnel. WE HAVE A HISTORY OF LOSSES, EXPECT FUTURE LOSSES AND MAY NEVER ACHIEVE PROFITABILITY. We have not achieved profitability and expect to continue to incur operating losses for the foreseeable future. We incurred net losses of $3.2 million, or more than 2.5 times the amount of our revenues, for the year ended December 31, 1998, and $3.8 million, or more than 1.75 times the amount of our revenues, for the six months ended June 30, 1999. As of June 30, 1999, our accumulated losses were $9.6 million, which represents our losses since we began our operations. We have recently increased our operating expenses and capital expenditures in order to accelerate our growth. We expect further increases in operating expenses, including at least $20.0 million of the proceeds of this offering, to significantly expand marketing and brand name promotion over the next 8 10 twelve months. Although our revenues have grown in recent quarters, we will need to significantly increase revenues to achieve profitability. Even if we do achieve profitability, we may be unable to sustain profitability on a quarterly or annual basis in the future. It is possible that our revenues will grow more slowly than we anticipate or that operating expenses will exceed our expectations. OUR QUARTERLY OPERATING RESULTS ARE UNCERTAIN AND MAY FLUCTUATE SIGNIFICANTLY, WHICH COULD NEGATIVELY AFFECT THE VALUE OF YOUR INVESTMENT. Our operating results have varied significantly from quarter to quarter in the past and may continue to fluctuate. As a result, we believe period-to-period comparisons of our operating results are not meaningful. For example, during the year ended December 31, 1998, the percentage of annual sales attributable to the first, second, third and fourth quarters were 17.6%, 16.7%, 25.7% and 40.0%, respectively. Our operating results for a particular quarter or year may fall below the expectations of securities analysts and investors, which could result in a decrease in our stock price. Our limited operating history and the new and rapidly evolving Internet markets make it difficult to ascertain the effects of seasonality on our business. We believe, however, that our revenue may be subject to seasonal fluctuations because advertisers generally place fewer advertisements during the first and third calendar quarters of each year. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions as well as budgeting and buying patterns. A decline in the economic prospects of advertisers could alter current or prospective advertisers' spending priorities, or the time periods in which they determine their budgets, or increase the time it takes to close a sale with our advertisers. During the three months ended June 30, 1999, approximately 90% of our contracts were month-to-month with automatic renewal unless terminated by either party with 10 days' notice. The loss of a significant number of these contracts in any one period might result in a significant decline in our quarterly operating results. WE HAVE EXPERIENCED RAPID GROWTH WHICH HAS PLACED A STRAIN ON OUR RESOURCES, AND ANY FAILURE TO MANAGE OUR GROWTH EFFECTIVELY COULD CAUSE OUR BUSINESS TO SUFFER. We do not have a proven record in managing our growth and may not be successful in doing so. We have grown from 29 employees on July 1, 1997 to 102 employees on July 31, 1999. We have recently hired key management personnel, acquired two businesses and added personnel in connection with these acquisitions. Due to our recent rapid growth and our inexperience in integrating newly acquired businesses, we may not be successful in integrating new personnel and acquired businesses into our existing operations. In addition, we plan to continue expanding our sales and marketing, customer support and research and development organizations. Past growth in these areas has placed, and any future growth will continue to place, a significant strain on our management systems and resources. IF WE ARE UNABLE TO STRENGTHEN THE FREESHOP BRAND NAME, WE MAY BE UNABLE TO COMPETE EFFECTIVELY AGAINST COMPETITORS WITH GREATER BRAND NAME RECOGNITION. We may be unsuccessful in strengthening our brand name. As competitive pressures in the online direct marketing industry increase, we expect that brand name strength will become increasingly important. If we cannot strengthen our brand name, we may be unable to maintain or increase traffic to our Web site, which would lead to decreased revenues from clients. We intend to devote substantial resources to promote the FreeShop brand name. The reputation of our brand name will depend on our ability to provide a high-quality online experience for consumers visiting our Web site or receiving our Club FreeShop email newsletters. Negative experiences of consumers or marketers with FreeShop might result in publicity that could damage our reputation and diminish the strength of our brand name. 9 11 IF WE CANNOT SECURE SUFFICIENT PROMOTIONAL OFFERS FROM OUR MARKETER CLIENTS, OUR BUSINESS WILL SUFFER. If we are unsuccessful in acquiring and renewing a continuing array of free, trial and promotional offers for our Web site, traffic on our site will likely decrease. The attractiveness of our Web site to consumers is based in part on our ability to provide a broad variety of offers of interest to consumers. In addition, a number of other Web sites give consumers access to similar offers. We face competition for free, trial and promotional offers from these Web sites as well as a variety of other online and traditional competitors. Without sufficient variety and quality of offers, our Web site will become less attractive to marketers, and our ability to generate revenue from marketer clients will be adversely affected. THE MAJORITY OF OUR CONTRACTS HAVE MONTH-TO-MONTH TERMS, AND THE LOSS OF A SIGNIFICANT NUMBER OF THESE CONTRACTS IN A SHORT PERIOD OF TIME COULD HARM OUR BUSINESS. During the three months ended June 30, 1999, approximately 90% of our contracts had month-to-month terms with automatic renewal unless terminated by either party with 10 days' notice. The loss of a significant number of these contracts in any one period could result in decreased traffic to our Web site, cause an immediate and significant decline in our revenues and cause our business to suffer. THE LOSS OF THE SERVICES OF ANY OF OUR EXECUTIVE OFFICERS OR KEY PERSONNEL WOULD LIKELY CAUSE OUR BUSINESS TO SUFFER. Our future success depends to a significant extent on the efforts and abilities of our senior management, particularly Timothy C. Choate, our Chairman, President and Chief Executive Officer, and other key employees, including our technical and sales personnel. The loss of the services of any of these individuals could harm our business. We may be unable to attract, motivate and retain other key employees in the future. Competition for employees in our industry is intense, and in the past we have experienced difficulty in hiring qualified personnel. We do not have employment agreements with any of our key personnel, nor do we have key-person insurance for any of our employees. IF WE ARE UNABLE TO INTEGRATE THE OPERATIONS FROM OUR ACQUISITIONS OF THE CATALOG SITE AND WORLDWIDE BROCHURES WEB SITES OR FROM ANY FUTURE ACQUISITIONS, OUR BUSINESS WILL SUFFER. We may be unsuccessful in integrating the operations from our two recent acquisitions or from any future acquisitions. In May 1999, we acquired the Catalog Site and Worldwide Brochures Web sites and related assets. These are our first acquisitions, and we have limited experience with completing and integrating acquisitions. We may be unable to integrate their offers into our Web site and their operations into our existing business. Both of these Web sites have earned their revenues from advertising contracts that require a flat fee for the period of the contract. We intend to seek to transition these flat fee contracts into contracts that require the clients to pay us for leads generated through our Web site. We cannot be certain that the acquired sites' advertisers will agree to enter into lead generation contracts or that we will be able to keep their business. Our business strategy includes growth through acquisitions, so we expect to pursue other acquisitions in the future. Our recent acquisitions and any future acquisitions present many risks and uncertainties generally associated with acquisitions, including: - difficulties integrating operations, personnel, technologies, products and information systems of acquired businesses; - potential loss of key employees of acquired businesses; - adverse effects on our results of operations from acquisition-related charges and amortization of goodwill and purchased technology; - increased fixed costs, which could delay profitability; 10 12 - inability to maintain the key business relationships and the reputations of acquired businesses; - potential dilution to current shareholders from the issuance of additional equity securities; - inability to maintain our standards, controls, procedures and policies; - responsibility for liabilities of companies we acquire; and - diversion of management's attention from other business concerns. IF WE ARE UNABLE TO DEVELOP AND MAINTAIN A POSITIVE BUSINESS RELATIONSHIP WITH FINGERHUT OR INITIATE A RELATIONSHIP WITH FEDERATED, OUR BUSINESS COULD SUFFER. Our business could be adversely affected if we fail to develop and maintain a positive relationship with Fingerhut or to initiate a relationship with Federated. We recently initiated a noncontractual direct marketing relationship with Fingerhut that will include Web site links, advertising and package and catalog inserts. Because Fingerhut only recently invested in us, and because Federated only recently acquired Fingerhut, we do not know what benefits, if any, we will receive from our relationship with Fingerhut or any future relationship we may initiate with Federated, or the degree to which, if any, these relationships may impact our business. Both Fingerhut and Federated operate independently of FreeShop and, subject to future contractual obligations, each remains free to act in its own interest regardless of the effect of its actions on us. In addition, although Fingerhut will retain a substantial equity interest in us immediately following this offering, apart from the exercise of its warrants, neither Fingerhut nor Federated has any obligation to make equity or other capital resources available to us in the future. Because no contractual relationship with Fingerhut currently exists, should Fingerhut become dissatisfied with its relationship with us or decide to change its general business strategy relating to the Internet, our relationship with Fingerhut, and our ability to develop a relationship with Federated, could be adversely affected. If Fingerhut were to decide to discontinue or curtail its relationship with us, our reputation and our stock price could be adversely affected. AN INCREASE IN THE NUMBER OF VISITORS TO OUR WEB SITE MAY STRAIN OUR SYSTEMS, AND WE ARE VULNERABLE TO SYSTEM MALFUNCTIONS. Any serious or repeated problems with the performance of our Web site could lead to the dissatisfaction of consumers or our marketer clients. The amount of traffic on our Web site has increased over time to approximately 2.7 million visitors in July 1999, and we are seeking to further increase traffic. The systems that support our Web site must be able to accommodate an increased volume of traffic. Although we believe our systems can currently accommodate approximately 10 million visitors monthly, in the past, our Web site and the Worldwide Brochures Web site have experienced slow response times and other systems problems for a variety of reasons, including failure of our Internet service providers, hardware failures and failure of software applications. In these instances, our Web site was typically unavailable or slow for approximately one and one-half to two hours. Although these failures did not have a material adverse effect on our business, we may experience similar problems in the future that could have a material adverse effect on our business. See "Business -- Operations and Technology." WE MAY FACE SYSTEM FAILURES RESULTING FROM YEAR 2000 RISKS. Because many computer applications have been written using two digits rather than four to define the applicable year, some date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This year 2000 problem could result in system failures or miscalculations causing disruptions of operations, including disruptions of our Web site. We have obtained confirmation from all but three of our third-party vendors that they have resolved their year 2000 issues. Until we have received responses from all of these vendors and completed our testing, we will not know the extent of our exposure to year 2000 risks. In addition, the systems and services provided by these vendors may fail to be year 2000 compliant despite their representations to the contrary. Failure of these systems or services to be year 2000 compliant could result in a systemic failure 11 13 beyond our control and prevent us from delivering our services to our customers, prevent users from accessing our Web site and decrease the use of the Internet generally. Our limited contingency plans to address the year 2000 problem include replacing noncompliant vendors and distributing our workload to servers located at various cities around the country to minimize the risk of systems failure. We do not intend to develop any further contingency plans. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Year 2000 Issues." WE FACE INTENSE COMPETITION FROM MARKETING-FOCUSED COMPANIES FOR MARKETER CLIENTS AND MAY BE UNABLE TO COMPETE SUCCESSFULLY. We may be unable to compete successfully with current or future competitors. We face intense competition from many companies, both traditional and online, to provide marketing and advertising services for marketer clients. Among the free-offer Web sites, our primary competitors include Volition.com and Free2Try.com. Among the lead-generation Web sites, our primary competitors are eNews, Cataloglink and Catalogcity. We expect competition from online competitors to increase significantly because there are no substantial barriers to entry in our industry. Increased competition could result in price reductions for online advertising space and marketing services, reduced gross margins and loss of our market share. Many of our existing competitors, as well as a number of potential new competitors, have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than FreeShop. These advantages may allow them to respond more quickly and effectively to new or emerging technologies and changes in customer requirements. It may also allow them to engage in more extensive research and development, undertake farther-reaching marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to potential employees, strategic partners and advertisers. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products or services to address the needs of our prospective marketer clients. Online marketing is a rapidly developing industry, and new types of products and services may emerge that are more attractive to consumers and marketers than the types of services we offer. As a result, it is possible that new competitors may emerge and rapidly acquire significant market share. See "Business -- Competition." IF OUR CUSTOMERS REQUEST PRODUCTS AND SERVICES DIRECTLY FROM OUR MARKETER CLIENTS INSTEAD OF REQUESTING THE PRODUCT OR SERVICE FROM US, OUR BUSINESS COULD SUFFER. Our marketer clients may offer the same free or trial products or services on their own Web sites that we offer on our Web site. Our customers may choose to request products or services directly from our marketer clients instead of requesting the product or service from us, which would result in lower revenues to FreeShop from lead generation and cause our business to suffer. WE MAY NEED TO INCUR LITIGATION EXPENSES IN ORDER TO DEFEND OUR INTELLECTUAL PROPERTY RIGHTS, AND MIGHT NEVERTHELESS BE UNABLE TO ADEQUATELY PROTECT THESE RIGHTS. We may need to engage in costly litigation to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the intellectual property rights of others. We cannot assure you that our efforts to prevent misappropriation or infringement of our intellectual property will be successful. An adverse determination in any litigation of this type could require us to make significant changes to the structure and operation of our online services and features or to license alternative technology from another party. Implementation of any of these alternatives could be costly and time-consuming and may not be successful. Any intellectual property litigation would likely result in substantial costs and diversion of resources and management attention. 12 14 Our success largely depends on our trademarks, including "Free Shop," and internally developed technologies, including our email systems and our collection, order-processing and lead-delivery systems, which we seek to protect through a combination of trademark, copyright and trade secret laws. Protection of our trademarks is crucial as we attempt to build our brand name and reputation. Despite actions we take to protect our intellectual property rights, it may be possible for third parties to copy or otherwise obtain and use our intellectual property without authorization or to develop similar technology independently. In addition, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in Internet-related businesses are uncertain and still evolving. Although we are not currently engaged in any lawsuits for the purpose of defending our intellectual property rights, we may need to engage in such litigation in the future. Moreover, we may be unable to maintain the value of our intellectual property rights in the future. IF THIRD PARTIES ACQUIRE DOMAIN NAMES THAT ARE SIMILAR TO OUR DOMAIN NAMES, THEY COULD DECREASE THE VALUE OF OUR TRADEMARKS AND TAKE CUSTOMERS AWAY FROM OUR WEB SITE. We currently hold the Internet domain names "freeshop.com," "catalogsite.com," "wwb.com" and "clubfreeshop.com" as well as various other related names. We may be unable to prevent third parties from acquiring similar domain names, which could reduce the value of our trademarks, potentially weaken our brand name and take customers away from our Web site. Domain names generally are regulated by Internet regulatory bodies. The regulation of domain names in the United States and in foreign countries is subject to change in the near future. Regulatory bodies could establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names. The relationship between regulations governing domain names and laws protecting trademarks and similar intellectual property rights is unclear. Therefore, we may be unable to prevent third parties from acquiring domain names that infringe on, or otherwise decrease the value of, our trademarks and other intellectual property rights. We believe there are online companies in other countries using domain names that potentially infringe on our trademarks. We may be unable to prevent them from using these domain names, and this use may decrease the value of our trademarks and our brand name. WE MAY FACE LITIGATION AND LIABILITY FOR INFORMATION DISPLAYED ON OUR WEB SITE. We may be subjected to claims for defamation, negligence, copyright or trademark infringement and various other claims relating to the nature and content of materials we publish on our Web site. These types of claims have been brought, sometimes successfully, against online services in the past. We could also face claims based on the content that is accessible from our Web site through links to other Web sites. Any litigation arising from these claims would likely result in substantial costs and diversion of resources and management attention, and an unsuccessful defense to one or more such claims could result in material damages. We have no insurance coverage for these types of claims. SECURITY AND PRIVACY BREACHES COULD SUBJECT US TO LITIGATION AND LIABILITY AND DETER CONSUMERS FROM USING OUR WEB SITE. We could be subject to litigation and liability if third parties penetrate our network security or otherwise misappropriate our users' personal or credit card information. This liability could include claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims. It could also include claims for other misuses of personal information, such as for unauthorized marketing purposes. In addition, the Federal Trade Commission and other federal and state agencies have been investigating various Internet companies in connection with their use of personal information. We could be subject to investigations and enforcement actions by these or other agencies. In addition, we rent customer names and street addresses to third parties. Although we provide an opportunity for our customers to remove their names from our rental list, we nevertheless may receive complaints from customers for these rentals. The need to transmit confidential information securely has been a significant barrier to electronic commerce and communications over the Internet. Any compromise of security could deter people 13 15 from using the Internet in general or, specifically, from using the Internet to conduct transactions that involve transmitting confidential information, such as purchases of goods or services. Many marketers seek to offer their products and services on our Web site because they want to encourage people to use the Internet to purchase their goods or services. Internet security concerns could frustrate these efforts. Also, our relationships with consumers may be adversely affected if the security measures we use to protect their personal information prove to be ineffective. We cannot predict whether events or developments will result in a compromise or breach of the technology we use to protect customers' personal information. We have no insurance coverage for these types of claims. Furthermore, our computer servers may be vulnerable to computer viruses, physical or electronic break-ins and similar disruptions. We may need to expend significant additional capital and other resources to protect against a security breach or to alleviate problems caused by any such breaches. We may be unable to prevent or remedy all security breaches. If any of these breaches occur, we could lose marketing clients and visitors to our Web site. WE MAY NEED ADDITIONAL FINANCING, AND OUR PROSPECTS FOR OBTAINING IT ARE UNCERTAIN. We may be unable to obtain necessary additional financing in the future. Our business does not generate the cash necessary to fund our operations. We currently anticipate that our available cash resources combined with the net proceeds from this offering will be sufficient to meet our anticipated capital expenditures and working capital requirements through the next twelve months. Thereafter, we expect we will need to raise additional funds to develop or enhance our services or products, fund expansion, respond to competitive pressures or acquire businesses or technologies. Unanticipated expenses, poor financial results or unanticipated opportunities that require financial commitments could give rise to earlier financing requirements. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our existing shareholders would be reduced, and these securities might have rights, preferences or privileges senior to those of our common stock. Additional financing may not be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our ability to fund our expansion, take advantage of business opportunities, develop or enhance services or products or otherwise respond to competitive pressures would be significantly limited, and we might need to significantly restrict our operations. RISKS RELATED TO OUR INDUSTRY IF THE ACCEPTANCE OF ONLINE ADVERTISING AND ONLINE DIRECT MARKETING DOES NOT CONTINUE TO INCREASE, OUR BUSINESS WILL SUFFER. The demand for online marketing may not develop to a level sufficient to support our continued operations or may develop more slowly than we expect. We expect to derive almost all of our revenues from contracts with marketer clients under which we provide online marketing services through our Web site and email newsletters. The Internet has not existed long enough as a marketing medium to demonstrate its effectiveness relative to traditional marketing methods. Marketers that have historically relied on traditional marketing methods may be reluctant or slow to adopt online marketing. Many marketers have limited or no experience using the Internet as a marketing medium. In addition, marketers that have invested substantial resources in traditional methods of marketing may be reluctant to reallocate these resources to online marketing. Those companies that have invested a significant portion of their marketing budgets in online marketing may decide after a time to return to more traditional methods if they find that online marketing is a less effective method of promoting their products and services than traditional marketing methods. We do not know if accepted industry standards for measuring the effectiveness of online marketing will develop. An absence of accepted standards for measuring effectiveness could discourage companies from committing significant resources to online marketing. There are a variety of pricing models for marketing on the Internet. We cannot predict which, if any, will emerge as the industry standard. Absence of such a standard makes it difficult to project our future pricing and revenues. 14 16 Email marketing is also vulnerable to potential negative public perception associated with unsolicited email, known as "spam." Although we do not send unsolicited email, public perception, press reports or governmental action related to spam could reduce the overall demand for email marketing in general and our Club FreeShop email newsletters in particular. IF WE ARE UNABLE TO ADAPT TO RAPID CHANGES IN THE ONLINE MARKETING INDUSTRY, OUR BUSINESS WILL SUFFER. Online marketing is characterized by rapidly changing technologies, frequent new product and service introductions, short development cycles and evolving industry standards. We may incur substantial costs to modify our services or infrastructure to adapt to these changes and to maintain and improve the performance, features and reliability of our services. We may be unable to successfully develop new services on a timely basis or achieve and maintain market acceptance. WE FACE RISKS FROM POTENTIAL GOVERNMENT REGULATION AND OTHER LEGAL UNCERTAINTIES RELATING TO THE INTERNET. Laws and regulations that apply to Internet communications, commerce and advertising are becoming more prevalent. The adoption of such laws could create uncertainty in use of the Internet and reduce the demand for our services. Recently, Congress enacted legislation regarding children's privacy on the Internet. Additional laws and regulations may be proposed or adopted with respect to the Internet, covering issues such as user privacy, freedom of expression, pricing, content and quality of products and services, taxation, advertising, intellectual property rights and information security. The passage of legislation regarding user privacy or direct marketing on the Internet may reduce demand for our services or limit our ability to provide customer information to marketers. Furthermore, the growth of electronic commerce may prompt calls for more stringent consumer protection laws. For example, the European Union recently adopted a directive addressing data privacy that may result in limits on the collection and use of consumer information. The adoption of consumer protection laws that apply to online marketing could create uncertainty in Internet usage and reduce the demand for our services. In addition, we are not certain how our business may be affected by the application of existing laws governing issues such as property ownership, copyrights, encryption and other intellectual property issues, taxation, libel, obscenity and export or import matters. It is possible that future applications of these laws to our business could reduce demand for our services or increase the cost of doing business as a result of litigation costs or increased service delivery costs. Our services are available on the Internet in many states and foreign countries, and these states or foreign countries may claim that we are required to qualify to do business in their jurisdictions. Currently, we are qualified to do business only in Washington, Minnesota and California. Our failure to qualify in other jurisdictions if we were required to do so could subject us to taxes and penalties and could restrict our ability to enforce contracts in those jurisdictions. RISKS RELATED TO THIS OFFERING WE WILL HAVE BROAD DISCRETION IN THE USE OF THE NET PROCEEDS FROM THIS OFFERING, AND THERE IS A RISK THAT WE MIGHT USE THEM INEFFECTIVELY. We will have broad discretion over how we use the net offering proceeds, and we could spend the proceeds in ways with which you might not agree. We cannot assure you that we will use these proceeds effectively. We plan to use the proceeds from this offering for marketing, working capital and general corporate purposes. We have not determined how we will allocate proceeds among these uses. Our business strategy includes growth through acquisitions, and we may use a substantial portion of the offering proceeds to buy businesses we have not yet identified. See "Use of Proceeds." 15 17 VIRTUALLY ALL OF OUR SHARES WILL BE ELIGIBLE FOR SALE SHORTLY AFTER THIS OFFERING, WHICH COULD RESULT IN A DECLINE IN OUR STOCK PRICE. If our shareholders sell substantial amounts of common stock in the public market following this offering, the market price of our common stock could fall. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. Based on shares outstanding as of July 31, 1999, upon completion of this offering, we will have 14,955,155 shares of common stock outstanding. Of these shares, the 3,200,000 shares being offered by this prospectus will be freely tradable, and the remaining 11,755,155 shares will become eligible for sale in the public market as follows:
NUMBER OF SHARES DATE - ---------------- ---- 123,530..... , 1999 (the date of this prospectus) 133,993..... , 1999 (90 days after the date of this prospectus) 7,838,844... , 2000 (180 days after the date of this prospectus) 3,658,788... At various times thereafter upon the expiration of one-year holding periods
This table reflects "lock-up agreements" in which the holders of approximately 11,497,632 shares have agreed not to offer or sell their shares until 180 days after the date of this prospectus, without the consent of Deutsche Bank Securities Inc. In addition, shortly after the effective date of this offering, we expect to register for sale up to 2,400,000 shares of common stock reserved for issuance under the 1997 Stock Option Plan. As of July 31, 1999, options to purchase 953,289 shares of common stock were outstanding. Shares acquired upon exercise of these options will be eligible for sale in the public market from time to time, subject to vesting. Holders of 94% of the outstanding option shares are subject to 180-day lockup restrictions that apply to the outstanding stock. These stock options generally have exercise prices significantly below the assumed initial public offering price of our common stock. Also, at the completion of this offering, we will have 27,700 shares of common stock issuable upon the exercise of outstanding warrants. The possible sale of a significant number of these shares may cause the price of our common stock to decline. None of Fingerhut, Timothy C. Choate or John P. Ballantine, who in the aggregate beneficially own approximately 68.9% of our capital stock as of July 31, 1999, are restricted from selling any of their FreeShop securities, other than as provided by lock-up agreements with Deutsche Bank Securities Inc., a stockholders agreement and applicable securities laws. Also, shareholders and warrant holders holding securities that represent approximately 5,184,175 shares of common stock may have the right to include their shares in registration statements relating to our securities. By exercising their registration rights and causing a large number of shares to be registered and sold in the public market, these holders could cause the price of our common stock to decline. OUR SECURITIES HAVE NO PRIOR MARKET, AND WE CANNOT PREDICT WHETHER AN ACTIVE TRADING MARKET WILL DEVELOP. There has not been a public market for our common stock. We cannot predict the extent to which investor interest in our common stock will lead to the development of an active trading market or how liquid that market might become. The initial public offering price for the shares will be determined by negotiations between us and the representatives of the underwriters and may not be indicative of prices that will prevail in the trading market. THE PRICE OF OUR COMMON STOCK AFTER THIS INITIAL PUBLIC OFFERING IS LIKELY TO BE VOLATILE AND MAY FALL BELOW THE INITIAL PUBLIC OFFERING PRICE. The stock market has experienced significant price and volume fluctuations, and the market prices of securities of Internet-related companies have been particularly volatile. Investors may be unable to resell their shares at or above the initial public offering price. In the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action 16 18 litigation. A securities class action lawsuit against us could result in substantial costs and a diversion of management's attention and resources. EXISTING SHAREHOLDERS WILL BE ABLE TO EXERCISE CONTROL OF OUR COMMON STOCK AND MAY MAKE DECISIONS THAT ARE NOT IN THE BEST INTERESTS OF ALL SHAREHOLDERS. Insider control of a large amount of our common stock could have an adverse effect on the market price of our common stock. At the completion of this offering, Fingerhut will own approximately 34.3% of the outstanding shares of our common stock. In addition, following this offering, our founders, Messrs. Choate and Ballantine, will beneficially own or control approximately 26.2% of the outstanding shares of our common stock, and our executive officers and directors, including Messrs. Choate and Ballantine, will beneficially own or control approximately 27.6% of the outstanding shares of our common stock. Although they are under no obligation to do so, if our officers, directors, founders, their affiliates and Fingerhut were to vote together they would have the ability to control the election of our board of directors and the outcome of corporate actions requiring shareholder approval, including mergers and other changes of corporate control, going private transactions and other extraordinary transactions. This concentration of ownership may have the effect of delaying or preventing a change of control of FreeShop, even if this change of control would benefit shareholders. FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements based on our current expectations, assumptions, estimates and projections about our business and industry. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those anticipated in such forward-looking statements as a result of numerous factors, as more fully described in "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" and elsewhere in this prospectus. You should not unduly rely on these forward-looking statements, which apply only as of the date of this prospectus. 17 19 USE OF PROCEEDS We estimate the net proceeds from the sale of the 3,200,000 shares of common stock offered hereby at an assumed initial public offering price of $10.00 per share, after deducting the underwriting discounts and commissions and estimated offering expenses, will be $29.0 million, or $33.5 million if the underwriters' over-allotment option is exercised in full. We intend to use at least $20.0 million of the net proceeds from this offering to significantly expand marketing and brand name promotion spending over the next twelve months. We expect to use the remaining net proceeds of this offering for other general corporate purposes, including working capital and capital expenditures, and also for possible acquisitions of complementary businesses and technologies that increase the number and variety of offers on our Web site or increase the capability of our Web site. We have no current understandings, commitments or agreements with respect to any material acquisitions. Pending such uses, we will invest the net proceeds of this offering in short-term, interest-bearing, investment-grade securities. DIVIDEND POLICY We have never declared or paid any cash dividends on our capital stock and do not anticipate doing so in the foreseeable future. We may incur indebtedness in the future that may prohibit or effectively restrict the payment of dividends, although we have no current plans to do so. 18 20 CAPITALIZATION The following table sets forth our capitalization as of June 30, 1999, - on an actual basis; - on a pro forma basis to reflect (1) the issuance of series B convertible preferred stock upon the exercise of warrants, (2) the issuance of 8,820 additional shares of convertible preferred stock, and (3) the conversion of all series B convertible preferred stock into shares of common stock no later than the completion of this offering; and - on a pro forma as adjusted basis to reflect the estimated net proceeds from the sale of 3,200,000 shares of common stock in this offering at an assumed initial public offering price of $10.00 per share, after deducting underwriting discounts and commissions and estimated offering expenses.
AS OF JUNE 30, 1999 (UNAUDITED) ----------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED --------- --------- ----------- (IN THOUSANDS) Current portion of long-term obligations.................... $ 122 $ 122 $ 122 ======= ======= ======= Long-term obligations, less current portion................. $ 81 $ 81 $ 81 ------- ------- ------- Shareholders' equity: Preferred stock, undesignated, no par value; 6,814,516 shares authorized and no shares issued and outstanding actual, pro forma and pro forma as adjusted(1)......... -- -- -- Series A convertible preferred stock, no par value; 1,935,484 shares authorized and issued; no shares outstanding, actual, pro forma and pro forma as adjusted(2)............................................ -- -- -- Series B convertible preferred stock, no par value; 1,250,000 shares authorized, 472,608 issued and outstanding, actual; 1,250,000 shares authorized, no shares issued or outstanding pro forma and pro forma as adjusted(3)............................................ 8,615 -- -- Common stock, no par value, 40,000,000 shares authorized; 8,923,287 issued and 8,243,287 outstanding, 12,435,155 issued and 11,755,155 outstanding and 15,635,155 issued and 14,955,155 outstanding, actual, pro forma and pro forma as adjusted, respectively(4)..................... 8,956 26,450 55,460 Additional paid-in capital................................ 1,976 1,976 1,976 Deferred stock compensation............................... (1,076) (1,076) (1,076) Accumulated deficit....................................... (9,964) (9,964) (9,964) ------- ------- ------- Total shareholders' equity............................. 8,507 17,386 46,396 ------- ------- ------- Total capitalization.............................. $ 8,588 $17,467 $46,477 ======= ======= =======
- --------------- (1) Ten million shares of undesignated preferred stock are authorized, of which 1,935,484 shares were designated as series A convertible preferred stock and 1,250,000 shares were designated as series B convertible preferred stock. (2) Shares of series A convertible preferred stock were issued on June 30, 1997. On July 18, 1997, all of the shares of series A convertible preferred stock were converted into common stock. (3) The shares of series B convertible preferred stock were designated on May 21, 1999. As of June 30, 1999, 472,608 shares have been issued pursuant to the exercise of warrants. Prior to the completion of this offering, 396,539 additional shares of series B convertible preferred stock will be issued pursuant to the exercise of warrants and 8,820 shares of series B convertible preferred stock will be issued and sold. Upon completion of this offering, each share of series B convertible preferred stock will be converted into four shares of common stock. (4) Based on the number of shares outstanding as of June 30, 1999. Excludes 953,289 shares of common stock issuable upon the exercise of options then outstanding with a weighted average exercise price of $1.50 per share, and 27,700 shares of common stock issuable upon exercise of warrants then outstanding with a weighted average exercise price of $1.19 per share. See "Management -- Stock Option Plan" and Note 10 to FreeShop's audited financial statements included in this prospectus. 19 21 DILUTION The pro forma net tangible book value of FreeShop as of June 30, 1999, was approximately $14,889,000, or $1.27 per share of common stock. Pro forma net tangible book value per share represents the amount of total pro forma tangible assets less total pro forma liabilities, divided by the number of shares of common stock outstanding on a pro forma basis after giving effect to the conversion of the Series B convertible preferred stock into 3,511,868 shares of common stock concurrent with the closing of this offering. After giving effect to the sale of shares of common stock offered by FreeShop at an assumed initial public offering price of $10.00 per share and after deducting underwriting discounts and commissions and estimated offering expenses, the pro forma net tangible book value of FreeShop as of June 30, 1999 would have been $2.94 per share of common stock. This represents an immediate increase in pro forma net tangible book value of $1.67 per share to existing shareholders and an immediate dilution of $7.06 per share to new investors. The following table illustrates this per share dilution: Assumed initial public offering price per share............. $10.00 Pro forma net tangible book value per share before this offering............................................... $ 1.27 Increase per share attributable to new investors.......... 1.67 ------ Pro forma net tangible book value per share after this offering.................................................. 2.94 ------ Dilution per share to new investors......................... $ 7.06 ======
The following table summarizes, on a pro forma basis as of June 30, 1999, the differences between existing shareholders and new investors with respect to the number of shares of common stock purchased from FreeShop, the total consideration paid to FreeShop and the average price per share paid:
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE -------------------- --------------------- PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ---------- ------- ----------- ------- --------- Existing shareholders......................... 11,755,155 78.6% $26,450,036 45.3% $ 2.25 New investors................................. 3,200,000 21.4 32,000,000 54.7 10.00 ---------- ----- ----------- ----- ------ Total.................................... 14,955,155 100.0% $58,450,036 100.0% $ 3.91 ========== ===== =========== ===== ======
The foregoing discussion and tables assume no exercise of any stock options outstanding as of June 30, 1999. As of June 30, 1999, there were options outstanding to purchase a total of 953,289 shares of common stock with a weighted average exercise price of $1.50 per share and warrants outstanding to purchase a total of 27,700 shares of common stock with a weighted average exercise price of $1.19 per share. To the extent that any of the options or warrants are exercised, there will be further dilution to new investors. See "Management -- Stock Option Plan" and Note 10 to FreeShop's audited financial statements included in this prospectus. 20 22 SELECTED UNAUDITED PRO FORMA FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) The following unaudited pro forma statement of operations data reflects the acquisitions of the Catalog Site and Worldwide Brochures Web sites and related assets as if they had occurred on January 1, 1998. The following unaudited pro forma financial data is presented for informational purposes only and has been derived from the unaudited pro forma financial statements and accompanying notes appearing in this prospectus and should be read in conjunction with those financial statements. The selected unaudited pro forma financial data does not purport to be indicative of future operations and should not be construed as representative of future operations of the combined businesses. See Note 7 to FreeShop's unaudited pro forma combined financial information for a description of the method we used to compute our basic and diluted net loss per share of common stock.
PRO FORMA PRO FORMA YEAR ENDED SIX MONTHS ENDED DEC. 31, 1998 JUNE 30, 1999 ----------------- ------------------ STATEMENT OF OPERATIONS DATA: Revenues.................................................. $ 1,893 $ 2,381 Cost of revenues.......................................... 438 246 ----------- ------- Gross profit........................................... 1,455 2,135 Operating expenses: Sales and marketing.................................... 3,269 4,197 Research and development............................... 387 321 General and administrative............................. 605 598 Equity based compensation.............................. 174 622 Depreciation and amortization.......................... 1,253 552 ----------- ------- Total operating expenses.......................... 5,688 6,290 Operating loss............................................ (4,233) (4,155) Interest expense.......................................... 66 24 Other (income) expense.................................... (3) (87) ----------- ------- Net loss.................................................. $ (4,296) $(4,092) =========== ======= Basic and diluted net loss per common share............... $ (0.68) $ (0.46) =========== ======= Shares used to compute pro forma basic and diluted net loss per common share.................................. 6,277 8,858
21 23 SELECTED ACTUAL FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) The following selected actual financial data are qualified in their entirety by reference to, and you should read them in conjunction with, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and FreeShop's audited financial statements and accompanying notes appearing in this prospectus. We have derived the statements of operations data for December 31, 1998 from our audited financial statements that appear in this prospectus, and this data is qualified by reference to the financial statements. Prior to June 30, 1997, FreeShop's business operations were conducted as a division of Online Interactive. On June 30, 1997, Online Interactive contributed the FreeShop division to its wholly owned subsidiary, FreeShop International, which began operating as an independent entity with a fiscal year end of December 31. The statements of operations and balance sheet information for the three fiscal years ended June 30, 1995, 1996 and 1997 reflect the data of the FreeShop division of Online Interactive. The statements of operations and balance sheet information for the six months ended December 31, 1997, the fiscal year ended December 31, 1998 and the six-month periods ended June 30, 1998 and June 30, 1999 reflect data compiled since FreeShop began operating as an independent entity. See Note 1 to FreeShop's audited financial statements included in this prospectus.
FREESHOP DIVISION OF ONLINE INTERACTIVE, INC. FREESHOP ---------------------------- -------------------------------------------------------------- SIX MONTHS 12 MONTHS YEAR SIX MONTHS ENDED YEAR ENDED JUNE 30, ENDED ENDED ENDED JUNE 30, ---------------------------- DEC. 31, DEC. 31, DEC. 31, ----------------- 1995 1996 1997 1997 1997(1) 1998 1998 1999 -------- ------- ------- ------------ ------------ ------------ ------- ------- (UNAUDITED) STATEMENT OF OPERATIONS DATA: Revenues........................ $ 313 $ 1,271 $ 1,198 $ 535 $ 1,037 $ 1,251 $ 429 $ 2,147 Cost of revenues................ 85 310 314 140 259 217 76 190 -------- ------- ------- ------- ------- ------- ------- ------- Gross profit.................. 228 961 884 395 778 1,034 353 1,957 Operating expenses: Sales and marketing........... 134 624 1,810 1,175 2,225 3,088 1,030 4,141 Research and development...... 2 65 135 182 259 387 194 322 General and administrative.... 126 291 353 83 298 417 172 462 Equity-based compensation..... -- -- -- 63 64 174 122 622 Depreciation and amortization................ -- 9 30 35 52 104 49 260 -------- ------- ------- ------- ------- ------- ------- ------- Total operating expenses................ 262 989 2,328 1,538 2,898 4,170 1,567 5,807 Operating loss.................. (34) (28) (1,444) (1,143) (2,120) (3,136) (1,214) (3,850) Interest expense................ -- -- -- 6 6 66 28 23 Other (income) expense.......... -- -- -- 0 0 (3) 1 (87) -------- ------- ------- ------- ------- ------- ------- ------- Net loss........................ $ (34) $ (28) $(1,444) $(1,149) $(2,126) $(3,199) $(1,243) $(3,786) ======== ======= ======= ======= ======= ======= ======= ======= Basic and diluted net loss per common share.................. $ (0.01) $ (0.01) $ (0.31) $ (0.22) $ (0.51) $ (0.21) $ (0.46) ======== ======= ======= ======= ======= ======= ======= Shares used to compute basic and diluted net loss per common share......................... 4,601 4,601 4,601 5,189 6,224 5,822 8,183
AS OF JUNE 30, AS OF DEC. 31, ---------------------------- --------------------------- AS OF JUNE 30, 1995 1996 1997 1997 1998 1999 -------- ------- ------- ------------ ------------ ------------------ (UNAUDITED) BALANCE SHEET DATA: Cash and cash equivalents...... $ -- $ -- $ -- $ 26 $ 2,892 $ 4,330 Working capital (deficiency)... 3 80 322 (158) 2,014 5,190 Total assets................... 48 207 536 645 3,687 10,613 Long-term obligations, less current portion.............. -- -- 5 160 195 81 Total shareholders' equity..... 8 105 432 82 2,244 8,507
- --------------- (1) The financial information presented for the 12 months ended December 31, 1997 is an unaudited 12-month period prepared by our management for comparative purposes only. 22 24 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We began our direct marketing business in 1994 as the FreeShop division of Online Interactive, Inc., a company founded by Timothy C. Choate and John P. Ballantine. In addition to operating the FreeShop division, Online Interactive was also engaged in the business of selling software over the Internet. In July 1997, Micro Warehouse, Inc., a catalog retailer and direct marketer of computers, software and related products, purchased all of the stock of Online Interactive from its shareholders. Before the purchase was completed, Online Interactive transferred the FreeShop division to FreeShop International, Inc., a newly formed, wholly owned subsidiary, and spun off FreeShop International through a distribution to its shareholders. On February 19, 1999, FreeShop International changed its name to FreeShop.com, Inc. We began our online marketing operations in 1994 through a relationship with Prodigy Communications Corporation, a proprietary online service. In 1995, we also began a marketing relationship with America Online, Inc., another proprietary online service. We came to believe proprietary online environments, which provide content exclusively to their fee-paying members, were limiting our ability to develop the FreeShop brand and to access the growing number of people using the Internet. As a result, we terminated our relationship with Prodigy in August 1997 and our relationship with America Online in March 1998. Since March 1998, we have focused exclusively on our FreeShop.com Web site. With the Micro Warehouse purchase of Online Interactive in July 1997, Mr. Choate joined Micro Warehouse as a vice president. In March 1998, Mr. Choate rejoined FreeShop as chief executive officer and began initiatives to expand our sources of revenue beyond our primary business of lead generation by offering multiple advertising vehicles, such as banner advertising, site sponsorships and sponsorships of our Club FreeShop email newsletters. We also increased our efforts to expand consumer awareness of and visits to our Web site. We have continued our efforts to improve the attractiveness of the FreeShop.com Web site and to develop technology to improve our ability to offer services to clients and to monitor and manage our Web site. We derive our revenues primarily from online lead generation and advertising contracts. We receive lead generation revenues when we deliver customer information to a marketer in connection with an offer on our Web site. We receive advertising revenues from sales of banner advertising, site sponsorships and newsletter sponsorships. We also derive a small portion of our lead generation revenues from the rental of customer names and street addresses to third parties. Lead generation pricing is based on cost per lead and varies depending on the type of offer. Generally, pricing of advertising is based on cost per impression or cost per click through. The services we deliver are primarily sold under short-term agreements that are subject to cancellation. We recognize revenues in the period in which we deliver the service. See "Business -- Client Services" and Note 2 to FreeShop's audited financial statements included in this prospectus. Our ten largest clients accounted for 25.0% of our revenues in the year ended December 31, 1998 and 29.1% of our revenues in the six months ended June 30, 1999. No single client accounted for more than 6.7% of our revenues in the six months ended June 30, 1998, 3.8% of our revenues in the year ended December 31, 1998 or 8.3% of revenues in the six months ended June 30, 1999. In December 1998, Fingerhut invested $4.0 million in our business and received common stock and warrants. As of June 30, 1999, Fingerhut had exercised warrants for an additional investment of $8.6 million. Pursuant to the terms of a letter agreement and an escrow agreement, Fingerhut has agreed to exercise the remainder of its warrants for an additional investment of $8.9 million if this offering is completed on or before October 31, 1999. Assuming the exercise 23 25 of the warrants and conversion of the series B convertible preferred stock, Fingerhut will hold approximately 43.7% of the common stock immediately prior to the completion of this offering. Fingerhut's investments have given us more resources to accelerate the growth of our business and have permitted us to add experienced management, marketing and technical personnel. Apart from the exercise by Fingerhut of these warrants, however, Fingerhut has no obligation to make equity or other capital resources available to us in the future. See "Business -- Strategy" and "Related Party Transactions." Part of our strategy involves growth through the acquisition of businesses that will expand our offerings to consumers and our services to marketers. In May 1999, we purchased the Web sites and related assets of two companies, Commonsite, LLC, whose Catalog Site Web site offers more than 200 catalogs, and Travel Companions International, Inc., whose Worldwide Brochures Web site offers consumers more than 15,000 free travel brochures. Revenues generated by the Catalog Site and Worldwide Brochures Web sites primarily come from flat-fee advertising contracts. We intend to transition these advertising contracts to lead generation contracts. We accounted for these acquisitions as asset purchases and have included the results of the acquired businesses in our financial statements from the date we completed the acquisitions. These acquisitions resulted in the allocation of $2.7 million to goodwill and other intangible assets in May 1999. We are amortizing these intangible assets over periods ranging from one to five years. We have included unaudited pro forma combined financial information in this prospectus reflecting these acquisitions as if the acquisitions had occurred on January 1, 1998. Pro forma revenues were $2.4 million for the six months ended June 30, 1999 and $1.9 million for the year ended December 31, 1998. See our unaudited pro forma combined financial statements, the Commonsite audited financial statements and the Travel Companions International audited financial statements included in this prospectus. Our business has been operating at a loss and generating negative cash flow since inception. As of June 30, 1999, we had accumulated losses of approximately $9.6 million. After the completion of this offering, we plan to increase further the level of our investment in marketing and promotion, development of technology and expansion of our business. As a result, our losses and negative cash flow are likely to continue to increase. RESULTS OF OPERATIONS We changed our fiscal year end from June 30 to December 31 in connection with our spin-off from Online Interactive in June 1997. Due to this change, we believe comparison of the year ended December 31, 1998 to the six months ended December 31, 1997 is not appropriate. Therefore, management prepared financial information for the 12-month period ended December 31, 1997 for the purposes of comparison only. The following discussion compares the results of operations for the year ended December 31, 1998 to the unaudited 12-month period ended December 31, 1997 and compares the results of operations for the year ended June 30, 1997 to the year ended June 30, 1996. Our financial statements for the years ended June 30, 1996 and 1997 reflect the assets and liabilities and the revenues, expenses and cash flow of the FreeShop division of Online Interactive. Certain expenses of Online Interactive were allocated to us on a basis we believe reflects a reasonable allocation of expenses to present FreeShop as a stand-alone company. See Note 1 to FreeShop's audited financial statements included in this prospectus. 24 26 The following table sets forth statement of operations data for the periods indicated as a percentage of revenues:
YEAR ENDED 12 MONTHS YEAR SIX MONTHS ENDED JUNE 30, ENDED ENDED JUNE 30, --------------- DEC. 31, DEC. 31, ---------------- 1996 1997 1997(1) 1998 1998 1999 ----- ------ ------------ ---------- ------ ------ (UNAUDITED) Revenues....................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Cost of revenues............... 24.4 26.2 25.0 17.3 17.6 8.8 ----- ------ ------ ------ ------ ------ Gross profit................. 75.6 73.8 75.0 82.7 82.4 91.2 Operating expenses: Sales and marketing.......... 49.1 151.1 214.7 246.9 240.1 192.9 Research and development..... 5.1 11.3 25.0 30.9 45.2 15.0 General and administrative... 22.9 29.5 28.7 33.4 40.1 21.5 Equity-based compensation.... 0.0 0.0 6.1 13.9 28.6 29.0 Depreciation and amortization.............. 0.7 2.5 5.0 8.3 11.4 12.1 ----- ------ ------ ------ ------ ------ Total operating expenses................ 77.8 194.4 279.5 333.4 365.4 270.5 ----- ------ ------ ------ ------ ------ Operating loss................. (2.2) (120.6) (204.5) (250.7) (283.0) (179.3) Interest expense............... 0.0 0.0 0.7 5.2 6.6 1.1 Other (income) expense......... 0.0 0.0 0.0 (0.2) 0.2 (4.1) ----- ------ ------ ------ ------ ------ Net loss....................... (2.2)% (120.6)% (205.2)% (255.7)% (289.8)% (176.3)% ===== ====== ====== ====== ====== ======
- --------------- (1) The financial information for the 12 months ended December 31, 1997 is an unaudited 12-month period prepared by our management for comparative purposes only. SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998 (UNAUDITED) Revenues. We derive our revenues primarily from online lead generation and advertising contracts. Our revenues increased by $1.7 million, or 400%, to $2.1 million in the six months ended June 30, 1999, compared to $429,000 in the six months ended June 30, 1998. This growth in revenue was attributable to the introduction of advertising revenue in June 1998 and an increase in the number of visits to our Web site, which increased lead generation revenues. We introduced advertising, including banner ads, site sponsorships and newsletter sponsorships, in the second and third quarters of 1998. Revenues from advertising services were $839,000 in the six months ended June 30, 1999, compared to $13,000 in the six months ended June 30, 1998. Over the same period, lead generation revenues increased to $1.3 million from $416,000. Cost of revenues. Cost of revenues consists of expenses associated with the production and usage of the FreeShop.com Web site, including Internet connection charges, banner ad serving fees, equipment and software depreciation and personnel costs. Cost of revenues increased to $190,000 in the six months ended June 30, 1999 from $76,000 in the six months ended June 30, 1998. The increase was primarily due to costs related to additional Internet connection capacity and personnel costs to support our growth. Gross margin increased to 91.2% in the six months ended June 30, 1999, from 82.4% in the six months ended June 30, 1998. This increase in gross margin was primarily due to cost of revenues increasing at a lesser rate than revenues. Sales and marketing. Sales and marketing expenses consist primarily of marketing and promotional costs related to developing our brand, as well as personnel and other costs. Sales and marketing expenses increased by $3.1 million, or 302%, to $4.1 million in the six months ended June 30, 1999, compared to $1.0 million in the six months ended June 30, 1998. The increase was due primarily to a $1.9 million, or 626%, increase in advertising and brand awareness spending and a $726,000, or 131%, increase in personnel costs. We expect to continue to increase our advertising and brand awareness spending in the future. As a percentage of 25 27 revenues, sales and marketing expenses decreased to 192.9% in the six months ended June 30, 1999, from 240.1% in the six months ended June 30, 1998. This decrease was primarily due to sales and marketing expenses, other than advertising spending, increasing at a lesser rate than revenues. Research and development. Research and development expenses primarily include personnel costs related to maintaining and enhancing the features, content and functionality of our Web site and related systems. Research and development expenses increased by $128,000, or 66%, to $322,000 in the six months ended June 30, 1999, compared to $194,000 in the six months ended June 30, 1998. The increase was primarily due to hiring additional staff to support our growth. As a percentage of revenues, research and development expenses decreased to 15% in the six months ended June 30, 1999, from 45.2% in the six months ended June 30, 1998. The decrease was primarily due to research and development expenses increasing at a lesser rate than revenues. General and administrative. General and administrative expenses primarily consist of management, financial and administrative personnel expenses and related costs and professional service fees. General and administrative expenses increased by $290,000, or 169%, to $462,000 in the six months ended June 30, 1999, compared to $172,000 in the six months ended June 30, 1998. The increase was primarily due to increased personnel costs and professional service fees necessary to support our growth. As a percentage of revenues, general and administrative expenses decreased to 21.5% in the six months ended June 30, 1999, from 40.1% in the six months ended June 30, 1998. The decrease is primarily due to general and administrative expenses increasing at a lesser rate than revenues. Equity-based compensation. Equity-based compensation expenses consist of amortization of unearned compensation recognized in connection with stock options and recognition of expenses when our principal shareholders sell our stock to employees and directors at a price below the estimated fair market value of our common stock. Unearned compensation is recorded based on the intrinsic value when we issue stock options to employees at an exercise price below the estimated fair market value of our common stock at the date of grant. Unearned compensation is also recorded based on the fair value of the option granted as calculated using the Black-Scholes option pricing model when options or warrants are issued to advisors and other service providers. Unearned compensation is amortized over the vesting period of the option or warrant. Equity-based compensation expenses increased by $500,000, or 410%, to $622,000 in the six months ended June 30, 1999, compared to $122,000 in the six months ended June 30, 1998. This increase resulted primarily from recognition of $406,000 of expenses related to the sale of securities to an employee by a principal shareholder at a price below the estimated fair market value as an inducement for the employee to come to work for FreeShop. As a percentage of revenue, equity-based compensation expenses increased to 29.0% in the six months ended June 30, 1999, from 28.6% in the six months ended June 30, 1998. Depreciation and amortization. Depreciation and amortization expenses consist of depreciation on leased and owned computer equipment, software, office equipment and furniture and amortization on intellectual property, noncompete agreements and goodwill from acquisitions. Depreciation and amortization expenses increased by $211,000, or 431%, to $260,000 in the six months ended June 30, 1999, compared to $49,000 in the six months ended June 30, 1998. This increase resulted from the depreciation of approximately $700,000 in furniture and equipment acquired from July 1998 through June 1999 and the amortization of approximately $2.7 million in intangible assets related to the acquisition of substantially all of the assets of Commonsite and Travel Companions International. As a percentage of revenue, depreciation and amortization expenses increased to 12.1% in the six months ended June 30, 1999, from 11.4% in the six months ended June 30, 1998. 26 28 Interest expense. Interest expense primarily relates to capital equipment leases, and totaled $23,000 in the six months ended June 30, 1999 and $28,000 in the six months ended June 30, 1998. Other (income) expense. Other (income) expense consists primarily of interest income. Interest income increased to $87,000 in the six months ended June 30, 1999 from no interest income in the six months ended June 30, 1998, due to higher cash balances resulting from the investment by Fingerhut in December 1998. Income taxes. No provision for federal income taxes has been recorded for any of the periods presented. As of June 30, 1999, we had approximately $7.3 million of federal net operating loss carryforwards that are available to offset future taxable income; these carryforwards expire in various years beginning in 2012, if not previously utilized. We expect that Fingerhut will increase its ownership of our common stock prior to the completion of this offering which will limit, under the Tax Reform Act of 1986, the amounts of and benefits from our net operating loss carryforwards. Based on preliminary estimates, we believe the effect of such limitation, if imposed, will not have a material adverse effect on our business, results of operations and financial condition. YEAR ENDED DECEMBER 31, 1998 COMPARED TO UNAUDITED 12 MONTHS ENDED DECEMBER 31, 1997 Revenues. Our revenues increased by $214,000, or 21%, to $1.3 million in the year ended December 31, 1998, compared to $1.0 million in the 12 months ended December 31, 1997. The growth in revenue in 1998 was primarily attributable to the introduction of new revenue streams. We introduced advertising, including banner ads, site sponsorships and newsletter sponsorships in the second and third quarters of 1998. Revenues from advertising were $288,000 in 1998, compared to no advertising revenues in 1997. Revenues from lead generation were $963,000 in 1998, compared to $1.0 million in 1997. The overall growth in revenues was partially offset by a reduction in lead generation revenues resulting from the termination of our relationships with Prodigy in August 1997 and America Online in March 1998. Cost of revenues. Cost of revenues decreased to $217,000 in 1998 from $259,000 in 1997. The decrease in cost of revenues was primarily due to lower access charges for the Internet compared to the proprietary Prodigy and America Online environments. As a result, gross margin increased to 82.7% in 1998, from 75.0% in 1997. Sales and marketing. Sales and marketing expenses increased by $863,000, or 39%, to $3.1 million in 1998, compared to $2.2 million in 1997. The increase was primarily due to a $988,000, or 405%, increase in advertising and brand awareness spending which was partially offset by reduced contract labor spending. As a percentage of revenues, sales and marketing expenses increased to 246.9% in 1998, from 214.7% in 1997. Research and development. Research and development expenses increased by $128,000, or 49%, to $387,000 in 1998, compared to $259,000 in 1997. The increase was primarily due to hiring of additional staff to support our growth. As a percentage of revenues, research and development expenses increased to 30.9% in 1998, from 25.0% in 1997. General and administrative. General and administrative expenses increased by $119,000, or 40%, to $417,000 in 1998, compared to $298,000 in 1997. The increase was primarily a result of increased personnel costs and professional service fees necessary to support our growth. As a percentage of revenues, general and administrative expenses increased to 33.4% in 1998, from 28.7% in 1997. Equity-based compensation. Equity-based compensation expenses increased by $110,000, or 172%, to $174,000 in 1998, compared to $64,000 in 1997. This increase resulted primarily from option grants made to advisors and directors and four gifts of common stock made to employees 27 29 by principal shareholders. As a percentage of revenue, equity-based compensation expense increased to 13.9% in 1998, from 6.1% in 1997. Depreciation and amortization. Depreciation and amortization expense increased by $52,000, or 100%, to $104,000 in 1998, compared to $52,000 in 1997. This increase resulted from the depreciation of approximately $171,000 in furniture and equipment acquired during 1998. As a percentage of revenue, depreciation and amortization expense increased to 8.3% in 1998, from 5.0% in 1997. Interest expense. Interest expense increased by $60,000, to $66,000 in 1998, compared to $6,000 in 1997. The increase was due to the addition of leased capital equipment in the third and fourth quarters of 1997 and throughout 1998. Other (income) expense. Other (income) expense in 1998 consisted primarily of interest income in the amount of $11,000 offset by the write-off of obsolete assets in the amount of $9,000. There was no other (income) expense in 1997. YEAR ENDED JUNE 30, 1997 COMPARED TO YEAR ENDED JUNE 30, 1996 Revenues. Our revenues decreased by $73,000, or 6%, to $1.2 million in the year ended June 30, 1997, compared to $1.3 million in the year ended June 30, 1996. The decrease was primarily due to the decline in Prodigy's membership base. Revenues related to the Prodigy relationship were $396,000, or 33% of total revenue, in 1997 and $484,000, or 38% of total revenue, in 1996. Cost of revenues. Cost of revenues increased to $314,000 in 1997 from $310,000 in 1996. As a result, gross margin decreased to 73.8% in 1997 from 75.6% in 1996. Sales and marketing. Sales and marketing expenses increased by $1.2 million, or 190%, to $1.8 million in 1997, compared to $624,000 in 1996. The increase was primarily due to increased personnel costs related to building our own internal sales and marketing staff in 1997 and costs associated with termination of a contract with a third-party sales agent. As a percentage of revenues, sales and marketing expenses increased to 151.1% in 1997 from 49.1% in 1996. Research and development. Research and development expenses increased by $70,000, or 108%, to $135,000 in 1997, compared to $65,000 in 1996. The increase was primarily due to hiring of additional staff. As a percentage of revenues, research and development expenses increased to 11.3% in 1997 from 5.1% in 1996. General and administrative. General and administrative expenses increased by $62,000, or 21%, to $353,000 in 1997, compared to $291,000 in 1996. The increase was primarily a result of increased personnel costs and professional service fees. As a percentage of revenues, general and administrative expenses increased to 29.5% in 1997 from 22.9% in 1996. Equity-based compensation. No equity-based compensation expense was recognized in either period because FreeShop was operating as a division of Online Interactive during both periods. Depreciation and amortization. Depreciation and amortization expense increased by $21,000, or 233%, to $30,000 in 1997, compared to $9,000 in 1996. This increase resulted from the depreciation of approximately $109,000 in furniture and equipment acquired during 1997. As a percentage of revenue, depreciation and amortization expense increased to 2.5% in 1997 from 0.7% in 1996. 28 30 QUARTERLY RESULTS OF OPERATIONS The following table sets forth FreeShop's unaudited quarterly statement of operations data for the six quarters ended June 30, 1999. In the opinion of our management, this information was prepared on substantially the same basis as FreeShop's audited financial statements and accompanying notes included in this prospectus. In the opinion of our management, all necessary adjustments, consisting only of normal recurring adjustments and the adjustments necessary to record the acquisition of substantially all of the assets of the Catalog Site and Worldwide Brochures Web sites in May 1999, have been included in the amounts stated below to present fairly the unaudited quarterly results. You should read this quarterly data in conjunction with FreeShop's audited financial statements and accompanying notes included in this prospectus. Our operating results for any quarter are not necessarily indicative of the operating results for any future period.
QUARTER ENDED ----------------------------------------------------------------------- MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, 1998 1998 1998 1998 1999 1999 --------- -------- --------- -------- --------- -------- (IN THOUSANDS) STATEMENT OF OPERATIONS DATA: Revenues.................. $ 220 $ 209 $ 321 $ 501 $ 667 $ 1,480 Cost of revenues.......... 39 37 65 76 83 107 ----- ----- ------ ------ ------- ------- Gross profit........... 181 172 256 425 584 1,373 Operating expenses: Sales and marketing.... 459 571 981 1,077 1,496 2,645 Research and development.......... 113 81 86 107 141 181 General and administrative....... 89 83 94 151 210 252 Equity-based compensation......... 69 53 39 13 79 543 Depreciation and amortization......... 24 25 26 29 36 224 ----- ----- ------ ------ ------- ------- Total operating expenses.......... 754 813 1,226 1,377 1,962 3,845 ----- ----- ------ ------ ------- ------- Operating loss............ (573) (641) (970) (952) (1,378) (2,472) Interest expense.......... 12 16 16 22 13 10 Other (income) expense.... -- 1 6 (10) (25) (62) ----- ----- ------ ------ ------- ------- Net loss.................. $(585) $(658) $ (992) $ (964) $(1,366) $(2,420) ===== ===== ====== ====== ======= =======
29 31
QUARTER ENDED ----------------------------------------------------------------------- MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, 1998 1998 1998 1998 1999 1999 --------- -------- --------- -------- --------- -------- AS A PERCENTAGE OF REVENUES: Revenues.................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Cost of revenues.......... 17.5 17.8 20.2 15.2 12.5 7.2 ------ ------ ------ ------ ------ ------- Gross profit........... 82.5 82.2 79.8 84.8 87.5 92.8 Operating expenses: Sales and marketing.... 208.4 273.4 305.6 215.2 224.4 178.7 Research and development.......... 51.4 38.7 26.8 21.2 21.1 12.2 General and administrative....... 40.3 39.8 29.3 30.1 31.5 17.1 Equity-based compensation......... 31.6 25.5 12.2 2.5 11.9 36.7 Depreciation and amortization......... 10.9 11.9 8.1 5.9 5.4 15.1 ------ ------ ------ ------ ------ ------- Total operating expenses.......... 342.6 389.3 382.0 274.9 294.3 259.8 ------ ------ ------ ------ ------ ------- Operating loss............ (260.1) (307.1) (302.2) (190.1) (206.8) (167.0) Interest expense.......... 5.5 7.8 4.9 4.3 2.0 0.7 Other (income) expense.... 0.0 0.4 2.0 (1.9) (3.8) (4.2) ------ ------ ------ ------ ------ ------- Net loss.................. (265.6)% (315.3)% (309.1)% (192.5)% (205.0)% (163.5) ====== ====== ====== ====== ====== =======
Revenues. Our revenues increased in each quarter presented, except for the second quarter of 1998. Our revenues decreased by $11,000, or 5%, to $209,000 in the second quarter of 1998, compared to $220,000 in the first quarter of 1998. This decrease was due to the termination of our relationship with America Online in March 1998. The relationship with America Online had accounted for $111,000, or 50%, of total revenues in the first quarter of 1998. Revenues unrelated to America Online increased by $94,000, or 86%, to $203,000 in the second quarter of 1998 compared to $109,000 in the first quarter of 1998. In addition, our current chief executive officer, Timothy C. Choate, rejoined FreeShop in March 1998 and focused on creating new revenue streams and accelerating the growth of our business. Cost of revenues. As a percentage of revenues, cost of revenues increased during the first three quarters of 1998 as we built our infrastructure in anticipation of future revenues. Since the third quarter of 1998, we have recognized significant increases in gross margin due to cost of revenues increasing at a lesser rate than revenues. Sales and marketing. Sales and marketing expenses increased in absolute dollars in each quarter presented. As a percentage of revenues, there was a decrease in sales and marketing expenses in the fourth quarter of 1998 and the second quarter of 1999. The decrease as a percentage of revenues in the fourth quarter of 1998 resulted from an increase in revenues in the fourth quarter of 1998 without a corresponding increase in advertising and brand awareness spending. As a percentage of revenue, sales and marketing expenses have decreased in the second quarter of 1999. This decrease was primarily due to sales and marketing expenses, other than advertising spending, increasing at a lesser rate than revenues. Research and development. Research and development expenses decreased in the second quarter of 1998 primarily due to higher personnel costs and recruiting fees paid in the first quarter of 1998. Research and development expenses have increased steadily since the third quarter of 1998 as a result of increased personnel costs related to the continued enhancement of our systems and Web site. 30 32 General and administrative. General and administrative expenses decreased in the second quarter of 1998 primarily due to a decrease in personnel costs and one-time severance costs incurred in the first quarter of 1998 resulting from the departure of our former chief executive officer and another senior officer. General and administrative expenses have increased steadily since the second quarter of 1998 due primarily to additional personnel costs and professional service fees necessary to support our growth. Equity-based compensation. Equity-based compensation expenses for the first three quarters of 1998 relate primarily to recognition of compensation for gifts of stock made by a significant shareholder to some of our employees. Compensation expenses in the fourth quarter of 1998 and the first quarter of 1999 relate to options granted. Compensation expenses in the second quarter of 1999 include both amounts related to grants of options and $406,000 of expense related to the sale of securities to an employee by a significant shareholder at a price below the estimated fair market value of the stock. Depreciation and amortization. Depreciation and amortization expenses have increased during each quarter presented primarily due to the acquisition of additional computer equipment, software, office equipment and furniture. In the second quarter of 1999, depreciation and amortization expenses increased in absolute dollars and as a percentage of revenues. A significant portion of this increase resulted from the amortization of intangible assets related to the acquisition of substantially all of the assets of Commonsite, LLC and Travel Companions International, Inc. We anticipate our revenues may be subject to seasonal fluctuations. We believe advertisers generally place fewer advertisements during the first and third calendar quarters of each year. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions as well as budgeting and buying patterns. Our results of operations may fluctuate significantly in the future as a result of a variety of factors, many of which are beyond our control. STOCK OPTIONS GRANTED IN 1999 From January 1, 1999 to June 30, 1999, we granted options to purchase 191,616 shares of common stock under the 1997 Stock Option Plan. These options were granted to employees, directors and service providers at exercise prices of $2.50 to $4.27 per share which were below the fair market value of our common stock at the date of grant. In relation to these grants, we will recognize estimated compensation expenses of approximately $1.3 million over the vesting terms of one to four years. Compensation expense related to the options of approximately $566,000, $401,000, $207,000, $96,000 and $20,000 will be classified as operating expenses in the years ending 1999, 2000, 2001, 2002 and 2003, respectively. LIQUIDITY AND CAPITAL RESOURCES Since we began operating as an independent company in June 1997, we have financed our operations primarily through the issuance of capital stock. Gross proceeds from the issuance of stock through June 30, 1999 totaled $14.9 million, including $4.0 million raised in December 1998 and $8.6 million raised in May and in June 1999. As of June 30, 1999, we had a $500,000 bank line-of-credit available at prime plus 1.5%. As of June 30, 1999, we had approximately $5.8 million in cash and cash equivalents and short-term investments and working capital of $5.2 million. Net cash used in operating activities was $3.4 million in the six months ended June 30, 1999, $2.2 million in the year ended December 31, 1998 and $595,000 in the six months ended December 31, 1997. Cash used in operating activities for each period resulted primarily from net losses and increases in accounts receivable, which were partially offset by increases in accounts payable and accrued liabilities. Net cash used in investing activities was $3.7 million in the six months ended June 30, 1999, $67,000 in the year ended December 31, 1998 and $56,000 in the six months ended 31 33 December 31, 1997. In the six months ended June 30, 1999, $1.7 million was used to acquire substantially all of the assets of Commonsite, LLC and Travel Companions International, Inc., $1.5 million was used to purchase short-term commercial paper and $500,000 was used to purchase equipment and furniture. For the year ended December 31, 1998 and the six months ended December 31, 1997, cash used in investing activities was primarily related to purchases of property and equipment. Net cash provided by financing activities was $8.6 million in the six months ended June 30, 1999, $5.2 million in the year ended December 31, 1998 and $677,000 in the six months ended December 31, 1997. Net cash provided by financing activities resulted primarily from issuance of capital stock, which was partially offset by principal payments made on capital leases. We believe our current cash and cash equivalents, including expected net proceeds from this offering, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. Thereafter, we expect we will need to raise additional capital to meet our long-term operating requirements. Although we have increased revenues, our expenses also have continued to increase, and we expect to increase our expenses significantly in future periods, such that our expenses will exceed our revenues for the foreseeable future. Accordingly, we do not expect to be able to fund our operations from internally generated funds for the foreseeable future. Our cash requirements depend on several factors, including the level of expenditures on advertising and brand awareness, the rate of market acceptance of our services, and the extent to which we use cash for acquisitions and strategic investments. Unanticipated expenses, poor financial results or unanticipated opportunities that require financial commitments could give rise to earlier financing requirements. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our shareholders would be reduced, and these securities might have rights, preferences or privileges senior to those of our common stock. Additional financing may not be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our ability to fund our expansion, take advantage of business opportunities, develop or enhance services or products or otherwise respond to competitive pressures would be significantly limited, and we might need to significantly restrict our operations. We believe we do not have material market risk exposure due to the fact that we own no derivative instruments, engage in no hedging transactions, have a minimal amount of outstanding long-term debt and currently invest our excess cash in short-term commercial paper. YEAR 2000 ISSUES Because many computer applications have been written using two digits rather than four to define the applicable year, some date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. The year 2000 issue could result in system failures or miscalculations causing disruptions of operations, including disruptions of our Web site. We have completed a review of our internal information technology and non-information technology systems for year 2000 compliance. We do not believe that we have material exposure to the year 2000 issue with respect to our systems. We are in the process of obtaining confirmation from all of our third-party vendors that they have resolved their year 2000 issues. All of our vendors, except three, have responded either orally or in writing and either confirmed their compliance or provided patches for their affected software. We expect to receive a reply from one remaining third-party vendor by October 31, 1999. We do not expect the other two vendors to certify that their software or services are year 2000 compliant. The vendors who have already responded include all vendors related to our critical systems. We have completed an initial test of our internal systems and anticipate conducting tests with the cooperation of our vendors after September 30, 1999 to simulate the year 2000 rollover with hardware, software and key vendors. We plan to make any modifications resulting from the test by the fourth quarter of 1999. Based on the test results, if any vendor is found to be noncompliant, 32 34 our contingency plan is to attempt to find a replacement vendor. In addition, we have developed a limited contingency plan related to the functioning of our Web site and order processing systems. We plan to establish a number of servers in different cities to help prevent systems failures and slow response times on our Web sites and to provide backup in the event there is a power or other electrical failure that affects our computer servers and systems located in the Seattle area. Aside from the identification of new vendors and the establishment of offsite servers, we do not currently have any other contingency plans, and we do not anticipate developing any. To date, we have spent approximately $30,000 on year 2000 compliance. We expect total expenditures to be between $40,000 and $50,000. Most of our future expenses are expected to be operating expenses associated with the time spent by employees working on year 2000 compliance matters. The worst-case scenario pertaining to the year 2000 issue would be an overall failure of the Internet, electronic and telecommunications infrastructures. In addition, the systems and services provided by our third-party vendors may fail to be year 2000 compliant despite their representations to the contrary. The failure by these entities or systems to be year 2000 compliant could result in a systemic failure beyond our control, which could also prevent us from delivering our services to our customers or generally prevent users from accessing our Web site. This would have a material adverse effect on our business, results of operations and financial condition. RECENT ACCOUNTING PRONOUNCEMENTS In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use," which is effective for fiscal years beginning after December 15, 1998. SOP 98-1 provides guidance on accounting for the costs of computer software developed or obtained for internal use and defines specific criteria that determine when such costs are required to be expensed, and when such costs may be capitalized. The adoption of this standard has not had a material effect on our capitalization policy, results of operations, financial position or cash flows. In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-up Activities," which is effective for fiscal years beginning after December 15, 1998. SOP 98-5 provides guidance on the financial reporting of start-up costs and organization costs. It requires costs of start-up activities and organization costs to be expensed as incurred. As we have expensed these costs historically, the adoption of this standard has not had a significant impact on our results of operations, financial position or cash flows. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) 133, "Accounting for Derivative Instruments, and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. We do not expect the adoption of this statement to have a significant impact on our results of operations, financial position or cash flows. LIMITATION ON NET OPERATING LOSS CARRYFORWARDS We have approximately $7.3 million of federal net operating loss carryforwards as of June 30, 1999 which may be available to reduce the amount of U.S. federal income taxes payable by us in the future. The exercise of Fingerhut's warrants in May 1999 resulted in an ownership change for purposes of Section 382 of the Internal Revenue Code. As a result, the use of our pre-ownership change federal net operating loss carryforwards will be limited annually by Section 382 of the Internal Revenue Code. Section 382 of the Internal Revenue Code limits the amount of net operating losses that may be utilized from pre-ownership change years to offset taxable income in any post- ownership change year. The limitation on the utilization of federal net operating loss carryforwards in future years is not expected to be material. 33 35 BUSINESS OVERVIEW FreeShop provides online direct marketing services, giving consumers access to over 1,000 free, trial and promotional offers through our Web site and email newsletters. Consumers seeking to discover, learn about or try new products can choose from a collection of offers from over 100 companies. FreeShop enables consumers to seek out new products of specific interest to them, unlike the traditional direct marketing model, in which marketers communicate to broad audiences in search of new customers. Our primary source of revenue is lead generation. We post offers from our marketer clients for catalogs, magazine and newsletter subscriptions, product samples, coupons, and trial periods for services, software and publications. These clients pay us for each lead generated. We also offer marketers opportunities to advertise on our Web site and to sponsor the Club FreeShop newsletters. Club FreeShop members, who accounted for over 41% of our orders generated in July 1999, receive regular email newsletters informing them of special offers, exclusive contests and other opportunities. We believe our consumer-directed process creates a highly effective method of direct marketing in terms of cost, targeting, efficiency and consumer satisfaction. INDUSTRY BACKGROUND GROWTH OF THE INTERNET AND ONLINE COMMERCE Over the past several years, the Internet has emerged as a powerful and efficient new medium, enabling people worldwide to exchange information, communicate and conduct business electronically. The number of people using the Internet continues to expand rapidly. International Data Corporation (IDC) estimates that the number of people using the Internet will grow from approximately 160 million worldwide in 1998 to over 500 million worldwide by the end of 2003. Businesses have recognized the online commerce opportunity and are increasingly using the Internet to sell and distribute products and services. According to IDC, online commerce will increase from approximately $50 billion worldwide in 1998 to approximately $1.3 trillion worldwide in 2003, representing a compound annual growth rate of approximately 92%. As online commerce and the number of people using the Internet grow, advertisers and direct marketers are increasingly using the Internet to locate customers, advertise products or services and facilitate transactions. Forrester Research estimates that approximately $1.5 billion was spent on Internet advertising worldwide in 1998 and that this amount will grow to approximately $15.3 billion in 2003. DIRECT MARKETING Advertising expenditures can be broadly categorized as either brand advertising or direct marketing. Brand advertising is intended to generate brand name awareness and create a specific image for a particular company, product or service. Direct marketing involves any direct communication to a consumer intended to generate a specific response or action, generally the purchase of a product or service. The Direct Marketing Association estimates that direct marketing accounts for over 57% of total U.S. advertising expenditures and that in 1998, marketers spent $80.1 billion in the United States on direct marketing to consumers. Traditional Direct Marketing. Traditional direct marketing media include direct mail, telemarketing and newspaper, magazine, radio and television advertisements. Although traditional direct marketing is effective and widely used, it presents a number of challenges for marketers and consumers alike. Traditional direct marketers generally lack specific and timely information on a particular consumer's immediate interests. As a result, marketers spend considerable 34 36 resources on communications most consumers don't want or need. For example, according to BAIGlobal, Inc., the average response rate to the nearly 3.5 billion mailings of credit card solicitations in 1998 was only 1.2%. Given the costs associated with traditional direct marketing, which include telecommunications, postage, printing, assembly, labor and facilities, we believe the often low response rates make the process inefficient. Online Direct Marketing. Online direct marketing media include banner advertisements, targeted email solicitations and Web site sponsorships. We believe online direct marketing is more attractive than traditional direct marketing because it requires lower production costs and provides easier and faster customer response features. In addition, online direct marketing allows marketers to easily: - develop one-to-one relationships with consumers; - collect data and feedback on marketing campaigns; and - customize marketing campaigns to broad audiences or specific groups. Even with these advantages, direct marketers face challenges in realizing the full potential of the Internet as a marketing medium. With millions of Web sites, only a fraction of which have significant audiences, it is difficult for marketers to decide where to spend their marketing dollars. Even leading brand name marketers who build their own Web sites must find ways to attract a sizeable audience of visitors. In addition, technological hurdles may impede conventional direct marketers from successfully extending their activities to the Internet. In order to participate in most online marketing efforts, marketers must build and maintain Web sites as well as incorporate order-taking capabilities and develop systems to integrate online ordering with their traditional databases. We believe marketers desire a solution that benefits from the effectiveness of direct marketing while overcoming the challenges presented by both traditional and online marketing methods. THE FREESHOP SOLUTION FreeShop acts as an intermediary between consumers and marketers, through which consumers seeking to try new products are presented with a collection of free, trial and promotional offers from marketers seeking an audience of potential customers. We offer a consumer-directed process in which consumers select only those offers of immediate interest to them. We then forward those orders to our marketer clients. We believe FreeShop's solution creates a highly effective method of direct marketing in terms of cost, targeting, efficiency and consumer satisfaction. Marketers pay us for the number of customer leads delivered, the number of visitors we direct to their Web site, or the number of times an advertisement is viewed. Benefits to Consumers. FreeShop puts consumers in control of the direct marketing process by empowering them to select offers that most interest them and meet their individual needs. Through our FreeShop.com Web site, we bring together consumers and marketers in an interactive environment. FreeShop has more than 1,000 offers from over 100 companies. The offers include items such as catalogs, magazines, product samples, software and coupons, covering a variety of interests such as travel, personal finance, entertainment, automobiles and sports. In addition, because many offers are free samples or trial offers, consumers are able to try new products and services before making purchase decisions. Furthermore, because credit card information is not required for many offers, we believe FreeShop is attractive for visitors new to online shopping who may otherwise be reluctant to shop online. Benefits to Marketers. We believe FreeShop benefits marketers by offering an effective way to acquire customers. Our clients receive visibility from our traffic base of new and repeat customers. FreeShop offers marketers a diversity of programs designed to meet their objectives 35 37 throughout the entire marketing process, from awareness to interest to trial to sale. Our services include lead generation, advertising and sponsorship of the Club FreeShop newsletters. In addition, because set-up costs are minimal, marketers can test our direct marketing services with little risk. Most importantly, because consumers select the offers they receive, we believe marketers acquire higher quality leads and avoid the risk of tarnishing their brand image as a result of making numerous unwanted solicitations. STRATEGY Our objective is to be the dominant provider of online direct marketing services. We intend to achieve this objective through the following key strategies: Increase Traffic and Transactions. Our strategy of rapidly increasing consumer traffic to our Web site is focused on both new and repeat visitors. New visits will be driven primarily by our online and traditional advertising programs, our Associates Program of over 20,000 member sites, other traffic relationships, including our "Powered by FreeShop" participants, and word-of-mouth referrals. Our top four traffic relationships, based on the number of orders generated in July 1999, are Excite, Inc., Go2Net, Inc., Microsoft Corporation and Xoom.com, Inc. Under our traffic relationships, including our Associates Program, we configure a link to our Web site for the other party to place on its Web site, and we pay a fee for traffic and orders generated from that site. "Powered by FreeShop" is a program in which we contract with larger sites to create free offer content sites or promotions, which are co-branded with the brands of FreeShop and our partner. We provide the free offer content, our partner provides the promotion for the co-branded area, and we share any revenues generated from the co-branded area. We promote repeat visits through regular email communications to the over 1.5 million members of Club FreeShop. In addition, we encourage repeat visits and additional transactions by seeking to continually improve the consumer's experience with FreeShop by increasing the volume and quality of our offers and by improving the speed and overall ease-of-use of our Web site. In July 1999, over 50% of our orders came from repeat visitors. Finally, to help retain our loyal base of consumers, we monitor the performance of our client marketers in fulfilling orders generated through our Web site. Increase Client Base. We believe FreeShop offers marketers a cost-effective alternative to traditional direct marketing and, as a result, we believe we have a significant opportunity to increase the number of marketer clients we serve. In particular, we believe more and more companies with national consumer brand names are seeking Internet-based direct marketing vehicles, and we plan to initiate new relationships and expand our existing relationships with these companies. We are rapidly increasing our sales staff in order to drive this client growth. We plan to continue expanding the services we offer our clients, including enhanced marketing programs, new methods of presenting offers, expanded and customized data-gathering options and increased opportunities for following up on initial lead generation. In addition to enhancing our existing marketing programs, we will be developing new programs in an effort to meet the needs of new and different marketers. Finally, we are focusing on marketing our services to larger advertising agencies as a solution for their client companies to access the rapidly increasing number of consumers on the Internet. Continue to Build the FreeShop Brand Name. We intend to continue to increase the awareness and strength of the FreeShop brand name among both consumers and marketers through site design and focused and aggressive advertising. Because consumers and marketers tend to favor well-known Web sites, a strong brand name is critical to our efforts to grow visitor traffic, attract marketing clients and increase the number and quality of free, trial and promotional offers on our Web site. To date, we have used our Associates Program, other traffic partnerships, online advertising and public relations in an effort to create a leading brand name in our sector. 36 38 We plan to initiate a major traditional marketing campaign that will include outdoor, radio and print advertising in key metropolitan markets. Expand Offers. The number and quality of offers on our site are critical to our ability to attract visitors and increase revenues from our marketer client base. We believe we have a significant competitive advantage in attracting additional marketer clients with national consumer brand names due to the large number of consumers visiting our Web site and our selection of offers across multiple categories. We plan to expand the number of categories and increase the number of offers within each category. We will drive this content expansion through a combination of internal sales efforts, partnerships and acquisitions. As part of this strategy, we have recently entered into an agreement with NewSub Services, Inc., a magazine distributor, to offer consumers access to over 600 magazine titles. We have also greatly increased the number and quality of the catalog offers we provide through our recent acquisition of the Catalog Site Web site. In addition, the acquisition of the Worldwide Brochures Web site has dramatically increased the number of travel offers we provide. Other categories we intend to expand in the near future include product samples, coupons and personal finance. Continue to Develop and Use Technology to Enhance Web Site Capabilities. We have designed and implemented numerous proprietary systems that enable us to process orders from consumers within one business day of receipt and regularly deliver lead information to marketers. We regularly update our Web site and related system technologies to encourage consumers to place orders and frequently revisit FreeShop.com. As part of our effort to promote repeat visits and additional transaction volume, we continue to develop features that will make the FreeShop experience faster, easier and more personalized. Develop Relationship With Fingerhut and Federated. Fingerhut is the eighth largest cataloger and second largest general merchandise cataloger in the United States, selling general merchandise through catalogs and various Web sites. In 1999, we initiated a noncontractual direct marketing relationship with Fingerhut. As a result of this relationship, at no cost to FreeShop, Fingerhut places FreeShop advertisements and inserts cards listing Fingerhut's partner Web sites, including FreeShop.com, in some of Fingerhut's catalogs and order delivery packages. In addition, both FreeShop and Fingerhut have placed links on their Web sites to the other's Web sites. These links provide each company with additional sources of customers and customer information. A portion of the revenues generated by FreeShop and Fingerhut as a result of these links is shared with the other, based on fees prevailing in the market at the time. FreeShop hopes to initiate similar efforts with Federated Department Stores, Inc., which operates over 400 full-line department stores, direct mail catalog businesses and an electronic commerce business. Federated acquired Fingerhut in March 1999. OUR WEB SITE We have designed our Web site in an effort to make it fast and easy for consumers to use, to enhance the FreeShop brand name and to encourage consumers to request an offer. The site is organized around categories and promotions and is regularly updated to refresh the content and encourage repeat visits by consumers. The key features of FreeShop.com include offers, promotions, highlighted offers and Club FreeShop. Offers. Visitors are attracted to our Web site by the aggregation of free, trial and promotional offers. Our base of more than 1,000 offers is organized around categories, currently including: Auto Entertainment Business & Career Family Catalogs Health & Sports Computing & Electronics Hobbies
37 39 Home & Living New Offers Image & Fashion Personal Finance International Software Magazines Travel Men's Style
By organizing content into categories, we allow customers to review offers in their self-selected areas of interest, which provides our clients the ability to do more targeted direct marketing. Each offer page provides a description of the product offered, delivery information and any cancellation details for trial offers. The ordering process is straightforward and requires the customer to provide basic information only once. FreeShop saves this information, which allows the customer to order any additional offers in subsequent visits by clicking the "Express Order" button. Trial offers, such as magazines, may require the customer to enter credit card information, which we pass on to our marketer client who processes any charges. After a customer has ordered, we send emails to thank the customer for the order and, later, to confirm that the order was received. The emails include information on additional related offers, providing an opportunity to cross-promote and "upsell" other offers. Promotions. We organize offers from our clients around seasonal or other events. Promotions run for limited time periods and include both special offers created solely for individual promotions and offers listed under other categories elsewhere on the site. Promotions function much like categories, aggregating offers around a central theme. Highlighted Offers. We have the ability to highlight offers and manage the traffic directed to individual offers in various ways. Highlighted offers on our home page are selected and regularly updated by our staff. These offers are intended to provide a representation of the wide range of offers available on our Web site. On subsequent pages, offers are highlighted based on an automated ranking system. We also create a list of our site's top offers based on our own assessment of broad consumer appeal. This allows customers to review several of the site's best offers without having to explore every category. The list provides a type of "recommended viewing" guide for customers, which results in increased orders for such offers. Club FreeShop. We designed Club FreeShop to communicate with our most valued customers. Club members, totalling over 1,500,000 as of August 1999, regularly receive email newsletters informing them of special offers, exclusive contests and other opportunities. Membership in the club is free and available to any visitor who chooses to provide an email address to FreeShop. We invite customers who place orders on FreeShop to join Club FreeShop as a way of receiving updates about additional items of interest. We anticipate providing more personalized and targeted offers to Club FreeShop members in the future, which will allow for more focused marketing. Other Features. As part of our effort to increase traffic on our Web site from word-of-mouth advertising, we created Tell-a-Friend. This feature, available throughout our site, allows a customer to send an email to a friend with a link to a specific page or offer. In addition, to make our customers' shopping experience more comfortable, FreeShop has adopted strong privacy and customer service policies. Our privacy policy specifies that we disclose how customer information is used by FreeShop and our marketing customers, allows customers to remove their information from our customer databases and fully complies with the standards of the Direct Marketing Association. The Direct Marketing Association standards, among other things, allow customers to remove their information from our database, to refuse to allow us to sell, rent or exchange their customer information and to request that we not contact them in the future. Our privacy also 38 40 complies with the standards of TRUSTe, an independent, nonprofit entity which has established a recognized privacy standard for the Internet. In accordance with TRUSTe standards, we post disclosure on our Web site regarding our use of customer information, give our customers a choice on how their information is used and have implemented data security, quality and access measures to safeguard, update and correct customer information. In addition to enabling customers to limit use of their personal information by FreeShop, we provide our customers with access to general information about methods of limiting use of their personal information by other direct marketers. CLIENT SERVICES We offer marketers a diversity of services designed to meet their objectives throughout the entire marketing process, from awareness to interest to trial to sale. Our primary business is generating customer leads through free, trial and promotional offers. We also provide a number of advertising services on our Web site and within our Club FreeShop newsletters. In addition, we offer the rental of our customer lists to other marketers. - Lead Generation. We post offers from our clients for: - catalogs; - magazine and newsletter subscriptions; - product samples and information; - coupons and discounts; and - trial periods for services, software and publications. Consumers are able to place orders with us for these offers, and we deliver this information to our clients, who are responsible for fulfilling these orders. Information sent to our clients includes information required for order fulfillment as well as additional information requested by the marketer. Marketers pay us for each customer order, or lead, we generate. Through the aggregation of commerce opportunities on our Web site, we provide another form of lead generation to our clients. We group these commerce offers in the same categories as free and trial offers. When consumers decide to purchase a particular item, they click through from our site to the actual commerce site sponsoring the offer. In this way, we generate valuable leads to our commerce partners and are not responsible for processing and fulfilling orders for products. - Advertising. We provide advertising opportunities through banner ads, site sponsorships and sponsorships of our Club FreeShop newsletters. Banner advertising clients benefit from our high-traffic volume of consumers likely to be in a shopping mode. Marketer clients can also receive high-profile placement on our homepage and on specific category pages through our Web site sponsorship program. We believe Club FreeShop newsletter sponsorships appeal to marketers due to the receptive audience the newsletters reach. - List Rental. We also rent our consumer names and street addresses to third parties, unless the consumer has requested that they be excluded from any such use. We add consumer information to our database the first time a consumer requests an offer. During the three months ended June 30, 1999, approximately 90% of our contracts were month-to-month with automatic renewal unless terminated by either party with ten days' notice. Some of our advertising contracts have longer terms of up to eight months. In the first half of 1999, our top ten clients accounted for 29.1% of revenues, and no client accounted for more than 8.3% of revenues. 39 41 SALES AND MARKETING CONSUMER BASE DEVELOPMENT To encourage consumers to visit our Web site and increase transactions, we must continue to enhance the recognition of the FreeShop brand name and strengthen our position as a leader in the online direct marketing industry. Additional visitor traffic to our Web site provides increased opportunities to add members to our consumer base. The primary methods we use to build our traffic are online advertising, our Associates Program and other traffic relationships, traditional advertising and Club FreeShop. Online Advertising. We recognize the importance of well-placed advertising in building traffic and strengthening our brand name. FreeShop has a number of marketing relationships with leading Web sites that promote the FreeShop brand and specific offers to targeted audiences. We continue to seek new cost-effective advertising vehicles and to enhance our existing ones. Associates Program and Traffic Relationships. We launched our Associates Program in the fourth quarter of 1998 and, as of July 1999, we had over 20,000 associates. In July 1999, the Associates Program provided over 12.6% of our traffic and 10.8% of our orders. Under our "Powered by FreeShop" program, we have contracted with larger Web sites, including Go2Net and Excite, to create free-offer content sites or promotions, which are co-branded with the brands of FreeShop and our partners. We share revenues generated from the co-branded site, but we own any customer information generated. In July 1999, approximately 6.8% of our traffic and 8.0% of our orders were provided by other non-Associates Program traffic relationships, including the "Powered by FreeShop" program. Traditional Advertising. We plan to supplement our online presence with an increase in our traditional marketing efforts, which will include outdoor, radio and print advertising in key metropolitan markets. We recently hired a creative director and engaged an advertising agency to assist with campaign development and provide media placement services. Additionally, we have initiated direct marketing efforts with Fingerhut that will include package and catalog inserts. We also use public relations as a way to create customer awareness of the FreeShop brand name. We have been the subject of newspaper, magazine and television stories. Articles about FreeShop have appeared in Wired Magazine, Advertising Age and PC World, among other publications, and television stories featuring us have been aired nationally on CNBC and CNNfn. We believe ongoing media coverage will be essential to increase general brand name awareness and to attract new traffic to our site. Club FreeShop. We created Club FreeShop to communicate with our most valued customers. Consumers who join Club FreeShop regularly receive email newsletters informing them of special offers, exclusive contests and other opportunities. Consumer response to offers contained in the Club FreeShop newsletters is a significant source of repeat orders. CLIENT BASE DEVELOPMENT We sell our services to our marketer clients primarily through our direct sales force. The majority of FreeShop's sales organization, which included 13 salespeople as of July 31, 1999, focuses on small and medium-sized clients. Two of our salespeople target larger national clients and advertising agencies. By marketing directly to advertising agencies, we are able to position FreeShop as the online marketing solution for their numerous clients. Our salespeople are located in Washington, New York, Virginia and California. As part of our strategy to increase our client base, we intend to significantly increase our sales force in the near future. In addition, we have an ongoing advertising campaign designed to promote the FreeShop brand name to marketers through various trade and industry publications. 40 42 RECENT ACQUISITIONS In order to increase the number and types of offers available on our Web site and increase our visitor and client bases, we acquired two businesses in May 1999 which expanded our catalog and travel-related offerings. We acquired the Catalog Site Web site and substantially all of the related assets of Commonsite, LLC for $441,000 and 52,920 shares of our common stock. The Catalog Site Web site (www.catalogsite.com) offers over 200 catalogs. The business acquired had revenues of $540,000 for the fiscal year ended December 31, 1998 and generated 194,000 leads in the quarter ended March 31, 1999. We also acquired the Worldwide Brochures Web site and substantially all of the related assets of Travel Companions International, Inc. for $1.4 million. The Worldwide Brochures Web site (www.wwb.com) offers a selection of over 15,000 travel brochures for locations around the world. The business acquired had revenues of $220,000 for the fiscal year ended December 31, 1998 and generated 167,000 leads in the quarter ended March 31, 1999. OPERATIONS AND TECHNOLOGY We have implemented a broad array of site management, customer service, transaction processing and fulfillment systems using both proprietary and licensed technologies. During July 1999, we received a total of approximately 350,000 orders and transmitted order data in various formats and media to over 100 clients on a regular basis. In July 1999, we received approximately 2.7 million visitors to our FreeShop.com Web site. We believe our systems can currently accommodate approximately 10 million visitors over the course of a month and, as our traffic increases, we intend to increase our capacity by adding servers. All order information is integrated with our customer and Club FreeShop member databases to provide for high levels of internal data analysis. We have developed sophisticated databases and technology supporting these systems that are not available commercially to our competitors. Our systems are built around Microsoft Backoffice components to provide for a scalable and redundant platform. In addition to in-house software, we use a variety of third-party software and service solutions to support our business. LinkShare Corporation provides software and support for our Associates Program, DoubleClick Inc. provides banner ad serving and reporting, and Marketwave Corporation software is used for Web site traffic analysis. These tools are used in conjunction with in-house developed tools to enhance marketing efforts and to determine the effectiveness of various campaigns and content on our Web site. Performance monitoring of our Web site is provided by multiple sources, including Keynote Systems and our Internet service and Web site hosting partners. Web site content is posted and modified from our headquarters in Seattle and offices in Minnesota through a combination of internally developed applications. Visits to FreeShop.com are directed to a network of Microsoft IIS Web servers at the Mead Group, a hosting facility in Seattle. The Mead Group provides redundant power and environmental controls. In order to provide a high level of security, all order information is gathered using secure servers at our Seattle headquarters. The Internet connection to both facilities is provided by Savvis Communications in the form of DS-3 and multiple T-1 redundant services. In the near future we plan to establish a number of servers in different cities to help prevent systems failures and slow response times on our Web sites. COMPETITION We face intense competition from both traditional and online advertising and direct marketing companies. We also face competition from established online portals and community Web sites that engage in direct marketing. Although we believe no other company offers the 41 43 combination and quality of services we offer, we compete directly and indirectly for marketers and consumers with companies in various categories, including: - Free-Offer Web Sites. There are a number of sites, both large and small, that give consumers access to free offers, including Volition.com and Free2Try.com. - Specialty Lead-Generation Web Sites. Various sites focus on generating leads for a specific segment of the direct marketing industry, such as the catalog, magazine or coupon segments. While these sites typically provide a depth of offerings within their specific sector, they may not offer promotions across a broad spectrum of product categories. These sites include eNews, Cataloglink and Catalogcity. In some instances, we include their offerings on our Web site. - Other Web Sites. We also compete with a number of "community" sites that offer content, services or information about a particular topic, as well as other advertising networks. In addition, we compete with sites featuring loyalty programs that reward consumers for taking specific actions. The number of Web sites competing for consumer attention and marketers' dollars has proliferated, and we expect that competition will continue to intensify. We also compete with traditional media such as television, radio and print for a share of marketers' total marketing budgets. We may be unable to compete successfully against current or future competitors, many of which have significantly greater financial, technical and marketing resources. We believe that the principal competitive factors in our markets are: - brand recognition; - Web site speed and ease of use; - quality and diversity of offers; and - the volume of online visitors, duration and frequency of visits and their demographic profiles. GOVERNMENT REGULATION Laws and regulations that apply to Internet communications, commerce and advertising are becoming more prevalent. The adoption of such laws could create uncertainty in Internet usage and reduce the demand for all products and services offered on the Internet. Recently, Congress enacted legislation regarding children's privacy on the Internet. It is possible that additional laws and regulations may be proposed or adopted with respect to the Internet, covering issues such as user privacy, taxation, advertising, intellectual property rights and information security. Several states have proposed legislation to limit the use of personal user information gathered online or to require online services to establish privacy policies. The Federal Trade Commission recently reported that it has no present intention of proposing legislation to address online privacy in the near future, and that it believes self-regulation to be the best course of action, except for rules enacted to implement the Children's Online Privacy Protection Act, which governs the collection of personal information from children and the confidentiality of such information. However, the FTC has initiated action against at least one online service regarding the manner in which personal information was collected from users and provided to third parties. Legislation has recently been enacted in several states relating to sending unsolicited emails, a practice commonly referred to as "spamming." The federal government and several other states, including New York, are considering, or have considered, similar legislation. Although the provisions of these current and contemplated laws vary, generally they limit or prohibit both the transmission of unsolicited emails and the use of familiar spamming techniques, such as the use 42 44 of forged or fraudulent routing and header information. Some states, including California, require that unsolicited emails include opt-out instructions and that senders of such emails honor any opt-out requests. We believe that neither our email newsletters nor our email order confirmations will be affected by legislation directed at unsolicited emails because we do not send unsolicited messages and because our current practices are intended to comply with current and proposed legislation. However, if we are required to change our business practices as a result of new legislation, our business could suffer. We do not know how our business may be affected by the application to the Internet of existing laws governing issues such as property ownership, copyrights, encryption and other intellectual property issues, taxation, libel, obscenity and export or import matters. Most of these laws were adopted before the advent of the Internet and do not contemplate or address the unique issues of the Internet and related technologies. Changes in laws intended to address such issues could create uncertainty in the Internet marketplace. That uncertainty could reduce demand for our service or increase the cost of doing business as a result of litigation costs or increased service delivery costs. In addition, because our services are available on the Internet in multiple states and foreign countries, these states and countries may claim that we are required to qualify to do business in their jurisdictions. Currently, we are qualified to do business only in Washington, Minnesota and California. Our failure to qualify in other jurisdictions where we are required to do so could subject us to taxes and penalties. It could also restrict our ability to enforce contracts in those jurisdictions. The application of laws or regulations from jurisdictions whose laws do not currently apply to our business could have a material adverse effect on our business, results of operations and financial condition. The European Union has adopted a privacy directive that went into effect in 1998. Under this directive, business entities domiciled in member states of the EU are limited with respect to the transactions in which they may engage with business entities domiciled outside the EU, unless the non-EU entities are domiciled in jurisdictions with privacy laws comparable to the EU privacy directive. The United States presently does not have laws that satisfy the EU privacy directive. Discussions between representatives of the EU and the United States are ongoing and may lead to certain safe harbor provisions which, if adhered to, would allow business entities in the EU and the United States to continue doing business without limitation. If these negotiations are not successful and the EU begins enforcing the privacy directive, there could be an adverse impact on international Internet business. If we do business directly in the EU in the future, we will be required to comply with the EU privacy directive. INTELLECTUAL PROPERTY We regard our copyrights, service marks, trademarks, trade secrets, proprietary technology and similar intellectual property as critical to our success, and we rely on trademark and copyright law, trade secret protection and confidentiality and license agreements with our employees, customers, independent contractors, partners and others to protect our intellectual property rights. We have registered the trademark "Free Shop" in the United States and may apply for registration in the United States for other trademarks and service marks, including Club FreeShop, FreeShop Savings Club, Savings Central, FreeShop shopping assistant, Catalog Site, Catalog Channel, The Catalog Site and Worldwide Brochures. "Find It! Try It! Buy It!", "The starting point for smart online shopping," "Powered by FreeShop" and "FreeShop by Email" are service marks of FreeShop. However, effective trademark, service mark, copyright and trade secret protection may not be available in every country in which FreeShop's products and services are made available online. We have registered a number of domain names, including freeshop.com, catalogsite.com, wwb.com, and clubfreeshop.com, among others. Domain names generally are regulated by 43 45 Internet regulatory bodies. The regulation of domain names in the United States and in foreign countries is subject to change in the near future. Regulatory bodies could establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names. The relationship between regulations governing domain names and laws protecting trademarks and similar intellectual property rights is unclear. Therefore, we could be unable to prevent third parties from acquiring domain names that infringe on or otherwise decrease the value of our trademarks and other proprietary rights. We believe there are online companies in other countries using domain names that potentially infringe on our trademarks. FreeShop may be required to obtain licenses from others to refine, develop, market and deliver new services. We may be unable to obtain any such license on commercially reasonable terms, if at all, or guarantee that rights granted by any licenses will be valid and enforceable. EMPLOYEES As of July 31, 1999, FreeShop had a total of 102 employees, including 76 in sales and marketing, 17 in technology and development, and nine in finance and administration. None of our employees are represented by unions, and we consider relations with our employees to be good. FACILITIES We currently occupy 20,920 square feet in a leased facility in Seattle, Washington and 2,240 square feet in a leased facility in Detroit Lakes, Minnesota. We expect that these facilities will be adequate for our needs over the next 12 months. Our current lease for our Seattle space expires in May 2003. Our current lease for our Detroit Lakes space expires in May 2000. LEGAL PROCEEDINGS FreeShop is not currently a party to any material legal proceeding. 44 46 MANAGEMENT EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES The following table sets forth certain information, as of July 31, 1999, regarding the executive officers, directors and key employees of FreeShop:
NAME AGE POSITION ---- --- -------- Timothy C. Choate...................... 34 Chairman, President and Chief Executive Officer William H. Fritsch..................... 47 Executive Vice President, Marketing John A. Wade........................... 37 Secretary, Vice President, Finance and Chief Financial Officer Ronald C. Christiansen................. 46 Vice President, Sales Lisa C. Wolff.......................... 30 Vice President, Business Development Karen M. Leathers...................... 35 Vice President, Operations and Planning Mark S. Noblitt........................ 36 Vice President, Technology John P. Ballantine..................... 36 Director John B. Balousek....................... 54 Director William J. Lansing..................... 40 Director Kirk M. Loevner........................ 41 Director
Timothy C. Choate has served as Chairman, President and Chief Executive Officer since March 1998. From July 1997 to March 1998, Mr. Choate served as a Vice President of Micro Warehouse, Inc. In 1994, Mr. Choate co-founded Online Interactive, Inc., the former parent of FreeShop, and served as its Chairman, President and Chief Executive Officer until June 1997. Before 1994, Mr. Choate served as President of Softdisk Publishing LLC, a software publishing company. Mr. Choate's prior experience includes serving as a Senior Marketing Manager at Prodigy Communications Corporation, an Internet access and content provider, and developing and launching the New Products Division for Business Week, a division of the McGraw-Hill Companies Inc. Mr. Choate serves on the boards of directors of Digital River, Inc., a provider of electronic commerce outsourcing solutions, and Traveling Software, Inc., a software publishing company. Mr. Choate holds a B.S.E. degree in Marketing and Entrepreneurial Management from the Wharton School of Business at the University of Pennsylvania. William H. Fritsch has served as Executive Vice President, Marketing since February 1999. Mr. Fritsch joined FreeShop in January 1999 as Vice President, Sales and Marketing. In 1988, Mr. Fritsch co-founded CF2GS, a Seattle-based direct marketing agency, and served as its president until 1998. Before 1988, Mr. Fritsch served as Vice President for Sharp Hartwig Advertising, as the Director of Marketing Services at Walt Disney Productions, as Marketing Coordinator of The Smithers Company and as an auditor for Ernst & Ernst. Mr. Fritsch holds a B.S. degree in Accounting from the University of Akron in Ohio. John A. Wade has served as Secretary, Vice President, Finance and Chief Financial Officer since May 1998. From 1992 to May 1998, Mr. Wade served as the Chief Financial Officer and Chief Operating Officer of Buzz Oates Enterprises, a real estate development company. Prior to 1992, Mr. Wade served as the Controller of A&A Properties, Inc., an asset management corporation, the Controller of Labels West, a manufacturing concern, and as an auditor and taxation specialist at McGladrey and Pullen, an international accounting firm. Mr. Wade holds a B.S. degree in Business Administration with a concentration in Accounting from the San Diego State University School of Business. Ronald C. Christiansen has served as Vice President, Sales since January 1999. In 1988, Mr. Christiansen co-founded CF2GS and served as its New Business Development Director until 1998. Prior to 1988, Mr. Christiansen worked at several large national advertising agencies, 45 47 including Cole & Weber, an Ogilvy Mather company, and McCann Erickson. Mr. Christiansen holds an undergraduate degree in Advertising from Washington State University. Lisa C. Wolff has served as Vice President, Business Development since July 1998. Ms. Wolff joined FreeShop as Director of Business Development in July 1997. From 1995 to 1997, Ms. Wolff served as Director of Consumer Marketing and as Product Manager for Online Interactive. From May 1994 to August 1994, Ms. Wolff served as an Associate Product Manager for Microsoft Corporation's TechNet. Prior to May 1994, Ms. Wolff worked for two years in corporate sales and marketing at NeXT Computer, Inc., a computer software and hardware company. Ms. Wolff holds an M.B.A. degree from the University of Washington and a B.A. degree in Business Economics from the University of California at Santa Barbara. Karen M. Leathers has served as Vice President, Operations and Planning since July 1998. Since joining FreeShop in September 1997, Ms. Leathers has also served as Director, Operations and Human Resources and Manager of Operations. From March 1997 to August 1997, Ms. Leathers managed the Web-based data acquisition team at Affinity Publishing, a partner marketing technology services company. From 1993 to March 1997, Ms. Leathers managed the corporate Membership Services Department at Recreational Equipment Incorporated. Prior to 1993, Ms. Leathers served as a market analyst for Weyerhaeuser Company. Ms. Leathers holds a B.A. degree in Business Management and Computers from The Evergreen State College in Washington. Mark S. Noblitt has served as Vice President, Technology since February 1999. From July 1997 to February 1999, Mr. Noblitt served as Director of Technology, Production Engineering Manager and SQL Developer. From October 1996 to July 1997, Mr. Noblitt served as SQL Database Administrator for Online Interactive. From June 1987 to January 1996, Mr. Noblitt served as Project Manager and Lead Estimator for Leewens Corporation, a company specializing in hazardous waste containment projects. Mr. Noblitt also serves on the Board of Advisors for International Barter Corporation, an international commercial barter exchange company. Mr. Noblitt is a Microsoft Certified Systems Engineer with specialties in SQL, NT, Microsoft BackOffice, Microsoft Office and TCP/IP. John P. Ballantine has served as a Director since July 1997. Since March 1999, Mr. Ballantine has served as Chairman and Chief Executive Officer of iStart Ventures LLC, a developer of early-stage e-commerce concepts. From July 1997 to March 1998, Mr. Ballantine served as a Vice President of Micro Warehouse. In 1994, Mr. Ballantine co-founded Online Interactive and served as its Executive Vice President and later as President and Chief Executive Officer. From February 1993 to June 1994, Mr. Ballantine served as Vice President of Softdisk Publishing, where he managed online shopping applications with America Online, CompuServe, Prodigy and GEnie. From March 1989 to February 1993, Mr. Ballantine served as Vice President of Sales for DataEnvelope, a full-service software marketing and distribution company. Mr. Ballantine holds a B.S.E. degree in Finance and International Business from the San Diego State University School of Business. John B. Balousek has served as a Director since February 1999. In 1998 Mr. Balousek co-founded PhotoAlley.com, an online retailer of photographic equipment, supplies and services. From 1979 to 1997, Mr. Balousek served in various positions, including President/Chief Operating Officer and Director of Foote, Cone & Belding Communications, Inc., a global advertising and communications company. In 1996, Mr. Balousek served as Chairman/Chief Executive Officer of True North Technologies, a digital and interactive service of True North Communications, Foote, Cone & Belding's parent company. Mr. Balousek currently serves as a director for Geoworks Corporation, a provider of end-to-end solutions for the wireless communications market; Transilluminant Corporation, a privately held company focusing on electronic data marketing; and EDB Holdings, Inc., a superoptical retailing company. 46 48 Mr. Balousek holds an undergraduate degree from Creighton University and a graduate degree from Northwestern University. William J. Lansing has served as a Director since January 1999 and was appointed by Fingerhut pursuant to the terms of a stockholders agreement between us, Mr. Choate, Mr. Ballantine and Fingerhut. Mr. Lansing is the President and Chief Executive Officer of Fingerhut. From May 1998 to May 1999, Mr. Lansing served as President of Fingerhut. From November 1996 to May 1998, Mr. Lansing served as a Vice President for Business Development of General Electric Corp. From January 1996 to October 1996, he served as Chief Operating Officer of Prodigy. From 1986 to 1996, Mr. Lansing was a principal at McKinsey & Co., a management consulting company. Mr. Lansing also serves as a director of Digital River, Inc., an electronic commerce solutions provider, Select Comfort Corp., a specialty retailer and direct marketer of air beds, Net Perceptions, Inc., a developer of Internet marketing solutions, and BigStar Entertainment, Inc., an online filmed entertainment superstore. Mr. Lansing holds a B.A. degree in English from Wesleyan University and a J.D. degree from Georgetown University. Kirk M. Loevner has served as a Director since November 1998. In February 1999, Mr. Loevner founded PublishOne Inc., an online publishing service for businesses, of which he is currently President and Chief Executive Officer. From August 1996 to August 1998, Mr. Loevner served as President and Chief Executive Officer of the Internet Shopping Network, Inc., an online retailer and auction house. From November 1993 to July 1996, Mr. Loevner served as a Vice President and General Manager of Silicon Graphics Inc., a leading supplier of visual computing and high-performance computer systems. Before November 1993, Mr. Loevner served as a Vice President and General Manager of Apple Computer Inc., a computer manufacturing company. Mr. Loevner currently serves on the board of directors of the Software Industry and Information Association, a software industry association. Mr. Loevner holds a B.S.E. degree in Computer Science from Tufts University and an M.B.A. degree in General Management from Harvard University. FreeShop currently has authorized six directors. Each director is elected for a period of one year at our annual meeting of shareholders and serves until the next annual meeting or until his successor is duly elected and qualified. The executive officers serve at the discretion of the board. There are no family relationships among any of the directors and executive officers of FreeShop. BOARD COMMITTEES In May 1999, the board of directors established two standing board committees, an audit committee and a compensation committee. Audit Committee. The audit committee's responsibilities include reviewing our internal accounting procedures and consulting with and reviewing the services provided by our independent accountants. The audit committee currently consists of Messrs. Ballantine and Balousek. Compensation Committee. The compensation committee's responsibilities include reviewing and recommending to the board of directors the compensation and benefits of all our executive officers, administering our stock option plans and establishing and reviewing general policies relating to compensation and benefits of our employees. The compensation committee currently consists of Messrs. Ballantine, Lansing and Loevner. No interlocking relationships exist between our board of directors or compensation committee and the board of directors or compensation committee of any other company, nor has any such interlocking relationship existed in the past. 47 49 DIRECTOR COMPENSATION Directors do not currently receive cash compensation from FreeShop for their services as members of the board of directors, although they may be reimbursed for certain expenses in connection with attendance at board and committee meetings. We do not provide additional compensation for committee participation or special assignments of the board of directors. From time to time, certain of our directors have received grants of options to purchase shares of our common stock pursuant to the 1997 Stock Option Plan. In January 1998, we granted to Messrs. Choate and Ballantine options to purchase 16,000 shares of common stock at an exercise price of $1.02 per share. In addition, since March 1998, we have paid health insurance premiums on behalf of Mr. Ballantine of approximately $250 per month. In September 1998, we granted to Mr. Loevner an option to purchase 16,000 shares of common stock at an exercise price of $1.50 per share. In February 1999, we granted to Mr. Balousek an option to purchase 16,000 shares of common stock at an exercise price of $2.50 per share. See "-- Stock Option Plan." EXECUTIVE COMPENSATION The following table sets forth the compensation paid to our Chief Executive Officer and former Chief Executive Officer for the year ended December 31, 1998. No other executive officer of FreeShop earned compensation for such fiscal year in excess of $100,000. SUMMARY COMPENSATION TABLE
LONG-TERM ANNUAL COMPENSATION COMPENSATION ------------------ ------------ SECURITIES ALL OTHER NAME AND PRINCIPAL POSITION SALARY UNDERLYING OPTIONS COMPENSATION --------------------------- ------------ ------------------ ------------ Timothy C. Choate(1)....................... $26,825(2) 16,000 $ 5,085(3) Chairman, President and Chief Executive Officer Mike Schutzler(4).......................... $26,951 136,000 $43,488(5)
- --------------- (1) Mr. Choate became our Chief Executive Officer in March 1998. (2) Includes $19,220 in deferred compensation paid in January 1999. (3) Represents health insurance premiums paid by us on behalf of Mr. Choate. (4) Mr. Schutzler was the Chief Executive Officer until March 1998. (5) Represents a $7,000 cash payment for severance and $36,488 worth of common stock, at fair value, that Mr. Schutzler received on exercise of certain options. OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth certain information regarding stock option grants to our Chief Executive Officer and former Chief Executive Officer during the fiscal year ended December 31, 1998. The potential realizable value is calculated based on the assumption that the common stock appreciates at the annual rate shown, compounded annually, from the date of grant until the expiration of its term. These numbers are calculated based on Securities and Exchange Commission requirements and do not reflect our projection or estimate of future stock price growth. Potential realizable values are computed by: - multiplying the number of shares of common stock subject to a given option by the exercise price; - assuming that the aggregate stock value derived from that calculation compounds at the annual 5% or 10% rate shown in the table for the entire ten-year term of the option; and - subtracting from that result the aggregate option exercise price. 48 50 OPTION GRANTS IN 1998
INDIVIDUAL GRANTS POTENTIAL REALIZABLE ---------------------------------------------------------- VALUE AT ASSUMED NUMBER OF % OF TOTAL ANNUAL RATES OF STOCK SECURITIES OPTIONS PRICE APPRECIATION FOR UNDERLYING GRANTED TO EXERCISE OPTION TERM OPTIONS EMPLOYEES IN PRICE EXPIRATION ----------------------- NAME GRANTED FISCAL YEAR(1) (PER SHARE)(2) DATE 5% 10% ---- ---------- -------------- -------------- ---------- ---------- ---------- Timothy C. Choate(3)...... 16,000(4) 2.78% $1.02 1/15/08 $10,314 $26,137 Mike Schutzler(5)......... 120,000(6) 20.82% $1.02 3/16/01 $12,608 $25,830 16,000(7) 2.78% $1.02 1/15/08 $10,314 $26,137
- --------------- (1) During 1998, 140,000 options were issued as severance compensation, 80,000 options were issued as compensation to directors for their services on the board and 356,420 options were issued to employees. (2) The exercise price per share of each option was equal to the fair market value of the common stock on the date of grant as determined by the board of directors. (3) Mr. Choate became the Chief Executive Officer in March 1998. (4) Represents options vesting according to the following schedule: 50% vesting immediately and 6.25% vesting each following quarter over a period of two years. (5) Mr. Schutzler was the Chief Executive Officer until March 1998. (6) Represents fully vested options exercisable at any time after March 18, 1998. (7) Mr. Schutzler has forfeited these options. OPTION EXERCISES AND FISCAL YEAR-END VALUES The following table sets forth for our Chief Executive Officer and former Chief Executive Officer the number of shares acquired upon exercise of stock options during the fiscal year ended December 31, 1998 and the number of shares subject to exercisable and unexercisable stock options held at December 31, 1998. AGGREGATED OPTION EXERCISES IN 1998 AND YEAR-END OPTION VALUES
NUMBER OF SECURITIES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT SHARES DECEMBER 31, 1998 DECEMBER 31, 1998(1) ACQUIRED ON VALUE --------------------------- --------------------------- NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- ----------- -------- ----------- ------------- ----------- ------------- Timothy C. Choate.......... -- $ -- 11,000 5,000 $ 40,700 $18,500 Mike Schutzler............. 41,700 $36,488 120,000 -- $440,000 $ --
- --------------- (1) The value of unexercised in-the-money options at December 31, 1998 is based on $4.72 per share, the assumed fair market value of the common stock at such time, less the exercise price per share. STOCK OPTION PLAN On June 30, 1997, we adopted our 1997 Stock Option Plan, which was subsequently approved by our shareholders. The plan authorizes the board of directors, or a committee of independent directors, to act as the plan administrator. The plan provides for the grant of incentive stock options and nonqualified stock options to purchase up to 2,400,000 shares of common stock. The plan administrator may grant incentive stock options to our full-time employees or to our nonemployee directors only. Nonqualified stock options are available to employees, directors and other persons as the plan administrator shall select. 49 51 The plan authorizes the plan administrator to, among other things: - set the number of shares of common stock to be issued upon exercise of the options; - set the exercise price of the options, provided that, for incentive stock options granted to greater than 10% shareholders, the price cannot be less that 110% of the fair market value per share of common stock at the date of grant of such options; - designate the expiration date of the options, which, for incentive stock options, cannot be later than ten years from the date such options were granted; and - accelerate the vesting of the options, which otherwise vest over four years according to a set schedule. The 1997 Stock Option Plan will expire on June 30, 2007. The expiration of the plan, however, will not affect the exercisability of options granted under the plan prior to its expiration. 401(k) PLAN Our employees participate in the FreeShop.com, Inc. 401(k) plan, a tax-qualified savings and retirement plan intended to qualify under Section 401 of the Internal Revenue Code. All employees who satisfy the eligibility requirements relating to minimum age and length of service are eligible to participate in the plan and may enter the plan on the first day of any month after they become eligible to participate. Participants may make pre-tax contributions to the plan of up to 15% of their eligible earnings, subject to a statutorily prescribed annual limit. At our discretion, we may make matching contributions of up to 100% of the first 6% of the compensation elected for contribution to the plan by an employee. Each participant is fully vested in his or her contributions and the investment earnings thereon, but vesting in any matching contributions by us takes place over a period of five years. Contributions by the participants or us, and the income earned on such contributions, are generally not taxable to the participants until withdrawn. Contributions by us, if any, are generally deductible by us when made. Contributions are held in trust as required by law. Individual participants may direct the trustee to invest their accounts in authorized investment alternatives. We have made no matching contributions to the plan as of July 31, 1999. DIRECTOR AND OFFICER INDEMNIFICATION AND LIABILITY Our amended and restated articles of incorporation limit the liability of our directors to the fullest extent permitted by Washington law, and our articles incorporate by reference any later amendments to the Washington Business Corporation Act. This act provides that a corporation's articles of incorporation may contain a provision eliminating or limiting the personal liability of directors for monetary damages for breach of their fiduciary duty as directors, except for liability for: - acts or omissions that involve intentional misconduct or a knowing violation of law; - unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 23B.08.310 of the Washington Business Corporation Act; or - any transaction from which the director derived an improper personal benefit. Our bylaws provide that: - we must indemnify our directors and officers against all reasonable expenses incurred in a proceeding in which they are a party because they are or were directors or officers; 50 52 - we must indemnify our directors and officers against liability incurred in a proceeding in which they are a party because they are or were a directors or officers if: 1. they acted in good faith, and they reasonably believed, in the case of conduct in the individuals' official capacities, that their conduct was in our best interests and, in all other cases, that their conduct was at least not opposed to our best interests; and 2. in the case of a criminal proceeding, the individual had no reasonable cause to believe that his or her conduct was unlawful; - we may indemnify other employees and agents to the same extent that we indemnify our directors and officers, unless otherwise required by law, our articles of incorporation, our bylaws or agreements; and - we must advance expenses, as incurred, to our directors and officers in connection with a legal proceeding to the fullest extent permitted by Washington law. We have entered into agreements with each of our directors that, among other things, indemnify the director for reasonable expenses incurred in legal proceedings if the director acted in good faith and with a reasonable belief that such director's official conduct was in the best interests of FreeShop or, if not taken in an official capacity, not opposed to FreeShop's best interests. 51 53 RELATED-PARTY TRANSACTIONS TRANSACTIONS WITH MANAGEMENT AND OTHERS TRANSACTIONS WITH DIRECTORS AND OFFICERS In January and February 1998, Mr. Choate, our Chairman, President and Chief Executive Officer, who holds approximately 18.2% of our common stock prior to this offering, made three loans to us for a total of $55,000. The loans bore interest at a rate of 10% per year. We repaid these loans in full with interest in September 1998. In January and February 1998, Mr. Ballantine, a member of our board of directors, who holds approximately 16.3% of our common stock prior to this offering, made two loans to us for a total of $30,000. The loans bore interest at a rate of 10% per year. We repaid these loans in full with interest in September 1998. From May 1998 through August 1998, Messrs. Ballantine and Choate transferred shares of our common stock owned by them to our employees as compensation for services. Mr. Ballantine transferred a total of 46,000 shares with an estimated value of $69,000, and Mr. Choate transferred a total of 10,000 shares with an estimated value of $15,000. We have entered into indemnification agreements with each of our directors and officers containing provisions that may require us, among other things, to indemnify our directors and officers against liabilities that may arise by reason of their status or service as directors and officers, other than liabilities arising from willful misconduct of a culpable nature, and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. See "Management -- Director and Officer Indemnification and Liability." TRANSACTIONS WITH FINGERHUT On December 10, 1998, we issued 1,619,387 shares of our common stock to Fingerhut for $4.0 million, or $2.47 per share. Immediately following the issuance of the shares, Fingerhut owned 19.9% of our issued and outstanding common stock. On December 10, 1998, we entered into a warrant agreement with Fingerhut, pursuant to which we granted Fingerhut the following warrants to purchase our common stock. Subsequently, in May of 1999 we agreed to issue Fingerhut shares of our series B convertible preferred stock in lieu of common stock upon the exercise of these warrants. (1) Irrevocable "percentage warrants" The percentage warrants are designed to allow Fingerhut to increase its percentage ownership in us. If Fingerhut were to exercise all the percentage warrants and convert the series B convertible preferred stock, and if no dilution in Fingerhut's ownership percentage were to occur, Fingerhut would own approximately 40.0% of our common stock immediately prior to this offering. Fingerhut may exercise the percentage warrants at any time. The percentage warrants expire on the earlier of December 31, 2000 or the completion of a qualified public equity offering, which includes this offering, and include: - a warrant to purchase 293,536 shares of our series B convertible preferred stock at $17.18 per share; - a warrant to purchase 179,072 shares of our series B convertible preferred stock at $19.94 per share; and - a warrant to purchase 208,918 shares of our series B convertible preferred stock at $22.09 per share. 52 54 (2) "Anti-dilution" warrants The anti-dilution warrants are designed to allow Fingerhut to maintain its percentage ownership in us if the number of issued and outstanding shares increases due to the exercise of outstanding options and warrants or the exercise of options to be granted under our stock option plan. Upon any such dilutive event, the anti-dilution warrants may be exercised by Fingerhut at its discretion for up to 184,288 shares of our series B convertible preferred stock at $22.09 per share. As a result of this offering, all of the anti-dilution warrants are currently exercisable. The anti-dilution warrants expire on the earlier of December 31, 2000 or the completion of a qualified public equity offering, which includes this offering. (3) "Third-party agreement" warrants The third-party agreement warrants are designed to allow Fingerhut to maintain its ownership percentage in us if the number of issued and outstanding shares increases due to the exercise of rights to purchase additional shares of our common stock that are held by two parties. We agreed with Fingerhut that the third-party agreement warrants may be exercised by Fingerhut at its discretion in proportion to the exercise by one or both of the other parties for a total of up to 12,153 shares of our series B convertible preferred stock at $15.86 per share. The third-party agreement warrants expire on the earlier of December 31, 2000 or the completion of a qualified public equity offering, which includes this offering. On December 10, 1998, we entered into a stockholders agreement with Mr. Ballantine, Mr. Choate and Fingerhut. Under the terms of the stockholders agreement, we granted Fingerhut: - a preemptive right to purchase shares in the event of additional share issuances by us; - a right to approve any pledge of all of our assets, amendment to our articles of incorporation or bylaws, merger with another corporation or sale of substantially all of our assets; - a one-time right to demand registration of shares owned by Fingerhut, exercisable after June 30, 2001; - a right to "piggyback," or include shares owned by Fingerhut, in two registrations of shares initiated by us; and - a right to appoint up to two members of our board of directors. To date, Fingerhut has appointed only one director, William J. Lansing. Fingerhut's preemptive rights, special approval rights and board appointment rights expire upon the completion of this offering. In addition, Fingerhut, Mr. Choate and Mr. Ballantine have agreed not to make any public sale of any of our equity securities, or any securities convertible into any of our equity securities, during the 30-day period before, and the 180-day period after, the effective date of this offering or of any underwritten demand registration or piggyback registration in which their shares are included. The stockholders agreement terminates generally on the earlier of December 10, 2008 or the closing of the sale of all of our assets or the acquisition of us by merger or consolidation. In May and June of 1999, Fingerhut exercised the first two tranches of its percentage warrants, consisting of its $17.18 percentage warrants and its $19.94 percentage warrants for a total of 472,608 shares of series B convertible preferred stock, which are convertible into 1,890,432 shares of common stock. 53 55 On June 18, 1999, we entered into a letter agreement with Fingerhut under which Fingerhut agreed to exercise all of its remaining exercisable warrants upon completion of this offering, which consist of: - percentage warrants to purchase 208,918 shares of our series B convertible preferred stock at $22.09 per share; - anti-dilution warrants to purchase 184,288 shares of our series B convertible preferred stock at $22.09 per share; and - third-party warrants to purchase 3,333 shares of our series B convertible preferred stock at $15.86 per share. Additionally, Fingerhut agreed to purchase 8,820 shares of our series B convertible preferred stock at $15.86 per share. Upon completion of this offering, Fingerhut has agreed to convert all of the series B convertible preferred stock into common stock for a total of 3,511,868 shares of our common stock. In connection with the letter agreement, we entered into an escrow agreement with Fingerhut, pursuant to which Fingerhut agreed to deposit into escrow the full purchase price for the exercised warrants and the additional shares of series B convertible preferred stock to be purchased by Fingerhut, in exchange for the deposit into escrow by us of the warrant shares and the additional shares. The escrow agreement provides for the release of the escrowed funds to us and the shares to Fingerhut upon the completion of this offering. CERTAIN BUSINESS RELATIONSHIPS William J. Lansing, a member of our board of directors, is the President and Chief Executive Officer of Fingerhut. During the first two quarters of 1999, we provided approximately $23,000 in lead-generation services to Fingerhut. Mr. Lansing is also a director of BigStar Entertainment, Inc., a client of FreeShop. In 1998 and the first two quarters of 1999, we billed BigStar approximately $42,000 and $70,000, respectively, for our services. 54 56 PRINCIPAL SHAREHOLDERS The following table sets forth information concerning the beneficial ownership of our outstanding common stock as of July 31, 1999 and as adjusted to reflect the sale of the shares of common stock in this offering for: - each person or group that we know owns beneficially 5% or more of our common stock; - each of our directors and executive officers individually; and - all directors and executive officers as a group. The term "beneficial ownership" includes shares over which the indicated beneficial owner exercises voting and/or investment power. The rules also deem common stock subject to options or warrants currently exercisable, or exercisable within 60 days, to be outstanding for purposes of computing the percentage ownership of the person holding the options or warrants, but they do not deem such stock to be outstanding for purposes of computing the percentage ownership of any other person. The applicable percentage of ownership for each shareholder is based on 10,133,719 shares of common stock outstanding as of July 31, 1999 (including shares issuable upon conversion of all outstanding series B convertible preferred stock), together with applicable options and warrants for that shareholder. Except as otherwise indicated, we believe the beneficial owners of the common stock listed below, based on information furnished by them, have sole voting and investment power over the number of shares listed opposite their names. The information provided in the table below assumes no exercise of the underwriters' over-allotment option.
PERCENT OF SHARES OUTSTANDING -------------------- NAME AND ADDRESS NUMBER OF SHARES BEFORE AFTER OF BENEFICIAL OWNER BENEFICIALLY OWNED OFFERING OFFERING ------------------- ------------------ -------- -------- Fingerhut Companies, Inc.(1)..................... 5,131,255 43.7% 34.3% 4400 Baker Road Minnetonka, MN 55343 Timothy C. Choate(2)............................. 1,843,121 18.2% 13.8% 95 South Jackson Street, Ste. 300 Seattle, WA 98104 John P. Ballantine(3)............................ 1,655,739 16.3% 12.4% 95 South Jackson Street, Ste. 300 Seattle, WA 98104 Kirk M. Loevner(4)............................... 85,171 * * John B. Balousek(5).............................. 50,000 * * John A. Wade(6).................................. 45,481 * * William H. Fritsch(7)............................ 25,767 * * William J. Lansing............................... -- * * All directors and officers as a group (11 persons)(8)................................ 3,705,279 36.3% 27.6%
- --------------- * Less than one percent of the outstanding shares of common stock. (1) Represents 3,509,819 shares (including 472,608 shares of series B convertible preferred stock, which will be converted into 1,890,432 shares of common stock upon the completion of this offering) held by Fingerhut directly and 1,586,156 shares of common stock that Fingerhut has a right to acquire pursuant to warrants exercisable into series B convertible preferred stock and 35,280 shares of common stock issuable upon conversion of series B convertible preferred stock to be issued to Fingerhut within 60 days of July 31, 1999. Federated Department Stores, Inc. may be deemed to control Fingerhut by virtue of its ownership of 100% of Fingerhut's capital stock and its corresponding right to elect 55 57 Fingerhut's directors, and, therefore, our capital stock owned by Fingerhut may also be deemed to be beneficially owned by Federated. (2) Represents 1,817,121 shares held by Mr. Choate directly, 12,000 shares held by a trust established for Mr. Choate's children and 14,000 shares that Mr. Choate has a right to acquire pursuant to options exercisable within 60 days of July 31, 1999. (3) Represents 1,641,739 shares held by Mr. Ballantine directly and 14,000 shares that Mr. Ballantine has a right to acquire pursuant to options exercisable within 60 days of July 31, 1999. (4) Represents 73,171 shares held by Kirk Loevner Trust w/d/t dated 8/5/96 directly and 12,000 shares that Mr. Loevner has a right to acquire pursuant to options exercisable within 60 days of July 31, 1999. (5) Represents 30,000 shares held by the Balousek Family Limited Partnership, 10,000 shares held by the Balousek 1994 Irrevocable Trust and 10,000 shares that Mr. Balousek has a right to acquire pursuant to options exercisable within 60 days of July 31, 1999. (6) Represents 20,000 shares held by Mr. Wade directly and 25,481 shares that Mr. Wade has a right to acquire pursuant to options exercisable within 60 days of July 31, 1999. (7) Represents 16,667 shares held by Mr. Fritsch directly and 9,100 shares that Mr. Fritsch has a right to acquire pursuant to options exercisable within 60 days of July 31, 1999. (8) Represents 3,620,698 shares listed as to all current directors and executive officers and includes 84,581 shares issuable within 60 days of July 31, 1999 upon the exercise of outstanding options. 56 58 DESCRIPTION OF CAPITAL STOCK Our authorized capital stock consists of 40,000,000 shares of common stock, no par value per share, and 10,000,000 shares of preferred stock, no par value per share. COMMON STOCK As of July 31, 1999, there were 10,133,719 shares of our common stock issued and outstanding (including shares issuable upon conversion of outstanding series of preferred stock), held of record by 117 shareholders. Holders of common stock are entitled to one vote per share on all matters to be voted upon by the shareholders. The articles of incorporation do not authorize cumulative voting for the election of directors, which means that the holders of a majority of the shares voted can elect all of the directors then standing for election. Subject to preferences of any outstanding shares of preferred stock, holders of common stock are entitled to receive ratably any dividends the board of directors declares out of funds legally available for the payment of dividends. If we are liquidated, dissolved or wound up, the holders of common stock are entitled to share in proportion to the percentage of their ownership all assets remaining after payment of liabilities and liquidation preferences of any outstanding shares of preferred stock. Holders of shares of common stock have no preemptive or conversion rights or other subscriptive rights, and there are no redemption or sinking fund provisions that apply to the common stock. All outstanding shares of common stock are fully paid and nonassessable, and the shares of common stock in this offering will be fully paid and nonassessable. PREFERRED STOCK In June 1997, we designated 1,935,484 shares of series A convertible preferred stock, all of which was issued and later converted into common stock in July 1997. In May 1999, we designated 1,250,000 shares of series B convertible preferred stock. As of July 31, 1999, we had outstanding 472,608 shares of series B convertible preferred stock. We have agreed to issue an additional 405,359 shares prior to the completion of this offering, as long as this offering is completed on or before October 31, 1999. The series B convertible preferred stock has identical rights and preferences as our common stock, except that it has no voting rights. Each share of series B convertible preferred stock is convertible into four shares of common stock at the option of the holder or upon the completion of this offering. Subject to the provisions of the articles of incorporation and limitations prescribed by law, the board of directors has the authority to issue, without further vote or action by the shareholders, up to 6,814,516 additional shares of preferred stock in one or more series. The board has the authority to fix the rights, preferences, privileges and restrictions of the shares of each series, including dividend rights, convertibility, voting rights, redemption rights, liquidation preferences and the number of shares constituting any series and the designation of such series. Issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, a majority of our outstanding voting stock. WARRANTS As of July 31, 1999, Fingerhut held irrevocable "percentage warrants" to purchase 208,918 shares of our series B convertible preferred stock; "anti-dilution warrants" to purchase 184,288 of our series B convertible preferred stock; and "third-party agreement warrants" to purchase 3,333 shares of our series B convertible preferred stock. All Fingerhut warrants will expire at the closing of this offering, if not previously exercised. Pursuant to the terms of a letter agreement, Fingerhut has agreed to exercise the remainder of its warrants prior to the completion 57 59 of this offering, as long as this offering is completed on or before October 31, 1999. See "Related-Party Transactions." In addition to the warrants held by Fingerhut, as of July 31, 1999, we had warrants outstanding to purchase 27,700 shares of common stock. Generally, each warrant contains provisions for the adjustment of the exercise price and the number of shares issuable upon the exercise of the warrant upon the occurrence of events such as stock dividends, stock splits, reorganizations, reclassifications and consolidations. REGISTRATION RIGHTS According to the terms of a stockholders agreement between us, Fingerhut and Messrs. Choate and Ballantine, Fingerhut is entitled to make a one-time demand that we file a registration statement with respect to shares of common stock owned by Fingerhut. However, we are not required to effect this "demand registration" before June 30, 2001, and may postpone the registration for up to 180 days for bona fide business reasons. In addition, under the stockholders agreement, Fingerhut is entitled to "piggyback" registration rights in connection with any registration by us of our securities for our own account or for the account of other security holders (other than in this offering and in any registration of securities to be issued in connection with an acquisition or under our employee compensation plans). If we propose to register any shares of common stock under the Securities Act of 1933, as amended, Fingerhut is entitled to receive notice and to include its shares in the registration statement, subject to certain limitations. Fingerhut is entitled to two piggyback registrations under the agreement. We have also granted piggyback registration rights to Commonsite with respect to 52,920 shares of common stock in connection with our acquisition of substantially all of the assets of Commonsite. Under the terms of the registration rights agreement, after completion of this offering, Commonsite is entitled to one piggyback registration in connection with any registration by us of our securities for our own account or for the account of other security holders (other than any registration of securities to be issued in connection with an acquisition or under our employee compensation plans). If we propose to register any shares of common stock under the Securities Act, Commonsite is entitled to receive notice and to include its shares in the registration statement, subject to certain limitations. ANTITAKEOVER EFFECTS OF CERTAIN ARTICLES AND BYLAW PROVISIONS AND THE WASHINGTON BUSINESS CORPORATION ACT Articles and Bylaws. Our articles of incorporation and bylaws contain provisions that may have the effect of delaying, deferring or preventing a change in control. Neither the articles of incorporation nor the bylaws provide for cumulative voting in the election of directors. Furthermore, the authorization of undesignated preferred stock makes it possible for the board of directors to issue preferred stock with voting or other rights or preferences that could impede any attempt to change control of FreeShop. Washington Business Corporation Act. Washington law imposes restrictions on certain transactions between a corporation and certain significant shareholders. Chapter 23B.19 of the Washington Business Corporation Act prohibits a "target corporation," with some exceptions, from engaging in certain significant business transactions with a person or group of persons that beneficially owns 10% or more of the voting securities of the target corporation (an Acquiring Person) for a period of five years after such acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporation's board of directors prior to the time of acquisition. Transactions prohibited by this statute include, among others: - a merger or consolidation with, disposition of assets to, or issuance or redemption of stock to or from, the Acquiring Person; 58 60 - termination of 5% or more of the employees of the target corporation as a result of the Acquiring Person's acquisition of 10% or more of the shares; or - allowing the Acquiring Person to receive any disproportionate benefit as a shareholder. After the five-year period, a "significant business transaction" may occur, as long as it complies with certain "fair price" provisions of the statute. A public corporation may not "opt out" of this statute. This provision may have the effect of delaying, deferring or preventing a change in control of FreeShop. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for our common stock is ChaseMellon Shareholder Services, L.L.C. Its address is 400 South Oak Street, 4th Floor, Los Angeles, California 90071, and its telephone number at this location is (213) 553-9731 . LISTING Our common stock has been approved for quotation on the Nasdaq National Market under the trading symbol "FSHP," subject to official notice of issuance. SHARES ELIGIBLE FOR FUTURE SALE Future sales of substantial amounts of our common stock in the public market could adversely affect prevailing market prices of our common stock. Furthermore, because no shares will be available for sale shortly after this offering because of certain contractual and legal restrictions on resale described below, sales of substantial amounts of common stock in the public market after these restrictions lapse could adversely affect the prevailing market price and our ability to raise equity capital in the future. Upon completion of this offering and based on shares of common stock outstanding as of July 31, 1999, we will have outstanding an aggregate of 14,955,155 shares of our common stock, assuming no exercise of the underwriters' over-allotment option and no exercise of outstanding options, and assuming the exercise of all warrants held by Fingerhut and the conversion of all the series B convertible preferred stock. Of these shares, the 3,200,000 shares sold in this offering will be freely tradable without restriction or further registration under the Securities Act, unless such shares are purchased by "affiliates," as that term is defined in Rule 144 under the Securities Act. The remaining 11,755,155 shares of common stock held by existing shareholders are "restricted securities" as that term is defined in Rule 144 under the Securities Act. Restricted securities may be sold in the public market only if registered or if they qualify for an exemption from registration under Rule 144 or 701 promulgated under the Securities Act, which rules are summarized below. Lock-Up Agreements. A majority of shareholders, including each of our directors and officers, who hold an aggregate of 11,497,632 shares of common stock (which includes common stock issuable upon conversion of series B convertible preferred stock), have agreed not to offer, sell, contract to sell or otherwise dispose of, or enter into any transaction that is designed to, or could be expected to, result in the disposition of any portion of, any common stock for a period of 180 days after the effective date of the registration statement of which this prospectus is a part, without the prior written consent of Deutsche Bank Securities Inc. This consent may be given at any time without public notice. We have entered into a similar agreement, except that we may, without the prior written consent of Deutsche Bank Securities Inc., issue common stock: - as consideration or partial consideration for business acquisitions; - in connection with the formation of strategic alliances; - pursuant to the exercise of outstanding options and warrants; and 59 61 - in connection with the issuance and exercise of options granted under our stock option plan. Any shares so issued will be subject to a lock-up agreement for a period of 180 days after the effective date of the registration statement of which this prospectus is a part. In addition, Fingerhut, Mr. Ballantine and Mr. Choate have entered into a cross-lock-up agreement which prevents any of the parties from selling stock pursuant to a waiver from Deutsche Bank Securities Inc. under the lock-up agreements unless the other parties receive similar waivers. Before taking into account the lock-up agreements, the following shares will be eligible for sale in the public market at the following times: - Beginning on the effective date of the offering, 4,729,114 shares will be immediately available for sale in the public market. - Beginning 90 days after the effective date of this offering, approximately 6,567,253 shares will be eligible for sale pursuant to Rules 144 or 701. - An additional 3,658,788 shares will become eligible for sale pursuant to Rule 144 at various times after 90 days from the effective date of this offering. Shares eligible to be sold by affiliates pursuant to Rule 144 are subject to volume restrictions as described below. Rule 144. In general, under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person who has beneficially owned shares of our common stock for at least one year would be entitled to sell within any three-month period a number of shares that does not exceed the greater of: - 1% of the number of shares of common stock then outstanding, which will equal approximately 149,552 shares immediately after this offering; or - the average weekly trading volume of the common stock on the Nasdaq National Market during the four calendar weeks preceding the filing of a notice on Form 144 with respect to such sale. Sales under Rule 144 are also subject to certain manner of sale provisions and notice requirements and to the availability of current public information about us. Rule 144(k). Under Rule 144(k), a person who is not deemed to have been one of our affiliates at any time during the 90 days preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, including the holding period of any prior owner other than an affiliate, is entitled to sell such shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Therefore, unless otherwise restricted, "144(k) shares" may be sold immediately upon the completion of this offering. Rule 701. In general, under Rule 701 of the Securities Act as currently in effect, any of our employees, consultants or advisors who purchases shares from us in connection with a compensatory stock or option plan or other written agreement is eligible to resell such shares 90 days after the effective date of this offering in reliance on Rule 144, but without compliance with some restrictions, including the holding period, contained in Rule 144. Registration Rights. Upon completion of this offering, Fingerhut and Commonsite will be entitled to rights with respect to the registration of shares of our common stock under the Securities Act. See "Description of Capital Stock -- Registration Rights." After such a registration, these shares become freely tradable without restriction under the Securities Act. Neither Fingerhut nor Commonsite will have any obligation or other restrictions on resale with respect to any of our securities, other than restrictions imposed by lock-up agreements and applicable securities laws. Any sales of securities by these shareholders could have a material adverse effect on the trading price of our common stock. 60 62 Stock Options. Immediately after this offering, we intend to file a registration statement under the Securities Act covering up to 2,400,000 shares of common stock reserved for issuance under our 1997 Stock Option Plan. As of July 31, 1999, options to purchase 953,289 shares of common stock were issued and outstanding. Upon the expiration of the lock-up agreements described above, at least 623,688 shares of common stock will be subject to vested options (based on options outstanding as of July 31, 1999). Such registration statement is expected to be filed and become effective as soon as practicable after the effective date of this offering. Accordingly, shares registered under such registration statement will, subject to vesting provisions and Rule 144 volume limitations applicable to our affiliates, be available for sale in the open market immediately after the 180-day lock-up period expires. 61 63 UNDERWRITING Subject to the terms and conditions of the underwriting agreement, the underwriters named below, through their representatives Deutsche Bank Securities Inc., Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, Volpe Brown Whelan & Company, LLC and E*OFFERING Corp. have severally agreed to purchase from us the following respective numbers of shares of common stock at the public offering price less the underwriting discounts and commissions set forth on the cover page of this prospectus.
NUMBER UNDERWRITER OF SHARES ----------- --------- Deutsche Bank Securities Inc. .............................. Dain Rauscher Wessels....................................... Volpe Brown Whelan & Company, LLC........................... E*OFFERING Corp............................................. --------- Total............................................. 3,200,000 =========
The underwriting agreement provides that the obligations of the underwriters are subject to several conditions, including the absence of any material adverse change in our business and the receipt of certificates, opinions and letters from us, our counsel and our experts. The agreement also provides for the allocation of expenses incurred in the offering. In addition, the agreement provides that the underwriters will purchase all the shares of common stock offered by this prospectus, other than those covered by the over-allotment option described below, if any of such shares are purchased. Pursuant to the underwriting agreement, we have agreed to indemnify the underwriters against liabilities under the Securities Act, and to contribute to payments the underwriters may be required to make with respect to liabilities under the Securities Act. We have been advised by the representatives that the underwriters propose to offer the shares of common stock directly to the public at the offering price set forth on the cover page of this prospectus and to certain dealers at such price less a concession not in excess of $ per share. The underwriters may allow, and such dealers may re-allow, a concession not in excess of $ per share to certain other dealers. After the initial public offering, the offering price and other selling terms may be changed by the representatives. A prospectus in electronic format is being made available on Internet Web sites maintained by E*OFFERING Corp. and E*TRADE Securities, Inc. Internet purchases of the common stock offered by this prospectus will be available only to registered customers of E*TRADE Securities, Inc. who possess sufficient net worth and investment experience. All eligible accounts may submit a conditional offer to E*TRADE Securities, Inc. to purchase shares. If demand exceeds availability, E*TRADE Securities, Inc. will randomly allocate shares to applicants in 100-share lots in a round-robin fashion, meaning that no applicant will receive a second lot until all applicants have received one lot, and so forth, until all shares available to E*TRADE Securities, Inc. have been distributed. The common stock offered by this prospectus will not be directed to any additional Internet customers other than the registered customers of E*TRADE Securities, Inc. We have granted to the underwriters an option, exercisable not later than 30 days after the date of this prospectus, to purchase up to 480,000 additional shares of common stock at the public offering price less the underwriting discounts and commissions set forth on the cover page of this prospectus. The underwriters may exercise this option only to cover over-allotments made in connection with the sale of the common stock offered in this prospectus. To the extent the underwriters exercise the option, each of the underwriters will become obligated, subject to certain conditions, to purchase approximately the same percentage of additional shares of 62 64 common stock as the number of shares of common stock to be purchased by it in the above table bears to the total listed above. We will be obligated, pursuant to the option, to sell these shares to the underwriters to the extent the option is exercised. If any additional shares of common stock are purchased, the underwriters will offer such additional shares on the same terms as those on which the 3,200,000 shares are being offered. The underwriting fee is equal to the public offering price per share of common stock less the amount paid by the underwriters to us per share of common stock. We anticipate that the total underwriting fee will be approximately 7% of the aggregate initial public offering price. The following table summarizes the underwriting compensation that will be paid in connection with this offering.
TOTAL ------------------------------- WITHOUT WITH PER SHARE OVER-ALLOTMENT OVER-ALLOTMENT --------- -------------- -------------- Underwriting discounts and commissions paid by us.... $ $ $ Reimbursement of expenses to or on behalf of the underwriters....................................... $ $ $ Fees and expenses of underwriters' counsel relating to NASD review..................................... $ $ $
We estimate that the total expenses of the offering, excluding underwriting discounts and commissions, will be approximately $750,000. The representatives have advised us that the underwriters do not intend to confirm orders to any account over which they exercise discretionary authority. A majority of our shareholders, including each of our officers and directors, who hold an aggregate of 11,497,632 shares of common stock (which includes common stock issuable upon conversion of series B convertible preferred stock), have agreed not to offer, sell contract to sell or otherwise dispose of, or enter into any transaction that is designed to, or could be expected to, result in the disposition of any portion of, any common stock for a period of 180 days after the effective date of the registration statement of which this prospectus is a part, without the prior written consent of Deutsche Bank Securities Inc. This consent may be given at any time without public notice. We have entered into a similar agreement, except that we may, without the prior written consent of Deutsche Bank Securities Inc., issue common stock: - as consideration or partial consideration for business acquisitions; - in connection with the formation of strategic alliances; - pursuant to the exercise of outstanding options and warrants; and - in connection with the issuance and exercise of options granted under our stock option plan. Any shares so issued will be subject to a lock-up agreement for a period of 180 days after the effective date of the registration statement of which this prospectus is a part. In order to facilitate the offering of the common stock, the underwriters may engage in transactions that stabilize, maintain or otherwise affect the market price of the common stock. Specifically, the underwriters may over-allot shares of the common stock in connection with this offering, thus creating a short position in the common stock for their own account. Additionally, to cover these over-allotments or to stabilize the market price of the common stock, the underwriters may bid for, and purchase, shares of the common stock in the open market. Finally, the representatives, on behalf of the underwriters, may reclaim selling concessions allowed to an underwriter or dealer if the underwriting syndicate repurchases shares distributed by that underwriter or dealer. Any of these activities may maintain the market price of our common stock at a level above that which might otherwise prevail in the open market. The underwriters are not required to engage in these activities and, if commenced, may end any of these activities at any time. 63 65 At our request, the underwriters have reserved up to 288,000 shares of common stock for sale, at the initial public offering price, to our current full-time employees, our current shareholders and selected marketer clients and traffic partners, through a directed share program. In connection with this program, Deutsche Bank Securities Inc. intends to send a letter and questionnaire to potential interested participants and provide those parties from whom it has received indications of interest the opportunity to obtain a copy of this prospectus. The underwriters are seeking lock-up agreements from participants in the directed share program. The number of shares of common stock available for sale to the general public will be reduced to the extent these reserved shares are purchased. Any reserved shares not purchased will be offered by the underwriters to the general public on the same basis as the other shares offered by this prospectus. PRICING OF THE OFFERING Prior to this offering, there has been no public market for our common stock. Consequently, the initial public offering price for our common stock will be determined by negotiation between FreeShop and the representatives of the underwriters. Among the primary factors to be considered in determining the public offering price will be: - prevailing market conditions; - our results of operations in recent periods; - the present stage of our development; - the market capitalizations and stages of development of other companies we and the representatives believe to the comparable to us; and - estimates of our business potential. LEGAL MATTERS Dorsey & Whitney LLP, Seattle, Washington, will pass upon the legality of the shares offered by this prospectus. Perkins Coie LLP, Seattle, Washington, is acting as legal counsel to the underwriters in connection with this offering. A partner of Dorsey & Whitney LLP owns an aggregate of 11,232 shares of our common stock. EXPERTS The financial statements of FreeShop as of December 31, 1997 and 1998 and for the years ended June 30, 1996 and 1997, the six months ended December 31, 1997 and the year ended December 31, 1998, included in this prospectus have been included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of PricewaterhouseCoopers LLP as experts in auditing and accounting. The financial statements of Commonsite as of December 31, 1998 and for the year then ended that are included in this prospectus have been included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of PricewaterhouseCoopers LLP as experts in auditing and accounting. The financial statements of Travel Companions International as of December 31, 1998 and for the year then ended that are included in this prospectus have been included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of PricewaterhouseCoopers LLP as experts in auditing and accounting. 64 66 WHERE YOU CAN FIND MORE INFORMATION We have filed with the Securities and Exchange Commission a registration statement on Form S-1 covering the shares being sold in this offering. We have not included in this prospectus some information contained in the registration statement, and you should refer to the registration statement, including exhibits and schedules filed with the registration statement, for further information. You may review without charge a copy of the registration statement at the public reference section of the Commission in Room 1024, Judiciary Plaza, 450 5th Street, N.W., Washington, D.C. 20549; and at the SEC's Regional Office located at 7 World Trade Center, Suite 1300, New York, New York 10048 and 1400 Citicorp Center, 500 West Madison Street, Chicago, Illinois 60661. You may also obtain copies of such materials at prescribed rates from the public reference section at the Commission, Room 1024, Judiciary Plaza, 450 5th Street, N.W., Washington, D.C. 20549. In addition, the SEC maintains a Web site on the Internet at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. 65 67 INDEX TO FINANCIAL STATEMENTS FREESHOP.COM, INC. FINANCIAL STATEMENTS
PAGE ---- Report of Independent Accountants........................... F-2 Balance Sheet for the periods ended December 31, 1997, December 31, 1998 and June 30, 1999 (unaudited)........... F-3 Statement of Operations for the periods ended June 30, 1996, June 30, 1997, December 31, 1997, December 31, 1998, June 30, 1998 (unaudited) and June 30, 1999 (unaudited)........ F-4 Statement of Changes in Mandatorily Redeemable Preferred Stock and Shareholders' Equity/Division Equity for the periods ended June 30, 1996, June 30, 1997, December 31, 1997, December 31, 1998 and June 30, 1999 (unaudited)..... F-5 Statement of Cash Flows for the periods ended June 30, 1996, June 30, 1997, December 31, 1997, December 31, 1998, June 30, 1998 (unaudited) and June 30, 1999 (unaudited)........ F-6 Notes to Financial Statements............................... F-7 COMMONSITE, LLC FINANCIAL STATEMENTS Report of Independent Accountants........................... F-20 Statement of Financial Position as of December 31, 1998 and March 31, 1999 (unaudited)................................ F-21 Statement of Operations and Members' Deficit for the periods ended December 31, 1998, March 31, 1998 (unaudited) and March 31, 1999 (unaudited)................................ F-22 Statement of Cash Flows for the periods ended December 31, 1998, March 31, 1998 (unaudited) and March 31, 1999 (unaudited)............................................... F-23 Notes to Financial Statements............................... F-24 TRAVEL COMPANIONS INTERNATIONAL, INC. FINANCIAL STATEMENTS Report of Independent Accountants........................... F-28 Balance Sheet as of December 31, 1998 and March 31, 1999 (unaudited)............................................... F-29 Statement of Income for the periods ended December 31, 1998, March 31, 1998 (unaudited) and March 31, 1999 (unaudited)............................................... F-30 Statement of Stockholders' Deficit for the periods ended December 31, 1998 and March 31, 1999 (unaudited).......... F-31 Statement of Cash Flows for the periods ended December 31, 1998, March 31, 1998 (unaudited) and March 31, 1999 (unaudited)............................................... F-32 Notes to Financial Statements............................... F-33 FREESHOP.COM, INC. UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION Unaudited Pro Forma Combined Financial Information.......... F-36 Unaudited Pro Forma Combined Statement of Operations for the year ended December 31, 1998 and the six months ended June 30, 1999.................................................. F-37 Notes to Unaudited Pro Forma Combined Financial Statements................................................ F-38
F-1 68 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of FreeShop.com, Inc. In our opinion, the accompanying balance sheet and the related statements of operations, of changes in mandatorily redeemable convertible preferred stock and shareholders' equity/division equity and of cash flows present fairly, in all material respects, the financial position of FreeShop.com, Inc. at December 31, 1997 and 1998, and the results of its operations and its cash flows for the years ended June 30, 1996 and 1997, the six-month period ended December 31, 1997 and the year ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As described in Note 1, FreeShop.com, Inc. was a wholly owned subsidiary of Online Interactive, Inc. prior to July 1, 1997. PricewaterhouseCoopers LLP Seattle, Washington April 16, 1999, except as to paragraphs three through seven of Note 13 which are as of June 18, 1999, and paragraph eight of Note 13 which is as of August 9, 1999. F-2 69 FREESHOP.COM, INC. BALANCE SHEET
DECEMBER 31, JUNE 30, ------------------------- ------------ 1997 1998 1999 ----------- ----------- ------------ (UNAUDITED) ASSETS Cash and cash equivalents........................ $ 26,329 $ 2,892,144 $ 4,330,067 Accounts receivable, net......................... 204,691 339,179 1,019,058 Prepaid expenses................................. 13,598 30,497 380,377 Short-term investments........................... 1,485,600 ----------- ----------- ------------ Total current assets........................ 244,618 3,261,820 7,215,102 Property and equipment, net...................... 354,496 381,296 857,397 Intangible assets................................ 2,496,929 Other assets and deposits........................ 45,818 43,454 43,454 ----------- ----------- ------------ $ 644,932 $ 3,686,570 $ 10,612,882 =========== =========== ============ LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable................................. $ 247,491 $ 464,872 $ 966,227 Accrued and other liabilities.................... 68,966 670,857 936,728 Payable to Online Interactive, Inc............... 27,269 Current portion of capital lease obligations..... 59,081 112,327 122,144 ----------- ----------- ------------ Total current liabilities................... 402,807 1,248,056 2,025,099 ----------- ----------- ------------ Long-term convertible debt....................... 50,000 Capital lease obligations, net of current portion........................................ 159,757 144,727 81,219 Commitments (Note 9) Mandatorily redeemable preferred stock, series A convertible, no par value; 10,000,000 shares authorized, none issued and outstanding at December 31, 1997 and 1998 and June 30, 1999, liquidation value $0.086....................... Shareholders' equity Series B convertible preferred stock, no par value; no shares authorized, issued or outstanding at December 31, 1997 and 1998, 1,250,000 shares authorized, 472,608 issued and outstanding at June 30, 1999 (unaudited)................................. 8,615,125 Common stock, no par value; 40,000,000 shares authorized, 6,117,595 issued and 5,597,595 outstanding at December 31, 1997, 8,660,959 issued and 8,140,959 outstanding at December 31, 1998 and 8,923,287 issued and 8,243,287 outstanding at June 30, 1999 (unaudited).... 2,699,518 7,816,328 8,955,511 Additional paid-in capital..................... 62,968 294,529 1,975,849 Note receivable from shareholder............... (25,000) Deferred stock compensation.................... (12,927) (1,075,975) Accumulated deficit............................ (2,655,118) (5,854,143) (9,963,946) ----------- ----------- ------------ Total shareholders' equity.................. 82,368 2,243,787 8,506,564 ----------- ----------- ------------ $ 644,932 $ 3,686,570 $ 10,612,882 =========== =========== ============
The accompanying notes are an integral part of these financial statements. F-3 70 FREESHOP.COM, INC. STATEMENT OF OPERATIONS
SIX MONTHS SIX MONTHS ENDED YEAR ENDED JUNE 30, ENDED YEAR ENDED JUNE 30, ------------------------ DECEMBER 31, DECEMBER 31, -------------------------- 1996 1997 1997 1998 1998 1999 ---------- ----------- ------------ ------------ ------------ ----------- (UNAUDITED) Net revenues........... $1,270,949 $ 1,197,757 $ 534,733 $ 1,250,940 $ 429,002 $ 2,146,662 Cost of revenues....... 310,308 313,672 139,451 216,557 75,631 189,898 ---------- ----------- ----------- ----------- ------------ ----------- Gross profit........... 960,641 884,085 395,282 1,034,383 353,371 1,956,764 ---------- ----------- ----------- ----------- ------------ ----------- Operating expenses Sales and marketing.......... 624,560 1,809,912 1,174,745 3,088,446 1,029,839 4,141,323 Research and development........ 64,673 135,121 182,532 386,629 194,069 321,517 General and administrative..... 290,821 352,923 83,217 416,766 171,820 462,060 Equity based compensation....... -- -- 62,968 174,102 122,696 621,756 Depreciation and amortization....... 9,008 30,011 34,468 104,393 48,811 259,911 ---------- ----------- ----------- ----------- ------------ ----------- Total operating expenses........ 989,062 2,327,967 1,537,930 4,170,336 1,567,235 5,806,567 ---------- ----------- ----------- ----------- ------------ ----------- Operating loss......... (28,421) (1,443,882) (1,142,648) (3,135,953) (1,213,864) (3,849,803) Interest expense....... 6,226 65,654 28,457 23,492 Other (income) expense.............. (2,582) 761 (86,992) ---------- ----------- ----------- ----------- ------------ ----------- Loss before income tax expense.............. (28,421) (1,443,882) (1,148,874) (3,199,025) (1,243,082) (3,786,303) Income tax expense..... ---------- ----------- ----------- ----------- ------------ ----------- Net loss............... $ (28,421) $(1,443,882) $(1,148,874) $(3,199,025) $ (1,243,082) $(3,786,303) ========== =========== =========== =========== ============ =========== Basic and diluted net loss per share....... $ (0.01) $ (0.31) $ (0.22) $ (0.51) $ (0.21) $ (0.46) ========== =========== =========== =========== ============ =========== Weighted-average shares used in computing net loss per share....... 4,600,840 4,600,840 5,188,910 6,223,726 5,821,924 8,182,728 ========== =========== =========== =========== ============ ===========
The accompanying notes are an integral part of these financial statements. F-4 71 FREESHOP.COM, INC. STATEMENT OF CHANGES IN MANDATORILY REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY/DIVISION EQUITY
MANDATORILY REDEEMABLE CONVERTIBLE SERIES B CONVERTIBLE PREFERRED STOCK PREFERRED STOCK COMMON STOCK ADDITIONAL ---------------------- ----------------------- ----------------------- PAID-IN SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL ---------- --------- ---------- ---------- ---------- ---------- ---------- Balance at June 30, 1995......... -- $ -- -- -- -- $ -- $ -- Capital contributions............ Net loss......................... ---------- --------- ---------- ---------- ---------- ---------- ---------- Balance at June 30, 1996......... -- -- -- -- -- -- -- Capital contributions............ Issuance of common and Series A preferred stock in connection with spin-off................... 1,935,484 279,196 4,600,820 1,659,182 Net loss......................... ---------- --------- ---------- ---------- ---------- ---------- ---------- Balance at June 30, 1997......... 1,935,484 279,196 4,600,820 1,659,182 -- Forfeiture of common stock....... (520,000) Conversion of preferred stock.... (1,935,484) (279,196) 774,194 279,196 Issuance of common stock......... 718,190 736,140 Common stock issued in exchange for a note receivable........... 24,391 25,000 Stock options issued to third parties......................... 62,968 Net loss......................... ---------- --------- ---------- ---------- ---------- ---------- ---------- Balance at December 31, 1997..... -- -- 5,597,595 2,699,518 62,968 Issuance of common stock, net of offering expenses of $36,563.... 2,487,670 5,108,150 Exercise of stock options........ 55,694 8,660 Repayment of note receivable from shareholder..................... Stock options and warrants issued to third parties................ 147,561 Shares transferred to employees by principal shareholders....... 84,000 Amortization of deferred compensation.................... Net loss......................... ---------- --------- ---------- ---------- ---------- ---------- ---------- Balance at December 31, 1998..... -- -- 8,140,959 7,816,328 294,529 Repurchase of common stock (unaudited)..................... (160,000) (76,500) Issuance of common stock (unaudited)..................... 160,000 400,000 Issuance of common stock upon conversion of promissory note (unaudited)..................... 20,000 50,000 Issuance of common stock in connection with business combinations (unaudited)........ 52,920 736,000 Shares sold to employees by principal shareholders (unaudited)..................... 406,000 Exercise of stock options and warrants (unaudited)............ 472,608 8,615,125 29,408 29,683 Stock options and warrants issued to third parties (unaudited).... 1,275,320 Amortization of deferred compensation (unaudited)........ Net loss (unaudited)............. ---------- --------- ---------- ---------- ---------- ---------- ---------- Balance at June 30, 1999 (unaudited)..................... -- $ -- 472,608 8,615,125 8,243,287 $8,955,511 $1,975,849 ========== ========= ========== ========== ========== ========== ========== NOTE TOTAL RECEIVABLE SHAREHOLDERS' FROM DEFERRED DIVISION ACCUMULATED EQUITY/ SHAREHOLDER COMPENSATION EQUITY DEFICIT DIVISION EQUITY ----------- ------------ ----------- ----------- --------------- Balance at June 30, 1995......... $ -- $ -- $ 7,747 $ -- $ 7,747 Capital contributions............ 125,198 125,198 Net loss......................... (28,421) (28,421) -------- ----------- ----------- ----------- ----------- Balance at June 30, 1996......... -- -- 104,524 -- 104,524 Capital contributions............ 1,771,492 1,771,492 Issuance of common and Series A preferred stock in connection with spin-off................... (1,876,016) (62,362) (279,196) Net loss......................... (1,443,882) (1,443,882) -------- ----------- ----------- ----------- ----------- Balance at June 30, 1997......... -- -- -- (1,506,244) 152,938 Forfeiture of common stock....... -- Conversion of preferred stock.... 279,196 Issuance of common stock......... 736,140 Common stock issued in exchange for a note receivable........... (25,000) -- Stock options issued to third parties......................... 62,968 Net loss......................... (1,148,874) (1,148,874) -------- ----------- ----------- ----------- ----------- Balance at December 31, 1997..... (25,000) -- -- (2,655,118) 82,368 Issuance of common stock, net of offering expenses of $36,563.... 5,108,150 Exercise of stock options........ 8,660 Repayment of note receivable from shareholder..................... 25,000 25,000 Stock options and warrants issued to third parties................ (22,677) 124,884 Shares transferred to employees by principal shareholders....... 84,000 Amortization of deferred compensation.................... 9,750 9,750 Net loss......................... (3,199,025) (3,199,025) -------- ----------- ----------- ----------- ----------- Balance at December 31, 1998..... -- (12,927) -- (5,854,143) 2,243,787 Repurchase of common stock (unaudited)..................... (323,500) (400,000) Issuance of common stock (unaudited)..................... 400,000 Issuance of common stock upon conversion of promissory note (unaudited)..................... 50,000 Issuance of common stock in connection with business combinations (unaudited)........ 736,000 Shares sold to employees by principal shareholders (unaudited)..................... 406,000 Exercise of stock options and warrants (unaudited)............ 8,644,808 Stock options and warrants issued to third parties (unaudited).... (1,275,320) -- Amortization of deferred compensation (unaudited)........ 212,272 212,272 Net loss (unaudited)............. (3,786,303) (3,786,303) -------- ----------- ----------- ----------- ----------- Balance at June 30, 1999 (unaudited)..................... $ -- $(1,075,975) $ -- $(9,963,946) $ 8,506,564 ======== =========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements. F-5 72 FREESHOP.COM, INC. STATEMENT OF CASH FLOWS
SIX MONTHS SIX MONTHS ENDED YEAR ENDED JUNE 30, ENDED YEAR ENDED JUNE 30, ----------------------- DECEMBER 31, DECEMBER 31, ------------------------- 1996 1997 1997 1998 1998 1999 --------- ----------- ------------ ------------ ----------- ----------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES Net loss.................................. $ (28,421) $(1,443,882) $(1,148,874) $(3,199,025) $(1,243,082) $(3,786,303) Adjustments to reconcile net loss to net cash used in operating activities Depreciation and amortization......... 5,566 33,659 47,617 140,710 65,692 287,286 Bad debt expense...................... 58,907 146,310 122,485 56,551 20,156 51,040 Amortization of deferred compensation........................ 9,750 212,272 Shares sold to an employee by a principal shareholder............... 406,000 Shares transferred to employees by principal shareholders.............. 84,000 Issuance of stock options and warrants for services........................ 62,968 88,321 122,696 Issuance of stock for office rent..... 32,637 Loss on disposal of property and equipment........................... 8,624 1,240 896 Changes in assets and liabilities: Accounts receivable................. (198,548) (94,449) (196,560) (191,039) 19,173 (694,404) Prepaid expenses and other assets... (17,280) (43,559) (21,074) (14,323) (349,880) Accounts payable.................... 11,873 43,044 192,402 217,381 65,786 326,795 Accrued and other liabilities....... 50,502 (48,957) 27,545 601,891 270,017 125,109 Payable to Online Interactive, Inc............................... (280,918) 308,187 (27,269) (7,800) --------- ----------- ----------- ----------- ----------- ----------- Net cash used in operating activities........................ (100,121) (1,662,473) (595,152) (2,231,179) (700,445) (3,421,189) --------- ----------- ----------- ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment........ (25,077) (108,894) (55,902) (67,428) (17,169) (579,965) Payment for business combinations, net of cash acquired........................... (1,666,440) Purchase of short-term investments........ (1,485,660) --------- ----------- ----------- ----------- ----------- ----------- Net cash used in investing activities........................ (25,077) (108,894) (55,902) (67,428) (17,169) (3,732,005) --------- ----------- ----------- ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Contributed capital....................... 125,198 1,771,492 Proceeds from notes payable............... 135,000 135,000 Repayment of notes payable................ (85,000) Principal payments under capital leases... (26,245) (63,951) (16,375) (53,691) Proceeds from Shareholder Note Receivable.............................. 25,000 25,000 Repurchase of common stock................ (400,000) Issuance of common stock, net of issuance costs................................... 703,503 5,153,373 743,288 429,683 Issuance of series B preferred stock...... 8,615,125 --------- ----------- ----------- ----------- ----------- ----------- Net cash provided by (used in) financing activities.............. 125,198 1,771,492 677,258 5,164,422 886,913 8,591,117 --------- ----------- ----------- ----------- ----------- ----------- Net increase in cash and cash equivalents... -- 125 26,204 2,865,815 169,299 1,437,923 Cash and cash equivalents at beginning of period.................................... -- -- 125 26,329 26,329 2,892,144 --------- ----------- ----------- ----------- ----------- ----------- Cash and cash equivalents at end of period.................................... $ -- $ 125 $ 26,329 $ 2,892,144 $ 195,628 $ 4,330,067 ========= =========== =========== =========== =========== =========== Cash paid during the period for interest.... $ -- $ -- $ 6,226 $ 65,654 $ 23,608 $ 24,751 ========= =========== =========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements. F-6 73 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND BUSINESS FreeShop began as a division of Online Interactive, Inc. (Online), a Washington corporation, incorporated in July 1994. On June 30, 1997, Online Interactive contributed the FreeShop Division, including certain net assets, to its wholly owned subsidiary, FreeShop International, Inc., a Washington corporation incorporated on June 23, 1997, which then began operating as a separate entity. In connection with the spin-off, Online issued FreeShop common shares equal to the number of Online shares (both preferred and common) outstanding as of June 30, 1997. Online then distributed the FreeShop common shares to its shareholders. Each Online shareholder received a number of FreeShop shares equal to the number of Online shares held as of the Distribution Record Date. However, 1,300,000 shares of common stock were forfeited on July 18, 1997 in connection with agreements between Online and certain shareholders. As a result of the distribution, FreeShop ceased to be a subsidiary of Online. On February 19, 1999, FreeShop International, Inc. changed its name to FreeShop.com, Inc. (FreeShop or the Company). FreeShop operates an online direct marketing network from a Web site at http://www.freeshop.com. Essentially, FreeShop is an online marketing service that generates sales leads, creates product awareness, and initiates consumer purchases through multiple online marketing vehicles, including free and trial offers, banner advertising, email newsletter sponsorship, and others. The financial statements for the two years ended June 30, 1997 reflect the revenues, expenses and changes in division equity and cash flows of the FreeShop Division of Online. Certain general and administrative costs incurred by Online have been allocated to the Company on a basis which management believes represents a reasonable allocation of such costs to present FreeShop as a stand-alone company. These allocations consist primarily of corporate expenses such as executive and other compensation, depreciation, rent and legal expenses. The corporate expenses have been allocated based on an estimate of Online personnel time dedicated to the operations and management of FreeShop for the year ended June 30, 1996 and the nine months ended March 31, 1997. For the three-month period ended June 30, 1997, these corporate expenses were generally allocated on a specific identification basis rather than on the basis of personnel time. A summary of these allocations are as follows:
YEAR ENDED JUNE 30, -------------------- 1996 1997 -------- -------- Sales and marketing......................................... $ 97,564 $176,768 Research and development.................................... 77,147 110,230 General and administrative.................................. 282,694 362,810 -------- -------- $457,405 $649,808 ======== ========
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH AND CASH EQUIVALENTS Cash equivalents consist of short-term highly liquid investments that mature within three months of their acquisition. The Company deposits its cash and cash equivalents in interest-bearing demand deposit accounts with high credit quality financial institutions. The Company has not experienced any losses on its cash and cash equivalents. F-7 74 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation and are depreciated using the straight-line method over their estimated useful lives. The estimated useful lives are as follows: Office furniture and equipment.............................. Five years Computer hardware and software.............................. Three years
The cost of normal maintenance and repairs are charged to expense as incurred and expenditures for major improvements are capitalized, at cost. Gains or losses on the disposition of assets in the normal course of business are reflected in the results of operations at the time of disposal. IMPAIRMENT OF LONG-LIVED ASSETS The Company evaluates its long-lived assets for financial impairment and continues to evaluate them as events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable. The Company evaluates the recoverability of long-lived assets by measuring the carrying amount of the assets against the estimated undiscounted future cash flows associated with these assets. At the time such evaluations indicate that the future undiscounted cash flows of certain long-lived assets are not sufficient to recover the carrying value of such assets, the assets are adjusted to their fair values. No losses for impairment have been recognized. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximate fair value because of their short maturities. The carrying amount of the Company's capital leases and other equipment financing obligations approximates the fair value of such instruments based upon management's estimates of interest rates that would be available to the Company for similar debt obligations at December 31, 1998. DEFERRED REVENUES Deferred revenues consist of advance billings and payments on marketing contracts and are included in accrued and other liabilities in the accompanying balance sheet. REVENUE RECOGNITION The Company has several revenue sources from its online marketing service activities, including lead generation, advertising, list rental, barter and transaction fees. Lead generation revenue consists of fees received, generally on a per inquiry basis, for delivery of leads to clients. Revenue is recognized in the period the leads are provided to the client. Advertising revenues consist of email newsletter sponsorships, banner advertising, and anchor positions. Newsletter sponsorship revenue is derived from a fixed fee or a fee based on the circulation of the newsletter. Newsletter sponsorship revenue is recognized in the period in which the newsletter is delivered. Banner advertising and anchor positions can be based on impressions, fixed fees, or click throughs. Fixed fee contracts, which range from three months to two years, are recognized ratably over the term of the agreement, provided that no significant F-8 75 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Company obligations remain. Revenue from impressions or click through based contracts is recognized based on the number of impressions or click throughs delivered over the total number of guaranteed impressions or click throughs. List rental revenue is revenue received from the rental of customer names to third parties through the use of list brokers. Revenue from list rental activities is recognized in the period the names are delivered by the list broker to the third party. Transaction fees are recognized in the period the transaction occurred and was reported to the Company by the online merchant. Also included in revenues are barter revenues generated from exchanging lead generation and advertising services for advertising services. Such transactions are recorded at the lower of the estimated fair value of the advertisements received or delivered, whichever is more reliably measurable. Revenue from barter transactions is recognized when advertising or lead generation is provided, and services received are charged to expense when used. From July 1, 1995 through December 31, 1997 barter transactions were not significant. For the year ended December 31, 1998 and the unaudited six months ended June 30, 1999, the Company recognized approximately $83,000 and $250,000, respectively, of revenue from barter transactions. ADVERTISING COSTS The Company expenses advertising costs as incurred. Total advertising expense for the years ended June 30, 1996 and 1997, the six months ended December 31, 1997, and the year ended December 31, 1998 and the unaudited six months ended June 30, 1999, was $13,179, $148,543, $242,919, $1,190,811 and $2,061,978, respectively. RESEARCH AND DEVELOPMENT COSTS Research and development costs are expensed as incurred. INCOME TAXES The Company accounts for income taxes under the asset and liability method, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. If it is more likely than not that some portion of a deferred tax asset will not be realized, a valuation allowance is recorded. NET LOSS PER SHARE Basic net loss per share represents net loss available to common shareholders divided by the weighted-average number of shares outstanding during the period. Diluted net loss per share represents net loss available to common shareholders divided by the weighted-average number of shares outstanding, including the potentially dilutive impact of common stock options and warrants and series B convertible preferred stock. Common stock options and warrants are converted using the treasury stock method. Series B convertible preferred stock is converted using the if-converted method. Basic and diluted net loss per share are equal for all periods presented because the impact of common stock equivalents is antidilutive. Potentially dilutive securities totaling 528,536, 1,200,369, 4,315,977 and 4,492,857 shares for the year ended June 30, 1997, the six months ended December 31, 1997, the year ended December 31, 1998 and the six months ended June 30, 1999 (unaudited), respectively, were excluded from diluted net loss per share due to their antidilutive effect. F-9 76 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Adjusted net loss per share is computed using the weighted-average number of common shares outstanding, including the effects of the automatic conversion of the Company's series B convertible preferred stock into shares of the Company's common stock effective upon the closing of the Company's initial public offering as if such conversion occurred on the date the shares were originally issued. The following table sets forth the computation of the numerators and denominators in the basic and diluted and pro forma net loss per share calculations for the periods indicated:
SIX MONTHS SIX MONTHS ENDED YEAR ENDED JUNE 30, ENDED YEAR ENDED JUNE 30, ------------------------- DECEMBER 31, DECEMBER 31, ------------------------- 1996 1997 1997 1998 1998 1999 ----------- ----------- ------------ ------------ ----------- ----------- (UNAUDITED) Numerator: Net loss............. $ (28,421) $(1,443,882) $(1,148,874) $(3,199,025) $(1,242,321) $(3,786,303) =========== =========== =========== =========== =========== =========== Denominator: Weighted-average shares used in computing net loss per share.......... 4,600,840 4,600,840 5,188,910 6,223,726 5,821,924 8,182,728 =========== =========== =========== =========== Weighted-average effect of other securities: Series B convertible preferred stock.... 638,456 ----------- ----------- Weighted-average shares outstanding used in computing adjusted net loss per share... 6,223,726 8,821,184 =========== =========== Adjusted basic and diluted net loss per share................ $ (0.51) $ (0.43) =========== ===========
CONCENTRATIONS OF CREDIT RISK Concentrations of credit risk with respect to accounts receivable are limited due to the wide variety of customers to which the Company provides services, as well as their dispersion across many different geographic areas. As such, no single customer accounted for greater than 10% of total revenues or accounts receivable balances for either the period ended December 31, 1998 or June 30, 1999 (unaudited). The Company maintains an allowance for doubtful accounts receivable based upon its historical experience and the expected collectibility of all accounts receivable. Credit losses to date have been within management's estimates. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-10 77 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform with the current year's presentation. UNAUDITED INTERIM FINANCIAL STATEMENTS The interim financial data as of June 30, 1999 and for the six months ended June 30, 1998 and 1999 is unaudited; however, in the opinion of management, the interim data includes all adjustments, consisting only of the adjustments necessary to record the acquisition of substantially all of the assets of the Catalog Site and Worldwide Brochures Web sites in May 1999 and normal recurring adjustments necessary to present fairly the Company's financial position as of June 30, 1999 and the results of its operations and cash flows for the six months ended June 30, 1998 and 1999. STOCK COMPENSATION The Company follows SFAS No. 123, "Accounting for Stock-Based Compensation," which establishes financial accounting and reporting standards for stock-based employee compensation plans and for the issuance of equity instruments to acquire goods and services from nonemployees. The Company has elected to apply the disclosure-only provision of SFAS No. 123 for employee stock-based compensation plans. Accordingly, the Company accounts for stock-based compensation to employees using the intrinsic-value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Compensation expense for stock options is measured as the excess, if any, of the fair value of the Company's common stock at the date of grant over the exercise price. The Company records the fair value of equity instruments issued to nonemployees in accordance with the provisions of SFAS No. 123. COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted the provisions of SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting comprehensive income and its components in financial statements. Comprehensive income, as defined, includes all changes in equity during a period from nonowner sources. To date, the Company has not had any transactions that are required to be reported in comprehensive income other than its net loss. RECENT ACCOUNTING PRONOUNCEMENTS In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use." SOP 98-1 is effective for financial statements for years beginning after December 15, 1998. SOP 98-1 provides guidance on accounting for computer software developed for internal use, including the requirement to capitalize specified costs and amortization of such costs. Adoption of this standard during the first quarter of 1999 did not have a material effect on the Company's results of operations, financial position or cash flows. In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-up Activities." SOP 98-5, which is effective for fiscal years beginning after December 15, 1998, provides guidance on the financial reporting of start-up costs and organization costs. It requires costs of start-up activities and organization costs to be expensed as incurred. As the Company has F-11 78 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) expensed these costs historically, the adoption of this standard during the first quarter of 1999 did not have a significant impact on results of operations, financial position or cash flows. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not expect the adoption of this statement to have a significant impact on results of its operations, financial position or cash flows. 3. ACCOUNTS RECEIVABLE Accounts receivable consist of the following:
DECEMBER 31, -------------------- JUNE 30, 1997 1998 1999 -------- -------- ----------- (UNAUDITED) Accounts receivable.................................... $284,410 $381,830 $1,123,058 Less: Allowance for doubtful accounts.................. (79,719) (42,651) (104,000) -------- -------- ---------- $204,691 $339,179 $1,019,058 ======== ======== ==========
4. PROPERTY AND EQUIPMENT Property and equipment consist of the following:
DECEMBER 31, --------------------- JUNE 30, 1997 1998 1999 -------- --------- ----------- (UNAUDITED) Computer hardware and software....................... $310,595 $ 468,483 $ 926,839 Office furniture and equipment....................... 129,517 129,517 259,712 -------- --------- ----------- 440,112 598,000 1,186,551 Less: Accumulated depreciation and amortization...... (85,616) (216,704) (329,154) -------- --------- ----------- $354,496 $ 381,296 $ 857,397 ======== ========= ===========
5. ACCRUED AND OTHER LIABILITIES Accrued and other liabilities consist of the following:
DECEMBER 31, ------------------ JUNE 30, 1997 1998 1999 ------- -------- ----------- (UNAUDITED) Deferred revenue............................................ $20,000 $ 1,129 $ 98,232 Accrued advertising expense................................. 488,451 408,397 List rental deposit......................................... 74,538 5,446 Accrued vacation............................................ 12,802 37,169 53,163 Accrued commissions......................................... 3,313 13,918 116,000 Accrued commerce expense.................................... 164,465 Other....................................................... 32,851 55,652 91,025 ------- -------- -------- $68,966 $670,857 $936,728 ======= ======== ========
F-12 79 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 6. BANK LINE-OF-CREDIT FACILITY The Company has a line-of-credit facility with a bank. Pursuant to the terms of the facility agreement, the Company may borrow up to $500,000 at the bank's prime rate plus 1.5%, which was 9.25% at December 31, 1998. The line of credit is collateralized by all assets of the Company and guaranteed up to $200,000 by the Company's President and Chief Executive Officer. The credit facility matures September 18, 1999, contains covenants not to encumber trade accounts receivable and requires maintenance of certain financial ratios. At December 31, 1998, the Company was in compliance with the loan covenants, and no balance was outstanding under the line. 7. RELATED PARTY TRANSACTIONS In January and February 1998, the Company issued notes payable to shareholders in the amount of $85,000. Such notes included interest at 10%. The outstanding balance, including accrued interest of $5,745, was repaid in September 1998. During 1998, two of the Company's principal shareholders transferred 56,000 shares of common stock to certain employees of the Company as incentive compensation. As a result, the Company recorded $84,000 of compensation expense based on the fair market value of the Company's common stock on the date of transfer. During January 1999 (unaudited), the Company repurchased 50,000 shares of common stock from a principal shareholder for $125,000 and subsequently retired the shares. The repurchase price of $2.50 per share was less than the $5.20 per share estimated fair value of the common stock at the date of repurchase. 8. LONG-TERM CONVERTIBLE DEBT In March 1998, the Company issued an uncollateralized 10% convertible promissory note totaling $50,000 to a third party. The note matures in March 2000. At any time prior to the maturity date, the third party may convert the outstanding principal balance into shares of the Company's preferred stock at the price at which such stock is being offered to other investors. During the first quarter of 1999, the terms of the note were modified to allow conversion into shares of common stock and the note was then converted. See Note 13 for further discussion. 9. COMMITMENTS In May 1998, a promotion agreement was entered into with CNET, Inc. which provides for CNET to invest in FreeShop an amount equal to 20% of the amount paid or payable to CNET for promotion. The agreement called for an investment to be made on September 30, 1998 on the same terms and conditions, including price, as FreeShop was then closing the sale of such securities to other investors. Subsequent investments are to be made on the scheduled closing date of each subsequent equity financing on the same terms and conditions, including price, as FreeShop is then closing the sale of such securities to other investors. If no equity investments are closed within nine months of the previous investment by CNET, then one day after nine months CNET will make an equity investment using the same terms and conditions as the previous investment made by CNET. No investment was made by CNET during the year ended December 31, 1998. The Company's office facilities are leased under operating leases that provide for minimum rentals and require payment of property taxes and include escalation clauses. In addition, the Company also rents certain equipment under agreements treated for financial reporting purposes F-13 80 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) as capital leases. The Company's property under capital leases which is included in property and equipment on the balance sheet at December 31, 1997 and 1998 was $221,801 and $246,299, respectively, which is net of accumulated amortization of $16,045 and $92,150, respectively. Future minimum lease payments under the noncancellable leases are as follows.
CAPITAL OPERATING YEAR ENDING DECEMBER 31, LEASES LEASES ------------------------ --------- ---------- 1999...................................................... $ 149,397 $ 289,105 2000...................................................... 120,798 403,730 2001...................................................... 42,969 426,648 2002...................................................... 448,397 2003...................................................... 192,055 --------- ---------- Total minimum lease payments................................ 313,164 $1,759,935 ========== Less: Amount representing interest.......................... (56,110) --------- Present value of capital lease obligations.................. 257,054 Less: Current portion....................................... (112,327) --------- Capital lease obligations, noncurrent portion............... $ 144,727 =========
Rent expense for the years ended June 30, 1996 and 1997, the six months ended December 31, 1997 and year ended December 31, 1998, was $42,468, $49,003, $60,594 and $199,136, respectively. 10. SHAREHOLDERS' EQUITY MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK On June 30, 1997, the Company's Board of Directors approved the designation and issuance of 1,935,484 shares of series A redeemable convertible preferred stock. The preferred series A shares are convertible into one share of common stock (subject to anti-dilution adjustments) at any time at the option of the holder. On July 18, 1997, subsequent to the spin-off of FreeShop from Online, all outstanding shares of Series A redeemable convertible preferred stock were converted into common stock at a rate of 2.5 shares of preferred to one share of common. COMMON STOCK On December 10, 1998, FreeShop issued 1,619,387 shares of the Company's common stock to Fingerhut Companies Inc. (Fingerhut) at a price of $2.47 per share. The shares were partially paid for by surrender and cancellation of the $500,000 Convertible Promissory Note, which the Company had issued to Fingerhut on December 4, 1998. The Company and Fingerhut also entered into a Stockholders Agreement on December 10, 1998 which grants Fingerhut a right of first refusal on shares proposed for transfer by the Company's two principal shareholders, contains certain agreements regarding composition of the Company's Board of Directors, requires Board approval of certain specified actions by the Company, grants Fingerhut preemptive rights to maintain its percentage ownership interest in connection with proposed share issuances by the Company, grants certain demand and piggyback registration rights to Fingerhut, and provides for certain drag-along and tag-along rights among the parties with respect to proposed sales of shares to third parties. The Stockholders Agreement terminates on the earliest of December 10, 2008, the closing of a sale of the Company's assets or F-14 81 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) the acquisition of the Company by merger or consolidation. Certain specific provisions of the agreement terminate upon the consummation of an underwritten public offering of the Company's securities in which the deemed market capitalization of the Company is at least $75 million. WARRANTS In connection with the sale of common stock to Fingerhut, the Company issued to Fingerhut a series of warrants to purchase shares of the Company's common stock as follows: a warrant to purchase 1,174,143 shares at $4.30 per share; a warrant to purchase 716,290 shares at $4.99 per share; a warrant to purchase 835,672 shares at $5.53 per share; warrants to purchase from time to time at $5.53 per share a number of shares equal to specified percentages of shares of common stock that are issued upon exercise of specified options and warrants; and warrants to purchase at exercise prices ranging from $2.47 per share to $5.53 per share a number of shares of common stock equal to specified percentages of shares of common stock that are issued to certain named third parties pursuant to existing contractual arrangements. Unless sooner exercised, all such warrants expire on the earlier of December 31, 2000, or the consummation of an underwritten public offering of the Company's securities in which the deemed market capitalization of the Company is at least $75 million. In connection with the equipment acquired under capital lease as described in Note 9, the Company issued warrants to purchase 16,400 shares of common stock. The warrants are exercisable at a price equal to $1.02 per share and expire from October 2002 to January 2003. The Company determined the fair value of the warrants to be $12,019 using the Black-Scholes option pricing model and recognized the entire expense during 1998. In return for recruiting services, the Company issued warrants to purchase 11,300 shares of common stock in January 1998. The warrants are exercisable at a price equal to $1.02 per share and expire in January 2003. The Company determined the fair value of these warrants to be $8,277 using the Black-Scholes option pricing model and recognized the entire expense during 1998. A warrant to purchase 10,000 shares of the Company's common stock at an exercise price of $1.50 per share was issued to the bank in connection with the line of credit described in Note 6. The warrant expires in September 2003. The Company determined the fair value of the warrants to be $10,625 using the Black-Scholes option pricing model. The fair value was recorded as prepaid loan fees during 1998 and will be amortized over the life of the credit facility. STOCK OPTIONS Effective June 30, 1997, the Company approved the 1997 Stock Option Plan (the Plan) to provide for the granting of stock options to employees, directors and consultants of the Company to acquire ownership in the Company and provide them with incentives for their service. Under the terms of the Plan, 1,064,306 shares of common stock have been reserved for issuance to plan participants. The Plan is administered by the Board of Directors of the Company, which determines the terms and conditions of the options granted, including exercise price, number of options granted and the vesting period of such options. The maximum term of options is ten years from the date of grant. The options are generally granted at the estimated fair value of the underlying stock, as determined by the Board of Directors, on the date of grant. As of December 31, 1998, options to purchase 249,286 shares of common stock were available for future grant under the Plan. No F-15 82 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) compensation expense has been recognized relative to options issued to employees for the years ended June 30, 1996 and 1997, the six months ended December 31, 1997, or the year ended December 31, 1998. For the year ended December 31, 1998, $3,177 of deferred compensation was recorded and will be amortized over the vesting period of the related options. During the six-month period ended June 30, 1999 (unaudited), the Company granted options to purchase 191,616 shares of common stock to employees and service providers at an average exercise price of $3.15. Of those granted, options to purchase 8,000 shares were forfeited. The Company recorded $1,275,320 of deferred compensation based upon the average deemed fair value of $6.95 which will be amortized over the vesting period of the related options. Had compensation expense for employee-related options been determined based on the fair value at the grant dates consistent with the method of SFAS No. 123, "Accounting for Stock Based Compensation," the Company's net loss and loss per share for the six months ended December 31, 1997 and the year ended December 31, 1998 would have been increased to the pro forma amounts indicated below:
1997 1998 ----------- ----------- Net loss As reported.............................. $(1,148,874) $(3,199,025) Pro forma................................ $(1,167,435) $(3,248,168) Loss per share As reported.............................. $ (0.22) $ (0.51) Pro forma................................ $ (0.22) $ (0.52)
For SFAS No. 123 pro forma disclosure, the fair value of each option is estimated on the date of grant using the minimum value method with the following assumptions used for grants to employees in 1998 and 1997; weighted-average risk-free interest rates of 4.78% and 5.70%, respectively, and expected lives of four years. The following table presents activity under the Plan:
JUNE 30, 1999 JUNE 30, 1997 DECEMBER 31, 1997 DECEMBER 31, 1998 (UNAUDITED) ------------------- --------------------- --------------------- ------------------- WEIGHTED- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE SHARES PRICE ------- --------- --------- --------- --------- --------- ------- --------- Outstanding at beginning of period...................... 528,536 $0.15 1,002,847 $0.56 815,021 $1.12 Granted....................... 528,536 $0.15 474,311 1.02 645,420 1.30 191,616 3.15 Exercised..................... 55,694 0.15 19,408 0.98 Forfeited..................... 777,552 0.60 33,940 2.09 ------- --------- --------- ------- ----- Outstanding at end of period...................... 528,536 $0.15 1,002,847 $0.56 815,021 $1.12 953,289 $1.50 ======= ========= ========= ======= Weighted-average fair value of options granted during the period...................... $0.03 $0.30 $0.34 $6.95
F-16 83 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) The following table summarizes information about stock options outstanding under the Plan at December 31, 1998:
WEIGHTED- NUMBER AVERAGE WEIGHTED- NUMBER WEIGHTED- RANGE OF OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE PRICES 1998 LIFE PRICE 1998 PRICE - -------- -------------- ----------- --------- -------------- --------- $0.15 100,934 8.5 $0.15 50,460 $0.15 1.02 367,667 6.0 1.02 242,394 1.02 1.50 342,420 9.0 1.50 59,306 1.50 2.50 4,000 10.0 2.50 2.50 --------- ------- 815,021 7.6 $1.12 352,160 $0.98 ========= =======
During the six months ended December 31, 1997, the Company granted options to purchase 195,122 shares of common stock to certain investors. These grants were made outside of the stock option plan. As of December 31, 1998, all of these options had expired without exercise. During the year ended December 31, 1998, the Company granted options to purchase 209,000 shares of common stock to consultants, advisors and investment managers and as severance to certain employees. The Company follows SFAS No. 123 in accounting for options and warrants issued to non employees. As such, the Company recognized $62,968 of expense for the six months ended December 31, 1997 in connection with options issued to third parties. During the year ended December 31, 1998, the Company recognized $67,150 of expense in connection with options issued to terminated employees and advisors. The remaining fair value of options issued to advisors of $9,750 is recorded as deferred compensation in the shareholders' equity section and will be amortized over the remaining vesting period of the options. Additionally, in connection with the sale of common stock, the Company issued options to certain investment managers. The fair value of those options of $36,563 was netted against the proceeds recorded in the transaction. In determining fair value of the options and warrants on the date of grant, the Company used the Black-Scholes option-pricing model with the following assumptions used for grants in 1997 and 1998; no dividend yield; expected volatility of 100%; weighted-average risk-free interest rates of 5.17% and 5.14%, respectively, and weighted-average expected lives of .55 years and 1.3 years, respectively. The weighted-average fair value of warrants issued during 1998 was $0.83 per share. 11. INCOME TAXES A current provision for income taxes was not recorded for the six months ended December 31, 1997 or the year ended December 31, 1998 due to taxable losses incurred during such periods. A valuation allowance has been recorded for deferred tax assets because realization is primarily dependent on generating sufficient taxable income prior to the expiration of net operating loss carry-forwards. Net operating losses of the FreeShop Division of Online did not carry over to the Company. F-17 84 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Deferred tax assets at December 31, 1997 and 1998 are as follows:
DECEMBER 31, ------------------------ 1997 1998 --------- ----------- Net operating loss carryforwards............................ $ 371,326 $ 1,412,566 Nondeductible allowances.................................... 23,779 39,544 Expense related to stock options and restricted stock rights.................................................... 21,416 30,635 Other....................................................... 2,176 --------- ----------- 418,697 1,482,745 Less: Valuation allowance................................... (418,697) (1,482,745) --------- ----------- $ -- $ -- ========= ===========
At December 31, 1997 and 1998, the Company had net operating loss carry-forwards of approximately $1,092,000 and $4,155,000, respectively, for federal income tax reporting purposes. The net operating losses will expire beginning in 2012 if not previously utilized. As specified in Section 382 of the Internal Revenue Code, a 50% or more ownership change by certain combinations of the Company's shareholders during any three-year period would result in limitations on the Company's ability to utilize its net operating loss carry-forwards. Such an ownership change occurred as a result of the equity issuances as described in Note 13. The limitation on the utilization of federal net operating loss carryforwards in future years is not expected to be material. 12. SUPPLEMENTAL CASH FLOW INFORMATION The following items are supplemental information of noncash investing and financing activities:
YEAR ENDED SIX MONTHS SIX MONTHS ENDED JUNE 30, ENDED YEAR ENDED JUNE 30, --------------- DECEMBER 31, DECEMBER 31, ----------------- 1996 1997 1997 1998 1998 1999 ------ ------ ------------ ------------ ------ -------- (UNAUDITED) Property and equipment acquired with capital leases.......... $ -- $7,237 $237,846 $102,167 $ -- $ -- ====== ====== ======== ======== ====== ======== Common stock issued in exchange for note receivable from shareholder.................. $ -- $ -- $ 25,000 $ -- $ -- $ -- ====== ====== ======== ======== ====== ======== Common stock issued in connection with business combination.................. $ -- $ -- $ -- $ -- $ -- $736,000 ====== ====== ======== ======== ====== ======== Conversion of preferred stock........................ $ -- $ -- $279,196 $ -- $ -- $ -- ====== ====== ======== ======== ====== ======== Conversion of note payable..... $ -- $ -- $ -- $ -- $ -- $ 50,000 ====== ====== ======== ======== ====== ========
13. SUBSEQUENT EVENTS In January 1999, the Company repurchased 160,000 shares of common stock for $2.50 per share. As described in Note 7 50,000 of these shares were repurchased from a principal shareholder. The repurchase price of the common stock was less than the $5.20 per share estimated fair value of the stock on the date of repurchase. Concurrent with the repurchase, the Company retired the shares and sold 160,000 shares to unrelated third parties for $2.50 per share. F-18 85 FREESHOP.COM, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) On March 1, 1999, the terms of the convertible promissory note described in Note 8 were modified to allow conversion into shares of common stock. The note was then retired through conversion into 20,000 shares of common stock. In May 1999, the warrants issued to Fingerhut as described in Note 10 were modified to provide for issuance of series B convertible preferred stock. Each share of series B convertible preferred stock is convertible into four shares of common stock. Each share of series B convertible preferred stock has similar rights and obligations as four shares of common stock, except it has no voting rights. Fingerhut then exercised one warrant to purchase 293,536 shares of series B convertible preferred stock at a purchase price of $17.18 per share and one warrant to purchase 179,072 shares of series B convertible preferred stock at a purchase price of $19.94 per share on May 24, 1999 and June 18, 1999, respectively. In May 1999, the Board of Directors of the Company, authorized the Company's management to file a registration statement for an initial public offering of the Company's common stock. In May 1999, FreeShop entered into purchase and sale agreements to acquire substantially all of the assets of Commonsite LLC (Commonsite) and Travel Companions International, Inc. (Travel). Total consideration for the acquired assets of the two companies is $2,577,000, which is comprised of $1,841,000 in cash and 52,920 shares of common stock. The aggregate purchase price will be allocated to the net assets acquired, based upon their respective fair market values. The excess of the purchase price over the fair market value of the assets acquired and liabilities assumed of $1,382,247 has been allocated to cost in excess of net assets acquired and will be amortized over three years. In connection with the acquisition, liabilities were assumed as follows: Fair value of assets acquired............................... $ 1,339,808 Cash paid................................................... (1,841,000) Common stock issued......................................... (736,000) Cost in excess of net assets acquired....................... 1,382,247 ----------- Liabilities assumed......................................... $ 145,055 ===========
The following summarizes the unaudited pro forma results of operations, on a combined basis, as if the Company's acquisition of Commonsite and Travel occurred as of the beginning of each of the periods presented, after including the impact of certain adjustments such as amortization of cost in excess of net assets acquired:
SIX MONTHS YEAR ENDED ENDED DECEMBER 31, JUNE 30, 1998 1999 ------------ ------------ (UNAUDITED) Revenues.................................................... $ 1,893,267 $ 2,380,815 Pro forma net loss.......................................... (4,295,661) (4,091,812) Pro forma basic and diluted net loss per share.............. $ (0.68) $ (0.50)
The unaudited pro forma results are not necessarily indicative of the results of operations which would actually have been reported had the acquisition occurred prior to the beginning of the periods presented. In addition, they are not intended to be indicative of future results. Effective August 9, 1999, the Board of Directors declared a 1 for 2.5 reverse stock split on the Company's common stock. Common stock issued, stock option, warrant and convertible preferred stock information in these financial statements have been restated to reflect this reverse split. F-19 86 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of FreeShop.com, Inc. In our opinion, the accompanying statement of financial position and the related statements of operations and members' deficit and of cash flows present fairly, in all material respects, the financial position of Commonsite, LLC. (the "Company") at December 31, 1998, and the results of its operations and its cash flows for the year ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. As described in Note 6, subsequent to year-end, the members approved and authorized the sale of substantially all of the Company's assets. PricewaterhouseCoopers LLP Seattle, Washington May 6, 1999 F-20 87 COMMONSITE, LLC STATEMENT OF FINANCIAL POSITION
DECEMBER 31, MARCH 31, 1998 1999 ------------ ----------- (UNAUDITED) ASSETS Cash........................................................ $ 12,811 $ 23,652 Accounts receivable, net.................................... 42,358 29,151 -------- -------- Total current assets................................... 55,169 52,803 Property and equipment, net................................. 9,728 8,097 -------- -------- Total assets........................................... $ 64,897 $ 60,900 ======== ======== LIABILITIES AND MEMBERS' DEFICIT Accounts payable............................................ $ 6,536 $ 567 Related party payable....................................... 16,245 11,946 Accrued liabilities......................................... 6,609 6,046 Deferred revenue............................................ 109,337 120,422 -------- -------- Total current liabilities.............................. 138,727 138,981 -------- -------- Members' deficit............................................ (73,830) (78,081) -------- -------- Total liabilities and members' deficit................. $ 64,897 $ 60,900 ======== ========
The accompanying notes are an integral part of these financial statements. F-21 88 COMMONSITE, LLC STATEMENT OF OPERATIONS AND MEMBERS' DEFICIT
THREE MONTHS ENDED MARCH 31, DECEMBER 31, ---------------------- 1998 1998 1999 ------------ --------- --------- (UNAUDITED) Revenues............................................ $540,114 $ 106,053 $ 106,435 Cost of revenues.................................... 180,244 47,289 21,492 -------- --------- --------- Gross profit........................................ 359,870 58,764 84,943 -------- --------- --------- Operating expenses Sales and marketing............................... 276,378 73,887 36,463 General and administrative........................ 72,290 30,446 52,731 -------- --------- --------- Total operating expenses.................. 348,668 104,333 89,194 -------- --------- --------- Net income.......................................... 11,202 (45,569) (4,251) Members' deficit, end of period..................... (85,032) (85,032) (73,830) -------- --------- --------- Members' deficit, beginning of period............... $(73,830) $(130,601) $ (78,081) ======== ========= =========
The accompanying notes are an integral part of these financial statements. F-22 89 COMMONSITE, LLC STATEMENT OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, DECEMBER 31, ------------------ 1998 1998 1999 ------------ -------- ------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES Net income............................................... $ 11,202 $(45,569) $(4,251) Adjustments to reconcile net income to net cash used in operating activities Depreciation.......................................... 6,525 1,631 1,631 Bad debt expense...................................... 9,999 1,150 1,422 (Increase) decrease in accounts receivable............ (35,846) (18,098) 11,785 Decrease in accounts payable.......................... (9,005) (5,572) (5,969) Increase (decrease) in related party payable.......... 16,245 12,803 (4,299) Decrease in accrued liabilities....................... (6,449) (440) (563) Increase in unearned revenue.......................... 2,272 56,665 11,085 -------- -------- ------- Net cash (used in) provided by operating activities..................................... (5,057) 2,570 10,841 -------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from member contributions....................... 5,000 -------- -------- ------- Net cash provided by financing activities........ 5,000 -- -- -------- -------- ------- Net (decrease) increase in cash and cash equivalents....... (57) 2,570 10,841 Cash and cash equivalents, beginning of period............. 12,868 12,868 12,811 -------- -------- ------- Cash and cash equivalents, end of period................... $ 12,811 $ 15,438 $23,652 ======== ======== =======
The accompanying notes are an integral part of these financial statements. F-23 90 COMMONSITE, LLC NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND BUSINESS Commonsite, LLC ("Commonsite" or "the Company") is a limited liability company in which there are seven limited partners. The Company was formed in September 1995 to develop and operate a shopping portal focusing on catalog companies. Essentially, the Company provides catalog companies with consumer requests for their catalogs. In addition, the Company provides catalog companies with the development and hosting of online stores, links directly to their existing Web sites and a software solution for tracking online sales back to the traffic source. Profits and losses of the Company are allocated based upon the ownership percentages of the members. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH AND CASH EQUIVALENTS Cash equivalents consist of highly liquid investments purchased within 90 days or less of maturity. They are recorded at cost which approximates fair value. The Company deposits its cash and cash equivalents with high credit quality financial institutions. The Company has not experienced any losses on its cash and cash equivalents. PROPERTY AND EQUIPMENT Property and equipment, consisting of computer hardware and software, are stated at cost less accumulated depreciation and are depreciated using the straight-line method over their estimated useful lives of three years. The cost of normal maintenance and repairs are charged to expense as incurred. IMPAIRMENT OF LONG-LIVED ASSETS The Company evaluates its long-lived assets for financial impairment and continues to evaluate them as events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable. The Company evaluates the recoverability of long-lived assets by measuring the carrying amount of the assets against the estimated undiscounted future cash flows associated with these assets. At the time such evaluations indicate that the future undiscounted cash flows of certain long-lived assets are not sufficient to recover the carrying value of such assets, the assets are adjusted to their fair values. No losses from impairment have been recognized. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximate fair value because of their short maturities. DEFERRED REVENUE Deferred revenue consists of advance billings and payments on marketing contracts. REVENUE RECOGNITION Revenue is recognized based on the type of contract. Fixed fee contracts, which range from three months to one year, are recognized ratably over the term of the agreement, provided that no significant Company obligations remain. Revenue from click through based contracts is F-24 91 COMMONSITE, LLC NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) recognized in the period in which the click throughs are delivered. Revenue from catalog development is recognized under the percentage of completion method, whereby revenue is recognized upon completion of agreed upon milestones. CONCENTRATIONS OF CREDIT RISK Concentrations of credit risk with respect to accounts receivable are limited due to the wide variety of customers to which the Company provides services, as well as their dispersion across many different geographic areas. As such, no single customer accounted for greater than 10% of total revenues or accounts receivable balances for the year ended December 31, 1998. The Company maintains an allowance for doubtful accounts receivable based upon its historical experience and the expected collectibility of all accounts receivable. Credit losses to date have been within management's estimates. INCOME TAXES The Company is not subject to federal income tax. The pro rata income or loss is included in the tax returns of the individual members. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reporting amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses. Actual results could differ from those estimates. UNAUDITED INTERIM FINANCIAL STATEMENTS The interim financial data as of March 31, 1999 and for the three months ended March 31, 1998 and 1999 is unaudited; however, in the opinion of management, the interim data includes all adjustments, consisting only of normal recurring adjustments necessary to present fairly the Company's financial position as of March 31, 1999 and the results of its operations and cash flows for the three months ended March 31, 1998 and 1999. RECENT ACCOUNTING PRONOUNCEMENTS In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use." SOP 98-1 is effective for financial statements for years beginning after December 15, 1998. SOP 98-1 provides guidance on accounting for computer software developed for internal use, including the requirement to capitalize specified costs and amortization of such costs. The Company does not expect the adoption of this standard to have a material effect on its results of operations, financial position or cash flows. In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-up Activities." SOP 98-5, which is effective for fiscal years beginning after December 15, 1998, provides guidance on the financial reporting of start-up costs and organization costs. It requires costs of start-up activities and organization costs to be expensed as incurred. As the Company has expensed these costs historically, the adoption of this standard is not expected to have a significant impact on its results of operations, financial position or cash flows. F-25 92 COMMONSITE, LLC NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company does not expect the adoption of this statement to have a significant impact on its results of operations, financial position or cash flows. 3. RELATED PARTY TRANSACTIONS The Company pays Bennett Company (Bennett) for services provided in relation to the operations and management of the Company. A member of Commonsite owns Bennett. Costs incurred by Bennett were billed to the Company based on an estimate of Bennett personnel time dedicated to the operations and management of Commonsite. A summary of these expenses is as follows:
THREE MONTHS ENDED MARCH 31, YEAR ENDED ------------------- DECEMBER 31, 1998 1998 1999 ----------------- -------- -------- (UNAUDITED) Salaries.................................... $230,979 $73,123 $34,574 Equipment................................... 16,236 6,287 9,146 Connectivity................................ 22,957 5,136 4,487 Rent........................................ 12,637 2,575 3,475 Internet marketing.......................... 26,134 6,970 -- Other....................................... 5,848 1,234 841 -------- ------- ------- $314,791 95,325 52,523 ======== ======= =======
4. ACCOUNTS RECEIVABLE Accounts receivable consist of the following:
DECEMBER 31, MARCH 31, 1998 1999 ------------ ----------- (UNAUDITED) Accounts receivable................................... $ 66,866 $ 55,081 Less: Allowance for doubtful accounts................. (24,508) (25,930) -------- -------- $ 42,358 $ 29,151 ======== ========
5. PROPERTY AND EQUIPMENT Property and equipment consist of the following:
DECEMBER 31, MARCH 31, 1998 1999 ------------ ----------- (UNAUDITED) Computer hardware and software........................ $19,578 $ 19,578 Less: Accumulated depreciation........................ (9,850) (11,481) ------- -------- $ 9,728 $ 8,097 ======= ========
F-26 93 COMMONSITE, LLC NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 6. SUBSEQUENT EVENT In May 1999, Commonsite entered into a purchase and sale agreement to sell substantially all of its assets to FreeShop.com, Inc. Total consideration for the assets is approximately $1,200,000 which is comprised of $441,000 in cash and 52,920 shares of common stock. F-27 94 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of FreeShop.com, Inc. In our opinion, the accompanying balance sheet and the related statements of income, stockholders' equity and cash flows present fairly, in all material respects, the financial position of Travel Companions International, Inc. (the Company) at December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. As described in Note 6, subsequent to year-end, the stockholders of the Company approved and authorized the sale of substantially all of the Company's assets. PricewaterhouseCoopers LLP Minneapolis, Minnesota May 24, 1999 F-28 95 TRAVEL COMPANIONS INTERNATIONAL, INC. BALANCE SHEET
DECEMBER 31, MARCH 31, 1998 1999 ------------ ----------- (UNAUDITED) ASSETS Current assets: Cash...................................................... $ 5,091 $ 3,545 Accounts receivable....................................... 8,772 34,225 Prepaid expenses.......................................... 700 820 --------- --------- Total current assets................................... 14,563 38,590 Property and equipment, net................................. 3,050 2,265 --------- --------- Total assets........................................... $ 17,613 $ 40,855 ========= ========= LIABILITIES AND STOCKHOLDERS' DEFICIT Liabilities: Current liabilities: Debt................................................... $ 52,603 $ 51,668 Accounts payable....................................... 4,600 4,600 Accrued expenses....................................... 3,038 3,296 Deferred revenue....................................... 11,299 24,956 --------- --------- Total current liabilities.............................. 71,540 84,520 Notes payable to stockholders............................. 459,678 454,678 --------- --------- Total liabilities...................................... 531,218 539,198 --------- --------- Stockholders' deficit: Common stock, no par value; 5,000 shares authorized, 5,000 shares issued and outstanding.......................... 5,000 5,000 Accumulated deficit....................................... (518,605) (503,343) --------- --------- Total stockholders' deficit............................ (513,605) (498,343) --------- --------- Total liabilities and stockholders' deficit............ $ 17,613 $ 40,855 ========= =========
The accompanying notes are an integral part of these financial statements. F-29 96 TRAVEL COMPANIONS INTERNATIONAL, INC. STATEMENT OF INCOME
YEAR ENDED THREE MONTHS ENDED DECEMBER 31, MARCH 31, ------------ ------------------ 1998 1998 1999 ------------ ------- ------- (UNAUDITED) Revenues................................................ $219,813 $58,380 $72,188 Cost of revenues........................................ 94,875 23,570 25,866 -------- ------- ------- 124,938 34,810 46,322 -------- ------- ------- Operating expenses: Sales and marketing................................... 9,393 3,324 1,950 General and administrative............................ 92,645 27,876 28,000 -------- ------- ------- Total operating expenses........................... 102,038 31,200 29,950 -------- ------- ------- Operating income........................................ 22,900 3,610 16,372 Interest expense........................................ 4,287 1,147 1,110 -------- ------- ------- Net income.............................................. $ 18,613 $ 2,463 $15,262 ======== ======= =======
The accompanying notes are an integral part of these financial statements. F-30 97 TRAVEL COMPANIONS INTERNATIONAL, INC. STATEMENT OF STOCKHOLDERS' DEFICIT
COMMON STOCK ACCUMULATED SHARES AMOUNT DEFICIT TOTAL ------ ------ ----------- --------- Balances, December 31, 1997................. 5,000 $5,000 $(537,218) $(532,218) Net income.................................. 18,613 18,613 ----- ------ --------- --------- Balances, December 31, 1998................. 5,000 $5,000 $(518,605) $(513,605) ===== ====== ========= ========= Net income (unaudited)...................... 15,262 15,262 ----- ------ --------- --------- Balance, March 31, 1999 (unaudited)......... 5,000 $5,000 $(503,343) $(498,343) ===== ====== ========= =========
The accompanying notes are an integral part of these financial statements. F-31 98 TRAVEL COMPANIONS INTERNATIONAL, INC. STATEMENT OF CASH FLOWS
THREE MONTHS ENDED YEAR ENDED MARCH 31, DECEMBER 31, ------------------ 1998 1998 1999 ------------ ------- -------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................................... $ 18,613 $ 2,463 $ 15,262 Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization......................... 2,790 424 785 Changes in assets and liabilities: Accounts receivable................................. 4,159 (25,453) Prepaid expenses.................................... 78 28 (120) Inventory........................................... 300 (74) Deferred revenue.................................... (40) (40) 13,657 Accrued and other liabilities....................... 1,230 693 258 -------- ------- -------- Net cash provided by operating activities........ 27,130 3,494 4,389 -------- ------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of furniture and equipment...................... (1,139) -- -- -------- ------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments of debt............................... (3,209) (935) Principal payments of notes payable to stockholders...... (19,700) (1,304) (5,000) -------- ------- -------- Net cash used in financing activities............ (22,909) (1,304) (5,935) -------- ------- -------- Net increase (decrease) in cash............................ 3,082 2,190 (1,546) Cash at beginning of period................................ 2,009 2,009 5,091 -------- ------- -------- Cash at end of period...................................... $ 5,091 $ 4,199 $ 3,545 ======== ======= ======== SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest.............................................. $ 4,323 $ 1,250 $ 1,121 Significant non-cash financing activities: Refinancing of accrued interest to debt............... 5,000
The accompanying notes are an integral part of these financial statements. F-32 99 TRAVEL COMPANIONS INTERNATIONAL, INC. NOTES TO FINANCIAL STATEMENTS 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS DESCRIPTION Travel Companions International, Inc. (the Company), an S Corporation, was incorporated in the State of Minnesota in October 1988. The Company is in the business of distributing travel literature in conjunction with various travel programs offered through American Express for its cardholders, as well as programs implemented by Norvista, the global group of travel agencies and tour operators belonging to the Finnair Group. The Company also publishes Worldwide Brochures, a listing of over 15,000 free travel maps, guides, and brochures from over 10,000 companies. USE OF ESTIMATES The preparation of the Company's financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH EQUIVALENTS The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation and amortization are determined using the straight-line method over the estimated useful lives of the assets of three to seven years. The cost and related accumulated depreciation or amortization on asset disposals are removed from the accounts and any gain or loss thereon is included in operations in the year of disposal. Maintenance, repairs and minor renewals are charged to expense as incurred, while additions and betterments are capitalized. REVENUE RECOGNITION Literature distribution revenue, which comprises over 80% of total revenue, consists of fees received for delivery of travel literature to both American Express cardholders and Norvista customers. Revenue is recognized in the period the literature is sent to the customer. Advertising revenue consists of banner advertising and priority listings placed on the Company's Web site. Both banner advertising and priority listing revenue are derived from fixed fee contracts, with no guaranteed number of impressions. Fixed fee contracts are recognized ratably over the term of the agreement, provided that no significant Company obligations remain. Deferred revenue consists of payments received from customers for future advertising services to be performed by the Company under contract. CONCENTRATIONS OF CREDIT RISK AND SIGNIFICANT CUSTOMERS Financial instruments that potentially subject the Company to credit risk consist primarily of accounts receivable. The Company grants credit to customers in the ordinary course of business. Two customers accounted for approximately 59% and 21% of total revenues during 1998. F-33 100 TRAVEL COMPANIONS INTERNATIONAL, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Receivables from these same two customers accounted for approximately 68% and 32% of total receivables at December 31, 1998, respectively. INCOME TAXES The Company has elected to be taxed as an S corporation under the provisions of the Internal Revenue Code (the Code) and comparable state income tax law. Under those provisions, the Company's income is reported on the individual tax returns of the Company's stockholders. As such, the Company is generally not subject to corporate income taxes. Therefore, no provision or liability for income taxes is reflected in the financial statements of the Company. UNAUDITED INTERIM FINANCIAL STATEMENTS The interim financial data as of March 31, 1999 and for the three months ended March 31, 1998 and 1999 is unaudited; however, in the opinion of management, the interim data includes all adjustments, consisting only of normal recurring adjustments necessary to present fairly the Company's financial position as of March 31, 1999 and the results of its operations and cash flows for the three months ended March 31, 1998 and 1999. 2. PROPERTY AND EQUIPMENT
DECEMBER 31, MARCH 31, 1998 1999 ------------ ----------- (UNAUDITED) Property and equipment: Computer equipment........................................ $23,488 $ 23,488 Furniture and office equipment............................ 23,881 23,881 Leasehold improvements.................................... 878 878 ------- ----------- 48,247 48,247 Less accumulated depreciation and amortization.............. 45,197 45,982 ------- ----------- $ 3,050 $ 2,265 ======= ===========
3. BORROWING ARRANGEMENTS DEBT The Company has a note with a local development authority. The loan bears simple interest at a rate of 8.5% and calls for monthly principal and interest payments of $682 per month for five years with the remaining principal and accrued interest due in April 2003. As of December 31, 1998, the balance outstanding under this loan agreement was $52,603. The outstanding balance has been classified as current in accordance with the terms of the agreement due to the pending acquisition of the majority of the Company's assets as described in Note 6. In the event that the acquisition is not consummated, approximately $48,700 of the outstanding debt balance would be reclassified to long-term. Borrowings outstanding under the agreement are collateralized by all inventory and equipment of the Company and are personally guaranteed by the stockholders. In addition, the borrowings are collateralized by the proceeds from life insurance policies maintained by the Company on all of its stockholders, with a face value of $300,000. F-34 101 TRAVEL COMPANIONS INTERNATIONAL, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) NOTES PAYABLE TO STOCKHOLDERS The Company has entered into subordinated note agreements with its stockholders. The amounts outstanding under the note agreements totaled $459,678 and $454,678 as of December 31, 1998 and March 31, 1999 (unaudited), respectively. These amounts do not bear interest and are due on demand subsequent to May 31, 2000. 4. RELATED PARTY TRANSACTIONS The Company leases office space on a month-to-month basis from one of its stockholders. The Company recognized $18,000 of rent expense related to this arrangement during the year ended December 31, 1998 and $4,500 during the three months ended March 31, 1999 (unaudited). 5. RECENT ACCOUNTING PRONOUNCEMENTS In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use." SOP 98-1 is effective for financial statements for years beginning after December 15, 1998. SOP 98-1 provides guidance on accounting for computer software developed for internal use, including the requirement to capitalize specified costs and amortization of such costs. The Company does not expect the adoption of this standard to have a material effect on the results of its operations, financial position or cash flows. 6. SUBSEQUENT EVENTS In May 1999, the Company entered into an asset purchase agreement to sell substantially all of its assets to FreeShop.com, Inc. for a purchase price of $1,400,000 in cash. F-35 102 UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION In May 1999, FreeShop.com, Inc. (FreeShop) entered into purchase and sale agreements to acquire substantially all of the assets of Commonsite, LLC (Commonsite) and Travel Companions International, Inc. (Travel). Total consideration for the two companies is $2,576,000, which is comprised of $1,841,000 in cash and 52,920 shares of common stock. The unaudited pro forma combined statements of operations are based on individual historical results of operations of FreeShop, Commonsite and Travel for the year ended December 31, 1998 and for the six months ended June 30, 1999, after giving effect to the acquisitions of Commonsite and Travel as if they had occurred on January 1, 1998. In addition, the pro forma weighted-average shares used in calculating pro forma net loss per share include the effects of the automatic conversion of FreeShop's series B convertible preferred stock into shares of FreeShop's common stock effective upon the closing of FreeShop's initial public offering as if such conversion occurred on the date the shares were originally issued. The unaudited pro forma combined financial statements should be read in conjunction with the historical financial statements and notes thereto of FreeShop, Commonsite and Travel. The unaudited pro forma combined financial statements are presented for illustrative purposes only and are not necessarily indicative of results of operations that would have actually occurred had the acquisitions of Commonsite and Travel been effected on the date assumed. F-36 103 UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998 -------------------------------------------------------------------------------- PRO FORMA FREESHOP COMMONSITE TRAVEL COMBINED ADJUSTMENTS PRO FORMA ----------- ---------- -------- ----------- ----------- ----------- Net revenues.................... $ 1,250,940 $540,114 $219,813 $ 2,010,867 $ (117,600)(3) $ 1,893,267 Cost of revenues................ 216,557 180,244 61,872 458,673 (20,547)(4) 438,126 ----------- -------- -------- ----------- ----------- ----------- Gross profit.................... 1,034,383 359,870 157,941 1,552,194 (97,053) 1,455,141 Operating expenses Sales and marketing........... 3,088,446 276,378 9,393 3,374,217 (105,000)(4) 3,269,217 Research and development...... 386,629 386,629 386,629 General and administrative.... 416,766 65,765 122,858 605,389 605,389 Equity-based compensation..... 174,102 174,102 174,102 Depreciation and amortization................ 104,393 6,525 2,790 113,708 1,141,000(2) 1,252,393 (2,315)(6) ----------- -------- -------- ----------- ----------- ----------- Total operating expenses........ 4,170,336 348,668 135,041 4,654,045 1,033,685 5,687,730 ----------- -------- -------- ----------- ----------- ----------- Loss from operations............ (3,135,953) 11,202 22,900 (3,101,851) (1,130,738) (4,232,589) Interest expense................ 65,654 65,654 65,654 Other (income) expense.......... (2,582) 4,287 1,705 (4,287)(5) (2,582) ----------- -------- -------- ----------- ----------- ----------- Net (loss) income............... $(3,199,025) $ 11,202 $ 18,613 $(3,169,210) $(1,126,451) $(4,295,661) =========== ======== ======== =========== =========== =========== Basic and diluted net loss per share......................... $ (0.51) $ (0.68) =========== =========== Weighted-average shares used in computing net loss per share......................... 6,223,726 52,920(1) 6,276,646(7) =========== =========== ===========
SIX MONTHS ENDED JUNE 30, 1999 -------------------------------------------------------------------------------- PRO FORMA FREESHOP COMMONSITE TRAVEL COMBINED ADJUSTMENTS PRO FORMA ----------- ---------- -------- ----------- ----------- ----------- Net revenues.................... $ 2,146,662 $146,345 $ 87,808 $ 2,380,815 $ 2,380,815 Cost of revenues................ 189,898 25,689 30,241 245,828 245,828 ----------- -------- -------- ----------- ----------- Gross profit.................... 1,956,764 120,656 57,567 2,134,987 2,134,987 Operating expenses Sales and marketing........... 4,141,323 53,084 2,675 4,197,082 4,197,082 Research and development...... 321,517 321,517 321,517 General and administrative.... 462,060 73,476 62,260 597,796 597,796 Equity-based compensation..... 621,756 621,756 621,756 Depreciation and amortization................ 259,911 652 240 260,803 $ 292,014(2) 552,149 (668)(6) ----------- -------- -------- ----------- ----------- ----------- Total operating expenses........ 5,806,567 127,212 65,175 5,998,954 291,346 6,290,300 ----------- -------- -------- ----------- ----------- ----------- Loss from operations............ (3,849,803) (6,556) (7,608) (3,863,967) (291,346) (4,155,313) Interest expense................ 23,492 1,155 24,647 (1,155)(5) 23,492 Other (income) expense.......... (86,992) (86,992) (86,992) ----------- -------- -------- ----------- ----------- ----------- Net loss........................ $(3,786,303) $ (6,556) $ (8,763) $(3,801,622) $ (290,191) $(4,091,813) =========== ======== ======== =========== =========== =========== Basic and diluted net loss per share......................... $ (0.46) $ (0.46) =========== =========== Weighted-average shares used in computing net loss per share......................... 8,182,728 675,003(1) 8,857,731(7)
F-37 104 NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS 1. Reflects the issuance of 52,920 shares of FreeShop common stock in connection with the Commonsite acquisition. 2. Reflects the amortization of the client lists, customer lists, data base content, covenants not to compete and goodwill acquired in their business combinations, which are being amortized over one, two, five, two and three years, respectively. 3. Represents the revenue stream generated by Commonsite for online catalog development. Online catalog development services will not be provided by FreeShop, and no assets related to this service are included in the acquisition. 4. Represents additional programming and management service fees of Commonsite that FreeShop would not have required due to the similarity in business operations. 5. Represents elimination of interest expense for debt not assumed in the acquisitions. 6. Represents elimination of depreciation expense related to property and equipment not purchased in the Commonsite acquisition, offset by the additional depreciation expense recorded for the increase in the value of the property and equipment acquired in the Travel acquisition. 7. Basic and diluted net loss per share is computed using the weighted-average number of shares of common stock outstanding after the issuance of FreeShop common stock in connection with the Commonsite acquisition, including the pro forma effects of the automatic conversion of the Company's series B convertible preferred stock into shares of the Company's common stock effective upon the closing of FreeShop's initial public offering as if such conversion occurred on the date the shares were originally issued. F-38 105 [ON INSIDE BACK COVER] [The FreeShop logo is centered on the page with the phrase "PUTTING CONSUMERS IN CONTROL OF THE DIRECT MARKETING PROCESS."] 106 YOU MAY RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS PROSPECTUS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR SALE OF COMMON STOCK MEANS THAT INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT AFTER THE DATE OF THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY THESE SHARES OF COMMON STOCK IN ANY CIRCUMSTANCES UNDER WHICH THE OFFER OR SOLICITATION IS UNLAWFUL. TABLE OF CONTENTS Prospectus Summary....................... 3 Risk Factors............................. 8 Forward-Looking Statements............... 17 Use of Proceeds.......................... 18 Dividend Policy.......................... 18 Capitalization........................... 19 Dilution................................. 20 Selected Unaudited Pro Forma Financial Data................................... 21 Selected Actual Financial Data........... 22 Management's Discussion and Analysis of Financial Condition and Results of Operations............................. 23 Business................................. 34 Management............................... 45 Related-Party Transactions............... 52 Principal Shareholders................... 55 Description of Capital Stock............. 57 Shares Eligible for Future Sale.......... 59 Underwriting............................. 62 Legal Matters............................ 64 Experts.................................. 64 Where You Can Find More Information...... 65 Index to Financial Statements............ F-1
DEALER PROSPECTUS DELIVERY OBLIGATION: UNTIL , 1999 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS THAT BUY, SELL OR TRADE THESE SHARES OF COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. FREESHOP LOGO 3,200,000 SHARES COMMON STOCK DEUTSCHE BANC ALEX. BROWN DAIN RAUSCHER WESSELS a division of Dain Rauscher Incorporated VOLPE BROWN WHELAN & COMPANY E*OFFERING Prospectus , 1999 107 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table states the costs and expenses, other than the underwriting discounts and commissions, payable by the registrant in connection with the sale of common stock being registered by this registration statement. All amounts shown are estimates, except the Securities and Exchange Commission registration fee, the NASD filing fee and the Nasdaq National Market listing fee.
AMOUNT -------- Securities and Exchange Commission Registration Fee......... $ 12,788 NASD Filing Fee............................................. 5,100 Nasdaq National Market Listing Fee.......................... 87,500 Legal Fees and Expenses..................................... 250,000 Accountants' Fees and Expenses.............................. 200,000 Blue Sky Filing and Counsel Fees and Expenses............... 5,000 Printing and Engraving Expenses............................. 170,000 Transfer Agent and Registrar Fees........................... 3,500 Miscellaneous Expenses...................................... 16,112 -------- Total............................................. $750,000
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Sections 23B.08.500 through 23B.08.600 of the Washington Business Corporation Act (the "Washington Act") authorize a court to award, or a corporation's board of directors to grant, indemnification to directors and officers on terms sufficiently broad to permit indemnification under certain circumstances for liabilities arising under the Securities Act of 1933, as amended (the "Securities Act"). Article 6 of the registrant's Second Amended and Restated Articles of Incorporation and Article IX of the registrant's Amended and Restated Bylaws provide for indemnification of the registrant's directors, officers, employees and agents to the maximum extent permitted by Washington law. The registrant has entered into agreements with its directors and officers arising out of their service as officers and director, as applicable, and has agreed to advance expenses to defend claims subject to indemnification. The directors and officers of the registrant also may be indemnified against liability they may incur for serving in that capacity pursuant to a liability insurance policy maintained by the registrant for such purpose. Section 23B.08.320 of the Washington Act authorizes a corporation to limit a director's liability to the corporation or its shareholders for monetary damages for acts or omissions as a director, except in certain circumstances involving intentional misconduct, self-dealing or illegal corporate loans or distributions, or any transaction from which the director personally receives a benefit in money, property or services to which the director is not legally entitled. Article 6 of the registrant's Articles of Incorporation contains provisions implementing, to the fullest extent permitted by Washington law, such limitations on a director's liability to the registrant and its shareholders. Reference is also made to the form of Underwriting Agreement filed as Exhibit 1.1 to this Registration Statement for certain provisions regarding the indemnification of officers and directors of the registrant by the underwriters in connection with matters specifically provided in writing by the underwriters for inclusion in this Registration Statement. II-1 108 ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. Since the registrant's inception in June 1997, the registrant has issued and sold the following unregistered securities: 1. On June 30, 1997, the registrant issued 4,600,820 shares of common stock and 774,194 shares of series A convertible preferred stock to Online Interactive, Inc. for aggregate consideration consisting of the contribution to the registrant of the operating assets and liabilities of the FreeShop Division of Online Interactive, Inc. The 774,194 shares of series A convertible preferred stock were convertible into the same number of shares of common stock. 2. On July 18, 1997, the registrant issued 387,097 shares of Common Stock to Timothy C. Choate and 387,097 shares of common stock to John P. Ballantine upon conversion of series A preferred stock held by each of them. 3. During the period July 1997 through June 1998, the registrant issued an aggregate of 964,872 shares of common stock to 21 investors for a consideration of $1.025 per share, or an aggregate of $989,003. 4. On August 22, 1997, the registrant issued options for 24,391 shares of common stock exercisable at a price of $1.025 per share, expiring February 22, 1998, to each of Othneil D. Palomino and Dwayne Walker. These options were issued outside of the registrant's 1997 stock option plan. 5. On September 7, 1997, the registrant issued options for 146,340 shares of common stock exercisable at a price of $1.025 per share, expiring October 30, 1997, to Michael Tannen and Johan Liedgren. The expiration of these options was extended to January 15, 1998. These options were issued outside of the registrant's 1997 stock option plan. 6. On October 15, 1997, the registrant issued Warrants for 2,400 shares of common stock exercisable at a price of $1.02 per share, expiring October 23, 2002, to Hallco Leasing Corporation in partial consideration of an equipment lease. 7. During the period October 1997 through December 1997, the registrant issued a total of 31,841 shares of common stock to its landlord, Merrill Place LLC, in lieu of rent payments in the aggregate amount of $32,637. 8. On January 16, 1998, the registrant issued Warrants for 1,300 shares of common stock exercisable at a price of $1.02 per share, expiring January 16, 2002, to Karrie Lee for consulting services. 9. On January 19, 1998, the registrant issued Warrants for 14,000 shares of common stock exercisable at a price of $1.02 per share, expiring January 23, 2003, to Hallco Leasing Corporation in partial consideration of an equipment lease. 10. On January 23, 1998, the registrant issued Warrants for 400 shares of common stock exercisable at a price of $1.02 per share, expiring December 31, 2002, to Dennis Green for consulting services. 11. On January 23, 1998, the registrant issued Warrants for 10,000 shares of common stock exercisable at a price of $1.02 per share, expiring January 23, 2002, to Employco, Inc. for consulting services. 12. On March 17, 1998, the registrant issued a $50,000 convertible promissory note to Oki Enterprises, LLC, with a maturity date of March 1, 2000. The principal balance of the note was convertible at the discretion of the holder at any time prior to the maturity date into shares of the registrant's preferred stock on the same terms at which the registrant may then be offering preferred stock to other investors. II-2 109 13. On June 30, 1998, the registrant issued 1,456 shares of common stock to Anthony Lee Simonelli in consideration of consulting services valued at $1,492 rendered to the registrant. 14. During the period June 1998 through September 1998, the registrant issued an aggregate of 612,674 shares of common stock to 22 investors at $1.50 per share for aggregate consideration of $919,004. 15. On September 18, 1998, the registrant issued Warrants for 10,000 shares of common stock exercisable at a price of $1.50 per share, expiring September 18, 2003, to Imperial Bank in partial consideration of a credit facility. 16. On December 11, 1998, the registrant issued 1,619,387 shares of common stock, and Warrants to purchase 2,935,356 shares of common stock at $4.29565 per share, 716,290 shares at $4.986 per share and 1,572,822 shares at $5.522975 per share and 13,332 shares of common stock at $3.965 per share to Fingerhut for an aggregate consideration of $4,000,000. 17. In February 1999, the registrant issued an aggregate of 160,000 shares of common stock to a total of ten investors at $2.50 per share for aggregate consideration of $400,000. 18. On April 5, 1999, the registrant issued 20,000 shares of common stock to Oki Enterprises, LLC, in exchange for the $50,000 convertible promissory note referenced in paragraph 12 above. 19. On May 6, 1999, in accordance with an Asset Purchase Agreement among the registrant, Commonsite, LLC and a shareholder of Commonsite, the registrant issued 52,920 shares of common stock to Commonsite in connection with the registrant's purchase of certain of Commonsite's assets. 20. On May 24, 1999, the registrant issued 293,536 shares of series B convertible preferred stock in lieu of common stock to Fingerhut for aggregate consideration of $5,043,704 upon the exercise by Fingerhut of a Warrant identified in paragraph 16 above. Each share of series B convertible preferred stock is convertible into four shares of common stock. 21. On May 25, 1999, the registrant issued 10,000 shares of common stock to Employco for aggregate consideration of $15,000 upon the exercise by Employco of Warrants identified in paragraph 11 above. 22. On June 8, 1999, the registrant issued 179,072 shares of series B convertible preferred stock in lieu of common stock to Fingerhut for aggregate consideration of $3,571,420 upon the exercise by Fingerhut of a warrant identified in paragraph 16 above. Each share of series B convertible preferred stock is convertible into four shares of common stock. 23. Since inception, the registrant has issued an aggregate of 1,648,267 options to purchase common stock, with exercise prices ranging from $0.06 to $1.71 per share, to employees, directors, advisors and service providers under the registrant's 1997 stock option plan. Of these options, options for 809,992 shares have been canceled without being exercised, options for 73,602 shares have been exercised and options for 953,289 shares remain outstanding. The sales and issuances of securities described in paragraphs 3, 14, 16, 17, 19, 20 and 22 above were exempt from Securities Act registration pursuant to Rule 506 of Regulation D under the Securities Act. The sales and issuances of securities described in paragraphs 1, 2, 6-13, 15, 18 and 21 above were exempt from Securities Act registration under Section 4(2) of the Securities Act, on the basis that the transactions did not involve a public offering. The sales and issuances of securities described in paragraphs 4, 5 and 23 above were exempt from Securities Act registration under Rule 701 under the Securities Act, on the basis that these options were offered and sold in accordance with a written compensatory benefit plan or contract. II-3 110 No underwriters were used in connection with these sales and issuances. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. A. Exhibits
EXHIBIT NO. DESCRIPTION ----------- ----------- 1.1 Form of Underwriting Agreement. 3.1 Second Amended and Restated Articles of Incorporation of registrant. 3.2 Amended and Restated Bylaws of registrant. 4.1** Specimen Stock Certificate. 4.2** Form of Common Stock Warrant. 5.1 Opinion of Dorsey & Whitney LLP. 10.1** Form of Indemnification Agreement between the registrant and each of its directors. 10.2** 1997 Stock Option Plan, as amended. 10.3** Form of Stock Option Agreement. 10.4** Investor Subscription Agreement, dated December 10, 1998, between registrant and Fingerhut Companies, Inc. 10.5** Warrant Agreement, dated December 10, 1998, between registrant and Fingerhut Companies, Inc. 10.6** Stockholders Agreement, dated December 10, 1998, among registrant, Timothy C. Choate, John P. Ballantine and Fingerhut Companies, Inc. 10.7** Asset Purchase Agreement, dated May 5, 1999, among registrant, Travel Companions International, Inc., Jeff Mohr and Janet Mohr. 10.8** Asset Purchase Agreement, dated May 6, 1999, among registrant, Commonsite, LLC and Alan Bennett. 10.9** Registration Rights Agreement, dated May 6, 1999, between registrant and Commonsite, LLC. 10.10** Loan and Security Agreement, dated September 18, 1998, between registrant and Imperial Bank. 10.11** Lease Agreement, dated September 23, 1997 and amended as of February 16, 1999, between registrant and Merrill Place LLC. 10.12 Promotion Agreement, dated May 18, 1998 and amended as of June 30, 1998 and September 30, 1998, between registrant and CNET, Inc. 10.13+** Linkshare Network Membership Agreement, dated September 23, 1998, between registrant and Linkshare Corporation. 10.14** Letter Agreement dated June 18, 1999 between registrant and Fingerhut. 10.15** Escrow Agreement dated June 18, 1999 between registrant and Fingerhut. 10.16** Common Stock Purchase Warrant dated January 26, 1998 in favor of Karrie Lee. 10.17** Warrant to Purchase Stock dated September 18, 1998 in favor of Imperial Bank. 10.18** Common Stock Purchase Warrant dated January 23, 1998 in favor of Hallco Leasing Corporation. 10.19** Common Stock Purchase Warrant dated December 4, 1997 in favor of Hallco Leasing Corporation. 10.20** Common Stock Purchase Warrant dated January 26, 1998 in favor of Employco, Inc. 10.21+** Marketing Agreement with NewSub Services, Inc. effective as of June 1, 1999. 23.1 Consent of PricewaterhouseCoopers LLP, independent auditors. 23.2 Consent of Dorsey & Whitney LLP (included in Exhibit 5.1).
II-4 111
EXHIBIT NO. DESCRIPTION ----------- ----------- 24.1** Power of Attorney (included on the signature page). 27.1** Financial Data Schedule.
- ------------------------- ** Previously filed. + Confidential treatment has been requested as to certain portions of this exhibit. Omitted portions will be filed separately with the Securities and Exchange Commission. B. Financial Statement Schedules. All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are inapplicable or not material, or the information called for thereby is otherwise included in the financial statements and therefore has been omitted. ITEM 17. UNDERTAKINGS. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned registrant hereby undertakes to provide to the underwriter at the closing specified in the underwriting agreements, certificates in such denominations and registered in such names by the underwriter to permit prompt delivery to each purchaser. The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be a part of this Registration Statement as of the time it was declared effective. (2) For the purposes of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 112 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Seattle, state of Washington, on September 20, 1999. FREESHOP.COM, INC. By: /s/ TIMOTHY C. CHOATE ------------------------------------ Timothy C. Choate Chairman, President and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, as amended, this registration statement has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ TIMOTHY C. CHOATE Chairman, President and September 20, 1999 - ----------------------------------------------------- Chief Executive Officer Timothy C. Choate (principal executive officer) /s/ JOHN A. WADE Secretary, Vice President, September 20, 1999 - ----------------------------------------------------- Finance and Chief John A. Wade Financial Officer (principal finance and accounting officer) * Director September 20, 1999 - ----------------------------------------------------- John P. Ballantine * Director September 20, 1999 - ----------------------------------------------------- Kirk M. Loevner * Director September 20, 1999 - ----------------------------------------------------- John B. Balousek Director - ----------------------------------------------------- William J. Lansing * /s/ TIMOTHY C. CHOATE - ----------------------------------------------------- Attorney-in-fact
II-6 113 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION - ----------- ----------- 1.1 Form of Underwriting Agreement. 3.1 Second Amended and Restated Articles of Incorporation of registrant. 3.2 Amended and Restated Bylaws of registrant. 4.1** Specimen Stock Certificate. 4.2** Form of Common Stock Warrant. 5.1 Opinion of Dorsey & Whitney LLP. 10.1** Form of Indemnification Agreement between the registrant and each of its directors. 10.2** 1997 Stock Option Plan, as amended. 10.3** Form of Stock Option Agreement. 10.4** Investor Subscription Agreement, dated December 10, 1998, between registrant and Fingerhut Companies, Inc. 10.5** Warrant Agreement, dated December 10, 1998, between registrant and Fingerhut Companies, Inc. 10.6** Stockholders Agreement, dated December 10, 1998, among registrant, Timothy C. Choate, John P. Ballantine and Fingerhut Companies, Inc. 10.7** Asset Purchase Agreement, dated May 5, 1999, among registrant, Travel Companions International, Inc., Jeff Mohr and Janet Mohr. 10.8** Asset Purchase Agreement, dated May 6, 1999, among registrant, Commonsite, LLC and Alan Bennett. 10.9** Registration Rights Agreement, dated May 6, 1999, between registrant and Commonsite, LLC. 10.10** Loan and Security Agreement, dated September 18, 1998, between registrant and Imperial Bank. 10.11** Lease Agreement, dated September 23, 1997 and amended as of February 16, 1999, between registrant and Merrill Place LLC. 10.12 Promotion Agreement, dated May 18, 1998 and amended as of June 30, 1998 and September 30, 1998, between registrant and CNET, Inc. 10.13+** Linkshare Network Membership Agreement, dated September 23, 1998, between registrant and Linkshare Corporation. 10.14** Letter Agreement dated June 18, 1999 between registrant and Fingerhut. 10.15** Escrow Agreement dated June 18, 1999 between registrant and Fingerhut. 10.16** Common Stock Purchase Warrant dated January 26, 1998 in favor of Karrie Lee. 10.17** Warrant to Purchase Stock dated September 18, 1998 in favor of Imperial Bank. 10.18** Common Stock Purchase Warrant dated January 23, 1998 in favor of Hallco Leasing Corporation. 10.19** Common Stock Purchase Warrant dated December 4, 1997 in favor of Hallco Leasing Corporation. 10.20** Common Stock Purchase Warrant dated January 26, 1998 in favor of Employco, Inc.
114
EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.21+** Marketing Agreement with NewSub Services, Inc. effective as of June 1, 1999. 23.1 Consent of PricewaterhouseCoopers LLP, independent auditors 23.2 Consent of Dorsey & Whitney LLP (included in Exhibit 5.1). 24.1** Power of Attorney (included on the signature page). 27.1** Financial Data Schedule.
- ------------------------- ** Previously filed. + Confidential treatment has been requested as to certain portions of this Exhibit. Omitted portions will be filed separately with the Securities and Exchange Commission. EX-1.1 2 FORM OF UNDERWRITING AGREEMENT 1 _______________ SHARES FREESHOP.COM, INC. COMMON STOCK (NO PAR VALUE) EQUITY UNDERWRITING AGREEMENT _______________, 1999 Deutsche Bank Securities Inc. Dain Rauscher Wessels Volpe Brown Whelan & Company, LLC E*OFFERING Corp. As Representatives of the Several Underwriters c/o Deutsche Bank Securities Inc. __________________________________ __________________________________ Ladies and Gentlemen: FreeShop.com, Inc., a Washington corporation (the "Company"), proposes to sell to the several underwriters (the "Underwriters") named in Schedule I hereto for whom you are acting as representatives (the "Representatives") an aggregate of __________ shares of the Company's Common Stock, no par value (the "Firm Shares"). The respective amounts of the Firm Shares to be so purchased by the several Underwriters are set forth opposite their names in Schedule I hereto. The Company also proposes to sell to the Underwriters at the Underwriters' option an aggregate of up to __________ additional shares of the Company's Common Stock (the "Option Shares") as set forth below. As the Representatives, you have advised the Company (a) that you are authorized to enter into this Agreement on behalf of the several Underwriters, and (b) that the several Underwriters are willing, acting severally and not jointly, to purchase the numbers of Firm Shares set forth opposite their respective names in Schedule I, plus their pro rata portion of the Option Shares if you elect to exercise the over-allotment option in whole or in part for the accounts of the several Underwriters. The Firm Shares and the Option Shares (to the extent the aforementioned option is exercised) are herein collectively called the "Shares." 2 In consideration of the mutual agreements contained herein and of the interests of the parties in the transactions contemplated hereby, the parties hereto agree as follows: 1. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and warrants to each of the Underwriters as follows: (a) A registration statement on Form S-1 (File No. 333-81151) with respect to the Shares has been prepared by the Company in conformity with the requirements of the Securities Act of 1933, as amended (the "Act"), and the Rules and Regulations (the "Rules and Regulations") of the Securities and Exchange Commission (the "Commission") thereunder and has been filed with the Commission. Copies of such registration statement, including any amendments thereto, the preliminary prospectuses (meeting the requirements of the Rules and Regulations) contained therein and the exhibits, financial statements and schedules, as finally amended and revised, have heretofore been delivered by the Company to you. Such registration statement, together with any registration statement filed by the Company pursuant to Rule 462(b) of the Act, herein referred to as the "Registration Statement," which shall be deemed to include all information omitted therefrom in reliance upon Rule 430A and contained in the Prospectus referred to below, has become effective under the Act and no post-effective amendment to the Registration Statement has been filed as of the date of this Agreement. "Prospectus" means the form of prospectus first filed with the Commission pursuant to Rule 424(b). Each preliminary prospectus included in the Registration Statement prior to the time it becomes effective is herein referred to as a "Preliminary Prospectus." (b) The Company has been duly organized and is validly existing as a corporation in good standing under the laws of the State of Washington, with corporate power and authority to own or lease its properties and conduct its business as described in the Registration Statement. The Company is duly qualified to transact business in all jurisdictions in which the conduct of its business requires such qualification except such jurisdictions in which, when considered in the aggregate, the failure to be so qualified would not have a material adverse effect on the Company. The Company does not own any equity interest, directly or indirectly, in any corporation, partnership, joint venture or other entity and has no subsidiaries. (c) The outstanding shares of Common Stock of the Company have been duly authorized and validly issued and are fully paid and non-assessable. The Shares to be issued and sold by the Company have been duly authorized and when issued and paid for as contemplated herein will be validly issued, fully paid and non-assessable; and no preemptive rights of shareholders exist with respect to any of the Shares or the issue and sale thereof. Neither the filing of the Registration Statement nor the offering or sale of the Shares as contemplated by this Agreement gives rise to any rights, other than those which have been waived or satisfied, for or relating to the registration of any shares of Common Stock. (d) The information set forth under the caption "Capitalization" in the Prospectus is true and correct. All of the Shares conform to the description thereof contained in the Registration Statement. The form of certificates for the Shares conforms to the requirements of the Business Corporation Act of the State of Washington. -2- 3 (e) The Commission has not issued an order preventing or suspending the use of any Prospectus relating to the proposed offering of the Shares nor instituted proceedings for that purpose. The Registration Statement contains, and the Prospectus and any amendments or supplements thereto will contain, all statements which are required to be stated therein by, and will conform, to the requirements of the Act and the Rules and Regulations. The Registration Statement and any amendment thereto do not contain, and will not contain, any untrue statement of a material fact and do not omit, and will not omit, to state any material fact required to be stated therein or necessary to make the statements therein not misleading. The Prospectus and any amendments and supplements thereto do not contain, and will not contain, any untrue statement of material fact; and do not omit, and will not omit, to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading. The three preceding sentences do not apply to statements in or omissions from the Registration Statement or the Prospectus, or any such amendment or supplement, based upon written information furnished to the Company by or on behalf of any Underwriter through the Representatives, specifically for use in the preparation thereof. (f) The financial statements of the Company, Commonsite, LLC ("Commonsite") and Travel Companions International, Inc. ("Travel Companions"), together with related notes and schedules as set forth in the Registration Statement and the Prospectus, present fairly the financial position and the results of operations and cash flows of the Company, Commonsite and Travel Companions at the indicated dates and for the indicated periods. Such financial statements and related schedules have been prepared in accordance with generally accepted principles of accounting, consistently applied throughout the periods involved, except as disclosed therein, and all adjustments necessary for a fair presentation of results for such periods have been made. The summary financial and statistical data included in the Registration Statement presents fairly the information shown therein and such data has been compiled on a basis consistent with the financial statements presented therein and the books and records of the Company Commonsite and Travel Companions. The pro forma financial statements and other pro forma financial information included in the Registration Statement and the Prospectus present fairly the information shown therein, have been prepared in accordance with the Commission's rules and guidelines with respect to pro forma financial statements, have been properly compiled on the pro forma bases described therein, and, in the opinion of the Company, the assumptions used in the preparation thereof are reasonable and the adjustments used therein are appropriate to give effect to the transactions or circumstances referred to therein. (g) PricewaterhouseCoopers LLP ("PricewaterhouseCoopers"), who have certified certain of the financial statements filed with the Commission as part of the Registration Statement, are independent public accountants as required by the Act and the Rules and Regulations. (h) There is no action, suit, claim or proceeding pending or, to the knowledge of the Company, threatened against the Company before any court or administrative agency or otherwise which, if determined adversely to the Company, might, individually or in the aggregate, result in any material adverse change in the earnings, business, management, properties, assets, rights, operations, condition (financial or otherwise) or prospects of the Company or to prevent -3- 4 the consummation of the transactions contemplated hereby, except as set forth in the Registration Statement. (i) The Company has good and marketable title to all of the properties and assets reflected in the financial statements (or as described in the Registration Statement) hereinabove described, subject to no lien, mortgage, pledge, charge or encumbrance of any kind except those reflected in such financial statements (or as described in the Registration Statement) or which are not material in amount. The Company occupies its leased properties under valid and binding leases conforming in all material respects to the description thereof set forth in the Registration Statement. (j) The Company has filed all Federal, State, local and foreign tax returns which have been required to be filed and has paid all taxes indicated by said returns and all assessments received by it to the extent that such taxes have become due and are not being contested in good faith and for which an adequate reserve for accrual has been established in accordance with generally accepted accounting principles. All tax liabilities have been adequately provided for in the financial statements of the Company, and the Company does not know of any actual or proposed additional material tax assessments. (k) Since the respective dates as of which information is given in the Registration Statement, as it may be amended or supplemented, there has not been any material adverse change or any development involving a prospective material adverse change in or affecting the earnings, business, management, properties, assets, rights, operations, condition (financial or otherwise), or prospects of the Company, whether or not occurring in the ordinary course of business, and there has not been any material transaction entered into or any material transaction that is probable of being entered into by the Company, other than transactions in the ordinary course of business and changes and transactions described in the Registration Statement, as it may be amended or supplemented. The Company has no material contingent obligations which are not disclosed in the Company's financial statements which are included in the Registration Statement. (l) The Company is not, nor with the giving of notice or lapse of time or both, will be, in violation of or in default under its Second Amended and Restated Articles of Incorporation or Amended and Restated Bylaws or under any agreement, lease, contract, indenture or other instrument or obligation to which it is a party or by which it, or any of its properties, is bound and which default is of material significance in respect of the condition (financial or otherwise) of the Company or the business, management, properties, assets, rights, operations, condition (financial or otherwise) or prospects of the Company. The execution and delivery of this Agreement and the consummation of the transactions herein contemplated and the fulfillment of the terms hereof will not conflict with or result in a breach of any of the terms or provisions of, or constitute a default under, any indenture, lease, deed of trust or other agreement or instrument to which the Company is a party, or of the Second Amended and Restated Articles of Incorporation or Amended and Restated Bylaws of the Company or any order, rule or regulation applicable to the Company of any court or of any regulatory body or administrative agency or other governmental body having jurisdiction. -4- 5 (m) Each approval, consent, order, authorization, designation, declaration or filing by or with any regulatory, administrative or other governmental body necessary in connection with the execution and delivery by the Company of this Agreement and the consummation of the transactions herein contemplated (except such additional steps as may be required by the Commission, the National Association of Securities Dealers, Inc. (the "NASD") or such additional steps as may be necessary to qualify the Shares for public offering by the Underwriters under state securities or Blue Sky laws) has been obtained or made and is in full force and effect. (n) The Company holds all material licenses, certificates and permits from governmental authorities which are necessary to the conduct of its business; and the Company to its knowledge has not infringed any patents, patent rights, trade names, trademarks or copyrights. The Company knows of no material infringement by others of patents, patent rights, trade names, trademarks or copyrights owned by or licensed to the Company. (o) Neither the Company, nor to the Company's knowledge, any of its affiliates, has taken or may take, directly or indirectly, any action designed to cause or result in, or which has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of the shares of Common Stock to facilitate the sale or resale of the Shares. The Company acknowledges that the Underwriters may engage in passive market making transactions in the Shares on The Nasdaq Stock Market in accordance with Regulation M under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). (p) The Company is not an "investment company" within the meaning of such term under the Investment Company Act of 1940 (as amended, the "1940 Act"), and the rules and regulations of the Commission thereunder. (q) The Company maintains a system of internal accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorization; (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets; (iii) access to assets is permitted only in accordance with management's general or specific authorization; and (iv) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (r) The Company carries, or is covered by, insurance in such amounts and covering such risks as is adequate for the conduct of its business and the value of its properties and as is customary for companies engaged in similar businesses. (s) The Company is in compliance in all material respects with all presently applicable provisions of the Employee Retirement Income Security Act of 1974, as amended, including the regulations and published interpretations thereunder ("ERISA"); no "reportable event" (as defined in ERISA) has occurred with respect to any "pension plan" (as defined in ERISA) for which the Company would have any liability; the Company has not incurred and does not expect to incur liability under (i) Title IV of ERISA with respect to termination of, or -5- 6 withdrawal from, any "pension plan" or (ii) Sections 412 or 4971 of the Internal Revenue Code of 1986, as amended, including the regulations and published interpretations thereunder (the "Code"); and each "pension plan" for which the Company would have any liability that is intended to be qualified under Section 401(a) of the Code is so qualified in all material respects and nothing has occurred, whether by action or by failure to act, which would cause the loss of such qualification. (t) To the Company's knowledge, there are no affiliations or associations between any member of the NASD and any of the Company's officers, directors or 5% or greater securityholders, except as set forth in the Registration Statement. 2. PURCHASE, SALE AND DELIVERY OF THE FIRM SHARES (a) On the basis of the representations, warranties and covenants herein contained, and subject to the conditions herein set forth, the Company agrees to sell to the Underwriters and each Underwriter agrees, severally and not jointly, to purchase, at a price of $_____ per share, the number of Firm Shares set forth opposite the name of each Underwriter in Schedule I hereof, subject to adjustments in accordance with Section 9 hereof. (b) Payment for the Firm Shares to be sold hereunder is to be made by wire transfer in Federal (same day) funds against delivery of certificates therefor to the Representatives for the several accounts of the Underwriters. Such payment and delivery are to be made through the facilities of the Depository Trust Company, New York, New York at 10:00 a.m., New York time, on the third business day after the date of this Agreement or at such other time and date not later than five business days thereafter as you and the Company shall agree upon, such time and date being herein referred to as the "Closing Date." (As used herein, "business day" means a day on which the New York Stock Exchange is open for trading and on which banks in New York are open for business and are not permitted by law or executive order to be closed.) The certificates for the Firm Shares shall be delivered in such denominations and in such registrations as the Representatives request in writing not later than the second full business day prior to the Closing Date, and will be made available for inspection by the Representatives at least one business day prior to the Closing Date. (c) In addition, on the basis of the representations and warranties herein contained and subject to the terms and conditions herein set forth, the Company hereby grants an option to the several Underwriters to purchase the Option Shares at the price per share as set forth in the first paragraph of this Section 2. The option granted hereby may be exercised in whole or in part by giving written notice (i) at any time before the Closing Date and (ii) only once thereafter within 30 days after the date of this Agreement, by you, as Representatives of the several Underwriters, to the Company setting forth the number of Option Shares as to which the several Underwriters are exercising the option, the names and denominations in which the Option Shares are to be registered and the time and date at which such certificates are to be delivered. The time and date at which certificates for Option Shares are to be delivered shall be determined by the Representatives but shall not be earlier than three nor later than 10 full business days after the exercise of such option, nor in any event prior to the Closing Date (such time and date being herein referred to as the "Option Closing Date"). If the date of exercise of the option is three or -6- 7 more days before the Closing Date, the notice of exercise shall set the Closing Date as the Option Closing Date. The number of Option Shares to be purchased by each Underwriter shall be in the same proportion to the total number of Option Shares being purchased as the number of Firm Shares being purchased by such Underwriter bears to the total number of Firm Shares purchased by the Underwriters, adjusted by you in such manner as to avoid fractional shares. The option with respect to the Option Shares granted hereunder may be exercised only to cover over-allotments in the sale of the Firm Shares by the Underwriters. You, as Representatives of the several Underwriters, may cancel such option at any time prior to its expiration by giving written notice of such cancellation to the Company. To the extent, if any, that the option is exercised, payment for the Option Shares shall be made by wire transfer on the Option Closing Date in Federal (same day) funds against delivery of certificates thereof through the facilities of the Depository Trust Company in New York, New York, drawn to the order of the Company. 3. OFFERING BY THE UNDERWRITERS It is understood that the several Underwriters are to make a public offering of the Firm Shares as soon as the Representatives deem it advisable to do so. The Firm Shares are to be initially offered to the public at the initial public offering price set forth in the Prospectus. The Representatives may from time to time thereafter change the public offering price and other selling terms. To the extent, if at all, that any Option Shares are purchased pursuant to Section 2 hereof, the Underwriters will offer them to the public on the foregoing terms. It is further understood that you will act as the Representatives for the Underwriters in the offering and sale of the Shares in accordance with a Master Agreement Among Underwriters entered into by you and the several other Underwriters. 4. COVENANTS OF THE COMPANY The Company covenants and agrees with the several Underwriters that: (a) The Company will (i) use its best efforts to cause the Registration Statement to become effective and, if the procedure in Rule 430A of the Rules and Regulations is followed, to prepare and timely file with the Commission under Rule 424(b) of the Rules and Regulations a Prospectus in a form approved by the Representatives containing information previously omitted at the time of effectiveness of the Registration Statement in reliance on Rule 430A of the Rules and Regulations and (ii) not file any amendment to the Registration Statement or supplement to the Prospectus of which the Representatives shall not previously have been advised and furnished with a copy or to which the Representatives shall have reasonably objected in writing or which is not in compliance with the Rules and Regulations. (b) The Company will advise the Representatives promptly (i) when the Registration Statement or any post-effective amendment thereto shall have become effective, (ii) of receipt of any comments from the Commission, (iii) of any request of the Commission for amendment of the Registration Statement or for supplement to the Prospectus or for any additional information, and (iv) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or the use of the Prospectus or of the institution of any proceedings for that purpose. The Company will use its best efforts to prevent the issuance -7- 8 of any such stop order preventing or suspending the use of the Prospectus and to obtain as soon as possible the lifting thereof, if issued. (c) The Company will cooperate with the Representatives in endeavoring to qualify the Shares for sale under the securities laws of such jurisdictions as the Representatives may reasonably have designated in writing and will make such applications, file such documents, and furnish such information as may be reasonably required for that purpose, provided the Company shall not be required to qualify as a foreign corporation or to file a general consent to service of process in any jurisdiction where it is not now so qualified or required to file such a consent. The Company will, from time to time, prepare and file such statements, reports, and other documents, as are or may be required to continue such qualifications in effect for so long a period as the Representatives may reasonably request for distribution of the Shares. (d) The Company will deliver to, or upon the order of, the Representatives, from time to time, as many copies of any Preliminary Prospectus as the Representatives may reasonably request. The Company will deliver to, or upon the order of, the Representatives during the period when delivery of a Prospectus is required under the Act, as many copies of the Prospectus in final form, or as thereafter amended or supplemented, as the Representatives may reasonably request. The Company will deliver to the Representatives at or before the Closing Date, four signed copies of the Registration Statement and all amendments thereto including all exhibits filed therewith, and will deliver to the Representatives such number of copies of the Registration Statement (including such number of copies of the exhibits filed therewith that may reasonably be requested), and of all amendments thereto, as the Representatives may reasonably request. (e) The Company will comply with the Act and the Rules and Regulations, and the Exchange Act, and the rules and regulations of the Commission thereunder, so as to permit the completion of the distribution of the Shares as contemplated in this Agreement and the Prospectus. If during the period in which a prospectus is required by law to be delivered by an Underwriter or dealer, any event shall occur as a result of which, in the judgment of the Company or in the reasonable opinion of the Underwriters, it becomes necessary to amend or supplement the Prospectus in order to make the statements therein, in the light of the circumstances existing at the time the Prospectus is delivered to a purchaser, not misleading, or, if it is necessary at any time to amend or supplement the Prospectus to comply with any law, the Company promptly will prepare and file with the Commission an appropriate amendment to the Registration Statement or supplement to the Prospectus so that the Prospectus as so amended or supplemented will not, in the light of the circumstances when it is so delivered, be misleading, or so that the Prospectus will comply with the law. (f) The Company will make generally available to its security holders, as soon as it is practicable to do so, but in any event not later than 15 months after the effective date of the Registration Statement, an earning statement (which need not be audited) in reasonable detail, covering a period of at least 12 consecutive months beginning after the effective date of the Registration Statement, which earning statement shall satisfy the requirements of Section 11(a) of the Act and Rule 158 of the Rules and Regulations and will advise you in writing when such statement has been so made available. -8- 9 (g) Prior to the Closing Date, the Company will furnish to the Underwriters, as soon as they have been prepared by or are available to the Company, a copy of any unaudited interim financial statements of the Company for any period subsequent to the period covered by the most recent financial statements appearing in the Registration Statement and the Prospectus. (h) No offering, sale, short sale or other disposition of any shares of Common Stock of the Company or other securities convertible into or exchangeable or exercisable for shares of Common Stock or derivative of Common Stock (or agreement for such) will be made for a period of 180 days after the date of this Agreement, directly or indirectly, by the Company otherwise than hereunder or with the prior written consent of Deutsche Bank Securities Inc., except that the Company may issue such shares (i) as consideration or partial consideration for business acquisitions, (ii) in connection with the formation of a strategic alliance, or (iii) on the exercise of currently outstanding stock options or warrants or on the exercise of options granted pursuant to the Company's stock option plan; provided, however, that upon issuance such shares shall be subject to a lock-up agreement that prohibits the offering, sale, short sale or other disposition of such shares for a period of 180 days after the effective date of the Registration Statement. (i) The Company will use its best efforts to list, subject to notice of issuance, the Shares on the The Nasdaq Stock Market. (j) The Company has caused each officer and director and specific shareholders of the Company to furnish to you, on or prior to the date of this agreement, a letter or letters, in form and substance satisfactory to the Underwriters, pursuant to which each such person shall agree, subject to certain exceptions set forth in such letter or letters, not to offer, sell, contract to sell, make any short sale, grant any option to purchase or otherwise dispose of any shares of Common Stock of the Company or other capital stock of the Company, or any other securities convertible, exchangeable or exercisable for Common Shares or derivative of Common Shares owned by such person or request the registration for the offer or sale of any of the foregoing (or as to which such person has the right to direct the disposition of) for a period of 180 days after the date of this Agreement, directly or indirectly, except with the prior written consent of Deutsche Bank Securities Inc. (the "Lockup Agreements"). (k) The Company shall apply the net proceeds of its sale of the Shares as set forth in the Prospectus and shall file such reports with the Commission with respect to the sale of the Shares and the application of the proceeds therefrom as may be required in accordance with Rule 463 under the Act. (l) The Company shall not invest, or otherwise use the proceeds received by the Company from its sale of the Shares in such a manner as would require the Company to register as an investment company under the 1940 Act. (m) The Company will maintain a transfer agent and, if necessary under the jurisdiction of incorporation of the Company, a registrar for the Common Stock. -9- 10 (n) The Company will not take, directly or indirectly, any action designed to cause or result in, or that has constituted or might reasonably be expected to constitute, the stabilization or manipulation of the price of any securities of the Company. 5. COSTS AND EXPENSES The Company will pay all costs, expenses and fees incident to the performance of the obligations of the Company under this Agreement, including, without limiting the generality of the foregoing, the following: accounting fees of the Company; the fees and disbursements of counsel for the Company; the cost of printing and delivering to, or as requested by, the Underwriters copies of the Registration Statement, Preliminary Prospectuses, the Prospectus, this Agreement, the Underwriters' Selling Memorandum, the Underwriters' Invitation Letter, the Listing Application, the Blue Sky Survey and any supplements or amendments thereto; the filing fees of the Commission; the filing fees and expenses (including legal fees and disbursements) incident to securing any required review by the NASD of the terms of the sale of the Shares; the Listing Fee of the Nasdaq Stock Market; and the expenses, including the fees and disbursements of counsel for the Underwriters, incurred in connection with the qualification of the Shares under State securities or Blue Sky laws. The Company agrees to pay all costs and expenses of the Underwriters, including the fees and disbursements of counsel for the Underwriters, incident to the offer and sale of any directed shares of the Common Stock by the Underwriters. The Company shall not, however, be required to pay for any of the Underwriters expenses (other than those related to qualification under NASD regulation and State securities or Blue Sky laws) except that, if this Agreement shall not be consummated because the conditions in Section 6 hereof are not satisfied, or because this Agreement is terminated by the Representatives pursuant to Section 11 hereof, or by reason of any failure, refusal or inability on the part of the Company to perform any undertaking or satisfy any condition of this Agreement or to comply with any of the terms hereof on its part to be performed, unless such failure to satisfy said condition or to comply with said terms be due to the default or omission of any Underwriter, then the Company shall reimburse the several Underwriters for reasonable out-of-pocket expenses, including fees and disbursements of counsel, reasonably incurred in connection with investigating, marketing and proposing to market the Shares or in contemplation of performing their obligations hereunder; but the Company shall not in any event be liable to any of the several Underwriters for damages on account of loss of anticipated profits from the sale by them of the Shares. 6. CONDITIONS OF OBLIGATIONS OF THE UNDERWRITERS The several obligations of the Underwriters to purchase the Firm Shares on the Closing Date and the Option Shares, if any, on the Option Closing Date are subject to the accuracy, as of the Closing Date or the Option Closing Date, as the case may be, of the representations and warranties of the Company contained herein, and to the performance by the Company of its covenants and obligations hereunder and to the following additional conditions: (a) The Registration Statement and all post-effective amendments thereto shall have become effective and any and all filings required by Rule 424 and Rule 430A of the Rules and Regulations shall have been made, and any request of the Commission for additional information (to be included in the Registration Statement or otherwise) shall have been disclosed -10- 11 to the Representatives and complied with to their reasonable satisfaction. No stop order suspending the effectiveness of the Registration Statement, as amended from time to time, shall have been issued and no proceedings for that purpose shall have been taken or, to the knowledge of the Company, shall be contemplated by the Commission and no injunction, restraining order, or order of any nature by a Federal or state court of competent jurisdiction shall have been issued as of the Closing Date which would prevent the issuance of the Shares. (b) The Representatives shall have received on the Closing Date or the Option Closing Date, as the case may be, the opinions of Dorsey & Whitney LLP ("Dorsey & Whitney"), counsel for the Company, dated the Closing Date or the Option Closing Date, as the case may be, addressed to the Underwriters (and stating that it may be relied upon by counsel to the Underwriters) to the effect that: (i) The Company has been duly organized and is validly existing as a corporation in good standing under the laws of the State of Washington, with corporate power and authority to own or lease its properties and conduct its business as described in the Registration Statement; the Company is duly qualified to transact business in all jurisdictions in which the conduct of its business requires such qualification, or in which the failure to qualify would have a materially adverse effect upon the business of the Company. (ii) The Company has authorized and outstanding capital stock as set forth under the caption "Capitalization" in the Prospectus as of the date and based on the assumptions stated therein; the authorized shares of the Company's Common Stock have been duly authorized; the outstanding shares of the Company's Common Stock have been duly authorized and validly issued and are fully paid and non-assessable; and all of the Shares conform to the description thereof contained in the Prospectus; the certificates for the Shares, assuming they are in the form filed with the Commission, are in due and proper form in all material respects. (iii) The shares of Common Stock, including the Option Shares, if any, to be sold by the Company pursuant to this Agreement have been duly authorized and will be validly issued, fully paid and non-assessable when issued and paid for as contemplated by this Agreement, and no preemptive rights of shareholders exist with respect to any of the Shares or the issue or sale thereof. (iv) Except as described in or contemplated by the Prospectus, to the knowledge of such counsel, there are no outstanding securities of the Company convertible or exchangeable into or evidencing the right to purchase or subscribe for any shares of capital stock of the Company and there are no outstanding or authorized options, warrants or rights of any character obligating the Company to issue any shares of its capital stock or any securities convertible or exchangeable into or evidencing the right to purchase or subscribe for any shares of such stock; and except as described in the Prospectus, to the knowledge of such counsel, no holder of any securities of the Company or any other person has the right, contractual or otherwise, which has not been satisfied or effectively waived, to cause the Company to sell or otherwise issue to them, or to permit them to underwrite the sale of, any of the Shares or the right to have any Common Shares or other securities of the Company included in the Registration -11- 12 Statement or the right, as a result of the filing of the Registration Statement, to require registration under the Act of any shares of Common Stock or other securities of the Company. (v) Based solely upon oral advice of the Staff of the Commission, the Registration Statement has become effective under the Act and, to the best of the knowledge of such counsel, no stop order proceedings with respect thereto have been instituted or are pending or threatened under the Act. (vi) The Registration Statement, the Prospectus and each amendment or supplement thereto and document incorporated by reference therein comply as to form in all material respects with the requirements of the Act and the applicable rules and regulations thereunder (except that such counsel need express no opinion as to the financial statements and related schedules therein). (vii) The statements under the captions "Business - Government Regulation," "Management - Director and Officer Indemnification and Liability," "Related Party Transactions," "Description of Capital Stock" and "Shares Eligible for Future Sale" in the Prospectus, insofar as such statements constitute a summary of documents referred to therein or matters of law, fairly summarize in all material respects the information called for with respect to such documents and matters. (viii) Such counsel does not know of any contracts or documents required to be filed as exhibits to the Registration Statement or described in the Registration Statement or the Prospectus which are not so filed or described as required, and such contracts and documents as are summarized in the Registration Statement or the Prospectus are fairly summarized in all material respects. (ix) Such counsel knows of no material legal or governmental proceedings pending or threatened against the Company required to be described in the Prospectus except as set forth in the Prospectus. (x) The execution and delivery of this Agreement and the consummation of the transactions herein contemplated do not and will not conflict with or result in a breach of any of the terms or provisions of, or constitute a default under, the Second Amended and Restated Articles of Incorporation or Amended and Restated Bylaws of the Company, or any agreement or instrument known to such counsel to which the Company is a party or by which the Company may be bound. (xi) This Agreement has been duly authorized, executed and delivered by the Company. (xii) No approval, consent, order, authorization, designation, declaration or filing by or with any regulatory, administrative or other governmental body is necessary in connection with the execution and delivery of this Agreement and the consummation of the transactions herein contemplated (other than as may be required by the NASD or as required by State securities and Blue Sky laws as to which such counsel need express no opinion) except such as have been obtained or made, specifying the same, and except where the failure to obtain such, -12- 13 when considered together with all other such failures, would not reasonably be expected to have a material adverse effect on the Company. (xiii) The Company is not, and will not become, as a result of the consummation of the transactions contemplated by this Agreement, and application of the net proceeds therefrom as described in the Prospectus, required to register as an investment company under the 1940 Act. In rendering such opinion, Dorsey & Whitney may rely as to matters governed by the laws of states other than Washington or Federal laws on local counsel in such jurisdictions, provided that in each case Dorsey & Whitney shall state that they believe that they and the Underwriters are justified in relying on such other counsel. In addition to the matters set forth above, such opinion shall also include a statement to the effect that nothing has come to the attention of such counsel which has caused them to believe that (i) the Registration Statement, at the time it became effective under the Act (but after giving effect to any modifications incorporated therein pursuant to Rule 430A under the Act) and as of the Closing Date or the Option Closing Date, as the case may be, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, and (ii) the Prospectus, or any supplement thereto, on the date it was filed pursuant to the Rules and Regulations and as of the Closing Date or the Option Closing Date, as the case may be, contained an untrue statement of a material fact or omitted to state a material fact necessary in order to make the statements, in the light of the circumstances under which they are made, not misleading (except that such counsel need express no view as to financial statements, schedules and statistical information therein). With respect to such statement, Dorsey & Whitney may state that their belief is based upon the procedures set forth therein, but is without independent check and verification. (c) The Representatives shall have received from Perkins Coie LLP ("Perkins Coie"), counsel for the Underwriters, an opinion dated the Closing Date or the Option Closing Date, as the case may be, substantially to the effect specified in subparagraphs (iii), (iv), (v) and (ix) of Paragraph (b) of this Section 6, and that the Company is a duly organized and validly existing corporation under the laws of the State of Washington. In rendering such opinion, Perkins Coie may rely as to all matters governed other than by the laws of the State of Washington or Federal laws on the opinion of counsel referred to in Paragraph (b) of this Section 6. In addition to the matters set forth above, such opinion shall also include a statement to the effect that nothing has come to the attention of such counsel which leads them to believe that (i) the Registration Statement, or any amendment thereto, as of the time it became effective under the Act (but after giving effect to any modifications incorporated therein pursuant to Rule 430A under the Act) as of the Closing Date or the Option Closing Date, as the case may be, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, and (ii) the Prospectus, or any supplement thereto, on the date it was filed pursuant to the Rules and Regulations and as of the Closing Date or the Option Closing Date, as the case may be, contained an untrue statement of a material fact or omitted to state a material fact, necessary in order to make the statements, in the light of the circumstances under which they are made, not misleading (except that such counsel need express no view as to financial statements, schedules and statistical -13- 14 information therein). With respect to such statement, Perkins Coie may state that their belief is based upon the procedures set forth therein, but is without independent check and verification. (d) The Representatives shall have received at or prior to the Closing Date from Perkins Coie a memorandum or summary, in form and substance satisfactory to the Representatives, with respect to the qualification for offering and sale by the Underwriters of the Shares under the State securities or Blue Sky laws of such jurisdictions as the Representatives may reasonably have designated to the Company. (e) You shall have received, on each of the dates hereof, the Closing Date and the Option Closing Date, as the case may be, a letter dated the date hereof, the Closing Date or the Option Closing Date, as the case may be, in form and substance satisfactory to you, of PricewaterhouseCoopers confirming that they are independent public accountants within the meaning of the Act and the applicable published Rules and Regulations thereunder and stating that in their opinion the financial statements and schedules examined by them and included in the Registration Statement comply in form in all material respects with the applicable accounting requirements of the Act and the related published Rules and Regulations; and containing such other statements and information as is ordinarily included in accountants' "comfort letters" to underwriters with respect to the financial statements and certain financial and statistical information contained in the Registration Statement and Prospectus. (f) The Representatives shall have received on the Closing Date or the Option Closing Date, as the case may be, a certificate or certificates of the Chief Executive Officer and the Chief Financial Officer of the Company to the effect that, as of the Closing Date or the Option Closing Date, as the case may be, each of them severally represents as follows: (i) The Registration Statement has become effective under the Act and no stop order suspending the effectiveness of the Registration Statement has been issued, and no proceedings for such purpose have been taken or are, to his knowledge, contemplated by the Commission; (ii) The representations and warranties of the Company contained in Section 1 hereof are true and correct as of the Closing Date or the Option Closing Date, as the case may be; (iii) All filings required to have been made pursuant to Rules 424 or 430A under the Act have been made; (iv) He has carefully examined the Registration Statement and the Prospectus and, in his opinion, as of the effective date of the Registration Statement, the statements contained in the Registration Statement were true and correct, and such Registration Statement and Prospectus did not omit to state a material fact required to be stated therein or necessary in order to make the statements therein not misleading, and since the effective date of the Registration Statement, no event has occurred which should have been set forth in a supplement to or an amendment of the Prospectus which has not been so set forth in such supplement or amendment; and -14- 15 (v) Since the respective dates as of which information is given in the Registration Statement and Prospectus, there has not been any material adverse change or any development involving a prospective material adverse change in or affecting the condition, financial or otherwise, of the Company or the earnings, business, management, properties, assets, rights, operations, condition (financial or otherwise) or prospects of the Company, whether or not arising in the ordinary course of business. (g) The Company shall have furnished to the Representatives such further certificates and documents confirming the representations and warranties, covenants and conditions contained herein and related matters as the Representatives may reasonably have requested. (h) The Firm Shares and Option Shares, if any, have been approved for designation upon notice of issuance on The Nasdaq Stock Market. (i) The Lockup Agreements described in Section 4 (j) are in full force and effect. The opinions and certificates mentioned in this Agreement shall be deemed to be in compliance with the provisions hereof only if they are in all material respects satisfactory to the Representatives and to Perkins Coie, counsel for the Underwriters. If any of the conditions hereinabove provided for in this Section 6 shall not have been fulfilled when and as required by this Agreement to be fulfilled, the obligations of the Underwriters hereunder may be terminated by the Representatives by notifying the Company of such termination in writing or by telegram at or prior to the Closing Date or the Option Closing Date, as the case may be. In such event, the Company and the Underwriters shall not be under any obligation to each other (except to the extent provided in Sections 5 and 8 hereof). 7. CONDITIONS OF THE OBLIGATIONS OF THE COMPANY The obligations of the Company to sell and deliver the portion of the Shares required to be delivered as and when specified in this Agreement are subject to the conditions that at the Closing Date or the Option Closing Date, as the case may be, no stop order suspending the effectiveness of the Registration Statement shall have been issued and in effect or proceedings therefor initiated or threatened. 8. INDEMNIFICATION (a) The Company agrees: (i) to indemnify and hold harmless each Underwriter and each person, if any,who controls any Underwriter within the meaning of the Act, against any losses, claims, damages or liabilities to which such Underwriter or any such controlling person may become subject under the Act or otherwise, insofar as such losses,claims, damages or liabilities (or actions or -15- 16 proceedings in respect thereof) arise out of or are based upon (A) any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto, (B) the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances in which they were made, or (C) any act, alleged act or failure to act by any Underwriter in connection with, or relating in any manner to, the Shares or the offering contemplated hereby, and which is included as part of or referred to in any loss, claim, damage, liability or action arising out of or based upon matters covered by clause (A) or (B) above (provided that the Company shall not be liable under this clause (C) to the extent that it is determined in a final judgment by a court of competent jurisdiction that such loss, claim, damage, liability or action resulted directly from any such acts or failures to act undertaken or omitted to be taken by such Underwriter through its gross negligence or willful misconduct); provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement, or omission or alleged omission made in the Registration Statement, any Preliminary Prospectus, the Prospectus, or such amendment or supplement, in reliance upon and in conformity with written information furnished to the Company by or through the Representatives specifically for use in the preparation thereof; and provided further that the foregoing indemnity agreement with respect to any Preliminary Prospectus shall not inure to the benefit of any Underwriter from whom the person asserting any such losses, claims, damages or liabilities purchased shares, or any person controlling such Underwriter, if a copy of the Prospectus (as then amended or supplemented if the Company shall have furnished any amendments or supplements thereto) was not sent or given by or on behalf of such Underwriter to such person at or prior to the written confirmation of the sale of the Shares to such person, and if the Prospectus (as so amended or supplemented) would have cured the defect giving rise to such losses, claims, damages or liabilities, unless such failure is the result of non-compliance by the Company with Section 4(d) hereof. This indemnity obligation will be in addition to any liability which the Company may otherwise have. (ii) to reimburse each Underwriter and each such controlling person upon demand for any legal or other out-of-pocket expenses reasonably incurred by such Underwriter or such controlling person in connection with investigating or defending any such loss, claim, damage or liability, action or proceeding or in responding to a subpoena or governmental inquiry related to the offering of the Shares, whether or not such Underwriter or controlling person is a party to any action or proceeding. In the event that it is finally judicially determined that the Underwriters were not entitled to receive payments for legal and other expenses pursuant to this subparagraph, the Underwriters will promptly return all sums that had been advanced pursuant hereto. (b) Each Underwriter severally and not jointly will indemnify and hold harmless the Company, each of its directors, each of its officers who have signed the Registration Statement and each person, if any, who controls the Company within the meaning of the Act, against any losses, claims, damages or liabilities to which the Company or any such director, officer or controlling person may become subject under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions or proceedings in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in the -16- 17 Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto, or (ii) the omission or the alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances under which they were made; and will reimburse any legal or other expenses reasonably incurred by the Company or any such director, officer or controlling person in connection with investigating or defending any such loss, claim, damage, liability, action or proceeding; provided, however, that each Underwriter will be liable in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission has been made in the Registration Statement, any Preliminary Prospectus, the Prospectus or such amendment or supplement, in reliance upon and in conformity with written information furnished to the Company by or through the Representatives specifically for use in the preparation thereof. This indemnity agreement will be in addition to any liability which such Underwriter may otherwise have. (c) In case any proceeding (including any governmental investigation) shall be instituted involving any person in respect of which indemnity may be sought pursuant to this Section 8, such person (the "indemnified party") shall promptly notify the person against whom such indemnity may be sought (the "indemnifying party") in writing. No indemnification provided for in Section 8(a) or (b) shall be available to any party who shall fail to give notice as provided in this Section 8(c) if the party to whom notice was not given was unaware of the proceeding to which such notice would have related and was materially prejudiced by the failure to give such notice, but the failure to give such notice shall not relieve the indemnifying party or parties from any liability which it or they may have to the indemnified party for contribution or otherwise than on account of the provisions of Section 8(a) or (b). In case any such proceeding shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party and shall pay as incurred the fees and disbursements of such counsel related to such proceeding. In any such proceeding, any indemnified party shall have the right to retain its own counsel at its own expense. Notwithstanding the foregoing, the indemnifying party shall pay as incurred (or within 30 days of presentation) the fees and expenses of the counsel retained by the indemnified party in the event (i) the indemnifying party and the indemnified party shall have mutually agreed to the retention of such counsel, (ii) the named parties to any such proceeding (including any impleaded parties) include both the indemnifying party and the indemnified party and representation of both parties by the same counsel would be inappropriate due to actual or potential differing interests between them or (iii) the indemnifying party shall have failed to assume the defense and employ counsel acceptable to the indemnified party within a reasonable period of time after notice of commencement of the action. It is understood that the indemnifying party shall not, in connection with any proceeding or related proceedings in the same jurisdiction, be liable for the reasonable fees and expenses of more than one separate firm for all such indemnified parties. Such firm shall be designated in writing by you in the case of parties indemnified pursuant to Section 8(a) and by the Company in the case of parties indemnified pursuant to Section 8(b). The indemnifying party shall not be liable for any settlement of any proceeding effected without its written consent but if settled with such consent or if there be a final judgment for the plaintiff, the indemnifying party agrees to indemnify the indemnified party from and against any loss or liability by reason of such -17- 18 settlement or judgment. In addition, the indemnifying party will not, without the prior written consent of the indemnified party, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action or proceeding of which indemnification may be sought hereunder (whether or not any indemnified party is an actual or potential party to such claim, action or proceeding) unless such settlement, compromise or consent includes an unconditional release of each indemnified party from all liability arising out of such claim, action or proceeding. (d) If the indemnification provided for in this Section 8 is unavailable to or insufficient to hold harmless an indemnified party under Section 8(a) or (b) above in respect of any losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to therein, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions or proceedings in respect thereof) in such proportion as is appropriate to reflect the relative benefits received by the Company on the one hand and the Underwriters on the other from the offering of the Shares. If, however, the allocation provided by the immediately preceding sentence is not permitted by applicable law then each indemnifying party shall contribute to such amount paid or payable by such indemnified party in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of the Company on the one hand and the Underwriters on the other in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities, (or actions or proceedings in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Company on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total net proceeds from the offering (before deducting expenses) received by the Company bear to the total underwriting discounts and commissions received by the Underwriters, in each case as set forth in the table on the cover page of the Prospectus. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company on the one hand or the Underwriters on the other and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Underwriters agree that it would not be just and equitable if contributions pursuant to this Section 8(d) were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 8(d). The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to above in this Section 8(d) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 8(d), (i) no Underwriter shall be required to contribute any amount in excess of the underwriting discounts and commissions applicable to the Shares purchased by such Underwriter and (ii) no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. -18- 19 (e) In any proceeding relating to the Registration Statement, any Preliminary Prospectus, the Prospectus or any supplement or amendment thereto, each party against whom contribution may be sought under this Section 8 hereby consents to the jurisdiction of any court having jurisdiction over any other contributing party, agrees that process issuing from such court may be served upon him or it by any other contributing party and consents to the service of such process and agrees that any other contributing party may join him or it as an additional defendant in any such proceeding in which such other contributing party is a party. (f) Any losses, claims, damages, liabilities or expenses for which an indemnified party is entitled to indemnification or contribution under this Section 8 shall be paid by the indemnifying party to the indemnified party as such losses, claims, damages, liabilities or expenses are incurred. The indemnity and contribution agreements contained in this Section 8 and the representations and warranties of the Company set forth in this Agreement shall remain operative and in full force and effect, regardless of (i) any investigation made by or on behalf of any Underwriter or any person controlling any Underwriter, the Company, its directors or officers or any persons controlling the Company, (ii) acceptance of any Shares and payment therefor hereunder, and (iii) any termination of this Agreement. A successor to any Underwriter, or to the Company, its directors or officers, or any person controlling the Company, shall be entitled to the benefits of the indemnity, contribution and reimbursement agreements contained in this Section 8. 9. DEFAULT BY UNDERWRITERS If on the Closing Date or the Option Closing Date, as the case may be, any Underwriter shall fail to purchase and pay for the portion of the Shares which such Underwriter has agreed to purchase and pay for on such date (otherwise than by reason of any default on the part of the Company), you, as Representatives of the Underwriters, shall use your reasonable efforts to procure within 36 hours thereafter one or more of the other Underwriters, or any others, to purchase from the Company such amounts as may be agreed upon and upon the terms set forth herein, the Firm Shares or Option Shares, as the case may be, which the defaulting Underwriter or Underwriters failed to purchase. If during such 36 hours you, as such Representatives, shall not have procured such other Underwriters, or any others, to purchase the Firm Shares or Option Shares, as the case may be, agreed to be purchased by the defaulting Underwriter or Underwriters, then (a) if the aggregate number of shares with respect to which such default shall occur does not exceed 10% of the Firm Shares or Option Shares, as the case may be, covered hereby, the other Underwriters shall be obligated, severally, in proportion to the respective numbers of Firm Shares or Option Shares, as the case may be, which they are obligated to purchase hereunder, to purchase the Firm Shares or Option Shares, as the case may be, which such defaulting Underwriter or Underwriters failed to purchase, or (b) if the aggregate number of shares of Firm Shares or Option Shares, as the case may be, with respect to which such default shall occur exceeds 10% of the Firm Shares or Option Shares, as the case may be, covered hereby, the Company or you as the Representatives of the Underwriters will have the right, by written notice given within the next 36-hour period to the parties to this Agreement, to terminate this Agreement without liability on the part of the non-defaulting Underwriters or of the Company except to the extent provided in Section 8 hereof. In the event of a default by any Underwriter or Underwriters, as set forth in this Section 9, the Closing Date or Option Closing Date, as the case may be, may be postponed for such period, not exceeding seven days, as you, as Representatives, -19- 20 may determine in order that the required changes in the Registration Statement or in the Prospectus or in any other documents or arrangements may be effected. The term "Underwriter" includes any person substituted for a defaulting Underwriter. Any action taken under this Section 9 shall not relieve any defaulting Underwriter from liability in respect of any default of such Underwriter under this Agreement. 10. NOTICES All communications hereunder shall be in writing and, except as otherwise provided herein, will be mailed, delivered, telecopied or telegraphed and confirmed as follows: if to the Underwriters, to Deutsche Bank Securities Inc. One South Street Baltimore, Maryland 21202 Attention: ____________________; with copies to Deutsche Bank Securities Inc. One Bankers Trust Plaza 130 Liberty Street New York, NY 10006 Attention: General Counsel; and Perkins Coie LLP 1201 Third Avenue, 48th Floor Seattle, WA 98101 Attention: Stephen M. Graham if to the Company, to FreeShop.com, Inc. 95 South Jackson Street, Suite 300 Seattle, WA 98104 Attention: Timothy C. Choate with a copy to Dorsey & Whitney LLP 1420 Fifth Ave., Suite 4200 Seattle, WA 98101 Attention: Bryce Holland -20- 21 11. TERMINATION (a) This Agreement may be terminated by you by notice to the Company at any time prior to the Closing Date if any of the following has occurred: (i) since the respective dates as of which information is given in the Registration Statement and the Prospectus, any material adverse change or any development involving a prospective material adverse change in or affecting the condition, financial or otherwise, of the Company or the earnings, business, management, properties, assets, rights, operations, condition (financial or otherwise) or prospects of the Company, whether or not arising in the ordinary course of business, (ii) any outbreak or escalation of hostilities or declaration of war or national emergency or other national or international calamity or crisis or change in economic or political conditions if the effect of such outbreak, escalation, declaration, emergency, calamity, crisis or change on the financial markets of the United States would, in your reasonable judgment, make it impracticable or inadvisable to market the Shares or to enforce contracts for the sale of the Shares, or (iii) suspension of trading in securities generally on the New York Stock Exchange, the American Stock Exchange or the Nasdaq Stock Market, or limitation on prices (other than limitations on hours or numbers of days of trading) for securities on the New York Stock Exchange, the American Stock Exchange or the Nasdaq Stock Market, (iv) the enactment, publication, decree or other promulgation of any statute, regulation, rule or order of any court or other governmental authority which in your opinion materially and adversely affects or may materially and adversely affect the business or operations of the Company, (v) declaration of a banking moratorium by United States or New York State authorities, (vi) the suspension of trading of the Company's common stock by the Nasdaq Stock Market, the Commission, or any other governmental authority or, (vii) the taking of any action by any governmental body or agency in respect of its monetary or fiscal affairs which in your reasonable opinion has a material adverse effect on the securities markets in the United States; or (b) as provided in Sections 6 and 9 of this Agreement. 12. SUCCESSORS This Agreement has been and is made solely for the benefit of the Underwriters and the Company and their respective successors, executors, administrators, heirs and assigns, and the officers, directors and controlling persons referred to herein, and no other person will have any right or obligation hereunder. No purchaser of any of the Shares from any Underwriter shall be deemed a successor or assign merely because of such purchase. 13. INFORMATION PROVIDED BY UNDERWRITERS The Company and the Underwriters acknowledge and agree that the only information furnished or to be furnished by any Underwriter to the Company for inclusion in any Prospectus or the Registration Statement consists of the information set forth in the last paragraph on the front cover page (insofar as such information relates to the Underwriters), the legends required by Item 502 of Regulation S-K under the Act and the information under the caption "Underwriting" in the Prospectus. -21- 22 14. MISCELLANEOUS The reimbursement, indemnification and contribution agreements contained in this Agreement and the representations, warranties and covenants in this Agreement shall remain in full force and effect regardless of (a) any termination of this Agreement, (b) any investigation made by or on behalf of any Underwriter or controlling person thereof, or by or on behalf of the Company or its directors or officers and (c) delivery of and payment for the Shares under this Agreement. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. This Agreement shall be governed by, and construed in accordance with, the laws of the State of Maryland. [SIGNATURE PAGE FOLLOWS] -22- 23 If the foregoing letter is in accordance with your understanding of our agreement, please sign and return to us the enclosed duplicates hereof, whereupon it will become a binding agreement among the Company and the several Underwriters in accordance with its terms. Very truly yours, FREESHOP.COM, INC. By -------------------------------- Timothy C. Choate Chairman, President and Chief Executive Officer The foregoing Underwriting Agreement is hereby confirmed and accepted as of the date first above written. DEUTSCHE BANK SECURITIES, INC. - --------------------------------- - --------------------------------- As Representatives of the several Underwriters listed on Schedule I By: Deutsche Bank Securities Inc. By: ------------------------------ Authorized Officer -23- 24 SCHEDULE I SCHEDULE OF UNDERWRITERS NUMBER OF FIRM SHARES UNDERWRITER TO BE PURCHASED - --------------------------------- --------------------- Deutsche Bank Securities Inc. Dain Rauscher Wessels Volpe Brown Whelan & Company, LLC E*OFFERING Corp. --------------- Total =============== EX-3.1 3 SECOND AMENDED AND RESTATED ARTICLES/INCORPORATION 1 SECOND AMENDED AND RESTATED ARTICLES OF INCORPORATION OF FREESHOP.COM, INC. ARTICLE 1. NAME The name of the corporation (the "Corporation") is FreeShop.com, Inc. ARTICLE 2. CAPITAL STOCK 2.1 AUTHORIZED CAPITAL 2.1.1 Every 2.5 shares of issued and outstanding Common Stock of this Corporation are, on the effective date hereof, automatically reclassified into one share of Common Stock of this Corporation, thereby giving effect to a 1-for-2.5 reverse stock split (the "Reverse Stock Split"). All outstanding rights and obligations (including option plans, stock options and the exercise price thereof, stock purchase warrants and the exercise prices thereof and the conversion terms of the Corporation's shares of Series A Convertible Preferred Stock and Series B Convertible Preferred Stock) relating to the Corporation's Common Stock shall be mathematically adjusted to reflect the Reverse Stock Split so that the proportionate ratio of such rights and obligations to the reclassified shares will be equal to the proportionate ratio of such rights and obligations to the shares outstanding immediately prior to such reclassification. In lieu of the issuance of any fractional shares that would otherwise result from the Reverse Stock Split, the Corporation shall issue one whole share to any shareholder that would otherwise receive fractional shares, the additional shares hereby issued being taken from authorized but theretofore unissued shares of Common Stock. 2.1.2 After giving effect to the Reverse Stock Split, the total authorized stock of the Corporation shall consist of 100,000,000 shares of Common Stock, no par value, and 10,000,000 shares of Preferred Stock, no par value. 2.2 ISSUANCE OF PREFERRED STOCK IN SERIES The Preferred Stock may be issued from time to time in one or more series, the shares of each series to have such voting powers, full or limited, and such designations, preferences and relative, participating, optional or other special rights and qualifications, limitations or restrictions thereof as are stated and expressed herein or in the resolution or resolutions providing for the issue of such series adopted by the Board of Directors. 1 2 2.2.1 AUTHORITY OF THE BOARD OF DIRECTORS Authority is hereby expressly granted to the Board of Directors of the Corporation, subject to the provisions of this Article 2 and to the limitations prescribed by law, to authorize the issue of one or more series of Preferred Stock, and with respect to each such series to fix by resolution or resolutions providing for the issue of each series the number of shares of such series, the voting powers, full or limited, if any, of the shares of such series and the designations, preferences and relative, participating, optional or other special rights and the qualifications, limitations or restrictions thereof. The authority of the Board of Directors with respect to each series of Preferred Stock shall include, but not be limited to, the determination or fixing of the following: (a) The number of shares of such series; (b) The designation of such series; (c) The dividends of such series, the conditions and dates upon which such dividends shall be payable, the relation which such dividends shall bear to the dividends payable on any other class or classes of stock and whether such dividends shall be cumulative or noncumulative; (d) Whether the shares of such series shall be subject to redemption by the Corporation and, if made subject to such redemption, the times, prices, rates, adjustments, and other terms and conditions of such redemption; (e) The terms and amounts of any sinking fund provided for the purchase or redemption of the shares of such series; (f) Whether or not the shares of such series shall be convertible into or exchangeable for shares of any other class or classes or of any other series of any class or classes of stock of the Corporation and, if provision be made for conversion or exchange, the times, prices, rates, adjustments, and other terms and conditions of such conversion or exchange; (g) The extent, if any, to which the holders of the shares of such series shall be entitled to vote with respect to the election of directors or otherwise, including the right to elect a specified number or class of directors, the number or percentage of votes required for certain actions, and the extent to which a vote by class or series shall be required for certain actions; (h) The restrictions, if any, on the issue or reissue of any Preferred Stock; (i) The rights of the holders of the shares of such series upon the dissolution of, or upon the distribution of the assets of, the Corporation; and (j) The extent, if any, to which any committee of the Board of Directors may fix the designations and any of the preferences or rights of the shares of such series relating to 2 3 dividends, redemption, dissolution, any distribution of assets of the Corporation or the conversion into or exchange of such shares for shares of any other class or classes of stock of the Corporation or any other series of the same or any other class or classes of stock of the Corporation, or fix the number of shares of any such series or authorize the increase or decrease in the shares of such series. 2.2.2 DIVIDENDS Subject to any preferential rights granted for any series of Preferred Stock, the holders of shares of the Common Stock shall be entitled to receive dividends, out of the funds of the Corporation legally available therefor, at the rate and at the time or times, whether cumulative or noncumulative, as may be provided by the Board of Directors. The holders of shares of the Preferred Stock shall be entitled to receive dividends to the extent provided herein or by the Board of Directors in designating the particular series of Preferred Stock. The holders of shares of the Common Stock shall not be entitled to receive any dividends thereon other than the dividends referred to in this section. 2.2.3 VOTING The holders of shares of the Common Stock, on the basis of one vote per share, shall have the right to vote for the election of members of the Board of Directors of the Corporation and the right to vote on all other matters, except those matters on which a separate class of the Corporation's Shareholders vote by class or series to the exclusion of the holders of the shares of the Common Stock. To the extent provided herein or by resolution or resolutions of the Board of Directors providing for the issue of a series of Preferred Stock, the holders of each such series shall have the right to vote for the election of members of the Board of Directors of the Corporation and the right to vote on all other matters, except those matters in which a separate class of the Corporation's shareholders vote by class or series to the exclusion of the holders of the shares of such series. 2.2.4 ISSUANCE OF SHARES The Corporation may from time to time issue and dispose of any of the authorized and unissued shares of the Common Stock or the Preferred Stock for such consideration as may be fixed from time to time by the Board of Directors, without action by the shareholders. The Board of Directors may provide for payment therefor to be received by the Corporation in cash, property, services or such other consideration as is approved by the Board of Directors. Any and all such shares of the Common Stock or the Preferred Stock of the Corporation, the issuance of which has been so authorized, and for which consideration so fixed by the Board of Directors has been paid or delivered, shall be deemed fully paid stock and shall not be liable to any further call or assessment thereon. 3 4 2.3 DESIGNATION OF SERIES A CONVERTIBLE PREFERRED STOCK The following series of Preferred Stock is hereby designated, which series shall have the rights, preferences, privileges and limitations as set forth below in this Section 2.3: 2.3.1 SERIES A PREFERRED STOCK The series of Series A Convertible Preferred Stock, consisting of 1,935,484 shares, no par value, authorized herein, shall be designated herein as the Series A Stock and shall be convertible into shares of the Corporation's Common Stock, as described in Section 4.3.5. The rights, preferences, restrictions and other matters relating to Series A Stock are set forth below. 2.3.2 DIVIDENDS (a) Subject to the rights of the holders, if any, of any outstanding shares of Preferred Stock of the Corporation having a preferential right to dividends ranking equal or superior to the rights of the holders of Series A Stock, holders of shares of Series A Stock, in preference to holders of shares of Common Stock of the Corporation, shall be entitled to receive out of funds that are legally available therefor when and as declared by the Board of Directors noncumulative cash dividends at the rate of $.000006 per annum on each outstanding share of Series A Stock (as adjusted for any stock dividends, combinations or splits with respect to such shares). (b) So long as any shares of Series A Stock shall remain outstanding, no dividend, whether in cash or property, shall be paid or declared, nor shall any other distribution be made, on any Common Stock until all declared and unpaid dividends on the Series A Stock have been paid. (c) No cash dividends shall be declared on the Common Stock or Preferred Stock having a preferential right to dividends ranking equal to the Series A Stock unless or until a cash dividend in an amount equal to or greater than the dividend declared on the Common Stock or such Preferred Stock having a preferential right to dividends equal to the Series A Stock (dividends shall be compared on an as-converted-to-Common-Stock basis) shall have been paid to, or declared and a sum sufficient for the payment thereof set apart for the Series A Stock. 2.3.3 LIQUIDATION RIGHTS Upon the voluntary or involuntary dissolution, liquidation or winding up of the Corporation, the assets of the Corporation available for distribution to its shareholders shall be distributed in the following order and amounts: 4 5 (a) General. (i) First, the holders, if any, of any outstanding shares of Preferred Stock of the Corporation having a preferential right to liquidation payments ranking superior to the rights of the holders of Series A Stock shall be entitled to receive the full preferential amount per share held by them (the "Superior Liquidation Amount"). If the assets of the Corporation shall be insufficient to permit the payment of the full Superior Liquidation Amount, then the assets of the Corporation available for distribution shall be distributed ratably among the holders of the shares of such superior Preferred Stock in the same proportions as the full Superior Liquidation Amount each such holder would otherwise be entitled to receive bears to the total of the full Superior Liquidation Amount that would otherwise be payable to all holders of such superior Preferred Stock. (ii) If, upon completion of the distribution required by subsection (i) of this Section 2.3.3(a), assets remain in the Corporation, (A) the holders of shares of Series A Stock shall be entitled to receive $.086 for each outstanding share of Series A Stock held by them and (B) the holders, if any, of any outstanding shares of Preferred Stock of the Corporation having a preferential right to liquidation payments ranking equal to the rights of the holders of the Series A Stock shall be entitled to receive the liquidation payment specified for such shares held by them; in addition, each such holder shall be entitled to receive any declared and unpaid dividend per share on such outstanding share of Series A Stock or other parity Preferred Stock (collectively, such liquidation payment amounts are referred to as the "Parity Liquidation Amount"). If, upon the occurrence of such event, the assets of the Corporation shall be insufficient to permit the payment of the full Parity Liquidation Amount, then the assets of the Corporation available for distribution shall be distributed ratably among the holders of shares of Series A Stock and the Preferred Stock, if any, ranking equal to the Series A Stock, in the same proportions as the aggregate of the Parity Liquidation Amount each such holder would otherwise be entitled to receive bears to the total of the Parity Liquidation Amount that would otherwise be payable to all such holders, and no distribution to other shareholders of the Corporation shall be made. (b) Limitation. Upon the completion of the distribution of the distributions contemplated pursuant to Section 2.3.3(a), if assets remain in the Corporation, such remaining assets shall be distributed to the holders of any other class or series of Preferred Stock of the Corporation having a liquidation preference to the extent of, and in accordance with, such preference, and then the holders of the Common Stock shall be entitled to share ratably in the remaining assets of the Corporation. (c) Treatment of Consolidations, Mergers and Sales of Assets. The sale of all or substantially all of the assets of the Corporation, or the acquisition of the Corporation by another entity by means of merger, consolidation, share exchange, reorganization or otherwise pursuant to which shares of capital stock of the Corporation are converted into cash, securities or other property of the acquiring entity or any of its affiliates shall be regarded as a liquidation within the meaning of this Section 2.3.3; provided, however, that each holder of Series A Stock or other shares of convertible Preferred Stock of the Corporation shall have the right to elect the benefits of the provisions of Section 2.3.5 or other applicable conversion provisions in lieu of receiving payment 5 6 in the event of the liquidation, dissolution or winding up of the Corporation pursuant to this Section 2.3.3; provided, further, that this provision shall not apply if the holders of voting capital stock of the Corporation immediately prior to such merger, consolidation, share exchange, reorganization or sale of assets beneficially own, directly or indirectly, 50% or more of the combined voting power of the capital stock of the surviving entity resulting from such merger, consolidation, share exchange or reorganization or the successor corporation in any such sale of assets. (d) Distributions Other Than Cash. Whenever the distribution provided for in this Section 2.3.3 shall be payable in property other than cash, the value of such distribution shall be the fair market value of such property as determined in good faith by the Board of Directors. 2.3.4 VOTING POWER (a) General. Each holder of Series A Stock shall be entitled to vote on all matters submitted to a vote of shareholders and shall be entitled to that number of votes equal to the largest number of whole shares of Common Stock into which such holder's shares of Series A Stock could be converted under Section 2.3.5, at the record date for the determination of shareholders entitled to vote on such matter, or, if no such record date is established, at the date on which notice of the meeting of shareholders at which the vote is to be taken is mailed, or the date any written consent of shareholders is solicited if the vote is not to be taken at a meeting. Except as otherwise expressly provided herein or by the Washington Business Corporation Act, the holders of shares of the Series A Stock and Common Stock shall vote together as a single class on all matters submitted to a vote of shareholders. (b) Series A Stock Voting. Without the affirmative consent of the holders of shares representing at least a majority (unless a greater number is otherwise required by law) of the voting power of the Series A Stock then outstanding, acting separately as a class, given by written consent or by vote at a meeting called for such purpose for which notice shall have been given to the holders of the Series A Stock, the Corporation shall not: (i) authorize or issue (or obligate itself to authorize or issue) any security of the Corporation having rights, preferences or privileges senior to the Series A Stock, (ii) amend its Articles of Incorporation or Bylaws in any manner that materially adversely affects the preferences, privileges, restrictions or other rights of the Series A Stock; (iii) declare or pay any dividends or other distributions on the Common Stock or Series A Stock, or redeem or repurchase any of the Corporation's capital stock (unless such shares are repurchased or redeemed pursuant to the redemption provisions of Section 2.3.7 hereof or from employees, officers, directors, consultants or other persons performing work for the Corporation upon termination of the employment, consulting or other relationship between the Corporation and such person pursuant to an employment or similar vesting agreement or other stock repurchase agreement where the redemption or repurchase price does not exceed the fair 6 7 market value of such shares (as determined by the Board of Directors, whose determination shall be conclusive) or, in the case of unvested shares, the cost of such shares to the holder thereof); (iv) effect any sale, lease, assignment, transfer or other conveyance of material assets of the Corporation to any person other than a wholly owned subsidiary of the Corporation, or any consolidation or merger in which the holders of the Corporation's equity securities do not hold at least a majority of the voting securities of the surviving corporation (v) authorize any increase in the number of authorized shares of Series A Stock; or (vi) approve or effect any liquidation or dissolution of the Corporation. 2.3.5 CONVERSION RIGHTS The holders of Series A Stock shall have the following rights with respect to the conversion of Series A Stock into shares of Common Stock: (a) General. (i) Voluntary Conversion. Any share of Series A Stock may, at the option of the holder, be converted at any time into such number of fully paid and nonassessable shares of Common Stock as is equal to the product obtained by multiplying the Series A Conversion Rate (determined under Section 2.3.5(b)) by the number of shares of Series A Stock being converted. (ii) Mandatory Conversion. Each share of Series A Stock shall be converted automatically, without any action by the holders of such shares and whether or not the certificates representing such shares are surrendered to the Corporation or its transfer agent, into the number of shares of Common Stock into which such Series A Stock is convertible pursuant to Section 2.3.5(a)(i) upon the earliest of, (A) immediately prior to the closing of a firmly underwritten, public offering by the Corporation of shares of Common Stock, registered under the Securities Act of 1933, as amended, in which the aggregate gross offering proceeds are in excess of $10,000,000 (before deduction of underwriters' discounts and commissions and expenses of the offering) and the per share price at which such shares of Common Stock are offered to the public is at least equal to $5.00 (appropriately adjusted to reflect the occurrence of any extraordinary Common Stock Event (as defined below)), or (B) the consent or vote by holders of at least two-thirds of the Series A Stock then outstanding to such conversion. Any such automatic conversion shall take precedence over and shall occur irrespective of any notice of redemption of any shares of Series A Stock if such conversion occurs prior to the applicable Redemption Date (as defined in Section 2.3.7(d)) for such shares. (b) Conversion Rate. The conversion rate for Series A Stock in effect at any time (the "Series A Conversion Rate") shall equal $.086 divided by the Series A Conversion Price, calculated as provided in Section 2.3.5(c). 7 8 (c) Conversion Price. The conversion price for Series A Stock in effect from time to time shall initially be $.086, subject to adjustment, in accordance with Section 2.3.5(d) (the "Series A Conversion Price"). (d) Adjustments to Applicable Conversion Price. (i) Extraordinary Common Stock Event. Upon the happening of an Extraordinary Common Stock Event (as defined below) after the date of the initial issuance of any shares of Series A Stock, the Series A Conversion Price shall, simultaneously with the happening of such Extraordinary Common Stock Event, be adjusted by multiplying the then effective Series A Conversion Price by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such Extraordinary Common Stock Event and the denominator of which shall be the number of shares of Common Stock outstanding immediately after such Extraordinary Common Stock Event, and the product so obtained shall thereafter be the Series A Conversion Price. The Series A Conversion Price, as so adjusted, shall be readjusted in the same manner upon the happening of any successive Extraordinary Common Stock Event or Events. "Extraordinary Common Stock Event" shall mean (x) the issuance of additional shares of Common Stock as a dividend or other distribution on outstanding Common Stock of the Corporation, (y) a subdivision of outstanding shares of Common Stock into a greater number of shares of Common Stock, or (z) a combination of outstanding shares of Common Stock into a smaller number of shares of Common Stock. (ii) Sale of Shares Below Applicable Conversion Price. (A) If the Corporation shall issue any Additional Stock (as defined in Section 2.3.5(d)(iii)) without consideration or for a consideration per share less than the Series A Conversion Price in effect immediately before the issuance of such Additional Stock, the Series A Conversion Price in effect upon issuance (except as otherwise provided in this Section 2.3.5(d)(ii)) shall be adjusted to a price equal to the quotient obtained by dividing the total computed under clause (x) below by the total computed under clause (y) below as follows: (x) an amount equal to the sum of (1) the result obtained by multiplying the number of shares of Common Stock deemed outstanding immediately prior to such issuance (which shall include the actual number of shares outstanding plus all shares issuable upon the conversion or exercise of all outstanding convertible securities, warrants and options) by the Series A Conversion Price then in effect, and (2) the aggregate consideration, if any, received by the Corporation upon the issuance of such Additional Stock; (y) the number of shares of Common Stock of the Corporation outstanding immediately after each issuance (including the shares deemed outstanding as provided above). (B) No adjustment of the Series A Conversion Price shall be made in an amount less than $.01 per share, provided that any adjustments that are not required to 8 9 be made by reason of this sentence shall be carried forward and shall be taken into account in any subsequent adjustment made to the Series A Conversion Price. Except as provided in Subsections 2.3.5(d)(i) and 2.3.5(d)(ii)(E)(3) and (4), no adjustment of the Series A Conversion Price pursuant to this Section 2.3.5(d)(ii) shall have the effect of increasing the Series A Conversion Price above the Series A Conversion Price in effect immediately before such adjustment. (C) In the case of the issuance of Common Stock for cash, the consideration shall be deemed to be the amount of cash paid therefor before deducting any discounts, commissions or other expenses allowed, paid or incurred by the Corporation for any underwriting or otherwise in connection with the issuance and sale thereof. (D) In the case of the issuance of Common Stock for consideration in whole or in part other than cash, the consideration other than cash shall be deemed to be the fair value thereof as determined by the Board irrespective of any accounting treatment. (E) In the case of the issuance of options to purchase or rights to subscribe for Common Stock, securities by their terms convertible into or exchangeable for Common Stock, or options to purchase or rights to subscribe for such convertible or exchangeable securities (which options, rights, or convertible or exchangeable securities are not excluded from the definition of Additional Stock), the following provisions shall apply: (1) the aggregate maximum number of shares of Common Stock deliverable upon exercise of such options to purchase or rights to subscribe for Common Stock shall be deemed to have been issued at the time such options or rights were issued for a consideration equal to the consideration (determined in the manner provided in Subsections 2.3.5(d)(ii)(C) and (D)) received by the Corporation upon the issuance of such options or rights, plus the minimum purchase price provided in such options or rights for the Common Stock covered thereby, but no further adjustment to the Series A Conversion Price shall be made for the actual issuance of Common Stock upon the exercise of such options or rights in accordance with their terms; (2) the aggregate maximum number of shares of Common Stock deliverable upon conversion of or in exchange for any such convertible or exchangeable securities or upon the exercise of options to purchase or rights to subscribe for such convertible or exchangeable securities and subsequent conversion or exchange thereof shall be deemed to have been issued at the time such securities were issued or such options or rights were issued for a consideration equal to the consideration received by the Corporation for any such securities and related options or rights, plus the additional consideration, if any, to be received by the Corporation upon the conversion or exchange of such securities or the exercise of any related options or rights (the consideration in each case to be determined in the manner provided in Subsections 2.3.5(d)(ii)(C) and (D)), but no further adjustments to the Series A Conversion Price shall be made for the actual issuance of Common Stock upon the conversion or exchange of such securities in accordance with their terms; 9 10 (3) if such options, rights, or convertible or exchangeable securities by their terms provide, with the passage of time or otherwise, for any increase in the consideration payable to the Corporation, or decrease in the number of shares of Common Stock issuable, upon the exercise, conversion or exchange thereof, the Series A Conversion Price computed upon the original issue thereof, and any subsequent adjustments based thereon, shall, upon such increase or decrease becoming effective, be recomputed to reflect such increase or decrease with respect to such options, rights and securities not already exercised, converted or exchanged before such increase or decrease became effective, but no further adjustment to the Series A Conversion Price shall be made for the actual issuance of Common Stock upon the exercise of any such options or rights or the conversion or exchange of such securities in accordance with their terms; (4) upon the expiration of any such options or rights, the termination of any such rights to convert or exchange, or the expiration of any options or rights related to such convertible or exchangeable securities, the Series A Conversion Price shall forthwith be readjusted to such Series A Conversion Price as would have been obtained had the adjustment that was made upon the issuance of such options, rights, or securities or options or rights related to such securities been made upon the basis of the issuance of only the number of shares of Common Stock actually issued upon the exercise of such options or rights, upon the conversion or exchange of such securities or upon the exercise of the options or rights related to such securities; and (5) if any such options or rights shall be issued in connection with the issuance and sale of other securities of the Corporation, together comprising one integral transaction in which no specific consideration is allocated to such options or rights by the parties thereto, such options or rights shall be deemed to have been issued for such consideration as determined in good faith by the Board. (iii) Additional Stock. "Additional Stock" shall mean any shares of Common Stock or securities convertible into or exchangeable or exercisable for shares of Common Stock issued (or deemed to have been issued pursuant to Subsection 2.3.5(d)(ii)(E)) by the Corporation after the date of first issuance of Series A Stock other than: (A) Common Stock issued pursuant to a transaction for which the Series A Conversion Price is adjusted under Section 2.3.5(d)(i); (B) up to 1,500,000 shares of Common Stock issued or issuable (whether directly or pursuant to stock options or warrants) to employees, directors, advisors or consultants; (C) Common Stock issued or issuable upon conversion of or as a dividend or distribution on Series A Stock; (D) Common Stock issued or issuable in connection with: (i) the acquisition of another corporation or entity by the Corporation or any subsidiary of the Corporation by means of a merger, consolidation, purchase of assets or other transaction or series of related 10 11 transactions whereby the Corporation owns a majority of the voting power of such other entity following such acquisition; (ii) the acquisition by the Corporation of intellectual property rights, including intellectual property licenses; or (iii) the creation of a corporate or other joint venture or any other strategic alliance with any other corporation or entity; provided, however, that each such transaction shall have been approved by the Board of Directors and that with respect to each such transaction or series of related transactions, the number of shares of Common Stock issued thereunder shall not exceed 10% of the number of shares of Common Stock outstanding immediately prior to such transaction or series of transactions. (e) Capital Reorganization or Reclassification. If the Common Stock issuable upon the conversion of Series A Stock shall be changed into the same or different number of shares of any class or classes of stock of the Corporation, whether by capital reorganization, reclassification or otherwise (other than a subdivision or combination of shares or stock dividend provided for in Section 2.3.5(d) or a merger, consolidation, share exchange or reorganization provided for in Section 2.3.3(c)), then and in each such event the holder of each share of Series A Stock shall have the right thereafter to convert such share into the kind and amount of shares of stock and other securities and property receivable upon such reorganization, reclassification or other change by holders of the number of shares of Common Stock into which such share of Series A Stock, respectively, could have been converted immediately prior to such reorganization, reclassification or change, all subject to further adjustment as provided herein. (f) Accountant's Certificate as to Adjustments, Notice by the Corporation. In each case of an adjustment or readjustment of the Series A Conversion Rate, the Corporation at its expense will furnish each holder of Series A Stock, as applicable, with a certificate, prepared by the Chief Financial Officer of the Corporation, showing such adjustment or readjustment and stating in detail the facts upon which such adjustment or readjustment is based. (g) Exercise of Conversion Privilege. (i) Generally. Promptly after receiving the certificate representing shares of any Series A Stock being converted, the Corporation shall: (A) issue and deliver to the holder of the shares being converted, or, if permitted by applicable securities laws, to the nominee or nominees of such holder, a certificate or certificates as such holder may request for the number of whole shares of Common Stock that is nearest to the number of shares of Common Stock issuable in accordance with the provisions of this Section 2.3.5 upon the conversion of such shares of Series A Stock and (B) pay to such holder or its nominee any declared but unpaid dividends on the shares being converted. Conversion shall be deemed to have been effected immediately prior to the close of business on the Conversion Date (as defined below for voluntary conversions and for mandatory conversions), and at such time, whether or not certificates representing the shares being converted shall have been received by the Corporation or its transfer agent in the case of a mandatory conversion, the rights of the holder as holder of the converted shares of Series A Stock, as applicable, shall cease and the person or persons in whose name or names any certificate or certificates for shares of Common Stock shall be issuable upon such conversion shall be deemed to have become the holder or holders of record of the shares of Common Stock represented thereby. 11 12 (ii) Voluntary Conversion. Before any holder of shares of Series A Stock shall be entitled to voluntarily convert such shares to Common Stock pursuant to Section 2.3.5(a)(i), such holder shall surrender the certificate or certificates therefor, duly endorsed, at the office of the Corporation or of any transfer agent for such shares and, if appropriate, shall give written notice by mail, postage prepaid, addressed to the same location at which the certificate or certificates were or will be surrendered, of the election to convert such shares and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. With respect to a voluntary conversion pursuant to Section 2.3.5(a)(i), the date when written notice of the holder's election to convert is received by the Corporation or a transfer agent for the shares to be converted, together with the certificate or certificates representing the shares to be converted, shall be the "Conversion Date." (iii) Mandatory Conversion. Holders of shares of Series A Stock converted pursuant to the mandatory conversion provisions of Section 2.3.5(a)(ii) shall promptly surrender the certificate or certificates therefor, duly endorsed, at the office of the Corporation or of any transfer agent for such shares and, if other than the record holder of the converted shares, shall state the name or names in which the certificate or certificates for shares of Common Stock are to be issued. Whether or not such certificate or certificates have been so surrendered, with respect to mandatory conversions pursuant to Section 2.3.5(a)(ii), the applicable date specified in Section 2.3.5(a)(ii) for automatic conversion shall be the "Conversion Date." (h) Partial Conversion. In the event some but not all of the shares of Series A Stock represented by a certificate or certificates surrendered by a holder are converted, the Corporation shall execute and deliver to or on the order of the holder, at the expense of the Corporation, a new certificate representing the shares of Series A Stock that were not converted. (i) Reservation of Common Stock. The Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of the shares of the Series A Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of the Series A Stock and, if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then outstanding shares of the Series A Stock, the Corporation shall immediately take such corporate action as may be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purpose. 2.3.6 NO REISSUANCE OF STOCK No share or shares of Series A Stock converted, purchased or otherwise acquired by the Corporation shall be reissued, and all such shares shall be cancelled, retired and eliminated from the shares that the Corporation shall be authorized to issue. The Corporation may from time to time take such appropriate corporate action as may be necessary to reduce the authorized number of shares of Series A Stock accordingly. 12 13 2.3.7 REDEMPTION (a) No Call. The Corporation shall not have the right to call for redemption all or any part of the Series A Stock, but may, pursuant to the terms of this Section 2.3.7, have the obligation to redeem Series A Stock. (b) Option to Require Redemption. On July 1, 2002, the Corporation shall, upon receipt of at least 60 days' prior written request by the holders of at least 60% of the Series A Stock then outstanding, redeem up to one-third of the Series A Stock then outstanding. On July 1, 2003, the Corporation shall, upon receipt of at least 60 days' prior written request by the holders of at least 60% of the Series A Stock then outstanding, redeem up to an additional one-third of the Series A Stock then outstanding. On July 1, 2004, the Corporation shall, upon receipt of at least 60 days' prior written request by the holders of at least 60% of the Series A Stock then outstanding, redeem up to the balance of the Series A Stock then outstanding. (c) Redemption Price. The redemption price per share of Series A Stock shall be equal to $.086 plus $.000006 per annum from the date such share was issued (the "Series A Redemption Price"). The Series A Redemption Price shall be appropriately adjusted for any stock dividends, splits or combinations applicable to the Series A Stock. (d) Notice of Redemption. Upon receiving a notice requesting redemption pursuant to Section 2.3.7(b), the Corporation shall within five business days mail by certified or registered mail a written notice (a "Redemption Notice") to each holder of record of Series A Stock, as applicable, at the address last shown on the records of the Corporation, with a copy of the Redemption Notice to each such holder sent by facsimile transmission or by tested or otherwise authenticated telex. Each Redemption Notice shall state that a redemption pursuant to this Section 2.3.7 has been requested and shall specify the date fixed for such redemption (the "Redemption Date"), which date shall be July 1 of the calendar year in which the redemption is requested or the first day thereafter on which banks in Seattle, Washington, are not authorized to be closed, and shall specify the maximum number of shares that could be redeemed from each Series A holder, and each holder of Series A Stock shall have until the close of business on the date 10 business days before each Redemption Date to request the redemption of up to the maximum number of shares of Series A Stock such holder is entitled to redeem. No defect in the Redemption Notice or any response thereto or in the mailing or publication thereof shall affect the validity of the redemption proceeding with respect to the Corporation or any holder of Series A Stock; provided, however, that the Corporation or such holder has timely received actual notice of the redemption. (e) Surrender of Stock. On or after the Redemption Date, each holder of shares of Series A Stock, the redemption of which was requested by the holder pursuant to Section 2.3.7(d), shall surrender the certificate or certificates evidencing such shares to the Corporation at any place designated for such surrender in the Redemption Notice and shall then be entitled to receive payment in cash, by wire transfer or by bank-certified check of the Series A Redemption Price for each share of Series A Stock to be redeemed. If less than all the shares represented by a 13 14 share certificate are to be redeemed, the Corporation shall promptly issue a new certificate representing the shares not redeemed (f) Failure to Redeem. If the Corporation shall fail to discharge its obligation to redeem shares of Series A Stock pursuant to this Section 2.3.7 (the "Redemption Obligation"), the Redemption Obligation shall be discharged, pro rata with respect to each holder based on the number of shares requested to be redeemed, as soon as the Corporation is permitted by law to discharge such Redemption Obligation. If and so long as any Redemption Obligation shall not fully be discharged, the Corporation shall not, directly or indirectly, declare or pay any dividend or make any distribution on, or purchase, redeem, or satisfy any mandatory redemption, sinking fund or other similar obligation in respect of, any securities ranking junior to the Series A Stock with respect to liquidation preference, redemption rights or warrants, rights or options exercisable for any such junior securities. If and so long as any Redemption Obligation shall not fully be discharged, the Corporation shall not, directly or indirectly, declare or pay any dividend or make any distribution on, or purchase, redeem, or satisfy any mandatory redemption, sinking fund or other similar obligation in respect of, any securities ranking on a parity to the Series A Stock with respect to liquidation preference or redemption rights ("parity securities"), unless such dividends or distributions on the shares of Series A Stock and the shares of such parity securities are declared and paid on a pro rata basis, or, in the event any mandatory redemption, sinking fund or other similar obligation is then undischarged with respect to such parity securities, unless shares of Series A Stock and such parity securities are redeemed on a pro rata basis. For purposes of this Section 2.3.7(f), "pro rata basis" shall refer to the proportion that the distribution payable to holders of Series A Stock or parity securities, respectively, bears to the aggregate distribution payable to all holders of Series A Stock and parity securities. (g) Status of Redeemed Shares. From and after the Redemption Date, unless default shall be made by the Corporation in paying the Series A Redemption Price at the time and place specified in the Redemption Notice, all dividends on shares of Series A Stock to be redeemed on such Redemption Date shall cease and all rights of holders of such shares shall cease, except the right of holders of such shares to receive the Series A Redemption Price, as applicable, against delivery of certificates representing such shares, and such shares shall cease to be outstanding. 2.3.8 NOTICES OF RECORD DATE In the event of (a) any capital reorganization of the Corporation, any reclassification or recapitalization of the capital stock of the Corporation, any merger or consolidation of the Corporation, or any transfer of all or substantially all of the assets of the Corporation or (b) any voluntary or involuntary dissolution, liquidation or winding up of the Corporation, then and in each such event the Corporation shall mail or deliver or cause to be mailed or delivered to each holder of Series A Stock a notice specifying (i) the date on which any such reorganization, 14 15 reclassification, recapitalization, merger, consolidation, transfer, dissolution, liquidation or winding up is expected to become effective and (ii) the time, if any, that is to be fixed, as to when the holders of record of Common Stock (or other securities) shall be entitled to exchange their shares of Common Stock (or other securities) for securities or other property deliverable upon such reorganization, reclassification, recapitalization, merger, consolidation, transfer, dissolution, liquidation or winding up. Such notice shall be mailed or delivered at least 20 days prior to the date specified in such notice on which such action is to be taken. 2.4 DESIGNATION OF SERIES B CONVERTIBLE PREFERRED STOCK The following series of Preferred Stock is hereby designated, which series shall have the rights, preferences, privileges and limitations as set forth below in this Section 2.4: 2.4.1 SERIES B PREFERRED STOCK The series of Series B Convertible Preferred Stock, consisting of 1,250,000 shares, authorized herein, is designated in these Articles of Incorporation as the "Series B Stock" and will be convertible into shares of the Corporation's Common Stock, as described in Section 2.4.5. The rights, preferences, restrictions and other matters relating to Series B Stock are set forth below. 2.4.2 DIVIDENDS The holders of shares of Series B Stock shall be entitled to receive dividends, out of the funds of the corporation legally available therefor, at the rate and at the time or times, whether cumulative or noncumulative, as may be provided by the Board of Directors. This right to receive dividends shall be on an equal basis with the holders of shares of Common Stock but subject to any preferential rights granted for any other series of Preferred Stock. 2.4.3 LIQUIDATION RIGHTS Upon the voluntary or involuntary dissolution, liquidation or winding up of the Corporation, the assets of the Corporation available for distribution to its shareholders shall be distributed in the following order and amounts: (a) General. (i) First, the holders, if any, of any outstanding shares of Preferred Stock of the corporation having a preferential right to liquidation payments shall be entitled to receive the full preferential amount per share held by them (the "Superior Liquidation Amount"). If the assets of the corporation shall be insufficient to permit the payment of the full Superior Liquidation Amount, then the assets of the corporation available for distribution shall be distributed ratably among the holders of the shares of such superior Preferred Stock in the same proportions as the full Superior Liquidation Amount each such holder would otherwise be 15 16 entitled to receive bears to the total of the full Superior Liquidation Amount that would otherwise be payable to all holders of such superior Preferred Stock. (ii) If, upon completion of the distribution required by subsection (i) of this Section 2.6.3(a), assets remain in the corporation, the holders of outstanding shares of Series B Stock and Common Stock shall be entitled to share ratably in the such assets. (b) Distributions Other Than Cash. Whenever the distribution provided for in this Section 2.4.3 shall be payable in property other than cash, the value of such distribution shall be the fair market value of such property as determined in good faith by the Board of Directors. 2.4.4 VOTING POWER The holders of Series B Stock will have the right, as a separate voting group, to elect one director, who must be reasonably acceptable to the other directors. Except for such right or as otherwise expressly provided by the Washington Business Corporation Act, the holders of Series B Stock shall not be entitled to vote on any matter submitted to a vote of shareholders. 2.4.5 CONVERSION RIGHTS The holders of Series B Stock shall have the following rights with respect to the conversion of Series B Stock into shares of Common Stock: (a) General. (i) Voluntary Conversion. Any share of Series B Stock may, at the option of the holder, be converted at any time into such number of fully paid and nonassessable shares of Common Stock as is equal to the product obtained by multiplying the Series B Conversion Rate (determined under Section 2.4.5(b)) by the number of shares of Series B Stock being converted. (ii) Mandatory Conversion. Each share of Series B Stock shall be converted automatically, without any action by the holders of such shares and whether or not the certificates representing such shares are surrendered to the Corporation or its transfer agent, into the number of shares of Common Stock into which such Series B Stock is convertible pursuant to Section 2.4.5(a)(i) upon the earlier of (A) the closing of a firmly underwritten, public offering by the corporation of shares of Common Stock, registered under the Securities Act of 1933, as amended, on a Form S-1 or successor form in which the pre-money valuation of the corporation is at least $75,000,000, or (B) December 31, 2000. (b) Conversion Rate. The conversion rate for Series B Stock in effect at any time (the "Series B Conversion Rate") shall equal $1.00 divided by the Series B Conversion Price, calculated as provided in Section 2.4.5(c). 16 17 (c) Conversion Price. The conversion price for Series B Stock in effect from time to time shall initially be $0.10, subject to adjustment, in accordance with Section 2.4.5(d) (the "Series B Conversion Price"). (d) Adjustments to Applicable Conversion Price. (i) Extraordinary Common Stock Event. Upon the happening of an Extraordinary Common Stock Event (as defined below) after the date of the initial issuance of any shares of Series B Stock, the Series B Conversion Price shall, simultaneously with the happening of such Extraordinary Common Stock Event, be adjusted by multiplying the then effective Series B Conversion Price by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such Extraordinary Common Stock Event and the denominator of which shall be the number of shares of Common Stock outstanding immediately after such Extraordinary Common Stock Event, and the product so obtained shall thereafter be the Series B Conversion Price. The Series B Conversion Price, as so adjusted, shall be readjusted in the same manner upon the happening of any successive Extraordinary Common Stock Event or Events. "Extraordinary Common Stock Event" shall mean (x) the issuance of additional shares of Common Stock as a dividend or other distribution on outstanding Common Stock of the Corporation, (y) a subdivision of outstanding shares of Common Stock into a greater number of shares of Common Stock, or (z) a combination of outstanding shares of Common Stock into a smaller number of shares of Common Stock. (ii) Other Distributions. In the event this corporation shall declare a distribution payable in securities of other persons, evidences of indebtedness issued by this corporation or other persons, assets (excluding cash dividends), options or rights, then, in each such case for the purpose of this Subsection 2.4.5(d)(ii), the holders of the Series B Stock shall be entitled to a proportionate share of any such distribution as though they were the holders of the number of shares of Common Stock of this corporation into which their shares of Series B Stock are convertible as of the record date fixed for the determination of the holders of Common Stock of this corporation entitled to receive such distribution. (e) Capital Reorganization or Reclassification. If the Common Stock issuable upon the conversion of Series B Stock shall be changed into the same or different number of shares of any class or classes of stock of the Corporation, whether by capital reorganization, reclassification or otherwise (other than a subdivision or combination of shares or stock dividend provided for in Section 2.4.5(d)), then and in each such event the holder of each share of Series B Stock shall have the right thereafter to convert such share into the kind and amount of shares of stock and other securities and property receivable upon such reorganization, reclassification or other change by holders of the number of shares of Common Stock into which such share of Series B Stock, respectively, could have been converted immediately prior to such reorganization, reclassification or change, all subject to further adjustment as provided herein, and in any such case appropriate provisions shall be made with respect to the rights and interests of such holder to the end that the provisions hereof shall thereafter be applicable, as nearly as may be, in relation to any shares of stock, securities or assets thereafter deliverable upon the exercise of such conversion rights. 17 18 (f) Accountant's Certificate as to Adjustments, Notice by the Corporation. In each case of an adjustment or readjustment of the Series B Conversion Rate, the Corporation at its expense will furnish each holder of Series B Stock, as applicable, with a certificate, prepared by the Chief Financial Officer of the Corporation, showing such adjustment or readjustment and stating in detail the facts upon which such adjustment or readjustment is based. (g) Exercise of Conversion Privilege. (i) Generally. Promptly after receiving the certificate representing shares of any Series B Stock being converted, the Corporation shall: (A) issue and deliver to the holder of the shares being converted, or, if permitted by applicable securities laws, to the nominee or nominees of such holder, a certificate or certificates as such holder may request for the number of whole shares of Common Stock that is nearest to the number of shares of Common Stock issuable in accordance with the provisions of this Section 2.4.5 upon the conversion of such shares of Series B Stock and (B) pay to such holder or its nominee any declared but unpaid dividends on the shares being converted. Conversion shall be deemed to have been effected immediately prior to the close of business on the Conversion Date (as defined below for voluntary conversions and for mandatory conversions), and at such time, whether or not certificates representing the shares being converted shall have been received by the Corporation or its transfer agent in the case of a mandatory conversion, the rights of the holder as holder of the converted shares of Series B Stock, as applicable, shall cease and the person or persons in whose name or names any certificate or certificates for shares of Common Stock shall be issuable upon such conversion shall be deemed to have become the holder or holders of record of the shares of Common Stock represented thereby. The corporation shall not be required to issue any fraction of a share of Common Stock upon conversion of Series B Stock; if any fraction of a share of Common Stock would, except for the foregoing clause, be issuable to any holder on the conversion of any Series B Stock, the Corporation shall pay to the holder of such converted Series B Stock an amount in cash equal to the then current fair market value of such fractional interest. (ii) Voluntary Conversion. Before any holder of shares of Series B Stock shall be entitled to voluntarily convert such shares to Common Stock pursuant to Section 2.4.5(a)(i), such holder shall surrender the certificate or certificates therefor, duly endorsed, at the office of the Corporation or of any transfer agent for such shares and, if appropriate, shall give written notice by mail, postage prepaid, addressed to the same location at which the certificate or certificates were or will be surrendered, of the election to convert such shares and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. With respect to a voluntary conversion pursuant to Section 2.4.5(a)(i), the date when written notice of the holder's election to convert is received by the Corporation or a transfer agent for the shares to be converted, together with the certificate or certificates representing the shares to be converted, shall be the "Conversion Date." (iii) Mandatory Conversion. Holders of shares of Series B Stock converted pursuant to the mandatory conversion provisions of Section 2.4.5(a)(ii) shall promptly 18 19 surrender the certificate or certificates therefor, duly endorsed, at the office of the Corporation or of any transfer agent for such shares and, if other than the record holder of the converted shares, shall state the name or names in which the certificate or certificates for shares of Common Stock are to be issued. The Corporation will give such holders written notice at least five days prior to the date on which they are requested to surrender their certificate or certificates. Whether or not such certificate or certificates have been so surrendered, with respect to mandatory conversions pursuant to Section 2.4.5(a)(ii), the applicable date specified in Section 2.4.5(a)(ii) for automatic conversion shall be the "Conversion Date." (h) Partial Conversion. In the event some but not all of the shares of Series B Stock represented by a certificate or certificates surrendered by a holder are converted, the Corporation shall execute and deliver to or on the order of the holder, at the expense of the Corporation, a new certificate representing the shares of Series B Stock that were not converted. (i) Reservation of Common Stock. The Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of the shares of the Series B Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of the Series B Stock and, if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then outstanding shares of the Series B Stock, the Corporation shall immediately take such corporate action as may be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purpose. The Corporation covenants that all shares of Common Stock which shall be so issued shall be duly and validly issued and fully paid and nonassessable and free from all taxes, liens and charges with respect to the issue thereof. The Corporation will take such action as may be necessary to assure that all such shares of Common Stock may be so issued without violation of any applicable law or regulation, or of any requirement of any securities exchange upon which the Common Stock may be listed. 2.4.6 NO REISSUANCE OF STOCK No share or shares of Series B Stock converted, purchased or otherwise acquired by the Corporation shall be reissued, and all such shares shall be cancelled, retired and eliminated from the shares that the Corporation shall be authorized to issue. The Corporation may from time to time take such appropriate corporate action as may be necessary to reduce the authorized number of shares of Series B Stock accordingly. 2.4.7 NOTICES OF CERTAIN EVENTS If the Corporation becomes subject to: 19 20 (a) any capital reorganization of the Corporation, any reclassification or recapitalization of the Corporation's capital stock, any merger or consolidation of the Corporation, or any transfer of all or substantially all of the assets of the Corporation, or (b) any voluntary or involuntary dissolution, liquidation or winding up of the Corporation, then the Corporation will mail or deliver or cause to be mailed or delivered to each holder of Series B Stock at least twenty (20) days' prior written notice specifying (i) the expected effective date of such reorganization, reclassification, recapitalization, merger, consolidation, transfer, dissolution, liquidation or winding up, and (ii) the time, if any, that is to be fixed, as to when the holders of record of Common Stock (or other securities) will be entitled to exchange their shares of Common Stock (or other securities) for securities or other property deliverable upon such reorganization, reclassification, recapitalization, merger, consolidation, transfer, dissolution, liquidation or winding up. ARTICLE 3. DIRECTORS The number of directors of the Corporation and the manner in which such directors are to be elected shall be as set forth in the bylaws. The terms of the initial directors shall expire at the first shareholders' meeting at which directors are elected. ARTICLE 4. SHAREHOLDERS' RIGHTS Shareholders of the Corporation have no preemptive rights to acquire additional shares issued by the Corporation. ARTICLE 5. VOTING RIGHTS 5.1 APPROVAL OF CERTAIN TRANSACTIONS Subsequent to the date that a class of the Corporation's shares are registered pursuant to Section 12 or Section 15 under the Securities Exchange Act of 1934, as amended, a majority of all votes entitled to be cast by a voting group will be sufficient to approve any (a) amendment to the Articles of Incorporation, (b) plan of merger or share exchange, (c) sale of assets other than in the usual and regular course of business of the Corporation or (d) dissolution of the Corporation. 5.2 NO CUMULATIVE VOTING No cumulative voting for directors shall be permitted. 20 21 ARTICLE 6. DIRECTOR LIABILITY AND INDEMNIFICATION 6.1 LIMITATION OF DIRECTOR LIABILITY No director of the Corporation shall be personally liable to the Corporation or its shareholders for monetary damages for his or her conduct as a director, except for (i) acts or omissions that involve intentional misconduct of a knowing violation of law by the director, (ii) conduct violating RCW 23B.08.310, or (iii) any transaction from which the director will personally receive a benefit in money, property or services to which the director is not legally entitled. If the Washington Business Corporation Act is amended in the future to authorize corporate action further eliminating or limiting the personal liability of directors, then the liability of a director of the Corporation shall be deemed eliminated or limited to the fullest extent permitted by the Washington Business Corporation Act, as so amended, without any requirement of further action by the shareholders. 6.2 INDEMNIFICATION 6.2.1 The Corporation shall indemnify and hold harmless each individual who is or was serving as a director or officer of the Corporation or who, while serving as a director or officer of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise, against any and all liability incurred with respect to any proceeding to which the individual is or is threatened to be made a party because of such service, and shall make advances of reasonable expenses with respect to such proceeding, to the fullest extent permitted by law, without regard to the limitations in RCW 23B.08.510 through 23B.08.550; provided that no such indemnity shall indemnify any director or officer from or on account of (a) acts or omissions of the director or officer finally adjudged to be intentional misconduct or a knowing violation of law; (b) conduct of the director or officer finally adjudged to be in violation of RCW 23B.08.310; or (c) any transaction with respect to which it was finally adjudged that such director or officer personally received a benefit in money, property, or services to which the director or officer was not legally entitled. 6.2.2 The Corporation may purchase and maintain insurance on behalf of an individual who is or was a director, officer, employee, or agent of the Corporation or, who, while a director, officer, employee, or agent of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise against liability asserted against or incurred by the individual in that capacity or arising from the individual's status as a director, officer, employee, or agent, whether or not the Corporation would have power to indemnify the individual against such liability under RCW 23B.08.510 or 23B.08.520. 6.2.3 If, after the effective date of this Section 6.2, the Washington Business Corporation Act (the "Act") is amended to authorize further indemnification of directors or 21 22 officers, then directors and officers of the Corporation shall be indemnified to the fullest extent permitted by the Act as so amended. 6.2.4 To the extent permitted by law, the rights to indemnification and advance of reasonable expenses conferred in this Section 6.2 shall not be exclusive of any other right which any individual may have or hereafter acquire under any statute, provision of the Bylaws, agreement, vote of shareholders or disinterested directors, or otherwise. The right to indemnification conferred in this Section 6.2 shall be a contract right upon which each director or officer shall be presumed to have relied in determining to serve or to continue to serve as such. Any amendment to or repeal of this Section 6.2 shall not adversely affect any right or protection of a director or officer of the Corporation for or with respect to any acts or omissions of such director or officer occurring prior to such amendment or repeal. 6.2.5 If any provision of this Section 6.2 or any application thereof shall be invalid, unenforceable, or contrary to applicable law, the remainder of this Section 6.2, and the application of such provisions to individuals or circumstances other than those as to which it is held invalid, unenforceable, or contrary to applicable law, shall not be affected thereby. ARTICLE 7. INCORPORATOR The name and address of the incorporator are:
Name Address ---- ------- Bryce L. Holland, Jr. Two Union Square 601 Union Street Seattle, Washington 98101-2346
ARTICLE 8. AMENDMENT OF ARTICLES The Corporation reserves the right to amend, alter, change or repeal any provision contained in these Articles of Incorporation, in the manner now or hereafter prescribed by law, and all rights and powers conferred herein on shareholders and directors are subject to this reserved power. Dated: September __, 1999 FREESHOP.COM, INC. By -------------------------------------- Timothy Choate President and CEO EX-3.2 4 AMENDED AND RESTATED BYLAWS OF REGISTRANT 1 (as of September 8, 1999) AMENDED AND RESTATED BYLAWS OF FREESHOP.COM, INC. ARTICLE I Registered Office and Registered Agent 1. The registered office of the Corporation shall be located in the State of Washington at such place as may be fixed from time to time by the Board of Directors upon filing of such notices as may be required by law, and the registered agent shall have a business office identical with such registered office. A registered agent so appointed shall consent to appointment in writing and such consent shall be filed with the Secretary of State of the State of Washington. 2. If a registered agent changes the street address of the agent's business office, the registered agent may change the street address of the registered office of the Corporation by notifying the Corporation in writing of the change and signing, either manually or in facsimile, and delivering to the Secretary of State for filing a statement of such change, as required by law. 3. The Corporation may change its registered agent at any time upon the filing of an appropriate notice with the Secretary of State, with the written consent of the new registered agent either included in or attached to such notice. ARTICLE II Shareholders' Meetings 1. Meeting Place. All meetings of the shareholders shall be held, pursuant to proper notice as set forth in Article II Section 5 of these Bylaws, at the principal executive office of the Corporation, or at such other place as shall be determined from time to time by the Board of Directors. 2. Annual Meeting Time. The annual meeting of the shareholders for the election of directors and for the transaction of such other business as may properly come before the meeting shall be held each year on such date and at such hour as may be determined by resolution of the Board of Directors from time to time. In the absence of such determination, the annual meeting shall be held each year on the 15th day of March at the hour of 10:00 a.m. if not a 1 2 Saturday, Sunday or legal holiday, and if a Saturday, Sunday or legal holiday, then on the next business day following, at the same hour. 3. Annual Meeting - Order of Business. At the annual meeting of shareholders, the order of business shall be as follows: (a) Call to order. (b) Proof of notice of meeting (or filing of waiver). (c) Reading of minutes of last annual meeting. (d) Reports of officers. (e) Reports of committees. (f) Election of directors. (g) Other business. 4. Special Meetings. Special meetings of the shareholders for any purpose may be called at any time by the President, the Board of Directors or the holders of at least ten percent of all the votes entitled to be cast on any issue proposed to be considered at such special meeting in accordance with RCW 23B.07.020. Special shareholders' meetings shall be held at the Corporation's principal executive office or at such other place as shall be identified in the notice of such meeting. 5. Notice. (a) Except as provided in subsection (c) hereunder, notice of the date, time and place of the annual meeting of shareholders shall be given by delivering personally or by mailing a written or printed notice of the same, not less than ten (10) days, and not more than sixty (60) days, prior to the meeting to each shareholder of record entitled to vote at such meeting. (b) Except as provided in subsection (c) hereunder, written or printed notice of each special meeting of shareholders shall be given not less than ten (10) days and not more than sixty (60) days prior to the meeting. Such notice shall state the date, time and place of such meeting, and the purpose or purposes for which the meeting is called, and shall be delivered personally, or mailed to each shareholder of record entitled to vote at such meeting. (c) Notice of a shareholders' meeting at which the shareholders will be called to act on an amendment to the articles of incorporation, a plan of merger or share exchange, a proposed sale of assets other than in the regular course of business or the dissolution of the Corporation shall be given not less than twenty (20) days and not more than sixty (60) days before the meeting date. 6. Record Date. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders, or at any adjournment thereof, or entitled to receive dividends or distributions, the Board of Directors shall fix in advance a record date for 2 3 any such determination of shareholders, such date to be not more than seventy (70) days and, in case of a meeting of shareholders, not less than ten (10) days prior to the date on which the particular action requiring such determination of shareholders is to be taken. 7. Shareholders' List. After fixing a record date for a shareholders' meeting, the Corporation shall prepare an alphabetical list of the names of all its shareholders on the record date who are entitled to notice of a shareholders' meeting. Such list shall be arranged by voting group, and within each voting group by class or series of shares, and show the address of and number of shares held by each shareholder. The shareholders' list shall be kept on file at the registered office of the Corporation for a period beginning ten days prior to such meeting and shall be kept open at the time and place of such meeting for the inspection by any shareholder, or any shareholder's agent or attorney. 8. Quorum. Except as otherwise required by law, a quorum at any annual or special meeting of shareholders shall consist of shareholders representing, either in person or by proxy, a majority of the votes entitled to be cast on the matter by each voting group. 9. Voting. (a) Except as otherwise provided in the Articles of Incorporation and subject to the provisions of the laws of the State of Washington, each outstanding share, regardless of class, is entitled to one vote on each matter voted on at a shareholders' meeting. (b) If a quorum exists, action on a matter, other than the election of directors, is approved by a voting group if the votes cast within the voting group favoring the action exceed the votes cast within the voting group opposing the action, unless the question is one which by express provision of law, of the Articles of Incorporation or of these Bylaws a greater number of affirmative votes is required. (c) Unless otherwise provided in the Articles of Incorporation, in any election of directors the candidates elected are those receiving the largest numbers of votes cast by the shares entitled to vote in the election, up to the number of directors to be elected by such shares. 10. Proxies. A shareholder may vote either in person or by appointing a proxy by signing an appointment form, either personally or by the shareholder's attorney-in-fact or agent. An appointment of a proxy is effective when received by the person authorized to tabulate votes for the Corporation. An appointment of a proxy is valid for eleven months unless a longer period is expressly provided in the appointment form. 11. Action by Shareholders Without a Meeting. Any action required or which may be taken at a meeting of shareholders of the Corporation may be taken without a meeting if the action is taken by all the shareholders entitled to vote on the action. The action must be evidenced by one or more written consents describing the action taken, signed by all the 3 4 shareholders entitled to vote on the action, and delivered to the Corporation for inclusion in the minutes or filing with the Corporation's records. Action taken in accordance with this section shall be effective when all written consents have been delivered to the Corporation, unless the consent specifies a later effective date. 12. Waiver of Notice. A written waiver of any notice required to be given to any shareholder, signed by the person or persons entitled to such notice, whether before or after the time stated therein for the meeting, shall be deemed the giving of such notice by the Corporation, provided that such waiver has been delivered to the Corporation for inclusion in the minutes or filing with the Corporation's records. A shareholder's attendance at a meeting waives any notice required, unless the shareholder at the beginning of the meeting objects to holding the meeting or transacting business at the meeting. 13. Action of Shareholders by Communications Equipment. Shareholders may participate in any meeting of shareholders by any means of communication by which all persons participating in the meeting can hear each other during the meeting. A shareholder participating in a meeting by this means is deemed to be present in person at the meeting. 14. Shareholder Nomination of Director Candidates. Subject to the rights of holders of any class or series of stock having a preference over the Corporation's common stock as to dividends or upon liquidation, if any, nominations for the election of directors may be made by the Board of Directors or a committee appointed by the Board of Directors or by any shareholder entitled to vote in the election of directors generally. However, any shareholder entitled to vote in the election of directors generally may nominate one or more persons for election as directors at a meeting only if written notice of such shareholder's intent to make such nomination or nominations has been received by the Corporation, either by personal delivery or by United States mail, postage prepaid, to the Secretary of the Corporation not later than (a) with respect to the election to be held at an annual meeting of shareholders, ninety days prior to the date one year after the date of the immediately preceding annual meeting of shareholders, and (b) with respect to an election to be held at a special meeting of shareholders for the election of directors, the close of business on the tenth day following the date on which notice of such meeting is first given to shareholders. Each such notice shall set forth: (a) the name and address of the shareholder who intends to make the nomination and of the person or persons to be nominated; (b) a representation that the shareholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (c) a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (d) such other information regarding each nominee proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission, had the nominee been nominated, or intended to be nominated, by the Board of Directors; and (e) the consent of each nominee to serve as a director of the Corporation if so elected. The Chairman of the meeting may in his discretion determine and declare to the meeting that a nomination was not made in accordance 4 5 with the foregoing procedures, and if he should so determine, he shall so declare to the meeting and the defective nomination shall be disregarded. 5 6 15. Shareholder Proposals. Any shareholder may make any proposal at an annual meeting of shareholders and the same may be discussed and considered only if written notice of such shareholder's intent to make such proposal(s) has been received by the Corporation, either by personal delivery or by United States mail, postage prepaid, to the Secretary of the Corporation not later than ninety days prior to the date one year after the date of the immediately preceding annual meeting of shareholders. Each such notice shall set forth: (a) the name and address of the shareholder who intends to make the proposal(s); (b) a representation that the shareholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to vote for the proposal(s); and (c) such other information regarding each proposal as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission. The Chairman of the meeting may in his discretion determine and declare to the meeting that a proposal was not made in accordance with the foregoing procedures, and if he should so determine, he shall so declare to the meeting and the defective proposal shall be disregarded. ARTICLE III Shares of Stock 1. Issuance of Shares. No shares of the Corporation shall be issued unless authorized by the Board of Directors. Such authorization shall include the number of shares to be issued, the consideration to be received and a statement regarding the adequacy of the consideration. Shares may but need not be represented by certificates. Unless otherwise provided by law, the rights and obligations of shareholders are identical whether or not their shares are represented by certificates. 2. Certificated Shares. If shares are represented by certificates, certificates of stock shall be issued in numerical order, and each shareholder shall be entitled to a certificate signed, either manually or in facsimile, by the President, or a Vice President, and the Secretary, and such certificate may bear the seal of the Corporation or a facsimile thereof. If an officer who has signed or whose facsimile signature has been placed upon such certificate ceases to be such officer before the certificate is issued, it may be issued by the Corporation with the same effect as if the person were an officer on the date of issue. At a minimum each certificate of stock shall state: (a) the name of the Corporation; (b) that the Corporation is organized under the laws of the State of Washington; (c) the name of the person to whom the certificate is issued; 6 7 (d) the number and class of shares and the designation of the series, if any, the certificate represents; (e) if the Corporation is authorized to issue different classes of shares or different series within a class, the designations, relative rights, preferences and limitations applicable to each class and the variations in rights, preferences and limitations determined for each series, and the authority of the Board of Directors to determine variations for future series, must be summarized either on the front or back of the certificate. Alternatively, the certificate may state conspicuously on its front or back that the Corporation will furnish the shareholder this information without charge on request in writing; and (f) the transfer restrictions on the shares, as provided in Article III, Section 4 of these Bylaws. In case of any mutilation, loss or destruction of any certificate of stock, another certificate may be issued in its place on proof of such mutilation, loss or destruction. The Board of Directors may impose conditions on such issuance and may require the giving of a satisfactory bond or indemnity to the Corporation in such sum as it might determine or establish such other procedures as it deems necessary or appropriate. 3. Uncertificated Shares. (a) Unless the Articles of Incorporation provide otherwise, the Board of Directors may authorize the issue of any of the Corporation's classes or series of shares without certificates. This authorization does not affect shares already represented by certificates until they are surrendered to the Corporation. (b) Within a reasonable time after the issuance of shares without certificates, the Corporation shall send the shareholder a complete written statement of the information required on certificates as provided in Article III Section 2 of these Bylaws. 4. Transfers. (a) Transfers of stock shall be made only upon the stock transfer records of the Corporation, which records shall be kept at the registered office of the Corporation or at its principal place of business, or at the office of its transfer agent or registrar. The Board of Directors may, by resolution, open a share register in any state of the United States, and may employ an agent or agents to keep such register and to record transfers of shares therein. (b) Shares of certificated stock shall be transferred by delivery of the certificates therefor, accompanied either by an assignment in writing on the back of the certificate or an assignment separate from certificate, or by a written power of attorney to sell, assign and transfer the same, signed by the holder of said certificate. No shares of certificated 7 8 stock shall be transferred on the records of the Corporation until the outstanding certificates therefor have been surrendered to the Corporation or to its transfer agent or registrar. (c) Shares of uncertificated stock shall be transferred upon receipt by the Corporation of a written request for transfer signed by the shareholder. Within a reasonable time after the transfer of shares without certificates, the Corporation shall provide the new shareholder a complete written statement of the information required on certificates as provided in Article III, Sections 2 and 4(d) of these Bylaws. (d) Shares of certificated or uncertificated stock may not be transferred except for "Permitted Transfers" prior to the time the Corporation becomes a reporting company under the Securities Exchange Act of 1934, as amended. Permitted Transfers are defined as transfers or assignments (i) to the Corporation or its affiliates; (ii) to existing shareholders of the Corporation who were shareholders in Online Interactive, Inc. ("OLI") and received the Corporation's stock (the "Distribution Stock") in the stock distribution by OLI to OLI's shareholders; (iii) by gift, bequest or the laws of descent or distribution; (iv) in connection with a transfer to an unaffiliated third party pursuant to a merger, consolidation, stock for stock exchange, tender offer or similar transaction; (v) to a trust for the Corporation's employees established under a qualified employee benefit plan; (vi) by a trust to the trust's beneficiaries; (vii) in a transaction which would be exempt from the registration requirements of the Securities Act of 1933, as amended (the "Securities Act"), by virtue of Section 4(2) of the Securities Act if the transferor were the issuer of the Distribution Stock, provided that the transferee is an "accredited investor" within the meaning of Rule 501(a) under the Securities Act; or (viii) pursuant to an effective registration statement under the Securities Act. Transfers under clauses (ii), (iii) (vi) and (vii) are subject to the transferees agreeing to be bound by the same restrictions on transfer. These restrictions on transfer apply to all shares of the Corporation's stock including any shares issued as a result of any stock split, stock dividend or similar distribution made in respect of such shares. These restrictions will be noted conspicuously on the stock certificates of the Corporation as provided in Article II, Section 2 of these Bylaws and appropriate instructions will be noted on the stock transfer books of the Corporation. 5. Fractional Shares or Scrip. The Corporation may: (a) issue fractions of a share; (b) arrange for the disposition of fractional interests by the shareholders; (c) pay in money the value of fractions of a share; and (d) issue scrip in registered or bearer form which shall entitle the holder to receive a certificate for a full share upon the surrender of enough scrip to equal a full share. 8 9 6. Shares of Another Corporation. Shares owned by the Corporation in another corporation, domestic or foreign, may be voted by such officer, agent or proxy as the Board of Directors may determine or, in the absence of such determination, by the President of the Corporation. ARTICLE IV Board of Directors 1. Powers. The management of all the affairs, property and interests of the Corporation shall be vested in a Board of Directors. In addition to the powers and authorities expressly conferred upon it by these Bylaws and by the Articles of Incorporation, the Board of Directors may exercise all such powers of the Corporation and do all such lawful acts as are not prohibited by statute or by the Articles of Incorporation or by these Bylaws or as directed or required to be exercised or done by the shareholders. 2. General Standards for Directors. (a) A director shall discharge the duties of a director, including duties as a member of a committee: (i) in good faith; (ii) with the care an ordinary prudent person in a like position would exercise under similar circumstances; and (iii) in a manner the director reasonably believes to be in the best interests of the Corporation. 3. Number and Term. The Board of Directors shall consist of five (5) persons. Directors shall be elected by the shareholders at each annual shareholders' meeting to hold office until the next annual meeting of the shareholders and until their respective successors are elected and qualified. Directors need not be shareholders or residents of the State of Washington. 4. Change of Number. The number of directors may at any time be increased or decreased by resolution of either the shareholders or directors at any annual, special or regular meeting; provided, that no decrease in the number of directors shall have the effect of shortening the term of any incumbent director, except as provided in Sections 6 and 7 of this Article IV. 5. Vacancies. All vacancies in the Board of Directors, whether caused by resignation, death or otherwise, may be filled by the affirmative vote of a majority of the remaining directors in office though less than a quorum of the Board of Directors. A director elected to fill a vacancy shall hold office until the next shareholders' meeting at which directors 9 10 are elected and until his or her successor is elected and qualified. Any directorship to be filled by reason of an increase in the number of directors may be filled by the Board of Directors for a term of office continuing only until the next election of directors by the shareholders and until his or her successor is elected and qualified. 6. Resignation. A director may resign at any time by delivering written notice to the Board of Directors, the President or the Secretary. A resignation is effective when the notice is delivered unless the notice specifies a later effective date. 7. Removal of Directors. At a special meeting of shareholders called expressly for that purpose, the entire Board of Directors, or any member thereof, may be removed, with or without cause, by a vote of the holders of a majority of shares then entitled to vote at an election of such directors. A director or directors may be removed only if the number of votes cast to remove the director exceeds the number of votes cast not to remove the director. The notice of such special meeting must state that the purpose, or one of the purposes, of the meeting is removal of the director or directors, as the case may be. 8. Regular Meetings. Regular meetings of the Board of Directors or any committee may be held without notice at the principal place of business of the Corporation or at such other place or places, either within or without the State of Washington, as the Board of Directors or such committee, as the case may be, may from time to time designate. The annual meeting of the Board of Directors shall be held without notice immediately after adjournment of the annual meeting of shareholders. 9. Special Meetings. (a) Special meetings of the Board of Directors may be called at any time by the President or by any director, to be held at the principal place of business of the Corporation or at such other place or places as the Board of Directors or the person or persons calling such meeting may from time to time designate. Notice of all special meetings of the Board of Directors, stating the date, time and place thereof, shall be given at least one (1) day prior to the date of the meeting, in accordance with the provisions set forth in Article VII of these Bylaws. Such notice need not specify the business to be transacted at, or the purpose of, the meeting. (b) Special meetings of any committee of the Board of Directors may be called at any time by such person or persons and with such notice as shall be specified for such committee by the Board of Directors, or in the absence of such specification, in the manner and with the notice required for special meetings of the Board of Directors. 10. Waiver of Notice. A director may waive any notice required by law, by the Articles of Incorporation or by these Bylaws before or after the time stated for the meeting, and such waiver shall be equivalent to the giving of such notice. Such waiver must be in writing, signed by the director entitled to such notice and delivered to the Corporation for inclusion in the 10 11 minutes or filing with the corporate records. A director's attendance at or participation in a meeting shall constitute a waiver of any required notice to the director of the meeting unless the director at the beginning of the meeting, or promptly upon the director's arrival, objects to holding the meeting or transacting business at the meeting and does not thereafter vote for or assent to action taken at the meeting. 11. Quorum. A majority of the full Board of Directors shall be necessary at all meetings to constitute a quorum for the transaction of business. If a quorum is present when a vote is taken, the affirmative vote of a majority of directors present is the act of the Board of Directors. 12. Registering Dissent. A director who is present at a meeting of the Board of Directors at which action on a corporate matter is taken is deemed to have assented to such action unless: (a) the director objects at the beginning of the meeting, or promptly upon the director's arrival, to the holding of, or transaction of business at, the meeting; (b) the director's dissent or abstention from the action is entered in the minutes if the meeting; or (c) the director delivers written notice of the director's dissent or abstention to the presiding officer of the meeting before its adjournment or to the Corporation within a reasonable time after adjournment of the meeting. The right to dissent or abstain is not available to a director who voted in favor of the action taken. 13. Action by Directors Without a Meeting. (a) Any action required or permitted to be taken at a meeting of the Board of Directors, or of a committee thereof, may be taken without a meeting if the action is taken by all members of the Board of Directors. The action must be evidenced by one or more written consents setting forth the action taken, signed by each of the directors, or by each of the members of the committee, as the case may be, either before or after the action taken, and delivered to the Corporation for inclusion in the minutes or filing with the Corporation's records. (b) Action taken under this section is effective when the last director signs the consent, unless the consent specifies a later effective date. 14. Participation by Means of Communications Equipment. Any or all directors may participate in a regular or special meeting of the Board of Directors (or of a committee thereof) by, or may conduct the meeting through the use of, any means of communication by which all directors participating can hear each other during the meeting. 11 12 15. Committees. (a) The Board of Directors, by resolution adopted by a majority of the full Board of Directors, may create one or more committees of directors. Each committee must have two or more members who serve at the pleasure of the Board of Directors. To the extent specified by the Board of Directors, each committee may exercise the authority of the Board of Directors, except that no committee shall have the authority to: (i) authorize or approve a distribution except according to a general formula or method prescribed by the Board of Directors; (ii) approve or propose to shareholders action that by law is required to be approved by shareholders; (iii) fill vacancies on the Board of Directors or any of its committees; (iv) amend the Articles of Incorporation; (v) adopt, amend or repeal these Bylaws; (vi) approve a plan of merger not requiring shareholder approval; or (vii) authorize or approve the issuance or sale or contract for sale of shares, or determine the designation and relative rights, preferences and limitations of a class or series of shares, except that the Board of Directors may authorize a committee (or a senior executive officer of the Corporation) to do so within limits specifically prescribed by the Board of Directors. (b) The creation of, delegation of authority to or action by a committee does not alone constitute compliance by a director with the standards of conduct required by the Washington Business Corporation Act and these Bylaws. 16. Remuneration. No stated salary shall be paid directors, as such, for their service, but by resolution of the Board of Directors, a fixed sum and expenses of attendance, if any, may be allowed for attendance at each regular or special meeting of the Board of Directors or of a committee thereof; provided, that nothing herein contained shall be construed to preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. 12 13 ARTICLE V Officers 1. Designations. The officers of the Corporation shall be a President, a Secretary and, at the discretion of the Board of Directors, one or more Vice-Presidents and a Treasurer. The Board of Directors shall appoint all officers. Any two or more offices may be held by the same individual. The Board of Directors, in its discretion, may elect a Chairman from among its members to serve as Chairman of the Board of Directors, who, when present, shall preside at all meetings of the Board of Directors and the shareholders, and who shall have such other powers as the Board may determine. 2. Appointment and Term of Office. The officers of the Corporation shall be appointed annually by the Board of Directors at the first meeting of the Board of Directors held after each annual meeting of the shareholders. Each officer shall hold office until a successor shall have been appointed and qualified, or until such officer's earlier death, resignation or removal. 3. Powers and Duties. If the Board appoints persons to fill the following positions, such officers shall have the power and duties set forth below: (a) The President. The President of the Corporation shall be the Chief Executive Officer of the Corporation and, subject to the direction and control of the Board of Directors, shall have general control and management of the business affairs and policies of the Corporation. The President shall act as liaison from and as spokesman for the Board of Directors. The President shall participate in long-range planning for the Corporation and shall be available to the other officers of the Corporation for consultation. The President shall possess power to sign all certificates, contracts and other instruments of the Corporation. Unless a Chairman of the Board of Directors has been appointed and is present, the President shall preside at all meetings of the shareholders and of the Board of Directors. The President shall perform all such other duties as are incident to the office of President or are properly required by the Board of Directors. (b) Vice-Presidents. During the absence or disability of the President, the Executive or Senior Vice-Presidents, if any, and the Vice-Presidents, if any, in the order designated by the Board of Directors, shall exercise all the functions of the President. Each Vice-President shall have such powers and discharge such duties as may be assigned from time to time by the Board of Directors. (c) The Secretary. The Secretary shall issue notices for all meetings, except for notices for special meetings of the shareholders and special meetings of the directors 13 14 which are called by the requisite percentage of shareholders or number of directors, shall keep minutes of all meetings, shall have charge of the seal and the Corporation's books, and shall make such reports and perform such other duties as are incident to the office of Secretary, or are properly required of him or her by the Board of Directors. (d) The Treasurer. The Treasurer shall have the custody of all moneys and securities of the Corporation and shall keep regular books of account. The Treasurer shall disburse the funds of the Corporation in payment of the just demands against the Corporation or as may be ordered by the Board of Directors, taking proper vouchers or receipts for such disbursements, and shall render to the Board of Directors from time to time as may be required an account of all transactions as Treasurer and of the financial condition of the Corporation. The Treasurer shall perform such other duties incident to his or her office or that are properly required of him or her by the Board of Directors. 4. Standards of Conduct for Officers. (a) An officer with discretionary authority shall discharge such officer's duties under that authority: (i) in good faith; (ii) with the care an ordinary prudent person in a like position would exercise under similar circumstances; and (iii) in a manner the officer reasonably believes to be in the best interests of the Corporation. 5. Delegation. In the case of absence or inability to act of any officer of the Corporation and of any person herein authorized to act in such officer's place, the Board of Directors may from time to time delegate the powers or duties of such officer to any other officer or any director or other person whom it may in its sole discretion select. 6. Vacancies. Vacancies in any office arising from any cause may be filled by the Board of Directors at any regular or special meeting of the Board. 7. Other Officers. The Board of Directors, or a duly appointed officer to whom such authority has been delegated by Board resolution, may appoint such other officers and agents as it shall deem necessary or expedient, who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board of Directors. 8. Resignation. An officer may resign at any time by delivering notice to the Corporation. Such notice shall be effective when delivered unless the notice specifies a later 14 15 effective date. Any such resignation shall not affect the Corporation's contract rights, if any, with the officer. 9. Removal. Any officer elected or appointed by the Board of Directors may be removed at any time, with or without cause, by the affirmative vote of a majority of the whole Board of Directors, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. 10. Salaries and Contract Rights. The salaries, if any, of the officers shall be fixed from time to time by the Board of Directors. The appointment of an officer shall not of itself create contract rights. 11. Bonds. The Board of Directors may, by resolution, require any and all of the officers to give bonds to the Corporation, with sufficient surety or sureties, conditioned for the faithful performance of the duties of their respective offices, and to comply with such other conditions as may from time to time be required by the Board of Directors. ARTICLE VI Distributions and Finance 1. Distributions. The Board of Directors may authorize and the Corporation may make distributions to its shareholders; provided that no distribution may be made if, after giving it effect, either: (a) The Corporation would not be able to pay its debts as they become due in the usual course of business; or (b) The Corporation's total assets would be less than the sum of its total liabilities plus the amount which would be needed, if the Corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. The Board of Directors may authorize distributions to holders of record at the close of business on any business day prior to the date on which the distribution is made. If the Board of Directors does not fix a record date for determining shareholders entitled to a distribution, the record date shall be the date on which the Board of Directors authorizes the distribution. 2. Measure of Effect of a Distribution. For purposes of determining whether a distribution may be authorized by the Board of Directors and paid by the Corporation under Article VI, Section 1 of these Bylaws, the effect of the distribution is measured: 15 16 (a) In the case of a distribution of indebtedness, the terms of which provide that payment of principal and interest are made only if and to the extent that payment of a distribution to shareholders could then be made under this section, each payment of principal or interest is treated as a distribution, the effect of which is measured on the date the payment is actually made; or (b) In the case of any other distribution: (i) if the distribution is by purchase, redemption, or other acquisition of the Corporation's shares, the effect of the distribution is measured as of the earlier of the date any money or other property is transferred or debt incurred by the Corporation, or the date the shareholder ceases to be a shareholder with respect to the acquired shares; (ii) if the distribution is of an indebtedness other than described in subsection 2(a) and (b)(i) of this section, the effect of the distribution is measured as of the date the indebtedness is distributed; and (iii) in all other cases, the effect of the distribution is measured as of the date the distribution is authorized if payment occurs within 120 days after the date of authorization, or the date the payment is made if it occurs more than 120 days after the date of authorization. 3. Depositories. The monies of the Corporation shall be deposited in the name of the Corporation in such bank or banks or trust company or trust companies as the Board of Directors shall designate, and shall be drawn out only by check or other order for payment of money signed by such persons and in such manner as may be determined by resolution of the Board of Directors. ARTICLE VII Notices Except as may otherwise be required by law, any notice to any shareholder or director must be in writing and may be transmitted by: mail, private carrier or personal delivery; telegraph or teletype; or telephone, wire or wireless equipment which transmits a facsimile of the notice. Written notice by the Corporation to its shareholders shall be deemed effective when mailed, if mailed with first-class postage prepaid and correctly addressed to the shareholder's address shown in the Corporation's current record of shareholders. Except as set forth in the previous sentence, written notice shall be deemed effective at the earliest of the following: (i) when received; (ii) five days after its deposit in the United States mail, as evidenced by the postmark, if mailed with first-class postage, prepaid and correctly addressed; (iii) on the date shown on the return receipt, if sent by registered or certified mail, return receipt requested, and receipt is signed by or on behalf of the addressee; or (iv) if sent to a shareholder's address, 16 17 telephone number, or other number appearing on the records of the Corporation, when dispatched by telegraph, teletype or facsimile equipment. 17 18 ARTICLE VIII Seal The Corporation may adopt a corporate seal which seal shall be in such form and bear such inscription as may be adopted by resolution of the Board of Directors. ARTICLE IX Indemnification of Officers, Directors, Employees and Agents 1. Definitions. For purposes of this Article: (a) "Corporation" includes any domestic or foreign predecessor entity of the Corporation in a merger or other transaction in which the predecessor's existence ceased upon consummation of the transaction. (b) "Director" means an individual who is or was a director of the Corporation or an individual who, while a director of the Corporation, is or was serving at the Corporation's request as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise. A director is considered to be serving an employee benefit plan at the Corporation's request if the director's duties to the Corporation also impose duties on, or otherwise involve services by, the director to the plan or to participants in or beneficiaries of the plan. "Director" includes, unless the context requires otherwise, the estate or personal representative of a director. (c) "Expenses" include counsel fees. (d) "Liability" means the obligation to pay a judgment, settlement, penalty, fine, including an excise tax assessed with respect to an employee benefit plan, or reasonable expenses incurred with respect to a proceeding. (e) "Official capacity" means: (i) When used with respect to a director, the office of director in the Corporation; and (ii) when used with respect to an individual other than a director, as contemplated in Section 6 of this Article IX, the office in the Corporation held by the officer or the employment or agency relationship undertaken by the employee or agent on behalf of the Corporation. "Official capacity" does not include service for any other foreign or domestic corporation or any partnership, joint venture, trust, employee benefit plan, or other enterprise. (f) "Party" includes an individual who was, is, or is threatened to be made a named defendant or respondent in a proceeding. 18 19 (g) "Proceeding" means any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative or investigative and whether formal or informal. 2. Right to Indemnification. (a) The Corporation shall indemnify any person who was or is a party to any proceeding, whether or not brought by or in the right of the Corporation, by reason of the fact that such person is or was a director of the Corporation, against all reasonable expenses incurred by the director in connection with the proceeding. (b) Except as provided in subsection (e) of this Section 2, the Corporation shall indemnify an individual made a party to a proceeding because the individual is or was a director against liability incurred in the proceeding if: (i) The individual acted in good faith; and (ii) The individual reasonably believed: (A) In the case of conduct in the individual's official capacity with the Corporation, that the individual's conduct was in the Corporation's best interests; and (B) In all other cases, that the individual's conduct was at least not opposed to the Corporation's best interests; and (iii) In the case of any criminal proceeding, the individual had no reasonable cause to believe the individual's conduct was unlawful. (c) A director's conduct with respect to an employee benefit plan for a purpose the director reasonably believed to be in the interests of the participants in and beneficiaries of the plan is conduct that satisfies the requirement of subsection (b)(ii) of this Section 2. (d) The termination of a proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent is not, of itself, determinative that the director did not meet the standard of conduct described in this Section. (e) The Corporation shall not indemnify a director under this Section 2: (i) In connection with a proceeding by or in the right of the Corporation in which the director was adjudged liable to the Corporation; or 19 20 (ii) In connection with any other proceeding charging improper personal benefit to the director, whether or not involving action in the director's official capacity, in which the director was adjudged liable on the basis that personal benefit was improperly received by the director. (f) Indemnification under this Article IX, Section 2 in connection with a proceeding by or in the right of the Corporation is limited to reasonable expenses incurred in connection with the proceeding. 3. Advance for Expenses. (a) The Corporation shall pay for or reimburse the reasonable expenses incurred by a director who is a party to a proceeding in advance of final disposition of the proceeding and in advance of any determination and authorization of indemnification pursuant to Section 5 of this Article IX if: (i) The director furnishes the Corporation a written affirmation of the director's good faith belief that the director has met the standard of conduct described in Section 2 of this Article IX; and (ii) The director furnishes the Corporation a written undertaking, executed personally or on the director's behalf, to repay the advance if it is ultimately determined that the director did not meet the standard of conduct. (b) The undertaking required by subsection (a)(ii) of this Section 3 must be an unlimited general obligation of the director but need not be secured and may be accepted without reference to financial ability to make repayment. 4. Court-ordered Indemnification. A director of the Corporation who is a party to a proceeding may apply for indemnification or advance of expenses to the court conducting the proceeding or to another court of competent jurisdiction. On receipt of an application, the court after giving any notice the court considers necessary may order indemnification or advance of expenses if it determines: (a) The director is entitled to mandatory indemnification pursuant to RCW 23B.08.520, in which case the court shall also order the Corporation to pay the director's reasonable expenses incurred to obtain court-ordered indemnification; (b) The director is fairly and reasonably entitled to indemnification in view of all the relevant circumstances, whether or not the director met the standard of conduct set forth in Section 2 of this Article IX, or was adjudged liable as described in Section 2(e) of this Article IX, but if the director was adjudged so liable, the director's indemnification is limited to reasonable expenses incurred; or 20 21 (c) In the case of an advance of expenses, the director is entitled pursuant to the Articles of Incorporation, Bylaws, or any applicable resolution or contract, to payment or reimbursement of the director's reasonable expenses incurred as a party to the proceeding in advance of final disposition of the proceeding. 5. Determination and Authorization of Indemnification. (a) The Corporation shall not indemnify a director under this Article IX unless authorized in the specific case after a determination has been made that indemnification of the director is permissible in the circumstances because the director has met the standard of conduct set forth in Section 2(b) of this Article IX. (b) The determination shall be made: (i) By the Board of Directors by majority vote of a quorum consisting of directors not at the time parties to the proceeding; (ii) If a quorum cannot be obtained under (i) of this subsection, by majority vote of a committee duly designated by the Board of Directors, in which designation directors who are parties may participate, consisting solely of two or more directors not at the time parties to the proceeding; (iii) By special legal counsel: (A) Selected by the Board of Directors or its committee in the manner prescribed in (i) or (ii) of this subsection; or (B) If a quorum of the Board of Directors cannot be obtained under (i) of this subsection and a committee cannot be designated under (ii) of this subsection, selected by majority vote of the full Board of Directors, in which selection directors who are parties may participate; or (iv) By the shareholders, but shares owned by or voted under the control of directors who are at the time parties to the proceeding may not be voted on the determination. (c) Authorization of indemnification and evaluation as to reasonableness of expenses shall be made in the same manner as the determination that indemnification is permissible, except that if the determination is made by special legal counsel, authorization of indemnification and evaluation as to reasonableness of expenses shall be made by those entitled under subsection (b) (iii) of this Section to select counsel. 21 22 6. Indemnification of Officers (a) An officer of the Corporation who is not a director shall be indemnified pursuant to RCW 23B.08.520, and is entitled to apply for court-ordered indemnification under Section 4 of this Article IX, in each case to the same extent as a director; and (b) The Corporation shall indemnify and advance expenses to an officer who is not a director to the same extent as to a director under this Article IX. (c) The Corporation may also indemnify and advance expenses to an officer who is not a director to the extent, consistent with law, that may be provided by a general or specific action of its Board of Directors, or contract. 7. Indemnification of Employees and Agents. (a) The Corporation may indemnify employees and agents of the Corporation pursuant to RCW 23B.08.520, and may afford the right to such employees or agents to apply for court-ordered indemnification under Section 4 of this Article IX, in each case to the same extent as a director; and (b) The Corporation may indemnify and advance expenses to an employee or agent of the Corporation who is not a director to the same extent as to a director under this Article IX. (c) The Corporation may also indemnify and advance expenses to an employee or agent who is not a director to the extent, consistent with law, that may be provided by a general or specific action of its Board of Directors, or contract. 8. Insurance. The Corporation may purchase and maintain insurance on behalf of an individual who is or was a director, officer, employee, or agent of the Corporation, or who, while a director, officer, employee, or agent of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise, against liability asserted against or incurred by the individual in that capacity or arising from the individual's status as a director, officer, employee, or agent, whether or not the Corporation would have power to indemnify the individual against the same liability under this Article IX. 9. Indemnification as a Witness. This Article IX does not limit a Corporation's power to pay or reimburse expenses incurred by a director in connection with the director's appearance as a witness in a proceeding at a time when the director has not been made a named defendant or respondent to the proceeding. 22 23 10. Report to Shareholders. If the Corporation indemnifies or advances expenses to a director pursuant to this Article IX in connection with a proceeding by or in the right of the Corporation, the Corporation shall report the indemnification or advance in writing to the shareholders with or before the notice of the next shareholders' meeting. 11. Shareholder Authorized Indemnification. (a) If authorized by a resolution adopted or ratified, before or after the event, by the shareholders of the Corporation, the Corporation shall have the power to indemnify or agree to indemnify a director made a party to a proceeding, or obligate itself to advance or reimburse expenses incurred in a proceeding, without regard to the limitations contained in this Article IX (other than this Section 11); provided that no such indemnity shall indemnify any director from or on account of: (i) Acts or omissions of the director finally adjudged to be intentional misconduct or a knowing violation of law; (ii) Conduct of the director finally adjudged to be an unlawful distribution under RCW 23B.08.310; or (iii) Any transaction with respect to which it was finally adjudged that such director personally received a benefit in money, property, or services to which the director was not legally entitled. (b) Unless a resolution adopted or ratified by the shareholders of the Corporation provides otherwise, any determination as to any indemnity or advance of expenses under subsection (a) of this Section 11 shall be made in accordance with Section 5 of this Article IX. 12. Validity of Indemnification. A provision addressing the Corporation's indemnification of or advance for expenses to directors that is contained in these Bylaws, a resolution of its shareholders or Board of Directors, or in a contract or otherwise, is valid only if and to the extent the provision is consistent with RCW 23B.08.500 through 23B.08.580. 13. Interpretation. The provisions contained in this Article IX shall be interpreted and applied to provide indemnification to directors, officers, employees and agents of the Corporation to the fullest extent allowed by applicable law, as such law may be amended, interpreted and applied from time to time. 14. Savings Clause. If this Article IX or any portion thereof shall be invalidated on any ground by any court of competent jurisdiction, the Corporation shall nevertheless indemnify each director as to reasonable expenses and liabilities with respect to any proceeding, whether or not brought by or in the right of the Corporation, to the full extent 23 24 permitted by any applicable portion of this Article IX that shall not have been invalidated, or by any other applicable law. 15. Nonexclusivity of Rights. The right to indemnification under this Article IX for directors, officers, employees and agents shall not be exclusive of any other right which any person may have, or hereafter acquire, under any statute, provision of the Articles of Incorporation, Bylaws, other agreement, vote of shareholders or disinterested directors, insurance policy, principles of common law or equity, or otherwise. ARTICLE X Books and Records The Corporation shall maintain appropriate accounting records and shall keep as permanent records minutes of all meetings of its shareholders and Board of Directors, a record of all actions taken by the shareholders or the Board of Directors without a meeting and a record of all actions taken by a committee of the Board of Directors. In addition, the Corporation shall keep at its registered office or principal place of business, or at the office of its transfer agent or registrar, a record of its shareholders, giving the names and addresses of all shareholders in alphabetical order by class of shares showing the number and class of the shares held by each. Any books, records and minutes may be in written form or any other form capable of being converted into written form within a reasonable time. The Corporation shall keep a copy of the following records at its principal office: 1. The Articles of Incorporation and all amendments thereto currently in effect; 2. The Bylaws and all amendments thereto currently in effect; 3. The minutes of all shareholders' meetings, and records of all actions taken by shareholders without a meeting, for the past three years; 4. Its financial statements for the past three years, including balance sheets showing in reasonable detail the financial condition of the Corporation as of the close of each fiscal year, and an income statement showing the results of its operations during each fiscal year prepared on the basis of generally accepted accounting principles or, if not, prepared on a basis explained therein; 5. All written communications to shareholders generally within the past three years; 6. A list of the names and business addresses of its current directors and officers; and 24 25 7. Its most recent annual report delivered to the Secretary of State of Washington. ARTICLE XI Amendments 1. By Shareholders. These Bylaws may be amended or repealed by the shareholders in the manner set forth in Article II, Section 9 of these Bylaws at any regular or special meeting of the shareholders. 2. By Directors. The Board of Directors shall have power to amend or repeal the Bylaws of, or adopt new bylaws for, the Corporation. However, any such Bylaws, or any alteration, amendment or repeal of the Bylaws, may be subsequently changed or repealed by the holders of a majority of the stock entitled to vote at any shareholders' meeting. 3. Emergency Bylaws. The Board of Directors may adopt emergency Bylaws, subject to repeal or change by action of the shareholders, which shall be operative during any emergency in the conduct of the business of the Corporation resulting from an attack on the United States, any state of emergency declared by the federal government or any subdivision thereof, or any other catastrophic event. 25 EX-5.1 5 OPINION OF DORSEY & WHITNEY LLP 1 [letterhead of Dorsey & Whitney LLP] FreeShop.com, Inc. 95 South Jackson Street Suite 300 Seattle, Washington 98104 Re: Registration Statement on Form S-1 (File No. 333-81151) Ladies and Gentlemen: We have acted as counsel to FreeShop.com, Inc., a Washington corporation (the "Company"), in connection with a Registration Statement on Form S-1 (the "Registration Statement") relating to the sale by the Company of up to 3,200,000 shares of common stock of the Company, no par value per share (including 480,000 shares to be subject to the Underwriters' over-allotment option) (the "Common Stock"). We have examined such documents and have reviewed such questions of law as we have considered necessary and appropriate for the purposes of our opinions set forth below. In rendering our opinions set forth below, we have assumed the authenticity of all documents submitted to us as originals, the genuineness of all signatures and the conformity to authentic originals of all documents submitted to us as copies. We have also assumed the legal capacity for all purposes relevant hereto of all natural persons and, with respect to all parties to agreements or instruments relevant hereto other than the Company, that such parties had the requisite power and authority (corporate or otherwise) to execute, deliver and perform such agreements or instruments, that such agreements or instruments have been duly authorized by all requisite action (corporate or otherwise), executed and delivered by such parties and that such agreements or instruments are the valid, binding and enforceable obligations of such parties. As to questions of fact material to our opinions, we have relied upon certificates of officers of the Company and of public officials. We have also assumed that the Common Stock will be priced by the Pricing Committee established by the authorizing resolutions adopted by the Company's Board of Directors in accordance with such resolutions and will be issued and sold as described in the Registration Statement. Based on the foregoing, we are of the opinion that the shares of Common Stock to be sold by the Company pursuant to the Registration Statement have been duly authorized by all requisite corporate action and, upon issuance, delivery and payment 2 therefor as described in the Registration Statement, will be validly issued, fully paid and nonassessable. Our opinions expressed above are limited to the laws of the State of Washington and the federal laws of the United States. We hereby consent to the filing of this opinion as an exhibit to the Registration Statement, and to the reference to our firm under the heading "Legal Matters" in the Prospectus constituting part of the Registration Statement. Dated: September 21, 1999 Very truly yours, /s/ Dorsey & Whitney LLP EX-10.12 6 PROMOTION AGREEMENT 1 EXHIBIT 10.12 PROMOTION AGREEMENT 1. This Promotion Agreement (the "Agreement") is dated as of May 18, 1998 between CNET, Inc. ("CNET") and FreeShop International, Inc. (the "Company"). Pursuant to this Agreement, CNET will provide various links, placements and other online promotions (collectively, the "Promotions") from Snap! Online and SEARCH.COM and will provide advertising media ("Advertising") to the Company to assist the Company in promoting its products and services and facilitating the sale of products to potential buyers through its Internet site. CNET will be compensated by the Company for providing the Promotions and Advertising. Accordingly, the parties hereby agree as follows: 2. Background. 2.1 The Company. The Company operates an electronic retailing operation through its Internet site located at www.freeshop.com (together with any successors or derivatives to such site, the "Company Site"). Through the Company Site, the Company distributes and sells or facilitates the distribution and sale of various products and services, either directly or as an agent for third party vendors. All products and services offered for distribution or sale through the Company Site are referred to as the "Products." 2.2 CNET. CNET produces television programs and operates a network of Internet sites on the World Wide Web. For purposes of this Agreement, the "CNET Sites" refer to the sites referenced in Section 3.3 and Exhibit A. 3. CNET's Obligations. 3.1 Advertising media. CNET will provide Advertising media to the Company during the Term on the CNET Sites and at the rates described in Exhibit A. 3.2 Retail Promotions. CNET will provide various retail Promotions on Snap! Online and SEARCH.COM, which may include text/HTML or graphical Promotions that include embedded links to co-branded pages on CNET Sites or the Company Site. 3.3 Placement of Promotions. CNET will determine the location and type of each Promotion displayed on Snap! Online and SEARCH.COM and may phase in certain types of Promotions as they are developed. CNET currently intends to display Promotions consisting of text/HTML links, pre-filled with an appropriate query string or link ("Pre-Filled Links"), as set forth in this Section. 3.3.1 On SEARCH.COM, CNET intends to display a Pre-Filled Link on all category doors and on the search query pages as appropriate and mutually agreed upon. 3.3.2 On the home version of Snap! Online and all partner versions with partner approval, CNET intends to display a Pre-Filled Link to Snap! Shopping's Free Stuff page above the fold on the front door at least 25% 1 2 of the time and on pages related to Snap! Shopping as appropriate and mutually agreed upon. The Company will also serve as the sole "Anchor Tenant" for Snap! Shopping's Free Stuff! page (or equivalent page if subsequently renamed). As Anchor Tenant, the Company will receive prominent Graphical Promotions above the "fold" on the Free Stuff! page. For the purposes of clarity, the "fold" is defined as the visible portion of the screen on a standard 640 x 480 screen size. 3.4 Design and Production of Promotions. The Company will design any graphics required for the Promotions and provide pre-filled query strings or links for all of the Pre-Filled Links, with reasonable assistance from CNET, and the Company will supply digital copies of such graphics and other materials to CNET. CNET will be responsible for incorporating the Promotions into the CNET Sites and for ensuring that the Promotions are accessible to users of the CNET Sites ("Users"). 3.5 Reporting. Within 30 days after the end of each month during the Term, CNET will provide a report to the Company indicating the number of impressions of Promotions displayed on the CNET Sites during such month. CNET will also provide standard "real-time" reporting for media Advertising. 3.6 Investment. One hundred twenty days after the date of this Agreement and on the first scheduled closing date of each subsequent equity financing by the Company (each such date being an "Investment Date"), CNET will purchase a Participating Amount (as defined below) of the Company's equity securities on the same terms and conditions, including price, as the Company is then closing the sale of such securities to other investors; provided, that if an Investment Date does not occur within nine months after the immediately prior Investment Date (a "Prior Investment Date"), then one business day after the end of the nine month period CNET will purchase a Participating Amount of the same type of equity securities as were sold to CNET on the Prior Investment Date at the same price per share (subject to adjustment for stock dividends, combinations or splits with respect to such securities) at which the Company last sold securities. For purposes of this Section 3.6, "Participating Amount" means such dollar amount as will bring CNET's aggregate purchases of the Company's equity securities, after its then current purchase, to an amount equal to 20% of all amounts paid or payable to CNET by the Company under the terms of this Agreement on or before the end of the calendar month which includes the Investment Date. CNET will execute the same purchase documentation as other investors in connection with each purchase. The Company will have no obligation to sell equity securities to CNET on an Investment Date unless the Company reasonably determines that such sale to CNET is in compliance with all applicable state and federal securities laws. 4. The Company's Obligations: 4.1 Operation of Company Site. The Company will be responsible for ensuring that each link embedded within a Promotion takes the User to the appropriate area within the Company Site, and that the Company Site functions with reasonable 2 3 reliability and in a commercially reasonable manner throughout the Term. In particular, the Company agrees that the Company Site will comply with the performance standards set forth in Exhibit B throughout the Term. Any failure by the Company to comply with this paragraph will be deemed to be a material breach of this Agreement. 4.2 Reporting. Within 30 days after the end of each month during the Term, the Company will provide a report to CNET indicating the aggregate number of referrals from Promotions on the CNET Sites to the Company Site during such month and the resulting number of buyers for which the Company has received payment ("CNET Sales"). CNET Sales includes lead generation offers for which FreeShop receives a "per lead" fee and excludes any advertising including banners, promotions or other advertising fees received by the Company. CNET and the Company will agree on technical procedures to allow the easy and accurate tracking and reporting of CNET Sales. The Company will make this information available in a manner that allows CNET and the Company to understand the performance of the various Promotions. 4.3 Cash Consideration. 4.3.1 For each month during the Term, the Company will purchase at least $100,000 of Advertising media on the CNET Sites identified in Exhibit A, at the rates (expressed as Net CPM) identified for such CNET Sites in Exhibit A. CNET will guarantee the availability of at least $100,000 worth of this media at these rates. Payments under this paragraph for a particular month will be due within 30 days after the end of such month. 4.3.2 For each month of the Term, the Company will pay CNET $.50 for each CNET Sale except CNET Sales for which the Company receives less than $.80 per sale. In the case that the revenue to Company from a CNET Sale is less than $.80, Company will instead pay CNET 50% of lead generation revenue received on that CNET Sale. Such payments will be based on the reports prepared by the Company under Section 4.2 (although CNET may challenge such reports as contemplated by Section 10.5). Payments under this paragraph for a particular month will be due within 30 days after the end of such month. 4.4 User Information. At least once each calendar quarter, the Company will deliver to CNET aggregate data collected as a result of the CNET Sales, including but not limited to, demographic data, buying behavior as measured by conversion to sale, frequency of purchasing, and average order size, and a comparison to the average for the Company to the extent such information is collected by the Company. The Company and CNET agree to best efforts to evaluate the possible transfer of additional per user information to CNET on such terms and for such purposes as the parties may agree. To the extent provided, all such information will be provided by the Company to CNET at no charge. Additionally, the Company and CNET will conduct a review at least once per quarter to discuss the Company's business model and the way in which leads are collected and sold in order to ensure that the CNET Sales is an accurate reflection of the usage 3 4 of the leads. 5. Term and Termination. The term of this Agreement (the "Term") will begin on May 18, 1998 and end on the first anniversary of the date of this Agreement; provided that (a) either party may terminate this Agreement, effective at any time after the first three months of the Term, by giving 30 days' written notice of termination to the other party, and (b) either party may terminate this Agreement at any time by giving written notice of termination to the other party, if the other party commits a material breach of its obligations hereunder that is not cured within 30 days after notice thereof from the non-breaching party. The provisions of Sections 8, 9 and 10, as well as any obligations arising prior to expiration or termination, will survive any expiration or termination of the Term. 6. Exclusivity. For purposes of this agreement "Competing Free Product Retailer " means any company (other than the Company and CNET and their respective affiliates) that is engaged primarily in the retail distribution and sale, through the Internet, of products and services that are offered without any initial payment required with the exclusion of software products and classifieds. During the Term, CNET will not enter into any agreements under which CNET receives consideration from a Competing Free Product Retailer for displaying permanent links to or other fixed promotions for such Competing Free Product Retailer on any CNET Site provided that the foregoing will not restrict the display of standard advertisements for any Competing Free Product Retailer. The parties acknowledge that the foregoing will not prevent CNET from displaying text links and other references to Competing Free Product Retailers as reasonably necessary to provide appropriate editorial and search related services on the CNET Sites or within the context of standard advertising promotions. 7. Trademark Licenses. 7.1 The Company hereby grants to CNET a non-exclusive, revocable, royalty-free license, effective as long as this Agreement is in effect, to use, display and publish any of the Company's trademarks, tradenames, service marks and logos ("Company Marks") that may be delivered by the Company to CNET expressly for inclusion in the Promotions, solely for use in connection with the Promotions. Any use of the Company Marks by CNET must comply with any reasonable usage guidelines communicated by the Company to CNET from time to time. Nothing contained in this Agreement will give CNET any right, title or interest in or to the Company Marks or the goodwill associated therewith, except for the limited usage rights expressly provided above. CNET acknowledges and agrees that, as between the Company and CNET, the Company is the sole owner of all rights in and to the Company Marks. 7.2 CNET hereby grants to Company a non-exclusive, revocable, royalty-free license, effective as long as this Agreement is in effect, to use, display and publish any of the CNET's trademarks, tradenames, service marks and logos ("CNET Marks") that may be delivered by CNET to the Company expressly for inclusion in the Snap! co-branded Company store. Any use of the CNET Marks by Company must comply with any reasonable usage guidelines communicated by CNET to the Company from time to time. Nothing contained in this 4 5 Agreement will give the Company any right, title or interest in or to the CNET Marks or the goodwill associated therewith, except for the limited usage rights expressly provided above. The Company acknowledges and agrees that, as between the Company and CNET, CNET is the sole owner of all rights in and to the CNET Marks. 7.3 The Company hereby represents and warrants to CNET that the Company has, and will have throughout the Term, all necessary rights in and to the Company Marks to grant CNET the licenses and usage rights contemplated by this Agreement without violating the rights of any third party. CNET hereby represents and warrants to the Company that CNET has, and will have throughout the Term, all necessary rights in and to the CNET Marks to grant the Company the licenses and usage rights contemplated by this Agreement without violating the rights of any third party. 8. Responsibility for the Company Products. The Company acknowledges and agrees that, as between the Company and CNET, the Company will be solely responsible for any claims or other losses associated with or resulting from the marketing or operation of the Company Site or the offer, distribution or sale of any Products by the Company or in connection with the Company Site. CNET is not authorized to make, and agrees not to make, any representations or warranties concerning the Products, except to the extent (if any) contained within Promotions delivered to CNET by the Company. 9. Mutual Indemnification. 9.1 Indemnification by CNET. CNET shall indemnify and hold the Company harmless from and against any costs, losses, liabilities and expenses, including all court costs, reasonable expenses and reasonable attorney's fees (collectively, "Losses") that the Company may suffer, incur or be subjected to by reason of any legal action, proceeding, arbitration or other claim by a third party, whether commenced or threatened, arising out of or as a result of (a) any breach or alleged breach by CNET of its representations, warranties or covenants hereunder; or (b) the operation of the CNET Sites (except in cases where the Company is required to indemnify CNET under the following paragraph), including claims of infringement or misappropriation of intellectual property rights. 9.2 Indemnification by the Company. The Company shall indemnify and hold CNET harmless from and against any Losses that CNET may suffer, incur or be subjected to by reason of any legal action, proceeding, arbitration or other claim by a third party, whether commenced or threatened, arising out of or as a result of (a) any breach or alleged breach by the Company of its representations, warranties or covenants hereunder; (b) the use by CNET of the Company Marks or any content provided by the Company to CNET expressly for display in connection with or as part of the Promotions, including claims of infringement or misappropriation of intellectual property rights; or (c) the operation of the Company Site or the offer, distribution or sale of the Products by the Company or in connection with the Company Site. 5 6 9.3 Indemnification Procedures. If any party entitled to indemnification under this section (an "Indemnified Party") makes an indemnification request to the other, the Indemnified Party shall permit the other party (the "Indemnifying Party") to control the defense, disposition or settlement of the matter at its own expense; provided that the Indemnifying Party shall not, without the consent of the Indemnified Party enter into any settlement or agree to any disposition that imposes an obligation on the Indemnified Party that is not wholly discharged or dischargeable by the Indemnifying Party, or imposes any conditions or obligations on the Indemnified Party other than the payment of monies that are readily measurable for purposes of determining the monetary indemnification or reimbursement obligations of Indemnifying Party. The Indemnified Party shall notify Indemnifying Party promptly of any claim for which Indemnifying Party is responsible and shall cooperate with Indemnifying Party in every commercially reasonable way to facilitate defense of any such claim; provided that the Indemnified Party's failure to notify Indemnifying Party shall not diminish Indemnifying Party's obligations under this Section except to the extent that Indemnifying Party is materially prejudiced as a result of such failure. An Indemnified Party shall at all times have the option to participate in any matter or litigation through counsel of its own selection and at its own expense. 10. Miscellaneous. 10.1 LIMITATION OF DAMAGES. NEITHER PARTY WILL BE LIABLE FOR ANY SPECIAL, INDIRECT, CONSEQUENTIAL OR INCIDENTAL DAMAGES ARISING OUT OF OR RELATED TO THIS AGREEMENT, HOWEVER CAUSED AND ON ANY THEORY OF LIABILITY (INCLUDING NEGLIGENCE), AND EVEN IF SUCH PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. 10.2 Assignment. This Agreement may not be assigned by either party, except (a) to the transferee of substantially all of the business operations of such party (whether by asset sale, stock sale, merger or otherwise) or (b) to any entity that controls, is controlled by or is under common control with such party. 10.3 Relationship of Parties. This Agreement will not be construed to create a joint venture, partnership or the relationship of principal and agent between the parties hereto, nor to impose upon either party any obligations for any losses, debts or other obligations incurred by the other party except as expressly set forth herein. 10.4 Entire Agreement. This Agreement constitutes and contains the entire agreement between the parties with respect to the subject matter hereof and supersedes any prior oral or written agreements. This Agreement may not be amended except in writing signed by both parties. Each party acknowledges and agrees that the other has not made any representations, warranties or agreements of any kind, except as expressly set forth herein. 10.5 Audit Rights. Each party will have the right to engage an independent third party to audit the books and records of the other party relevant to the calculation of 6 7 Retail Impressions or CNET Sales, upon reasonable notice and during normal business hours, and the other party will provide reasonable cooperation in connection with any such audit. The party requesting the audit will pay all expenses of the auditor unless the audit reveals an underpayment by the other party of more than 5%, in which case the other party will reimburse all reasonable expenses of the auditor. 10.6 Applicable Law. This Agreement will be construed in accordance with and governed by the laws of the State of California, without regard to principles of conflicts of law. 10.7 Press Release. Each party may issue a press release concerning the business relationship contemplated by this Agreement, and each party will provide an appropriate quote from one of its senior executive officers for use in the other party's release. The Company agrees that CNET's press release may disclose the total consideration payable to CNET hereunder. Each party will provide the other with a reasonable opportunity to review and comment on its press release. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their duly authorized representatives as of the date first written above. CNET, INC. FreeShop International, Inc. By: /s/ MARTIN GREEN By: /s/ TIM CHOATE --------------------------------- ------------------------------- Martin Green Tim Choate Title: Vice President Title: President & CEO ------------------------------ ---------------------------- 7 8 EXHIBIT A ADVERTISING MEDIA For each of the first 12 calendar months of the Term, the Company will purchase a minimum of $100,000 of Advertising media on the following sites, and CNET will sell such Advertising media at the Net CPM's indicated for such sites:
CNET ADVERTISING MEDIA NET CPM DOWNLOAD.COM business banners $ 29.75 DOWNLOAD.COM business window $ 29.75 DOWNLOAD.COM business title download $ 35.70 DOWNLOAD.COM development tools banners $ 29.75 DOWNLOAD.COM development tools window $ 29.75 DOWNLOAD.COM development tools title download $ 35.70 DOWNLOAD.COM education banners $ 19.83 DOWNLOAD.COM education window $ 19.83 DOWNLOAD.COM education title download $ 32.73 DOWNLOAD.COM games banners $ 14.88 DOWNLOAD.COM games window $ 14.88 DOWNLOAD.COM games title download $ 32.73 DOWNLOAD.COM home & personal banners $ 19.83 DOWNLOAD.COM home & personal window $ 19.83 DOWNLOAD.COM home & personal title download $ 32.73 DOWNLOAD.COM Internet banners $ 19.83 DOWNLOAD.COM Internet window $ 19.83 DOWNLOAD.COM Internet title download $ 32.73 DOWNLOAD.COM multimedia & design banners $ 29.75 DOWNLOAD.COM multimedia & design window $ 29.75 DOWNLOAD.COM multimedia & design title download $ 35.70 DOWNLOAD.COM utilities banners $ 19.83 DOWNLOAD.COM utilities window $ 19.83 DOWNLOAD.COM utilities title download $ 32.73 Snap! Run-of-site banners $ 11.90 Snap! Shopping banners $ 29.75 Snap! Keyword search $ 32.73 SEARCH.COM frontdoor portal $ 3.97 SEARCH.COM keywords $ 32.73
8 9 Additionally, for each of the first 12 calendar months of the Term, CNET will provide the following Advertising media to the Company at no cost:
CNET ADVERTISING MEDIA IMPRESSIONS PER MONTH DOWNLOAD.COM run-of-site banners 800,000 Snap! run-of-site banners 1,000,000 SEARCH.COM run-of-site banners 1,250,000
9 10 EXHIBIT B PERFORMANCE STANDARDS The Company Site and the Company's related operations must comply with the following performance standards throughout the Term 1. The Company Site will be operational and functional in all material respects (i.e. capable of displaying information, receiving purchases and conducting transactions as contemplated in the ordinary course of business). The Company shall use commercially reasonable efforts to maintain the functionality of the Site. Should, the Company Site fail to be operational and functional in all material respects, then for the period of time during such failure, CNET may remove the Retail Promotions without breaching the terms of this agreement and without any negative financial consequence to CNET. 2. Without limiting the effect of 1, the Company shall provide to Users coming to the Company Site from the Promotions at least the same level of service as is offered to users coming directly to the Company Site or from agreements with other distribution partners. 10 11 AMENDMENT TO PROMOTION AGREEMENT This Amendment to Promotion Agreement (the "Amendment") is dated to be effective as of June 30, 1998 between CNET, Inc. ("CNET") and FreeShop International, Inc. (the "Company"). CNET and the Company entered into a Promotion Agreement dated as of May 18, 1998 (the "Original Agreement" and, as amended hereby, the "Agreement"). Capitalization terms used in this Amendment and not otherwise defined have the meanings assigned to such terms in the Original Agreement. CNET and the Company desire to amend the Original Agreement as set forth in this Amendment. According, CNET and the Company hereby agree as follows: 1. Section 4.3.1 of the Original Agreement is hereby amended and restated in its entirety as follows: "4.3.1 During June, July, August, September, October, November and December of 1998, the Company will purchase at least $100,000, $50,000, $200,000, $100,000, $100,000 and $100,000, respectively, of Advertising media on the CNET Sites identified in Exhibit A. During January 1999 and for each subsequent month of the Term, the Company will purchase at least $100,000 of Advertising media on the CNET Sites identified in Exhibit A. The foregoing Advertising media will be purchased at the rates (expressed as Net CPM) identified for such CNET Sites in Exhibit A. CNET will guarantee the availability of at least these minimum amounts of media at these rates. Payments under this paragraph for a particular month will be due within 30 days after the end of such month." 2. The first sentence of Section 3.6 of the Original Agreement is hereby amended by replacing the phrase "One hundred twenty days after the date of this Agreement" with the phrase "On September 30, 1998". 3. Section 5 of the Original Agreement is hereby amended by replacing clause (a) thereof with the following: "(a) either party may terminate this Agreement, effective at any time on or after October 1, 1998, by giving 30 days' written notice of termination to the other party". 4. Except as expressly set forth in this Agreement, the Original Agreement remains in full force and effect in accordance with its terms. References in the Original Agreement to the "Agreement" are hereby amended to refer to the Original Agreement, as amended by this Amendment. This Amendment and the Original Agreement constitute and contain the entire agreement between the parties with respect to the subject matter hereof and thereof and supersede any prior oral or written agreements. This Amendment will be construed in accordance with and governed by the laws of the State of California, without regard to principles of conflicts of law. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their duly authorized representatives as of the date first written above. CNET, INC. FREESHOP INTERNATIONAL, INC. 12 By: /s/ MARTIN GREEN By: /s/ TIM CHOATE ------------------------------ ---------------------------- Title: Vice President Title: President & CEO --------------------------- ------------------------- 13 SECOND AMENDMENT TO PROMOTION AGREEMENT This Second Amendment to Promotion Agreement (the "Amendment") is dated to be effective as of September 30, 1998 between CNET Inc. ("CNET") and FreeShop International, Inc. (the "Company"). CNET and the Company entered into a Promotion Agreement dated as of May 18, 1998, which was amended pursuant to an Amendment to Promotion Agreement dated as of June 30, 1998 (as so amended, the "Original Agreement" and, as further amended hereby, the "Agreement"). Capitalized terms used in this Amendment and not otherwise defined have the meanings assigned to such terms in the Original Agreement. CNET and the Company desire to amend the Original Agreement as set forth in this Amendment. Accordingly, CNET and the Company hereby agree as follows: 1. Section 4.3.1 of the Original Agreement is hereby amended and restated in its entirety as follows: "4.3.1 During June, July, August and September of 1998, the Company will purchase at least $100,000, $50,000, $50,000 and $200,000, respectively, of Advertising media on the CNET Sites identified in Exhibit A. During October 1998 and for each subsequent month of the Term, the Company will purchase at least $50,000 of Advertising media on the CNET Sites identified in Exhibit A. The foregoing Advertising media will be purchased at the rates (expressed as Net CPM) identified for such CNET Sites in Exhibit A. CNET will guarantee the availability of at least these minimum amounts of media at these rates. Payments under this paragraph for a particular month will be due within 30 days after the end of such month." 2. Section 5 of the Original Agreement is hereby amended by replacing clause (a) thereof with the following: "(a) either party may terminate this Agreement, effective at any time on or after January 1, 1999, by giving 30 days' written notice of termination to the other party". 3. The last paragraph of Exhibit A of the Original Agreement, which relates to Advertising to be provided to the Company at no cost, is hereby amended and restated in its entirety as follows: "Additionally, for each of the first 12 calendar months of the Term, CNET will provide the following Advertising media to the Company at no cost:
CNET ADVERTISING MEDIA IMPRESSIONS PER MONTH DOWNLOAD.COM run-of-site banners 266,667 Snap! Run-of-site banners 333,333 SEARCH.COM run-of-site banners 416,667"
4. Except as expressly set forth in this Amendment, the Original Agreement remains in full force and effect in accordance with its terms. References in the Original Agreement to the "Agreement" are hereby amended to refer to the Original Agreement, as amended by this Amendment. This Amendment and the Original Agreement constitute and contain the entire agreement between the parties with respect to the subject matter hereof and thereof and supersede any prior oral or written agreements. This Amendment will be construed in accordance with and governed by the laws of the State of California, without regard to principles of conflicts of law. 14 CNET, INC. FREESHOP INTERNATIONAL, INC. By: /s/ MARTIN GREEN By: /s/ TIM CHOATE ------------------------------ ---------------------------- Title: Vice President Title: President & CEO --------------------------- ------------------------- EX-23.1 7 CONSENT OF PRICEWATERHOUSECOOPERS LLP 1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in this Registration Statement on Form S-1/A of our report dated April 16, 1999, except for paragraphs three through seven of Note 13, which are as of June 18, 1999, and paragraph eight of Note 13, which is as of August 9, 1999, relating to the financial statements of FreeShop.com, Inc., of our report dated May 6, 1999, relating to the financial statements of Commonsite LLC, and of our report dated May 24, 1999, relating to the financial statements of Travel Companions International, Inc. which appear in such Registration Statement. We also consent to the references to us under the heading "Experts," in such Registration Statement. PricewaterhouseCoopers LLP Seattle, Washington September 21, 1999 -----END PRIVACY-ENHANCED MESSAGE-----