10-Q/A 1 f65994e10-qa.txt QUARTERLY REPORT FOR PERIOD ENDED 06-30-2000 1 United States Securities and Exchange Commission Washington D.C. 20549 FORM 10-Q/A [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2000 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Transition Period From ___________ to ___________. Commission File Number: 005-57829 EGREETINGS NETWORK, INC. (Exact name of registrant as specified in its charter) Delaware 94-3207092 (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification No.)

149 New Montgomery Street San Francisco, CA 94105 (Address of principal executive offices) Registrant's telephone number, including area code: (415) 375-4100 Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

AMENDMENT AND CORRECTION TO ANNUAL REPORT ON FORM 10-QA FOR QUARTER ENDED JUNE 30, 2000 The following additional information has been included in this amendment and correction on Form 10-Q/A for quarter ended June 30, 2000. In aggregate these amendments represent clarifications or additions to disclosures and do not affect net loss per share for any period reported in Egreetings Network Inc.'s Form 10-Q for the quarter ended June 30, 2000, filed on August 14, 2000. The disclosures in Part I, Item 1, "Financial Information", of net loss per share has been revised on the Statement of Operations and Note 2, "Significant Accounting Policies", to exclude presentation of pro forma basic and diluted net loss per share. The Condensed Statement of Operations appearing in Part I, Item 1, "Financial Information", has been amended to include the footnotes (1), (2), (3) and (4) relating to allocation of amortization of deferred content and deferred stock compensations costs to the line items entitled "Cost of Services", "Sales and Marketing", "Operations and Development" and "General and Administrative", respectively. Part I, Item I, "Financial Information", "Notes to the Condensed Financial Statements", Note 2, "Significant Accounting Policies" has been amended to include a description of the Company's business communications services as the sixth paragraph under the heading "Revenue Recognition". Part I, Item I, "Financial Information", "Notes to the Condensed Financial Statements", Note 2, "Significant Accounting Policies" has been amended to include the Company's accounting policies for investments in marketable debt securities. Part I, Item I, "Financial Information", "Notes to the Condensed Financial Statements" has been amended to include Note 4, "Investments", which provides the information required under Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities". The disclosure appearing in Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations", under the heading "Overview", second paragraph, has been revised to provide further description of the Company's business communications services. The disclosure appearing in Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations", under the heading "Revenues" has been amended to include a third paragraph to provide additional explanation of the change in deferred revenues. Except as noted above, information in the originally filed Form 10-Q for the quarter ended June 30, 2000, filed on August 14, 2000, is presented as of the original filing date and has not been updated in this amended filing. This Form 10-Q, as amended, has not been updated for any subsequent events. 2 TABLE OF CONTENTS 10-Q PART I - FINANCIAL INFORMATION Item 1 Condensed Financial Statements (unaudited) - Balance Sheets at June 30, 2000 and December 31, 1999 - Statements of Operations for the three months ended June 30, 2000 and 1999 and the six months ended June 30, 2000 and 1999 - Statements of Cash Flows for the six months ended June 30, 2000 and 1999 - Notes to Financial Statements Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3 Quantitative and Qualitative Disclosures About Market Risk PART II - OTHER INFORMATION Item 1 Legal Proceedings Item 6 Exhibits and Reports Signatures

2 3 EGREETINGS NETWORK, INC. CONDENSED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)

See notes to condensed financial statements. 3 4 EGREETINGS NETWORK, INC. CONDENSED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)

(1) Excluding $1,396 and $252 in amortization of deferred content costs for the three months ended June 30, 2000 and 1999, respectively, and $2,594 and $405 in amortization of deferred content costs for the six months ended June 30, 2000 and 1999, respectively. Also excluding $29 and $20 in amortization of deferred stock compensation for the three months ended June 30, 2000 and 1999, respectively, and $63 and $31 in amortization of deferred stock compensation for the six months ended June 30, 2000 and 1999, respectively. (2) Excluding $86 and $109 in amortization of deferred stock compensation for the three months ended June 30, 2000 and 1999, respectively, and $212 and $145 in amortization of deferred stock compensation for the six months ended June 30, 2000 and 1999, respectively. (3) Excluding $136 and $218 in amortization of deferred stock compensation for the three months ended June 30, 2000 and 1999, respectively, and $322 and $303 in amortization of deferred stock compensation for the six months ended June 30, 2000 and 1999, respectively. (4) Excluding $45 and $58 in amortization of deferred stock compensation for the three months ended June 30, 2000 and 1999, respectively, and $103 and $80 in amortization of deferred stock compensation for the six months ended June 30, 2000 and 1999, respectively. See notes to condensed financial statements. 4 5 EGREETINGS NETWORK, INC. CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS)

See notes to condensed financial statements. 5 6 EGREETINGS NETWORK, INC. NOTES TO THE CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. THE COMPANY AND BASIS OF PRESENTATION Egreetings Network, Inc. (the "Company") offers consumers and businesses a convenient and simple integrated solution for communicating and sending gifts online. The Company's Web site allows users to send personalized content-rich online cards and a wide variety of gifts. The Company operates in one business segment and generates revenue from corporate advertising and sponsorships, direct marketing, e-commerce, and business communication services. The business communication services include creating and distributing customized, media-rich communication products for business to send to their employees, customers and partners. The Company's platform card service also offers other Web sites a highly engaging and viral way to build and maintain traffic. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by general accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. The balance sheet at December 31, 1999 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999. Certain prior period balances have been reclassified to conform to current period presentation. 2. SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition Revenues are generated primarily as a result of advertising and sponsorship, direct marketing, Ecommerce activities, and business communications services. The duration of banner advertising and sponsorship commitments typically range from one month to one year. The Company's advertisement obligations typically include guarantees of a minimum number of impressions, or times that an advertisement appears in pages viewed by consumers using the Company's Web site. The Company recognizes revenues on the sale of banner advertisements as the impression is delivered or displayed. The Company recognizes revenues on the sale of sponsorship advertisements on a straight-line basis over the period in which the sponsor's message is displayed. To the extent minimum guaranteed impressions, if any, are not met, revenue recognition is deferred until the remaining guaranteed impressions are delivered. Revenue from direct marketing activities is recognized based on the ratio of the number of emails actually sent to the guaranteed number of emails to be sent. In each case, revenues are recognized only if the Company has no remaining significant obligations and collection is probable. Revenue from Ecommerce transactions is recognized on the date the digital gift certificate code is emailed to the buyer or designated recipient and on the date of shipment for physical goods. Revenue from business communications services is recognized on the date that the custom-made digital greeting is transmitted to the customer. Deferred revenue is primarily comprised of billings in excess of recognized revenue relating to advertising contracts and payments received pursuant to revenue generating contracts in advance of revenue recognition. Investments Management determines the appropriate classification of debt and equity securities at the time of purchase and reevaluates such designation as of each balance sheet date. At June 30, 2000, the Company's investment portfolio consisted of securities classified as available for sale. At December 31, 1999, the Company did not hold any investments in such securities. Unrealized holding gains and losses, if material, are included as a separate component of other comprehensive income on the Statement of Stockholders' Equity. At June 30, 2000, unrealized holding gains and losses are not material. Realized gains and losses are recorded in the Statement of Operations upon selling the security. Deferred Content Costs The Company records the value of deferred content costs as of the date of the related content licensing agreements and amortizes these costs to expense over the life of the contract using the straight-line method. Realization of deferred content costs is subject to the Company generating adequate revenues and other benefits as a result of the arrangement. Should the benefits under the various content agreements not accrue to the Company, the carrying value of the asset could become impaired and the Company would write 6 7 down the asset value to its net realizable value at that time. The Company continually evaluates the realizability of its deferred content costs for impairment. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Dependence on Third Parties and Related Party Transactions A common stockholder, Gibson Greetings, Inc. ("Gibson"), now a wholly-owned subsidiary of American Greetings Corp., provides a significant portion of the Company's online cards content pursuant to an agreement that obligates the Company to pay royalties. Under this agreement, the Company accrued royalties payable to this related party of $103,000 and $169,000 in the three months ended June 30, 2000 and 1999, respectively, and $212,000 and $236,000 in the six months ended June 30, 2000 and 1999, respectively. Royalty obligations arise as online cards containing third-party content are sent by consumers. Royalty expenses are recorded with a charge to cost of services in the statement of operations in the period during which the related obligations arise. In addition, the Company relies on another entity for Internet connectivity and to house and maintain its Web servers. The inability of any of these parties to fulfill their obligations with the Company could negatively impact the Company's future results. 3. NET LOSS PER SHARE DATA Basic and diluted net loss per share information for all periods is presented under the requirement of SFAS No. 128, "Earnings per Share" ("SFAS 128"). Basic earnings per share has been computed using the weighted-average number of common shares outstanding during the period, less shares subject to repurchase, and excludes any dilutive effects of stock options, warrants, and convertible securities. Potentially dilutive securities have also been excluded from the computation of diluted net loss per share as their inclusion would be antidilutive. The calculation of basic and diluted net loss per share is as follows (in thousands, except per share amounts):

4. INVESTMENTS At June 30, 2000, all marketable debt securities were classified as available for sale. At December 31, 1999, the Company did not hold any investments in securities. Investments consisted of the following (in thousands):

At June 30, 2000, maturities for long-term securities were between one and two years. At June 30, 2000, the estimated fair value of each investment approximated its amortized cost and, therefore, there were no significant unrealized gains or losses. 7 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion contains forward-looking statements that involve risks and uncertainties that are based on our current expectations about our company and our industry. We make such forward-looking statements under the provisions of the "Safe Harbor" section of the Private Securities Litigation Reform Act of 1995. Any forward-looking statements should be considered in light of the factors described below in Item 2 under "Factors That May Affect Future Results." Actual results may differ materially from those projected, anticipated or indicated in any forward-looking statements. In Item 2, we use the words "anticipates," "believes," "intends," "future," "could" and similar words and expressions referencing future events, conditions or circumstances identify forward-looking statements, but not all forward-looking statements include these words. Some of these forward-looking statements relate to our strategy, the launch of new services leveraging our Web site, our market opportunities, the ability to meet revenue-generating milestones with our current partners, the anticipated use of proceeds from our recent offering, our anticipated advertising revenues, our ability to attract and retain distribution partners, our ability to attract and retain quality e-commerce partners and generate revenues from such partnerships, our competitive position, our ability to continue to license and develop high quality content and services on our Web site, our management's discussion and analysis of our financial condition and results of operations. The section entitled "Risk Factors" appearing in this report describes those factors that we currently consider material and that could cause these differences. These factors also include, but are not limited to, those discussed in our other SEC filings, including our Registration Statement on Form S-1 declared effective December 16, 1999 by the SEC (File No. 333-88595) and in our Annual Report on Form 10-K filed June 30, 2000 with the SEC. We urge you to consider these cautionary statements carefully in evaluating our forward-looking statements. Except as required by law, we undertake no obligation to publicly update any forward-looking statements to reflect subsequent events and circumstances. You should read the following discussion and analysis in conjunction with our financial statements and related notes included in this report. OVERVIEW From our inception in July 1994 through the year ended 1996, we derived our revenues primarily from the sale of paper greeting cards, first through CD-ROM based catalogs and then through our Web site and our online store on America Online (AOL). In February 1997, we implemented AOL's first online cards service, and in late 1997, we launched our own online cards service from our Web site. Revenues through the year ended 1997 consisted primarily of fees from AOL and, to a lesser extent, sales of paper and online cards through our Web site. We discontinued the sale of paper greeting cards through our Web site in July 1997 in order to focus on our online cards service. Revenues for the year ended 1998 were derived largely from the sale of advertisements, sponsorships and online cards on our Web site and from content licensing fees paid to us by AOL. Our relationship with AOL ended in late 1998. In November 1998, we made a significant change to our business model and began offering our online cards for free. We made this change in order to more rapidly build a large and active user base, which increases our ability to sell advertisements and sponsorships on our Web site to third parties and has been the launching pad for our online direct marketing business. Our business model also includes e-commerce activities, primarily in the form of digital gift certificates, and a business communications service. Business communications services consist of developing custom-made digital greetings, announcements and invitations for companies for their communications with their customers, potential customers, employees or other business associates. Lastly, we are developing and marketing a platform card service licensed to other Websites as a tool for customer acquisition and retention. As we develop and introduce more products and services in the future, we anticipate that revenues from advertisements and sponsorships will decrease as a percentage of total revenues. RESULTS OF OPERATIONS Revenues Revenues grew to $3.1 million and $5.9 million for the three- and six- month periods ended June 30, 2000 from $621,000 and $724,000 for the corresponding periods ended June 30, 1999. The catalyst for this growth has been the significant increase in traffic to our Web site and in registration of members who opt in to receive sponsored email promotions, which in turn has driven growth in our advertising inventory and direct marketing base. We have capitalized on this growth by building our sales team steadily throughout 1999 and in the first two quarters of 2000. Deferred revenue increased to $1.2 million as of June 30, 2000 from $581,000 as of December 31, 1999. This increase is primarily attributable to a non-refundable fee of $1 million received from a platform card service customer. 8 9 We typically guarantee advertisers a minimum number of "impressions," or times that an advertisement appears in pages viewed by consumers using our Web site. We recognize revenues on the sale of advertisements based on the ratio of the number of impressions actually delivered to the guaranteed number of impressions. We recognize revenues on the sale of sponsorships on a straight-line basis over the period during which the sponsor's promotional message is displayed on our Web site. Direct marketing revenues are recognized based on the ratio of the number of emails actually sent to the guaranteed number of emails to be sent. E-commerce revenues are recognized upon electronic delivery of digital gift certificates or shipment of physical goods. In all cases, revenues are recognized only if we have no remaining significant obligations and the collection of the receivable is probable. Cost of Services Cost of services is comprised primarily of royalties paid to content licensors, the cost of our internal content production, Internet connectivity charges, server co-location costs, direct marketing list management costs and the cost of goods sold from our online gift store. Cost of services increased to $1.3 million and $2.4 million for the three- and six-month periods ended June 30, 2000 from $672,000 and $1.1 million for the corresponding periods ended June 30, 1999. The increase in this cost is primarily due to increases of in-house content costs resulting from the rise in demand for our online cards, as well as costs associated with two growing revenue streams, namely direct marketing list management costs and cost of goods sold from our online store which opened in late 1999. Content royalty fees actually decreased as our customers sent more online cards produced by the Company than online cards produced by third party publishers. Cost of services is not proportional to revenues and may increase or decrease as a percentage of revenues. Sales and Marketing Sales and marketing expenses consist primarily of expenses related to online and offline advertising, distribution, personnel and facilities, promotional activities and public relations costs. Distribution costs reflect amounts paid to online service providers, portals and other Web sites who market and provide links to our Web site. Sales and marketing expenses increased to $4.4 million and $10.3 million for the three- and six-month periods ended June 30, 2000 from $2.4 million and $5.3 million for the corresponding periods ended June 30, 1999. This increase is primarily attributable to an acceleration in television, radio, online and print advertising activities as well as increased marketing personnel costs. Sales related expenses also increased due to the growth in our sales team to 25 people at June 30, 2000 from 11 people at June 30, 1999, which growth was planned in order to monetize the large increase in our Web site traffic and resulting advertising inventory. Sales and marketing expense as a percentage of total revenues may fluctuate depending on the timing and type of new marketing programs and distribution agreements and the addition of sales and marketing personnel. Operations and Development Operations and development expenses consist primarily of personnel and facilities costs for our site management, product management, user experience, business development, engineering, information systems, site operations and site production departments. Operations and development expenses increased to $4.3 million and $8.5 million for the three- and six-month periods ended June 30, 2000 from $2.1 million and $3.4 million for the corresponding periods ended June 30, 1999. These increases primarily were due to increased personnel costs, including the cost of independent contractors assisting on various engineering projects. Depreciation expense also rose due to the addition of hardware and software to support greater levels of traffic on our Web site. These expenses as a percentage of revenues may fluctuate depending on the level of future revenues and the timing of new personnel hires to support and expand our site infrastructure and traffic. General and Administrative General and administrative expenses consist primarily of personnel and related costs for general corporate functions, including finance, accounting, facilities and administration, legal, human resources and fees for professional services. General and administrative expenses increased to $1.7 million and $3.7 million for the three- and six-month periods ended June 30, 2000 from $1.0 million and $2.0 million for the corresponding periods ended June 30, 1999. This increase is primarily the result of 9 10 increased personnel, facility and overhead costs necessary to support our growing business infrastructure. We have increased our office space from approximately 14,000 square feet in the second quarter of 1999 to approximately 70,000 square feet in the second quarter of 2000. General and administrative expense as a percentage of revenues may fluctuate depending on the level of future revenues and the timing of additional investments in general and administrative infrastructure. Amortization of Deferred Content Costs Amortization of deferred content costs increased to $1.3 million and $2.6 million for the three- and six-month periods ended June 30, 2000 from $252,000 and $405,000 for the corresponding periods ended June 30, 1999. This increase is primarily the result of a significant upward revaluation during 1999 of a warrant issued to Gibson Greetings, Inc. in connection with rights to distribute Gibson's content in the form of online cards. Also in late 1999, we incurred approximately $4.8 million of content costs in conjunction with a content licensing agreement signed with the National Broadcasting Company, Inc. We will periodically review the recoverability of the deferred content costs and will write these assets down to their net realizable value if impairment is deemed to have occurred. Amortization of Deferred Stock Compensation Amortization of deferred stock compensation decreased to $296,000 for the three-month period ended June 30, 2000 from $405,000 for the corresponding period ended June 30, 1999, compared with an increase to $700,000 for the six-month period ended June 30, 2000 from $559,000 for the corresponding period ended June 30, 1999. These charges relate to the amortization of deferred stock compensation over the vesting periods, generally four years, of options granted in 1998 and 1999 at exercise prices less than the deemed fair value of our common stock on the grant date. Interest Income (Expense), Net Net interest income increased to $782,000 for the three-month period ended June 30, 2000 from $59,000 for the corresponding period ended June 30, 1999. For the six months ended June 30, 2000, net interest income was $1.8 million compared to net interest expense of $107,000 for the corresponding period ending June 30, 1999. For the three- and six-month periods ended June 30, 2000, interest was earned primarily on proceeds from our initial public offering in December 1999. These proceeds are invested in high quality investments, including money market funds. Interest earned in both periods was offset by interest expense from equipment term loans. Investment income in future periods may fluctuate as a result of fluctuations in average cash balances maintained by the Company and changes in the market rates of its investments. Income Taxes There has been no provision made for federal or state income taxes for any period as we have incurred operating losses to date. LIQUIDITY AND CAPITAL RESOURCES Since inception, we have financed our operations primarily through the private placements of equity securities and, in December 1999, an initial public offering of common stock. To a lesser extent we have used equipment financing facilities to fund operations. Net cash used in operating activities was $19.7 million and $12.2 million for the six months ended June 30, 2000 and 1999, respectively. Cash used in operating activities resulted primarily from net losses and decreases in accounts payable and accrued liabilities which were somewhat offset by non-cash charges for depreciation of furniture and equipment and amortization of deferred content costs. Net cash used in investing activities was $47.9 million and $4.9 million for the six months ended June 30, 2000 and 1999, respectively. Of these amounts, approximately $7.5 million and $4.9 million for the six months ended June 30, 2000 and 1999, respectively, were used to acquire network hardware and software and other equipment to support our growth in Web site traffic and personnel. The remaining cash outflow of $40.4 million in 2000 represented net investment of proceeds from our initial public offering in high quality financial instruments. Net cash provided by financing activities was $3.7 million and $23.4 million for the six months ended June 30, 2000 and 1999, respectively, and was generated primarily through the sale of common stock, preferred stock, and borrowings offset by loan pay downs. Due to proceeds received from our initial public offering in December 1999, we did not actively pursue additional financing during the six months ended June 30, 2000 other than the exercise by our underwriters of their right to purchase allotted shares from the initial public offering. 10 11 As of June 30, 2000, we had approximately $17.9 million of cash and cash equivalents, $40.4 million of investments and working capital of $36.6 million. As of June 30, 2000, we have a material operating lease commitment for our San Francisco headquarters facility. Other commitments include less material facility leases and equipment operating leases as well as our equipment term loans. Although we have no material commitments for capital expenditures, we anticipate that we will experience an increase in our capital expenditures consistent with our anticipated growth in operation, infrastructure and personnel. We currently anticipate that our operating expenses will be a material use of our cash resources. The Company believes that current cash and cash equivalents will be sufficient to meet its anticipated cash needs for at least the next 12 months. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. If current cash and cash equivalents and cash that may be generated from operations are insufficient to satisfy the Company's liquidity requirements, the Company may seek to sell additional equity or obtain additional debt financing. The sale of additional equity could result in additional dilution to the Company's stockholders. There can be no assurance that financing will be available in amounts or on terms acceptable to the Company, if at all. NEW ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." SAB 101 provides guidance on the recognition, presentation, and disclosure of revenue in financial statements of all public registrants. Any change in the Company's revenue recognition policy resulting from the interpretation of SAB 101 would be reported as a change in accounting principle in the quarter ending December 31, 2000. While the Company has not fully assessed the impact of the adoption of SAB 101, it believes that implementation of SAB 101 will not have a material adverse impact on its existing revenue recognition policies or its reported results of operations for fiscal 2000. RISK FACTORS RISKS RELATED TO OUR BUSINESS AND PROSPECTS OUR BUSINESS AND OUR PROSPECTS ARE DIFFICULT TO EVALUATE BECAUSE OUR OPERATING HISTORY UNDER OUR CURRENT BUSINESS MODEL IS UNPROVEN AND WE MAY CHANGE OUR BUSINESS MODEL IN THE FUTURE. Though we were incorporated in and have been operating since July 1994, we have significantly changed our business model since November 1998. The changes to the business model include a shift from charging consumers for our online cards to a free online card service supported by the sale of advertising and sponsorships and revenues derived from the sale of products through our Web site. Because our business model is largely untested, we cannot be sure that it will yield expected results. Because the Internet is constantly changing, we have evolved and may also continue to change our current business model. Changes in our business model or organizational structure could impose significant burdens on our management team and our employees and could result in loss of productivity or increased employee attrition. We may also encounter numerous other risks as an early-stage company with a new and evolving business model. To address the risks we face, we must, among other things: - expand and enhance our product and service offerings; - continually enhance the technology we use to deliver our products and services; - maintain and enhance our brand; - increase the amount of traffic to our Web site; - increase the value of our products and services to consumers, advertisers and e-commerce merchants; and - attract, integrate, retain and motivate qualified personnel. We cannot be certain that our current and planned business strategies will be successful or that we will successfully address these risks. 11 12 BECAUSE OUR METHODS OF GENERATING REVENUES ARE RELATIVELY NEW, LARGELY UNTESTED AND CONTINUE TO CHANGE, WE MAY BE UNABLE TO GENERATE SUFFICIENT REVENUES. We only recently began generating a significant portion of our revenues from sales of advertising on our Web site. These sales may not grow at the rates we expect, among other reasons, because Internet advertising is still a new and largely unproven method of advertising. During 1999, our revenues were derived primarily from Internet advertising and secondarily from direct marketing activities. We expect revenues from Internet advertising and direct marketing activities to continue to comprise a significant portion of our revenues for the foreseeable future. The effectiveness of Internet advertising is difficult to gauge and advertisers may be reluctant to advertise on the Internet and may allocate only limited portions or none of their advertising budgets to Internet advertising in the future. Our business could suffer if Internet advertising spending decreases or does not continue to grow as expected. Even if Internet advertising and direct marketing become widely accepted, we may be unable to generate sufficient revenues from these activities because we have limited experience generating revenues from Internet advertising and direct marketing. Our business model is also based on generating increased advertising and direct marketing revenues. If we lose significant advertising or direct marketing customers or are forced to significantly reduce advertising or direct marketing rates in order to retain these customers, our business will suffer. Also, even if advertising and direct marketing on the Internet become widely accepted, the success of our business strategy will depend on the ability to: - provide quality content on our Web site that will continue to attract the numbers and types of consumers that advertising, direct marketing and e-commerce partners want to reach; - provide guaranteed impressions of our advertisers' ads by our consumers; and - sell existing and future Internet advertising inventory. Although we intend to offer more e-commerce services, we may not generate significant revenues from these services because we have very limited experience in e-commerce. Our future success will largely depend on our ability to generate revenues through the facilitation of e-commerce transactions, a business area in which we have limited experience. We intend to facilitate these transactions both by directing consumers to our partners and by enabling consumers to purchase products and services directly from our Web site. We also expect third parties to fulfill these orders and deliver to consumers the goods and services that are purchased on or through our Web site. These methods of revenue generation are relatively new and largely untested for us. Market pressure and increasing consolidation in the e-commerce industry may make the creation of partnerships more difficult or the facilitation of transactions less attractive. In addition, the development and implementation of our e-commerce services will require additional management, financial and operational resources and may strain our existing resources. Our expansion into e-commerce may not be timely or may not generate sufficient revenues to offset the cost of our expansion into that area. Our Internet advertising, direct marketing and e-commerce revenues will be negatively impacted if we are unable to collect or use data about our consumers in ways that allow us, our advertisers, sponsors and e-commerce partners to generate revenues. We intend to continue to increase advertising, direct marketing and e-commerce revenues by offering to our advertisers, sponsors and e-commerce partners non-personally identifiable aggregate information about our registered members that is often difficult to obtain, such as their gender, age, general location, interests and online activities. Our advertisers, sponsors and e-commerce partners, in turn, use this aggregated demographic and psychographic information to tailor their advertising campaigns, direct marketing efforts or product offerings to the characteristics of our registered members. The ability of our advertisers, sponsors and e-commerce partners to properly target their advertising and commercial offerings will depend significantly on our ability to successfully collect and use data about our registered members. Privacy concerns may cause consumers to resist providing personal data. For example, we currently allow our registered members to opt out of receiving marketing and related communications. If a majority of our registered members make this election, the amount of the demographic data we are able to provide to advertisers, sponsors and e-commerce partners will be reduced significantly, which could harm our ability to retain and attract advertisers, sponsors and e-commerce partners. In addition, in October 1999, we eliminated the requirement that consumers become registered members to use our services. Although we offer some features and other benefits to our registered members that are unavailable to unregistered consumers, many consumers choose to use out site without registering as members. Our ability to collect the data desired by advertisers, sponsors and e-commerce merchants may decrease as a result of this change. This could result in less advertising, direct marketing and reduced e-commerce activities on or through our Web site and less advertising via our online cards, which would result in reduced revenues from advertising, direct marketing and e-commerce. 12 13 WE HAVE A HISTORY OF NET LOSSES AND EXPECT TO CONTINUE TO INCUR NET LOSSES. OUR BUSINESS WILL BE SERIOUSLY HARMED IF OUR REVENUES DO NOT GROW. We have incurred significant net losses in each fiscal quarter since our inception, including a net loss of approximately $9.4 million and $20.3 million for the three- and six-month periods ended June 30, 2000. As of June 30, 2000, we had an accumulated deficit of approximately $70.0 million. We expect to have net losses and negative operating cash flows for the foreseeable future. The size of these net losses will depend, in part, on the rate of growth of our revenues from our advertisers, sponsors, e-commerce merchants, licensing revenues from newly launched business services and on our expenses. Through at least 2002, our reported operating results will be negatively impacted by the amortization of deferred expenses relating to warrants and stock options granted through December 1999. It is critical to our success that we continue to expend financial and management resources to develop and expand our consumer base through promotion, enhancement and expansion of all of our products and services. As a result, we expect that our operating expenses will increase significantly for the foreseeable future. With increased expenses, we will need to generate significant additional revenues to achieve profitability. Consequently, it is possible that we may never achieve profitability, and even if we do achieve profitability, we may not sustain or increase profitability on a quarterly or annual basis in the future. If we do not achieve, sustain or increase profitability in the future, then we will be unable to continue our operations. SOME OF OUR CONTENT MAY BECOME UNAVAILABLE IF OUR RELATIONSHIPS WITH OUR THIRD-PARTY CONTENT PROVIDERS, PARTICULARLY GIBSON GREETINGS, EXPIRE OR ARE TERMINATED. We rely on third-party content providers, such as Gibson Greetings, now wholly-owned by American Greetings Corp., NBC, music producers, movie studios, traditional card designers, cartoonists and independent artists, for a significant portion of our content. To be successful, we will need to maintain our existing relationships as well as establish similar relationships with new parties who can provide us with cross-media and promotional opportunities. If we fail to retain our existing content relationships or enter into new relationships, the variety and quality of the content on our Web site may be reduced, traffic to our Web site may decrease, our advertising revenues may be impaired and future e-commerce revenues may not materialize. For the three- and six-months ended June 30, 2000, 23% and 24%, respectively, of all online cards sent from our Web site contained content that we obtained pursuant to an exclusive license agreement with Gibson that expires in December 2002. Gibson may also terminate our rights to exclusivity if our consumers do not send at least 2.8 million online cards via our Web site in each month during the term of the license agreement and if this minimum delivery requirement is not exceeded in any of the three months following the month in which the shortfall occurred. If the license agreement terminates and we are unable to renew this arrangement, the amount of content we are able to offer our consumers will significantly decrease. In March 2000, American Greetings Corp. acquired Gibson. American Greetings also is the parent company of AmericanGreetings.com, which is one of our competitors in the online cards market. We have not yet fully determined how our relationship with Gibson or our rights pursuant to our license agreement with Gibson will be affected by this acquisition. If Gibson or American Greetings fail to perform under the terms of our license agreement, the amount of content we are able to offer our consumers will decrease significantly, which could harm our business. With the exception of our relationships with Gibson, NBC, and BMG Entertainment, our existing content alliances are pursuant to short-term agreements. When these agreements expire or otherwise terminate, we may be unable to renew them on favorable terms or at all or to obtain similar agreements with other parties. Additionally, our competitors may enter into agreements with existing or prospective content partners that may be or would have been integral to our future content and brand development. OUR GROWTH WILL DEPEND ON OUR ABILITY TO CONTINUE TO PROVIDE COMPELLING CONTENT, INCREASE GIFT CENTER OFFERINGS AVAILABLE ON OUR WEB SITE AND ENHANCE OVERALL SERVICES AND FUNCTIONALITY. To remain competitive we must continue to license and create compelling and entertaining content, increase the offerings of gifts and gift-giving services available on or through our Web site and enhance and improve the ease of use, responsiveness, functionality and features of our products and services. We may be unable to anticipate, monitor and successfully respond to rapidly changing consumer tastes so as to attract a sufficient number of consumers to our Web site. If we are unable to license and develop content, increase the variety of gifts available and enhance and improve the personalized services that allow us to attract, retain and expand a 13 14 loyal consumer base, we will be unable to generate advertising revenues or e-commerce revenues and our business will suffer. The development and integration of new functionality and services could be expensive and time consuming, and the cost of the content that we license may increase in the future. Any new content, gifts, features, functions or services that we license or develop for consumers, advertisers or e-commerce merchants may not achieve market acceptance. OUR CONTINUED GROWTH WILL DEPEND ON OUR ABILITY TO DEVELOP OUR BRAND. In October 1998, we changed our name to E-greetings Network and launched a marketing campaign to establish the brand name "Egreetings." We believe that continuing to establish and maintain the Egreetings brand and associated goodwill will be an important aspect of our efforts to retain our current consumers, attract and expand our Internet audience, license and create new content, and appeal to advertisers and e-commerce merchants. We believe that the importance of brand recognition will increase due to the growing number of Internet sites and the relatively low barriers to entry in providing Internet content. Accordingly, we intend to continue pursuing an aggressive brand enhancement strategy. We intend to incur significant expenditures on promotional programs and activities in the future. These expenditures may not result in a sufficient increase in revenues. In addition, even if our brand recognition increases, we may not acquire new consumers and customers for our business services, and even if we do, our revenues may not increase sufficiently to justify the expenditures. If our brand enhancement strategy is unsuccessful, we also may be unable to increase future revenues. WE FACE INTENSE COMPETITION FROM COMPANIES THAT PROVIDE SIMILAR SERVICES AND PRODUCTS TO OURS, AND WE THEREFORE MAY BE UNABLE TO COMPETE EFFECTIVELY IN THE INTERNET GREETING AND GIFTING BUSINESS. We compete with many Internet companies for content, consumer attention and time, advertising revenue, direct marketing revenue and e-commerce revenue. We expect this competition to increase. We compete, in particular, with the following types of companies: - Companies that offer online cards via the Internet. Companies or their affiliates such as American Greetings, Hallmark and 123greetings.com offer online cards via the Internet. In addition, some of these companies offer e-commerce merchants' products that can be purchased at or through their Web sites and direct marketing sponsorship opportunities. Several of these companies also offer features on their Web sites that are similar or identical to our Web site's features. - Internet content aggregators and other Internet companies that offer online cards and gifts. Companies such as Amazon.com, America Online, Excite@Home and Yahoo! offer online cards as a component of their overall product and service offerings or provide links to electronic greeting and gift companies. The online cards available on or through these Web sites often are free and may be sent with a gift purchased via the particular Web site or via the Web sites of e-commerce merchants that are partners or advertisers of the content aggregator or Internet company. - Internet companies that focus on gifts. Several Internet companies offer gifts on their Web sites. Although these companies currently do not offer online cards, they may begin to do so in the near future. In addition, they compete directly with our e-commerce business. - Media, entertainment and other companies using online cards. Media, entertainment and other companies with an online presence now offer or in the future may offer online cards to consumers featuring their characters, logos, brand names and other creative products. In December 1999, Excite@Home Network acquired Bluemountain.com, the online business of Blue Mountain Arts. Excite@Home has significantly greater resources than we do, and we expect it will use some of these resources to focus on the online cards market. This could harm our business and our ability to compete effectively. In addition, the acquisition of Gibson, as a wholly-owned subsidiary, by American Greetings Corp. was consummated in June 2000 and American Greetings became the controlling corporation of our largest stockholder. American Greetings competes with us in the online cards market through its affiliated company AmericanGreetings.com. As a competitor, American Greetings' interests may diverge from our interests, and it may take actions that would harm us competitively, despite its status as the corporate parent of our largest stockholder. Many of our current and potential competitors in the Internet market, including the companies named above, have significantly greater financial, publishing, technical and marketing resources than we have. Many of these companies also have longer operating 14 15 histories, greater name recognition, more traffic to their Web sites and more established relationships with advertisers and advertising agencies than we have. These competitors may be able to undertake more extensive marketing campaigns, adopt aggressive pricing policies and devote substantially more resources to developing Internet content and services than us. We may be unable to compete successfully for advertisers, direct marketing sponsors and e-commerce partners. The increasing number of Internet content and service providers has resulted in increased competition for advertising dollars. Internet companies currently sell advertisements largely based on the demographics of their audience, the quality of their content and their ability to deliver guaranteed "impressions," or the number of times an advertisement appears in Web pages viewed by consumers using their Web sites. Our competitors may be able to provide more desirable demographics, higher quality content and a higher number of guaranteed impressions than we are able to. This could make it difficult for us to obtain the advertising or direct marketing relationships that we will need in order to generate sufficient revenues. As increasing consolidation and market condition pressures affect companies in the e-commerce and Internet industry, our current and potential partners' budget dollars allocated to advertising and direct marketing spending may diminish or be eliminated. In addition, increased competition for advertising or direct marketing dollars could result in price reductions, reduced margins or loss of market share, any of which would harm our business. We lack experience in e-commerce and we may not compete successfully for e-commerce merchants or consumers. Unlike many of our competitors, we have limited experience operating in the e-commerce arena and we may not be successful in doing so. In addition, many of our current and potential competitors are retailers with established brand names and consumer loyalty, and we may be unable to attract consumers away from these competitors. Our inability to compete successfully for e-commerce merchants or consumers would harm our business significantly. OUR FUTURE SUCCESS WILL DEPEND ON THE INCREASING USE OF THE INTERNET AND THE GROWTH OF E-COMMERCE. Our future success will depend heavily on the acceptance and wide use of the Internet for direct marketing and e-commerce. If Web-base commerce does not continue to grow or grows more slowly than expected, demand for our products and services will be reduced. Market conditions affecting e-commerce providers may also impact our ability to grow the service and product offerings on our Web site. Consumers and businesses may reject the Internet as a viable commercial medium for a number of reasons, including potentially inadequate network infrastructure, slow development of enabling technologies, insufficient commercial support or privacy concerns. The Internet's infrastructure may be unable to support the demands placed on it by increased usage. Internet service providers, online service providers and other Web site operators have already experienced significant outages. In addition, delays in the development or adoption of new standards and protocols required to handle increased levels of Internet activity, or increased governmental regulation, could cause the Internet to lose its viability as a commercial medium. Even if the required infrastructure, standards, protocols and complementary products, services or facilities are developed, we may incur substantial expenses adapting to changing or emerging technologies. AS WE EXPAND OUR E-COMMERCE ACTIVITIES, WE WILL DEPEND ON THIRD PARTIES TO FULFILL ORDERS AND DELIVER GOODS AND SERVICES TO OUR CONSUMERS; THEIR FAILURE TO PERFORM ADEQUATELY WOULD HARM OUR BUSINESS. As we expand our e-commerce activities, our success will depend in large part on the ability of third parties to fulfill our consumers' orders and deliver goods and services to our consumers. Failure of vendors or shippers to fill our consumers' orders or deliver quality goods and services on time would harm our business. Increasing consolidation and pressure related to market conditions for third party e-commerce partners could cause delays or other problems related to delivery or orders of goods. In addition, strikes or other service interruptions affecting fulfillment and delivery services would impair our ability to deliver merchandise ordered by our consumers on a timely basis. OUR GROWTH WILL DEPEND SIGNIFICANTLY ON THE INCREASING ACCEPTANCE OF ONLINE CARDS AS A FORM OF ONLINE COMMUNICATIONS. Our future success is substantially dependent on the widespread acceptance of online cards as a form of online communications. As email increasingly affects the way people communicate for personal and business purposes, online cards evolve as a form of communication. We cannot accurately predict the future growth rate, if any, or the ultimate size of the consumer use of online cards as a form of online communication. The failure of online cards to gain widespread acceptance by consumers, advertisers, sponsors and e-commerce merchants as a form of online communication would materially harm our business. 15 16 WE RELY ON ONLINE DISTRIBUTION CHANNELS TO GENERATE TRAFFIC TO OUR WEB SITE. We rely on distribution relationships with high traffic Internet sites and leading Internet portals to increase the visibility of our Web site and to generate additional traffic. Our business could be materially harmed if any of our distribution relationships do not result in increased Web site traffic and visibility or are not available on commercially reasonable terms. Our distribution relationships are based on short-term agreements and may not be as favorable as the agreements of some of our competitors. Because there is intense competition for online distribution relationships among Web sites, we may be unable to maintain or renew these agreements or enter into new relationships on commercially reasonable terms or at all. In addition, our online distribution relationships may not generate enough additional traffic to our Web site or create sufficient visibility to justify the costs we incur for these relationships. FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS MAY CAUSE OUR STOCK PRICE TO DECLINE. It is likely that our operating results in one or more future quarters may be below the expectations of stock market analysts, if any, or our investors, and this could cause our stock price to decline. We expect that our quarterly operating results will continue to fluctuate significantly and be affected by many factors, including the following: - fluctuations in the demand for Internet advertising generally and advertising on our Web site and via our online cards specifically; - fluctuations in purchases of products via the Internet generally and through our Web site specifically; - seasonal trends in Internet use, e-commerce and advertising demand; - fluctuations in traffic on our Web site generally and as the result of special promotions or seasonal events; - introduction of new Web sites, products and services by competitors; - marketing expenses and technology infrastructure costs; - expansion in our sales and customer support staff; and - technical difficulties or system downtime affecting the Internet generally or the operation of our Web site specifically. We have experienced and expect to continue to experience seasonality in our business. Consumer traffic on our Web site generally is higher during holiday periods such as Valentine's Day, Mother's Day, Father's Day and Christmas and is considerably slower during the summer months. In addition, sales of traditional greeting cards and gifts tend to be lower in the third calendar quarter of each year. Similarly, advertising sales in traditional media, such as television and radio, generally are lower in the first calendar quarter of each year. We may experience similar seasonality in our business. In addition, because advertising on the Internet is an emerging market, additional seasonal and other patterns in the usage of our products and services may emerge as the market matures. Seasonal patterns like this may harm our business. As a result of all of the factors discussed above, period-to-period comparison of our operating results may not be a good indication of our future performance. OUR STOCK PRICE HAS DECLINED IN RECENT MONTHS; CONTINUED VOLATILITY IN THE STOCK MARKET MAY CAUSE FLUCTUATIONS AND/OR FURTHER DECLINE IN OUR STOCK PRICE The trading price of our common stock has been and may continue to be subject to cumulative decline and wide fluctuations. During the second quarter of 2000, the closing sale prices of our common stock on the NASDAQ National Market ranged from $5.00 on April 7, 2000 to $1.25 on June 23, 2000 and the sale price of our common stock on August 10, 2000 closed at $1.375. Our stock price may decline or fluctuate in response to any number of factors and events, such as quarterly fluctuations in operating results, announcements of technological innovations, strategic and content relationships, new product offerings by us or our competitors, changes in financial estimates and recommendations of securities analysts, the operating and stock price performance of other companies that investors may deem comparable, and news reports relating to trends in our markets. In addition, the stock market in general, particularly with respect to technology and Internet stocks, has experienced extreme volatility and a significant cumulative 16 17 decline in recent months. This volatility and decline has affected many companies, including our company, irrespective to the operating performance of such companies. These broad market influences and fluctuations may adversely affect the price of our stock, regardless of our operating performance. WE INTEND TO PURSUE STRATEGIC ACQUISITIONS, AND OUR BUSINESS COULD BE MATERIALLY HARMED IF WE FAIL TO SUCCESSFULLY INTEGRATE, USE AND DEVELOP ANY ACQUIRED BUSINESSES OR ASSETS. We continually evaluate opportunities to acquire additional product or content offerings or additional industry expertise and may in the future acquire companies, divisions or assets of companies. Any future acquisition could result in difficulties in assimilating acquired operations and products, diversion of management's attention to acquisition matters and amortization of acquired intangible assets. Our management has not had any experience in assimilating acquired organizations and products into our operations. We may be unable to integrate successfully any operations, personnel or products that we may acquire in the future, which would harm our business. EXPANSION OF OUR INTERNATIONAL OPERATIONS WILL REQUIRE MANAGEMENT ATTENTION AND RESOURCES AND MAY BE UNSUCCESSFUL. To date, we have offered content and services directed at consumers and businesses in the United States. We plan to offer localized content and services directed at international customers in the future in order to increase the international traffic to our Web site. We do not have any experience in localizing our content and services to conform to local cultures, standards and policies. We may have to compete with local companies that are likely to understand the local market better than we do. In addition, to achieve satisfactory performance for consumers, advertisers and e-commerce partners in international locations, it may be necessary to locate physical facilities, such as facilities to host our server computers, in the foreign market. We do not have experience establishing facilities in foreign countries. We may not be successful in appealing to a larger international market or in generating revenues from foreign advertising or e-commerce activities. In addition, different privacy, censorship and liability standards and regulations and different intellectual property laws in foreign countries could harm our business. RISKS RELATED TO OPERATIONS TO MANAGE OUR GROWTH, WE WILL NEED TO IMPROVE OUR SYSTEMS, CONTROLS AND PROCEDURES. We have recently experienced a period of rapid expansion in our Web site traffic, personnel, facilities and infrastructure. For example, the average number of daily visits to our Web site increased approximately 306% from 112,800 for the month of November 1998, the month we began to offer our online cards at no cost, to 457,700 for the month of June 2000, and our number of employees increased from 52 on October 30, 1998 to 172 on June 30, 2000, with most of this growth in the areas of marketing, engineering and operations. We expect that the number of our employees, including management-level employees, will continue to increase for the foreseeable future to address expected growth in our consumer base, expansion of our product and service offerings and the pursuit of e-commerce and other strategic opportunities. This growth and expansion have placed, and we expect they will continue to place, a significant strain on our management, operational and financial resources. In order to manage our growth, we must continue to improve our operational and financial systems and managerial controls and procedures, and we will need to continue to expand, train and manage our work force. We cannot assure you that our systems, procedures or controls will be adequate to support our operations or that we will be able to manage our growth effectively. Our failure to manage growth could disrupt our operations and ultimately prevent us from generating the revenues we expect. SYSTEM FAILURES, SLOW DOWNS OR SECURITY BREACHES WOULD HARM OUR REPUTATION AND THUS REDUCE OUR ATTRACTIVENESS TO OUR CURRENT AND FUTURE CONSUMERS, ADVERTISERS, E-COMMERCE PARTNERS AND BUSINESS CUSTOMERS. System failures and slow downs could permanently harm our reputation and brand, and reduce our attractiveness to consumers, advertisers and e-commerce partners. Our ability to attract consumers, advertisers and e-commerce partners will depend significantly on the performance of our network infrastructure. A key element of our strategy is to generate a high volume of traffic on our Web site. Accordingly, the satisfactory performance, reliability and availability of our Web site and our computer infrastructure are critical to our reputation and our ability to attract and retain consumers, advertisers and e-commerce merchants. An increase in the volume of consumer traffic could strain the capacity of our infrastructure. For example, during the week before Valentine's Day, we frequently experience heavy increases in traffic to our Web site, which result in slower response rates. While we have invested heavily in our technical infrastructure, we may be unable to improve our technical infrastructure sufficiently in relation to increased consumer 17 18 volume generally and, in particular, during peak capacity periods. If we experience outages, frequent or persistent system failures or degraded response times, our reputation and brand could be harmed permanently. In addition, we could lose advertising revenues during these interruptions and consumer satisfaction could be negatively impacted if our service is slow or unavailable. Furthermore, our consumers use Internet service providers, online service providers and other Web site operators for access to our Web site. Each of these providers has experienced significant outages in the past and could experience outages, delays and other difficulties due to system failures unrelated to our systems. A fundamental requirement for the online communications products and services we offer is the secure transmission of confidential information over the Internet. The occurrence or perception of security breaches could harm our business. Third parties may attempt to breach the security provided by our Web site. If they are successful, they could obtain confidential information about our consumers, including their passwords, financial account information, credit card numbers or other personal information. Our consumers may file suits against us for any breach in our Web site's security. If we are not held liable, a security breach could still harm our reputation, as even the perception of security risks, whether or not valid, could inhibit market acceptance of our products and services. Despite our implementation of security measures, our software is vulnerable to computer viruses, electronic break-ins and similar disruptions, which could lead to interruptions, delays or loss of data. We may be required to expend significant capital and other resources to license encryption or other technologies to protect against security breaches or to alleviate problems caused by these breaches. In addition, our consumers might decide to stop using our products and services if we experience security breaches. We use third-party software to manage and deliver advertisements and to provide our advertisers with advertisement performance data. The failure of these systems to function properly could discourage advertisers from placing advertisements on our Web site or merchants from offering their products through our Web site. The failure of these systems also could require us to incur additional costs or could result in interruptions in our business during the time spent replacing these systems. Our failure to expand and upgrade our network system, provide consumers with access to our service or timely address any system error or failure could materially harm our business and reputation. The occurrence of an earthquake or other natural disaster or unanticipated problems at our leased facility in San Francisco, California or at the location of servers that host or back-up our systems could result in interruptions or delays in our business, loss of data or could render us unable to provide services. In addition, our systems are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure, break-ins, and similar events. Our general liability insurance policies may not adequately compensate us for losses that may occur due to interruption in our service. WE MAY BE UNABLE TO EXPAND OUR ENGINEERING AND SALES ORGANIZATIONS BECAUSE QUALIFIED PERSONNEL ARE IN SHORT SUPPLY. We will need to substantially expand both our consumer marketing and corporate marketing efforts and advertising sales operations to increase market awareness and sales of our products and services. We recently expanded our sales forces and plan to hire additional sales personnel. Competition for highly qualified sales personnel is intense, and we may be unable to hire the type and number of sales personnel we are targeting. To support and enhance our technology infrastructure, we will also need to increase the personnel in our engineering department. Hiring of highly qualified engineers and sales and advertising support personnel is very competitive in our industry due to the limited number of people available with the necessary technical skills and understanding of the Internet. OUR SENIOR MANAGEMENT TEAM AND OTHER KEY EMPLOYEES ARE CRITICAL TO OUR BUSINESS, AND THEY MAY NOT REMAIN WITH US IN THE FUTURE. Our success will be substantially dependent on the performance of our senior management and key creative, technical and sales personnel, many of who joined us only in the last year. The loss of the services of any of our executive officers or other key employees, the loss of any of which could harm our business. We do not have employment agreements with our executive officers, senior management or other key personnel, other than an employment agreement with our Chief Executive Officer. In addition, our employees may voluntarily terminate their employment at any time. WE MAY BE UNABLE TO ADAPT TO EVOLVING INTERNET TECHNOLOGIES AND CONSUMER AND BUSINESS CUSTOMER DEMANDS. 18 19 To be successful, we must adapt to rapidly changing Internet technologies by continually enhancing our products and services and introducing new services to address our consumers' changing needs. We could incur substantial development or acquisition costs if we need to modify our services or infrastructure to adapt to changes affecting providers of Internet services. Our business could be harmed if we incur significant costs to adapt to these changes. If we cannot adapt to these changes, or do not sufficiently increase the features and functionality of our products and services, our consumers may switch to the product and service offerings of our competition. Furthermore, our competitors or potential competitors may develop products or services that are more appealing to our current and potential consumers. As a result, demand for our services may decrease. RISKS RELATED TO CONTENT, INTELLECTUAL PROPERTY AND GOVERNMENT REGULATION WE MAY BE SUED FOR CONTENT AVAILABLE OR POSTED ON OUR WEB SITE OR THE PRODUCTS AND SERVICES AVAILABLE THROUGH OUR WEB SITE. We provide a wide variety of content that enables consumers to send online cards and other communications, and we intend to offer services that will allow consumers to conduct business and engage in various online activities. The laws relating to the liability of providers of these online services for the activities of their consumers is currently unsettled. The Digital Millennium Copyright Act is intended to reduce the liability of online service providers for material posted on Web sites by third parties where such materials infringe copyrights or proprietary rights of others. The protections afforded by this legislation have not been fully determined. Claims could be made against us for negligence, defamation, libel, copyright or trademark infringement, personal injury or other legal claims based on the content that we license from third parties or create internally or based on content that may be posted online by our consumers. While we generally obtain written licenses to use third-party content on our Web site, in some instances we rely only upon oral licenses. In addition, we could be exposed to liability with respect to third-party or internally created content on our Web site or with respect to the content of third-party Web sites that may be accessible through our Web site. These claims might include, among others, that by providing access to third-party content or by linking to Web sites operated by third parties, we may be liable for copyright or trademark infringement or other unauthorized actions by third parties through those Web sites. Furthermore, we could be exposed to liability for content and materials that may be created by consumers in build-your-own customized online cards. Any claims like these, with or without merit, could be time consuming to defend, result in costly litigation, divert management's attention, require us to enter into costly royalty or licensing arrangements or prevent us from using important technologies, ideas or formats, any of which could materially harm our business. Although we carry general liability insurance, our insurance policy does not currently cover intellectual property infringement. Obtaining adequate insurance coverage or implementing measures to reduce our exposure to this type of liability may require us to spend substantial resources. We currently do not have plans to obtain insurance that would cover intellectual property infringement. OUR BUSINESS DEPENDS ON OUR PROTECTION OF OUR INTELLECTUAL PROPERTY RIGHTS, AND WE MAY BE UNABLE TO ADEQUATELY PROTECT THEM. Our success will depend on the protection of and the goodwill associated with our trademarks and other intellectual property rights to our products and services. A substantial amount of uncertainty exists concerning the application of copyright and trademark laws to the Internet and other digital media, and existing laws may not provide adequate protection of our content or our Internet addresses, commonly referred to as "domain names." We have registered the name "E-greetings" as our trademark and service mark in the United States. We also have filed and plan to file applications to register a number of our other trademarks, trade names and service marks in the United States and foreign jurisdictions. We may be unable to obtain some or all of these registrations. CONSUMER PRIVACY CONCERNS AND CONSUMER PROTECTION PRIVACY REGULATIONS COULD IMPAIR OUR ABILITY TO OBTAIN OR USE INFORMATION ABOUT OUR CONSUMERS. Privacy concerns may cause consumers to resist providing the personal data necessary to support our ability to collect information about our consumers. Our Web site currently uses "cookies" to track consumer preferences in order to tailor content to them. A "cookie" is information keyed to a specific server, file pathway or directory location that is stored on a consumer's hard drive, possibly without the consumer's knowledge, but is generally removable by the consumer. We also capture demographic and psychographic information when an individual registers as a member with us, and we capture and retain data based on online cards sent and received by our consumers. We utilize this information to assist advertisers in targeting their online advertising campaigns to consumers with particular demographic characteristics. Although we currently have a policy against providing our customers' personal information to third parties, we may decide in the future to provide some or all of this information to our advertising and e-commerce partners. In the past, the Federal Trade Commission has investigated companies that have taken actions like this without permission or in violation of the companies' stated privacy policies. If we begin providing information like this without permission or in violation of our privacy 19 20 policy, we may face potential liability for invasion of privacy. Even the perception of security and privacy concerns, whether or not valid, may indirectly inhibit market acceptance of our Web site products and services. In April 2000, the Children's Online Privacy Protection Act of 1998 went into effect regulating the collection and use of information with regard to children under the age of 13. As a result, the Company has ceased collecting personal information from children it knows to be under 13 and altered its privacy policy to reflect compliance with the Act. In addition, other legislative or regulatory requirements may heighten these concerns if businesses must notify Internet consumers that the data may be used by marketing entities to direct product promotion and advertising to the consumer. Other countries and political entities, such as the European Union, have adopted legislation and regulatory requirements like this. The United States may adopt similar legislation or regulatory requirements. If we do not adequately address consumer privacy concerns, our business could be materially harmed. GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES COULD RESULT IN ADDITIONAL COSTS OF DOING BUSINESS ON THE INTERNET. We currently are not subject to meaningful direct regulation applicable to access to, or commerce on, the Internet by any government agency. It is possible that in the future a number of laws and regulations may be adopted with respect to the Internet and other digital media, covering issues such as consumer privacy, e-commerce and the pricing, characteristics and quality of products and services. By conducting business via the Internet, we may be subject to the laws of foreign jurisdictions in an unpredictable manner. Several telecommunications companies have petitioned the Federal Communications Commission to regulate Internet service providers and providers of online services in a manner similar to long distance telephone carriers and to impose access fees on these companies. This could increase the cost of transmitting data over the Internet. Moreover, the applicability of existing laws relating to issues such as property ownership, defamation and personal privacy on the Internet is uncertain. Any new laws or regulations relating to the Internet could harm our business. We also could be exposed to liability arising from the activities of consumers of our content or services or with respect to the unauthorized duplication or insertion of material (such as material deemed obscene or inappropriate for children) accessed directly or indirectly through our services. Several private lawsuits seeking to impose such liability upon content providers, online services companies and Internet access providers currently are pending. In addition, legislation has been enacted that imposes, and further legislation may be proposed that may impose liability for, or prohibit the transmission over the Internet of, certain types of information and content. Any legislation or regulation like this, or the application of existing laws to the Internet, could expose us to significant liabilities associated with our content or services. There is also uncertainty regarding the imposition of sales and other taxes on e-commerce transactions, which may impair our ability to derive financial benefits from e-commerce activities. Although the Internet Tax Freedom Act precludes, for a period of three years ending January 2002, the imposition of state and local taxes that discriminate against or single out the Internet, it does not currently impact existing taxes. However, one or more states may seek to impose sales tax collection obligations on out-of-state companies, such as us, which engage in or facilitate online commerce. A number of proposals have been made at the state and local level that would impose additional taxes on the sale of goods and services through the Internet. Proposals like these, if adopted, could substantially impair the growth of e-commerce and could adversely affect our opportunity to derive financial benefits from e-commerce. Moreover, if any state or foreign country were to successfully assert that we should collect sales or other taxes on the sale of merchandise on or through our Web site, it could affect our cost of doing business. CHANGES IN REGULATION COULD REDUCE THE VALUE OF OUR DOMAIN NAME. We own the Internet domain name "Egreetings.com" in the United States. Internet regulatory bodies generally regulate domain names, and the regulation of domain names is subject to change. Regulatory bodies could establish new domain name systems, appoint additional domain name registrars or modify the requirements for holding domain names. In addition, regulations regarding foreign domain name registration vary from jurisdiction to jurisdiction and are subject to change. As a result, we might not acquire or maintain the "Egreetings.com" or comparable domain names in any of the countries in which we conduct business, which could harm our business. Furthermore, the relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is unclear and still evolving. Therefore, we might be unable to prevent third parties from acquiring domain names that infringe or otherwise decrease the value of our trademarks and other proprietary rights. If we are unable to protect our domain names, our business would suffer. ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND INTEREST RATE RISK 20 21 The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, our policy is to maintain our portfolio of cash equivalents and investments in marketable securities in a variety of securities, including both government and corporate obligations and money market funds. As of June 30, 2000, all of our funds were held in money market funds, U.S. government and agency securities and investment grade corporate bonds and equities. We did not hold derivative financial instruments as of June 30, 2000 and have never held these instruments in the past. PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights and other intellectual property rights. In addition, from time to time, third parties assert patent infringement claims against the Company in the form of letters, lawsuits and other forms of communication. The Company is not currently aware of any legal proceedings or claims that the Company believes are likely to have a material adverse effect on the Company's financial position of results of operations. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits

(b) Reports on Form 8-K None. 21 22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 9th day of November 2000. EGREETINGS NETWORK, INC. By: /s/ ANDREW J. MOLEY --------------------------------- Andrew J. Moley Chief Executive Officer and President (Principal Executive Officer) By: /s/ SCOTT F. NEAMAND --------------------------------- Scott F. Neamand Senior Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer) 22 23 EXHIBIT INDEX

EGREETINGS NETWORK INC 10-Q/A