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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
    FORM 10-Q     þ
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended: March 31, 2005 or  o
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from  to Commission File Number: 000-50879 PLANETOUT INC.  DELAWARE
    
    94-3391368(State or Other Jurisdiction of Incorporation or Organization)
    
    (I.R.S. Employer Identification No.)1355 SANSOME STREET, SAN FRANCISCO, CALIFORNIA
    
    94111(Address of Principal Executive Offices)
    
    (Zip Code)
 (415) 834-6500
(Registrants Telephone Number, Including Area Code)    Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. þ Yes o No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). o Yes þ No The number of shares outstanding of the registrants Common Stock, $0.001 par value, as of May
6, 2005 was 17,049,688.




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PlanetOut Inc. INDEX Form 10-Q For the Quarter ended March 31, 2005 PAGEPART I  FINANCIAL INFORMATIONItem 1 Unaudited Condensed Consolidated Financial Statements
    
    3Unaudited Condensed Consolidated Balance Sheets as of December 31, 2004 and March
31, 2005
    
    3Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended
March 31, 2004 and 2005
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2004 and 2005
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    6Item 2 Managements Discussion and Analysis on Financial Condition and Results of Operations
    
    12Item 3 Quantitative and Qualitative Disclosures About Market Risk
    
    29Item 4 Controls and Procedures
    
    29PART II  OTHER INFORMATIONItem 1 Legal Proceedings
    
    30Item 2 Unregistered Sales of Equity Securities And Use of Proceeds
    
    30Item 3 Defaults Upon Senior Securities
    
    31Item 4 Submission of Matters to a Vote of Security Holders
    
    31Item 5 Other Information
    
    31Item 6 Exhibits
    
    31SIGNATURESEXHIBIT INDEXEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I FINANCIAL INFORMATION PlanetOut Inc. 
 Item 1. Unaudited Condensed Consolidated Financial Statements 
 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share amount)
 December 31,
    
    
    March 31,2004
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    43,128
    
    
    $
    41,705Accounts receivable, net
    
    
    2,075
    
    
    
    1,492Prepaid expenses and other current assets
    
    
    2,209
    
    
    
    3,259Total current assets
    
    
    47,412
    
    
    
    46,456Property and equipment, net
    
    
    7,011
    
    
    
    7,404Goodwill
    
    
    3,403
    
    
    
    3,403Investment in unconsolidated affiliate
    
    
    57
    
    
    
    48Other assets
    
    
    1,325
    
    
    
    1,171Total assets
    
    $
    59,208
    
    
    $
    58,482LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    2,040
    
    
    $
    855Accrued liabilities
    
    
    1,469
    
    
    
    1,304Deferred revenue
    
    
    3,506
    
    
    
    3,870Capital lease obligations, current portion
    
    
    998
    
    
    
    741Notes payable, current portion
    
    
    190
    
    
    
    189Total current liabilities
    
    
    8,203
    
    
    
    6,959Capital lease obligations, less current portion
    
    
    491
    
    
    
    409Notes payable, less current portion
    
    
    142
    
    
    
    94Deferred rent
    
    
    1,608
    
    
    
    1,826Total liabilities
    
    
    10,444
    
    
    
    9,288Contingencies (Note 5)Stockholders equity:Common stock: $0.001 par value, 100,000 shares authorized, 16,943 and
17,040 shares issued and outstanding at December 31, 2004
and March 31, 2005, respectively
    
    
    17
    
    
    
    17Additional paid-in capital
    
    
    88,387
    
    
    
    88,202Note receivable from stockholder
    
    
    (603
    )
    
    
    (603
    )Unearned stock-based compensation
    
    
    (1,619
    )
    
    
    (1,181
    )Accumulated other comprehensive loss
    
    
    (106
    )
    
    
    (108
    )Accumulated deficit
    
    
    (37,312
    )
    
    
    (37,133
    )Total stockholders equity
    
    
    48,764
    
    
    
    49,194Total liabilities
and stockholders
equity
    
    $
    59,208
    
    
    $
    58,482
 See accompanying notes to unaudited condensed consolidated financial statements. 3




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PlanetOut Inc. 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
 Three months ended March 31,2004
    
    
    2005Revenue:Subscription fees
    
    $
    3,789
    
    
    $
    4,853Advertising
    
    
    1,097
    
    
    
    1,392Transaction services
    
    
    554
    
    
    
    420Total revenue
    
    
    5,440
    
    
    
    6,665Operating costs and expenses:Cost of revenue (inclusive of stock-based compensation expense of
$149 and $12 for the three months ended March 31, 2004 and 2005, respectively)
    
    
    2,143
    
    
    
    2,125Sales and marketing (inclusive of stock-based compensation expense of
$87 and $7 for the three months ended March 31, 2004 and 2005, respectively)
    
    
    1,672
    
    
    
    2,456General and administrative (inclusive of stock-based compensation expense
(benefit) of $243 and $(43) for the three months ended March 31, 2004 and
2005, respectively)
    
    
    1,295
    
    
    
    1,248Depreciation and amortization
    
    
    470
    
    
    
    820Total costs and expenses
    
    
    5,580
    
    
    
    6,649Income (loss) from operations
    
    
    (140
    )
    
    
    16Equity in net loss of unconsolidated affiliate
    
    
    (20
    )
    
    
    (9
    )Interest expense
    
    
    (60
    )
    
    
    (38
    )Other income (expense), net
    
    
    16
    
    
    
    239Income (loss) before income taxes
    
    
    (204
    )
    
    
    208Provision for income taxes
    
    
    
    
    
    
    (29
    )Net income (loss)
    
    
    (204
    )
    
    
    179Accretion on redeemable convertible preferred stock
    
    
    (438
    )
    
    
    Net earnings (loss) attributable to common stockholders
    
    $
    (642
    )
    
    $
    179Net earnings (loss) per share:Basic
    
    $
    (0.37
    )
    
    $
    0.01Diluted
    
    $
    (0.37
    )
    
    $
    0.01Weighted-average shares used to compute net earnings per share:Basic
    
    
    1,725
    
    
    
    16,939Diluted
    
    
    1,725
    
    
    
    18,269
 See accompanying notes to unaudited condensed consolidated financial statements. 4




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PlanetOut Inc. 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
 Three months ended March 31,2004
    
    
    2005Cash flows from operating activities:Net income (loss)
    
    $
    (204
    )
    
    $
    179Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:Depreciation and amortization
    
    
    470
    
    
    
    820Amortization of unearned stock-based compensation, net of cancellation
    
    
    451
    
    
    
    (24
    )Amortization of deferrred rent
    
    
    
    
    
    
    218Issuance of stock options and shares in exchange for services
    
    
    28
    
    
    
    Equity in net loss of unconsolidated affiliate
    
    
    20
    
    
    
    9Changes in operating assets and liabilities:Accounts receivable
    
    
    123
    
    
    
    583Prepaid expenses and other assets
    
    
    (154
    )
    
    
    (896
    )Accounts payable
    
    
    348
    
    
    
    (1,185
    )Accrued and other liabilities
    
    
    (854
    )
    
    
    (165
    )Deferred revenue
    
    
    135
    
    
    
    364Net cash provided by (used in)
operating activities
    
    
    363
    
    
    
    (97
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    (257
    )
    
    
    (1,179
    )Net cash used in investing activities
    
    
    (257
    )
    
    
    (1,179
    )Cash flows from financing activities:Proceeds from exercise of common stock and preferred stock options and warrants
    
    
    1
    
    
    
    277Repurchase of redeemable convertible preferred stock
    
    
    (1
    )
    
    
    Principal payments under capital lease obligations and notes payable
    
    
    (258
    )
    
    
    (422
    )Net cash used in financing activities
    
    
    (258
    )
    
    
    (145
    )Effect of exchange rate on cash and cash equivalents
    
    

    (19
    )
    
    
    (2
    )Net decrease in cash and cash equivalents
    
    
    (171
    )
    
    
    (1,423
    )Cash and cash equivalents, beginning of period
    
    
    2,282
    
    
    
    43,128Cash and cash equivalents, end of period
    
    $
    2,111
    
    
    $
    41,705Supplemental disclosure of noncash flow investing and financing activities:Property and equipment and related maintenance acquired under capital leases
    
    $
    646
    
    
    $
    34Accretion on redeemable convertible preferred stock
    
    $
    438
    
    
    $
    Unearned stock-based compensation
    
    $
    587
    
    
    $
    (238
    )
 See accompanying notes to unaudited condensed consolidated financial statements. 5




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PlanetOut Inc. 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1  The Company Online Partners.com, Inc. (OLP) was incorporated in Delaware in October 1997 and PlanetOut
Inc. (the Company) was incorporated in Delaware in December 2000 as a wholly owned subsidiary of
OLP for the sole purpose of acquiring all of the capital stock of PlanetOut Corporation (POC).
The transaction was structured in a manner that resulted in OLP and POC becoming wholly owned
subsidiaries of the Company, with the former stockholders of OLP holding a majority of the voting
securities of the Company. Accordingly, for accounting purposes, OLP is the accounting acquirer and
the historical financial statements of the Company are those of OLP. The Company is an online media company serving the lesbian, gay, bisexual and transgender, or
LGBT, community. Through its Gay.com and PlanetOut.com websites, the Company offers membership
based services and features. The Company generates revenue through subscription fees for premium
membership services on Gay.com and PlanetOut.com, as well as advertising sales and sales of
products and services through its e-commerce site, Kleptomaniac.com. Note 2  Basis of Presentation and Summary of Significant Accounting Policies Unaudited Interim Financial Information The accompanying unaudited condensed consolidated financial statements have been prepared and
reflect all adjustments, consisting only of normal recurring adjustments, which in the opinion of
management are necessary to state fairly the financial position and the results of operations for
the interim periods. The balance sheet at December 31, 2004 has been derived from audited financial
statements at that date. The unaudited condensed consolidated financial statements have been
prepared in accordance with the regulations of the Securities and Exchange Commission, but omit
certain information and footnote disclosure necessary to present the statements in accordance with
generally accepted accounting principles. Results of interim periods are not necessarily indicative
of results for the entire year. These unaudited condensed consolidated financial statements should
be read in conjunction with the Companys Annual Report on Form 10-K for the fiscal year ended
December 31, 2004. As of March 31, 2005, the Company had $41.7 million of cash and cash equivalents. The Company
believes that this cash, coupled with anticipated cash flows generated from operations, will be
sufficient to meet the Companys capital expenditure, working capital and corporate overhead
requirements within the Companys current identified business objectives. Use of Estimates The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America 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 revenue and
expenses during the reporting periods. Significant estimates and assumptions made by management
include the assessment of collectibility of accounts receivable, the determination of the allowance
of doubtful accounts, the determination of the fair market value of its preferred and common stock
prior to the Companys initial public offering, the valuation and useful life of its capitalized
software and long-lived assets and the valuation of deferred tax asset balances. Actual results
could differ from those estimates. Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization.
Depreciation is calculated using the straight line method over the estimated useful lives of the
related assets ranging from three to five years. Leasehold improvements are amortized over the
shorter of their economic lives or lease term, generally ranging from two to seven years.
Maintenance and repairs are charged to expense as incurred. When assets are retired or otherwise
disposed of, the cost and accumulated depreciation and amortization are removed from the accounts
and any resulting gain or loss is reflected in the consolidated statement of operations in the
period realized. Leasehold improvements made by the Company and reimbursable by the landlord as tenant
incentives are recorded by the Company as leasehold improvement assets and amortized over a term
consistent with the above guidance. The incentives from the landlord are recorded as deferred rent
and amortized as reductions to rent expense over the lease term. For the three months ended March
31, 2004 and 2005, leasehold improvement allowances totaled zero and $1,360,000, respectively, of
which zero and $45,000 were amortized to 6




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the accompanying unaudited condensed consolidated statement of operations as a reduction of
rent expense, respectively. At December 31, 2004 and March 31, 2005, the deferred rent balance
attributable to these incentives totaled $1,218,000 and $1,278,000, respectively. Future
amortization of the balance of these tenant incentives is estimated to be $139,000 for the nine
months ended December 31, 2005, $188,000 each year for 2006 to 2011, and $11,000 in 2012. At
December 31, 2004 and March 31, 2005, the Company had receivable balances for tenant incentives of
$1,255,000 and $1,360,000, respectively, recorded under prepaid expenses and other current assets
and other assets in the accompanying unaudited condensed consolidated balance sheets. Internal Use Software and Website Development Costs The Company capitalizes internally developed software costs in accordance with the Statement
of Position 98-1, Accounting for Costs of Computer Software Developed or Obtained for Internal
Use (SOP 98-1) and Emerging Issues Task Force Abstract No. 00-02, Accounting for Web Site
Development Costs (EITF 00-02). Capitalized costs are amortized on a straight-line basis over
the estimated useful life of the software, generally three years, once it is available for its
intended use. During the three months ended March 31, 2004 and 2005, the Company capitalized costs
of $205,000 and $617,000, respectively, and recorded $92,000 and $174,000 of related amortization
expense, respectively. The capitalized costs for the three months ended March 31, 2004 and 2005
included $5,000 and $399,000, respectively, paid to external consultants. Stock-based Compensation The Company accounts for stock-based employee compensation arrangements in accordance with
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, (APB No. 25), and related interpretations. The Company follows the disclosure
provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123), and related interpretations. Under APB No. 25, compensation expense
is based on the difference, if any, on the date of the grant, between the fair value of the
Companys stock and the exercise price. Employee stock-based compensation determined under APB No.
25 is recognized using the multiple option method prescribed by the Financial Accounting Standards
Board Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock
Option or Awards Plans (FIN No. 28), over the options vesting period, which is generally two to
four years. The Company accounts for equity instruments issued to non-employees in accordance with SFAS
No. 123, Emerging Task Force Issue No. 96-18, Accounting for Equity Instruments that are Issued to
Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services (EITF
96-18) and FIN No. 28. Accordingly, as these equity instruments vest, the Company will be required
to remeasure the fair value of the equity instruments at each reporting period prior to vesting and
then finally at the vesting date of the equity instruments. For the purposes of pro forma disclosures, the estimated fair value of the options granted
under the Companys stock option plans is amortized to expense over the vesting period of the
respective options, which is generally two to four years. The pro forma disclosures of the difference between compensation cost included in the net loss
and the related cost measured by the fair value method as required by SFAS 123, as amended, are
presented as follows (in thousands, except per share amounts): Three months ended March 31,2004
    
    
    2005(unaudited)Net income (loss) attributable to common stockholders, as reported:
    
    $
    (642
    )
    
    $
    179Add: Employee stock-based compensation expense (benefit) included in
reported net income (loss), net of tax
    
    
    451
    
    
    
    (23
    )Less: Total employee stock-based compensation expense
determined under fair value, net of tax
    
    
    (461
    )
    
    
    (85
    )Pro forma net (income) loss attributable to common stockholders
    
    $
    (652
    )
    
    $
    71Net income (loss) per share attributable to common stockholders:As reported  basic
    
    $
    (0.37
    )
    
    $
    0.01As reported  diluted
    
    $
    (0.37
    )
    
    $
    0.01Pro forma  basic
    
    $
    (0.37
    )
    
    $
    0.00Pro forma  diluted
    
    $
    (0.37
    )
    
    $
    0.00
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Prior to the Companys IPO, the fair value of each option grant was determined using the
minimum value method prescribed by SFAS No. 123. Subsequent to the offering, the fair value was
determined using the Black-Scholes model stipulated by SFAS No. 123. The following weighted average
assumptions were included in the estimated grant date fair value calculations for the Companys
stock option awards: Three months endedMarch 31,2004
    
    2005Preferred stock options:Expected lives (in years)
    
    2.5Risk free interest rates
    
    2.77 - 3.23%Dividend yield
    
    10%Volatility
    
    0%Common stock options:Expected lives (in years)
    
    5
    
    5Risk free interest rates
    
    2.77 - 3.23%
    
    3.59 - 4.01%Dividend yield
    
    0%
    
    0%Volatility
    
    0%
    
    85%
 Net Income (Loss) Per Share Basic income (loss) per share (Basic EPS) is computed by dividing net income (loss) available to
common shareholders by the sum of the weighted average number of common shares outstanding during
the period, net of shares subject to repurchase, using the two-class method. The two-class method
is an earnings allocation formula that determines earnings per share for each class of common stock
and participating security according to dividends declared (or accumulated) and participation
rights in undistributed earnings. Under the two-class method, income from continuing operations (or
net income) is reduced by the amount of dividends declared in the current period for each class of
stock and by the contractual amount of dividends (or interest on participating income bonds) that
must be paid for the current period. The remaining earnings are then allocated to common stock and
participating securities to the extent that each security may share in earnings as if all of the
earnings for the period had been distributed. The total earnings allocated to each security are
determined by adding together the amount allocated for dividends and the amount allocated for a
participation feature. The total earnings allocated to each security are then divided by the number
of outstanding shares of the security to which the earnings are allocated to determine the earnings
per share for the security. Diluted earnings per share (Diluted EPS) gives effect to all dilutive potential common
shares outstanding during the period. The computation of Diluted EPS does not assume conversion,
exercise or contingent exercise of securities that would have an anti-dilutive effect on earnings.
The dilutive effect of outstanding stock options and warrants is computed using the treasury stock
method. The following table sets forth the computation of basic and diluted net loss attributable to
common stockholders (in thousands, except per share amounts): Three months ended March 31,2004
    
    
    2005(unaudited)Numerator:Net earnings (loss) attributable to common stockholders
    
    $
    (642
    )
    
    $
    179Denominator:Weighted-average shares used to compute basic EPS
    
    
    1,725
    
    
    
    16,939Effect of dilutive securities:Dilutive common stock equivalents
    
    
    
    
    
    
    1,330Dilutive potential common shares
    
    
    
    
    
    
    1,330Weighted-average shares used to compute diluted EPS
    
    
    1,725
    
    
    
    18,269Net earnings per share:Basic
    
    $
    (0.37
    )
    
    $
    0.01Diluted
    
    $
    (0.37
    )
    
    $
    0.01
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The potential shares, which are excluded from the determination of basic and diluted net loss
per share for the three months ended March 31, 2004 and 2005 as their effect is anti-dilutive, are
as follows (in thousands): Three months ended March 31,2004
    
    
    2005(unaudited)Redeemable convertible preferred stock
    
    
    9,292
    
    
    
    Redeemable convertible preferred stock
options and warrants
    
    
    322
    
    
    
    Common stock options and warrants
    
    
    1,755
    
    
    
    846Common stock subject to repurchase
    
    
    2
    
    
    
    211,372
    
    
    
    848
 Recent Accounting Pronouncements In October 2004, the American Jobs Creation Act of 2004 (Jobs Act) was enacted. In December
2004, the FASB issued FSP FAS 109-2 to provide guidance with respect to the Jobs Act. Among other
provisions, the Jobs Act provides for a deduction for income from qualified domestic production
activities phased in from 2005 to 2010, and a temporary incentive for U.S. corporations to
repatriate accumulated income earned abroad. We do not plan to repatriate foreign earnings under
the Jobs Act and have not yet determined the impact of the deduction for domestic production
activities. Such deduction will first be available to the Company in fiscal year 2006. At this
time, the Company does not expect that the deduction will have a material impact on its reported
income tax rate in accordance with FSP No. FAS 109-2. In April 2005, the SEC amended the compliance dates for SFAS No. 123R, Shared-Based Payment.
The new rule allows public companies to implement SFAS No. 123R at the beginning of their next
fiscal year that begins after June 15, 2005. The Company will be required to adopt SFAS No. 123R in the
first quarter of 2006 and begin to recognize stock-based compensation related to employee equity
awards in our condensed consolidated statements of operations using a fair value based method on a
prospective basis. Since the Company currently accounts for equity awards granted to our employees using the
intrinsic value method under APB No. 25, we expect the
adoption of SFAS No. 123R will have a significant adverse impact on our financial position and
results of operations. The Company is currently in the process of
evaluating the extent of such impact. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB No. 107). SAB No. 107
covers key topics related to the implementation of SFAS No. 123R which include the valuation
models, expected volatility, expected option term, income tax effects of SFAS No. 123R,
classification of stock-based compensation cost, capitalization of compensation costs, and
disclosure requirements. The Company expects the adoption of SAB No. 107 will have a significant adverse
impact on our financial position and results of operations upon our adoption of SFAS No. 123R in
the first quarter of 2006. The Company is currently in the process of
evaluating the extent of such impact. 9




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Note 3  Other Balance Sheet Components December 31,
    
    
    March 31,2004
    
    
    2005(unaudited)Property and equipment (in thousands):Computer and network equipment
    
    $
    7,130
    
    
    $
    7,319Furniture and fixtures
    
    
    918
    
    
    
    1,053Computer software
    
    
    1,683
    
    
    
    1,808Leasehold improvements
    
    
    1,191
    
    
    
    1,339Capitalized software and website development
costs
    
    
    2,919
    
    
    
    3,53513,841
    
    
    
    15,054Less: Accumulated depreciation and amortization
    
    
    (6,830
    )
    
    
    (7,650
    )$
    7,011
    
    
    $
    7,404
 For the three months ended March 31, 2004 and 2005, depreciation and amortization
expense of property and equipment was $453,000 and $820,000, respectively. December 31,
    
    
    March 31,2004
    
    
    2005(unaudited)Prepaid expenses and other current assets (in thousands):Prepaid expenses and other current assets
    
    $
    1,262
    
    
    $
    1,899Receivable from landlord for tenant improvement
allowance, current portion
(Note 2)
    
    
    947
    
    
    
    1,360$
    2,209
    
    
    $
    3,259
 December 31,
    
    
    March 31,2004
    
    
    2005(unaudited)Other assets (in thousands):Other assets
    
    $
    838
    
    
    $
    979Receivable from landlord for tenant
improvement allowance, less current portion
(Note 2)
    
    
    308
    
    
    
    Interest on note receivable from stockholder
    
    
    179
    
    
    
    192$
    1,325
    
    
    $
    1,171
 December 31,
    
    
    March 31,2004
    
    
    2005(unaudited)Accrued liabilities (in thousands):Accrued payroll and related
liabilities
    
    $
    493
    
    
    $
    500Other accrued liabilites
    
    
    976
    
    
    
    804$
    1,469
    
    

    $
    1,304
 Note 4  Related Party Transactions Note Receivable In May 2001, the Company issued a promissory note to an executive of the Company for $603,000
to fund the purchase of Series D redeemable convertible preferred stock. The principal and interest
are due and payable in May 2006. Interest accrues at a rate of 8.5% per annum or the maximum rate
permissible by law, whichever is less and is full recourse. The note is full recourse with respect
to $24,000 in principal payment and the remainder of the principal is non-recourse. The note is
collateralized by the shares of preferred stock, common stock, warrants and options owned by the
executive. Interest income of $13,000 was recognized in each of the three months ended March 31,
2004 and 2005, respectively. 10




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Advertising Agreement In November 2001, the Company entered into an advertising agreement with Gay.it S.p.A., an
unconsolidated affiliate of which the Company owns 45%. Pursuant to this agreement, the Company
received $39,000 and $52,000 of subscription revenue for the three months ended March 31, 2004 and
2005, respectively and paid Gay.it S.p.A. a referral fee of $16,000 and $22,000 in 2004 and 2005,
respectively. 11




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Note 5 Contingencies Contingencies In November 2000, a former employee of ours filed a lawsuit against Online Partners.com, Inc.,
and a number of our current and former employees, including our current President, Mark Elderkin,
and his partner, Jeffery Bennett. The complaint alleged breach of contract, fraud and numerous
other business torts. The plaintiff, Mr. Elderkin and Mr. Bennett were the sole holders of
membership interests in Pridecom LLC, whose assets were assumed by Pridecom Inc. prior to its
acquisition by Online Partners.com, Inc. in 1999. The plaintiff claimed that the membership
interest he negotiated in Pridecom LLC did not accurately represent the value of his contribution
to Pridecom LLC or its successor entities. The plaintiff sought an unspecified amount of fully
vested stock, along with unspecified compensatory and exemplary damages. On January 31, 2005, this
matter was settled to the mutual satisfaction of all parties. The amount of the settlement was not
material to our financial condition and results of operations and was recorded as an accrued
expense at December 31, 2004. In April 2002, the Company was notified that DIALINK, a French company, had filed a lawsuit in
France against it and its French subsidiary, alleging that the Company had improperly used the
domain names Gay.net, Gay.com and fr.gay.com in France, as DIALINK alleges that it has exclusive
rights to use the word gay as a domain name and trademark in France. DIALINK seeks an injunction
against our use of the word gay as a domain name and
monetary damages of 300,000 (US $387,000
at March 31, 2005). The Company estimates that its range of possible loss is from no loss and no
injunction to the full amount of the plaintiffs petition for relief. The Company has not recorded
this contingency because of uncertainty as to the amount that would be required to be paid, if any.
The Company intends to defend itself vigorously in this matter and expects a trial decision by
June 2005. The Company is not currently subject to any additional significant legal proceedings. The
Company may from time to time, however, become a party to various legal proceedings, arising in the
ordinary course of business. The Company may also be indirectly affected by administrative or court
proceedings or actions in which the Company is not involved but which have general applicability to
the Internet industry. The Company does not believe, based on current knowledge, that any legal
proceedings or claims is likely to have a material adverse effect on its financial position,
results of operations or cash flows. 
 Item 2. Managements Discussion and Analysis on Financial Condition and Results of Operations The following discussion should be read in conjunction with the financial statements and
related notes which appear elsewhere in this document. This discussion contains forward-looking
statements that involve risks and uncertainties. In some cases, you can identify forward-looking
statements by terminology including would, could, may, will, should, expect, intend,
plan, anticipate, believe, estimate, predict, potential or continue, the negative of
these terms or other comparable terminology. These statements are only predictions. Forward-looking
statements include statements about our business strategy, future operating performance and
prospects. You should not place undue reliance on these forward-looking statements. Our actual
results could differ materially from those anticipated in these forward-looking statements as a
result of various factors, including those discussed below and elsewhere in this document and in
ourForm 10-Kfiled March 31, 2005. Overview We are a leading global online media company serving the LGBT community. Our network of
websites, including our flagship websites Gay.com and PlanetOut.com, allows our members to connect
with other members of the LGBT community around the world. Although we had positive net income in the three months ended March 31, 2005, we have incurred
significant losses since our inception. As of March 31, 2005, we had an accumulated deficit of
$37.1 million. We expect to incur significant marketing, engineering and technology, general and
administrative and stock-based compensation expenses for the foreseeable future. As a result, we
will need to continue to grow revenue and increase our operating margins to maintain and expand our
profitability. Results of Operations The following table sets forth the percentage of total revenue represented by items in our
consolidated statements of operations for the periods presented: 12




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Three months endedMarch 31,2004
    
    
    2005(As a percentage of totalrevenue; unaudited)Consolidated statement of operations data:Revenue:Subscription services
    
    
    69.7
    %
    
    
    72.8
    %Advertising services
    
    
    20.2
    
    
    
    20.9Transaction services
    
    
    10.1
    
    
    
    6.3Total revenue
    
    
    100.0

    
    
    
    100.0Operating costs and expenses:Cost of revenue
    
    
    39.4
    
    
    
    31.9Sales and marketing
    
    
    30.7
    
    
    
    36.8General and administrative
    
    
    23.8
    
    
    
    18.8Depreciation and amortization
    
    
    8.7
    
    
    
    12.3Total costs and expenses
    
    
    102.6
    
    
    
    99.8Income (loss) from operations
    
    
    (2.6
    )
    
    
    0.2Other income (expense), net
    
    
    (1.2
    )
    
    
    2.9Income (loss) before income taxes
    
    
    (3.8
    )
    
    
    3.1Provision for income taxes
    
    
    0.0
    
    
    
    (0.4
    )Net income (loss)
    
    
    (3.8
    )
    
    
    2.7
 The following provides some explanatory information with respect to our consolidated
statements of operations data: We derive our revenue from three main sources: subscription, advertising and transaction
services. For the forseeable future, we expect subscription and advertising services to remain our
largest sources of revenue and to be more of a focus for our internal operations than transaction
services. Subscription Services.We charge for subscriptions to our premium membership services on
Gay.com and PlanetOut.com. On both of these websites, the set of services for which we offer paid
premium memberships includes viewing, searching and replying to profiles, chat, instant messaging
and email. The Gay.com paid premium memberships also include premium chat features, video chat and
premium content. We currently offer Gay.com membership services in six languages to members who
identify themselves as residing in more than 100 countries through Gay.com and localized versions
of Gay.com. During 2003, 2004 and 2005, we have priced our premium membership services as follows,
excluding promotional discounts: Gay.com Premium Membership
Services Yearly
    
    
    Quarterly
    
    
    Monthly
    
    
    TrialsJanuary 2003 to March 2003
    
    $
    89.95
    
    
    $
    39.95
    
    
    $
    16.95
    
    
    $7.95 7-day trialMarch 2003 to May 2004
    
    $
    79.95
    
    
    $
    39.95
    
    
    $
    16.95
    
    
    $6.95 7-day trial March 2003 to April 2004$9.95 7-day trial April 2004 to May 2004May 2004 to October 2004
    
    $
    79.95
    
    
    $
    39.95
    
    
    $
    17.95
    
    
    $9.95 7-day trialOctober 2004 to present
    
    $
    89.95
    
    
    $
    42.95
    
    
    $
    19.95
    
    
    $9.95 7-day trial
 Yearly
    
    
    Quarterly
    
    
    Monthly
    
    
    TrialsPlanetOut Premium Membership
Services
    
    $
    69.95
    
    
    $
    29.95
    
    
    $
    12.95
    
    
    $4.95 3-day trial December 2002 to present
 13




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In managing our premium membership services, we track a number of operating metrics, including the
following: Premium Membership Service Operating Metrics
(excluding free trial promotions) 2003
    
    
    
    2004
    
    
    
    20051Q
    
    
    2Q
    
    
    3Q
    
    
    4Q
    
    
    
    FY
    
    
    
    1Q
    
    
    2Q
    
    
    3Q
    
    
    4Q
    
    
    
    FY
    
    
    
    1QTotal Subscribers
    
    
    
    88,776
    
    
    
    88,103
    
    
    
    91,886
    
    
    
    98,445
    
    
    
    
    98,445
    
    
    
    
    105,179
    
    
    
    110,598
    
    
    
    118,392
    
    
    
    127,527
    
    
    
    
    127,527
    
    
    
    
    137,500Gross Additions
    
    
    
    39,053
    
    
    
    34,305
    
    
    
    37,167
    
    
    
    40,721
    
    
    
    
    151,246
    
    
    
    
    42,635
    
    
    
    37,582
    
    
    
    41,082
    
    
    
    44,219
    
    
    
    
    165,518
    
    
    
    
    44,245Churn (Excluding Free Promotions)
    
    
    
    30,641
    
    
    
    34,978
    
    
    
    33,384
    
    
    
    34,162
    
    
    
    
    133,165
    
    
    
    
    35,901
    
    
    
    32,163
    
    
    
    33,288
    
    
    
    35,084
    
    
    
    
    136,436
    
    
    
    
    34,272Churn %
    
    
    
    12.1
    %
    
    
    13.2
    %
    
    
    12.4
    %
    
    
    12.0
    %
    
    
    
    12.4
    %
    
    
    
    11.8
    %
    
    
    9.9
    %
    
    
    9.7
    %
    
    
    9.5
    %
    
    
    
    10.1
    %
    
    
    
    8.6
    %Net Additions
    
    
    
    8,412
    
    
    
    -673
    
    
    
    3,783
    
    
    
    6,559
    
    
    
    
    18,081
    
    
    
    
    6,734
    
    
    
    5,419
    
    
    
    7,794
    
    
    
    9,135
    
    
    
    
    29,082
    
    
    
    
    9,973Average Lifetime (mos)
    
    
    
    8.3
    
    
    
    7.6
    
    
    
    8.1
    
    
    
    8.4
    
    
    
    
    8.1
    
    
    
    
    8.5
    
    
    
    10.1
    
    
    
    10.3
    
    
    
    10.5
    
    
    
    
    9.9
    
    
    
    
    11.6
 We have calculated these metrics using the following definitions:  
    Total Paid Subscribers: members with an active, paid subscription plan, excluding paid
trial subscribers, at the end of the period.
    Gross Additions: members who initiate a subscription during the period, excluding paid
trial subscriptions. Gross Additions during a period equals Net Additions plus Total Churn
during that period.
    Total Churn: total subscription cancellations during the period, including cancellations of
paid promotional subscriptions, but excluding cancellations of paid 3- and 7-day trial
subscriptions and free promotional subscriptions. Subscription cancellations include
subscriptions cancelled due to failed credit cards.
    Churn Rate: Total Churn divided by the average of the Total Paid Subscribers measured at
the beginning and end of the period, divided by the number of months in the period.
    Net Additions: Total Paid Subscribers at the end of the period minus the Total Paid
Subscribers at the beginning of the period. Because their terms are generally shorter than the periods that we measure, we exclude paid
trial subscriptions (currently, 3- and 7-day paid trials) from these operating metrics. We regularly test different promotional offers, including some free trial promotions. Members
who sign up for any of these promotional offers, discounted or free, provide us with payment
information and authorize us to bill them at our regular premium membership service rates, unless
they cancel their subscriptions prior to the end of their promotional terms. When these promotional
offers are for paid subscriptions to our annual, monthly, or quarterly plans we include these
cancellations in our churn calculations. However, because free subscribers do not count toward our definition of Total Paid
Subscribers, we exclude them from our definition of Total Churn. 14




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Currently, we expect to provide quarter-to-quarter information about these operating
metrics through the end of 2005. In addition to revenue from premium membership services, historically we derived revenue from
subscriptions for print and online versions of our Out&About newsletter. We published the
newsletter ten times a year. December 2004 was the date of the final printed issue and going
forward, we do not expect to produce new print or online editions of the newsletter. Instead, we
intend to offer general travel content on our Gay.com and PlanetOut.com websites and to offer
premium travel content as part of our premium membership services. Revenue from our Out&About
newsletter subscriptions was less than 2% of our total revenue in the three months ended March 31,
2004 and zero revenue for Out&About subscriptions for the three months ended March 31, 2005. As part of our plan to discontinue publication of the Out&About newsletter, we offered those
subscribers who were still active as of December 31, 2004 the option to receive a Gay.com premium
subscription instead. We provided those subscribers who did not opt to switch to other of our
subscription services a refund of the remaining value of their subscriptions to Out&About. Such
refunds totaled $38,000 through December 31, 2004 and were paid against a reduction of deferred
revenue, and did not reduce already recognized revenue. For both premium membership and in the past, Out&About subscriptions, we are paid up-front. We
recognize subscription revenue ratably over the subscription period. As of March 31, 2005, deferred
revenue related to premium membership subscriptions totaled approximately $3.6 million. As of March
31, 2005, there was no remaining deferred revenue from our Out&About subscriptions. Our
subscription revenue is not subject to sales or use tax in the United States, but is subject to
Value Added Tax, or VAT, in the European Union. Currently, we do not require our subscribers to
reimburse us for VAT and we offset this liability against revenue. Advertising Services.We derive advertising revenue principally from advertising contracts in
which we typically undertake to deliver a minimum number of impressions to users over a specified
time period for a fixed fee. Advertising rates, measured on a number of bases, including on a cost
per thousand impressions, or CPM, basis, depend on whether the impressions are for general rotation
throughout our network or for targeted audiences through our email newsletters or on our websites. We recognize advertising revenue ratably in the period in which the advertisement is
displayed, provided that we have no significant obligation remaining and the collection of the
resulting receivable is reasonably assured, at the lesser of the ratio of impressions delivered
over the total number of contracted impressions or the straight-line basis over the term of the
contract. To the extent that we do not provide the contracted number of impressions during a
specific time period, we defer recognition of the corresponding revenue until the thresholds are
achieved. Throughout 2004 and the first three months of 2005, our primary goals for advertising services
included attracting additional advertisers, diversifying our client base and increasing average
account size. We have succeeded in these efforts and expect to continue to pursue Fortune 500
companies and other clients and to provide increasingly customized and targeted advertising
campaigns. In addition to revenue from advertisers who place general online advertisements on our
websites, we derive advertising revenue from the sale of online classified listings, primarily for
travel-related businesses, and, historically, print advertising, as part of or accompanying our
Out&About newsletter. We expect to expand the scope of our online classifieds listings to include
more non-travel-related businesses. 15




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##### Table of Contents



Transaction Services.Our principal source of transaction services revenue is from sales
through Kleptomaniac.com, our e-commerce website and, to a lesser extent, through our other
websites. Through Kleptomaniac.com, we offer hundreds of products, including DVDs, music CDs and
fashion items, some of which we own and some of which are owned by third-parties. Revenue from
Kleptomaniac.com accounted for approximately 73% of our transaction services revenue and
approximately 7% of our overall revenue in 2004 and approximately 54% of our transaction services
revenue and approximately 3% of our overall revenue for the first three months of 2005. For those
items that we own, we recognize revenue when the product is shipped, net of estimated returns. We
recognize commissions for facilitating the sale of third-party products and services when earned,
based on reports provided by the vendors or upon cash receipt if no reports are provided. Cost of Revenue.Cost of revenue primarily consists of payroll and related benefits associated
with supporting our subscription-based services and producing and maintaining content for our
various websites and newsletters. Other expenses directly related to generating revenue included in
cost of revenue include transaction processing fees, computer maintenance, allocated occupancy
costs, co-location and Internet connectivity fees, purchased content and cost of goods sold. We research and test potential improvements to our hardware and software systems in an effort
to improve our productivity and enhance our members experience. We expect to continue to invest in
technology and improvements in our websites. We believe costs associated with certain projects have
ongoing benefit. If we believe that capitalization criteria in accordance with SOP 98-1 and EITF
00-02 have been met, we capitalize the development costs related to these projects which are
amortized on a straight-line basis over the estimated three year useful life of the software. The
amortization of capitalized software is included in depreciation and amortization. We expense the
costs associated with these projects only when we believe capitalization criteria have not been
met. Sales and Marketing.Sales and marketing expense consists of expenses related to selling,
marketing and promoting our products and services. Major expense items include:  
    payroll and related benefits for employees involved in sales, client service, customer
service, corporate marketing and other support functions;
    product and service marketing and promotions;
    general corporate marketing and promotions; and
    allocated occupancy costs. General and Administrative.General and administrative expense consists primarily of payroll
and related benefits for executive, finance and administrative personnel, allocated occupancy
costs, professional fees, insurance and other general corporate expenses. Occupancy Costs.Each of our cost of revenue, sales and marketing and general and
administrative expense categories include occupancy costs. The amount of charges from occupancy
costs allocated to each of these categories is based on the headcount associated with each of these
categories. In addition, we allocate to the general and administrative expense category the costs
of any one-time charges associated with lease terminations. Stock-based Compensation and Related Charges.Each of our cost of revenue, sales and marketing
and general and administrative expense categories include stock-based compensation charges for
equity instruments issued to employees and in some cases consultants for services. These charges
represent the intrinsic value, if any, between the respective exercise price of stock options or
stock grants and the fair market value of the underlying stock on the date of grant, or on the
reporting date if the option is subject to variable plan accounting. At March 31, 2005, we had options to acquire 44,318 shares of our capital stock subject to
variable plan accounting which requires us to measure the intrinsic value at each reporting date
until these options expire, or are exercised or forfeited. In any period, variable plan accounting
may result in increases or decreases in stock-based compensation, depending on the estimated fair
market value of our capital stock. We amortize deferred stock-based compensation over the vesting
periods of the individual options, using the multiple option method. Changes in fair market value
will result in stock-based compensation expense or benefit in each period. We recognized total
stock-based compensation expense of $480,000 in the first three months of 2004 and a benefit of
$24,000 in the first three months of 2005. At March 31, 2005, we had unearned stock-based compensation of $1.2 million, of which $580,000
will be amortized in 2005, $425,000 will be amortized in 2006, $164,000 will be amortized in 2007
and $11,000 will be amortized in 2008. We may recognize 16




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##### Table of Contents



additional stock-based compensation expense
(benefit) in the future if we grant additional options with an exercise price below the fair market
value of our stock. 17




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Comparison of the Three Months Ended March 31, 2005 and March 31, 2004 Revenue Total revenue increased approximately 23%, from $5.4 million in the three months ended March
31, 2004 to $6.7 million in the three months ended March 31, 2005. Subscription Services.From March 31, 2004 to March 31, 2005, the number of our subscribers
grew by approximately 31% from approximately 105,200 to approximately 137,500. As a result of this
increase, our subscription revenue for the three months ended March 31, 2004 and 2005 increased
approximately 28%, from $3.8 million to $4.9 million, respectively. Other factors that contributed
to this change in revenue included:  
    an expansion in the number of customer support representatives and their hours of
coverage;
    new features including the offer of subscriptions to popular magazines with premium
memberships beginning in May 2004, and the expansion and launch of online features such as
expanded messenger services, expanded ad searchable whos online features, and the addition
of Hot and Buddy lists, among others;
    the launch of new transaction processing capabilities such as Paypal and automated credit card updating;
    a price increase for our Gay.com membership services in October 2004;
    the migration of approximately 1,400 of our Out&About newsletter subscribers to our
premium membership services in December 2004;
    an increase in marketing and promotional activities including the Mr. Gay.com contest
and the Play for Keeps and Come Together campaigns, which received widespread press
coverage;
    the effect of periods during the fourth quarter of 2004 and the first quarter of 2005,
during which our transaction processing system were not available or did not perform as
expected, in part as a result of adding new transaction processing capabilities, subsequent
to which we have implemented technology upgrades to help address these issues; and
    a reduction in subscribers and revenue from our PlanetOut.com premium membership
service, as we have concentrated more of our marketing activities on our Gay.com premium
membership service. Revenue from our premium membership services made up 99% of subscription revenue in the three
months ended March 31, 2004 and 2005. Revenue from our premium membership services made up all of
our subscription revenue in the three months ended March 31, 2005. For the foreseeable future, we
expect subscription services to grow and to continue to remain our largest revenue area. Advertising Services.Our advertising services revenue increased approximately 27%, from $1.1
million in the three months ended March 31, 2004 to $1.4 million in the three months ended March
31, 2005. The majority of this increase came from increases in online advertising revenue on our
flagship websites, Gay.com and PlanetOut.com. While the number of accounts decreased for the three
months ended March 31, 2005 compared to the three months ended March 31, 2004, the average account
size increased, reflecting efforts to concentrate on large corporate accounts. Other factors that
affected our advertising revenue for the three months ended March 31, 2005 as compared to the three
months ended March 31, 2004 included:  
    the improvement in the advertising market generally and in the online advertising market specifically;
    the increasing interest of advertisers in targeting the LGBT community;
    the launch in key U.S. markets of major new marketing campaigns, headlined Play for
Keeps and Come Together, which generated increased traffic and heightened visibility
for the Gay.com brand; and
    the expansion of the companys Gay.com Metro local service listings, with 37 percent
growth in active featured listings during the first quarter of 2005. 18




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##### Table of Contents



For the foreseeable future, we expect online advertising to grow and remain the largest
portion of our overall advertising services revenue. Transaction Services.Our transaction services revenue declined from $554,000 in the three
months ended March 31, 2004 to $420,000 in the three months ended March 31, 2005. The decline was
largely due to the ongoing shift of internal promotional space on our websites away from
Kleptomaniac.com toward our premium membership services and advertising services. This decline also
reflects the fact that sales on Kleptomaniac.com were high in the first quarter of 2004 due to the
popularity of certain DVD compilations that were released in that quarter, while sales of the same
DVD compilations in 2005 occurred later, splitting between the first and second quarters. Revenue
from Kleptomaniac.com accounted for approximately 73% and 54% of transaction services revenue in
the three months ended March 31, 2004 and 2005, respectively. Transaction revenue from sources
other than Kleptomaniac.com, while relatively small in total dollar amounts, increased for the
first three months of 2005 as compared to the first three months of 2004. Operating Costs and Expenses Total operating expenses grew approximately 19%, from $5.6 million in the three months ended
March 31, 2004 to $6.6 million in the three months ended March 31, 2005. These numbers include
stock-based compensation expenses of $480,000 in the three months ended March 31, 2004, and a
stock-based compensation benefit of $24,000 in the three months ended March 31, 2005. Cost of Revenue.Our cost of revenue was flat at $2.1 million in the three months ended March
31, 2004 and the three months ended March 31, 2005. This was primarily the result of a decrease of
$137,000 in stock-based compensation expenses offset by an increase in corporate occupancy expenses
of $94,000, reflecting the move to our new corporate headquarters. Cost of revenue included a
credit to labor expense for capitalized development costs of $200,000 in the first three months of
2004 and $218,000 in the first three months of 2005. While we did not see significant increases in
cost of revenue for the three months ended March 31, 2005 compared to the three months ended March
31, 2004, for the foreseeable future, we expect cost of revenue, exclusive of stock-based
compensation, to increase in absolute dollars as our investment in headcount and other expenses
grows along with our revenue. Sales and Marketing.Our sales and marketing expenses increased approximately 47%, from $1.7
million in the three months ended March 31, 2004 to $2.4 million in the three months ended March
31, 2005. This change was attributable primarily to expanded investment in promotional activities
in the amount of $425,000, an increase in occupancy costs of $150,000 and an increase in
labor-related expenses of $177,000, associated with increases in headcount and compensation,
including a decrease in stock-based compensation expense of $80,000. For the foreseeable future, we
expect sales and marketing expenses, exclusive of stock-based compensation, to increase in absolute
dollars as we expand our investment in marketing activities. General and Administrative.Our general and administrative expenses decreased approximately 4% from
$1.3 million in the three months ended March 31, 2004 to $1.2 million in the three months ended
March 31, 2005. This change was primarily the result of a decrease in stock-based compensation
expense of $286,000, reflecting, in part, a $43,000 benefit to stock-based compensation due to
credits for terminations and stock price related variable accounting credits in the three months
ended March 31, 2005, offset by an increase in occupancy expenses of $190,000, reflecting the move
to new corporate headquarters in October 2004. The change also includes a $100,000 credit for
reimbursement of legal fees related to the settlement of a dispute, offset by a $77,000 increase in
accounting expenses, reflecting the increased costs of being a public company. For the foreseeable
future, we expect general and administrative expenses, exclusive of stock-based compensation, to
grow in absolute dollars. Depreciation and Amortization.Our depreciation and amortization expenses grew by
approximately 75%, from $470,000 to $820,000 in the three months ended March 31, 2004 and March 31,
2005, respectively, primarily reflecting increased investment in our product development and
technology infrastructure. For the foreseeable future, we expect depreciation and amortization
costs to increase in absolute dollars with the growth of our investment in hardware, software and
capitalized development costs. Other income and expense.Our other income and expense line grew from an expense of $64,000 to
income of $192,000 in the three months ended March 31, 2004 and 2005, respectively. This
year-over-year change reflects the interest income of $239,000 in the three months ended March 31,
2005 based on interest earned on the proceeds from our October 2004 initial public offering. Provisions for income taxes.Our provision for income taxes was $29,000 for the three months
ended March 31, 2005. There was no provision for income taxes for the three months ended March 31,
2004. This provision is made on a quarterly basis, and reflects the expectation of a net profit for
2005 as a whole, compared to a net loss for 2004 as a whole. 19




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Liquidity and Capital Resources We have historically financed our operations primarily through private sales of equity and
capitalized leases. During the three months ended March 31, 2004, net cash provided by operating
activities was $363,000, and was primarily attributable to the growth of our premium subscription
services, offset by $781,000 in payments to settle a lease dispute related to our former San
Francisco headquarters facility. During the three months ended March 31, 2005, net cash used by
operating activities was $97,000, and was primarily attributable to cash provided by the growth of
our premium subscription services, offset by a shift from almost entirely leasing purchased
equipment in the three months ended March 31, 2004 to paying cash for some major purchases in the
three months ended March 31, 2005, as well as the presence of one-time expenses in three months
ended March 31, 2005 related to registration fees and other requirements of our first quarter as a
publicly listed company. Net cash used in investing activities was $257,000 for the three months ended March 31, 2004,
and was primarily attributable to purchases of property and equipment. Net cash used in investing
activities was $1.1 million for the three months ended March 31, 2005, and was primarily
attributable to purchases of hardware, software, property and equipment, including $218,000 for
capitalization of internally developed software and $399,000 for capitalization of external product
development. While we expect to continue to invest in development and infrastructure in 2005, we
also expect to be able to realize tenant improvement allowances associated with the move of our
corporate headquarters in the third quarter of 2004. Net cash used by financing activities in the three months ended March 31, 2004 was $258,000
and was primarily attributable to payments of capitalized lease obligations. Net cash used by
financing activities in the three months ended March 31, 2005 was $145,000 and was primarily
attributable to payments of capital lease obligations. As of March 31, 2005, we had cash and cash
equivalents of approximately $41.7 million. We have not allocated a specific portion of our net proceeds from our initial public offering
to any particular purpose, other than the repayment of indebtedness under our senior subordinated
promissory note that occurred in October 2004. The amount and timing of our actual expenditures
will depend on numerous factors, such as the progress of our development and marketing efforts and
the amount of cash used by our other operations. Thus, we retain broad discretion over the use of
the net proceeds from our initial public offering. Our capital requirements depend on many factors, including growth of our revenue, the
resources we devote to developing, marketing and selling our services, the timing and extent of our
introduction of new features and services, the extent and timing of potential investments or
acquisitions and other factors. In particular, our premium membership services consist of prepaid
subscriptions that provide cash flows in advance of the actual provision of services. We expect to
devote substantial capital resources to expand our product development and marketing efforts, to
expand internationally and for other general corporate activities. In the three months ended March
31, 2005, we devoted approximately $218,000 to capitalized labor and
$399,000 to capitalized
external product development as well as $425,000 to marketing of our products and services both
domestically and internationally. Based on our current operations and planned growth, we expect that our available funds and
anticipated cash flows from operations, together with the proceeds from our initial public
offering, will be sufficient to meet our expected needs for working capital and capital
expenditures for the next twelve months. Thereafter, if we do not have sufficient cash available to
finance our operations, we may be required to obtain additional public or private debt or equity
financing. We cannot be certain that additional financing will be available to us on favorable
terms when required or at all. If we are unable to raise sufficient funds, we may need to reduce
our planned operations and expansion activities. Off-balance Sheet Liabilities We did not have any off-balance sheet liabilities as of March 31, 2005. 20




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Other Contractual Commitments The following table summarizes our contractual obligations as of March 31, 2005: Payments Due by PeriodRemainder ofTotal
    
    
    2005
    
    
    2006-2007
    
    
    2008-2009
    
    
    2010 & After(In thousands)Contractual obligations:Capital lease obligations
    
    $
    1,293
    
    
    $
    697
    
    
    $
    479
    
    
    $
    116
    
    
    $
    1Operating leases
    
    
    10,461
    
    
    
    1,025
    
    
    
    3,118
    
    
    
    3,198
    
    
    
    3,120Purchase obligations
    
    
    637
    
    
    
    495
    
    
    
    142
    
    
    
    
    
    
    
    Total contractual obligations:
    
    $
    12,391
    

    
    $
    2,217
    
    
    $
    3,739
    
    
    $
    3,314
    
    
    $
    3,121
 Capital Lease Obligations.We hold property and equipment under noncancelable capital leases
with varying maturities. Operating Leases.We lease or sublease office space and equipment under cancelable and
noncancelable operating leases with various expiration dates through January 20, 2012. In 2002, we
terminated our headquarters lease which resulted in a decrease in our rent expense in 2003 compared
to 2002. In July 2004, we entered into a new lease for our executive headquarters expiring in
January 2012. The new lease is for a larger facility at a higher average cost per square foot and
has resulted in an increase in our current occupancy cost. The future minimum lease payments are
$1.0 million in 2005; $1.3 million in 2006; $1.3 million in 2007; $1.4 million in 2008 and $1.4
million in 2009. The lease is cancelable after 2009, with proper notice and payment of a
termination fee of $851,000. Purchase Obligations.In January 2002, we entered into a co-location facility agreement with a
third-party service provider. In exchange for providing space for our network servers and committed
levels of telecommunications bandwidth, we pay a minimum monthly fee of $39,000. In the event that
bandwidth exceeds an allowed variance from committed levels, we pay for additional bandwidth at a
set monthly rate. Future total minimum payments under the co-location facility agreement are
$353,000 for 2005. In addition, in November 2004, we entered into a software maintenance agreement under which we
financed $332,000 with a vendor. This amount is payable in seven quarterly installments beginning
in January 2005. Future total minimum payments under this agreement are $142,000 for the remainder
of 2005 and $142,000 for 2006. Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amount of assets, liabilities,
revenue and expenses and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the basis on which we
make judgments about the carrying values of assets and liabilities that are not readily apparent
from other sources. Because this can vary in each situation, actual results may differ from the
estimates under different assumptions and conditions. We believe the following critical accounting policies require more significant judgments and
estimates in the preparation of our consolidated financial statements: Capitalized Website Development Costs.We capitalize the costs of enhancing and developing
features for our websites when we believe that the capitalization criteria for these activities
have been met in accordance with SOP 98-1 and EITF 00-2 and amortize these costs on a straight-line
basis over the estimated useful life of the capitalized application, generally three years. For the
three months ended March 31, 2004 and 2005, we capitalized $205,000 and $617,000, respectively. We
expense the cost of enhancing and developing features for our websites in cost of revenue only when
we believe that capitalization criteria have not been met. We exercise judgment in determining when
to begin capitalizing costs and the period over which we amortize the capitalized costs. If
different judgments were made, it would have an impact on our results of operations. There have been no significant changes in the Companys critical accounting policies from
those listed in the Companys Form 10-K for the fiscal year ended December 31, 1004. 21




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Seasonality and Inflation We anticipate that our business may be affected by the seasonality of certain revenue lines.
For example, print and online advertising buys are usually higher approaching year-end and lower at
the beginning of a new year than at other points during the year, and sales on Kleptomaniac.com are
affected by the holiday season and by the timing of the release of compilations of new seasons of
popular television series. Inflation has not had a significant effect on our revenue or expenses historically and we do
not expect it to be a significant factor in the short-term. However, inflation may affect our
business in the medium- to long-term. In particular, our operating expenses may be affected by a
tightening of the job market, resulting in increased pressure for salary adjustments for existing
employees and higher cost of replacement for employees that are terminated or resign. Recent Accounting Pronouncements In October 2004, the American Jobs Creation Act of 2004 (Jobs Act) was enacted. In December
2004, the FASB issued FSP FAS 109-2 to provide guidance with respect to the Jobs Act. Among other
provisions, the Jobs Act provides for a deduction for income from qualified domestic production
activities phased in from 2005 to 2010, and a temporary incentive for U.S. corporations to
repatriate accumulated income earned abroad. We do not plan to repatriate foreign earnings under
the Jobs Act and have not yet determined the impact of the deduction for domestic production
activities. Such deduction will first be available to the Company in fiscal year 2006. At this
time, the Company does not expect that the deduction will have a material impact on its reported
income tax rate in accordance with FSP No. FAS 109-2. In April 2005, the SEC amended the compliance dates for SFAS No. 123R, Shared-Based Payment.
The new rule allows public companies to implement SFAS No. 123R at the beginning of their next
fiscal year that begins after June 15, 2005. The Company will be required to adopt SFAS No. 123R in the
first quarter of 2006 and begin to recognize stock-based compensation related to employee equity
awards in our condensed consolidated statements of operations using a fair value based method on a
prospective basis. Since the Company currently accounts for equity awards granted to our employees using the
intrinsic value method under APB No. 25, we expect the adoption of SFAS No. 123R will have a significant adverse impact on our financial position and
results of operations. The Company is currently in the process of
evaluating the extent of such impact. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB No. 107). SAB No. 107
covers key topics related to the implementation of SFAS No. 123R which include the valuation
models, expected volatility, expected option term, income tax effects of SFAS No. 123R,
classification of stock-based compensation cost, capitalization of compensation costs, and
disclosure requirements. The Company expects the adoption of SAB No. 107 will have a significant adverse
impact on our financial position and results of operations upon our adoption of SFAS No. 123R in
the first quarter of 2006. The Company is currently in the process of
evaluating the extent of such impact. Risk Factors We have a history of significant losses. If we do not sustain profitability, our financial
condition and stock price could suffer. We have experienced significant net losses and we may continue to incur losses in the future
given our anticipated increase in sales and marketing expenditures. As of March 31, 2005, our
accumulated deficit was approximately $37.1 million. Although we had positive net income in the
three months ended March 31, 2005, our operating expenses are higher than we expect, and we may not
be able to sustain or increase profitability in the near future, causing our financial condition to
suffer and our stock price to decline. If our efforts to attract and retain subscribers are not successful, our revenue will
decrease. Because most of our revenue is derived from our premium membership services, we must continue
to attract and retain subscribers. Many of our new subscribers originate from word-of-mouth
referrals from existing subscribers within the LGBT community. If our subscribers do not perceive
our service offerings to be of high quality or sufficient breadth, if we introduce new services
that are not favorably received or if we fail to introduce compelling new features or enhance our
existing offerings, we may not be able to attract new subscribers or retain our current
subscribers. As a result, our revenue would decrease. Our base of likely potential subscribers is
also limited to members of the LGBT community, who collectively comprise a small portion of the
general adult population. While seeking to add new subscribers, we must also minimize the loss of existing subscribers.
We lose our existing subscribers primarily as a result of cancellations and credit card failures
due to expirations or exceeded credit limits. In the three months ended March 31, 2005, our churn
rates on our premium membership services, which include subscription cancellations and credit card
failures, averaged 8.6% per month excluding cancellations from free trials, or 9.6% including
cancellations from free trials. We 22




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calculate our average monthly churn over a particular period by dividing the sum of the number
of cancellations and credit card failures for that period by the average number of subscribers in
that period. We calculate the average number of subscribers in a given period by adding the number
of subscribers at the beginning and the end of the period and dividing by two. Subscribers cancel
their subscription to our service for many reasons, including a perception, among some subscribers,
that they do not use the service sufficiently, that the service is a poor value and that customer
service issues are not satisfactorily resolved. Members may decline to subscribe or existing
subscribers may cancel their subscriptions if our websites experience a disruption or degradation
of services, including slow response times or excessive down time due to scheduled or unscheduled
hardware or software maintenance or denial of service attacks. We must continually add new
subscribers both to replace subscribers who cancel or whose subscriptions are not renewed due to
credit card failures and to continue to grow our business beyond our current subscriber base. If
excessive numbers of subscribers cancel our service, we may be required to incur significantly
higher marketing expenditures than we currently anticipate to replace these subscribers with new
subscribers, which will harm our financial condition. If we do not continue to attract and retain qualified personnel, we may not be able to expand our
business. Our success depends on the collective experience of our senior executive team and on our
ability to hire, train, retain and manage other highly skilled employees. Disruptions in our senior
executive team could harm our business and financial results or limit our ability to grow and
expand our business. We cannot provide assurance that we will be able to attract and retain a
sufficient number of qualified employees or that we will successfully train and manage the
employees that we do hire. Our success depends, in part, upon the growth of Internet advertising and upon our ability to
accurately predict the cost of customized campaigns. We compete with traditional media including television, radio and print, in addition to
high-traffic websites, such as those operated by Yahoo!, Google, AOL and MSN, for a share of
advertisers total online advertising expenditures. We face the risk that advertisers might find
the Internet to be less effective than traditional media in promoting their products or services,
and as a result they may reduce or eliminate their expenditures on Internet advertising. Many
potential advertisers and advertising agencies have only limited experience advertising on the
Internet and historically have not devoted a significant portion of their advertising expenditures
to Internet advertising. Additionally, filter software programs that limit or prevent
advertisements from being displayed on or delivered to a users computer are becoming increasingly
available. If this type of software becomes widely accepted, it would negatively affect Internet
advertising. Our business could be harmed if the market for Internet advertising does not grow. Currently, we offer advertisers a number of alternatives to advertise their products or
services on our websites and to our members, including banner advertisements, rich media
advertisements, email campaigns, text links and sponsorships of our channels, topic sections,
directories and other online databases and content. Frequently, advertisers request advertising
campaigns consisting of a combination of these offerings, including some that may require custom
development. If we are unable to accurately predict the cost of developing these custom campaigns
for our advertisers, our expenses will increase and our margins will be reduced. If advertisers do not find the LGBT market to be economically profitable, our business will be
harmed. We focus our services exclusively on the LGBT community. Advertisers and advertising agencies
may not consider the LGBT community to be a broad enough or profitable enough market for their
advertising budgets, and they may prefer to direct their online advertising expenditures to larger
higher-traffic websites that focus on broader markets. If we are unable to attract new advertisers,
if our advertising campaigns are unsuccessful with the LGBT community or if our existing
advertisers do not renew their contracts with us, our revenue will decrease and operating results
will suffer. Our limited operating history makes it difficult to evaluate our business. As a result of our recent growth and limited operating history, it is difficult to forecast
our revenue, gross profit, operating expenses, number of subscribers and other financial and
operating data. Our inability, or the inability of the financial community at large, to accurately
forecast our operating results could cause our subscriber numbers to grow slower or our net losses
to be greater than expected, which could cause a decline in the trading price of our common stock. We expect our operating results to fluctuate, which may lead to volatility in our stock price. Our operating results have fluctuated in the past and may fluctuate significantly in the
future due to a variety of factors, many of which are outside of our control. As a result, we
believe that period-over-period comparisons of our operating results are not necessarily meaningful
and that you should not rely on the results of one period as an indication of our future or
long-term performance. Our operating results in future quarters may be below the expectations of
public market analysts and investors, which may result in a decline in our stock price. 23




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Any significant disruption in service on our websites or in our computer and communications
hardware and software systems could harm our business. Our ability to attract new visitors, members, subscribers, advertisers and other customers to
our websites is critical to our success and largely depends upon the efficient and uninterrupted
operation of our computer and communications hardware and software systems. Our systems and
operations are vulnerable to damage or interruption from power outages, computer and
telecommunications failures, computer viruses, security breaches, catastrophic events and errors in
usage by our employees and customers, which could lead to interruption in our service and
operations, and loss, misuse or theft of data. For example, during the fourth quarter of 2004 and
the first quarter of 2005, our websites experienced unexpected periods of degraded performance and
periods during which our transaction processing systems were not available or did not perform as
expected, in part as a result of rapid growth and the introduction of new features and transaction
processing capabilities. Our websites could also be targeted by direct attacks intended to cause a
disruption in service or to siphon off customers to other Internet services. Among other risks, our
chat rooms may be vulnerable to infestation by software programs or scripts that we refer to as
adbots. An adbot is a software program that creates a registration profile, enters a chat room and
displays third-party advertisements. Any successful attempt by hackers to disrupt our websites
services or our internal systems could harm our business, be expensive to remedy and damage our
reputation, resulting in a loss of visitors, members, subscribers, advertisers and other customers. The risks of transmitting confidential information online, including credit card information, may
discourage customers from subscribing to our services or purchasing goods from us. In order for the online marketplace to be successful, we and other market participants must be
able to transmit confidential information, including credit card information, securely over public
networks. Third parties may have the technology or know-how to breach the security of our customer
transaction data. Any breach could cause consumers to lose confidence in the security of our
websites and choose not to subscribe to our services or purchase goods from us. We cannot guarantee
that our security measures will effectively prohibit others from obtaining improper access to our
information or that of our users. If a person is able to circumvent our security measures, he or
she could destroy or steal valuable information or disrupt our operations. Any security breach
could expose us to risks of data loss, litigation and liability and may significantly disrupt our
operations and harm our reputation, operating results or financial condition. If we are unable to provide satisfactory customer service, we could lose subscribers. Our ability to provide satisfactory customer service depends, to a large degree, on the
efficient and uninterrupted operation of our customer service center. Any significant disruption or
slowdown in our ability to process customer calls resulting from telephone or Internet failures,
power or service outages, natural disasters or other events could make it difficult or impossible
to provide adequate customer service and support. Further, we may be unable to attract and retain
adequate numbers of competent customer service representatives, which is essential in creating a
favorable interactive customer experience. If we are unable to continually provide adequate
staffing for our customer service operations, our reputation could be harmed and we may lose
existing and potential subscribers. In addition, we cannot assure you that email and telephone call
volumes will not exceed our present system capacities. If this occurs, we could experience delays
in responding to customer inquiries and addressing customer concerns. If we are unable to compete effectively, we may lose market share and our revenue may decline. Our markets are intensely competitive and subject to rapid change. We compete with a number of
large and small companies, such as vertically integrated Internet portals and specialty focused
media that provide online and offline products and services to the LGBT community. In our
subscription business, we compete with other online services, such as those offered by Match.com
and Yahoo! Personals, as well as a number of other smaller online companies focused specifically on
the LGBT community. In our online advertising business, we compete with a broad variety of content
providers. We also compete with offline LGBT media companies, including local newspapers, national
and regional magazines, satellite radio and television shows. If we are unable to successfully
compete with current and new competitors, we may not be able to achieve or maintain adequate market
share, increase our revenue or achieve and maintain profitability. Some of these competitors have longer operating histories, larger customer bases, greater
brand recognition and significantly greater financial, marketing and other resources than we do.
Some of our competitors have adopted, and may continue to adopt, aggressive pricing policies and
devote substantially more resources to marketing and technology development than we do. The rapid
growth of our online subscription business since our inception may attract direct competition from
larger companies with significantly greater financial resources and national brand recognition,
such as InterActiveCorp, Microsoft, Time Warner, Viacom or Yahoo! which may choose to increase
their focus on the LGBT market. Increased competition may result in reduced operating margins, loss
of market share and reduced revenue. 24




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We may be the target of negative publicity campaigns or other actions by advocacy groups that
could disrupt our operations because we serve the LGBT community. Advocacy groups may target our business through negative publicity campaigns, lawsuits and
boycotts seeking to limit access to our services or otherwise disrupt our operations because we
serve the LGBT community. These actions could impair our ability to attract and retain customers,
especially in our advertising business, resulting in decreased revenue, and cause additional
financial harm by requiring that we incur significant expenditures to defend our business and by
diverting managements attention. Further, some investors, investment banking entities, market
makers, lenders and others in the investment community may decide not to invest in our securities
or provide financing to us because we serve the LGBT community, which, in turn, may hurt the value
of our stock. If we are unable to protect our domain names, our reputation and brand could be harmed if third
parties gain rights to, or use, these domain names in a manner that would confuse or impair our
ability to attract and retain customers. We have registered various domain names relating to our brand, including Gay.com,
PlanetOut.com, Kleptomaniac.com and OutandAbout.com. If we fail to maintain these registrations, a
third party may be able to gain rights to these domain names, which will make it more difficult for
users to find our websites and our service. The acquisition and maintenance of domain names are
generally regulated by governmental agencies and their designees. The regulation of domain names in
the United States may change in the near future. Governing bodies may designate additional
top-level domains, such as .eu, in addition to currently available domains such as .biz, .net or
 .tv, for example, appoint additional domain name registrars or modify the requirements for holding
domain names. As a result, we may be unable to acquire or maintain relevant domain names. If a
third party acquires domain names similar to ours and engages in a business that may be harmful to
our reputation or confusing to our subscribers and other customers, our revenue may decline, and we
may incur additional expenses in maintaining our brand and defending our reputation. Furthermore,
the relationship between regulations governing domain names and laws protecting trademarks and
similar proprietary rights is unclear. We may be unable to prevent third parties from acquiring
domain names that are similar to, infringe upon or otherwise decrease the value of our trademarks
and other proprietary rights. If we fail to adequately protect our trademarks and other proprietary rights, or if we get
involved in intellectual property litigation, our revenue may decline and our expenses may
increase. We rely on a combination of confidentiality and license agreements with our employees,
consultants and third parties with whom we have relationships, as well as trademark, copyright and
trade secret protection laws, to protect our proprietary rights. If the protection of our
proprietary rights is inadequate to prevent use or appropriation by third parties, the value of our
brand and other intangible assets may be diminished, competitors may be able to more effectively
mimic our service and methods of operations, the perception of our business and service to
subscribers and potential subscribers may become confused in the marketplace and our ability to
attract subscribers and other customers may suffer, resulting in loss of revenue. The Internet content delivery market is characterized by frequent litigation regarding patent
and other intellectual property rights. As a publisher of online content, we face potential
liability for negligence, copyright, patent or trademark infringement or other claims based on the
nature and content of materials that we publish or distribute. For example, we have received, and
may receive in the future, notices or offers from third parties claiming to have intellectual
property rights in technologies that we use in our businesses and inviting us to license those
rights. Litigation may be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets, to determine the validity and scope of the proprietary rights of others
or to defend against claims of infringement or invalidity, and we may not prevail in any future
litigation. Adverse determinations in litigation could result in the loss of our proprietary
rights, subject us to significant liabilities, require us to seek licenses from third parties or
prevent us from licensing our technology or selling our products, any of which could seriously harm
our business. An adverse determination could also result in the issuance of a cease and desist
order, which may force us to discontinue operations through our website or websites. Intellectual
property litigation, whether or not determined in our favor or settled, could be costly, could harm
our reputation and could divert the efforts and attention of our management and technical personnel
from normal business operations. If we fail to manage our growth, including through acquisitions and our planned international
expansion, our business will suffer. We have significantly expanded our operations and anticipate that further expansion, including
the possible acquisition of third-party assets, technologies or businesses, will be required to
address potential growth in our customer base and market opportunities. This expansion has placed,
and is expected to continue to place, a significant strain on our management, operational and
financial resources. If we make future acquisitions or continue to expand our marketing efforts, we
may issue shares of stock that dilute the interests of our other stockholders, expend cash, incur
debt, assume contingent liabilities, create additional expenses or face 25




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difficulties in integrating acquired assets or businesses into our operations, any of which
might harm our financial condition or results of operations. In addition, we offer services and products to the LGBT community outside the United States,
and we intend to continue to expand our international presence, which may be more difficult or take
longer than anticipated especially due to international challenges, such as language barriers,
currency exchange issues and the fact that Internet infrastructure in foreign countries may be less
advanced than Internet infrastructure in the United States. Expansion into international markets
requires significant resources that we may fail to recover by generating additional revenue. If we are unable to successfully expand our international operations, manage growth
effectively or successfully integrate any assets, technologies or businesses that we may acquire,
our revenue may decline and our profit margins will be reduced. Existing or future government regulation in the United States and other countries could limit our
growth and result in loss of revenue. We are subject to federal, state, local and international laws affecting companies conducting
business on the Internet, including user privacy laws, regulations prohibiting unfair and deceptive
trade practices and laws addressing issues such as freedom of expression, pricing and access
charges, quality of products and services, taxation, advertising, intellectual property rights and
information security. In particular, we are currently required, or may in the future be required,
to:  
    conduct background checks on our members prior to allowing them to interact with other
members on our websites or, alternatively, provide notice on our websites that we have not
conducted background checks on our members, which may result in our members canceling their
membership or failing to subscribe or renew their subscription, resulting in reduced
revenue;
    provide advance notice of any changes to our privacy policies or to our policies on
sharing non-public information with third parties, and if our members or subscribers
disagree with these policies or changes, they may cancel their membership or subscription,
which will reduce our revenue;
    with limited exceptions, give consumers the right to prevent sharing of their non-public
personal information with unaffiliated third parties, and if a significant portion of our
members choose to request that we dont share their information, our advertising revenue
that we receive from renting our mailing list to unaffiliated third parties may decline;
    provide notice to residents in some states if their personal information was, or is
reasonably believed to have been, obtained by an unauthorized person such as a computer
hacker, which may result in our members or subscribers deciding to cancel their membership
or subscription, reducing our membership base and subscription revenue;
    comply with current or future anti-spam legislation by limiting or modifying some of our
marketing and advertising efforts, such as email campaigns, which may result in a reduction
in our advertising revenue;
    comply with the European Union privacy directive and other international regulatory
requirements by modifying the ways in which we collect and share our users personal
information; if these modifications render our services less attractive to our members or
subscribers, for example by limiting the amount or type of personal information our members
or subscribers could post to their profiles, they may cancel their memberships or
subscriptions, resulting in reduced revenue;
    qualify to do business in various states and countries, in addition to jurisdictions
where we are currently qualified, because our websites are accessible over the Internet in
multiple states and countries, which if we fail to so qualify, may prevent us from enforcing
our contracts in these states or countries and may limit our ability to grow our business;
    limit our domestic or international expansion because some jurisdictions may limit or
prevent access to our services as a result of the availability of some content intended for
mature viewing on some of our websites, which may render our services less attractive to our
members or subscribers and result in a decline in our revenue; and
    limit or prevent access, from some jurisdictions, to some or all of the member-generated
content available through our websites, which may render our services less attractive to our
members or subscribers and result in a decline in our revenue. The restrictions imposed by, and costs of complying with, current and possible future laws and
regulations related to our business could limit our growth and reduce our membership base and
revenue. 26




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If one or more states or countries successfully assert that we should collect sales or other taxes
on the use of the Internet or the online sales of goods and services, our expenses will increase,
resulting in lower margins. In the United States, federal and state tax authorities are currently exploring the
appropriate tax treatment of companies engaged in online commerce, and new state tax regulations
may subject us to additional state sales and income taxes, which could increase our expenses and
decrease our profit margins. In 2003, the European Union implemented new rules regarding the collection and payment of
value added tax, or VAT. These rules require VAT to be charged on products and services delivered
over electronic networks, including software and computer services, as well as information and
cultural, artistic, sporting, scientific, educational, entertainment and similar services. These
services are now being taxed in the country where the purchaser resides rather than where the
supplier is located. Historically, suppliers of digital products and services that existed outside
the European Union were not required to collect or remit VAT on digital orders made to purchasers
in the European Union. With the implementation of these rules, we are required to collect and remit
VAT on digital orders received from purchasers in the European Union, effectively reducing our
revenue by the VAT amount because we currently do not pass this cost on to our customers. We also do not currently collect sales, use or other similar taxes for sales of our
subscription services or for physical shipments of goods into states other than California. In the
future, one or more local, state or foreign jurisdictions may seek to impose sales, use or other
tax collection obligations on us. If these obligations are successfully imposed upon us by a state
or other jurisdiction, we may suffer decreased sales into that state or jurisdiction as the
effective cost of purchasing goods or services from us will increase for those residing in these
states or jurisdictions. We may need additional capital and may not be able to raise additional funds on favorable terms or
at all, which could increase our costs, limit our ability to grow and dilute the ownership
interests of existing stockholders. We anticipate that we may need to raise additional capital in the future to facilitate
long-term expansion, to respond to competitive pressures or to respond to unanticipated financial
requirements. We cannot be certain that we will be able to obtain additional financing on
commercially reasonable terms or at all. If we raise additional funds through the issuance of
equity, equity-related or debt securities, these securities may have rights, preferences or
privileges senior to those of the rights of our common stock, and our stockholders will experience
dilution of their ownership interests. A failure to obtain additional financing or an inability to
obtain financing on acceptable terms could require us to incur indebtedness that has high rates of
interest or substantial restrictive covenants, issue equity securities that will dilute the
ownership interests of existing stockholders, or scale back, or fail to address opportunities for
expansion or enhancement of, our operations. We cannot assure you that we will not require
additional capital in the near future. Our executive offices and our data center are located in the San Francisco Bay area. In the event
of an earthquake, other natural or man-made disaster, or power loss, our operations could be
interrupted, resulting in lower revenue. Our executive offices and our data center are located in the San Francisco Bay area. Our
business and operations could be disrupted in the event of electrical blackouts, fires, floods,
earthquakes, power losses, telecommunications failures, break-ins or similar events. Because the
San Francisco Bay area is located in an earthquake-sensitive area, we are particularly susceptible
to the risk of damage to, or total destruction of, our systems and infrastructure. We are not
insured against any losses or expenses that arise from a disruption to our business due to
earthquakes. Further, the State of California has experienced deficiencies in its power supply over
the last few years, resulting in occasional rolling blackouts. If rolling blackouts or other
disruptions in power occur, our business and operations could be disrupted, and we will lose
revenue. Recent and proposed regulations related to equity compensation could adversely affect our ability
to attract and retain key personnel. We have used stock options and other long-term incentives as a fundamental component of our
employee compensation packages. We believe that stock options and other long-term equity incentives
directly motivate our employees to maximize long-term stockholder value and, through the use of
vesting, encourage employees to remain with our company. Several regulatory agencies and entities
are considering regulatory changes that could make it more difficult or expensive for us to grant
stock options to employees. For example, the Financial Accounting Standards Board has adopted
changes to the U.S. generally accepted accounting principles that will require us to record a
charge to earnings for employee stock option grants. In addition, regulations implemented by the
Nasdaq National Market generally requiring stockholder approval for all stock option plans could
make it more difficult for us to grant options to employees in the future. To the extent that new
regulations make it more difficult or expensive to grant stock options to employees, we may incur
increased compensation costs, change our equity compensation strategy or find it difficult to
attract, retain and motivate employees, each of which could materially and adversely affect our
business. 27




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In the event we are unable to satisfy regulatory requirements relating to internal control over
financial reporting, or if these internal controls are not effective, our business and our stock
price could suffer. Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to do a comprehensive and
costly evaluation of their internal controls. As a result, our management will be required to
perform an evaluation of our internal control over financial reporting and have our independent
registered public accounting firm attest to such evaluations. We have prepared an internal plan of
action for compliance, which includes a timeline and scheduled activities with respect to
preparation of such evaluation. Our efforts to comply with Section 404 and related regulations
regarding our managements required assessment of internal control over financial reporting and our
independent registered public accounting firms attestation of that assessment has required, and
continues to require, the commitment of significant financial and managerial resources. If we fail
to timely complete this evaluation, or if our independent registered public accounting firm cannot
timely attest to our evaluation, we could be subject to regulatory scrutiny and a loss of public
confidence in our internal controls, which could have an adverse effect on our business and our
stock price. Our stock price may be volatile and you may lose all or a part of your investment. Since our initial public offering in October 2004, our stock price has been and may continue
to be subject to wide fluctuations. From October 14, 2004 through March 31, 2005, the closing sale
prices of our common stock on the Nasdaq ranged from $8.10 to $14.26 per share and the closing sale
price on May 6, 2005 was $7.25. Our stock price may fluctuate in response to a number of events and
factors, such as quarterly variations in our operating results, changes in financial estimates and
recommendations by securities analysts and the operating and stock price performance of other
companies that investors or analysts deem comparable to us. In addition, the stock markets have experienced significant price and trading volume
fluctuations, and the market prices of Internet-related and e-commerce companies in particular have
been extremely volatile and have recently experienced sharp share price and trading volume changes.
These broad market fluctuations may impact the trading price of our common stock. In the past,
following periods of volatility in the market price of a public companys securities, securities
class action litigation has often been instituted against that company. This type of litigation
could result in substantial costs to us and a likely diversion of our managements attention. 28




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Provisions in our charter documents and under Delaware law could discourage a takeover that
stockholders may consider favorable. Our charter documents may discourage, delay or prevent a merger or acquisition that a
stockholder may consider favorable because they will:  
    authorize our board of directors, without stockholder approval, to issue up to 5,000,000
shares of undesignated preferred stock;
    provide for a classified board of directors;
    prohibit our stockholders from acting by written consent;
    establish advance notice requirements for proposing matters to be approved by stockholders at stockholder meetings; and
    prohibit stockholders from calling a special meeting of stockholders. As a Delaware corporation, we are also subject to Delaware law anti-takeover provisions. Under
Delaware law, a corporation may not engage in a business combination with any holder of 15% or more
of its capital stock unless the holder has held the stock for three years or, among other things,
the board of directors has approved the transaction. Our board of directors could rely on Delaware
law to prevent or delay an acquisition of us. 
 Item 3. Qualitative and Quantitative Disclosures About Market Risk 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, we
maintain our portfolio in primarily money market funds. We do not use derivative financial instruments in our investment portfolio and have no foreign
exchange contracts. Our financial instruments consist of cash and cash equivalents, trade accounts
receivable, accounts payable and long-term obligations. We consider investments in highly-liquid
instruments purchased with a remaining maturity of 90 days or less at the date of purchase to be
cash equivalents. Our exposure to market risk for changes in interest rates relates primarily to
our short-term investments and short-term obligations; thus, fluctuations in interest rates may
have a material impact on the fair value of these securities. A hypothetical 1% increase or
decrease in interest rates would increase (decrease) our earnings or loss by approximately $105,000
per quarter. Our operations have been conducted primarily in United States currency and as such have not
been subject to material foreign currency exchange rate risk. However, the growth in our
international operations is increasing our exposure to foreign currency fluctuations as well as
other risks typical of international operations, including, but not limited to differing economic
conditions, changes in political climate, differing tax structures and other regulations and
restrictions. Accordingly, our future results could be materially adversely impacted by changes in
these or other factors. We translate income statement amounts that are denominated in foreign
currency into U.S. dollars at the average exchange rates in each applicable period. To the extent
the U.S. dollar weakens against foreign currencies, the translation of these foreign currency
denominated transactions results in increased net revenue operating expenses and net income.
Conversely, our net revenue operating expenses and net income will decrease when the U.S. dollar
strengthens against foreign currencies. The effect of foreign exchange rate fluctuations for 2004
was not material. 
 Item 4. Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure that information
required to be disclosed in our Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the SECs rules and forms, and that such information
is accumulated and communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of March 31, 2005, the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management, including our Chief
Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation
of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and
Chief Financial Officer concluded that our disclosure controls and procedures were effective at the
reasonable-assurance level. There has been no change in our internal control over financial reporting during our most
recent fiscal quarter that has materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting. 29




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PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings In November 2000, a former employee of ours filed a lawsuit against Online Partners.com, Inc.,
and a number of our current and former employees, including our current President, Mark Elderkin,
and his partner, Jeffery Bennett. The complaint alleged breach of contract, fraud and numerous
other business torts. The plaintiff, Mr. Elderkin and Mr. Bennett were the sole holders of
membership interests in Pridecom LLC, whose assets were assumed by Pridecom Inc. prior to its
acquisition by Online Partners.com, Inc. in 1999. The plaintiff claimed that the membership
interest he negotiated in Pridecom LLC did not accurately represent the value of his contribution
to Pridecom LLC or its successor entities. The plaintiff sought an unspecified amount of fully

vested stock, along with unspecified compensatory and exemplary damages. On January 31, 2005, this
matter was settled to the mutual satisfaction of all parties. The amount of the settlement was not
material to our financial condition and results of operations and was recorded as an accrued
expense at December 31, 2004. In April 2002, the Company was notified that DIALINK, a French company, had filed a lawsuit in
France against it and its French subsidiary, alleging that the Company had improperly used the
domain names Gay.net, Gay.com and fr.gay.com in France, as DIALINK alleges that it has exclusive
rights to use the word gay as a domain name and trademark in France. DIALINK seeks an injunction
against our use of the word gay as a domain name and
monetary damages of 300,000 (US $387,000
at March 31, 2005). The Company estimates that its range of possible loss is from no loss and no
injunction to the full amount of the plaintiffs petition for relief. The Company has not recorded
this contingency because of uncertainty as to the amount that would be required to be paid, if any.
The Company intends to defend itself vigorously in this matter and expects a trial decision by
June 2005. The Company is not currently subject to any additional significant legal proceedings. The
Company may from time to time, however, become a party to various legal proceedings, arising in the
ordinary course of business. The Company may also be indirectly affected by administrative or court
proceedings or actions in which the Company is not involved but which have general applicability to
the Internet industry. The Company does not believe, based on current knowledge, that any legal
proceedings or claims is likely to have a material adverse effect on its financial position,
results of operations or cash flows. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. During the period January 1 through March 31, 2005, we granted options to purchase an
aggregate of 48,489 shares of capital stock, at exercise prices ranging from $9.71 to $13.60 per
share, under our 2004 equity incentive plan. During the same period, a total of 30,644 shares of
capital stock were issued upon exercise of outstanding options, at exercise prices ranging from
$0.44 to $9.02 per share, under our equity incentive plans, and
69,599 shares of capital stock were issued upon exercise of two
outstanding warrants at and exercise price of $4.07 per share. One
warrant was net exercised without the payment of additional
consideration, and the second warrant was exercised for cash in the
amount of $257,496.69. There were no underwriters employed in
connection with any of these issuances. These issuances were deemed exempt from registration under
the Securities Act in reliance on Section 4(2) thereof, as
transactions by an issuer not involving any public offering, or Rule 701 promulgated thereunder as transactions
pursuant to compensatory benefit plans and contracts relating to compensation. The recipients in
each such issuance represented their intention to acquire the securities for investment only and
not with a view to or for sale in connection with any distribution thereof and appropriate legends
were affixed to the share certificates and other instruments issued in such transactions. All
recipients either received adequate information about PlanetOut or had access, through employment
or other relationships, to such information. On October 13, 2004, a registration statement on Form S-1 (No. 333-114988) was declared
effective by the Securities and Exchange Commission, pursuant to which 5,347,500 shares of common
stock were offered and sold by us at a price of $9.00 per share, generating total proceeds, net of
underwriting discounts and commissions and issuance costs of approximately $42.9 million. In
connection with the offering, we incurred approximately $2.9 million in underwriting discounts and
commissions and approximately $1.9 million in other related expenses. The managing underwriters
were SG Cowen & Co., LLC, RBC Capital Markets Corporation and WR Hambrecht + Co, LLC. We have used
the net proceeds from our initial public offering to invest in short-term, investment grade
interest-bearing securities, to pay off the principal and interest under our senior subordinated
promissory note and for working capital needs. We may use a portion of the net proceeds to acquire
or invest in products and technologies that are complementary to our own, although no portion of
the net proceeds has been allocated for any specific acquisition. None of the net proceeds of the
initial public offering were paid directly or indirectly to any director, officer, general partner
of PlanetOut or their associates, persons owning 10% or more of any class of our or our affiliates
equity securities. From the time of receipt through December 31, 2004, the proceeds were applied toward repayment
of the principal and interest of the senior subordinated note in the amount of $5,031,000. The
remaining proceeds of $37,869,000 are being used as working capital and are included within cash
and cash equivalents. We expect that the use of the remaining proceeds will conform to the intended
use of proceeds as described in our initial public offering prospectus filed on October 14, 2004. 30




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Issuer Purchases of Equity Securities. (c) Total Number of
    
    
    (d) Maximum Number(a) Total
    
    
    
    
    
    
    Shares Purchased as
    
    
    or Approximate DollarNumber of
    
    
    (b) Average
    
    
    Part of Publicly
    
    
    Value) of Shares that MayShares
    
    
    Price Paid per
    
    
    Announced Plans or
    
    
    Yet Be Purchased Under thePeriod
    
    Purchased (1)
    
    
    Share
    
    
    Programs
    
    
    Plans or ProgramsJanuary 1, 2005 - January 31, 2005
    
    
    518
    
    
    $
    0.43
    
    
    
    
    
    
    
    February 1, 2005 - February 28, 2005
    
    
    26
    
    
    $
    0.43
    
    
    
    
    
    
    
    March 1, 2005 - March 31, 2005
    
    
    207
    
    
    $
    0.43
    
    
    
    
    
    
    
    Total
    
    
    751
    
    
    $
    0.43
    
    
    
    
    
    
    
    
    
 Item 3. Defaults Upon Senior Securities. Not Applicable. 
 Item 4. Submission of Matters to a Vote of Security Holders. No matters were submitted to a vote of security holders during the first quarter of 2005. 
 Item 5. Other Information. Not Applicable. 
 Item 6. Exhibits (a) Exhibits ExhibitNumber
    
    Description of Documents3.1
    
    
    Amended and Restated Certificate of Incorporation, as currently in effect (filed
as Exhibit 3.3 to our Registration Statement on Form S-1, File No. 333-114988,
initially filed on April 29, 2004, declared effective on October 13, 2004, and
incorporated herein by reference).3.2
    
    
    Amended and Restated Bylaws, as currently in effect (filed as Exhibit 3.4 to our
Registration Statement on Form S-1, File No. 333-114988, initially filed on April
29, 2004, declared effective on October 13, 2004, and incorporated herein by
reference).4.1
    
    
    Specimen of Common Stock Certificate (filed as Exhibit 4.1 to our Registration
Statement on Form S-1, File No. 333-114988, initially filed on April 29, 2004,
declared effective on October 13, 2004, and incorporated herein by reference).10.24
    
    
    Employment Agreement dated as of January 31, 2005 by and between Donna L. Gibbs
and PlanetOut Inc. (filed as Exhibit 99.1 to our Current Report on Form 8-K, File
No. 000-50879, filed on February 4, 2005, and incorporated herein by reference).31.1
    
    
    Certificate of Chief Executive Officer pursuant to the Securities Exchange Act
Rules 13a-14(a) and 15d-14(a) as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    
    Certificate of Chief Financial Officer pursuant to the Securities Exchange Act
Rules 13a-14(a) and 15d-14(a) as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    
    Certificate of Chief Executive Officer pursuant to Section 18 U.S.C section 1350.32.2
    
    
    Certificate of Chief Financial Officer pursuant to Section 18 U.S.C. section 1350.
 31




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PLANETOUT INC.Date:
May 12, 2005By:
    
    /s/ Jeffrey T. SoukupJeffrey T. SoukupChief Financial Officer(Principal Financial and Accounting Officer)
 32




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EXHIBIT INDEX ExhibitNumber
    
    Description of Documents3.1
    
    
    Amended and Restated Certificate of Incorporation, as currently in effect (filed
as Exhibit 3.3 to our Registration Statement on Form S-1, File No. 333-114988,
initially filed on April 29, 2004, declared effective on October 13, 2004, and
incorporated herein by reference).3.2
    
    
    Amended and Restated Bylaws, as currently in effect (filed as Exhibit 3.4 to our
Registration Statement on Form S-1, File No. 333-114988, initially filed on April
29, 2004, declared effective on October 13, 2004, and incorporated herein by
reference).4.1
    
    
    Specimen of Common Stock Certificate (filed as Exhibit 4.1 to our Registration
Statement on Form S-1, File No. 333-114988, initially filed on April 29, 2004,
declared effective on October 13, 2004, and incorporated herein by reference).10.24
    
    
    Employment Agreement dated as of January 31, 2005 by and between Donna L. Gibbs
and PlanetOut Inc. (filed as Exhibit 99.1 to our Current Report on Form 8-K, File
No. 000-50879, filed on February 4, 2005, and incorporated herein by reference).31.1
    
    
    Certificate of Chief Executive Officer pursuant to the Securities Exchange Act
Rules 13a-14(a) and 15d-14(a) as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    
    Certificate of Chief Financial Officer pursuant to the Securities Exchange Act
Rules 13a-14(a) and 15d-14(a) as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    
    Certificate of Chief Executive Officer pursuant to Section 18 U.S.C section 1350.32.2
    
    
    Certificate of Chief Financial Officer pursuant to Section 18 U.S.C. section 1350.
 33