##### Table of Contents









UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


FORM 10-K


|                                             |  |                                                                                                 
|-------------------------------------------- |  | ------------------------------------------------------------------------------------------------
|x                                            |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934    
|                                            
|For the fiscal year ended March 31,
    2004
|                                            
|o                                            |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|                                            
|Commission File Number: 000-27787           

DIGITAL IMPACT, INC.

(Exact name of the registrant as specified in
its charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                           |  | 94-3286913                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. employer
    Identification No.)
|                                                                  
|177 Bovet Road, San Mateo,
    California                          |  | 94402                                   
|(Address of principal executive
    offices)                       |  | (Zip Code)                              

Registrants telephone number, including
area code: (650) 356-3400

Securities registered pursuant to
Section 12(b) of the Act:

None


Securities registered pursuant to Section
12(g) of the Act:

Common Stock, $0.001 par value


Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past 90 days.

Yes x     No o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any
amendment to this
Form 10-K.     o

Indicate by check mark whether registrant is an
accelerated filer (as defined in Exchange Act
Rule 12b-2).     Yes o     No x

The aggregate market value of the voting Common
Stock held by non-affiliates of the Registrant, based upon the
closing sale price of the Common Stock on September 30,
2003 as reported on the Nasdaq National Market, was
approximately $67 million.

As of June 8, 2004, the Registrant had
outstanding approximately 34 million shares of Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our definitive Proxy Statement for
our 2004 Annual Meeting of Stockholders, which will be filed
with the Securities and Exchange Commission within 120 days
after the end of our fiscal year, are incorporated by reference
into Part III hereof.



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FORM 10-K

ANNUAL REPORT


For the Year Ended March 31,
2004


TABLE OF CONTENTS

|              |  |                                                                                                                      |    |      |    | 
|------------- |  | -------------------------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|              |  |                                                                                                                      |    | Page
|              |  |                                                                                                                      |    |     
|PART I       
|Item 1.       |  | Business                                                                                                             |    |      | 1  | 
|Item 2.       |  | Properties                                                                                                           |    |      | 8  | 
|Item 3.       |  | Legal Proceedings                                                                                                    |    |      | 9  | 
|Item 4.       |  | Submission of Matters to a
    Vote of Security Holders                                                              |    |      | 9  | 
|             
|PART II      
|Item 5.       |  | Market for Registrants
    Common Equity, Related Stockholder Matters and Issuer Purchases
    of Equity Securities |    |      | 10 | 
|Item 6.       |  | Selected Financial Data                                                                                              |    |      | 10 | 
|Item 7.       |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations                            |    |      | 12 | 
|Item 7A.      |  | Quantitative and Qualitative
    Disclosures About Market Risk                                                       |    |      | 23 | 
|Item 8.       |  | Financial Statements and
    Supplementary Data                                                                      |    |      | 24 | 
|Item 9.       |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure                             |    |      | 45 | 
|Item 9A.      |  | Controls and Procedures                                                                                              |    |      | 45 | 
|             
|PART III     
|Item 10.      |  | Directors and Executive
    Officers of the Registrant                                                               |    |      | 45 | 
|Item 11.      |  | Executive Compensation                                                                                               |    |      | 46 | 
|Item 12.      |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters               |    |      | 46 | 
|Item 13.      |  | Certain Relationships and
    Related Transactions                                                                   |    |      | 46 | 
|Item 14.      |  | Principal Accountant Fees
    and Services                                                                           |    |      | 46 | 
|             
|PART IV      
|Item 15.      |  | Exhibits, Financial
    Statements Schedules, and Reports on Form 8-K                                                |    |      | 46 | 
|Signatures    |  |                                                                                                                      | 50 |     
|EXHIBIT 10.15
|EXHIBIT 21.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 



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PART I

Forward-Looking Information

THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS
RELATED TO FUTURE EVENTS AND OUR FUTURE PERFORMANCE WITHIN THE
MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS
AMENDED, AND SECTION 21E OF THE SECURITIES AND EXCHANGE ACT
OF 1934, AS AMENDED. STOCKHOLDERS ARE CAUTIONED THAT SUCH
STATEMENTS INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS
AND TIMING OF CERTAIN EVENTS COULD DIFFER MATERIALLY FROM THOSE
ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF
CERTAIN FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE SET FORTH
UNDER RISK FACTORS AND ELSEWHERE IN THIS REPORT AND
IN OUR OTHER PUBLIC FILINGS WITH THE SECURITIES AND EXCHANGE
COMMISSION. IT IS ROUTINE FOR INTERNAL PROJECTIONS AND
EXPECTATIONS TO CHANGE AS THE YEAR OR EACH QUARTER IN THE YEAR
PROGRESSES, AND THEREFORE IT SHOULD BE CLEARLY UNDERSTOOD THAT
THE INTERNAL PROJECTIONS AND BELIEFS UPON WHICH WE BASE OUR
EXPECTATIONS MAY CHANGE PRIOR TO THE END OF EACH QUARTER OR THE
YEAR. ALTHOUGH THESE EXPECTATIONS MAY CHANGE, WE MAY NOT INFORM
YOU IF THEY DO. OUR COMPANY POLICY IS GENERALLY TO PROVIDE OUR
EXPECTATIONS ONLY ONCE PER QUARTER, BUT WE MAY CHOOSE NOT TO
UPDATE THAT INFORMATION UNTIL THE NEXT QUARTER EVEN IF
CIRCUMSTANCES CHANGE.






|        |         
|------- | --------
|Item 1. | Business

Overview

Digital Impact, Inc. (Digital Impact
or the Company) was incorporated in California in
October 1997 and reincorporated in Delaware in October 1999.
Digital Impact is a leading provider of integrated digital
marketing solutions for enterprises. Our solutions enable
corporations to create and deliver integrated digital marketing
programs that drive revenue, influence behavior and deepen
customer relationships. Our solutions provide customer insight
and powerful program execution through a combination of hosted
applications, technology infrastructure and world class services.

The IMPACT TM hosted application
(IMPACT) forms the core of our integrated digital
marketing solutions. Leveraging a scalable, hosted technology
infrastructure, the IMPACT application facilitates many aspects
of integrated digital marketing  including data
management, marketing analytics, campaign management and message
delivery. IMPACT is the first integrated digital marketing
application built specifically for enterprise marketing teams to
collaborate across departments, geographies and external
agencies to quickly analyze, design, implement and execute
complex targeted email marketing campaigns.

Enterprise marketers face two major challenges in
their email marketing programs: easily accessing and analyzing
large quantities of cross-channel customer information, often
stored in Customer Relationship Management (CRM) databases, as
well as coordinating the time-sensitive email campaign process
across marketing groups, corporate divisions and outside
agencies. IMPACT solves these problems by providing integrated
marketing and analytics workflow and task management. IMPACT
lets marketers control and accelerate the process of creating
coordinated email marketing campaigns with collaboration among
all stakeholders.

We provide our technology through a flexible
outsourcing model minimizing systems and application support
burden and giving clients a range of full-service and
self-service alternatives. Many of our clients contract for a
combination of professional services and industry-leading
technology, ensuring that we jointly create and implement
marketing campaigns that achieve optimal results.

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Digital Impact is organized into two segments:
Customer Marketing and Professional Services. The respective
revenue and gross profit of each of these segments is detailed
in Note 7 to the Consolidated Financial Statements.



| |                             
| | ----------------------------
| | Customer Marketing Solutions

We provide comprehensive solutions for creating
and executing digital marketing programs. Our solutions are
designed to enable marketers to build the foundation required to
reach new customers and maximize the value of existing
customers. Our solutions consist of the following offerings:



| |       
| | ------
| | IMPACT

IMPACT is a leading hosted online direct
marketing application built specifically to address the complex
needs of global enterprise marketers. IMPACT provides round-trip
integration of sophisticated marketing analytics with
collaborative email campaign management. Marketers can quickly
access and analyze a wide range of cross-channel CRM data,
identify new customer segments, easily create and deliver email
campaigns to those segments, and track and measure the results,
all in one application.

Campaign Services provide clients with an account
team to efficiently execute their online direct marketing
programs. Based upon a clients guidance, Campaign Services
target, test, and execute email marketing campaigns utilizing
the IMPACT hosted application. Clients maintain control and
visibility over the entire process.

Program Services provide clients with an expert
team designed to proactively build and manage their online
direct marketing programs around their email marketing goals.
This team delivers insight, analysis and management to optimize
the value of online customer relationships.



| |                      
| | ---------------------
| | Professional Services

Professional services provide specific solutions
to enhance marketing programs and improve results. Digital
Impact offers services to fulfill clients online direct
marketing needs in each of the following categories: Strategy,
Analysis, Data Management, Solutions Engineering, Web
Development, Creative Design and Customer Acquisition.

Customer Acquisition is a full service marketing
offering that enables clients to cost-effectively reach new
prospects and drive online revenue by converting prospects into
customers. Digital Impact helps clients achieve superior results
by providing access to a rich base of prospect sources,
negotiating competitive rates and optimizing campaigns to reach
the highest value customers. Our Customer Acquisition clients
receive full service program management including strategic
media plan development, comprehensive testing and results
analysis.

Research and Development

We believe that strong product development
capabilities are essential to our strategy of enhancing our core
technology, developing additional applications incorporating
that technology and maintaining the competitiveness of our
product and service solutions. Digital Impact invests
significant time and resources in creating a structured process
for undertaking all product development. This process involves
several functional groups at all levels within our organization
and is designed to provide a framework for defining and
addressing the activities required to bring product concepts and
development projects to market successfully. For the fiscal year
ended March 31, 2004 we spent $5.1 million on research
and development activities.

Sales and Marketing

We sell our products and services in the United
States through a sales, client services and marketing
organization that consisted of 178 employees as of
March 31, 2004. These employees are primarily located at
our headquarters in San Mateo, California and also in our
office in New York. We also maintain a sales and client services
organization of 13 employees in London, England supporting the
European region.

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Clients

Our clients consist of a diverse group of
companies operating in many industries primarily throughout the
United States, ranging from Fortune 500 to smaller corporations.
For the year ended March 31, 2004, two clients,
Hewlett-Packard and Gap Inc. Direct, accounted for 12% and 11%
of our total revenue, respectively.

Competition

The market for online direct marketing services
is highly competitive, evolves rapidly and experiences rapid
technological change. We expect these market conditions to
continue as the use of the Internet for direct marketing expands
and because there are limited barriers to entry into our market.

We believe that the factors on which we
successfully compete include:



| |   |                                                                      
| | - | ---------------------------------------------------------------------
| |  | Quality of online direct marketing services                          
|
| |  | Technology-enhanced service offerings                                
|
| |  | Sophistication and reliability of technology                         
|
| |  | Speed of implementation of online direct
    marketing campaigns     
|
| |  | Cost-effective online direct marketing solutions                     
|
| |  | Measurable results                                                   
|
| |  | Credibility of clients and their willingness to
    act as references

Our principal competitors include providers of
online direct marketing solutions such as DoubleClick,
Responsys, Experian, Silverpop, Bigfoot Interactive and InfoUSA,
as well as the in-house information technology departments of
our existing and prospective clients. In the future, we may
experience competition from Internet service providers,
advertising and direct marketing agencies and other large
established businesses possessing large, existing customer
bases, substantial financial resources and established
distribution channels and could develop, market or resell a
number of online direct marketing solutions. These potential
competitors may also choose to enter, or have already entered,
the market for online direct marketing by acquiring one of our
existing competitors or by forming strategic alliances with a
competitor.

Intellectual Property

We rely upon a combination of patent, copyright,
trade secret and trademark laws to protect our intellectual
property. We currently have one issued U.S. patent and
several U.S. patent applications pending.

In addition, we have several registered
U.S. trademarks and several more trademark applications
pending in the U.S., Europe and Japan. Although we rely on
patent, copyright, trade secret and trademark law to protect our
technology, we believe that factors such as the technological
and creative skills of our personnel, new product developments,
frequent product enhancements and reliable product maintenance
are more essential to establishing and maintaining a technology
leadership position. Others may develop technologies that are
similar or superior to our technology and may receive and
enforce patents on such technology.

Seasonality

The traditional direct marketing industry has
typically generated lower revenue during the summer months and
higher revenue during the calendar year-end months. We believe
our business is affected by similar revenue fluctuations, driven
primarily by our retail clients, but we are unable to isolate
and predict the magnitude of these effects due to service and
client mix variables.

Employees

As of March 31, 2004, we had 278 employees.
Of the total number of employees, 27 were engaged in research
and development, 34 in sales, marketing and business
development, 157 in account management, professional services
and production and 60 in operations, finance, and
administration. None of our employees

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is represented by a labor union. We have not
experienced any work stoppages and consider our relations with
our employees to be good.


Executive Officers

For information related to our executive
officers, please refer to our Proxy Statement.

Website Access to Reports

Our website address is www.digitalimpact.comand our periodic and current reports, and amendments to
those reports, are available free of charge on our website as
soon as reasonably practicable after such material is
electronically filed with, or furnished to, the SEC.

Risk Factors



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our future operating results may vary
    substantially from period to period due to a number of factors,
    many of which are beyond our control. The following discussion
    highlights some of these factors and the possible impact of
    these factors on future results of operations. If any of the
    following factors actually occur, our business, financial
    condition or results of operations could be harmed. In that
    case, the price of our common stock could decline, and investors
    could experience losses on their investment.



| |                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Because of our limited operating history
    and the emerging nature of the online direct marketing industry,
    any predictions about our future revenues and expenses may not
    be as accurate as they would be if we had a longer business
    history, and we cannot determine trends that may affect our
    business.

We were incorporated in October 1997 in
California and reincorporated in Delaware in October 1999. Our
limited operating history makes financial forecasting and
evaluation of our business difficult. Since we have limited
financial data, any predictions about our future revenues and
expenses may not be as accurate as they would be if we had a
longer business history. Because of the emerging nature of the
online direct marketing industry, we cannot determine trends
that may emerge in our market or affect our business. The
revenue and income potential of the online direct marketing
industry, and our business, are unproven.



| |                                                                                                                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our operating results have varied
    significantly in the past and are likely to vary significantly
    from period to period, and our stock price may decline if we
    fail to meet the expectations of analysts and
    investors.

Our operating results have varied significantly
in the past and are likely to vary significantly from period to
period. As a result, our operating results are difficult to
predict and may not meet the expectations of securities analysts
or investors. If this occurs, the price of our common stock
would likely decline.



| |                                                                                                                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We derive our revenue from marketing
    services, which revenues tend to be cyclical and dependent on
    the economic prospects of our clients and the economy in
    general. A sustained reduction in expenditures by our clients or
    a sustained downturn in the economy could cause our revenues to
    decline significantly in any given period.

Our clients marketing and advertising
expenditures tend to be cyclical, reflecting overall economic
conditions as well as budgeting and buying patterns. The overall
market for marketing and advertising services, including
Internet marketing and advertising services, has experienced
lower prices in recent quarters. We also cannot assure you that
if economic conditions improve, marketing budgets and
advertising spending will increase from current levels. A
continued decline in the economic prospects of our clients or
the economy in general could alter pending priorities or
increase the time it takes to close a sale with a prospective
client. As a result, our revenues from marketing services may
decline significantly in any given period.



| |                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may not be able to forecast our revenues
    accurately because our customers marketing budgets are
    difficult to predict and may fluctuate from period to
    period.

Our revenue and operating results depend upon the
marketing budgets of our existing and new customers. These
marketing budgets are difficult to predict and may vary from
period to period as a result of factors that

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are beyond our control, including our
customers marketing objectives for a particular period,
the general state of the economy and our customers success
in the marketplace. Consequently, we face difficulty in
predicting the amount of revenues each client will generate in
any particular quarter. As a result, our operating results are
difficult to predict and may not meet the expectations of
securities analysts or investors. If this occurs, the price of
our common stock would likely decline.




| |                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------
| | Seasonal trends may cause our quarterly
    operating results to fluctuate, which may adversely affect the
    market price of our common stock.

The traditional direct marketing industry has
typically generated lower revenues during the summer months and
higher revenues during the calendar year-end months. We believe
our business is affected by similar revenue fluctuations, but
our limited operating history is insufficient to isolate and
predict the magnitude of these effects. Because we do experience
these effects, analysts and investors may not be able to predict
our quarterly or annual operating results. If we fail to meet
expectations of analysts and investors, our stock price could
decline.



| |                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If businesses and consumers fail to accept
    online direct marketing as a means to attract new customers,
    demand for our services may not develop and the price of our
    stock could decline.

The market for online direct marketing services
is relatively new and rapidly evolving, and our business may be
harmed if sufficient demand for our services does not develop.
Our current and planned services are very different from the
traditional methods that many of our clients have historically
used to attract new customers and maintain customer
relationships.



| |                                                                             
| | ----------------------------------------------------------------------------
| | The loss of a major client could result in
    lower than expected revenues.

The loss of a major client could harm our
business. While only two clients each accounted for more than
10% of our revenues for the fiscal year 2004, the loss of one of
these clients or another major client could have a material
adverse effect on our business and results of operations.



| |                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The online direct marketing industry is
    highly competitive, and if we are unable to compete effectively,
    the demand for, or the prices of, our services may
    decline.

The market for online direct marketing is highly
competitive, rapidly evolving and experiencing rapid
technological change. Intense competition may result in price
reductions, reduced sales, gross margins and operating margins,
and loss of market share. Our principal competitors include
providers of online direct marketing solutions such as
DoubleClick, Responsys, Experian, Silverpop, Bigfoot Interactive
and InfoUSA, as well as the in-house information technology
departments of our existing and prospective clients. The loss of
a client due to service quality or technology problems could
result in reputational harm to us and, as a result, increase the
effect of competition and negatively impact our ability to
attract new clients.

In addition, we expect competition to persist and
intensify in the future, which could harm our ability to
increase sales and maintain our prices. In the future, we may
experience competition from Internet service providers,
advertising and direct marketing agencies and other large
established businesses possessing large, existing customer
bases, substantial financial resources and established
distribution channels and could develop, market or resell a
number of online direct marketing solutions. These potential
competitors may also choose to enter, or have already entered,
the market for online direct marketing by acquiring one of our
existing competitors or by forming strategic alliances with a
competitor.

Many of these potential competitors have broad
distribution channels and they may bundle competing products or
services. As a result of future competition, the demand for our
services could substantially decline. Any of these occurrences
could harm our ability to compete effectively.

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| |                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to respond to changing customer
    preferences in our market, demand for our technology and
    services may decline, causing our revenues to
    suffer.

If we do not continue to develop new technology
and services that keep pace with competitive developments,
satisfy diverse and rapidly evolving customer requirements and
achieve market acceptance, we might be unable to attract new
customers and retain existing customers. The development of
proprietary technology and service enhancements and the
migration of customers to this new technology entail significant
technical and business risks and requires substantial
expenditures and lead-time. We might not be successful in
marketing and supporting recently released versions of our
technology and services on a timely or cost-effective basis. In
addition, even if new technology and services are developed and
released, they might not achieve market acceptance. We have
experienced delays in releasing new or enhanced technology and
services in the past and could experience similar delays in the
future, which could cause us to lose customers. Also, if we are
not successful in a smooth migration of our customers to our new
or enhanced technology and services, we could lose customers.



| |                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------
| | If we do not attract and retain additional
    highly skilled personnel, we may be unable to execute our
    business strategy.

Our business depends on the continued
technological innovation of our core products and services and
our ability to provide comprehensive online direct marketing
expertise. Our main offices are located in the
San Francisco Bay Area and New York City, where
competition for personnel with Internet-related technology and
marketing skills has traditionally been intense. In addition, we
restructure our organization from time to time, including
reductions in our workforce, to streamline operations and reduce
costs. These measures may have unanticipated consequences, such
as low morale, unexpected litigation and difficulty in future
employee hiring and retention. If we fail to identify, attract,
retain and motivate these highly skilled personnel, we may be
unable to successfully introduce new services or otherwise
implement our business strategy.



| |                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If the delivery of our email messages is
    limited or blocked, then the amount we may be able to charge our
    clients for producing and sending their campaigns may be reduced
    and our clients may discontinue their use of our
    services.

Our business model relies on our ability to
deliver emails over the Internet through Internet service
providers and to recipients in major corporations. In
particular, a significant percentage of our emails are sent to
recipients who use AOL. We do not have, nor are we required to
have, an agreement with AOL to deliver emails to their
customers. AOL uses a proprietary set of technologies to handle
and deliver email and the value of our services will be reduced
if we are unable to provide emails compatible with these
technologies.

In addition, AOL and other Internet service
providers are able to block messages from reaching their users.
Recent releases of Internet service provider software and the
implementation of stringent new policies by Internet service
providers have caused periodic temporary blockages of our
ability to successfully deliver emails to their customers. We
continually improve our own technology and work with Internet
service providers to improve our ability to successfully deliver
our emails. However, if Internet service providers materially
limit or halt the delivery of our emails, or if we fail to
deliver emails in such a way as to be compatible with these
companies email handling technologies, then the amount we
may be able to charge our clients for producing and sending
their online direct marketing campaigns may be reduced and our
clients may discontinue their use of our services. In addition,
the effectiveness of email marketing may decrease as a result of
increased consumer resistance to email marketing in general.



| |                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our facilities and systems are vulnerable
    to natural disasters and other unexpected events, and any of
    these events could result in an interruption of our ability to
    execute our clients online direct marketing
    campaigns.

We depend on the efficient and uninterrupted
operations of our data center and hardware systems. Our data
center and hardware systems are located in northern California,
an area susceptible to earthquakes. Our data center and hardware
systems are also vulnerable to damage from fire, floods, power
loss, telecommunica-

6



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tions failures, and similar events. If any of
these events results in damage to our data center or systems, we
may be unable to execute our clients online direct
marketing campaigns until the damage is repaired, and may
accordingly lose clients and revenues. In addition, subject to
applicable insurance coverage, we may incur substantial costs in
repairing any damage.




| |                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our data center is located at facilities
    provided by a third party, and if this party is unable to
    adequately protect our data center, our reputation may be harmed
    and we may lose clients.

Our data center, which is critical to our ongoing
operations, is located at facilities provided by a third party.
Our operations depend on this partys ability to protect
our data center from damage or interruption from human error,
break-ins, sabotage, computer viruses, intentional acts of
vandalism and similar events. If this party is unable to
adequately protect our data center and information is lost or
our ability to deliver our services is interrupted, our
reputation may be harmed and we may lose clients.



| |                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we are unable to protect our
    intellectual property or if third parties develop superior
    intellectual property, third parties could use our intellectual
    property without our consent and prevent us from using their
    technology.

Our ability to successfully compete is
substantially dependent upon our internally developed technology
and intellectual property, which we protect through a
combination of patent, copyright, trade secret and trademark
law, as well as contractual obligations. We have one issued
U.S. patent and have three U.S. patent applications
pending. We have several registered trademarks in the U.S. and
Japan and have several more applications pending in the U.S.,
Europe and Japan. We may not be able to protect our proprietary
rights. Unauthorized parties may attempt to obtain and use our
proprietary information. Policing unauthorized use of our
proprietary information is difficult, and we cannot be certain
that the steps we have taken will prevent misappropriation,
particularly in foreign countries where the laws may not protect
our proprietary rights as fully as in the United States.

We are one of several companies rapidly building
new technologies in our industry. It is possible that a third
party could be awarded a patent that applies to some portion of
our technology. If this occurs, we may be required to incur
substantial legal fees, cease using the technology or pay
significant licensing fees for such use.



| |                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we are unable to safeguard the
    confidential information in our data warehouse, our reputation
    may be harmed and we may be exposed to liability.

We currently store confidential customer
information in a secure data warehouse. We cannot be certain,
however, that we will be able to prevent unauthorized
individuals from gaining access to this data warehouse. If any
compromise or breach of security were to occur, it could harm
our reputation and expose us to possible liability. Any
unauthorized access to our servers could result in the
misappropriation of confidential customer information or cause
interruptions in our services. It is also possible that one of
our employees could attempt to misuse confidential customer
information, exposing us to liability. In addition, our
reputation may be harmed if we lose customer information
maintained in our data warehouse due to systems interruptions or
other reasons.



| |                                                                                                       
| | ------------------------------------------------------------------------------------------------------
| | Activities of our clients could damage our
    reputation or give rise to legal claims against
    us.

Our clients promotion of their products and
services may not comply with federal, state and local laws. We
cannot predict whether our role in facilitating these marketing
activities would expose us to liability under these laws. Any
claims made against us could be costly and time-consuming to
defend. If we are exposed to this kind of liability, we could be
required to pay fines or penalties, redesign our business
methods, discontinue some of our services or otherwise expend
resources to avoid liability.

Our services involve the transmission of
information through the Internet. Our services could be used to
transmit harmful applications, negative messages, unauthorized
reproduction of copyrighted material, inaccurate data or
computer viruses to end-users in the course of delivery. Any
transmission of this kind could damage our reputation or could
give rise to legal claims against us. We could spend a
significant amount of time and money defending against these
legal claims.

7



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##### Table of Contents





| |                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | New regulation of, and uncertainties
    regarding the application of existing laws and regulations to,
    online direct marketing and the Internet could prohibit, limit
    or increase the cost of our business.

Congress recently enacted the CAN-SPAM Act of
2003, legislation that regulates the sending of commercial
email. This legislation pre-empts state laws regulating
commercial email. The effect of this legislation on marketers is
difficult to predict. We cannot assure you that this or future
legislation regarding commercial email will not harm our
business. Moreover, list rental and other types of affiliate
marketing programs must be modified to comply with certain
aspects of CAN-SPAM. Some of these modifications may add to the
cost of conducting these types of programs. As a result, there
may be a decline in our Customer Acquisition revenues.

Our business could be negatively impacted by new
laws or regulations applicable to online direct marketing or the
Internet, the application of existing laws and regulations to
online direct marketing or the Internet or the application of
new laws and regulations to our business as we expand into new
jurisdictions. There is a growing body of laws and regulations
applicable to access to, or commerce on, the Internet. Moreover,
the applicability to the Internet of existing laws is uncertain
and may take years to resolve. Due to the increasing popularity
and use of the Internet, it is likely that additional laws and
regulations will be adopted covering issues such as privacy,
pricing, content, copyrights, distribution, taxation, antitrust,
characteristics and quality of services and consumer protection.
The adoption of any additional laws or regulations may impair
the growth of the Internet or online direct marketing, which
could, in turn, decrease the demand for our services and
prohibit, limit or increase the cost of our doing business.



| |                                                                                                               
| | --------------------------------------------------------------------------------------------------------------
| | Internet-related stock prices are
    especially volatile and this volatility may depress our stock
    price.

The stock market and specifically the stock
prices of Internet-related companies have been very volatile.
Because we are an Internet-related company, we expect our stock
price to be similarly volatile. As a result of this volatility,
the market price of our common stock could significantly
decrease. This volatility is often not related to our operating
performance and may accordingly reduce the price of our common
stock without regard to our operating performance.



| |                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------
| | If our internal controls are inadequate,
    there is a greater risk of misstatements in our financial
    reports, fraud or incomplete disclosures.

In connection with section 404 of
Sarbanes-Oxley Act of 2002, the Companys auditors will
provide an attestation on the effectiveness of internal controls
over financial reporting in either March 2005 or March 2006. The
company has never undergone testing under the new standards. If
the auditors are not able to attest to the adequacy of controls,
this would indicate that there is not high assurance that the
companys controls would prevent mistatements in our
financial reports, fraud or incomplete disclosures.






|        |           
|------- | ----------
|Item 2. | Properties

Our principal executive offices are located in
San Mateo, California, where we lease approximately
36,000 square feet under three leases that expire in dates
ranging from 2005 to 2007. Digital Impact also leases office
space in New York City and London for local sales and client
service personnel, and Santa Monica, California for research and
development staff. The Santa Monica office will be closed in
June 2004 as part of our restructuring initiated in February
2004.

A summary of our significant leased office and
data center facilities is as follows:

|                                     |  |                       |        |               |  |            
|------------------------------------ |  | --------------------- | ------ | ------------- |  | -----------
|                                     |  | Approximate Number of |        | Expiration of
|Location                             |  | Square Feet Leased(1) |        | Lease        
|                                     |  |                       |        |              
|San Mateo, California (headquarters) |  |                       | 36,000 |               |  | March 2007 
|New York, New York                   |  |                       | 12,000 |               |  | August 2007
|Santa Monica, California             |  |                       | 7,000  |               |  | June 2004  
|London, England                      |  |                       | 1,200  |               |  | April 2005 

8



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---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | We currently occupy approximately
    36,000 square feet of our San Mateo facility,
    approximately 9,000 square feet of our New York facility,
    4,200 square feet of our Santa Monica facility and
    1,200 square feet of our London facility. As of
    March 31, 2004 the remaining obligations under the
    San Mateo and New York leases are approximately
    $5 million and $2 million, respectively.

Our datacenter is primarily located at facilities
operated by Globix Corporation in Northern California. Our
agreement with Globix expires in September 2004. As of
March 31, 2004, the remaining obligation under the Globix
lease is approximately $447,000.

We are continually evaluating our facilities
requirements. Periodically, we evaluate the expenses likely to
be incurred for our facilities, and where appropriate, have
exited facilities and taken restructuring charges with respect
to these expenses. We cannot assure you that there will not be
additional restructuring charges recognized with respect to our
excess or idle facilities.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

In June 2001, a series of putative securities
class actions were filed in United States District Court for the
Southern District of New York against certain investment bank
underwriters for the Companys initial public offering
(IPO), the Company, and various of the
Companys officers and directors. The complaints, which
have been consolidated under the caption In re Digital Impact,
Inc. Initial Public Offering Securities Litigation, Civil Action
No. 01-CV-4942, allege undisclosed and improper practices
concerning the allocation of the Companys IPO shares, in
violation of the federal securities laws, and seek unspecified
damages on behalf of persons who purchased the Companys
stock during the period from November 22, 1999 to
December 6, 2000. The Court has appointed a lead plaintiff
for the consolidated cases. On April 19, 2002, plaintiffs
filed an amended complaint. Other actions have been filed making
similar allegations regarding the IPOs of more than 300 other
companies. All of these lawsuits have been coordinated for
pretrial purposes as In re Initial Public Offering Securities
Litigation, Civil Action No. 21-MC-92. Defendants in these
cases filed omnibus motions to dismiss on common pleading
issues. Oral argument on these omnibus motions to dismiss was
held on November 1, 2002. The Companys officers and
directors have been dismissed without prejudice in this
litigation. On February 19, 2003, the court granted in part
and denied in part the omnibus motion to dismiss. The
courts order did not dismiss any claims against the
Company.

A proposal has been made for the settlement and
release of claims against the issuer defendants, including the
Company, in exchange for a guaranteed recovery to be paid by the
issuer defendants insurance carriers and an assignment of
certain claims. The settlement is subject to a number of
conditions, including approval of the proposed settling parties
and the court. If the settlement does not occur, and litigation
against the Company continues, the Company believes it has
meritorious defenses and intends to defend the case vigorously.

On February 23, 2004, the Company filed a
patent infringement lawsuit against Responsys, Inc., a
competitor of the Company. The lawsuit, captioned Digital
Impact, Inc. v. Responsys, Inc., N. D. Cal., Case
No. C04 00734 (SBA), alleges that Responsys has infringed
and is continuing to infringe the Companys
U.S. Patent No. 6,449,634. The complaint seeks
injunctive relief and unspecified damages. Responsys filed an
answer and counterclaim on March 15, 2004. The counterclaim
seeks a declaration that the patent is invalid or, in the
alternative, that Responsyss technology does not infringe
the patent. The Company replied to the counterclaim on
April 7, 2004, denying all material allegations. Responsys
then filed a motion for judgment on the pleadings, which was
denied on June 4, 2004.






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

No matters were submitted to a vote of our
stockholders during the fourth quarter of the fiscal year ended
March 31, 2004.

9



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##### Table of Contents






PART II






|        |                                                                                                                          
|------- | -------------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for the Registrants Common
    Equity, Related Stockholder Matters and Issuer Purchases of
    Equity Securities.



| |                   
| | ------------------
| | Market Information

Our common stock has been quoted on the Nasdaq
National Market under the symbol DIGI since our initial public
offering on November 23, 1999. The following table sets
forth, for the periods indicated, the high and low bid
quotations for our common stock as quoted on the Nasdaq National
Market.

|                  |                                        |      |  |      |  |  |  |      | 
|----------------- | -------------------------------------- | ---- |  | ---- |  |  |  | ---- | 
|                  |                                        | High |  | Low 
|                  |                                        |      |  |     
|Fiscal Year 2003: |                                        |      |  |      |  |  |  |     
|                  | First quarter (from 4/01/02  6/30/02) |      |  | 3.25 |  |  |  | 1.53 | 
|                  | Second quarter                         |      |  | 1.90 |  |  |  | 1.25 | 
|                  | Third quarter                          |      |  | 2.03 |  |  |  | 1.23 | 
|                  | Fourth quarter                         |      |  | 2.01 |  |  |  | 1.26 | 
|Fiscal Year 2004: |                                        |      |  |      |  |  |  |     
|                  | First quarter (from 4/01/03  6/30/03) |      |  | 2.56 |  |  |  | 1.25 | 
|                  | Second quarter                         |      |  | 3.50 |  |  |  | 1.80 | 
|                  | Third Quarter                          |      |  | 3.22 |  |  |  | 2.18 | 
|                  | Fourth Quarter                         |      |  | 3.35 |  |  |  | 2.09 | 

On March 31, 2004, the last sale price of
our common stock reported by the Nasdaq National Market was
$2.64 per share. On June 8, 2004 the last sale price
of our common stock reported by the Nasdaq National Market was
$1.70 per share. As of June 8, 2004, the approximate number
of common stockholders was 4,605.

Digital Impact has never declared or paid any
cash dividends on its capital stock. Digital Impact currently
intends to retain its future earnings, if any, to fund the
development and growth of its business and, therefore, does not
anticipate paying any cash dividends in the foreseeable future.






|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The selected consolidated financial data set
forth below with respect to Digital Impacts Consolidated
Statement of Operations for each of the years ended
March 31, 2004, 2003 and 2002 and with respect to Digital
Impacts Consolidated Balance Sheets as of March 31,
2004 and 2003 have been derived from the audited financial
statements which are included elsewhere herein. The selected
consolidated data set forth with respect to Digital
Impacts Consolidated Statement of Operations for each of
the periods ended March 31, 2001 and 2000 and with respect
to Digital Impacts Consolidated Balance Sheet as of
March 31, 2002, 2001, and 2000 are derived from the audited
financial statements of Digital Impact which are not included
herein. The selected financial data set forth below is qualified
in its entirety by, and should be read in conjunction with,
Managements Discussion and Analysis of Financial
Condition and Results of Operations and the Consolidated
Financial Statements and the notes to those statements included
elsewhere herein.

|                                                                            |  |                             |        |      |  |      |        |      |  |      |         |      |  |   |         |      |  |   |         |  
|--------------------------------------------------------------------------- |  | --------------------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------- | ---- |  | - | ------- | ---- |  | - | ------- | -
|                                                                            |  |                            
|                                                                            |  | Fiscal year ended March 31,
|                                                                            |  |                            
|                                                                            |  | 2004                        |        | 2003 |  | 2002 |        | 2001 |  | 2000
|                                                                            |  |                             |        |      |  |      |        |      |  |     
|Statement of Operations Data                                                |  |                             |        |      |  |      |        |      |  |      |         |      |  |   |         |      |  |   |         |  
|Revenues                                                                    |  | $                           | 43,712 |      |  | $    | 44,010 |      |  | $    | 39,038  |      |  | $ | 40,153  |      |  | $ | 12,991  |  
|Gross profit                                                                |  |                             | 24,186 |      |  |      | 25,751 |      |  |      | 20,494  |      |  |   | 22,317  |      |  |   | 6,813   |  
|Loss from operations                                                        |  |                             | (507   | )    |  |      | (3,767 | )    |  |      | (19,975 | )    |  |   | (59,763 | )    |  |   | (23,130 | )
|Net loss                                                                    |  |                             | (580   | )(1) |  |      | (3,974 | )(2) |  |      | (19,678 | )(3) |  |   | (56,731 | )(4) |  |   | (21,653 | )
|Net loss per common share  basic and
    diluted                           |  | $                           | (0.02  | )    |  | $    | (0.13  | )    |  | $    | (0.70   | )    |  | $ | (2.33   | )    |  | $ | (2.28   | )
|Weighted average shares used in basic and diluted
    per share calculation |  |                             | 32,950 |      |  |      | 30,290 |      |  |      | 27,960  |      |  |   | 24,350  |      |  |   | 9,510   |  

10



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##### Table of Contents



|                                                  |  |           |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|------------------------------------------------- |  | --------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------ | 
|                                                  |  |          
|                                                  |  | March 31,
|                                                  |  |          
|                                                  |  | 2004      |        | 2003 |  | 2002 |        | 2001 |  | 2000
|                                                  |  |           |        |      |  |      |        |      |  |     
|Balance Sheet Data                                |  |           |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|Cash, cash equivalents and short-term investments |  | $         | 26,158 |      |  | $    | 23,767 |      |  | $    | 25,588 |  |  | $ | 35,038 |  |  | $ | 68,073 | 
|Total assets                                      |  |           | 45,361 |      |  |      | 46,017 |      |  |      | 49,633 |  |  |   | 69,019 |  |  |   | 81,102 | 
|Long-term debt and capital lease obligations      |  |           | 80     |      |  |      |       |      |  |      | 1,324  |  |  |   | 2,653  |  |  |   | 726    | 
|Stockholders equity                              |  |           | 39,016 |      |  |      | 36,455 |      |  |      | 38,889 |  |  |   | 55,555 |  |  |   | 73,530 | 



---



|    |                                                                                                                                                                                        
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The 2004 net loss includes restructuring
    charges and write-off of fixed assets of $326,000.                                                                                        
|   
|(2) | The 2003 net loss includes restructuring
    charges and write-off of fixed assets of $546,000.                                                                                        
|   
|(3) | The 2002 net loss includes a restructuring
    charge of $1.2 million and write-off of fixed assets of
    $600,000.                                                                   
|   
|(4) | The 2001 net loss includes a goodwill
    impairment charge of $19.0 million and the write-off of
    acquired in-process research and development and fixed assets of
    $4.6 million

QUARTERLY RESULTS OF OPERATIONS

The following table sets forth certain unaudited
consolidated quarterly statement of operations data for the
eight quarters ended March 31, 2004. This information is
unaudited, but in the opinion of management, it has been
prepared on substantially the same basis as the audited
Consolidated Financial Statements appearing elsewhere in this
report, and all necessary adjustments, consisting only of normal
recurring adjustments, have been included in the amounts stated
below to present fairly the unaudited consolidated quarterly
results of operation. The consolidated quarterly data should be
read in conjunction with our audited Consolidated Financial
Statements and the notes to such statements appearing elsewhere
in this report. The results of operations for any quarter are
not necessarily indicative of the results of operations for any
future period.

|                     |              |                                       |   |        |  |             |   |            |  |                  |   |                  |   |           |   |             |   |  |  |        |  |  |  |        |  |  |   |       |   |  |   |       |  
|-------------------- | ------------ | ------------------------------------- | - | ------ |  | ----------- | - | ---------- |  | ---------------- | - | ---------------- | - | --------- | - | ----------- | - |  |  | ------ |  |  |  | ------ |  |  | - | ----- | - |  | - | ----- | -
|                     |              |                                       |   |        |  |             |   |            |  |                  |   |                  |   | Basic Net |   | Diluted Net
|                     |              |                                       |   |        |  | Income      |   |            |  | Weighted Average |   | Weighted Average |   | Loss per  |   | Loss per   
|                     |              |                                       |   | Gross  |  | (Loss) From |   | Net Income |  | Common Shares    |   | Common Shares    |   | Common    |   | Common     
|Fiscal Quarter Ended |              | Revenues                              |   | Profit |  | Operations  |   | (Loss)     |  | Basic            |   | Diluted          |   | Share     |   | Share      
|                     |              |                                       |   |        |  |             |   |            |  |                  |   |                  |   |           |   |            
|                     |              |                                      
|                     |              | (In thousands, except per share data)
|2004                 |              |                                       |   |        |  |             |   |            |  |                  |   |                  |   |           |   |             |   |  |  |        |  |  |  |        |  |  |   |       |   |  |   |      
|                     | June 30      |                                       | $ | 10,928 |  |             | $ | 6,146      |  |                  | $ | (239             | ) |           | $ | (293        | ) |  |  | 31,670 |  |  |  | 31,670 |  |  | $ | (0.01 | ) |  | $ | (0.01 | )
|                     | September 30 |                                       |   | 10,924 |  |             |   | 6,183      |  |                  |   | 174              |   |           |   | 108         |   |  |  | 32,780 |  |  |  | 35,662 |  |  |   | 0.00  |   |  |   | 0.00  |  
|                     | December 31  |                                       |   | 11,509 |  |             |   | 6,588      |  |                  |   | 436              |   |           |   | 489         |   |  |  | 33,490 |  |  |  | 36,022 |  |  |   | 0.01  |   |  |   | 0.01  |  
|                     | March 31     |                                       |   | 10,351 |  |             |   | 5,269      |  |                  |   | (878             | ) |           |   | (884        | ) |  |  | 33,870 |  |  |  | 33,870 |  |  |   | (0.03 | ) |  |   | (0.03 | )
|2003                 |              |                                       |   |        |  |             |   |            |  |                  |   |                  |   |           |   |             |   |  |  |        |  |  |  |        |  |  |   |       |   |  |   |      
|                     | June 30      |                                       | $ | 10,518 |  |             | $ | 6,165      |  |                  | $ | (1,139           | ) |           | $ | (1,193      | ) |  |  | 29,640 |  |  |  | 29,640 |  |  | $ | (0.04 | ) |  | $ | (0.04 | )
|                     | September 30 |                                       |   | 11,128 |  |             |   | 6,626      |  |                  |   | (1,145           | ) |           |   | (1,163      | ) |  |  | 29,990 |  |  |  | 29,990 |  |  |   | (0.04 | ) |  |   | (0.04 | )
|                     | December 31  |                                       |   | 11,490 |  |             |   | 6,954      |  |                  |   | (254             | ) |           |   | (297        | ) |  |  | 30,510 |  |  |  | 30,510 |  |  |   | (0.01 | ) |  |   | (0.01 | )
|                     | March 31     |                                       |   | 10,874 |  |             |   | 6,006      |  |                  |   | (1,229           | ) |           |   | (1,321      | ) |  |  | 31,010 |  |  |  | 31,010 |  |  |   | (0.04 | ) |  |   | (0.04 | )

In the fourth quarter of fiscal 2004, Digital
Impact recorded restructuring charges and write-off of fixed
assets totaling $249,000. The charge was primarily related to
closure of our Santa Monica office and severance payments
related to the involuntary termination of 19 employees. (See
Note 6 to the Consolidated Financial Statements.) The
write-off of fixed assets for the first three fiscal quarters of
2004 totaled $77,000.

In the fourth quarter of fiscal 2003, Digital
Impact recorded restructuring charges and write-off of fixed
assets totaling $546,000. The charge was primarily related to
closure of our Cupertino facility and severance payments related
to the involuntary termination of 18 employees. (See Note 6
to the Consolidated Financial Statements.)

11



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##### Table of Contents



The amount and timing of our operating expenses
will vary from quarter to quarter depending on our level of
actual and anticipated business activity. Our revenues and
operating results are difficult to forecast and will fluctuate,
and we believe you should not rely on them as an indication of
future performance.






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion contains
forward-looking statements that involve risks and uncertainties.
Our actual results could differ materially from those discussed
below. Additional factors that could cause or contribute to such
differences include, but are not limited to, those identified
below, and those discussed in the section entitled Risk
Factors, included elsewhere in this Annual Report. When
used in this document, the words believes,
expects, anticipates,
intends, plans and similar expressions,
are intended to identify certain of these forward-looking
statements. However, these words are not the exclusive means of
identifying such statements. In addition, any statements that
refer to expectations, projections or other characterizations of
future events or circumstances are forward-looking statements.
The cautionary statements made in this document should be read
as being applicable to all related forward-looking statements
wherever they appear in this document. You should read the
following discussion in conjunction with our Consolidated
Financial Statements and related notes.

Overview

Digital Impact is a leading provider of
integrated digital marketing solutions for Global 2000
enterprises. We draw on our industry specific expertise, our
comprehensive methodology for creating programs to address
specific marketing objectives and our proprietary technology
platform to deliver marketing campaigns through email as well as
website, search and other media. We derive revenues and cash
flows primarily from two business segments: Customer Marketing
and Professional Services (also known as Agency Services).

The Customer Marketing segment derives revenue
from the IMPACT email software platform sold as a
subscription-based hosted service, account management services
such as email campaign targeting, testing, delivery and
reporting and program management teams which provide expertise
in the design, management, analysis and optimization of
marketing campaigns.

The Professional Services segment derives revenue
from project-based and retainer-based fees for marketing
strategy, advanced analytics, data management, creative webpage
design, customer acquisition and search engine marketing
services.

Personnel expenses and data center equipment,
software and hosting expenses comprise the major components of
our costs of revenues.

Members of our senior management regularly review
key financial information including net revenues by segment,
operating expenses and margins, net income, earnings per share,
and cash flow. They also review key operating metrics such as
email delivery volume, service mix and major account trends.
This information allows us to monitor the growth and
profitability of our business and evaluate the effectiveness of
investments that we have made and continue to make in the areas
of client services, product development, marketing and data
center operations.

During the fiscal year ended March 31, 2004,
total revenues declined by 1% from the prior fiscal year as
price erosion offset a 25% increase in email volume. Our net
loss improved to $580,000 in fiscal 2004 from a loss of
$4.0 million in fiscal 2003 primarily as a result of cost
reductions from restructuring actions in fiscal 2003. We expect
modest growth in net revenues during fiscal 2005, primarily in
the second half of the year. Our operating margin is
substantially dependent upon the second half growth as we expect
to make investments in professional services, product
development and our infrastructure to help us achieve our
long-term growth and profitability objectives.

Critical Accounting Policies and
Estimates

Digital Impacts consolidated financial
statements have been prepared in accordance with accounting
principles generally accepted in the United States. The
preparation of these financial statements requires

12



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##### Table of Contents



management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. On an on-going
basis, management evaluates its estimates, including those
related to the revenue recognition, accounting for internal-use
software, allowance for doubtful accounts, valuation of
long-lived assets and goodwill, and accounting for stock-based
compensation. Management bases its estimates on historical
experience and various factors that are believed to be
reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under
different assumptions or conditions.


Management believes that the following critical
accounting policies, among others, affect its more significant
judgments and estimates used in the preparation of its
consolidated financial statements:



| |   |                                                                                       
| | - | --------------------------------------------------------------------------------------
| |  | revenue recognition;                                                                  
|
| |  | estimating valuation allowances, specifically the
    allowance for doubtful accounts;
|
| |  | accounting for internal-use software;                                                 
|
| |  | valuation of long-lived assets and
    goodwill; and                                  
|
| |  | accounting for stock-based compensation.                                              

Revenue recognition.We generate revenue from the sale of solutions that enable
businesses to proactively communicate with their customers
online.

Digital Impact applies the provisions of Staff
Accounting Bulletin 104 Revenue Recognition and
recognizes revenue when persuasive evidence of an arrangement
exists, the service has been delivered, the fee is fixed or
determinable and collection of the resulting receivables is
reasonably assured. Customer Marketing revenues are recognized
upon sending of the campaigns. Revenues attributable to one-time
set-up fees for service initiation are deferred and recognized
ratably over the term of the clients service agreement,
typically twelve months. Customer Acquisition revenues are
derived primarily from programs that assist clients in growing
their email lists through the use of third-party providers.
Customer Acquisition programs fall into three general
categories: List Rental programs, ProspectNet programs, and
search engine marketing. List Rental programs involve the
execution and delivery of email campaigns to a defined number of
individuals provided by a third-party list rental or email
address matching service. ProspectNet programs involve the
strategic placement of a Digital Impact client offer on a
third-party site for the purpose of generating new opt-in email
addresses for the client. Search engine marketing involves
assisting clients in the use of search engines to acquire
customers. Digital Impact contracts with third-party providers
to deliver names of individuals who opt-in to join the
clients email list or, in the use of search, to deliver
specific content in response to user search queries. Digital
Impact is obligated to make payments to third-parties for the
cost of services associated with the execution of List Rental,
ProspectNet and search engine marketing programs. Digital Impact
accounts for revenues and costs associated with Customer
Acquisition programs in accordance with Emerging Issues Task
Force Issue No. 99-19 (EITF 99-19), Reporting Revenue
Gross as a Principal versus Net as an Agent. The costs of
Customer Acquisition campaigns are estimated using work order
commitments when final vendor invoices have not been received.
The costs of Customer Acquisition campaigns are recognized in
the period that the programs are executed and are netted against
program revenue.

Digital Impact recognizes revenue net of
third-party costs because the majority of client and supplier
contracts have the following characteristics: the supplier, not
the Company, is the primary obligor in the arrangement, the
Company has limited latitude in establishing the price charged
to the client, the Companys credit risk is sometimes
mitigated by receiving prepayment or reduced credit terms from
its clients before ordering from the supplier, the Company does
not maintain any inventory related to Customer Acquisition
programs, the Company does not make changes to any data acquired
from the supplier, and the client approves the supplier
selection and the service specifications.

Digital Impact provides other complementary
services to clients, such as strategy, solutions engineering,
web-page development, creative design and data analytics. These
services are typically billed on an hourly rate

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or as a fixed project price. The revenue for
engagements that support the delivery of future products and
services, such as custom solutions, is deferred at the time of
delivery and recognized pro-rata over the future periods of
usage. The period over which the revenue is recognized varies,
generally between one and twelve months, depending on the term
of the contract or the estimated period of usage. Management
uses its best estimates to determine the appropriate period for
revenue deferral.


We assess probability of collection based on a
number of factors, including our past transaction history with
the customer and the credit-worthiness of the customer. New
customers and certain existing customers are subject to a credit
review process that evaluates the customers financial
position and ultimately their ability to pay according to the
original terms of the arrangement. Based on our review process,
if it is determined from the outset or during the term of an
arrangement that collection of the resulting receivable is not
reasonably assured, then revenue is recognized on a
cash-collected basis.

Allowance for doubtful
accounts.The preparation of financial
statements requires our management to make estimates and
assumptions that affect the reported amount of assets and
disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and
expenses during the reported period. Specifically, management
must make estimates of the uncollectable portion of our accounts
receivable. Management specifically analyzes accounts receivable
and analyzes historical bad debt experience, customer account
disputes, customer credit worthiness, current economic trends
and changes in our customer payment terms when evaluating the
adequacy of the allowance for doubtful accounts. Our accounts
receivable balance was $8.2 million, net of allowance for
doubtful accounts of $263,000, as of March 31, 2004.

Accounting for internal-use
software.We account for internal-use
software in accordance with AICPA Statement of Position 98-1,
Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use. Internal-use software
costs, including any fees paid to third parties to implement the
software, are capitalized beginning when we have determined
various factors are present, including among others, that the
technology exists to achieve the performance requirements, we
have made a decision as to whether we will purchase the software
or develop it internally and we have authorized funding for the
project. Capitalization of software costs ceases when the
software implementation is substantially complete and is ready
for its intended use, and the capitalized costs are amortized
over the softwares estimated useful life (generally two
years) using the straight-line method. The estimated useful life
is based on technical and marketing management judgment as to
the product or feature life cycle. During the fiscal year 2004,
we capitalized $311,000 related to internal-use software costs,
none of which has been subject to amortization based upon
deployment dates of the related products.

When events or circumstances indicate the
carrying value of internal use software might not be
recoverable, we assess the recoverability of these assets by
determining whether the amortization of the asset balance over
its remaining life can be recovered through undiscounted future
operating cash flows. The amount of impairment, if any, is
recognized to the extent that the carrying value exceeds the
projected discounted future operating cash flows and is
recognized as a write down of the asset. In addition, if it is
no longer probable that computer software being developed will
be placed in service, the asset will be adjusted to the lower of
its carrying value or fair value, if any, less direct selling
costs. Any such adjustment would result in an expense in the
period recorded, which could have a material adverse effect on
our Consolidated Statement of Operations. As of March 31,
2004, we believe that no such impairment of internal-use
software existed.

Valuation of long-lived assets and
goodwill.We assess the impairment of
identified intangibles, long-lived assets and goodwill annually
and whenever events or a change in circumstances indicate the
carrying value may not be recoverable. Factors we consider
important which could trigger an impairment review include the
following:



| |   |                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------
| |  | significant underperformance relative to expected
    historical or projected future operating results;          
|
| |  | significant changes in the manner of our use of
    the acquired assets or the strategy for our overall business;
|
| |  | significant negative industry or economic trends;                                                                

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| |   |                                                                               
| | - | ------------------------------------------------------------------------------
| |  | significant decline in our stock price for a
    sustained period of time; and
|
| |  | our market capitalization relative to net book
    value.                     

When we determine that the carrying value of
intangible assets, long-lived assets or goodwill may not be
recoverable based upon the existence of one or more of the above
indicators of impairment, we measure any potential impairment
based on a projected discounted cash flow method using a
discount rate determined by our management to be commensurate
with the risk inherent in our current business model. Long-lived
assets and goodwill amounted to $8.1 million as of
March 31, 2004.

Accounting for Stock-Based
Compensation

The Company accounts for stock-based awards to
employees and directors using the intrinsic value method of
accounting in accordance with Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to
Employees (APB No. 25). Under the intrinsic value
method, because the exercise price of the Companys
employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is
recognized in the Companys Consolidated Statement of
Operations. We believe this method is appropriate for the
Company because it avoids the volatility of other expense
methods which determine stock compensation expense typically by
using the Black-Scholes option pricing model which was developed
for use in estimating the value of traded options that have no
vesting restrictions and are fully transferable. In addition,
option pricing models require input of highly subjective
assumptions including the expected stock price volatility.

We have currently elected to apply the
disclosure-only provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. In
accordance with the provisions of SFAS No. 123, the
Company applies APB No. 25, and related interpretations in
accounting for its stock option plans. On March 31, 2004,
the FASB issued a proposed Statement, Share-Based Payment,
an amendment of FASB Statements Nos. 123 and 95. The
proposed statement would eliminate the ability to account for
share-based compensation transactions using APB No. 25 and
generally would require that such transactions be accounted for
using a fair-value-based method and recognized as expenses in
our consolidated statement of operations. Should this proposed
statement be finalized in its current form, it will have a
significant impact on our consolidated statement of operations.

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Results of Operations

The following table sets forth, as a percentage
of revenues, statement of operations data for the periods
indicated. These operating results are not necessarily
indicative of results for any future periods.

|                                                |                          |                                          |        |        |   |      |       |      |    |   |        |        |   |  |       |      |    |   |         |         |   |  |       |       |   
|----------------------------------------------- | ------------------------ | ---------------------------------------- | ------ | ------ | - | ---- | ----- | ---- | -- | - | ------ | ------ | - |  | ----- | ---- | -- | - | ------- | ------- | - |  | ----- | ----- | --
|                                                |                          |                                         
|                                                |                          | Year ended March 31,                    
|                                                |                          |                                         
|                                                |                          |                                          |        |        |   |     
|                                                |                          | 2004                                     |        | 2003   |   | 2002
|                                                |                          |                                          |        |        |   |     
|                                                |                          |                                          |        |        |   |      |       |      |    |   |        |       
|                                                |                          |                                         
|                                                |                          | (In thousands except percentage amounts)
|Consolidated Statements of
    Operations Data: |                          |                                          |        |        |   |      |       |      |    |   |        |        |   |  |       |      |    |   |         |         |   |  |       |      
|Net Revenues                                    |                          | $                                        | 43,712 |        |   |      | 100.0 | %    |    | $ | 44,010 |        |   |  | 100.0 | %    |    | $ | 39,038  |         |   |  | 100.0 | %    
|Cost of revenues                                |                          |                                          | 19,526 |        |   |      | 44.7  |      |    |   | 18,259 |        |   |  | 41.5  |      |    |   | 18,544  |         |   |  | 47.5  |      
|                                                |                          |                                          |        |        |   |      |       |      |    |   |        |        |   |  |       |      |    |   |         |         |   |  |       |      
|Gross profit:                                   |                          |                                          | 24,186 |        |   |      | 55.3  |      |    |   | 25,751 |        |   |  | 58.5  |      |    |   | 20,494  |         |   |  | 52.5  |      
|                                                |                          |                                          |        |        |   |      |       |      |    |   |        |        |   |  |       |      |    |   |         |         |   |  |       |      
|Research and development                        |                          |                                          | 5,080  |        |   |      | 11.6  |      |    |   | 7,481  |        |   |  | 17.0  |      |    |   | 11,668  |         |   |  | 29.9  |      
|Sales and marketing                             |                          |                                          | 12,031 |        |   |      | 27.4  |      |    |   | 13,800 |        |   |  | 31.3  |      |    |   | 15,728  |         |   |  | 40.3  |      
|General and administrative                      |                          |                                          | 7,280  |        |   |      | 16.7  |      |    |   | 7,207  |        |   |  | 16.4  |      |    |   | 8,610   |         |   |  | 22.1  |      
|Stock-based compensation                        |                          |                                          | 88     |        |   |      | 0.2   |      |    |   | 386    |        |   |  | 0.9   |      |    |   | 2,319   |         |   |  | 5.9   |      
|Amortization of goodwill                        |                          |                                          |       |        |   |      |      |      |    |   |       |        |   |  |      |      |    |   | 1,500   |         |   |  | 3.8   |      
|Amortization of purchased intangibles           |                          |                                          | 214    |        |   |      | 0.5   |      |    |   | 644    |        |   |  | 1.5   |      |    |   | 644     |         |   |  | 1.7   |      
|                                                |                          |                                          |        |        |   |      |       |      |    |   |        |        |   |  |       |      |    |   |         |         |   |  |       |      
|                                                | Total operating expenses |                                          |        | 24,693 |   |      |       | 56.4 |    |   |        | 29,518 |   |  |       | 67.1 |    |   |         | 40,469  |   |  |       | 103.7 |   
|                                                |                          |                                          |        |        |   |      |       |      |    |   |        |        |   |  |       |      |    |   |         |         |   |  |       |      
|Loss from operations                            |                          |                                          | (507   | )      |   |      | (1.1  | )    |    |   | (3,767 | )      |   |  | (8.6  | )    |    |   | (19,975 | )       |   |  | (51.2 | )    
|Other income and (expense)                      |                          |                                          | (73    | )      |   |      | (0.2  | )    |    |   | (207   | )      |   |  | (0.4  | )    |    |   | 297     |         |   |  | 0.8   |      
|                                                |                          |                                          |        |        |   |      |       |      |    |   |        |        |   |  |       |      |    |   |         |         |   |  |       |      
|                                                | Net loss                 |                                          | $      | (580   | ) |      |       | (1.3 | )% |   | $      | (3,974 | ) |  |       | (9.0 | )% |   | $       | (19,678 | ) |  |       | (50.4 | )%
|                                                |                          |                                          |        |        |   |      |       |      |    |   |        |        |   |  |       |      |    |   |         |         |   |  |       |      

COMPARISON OF THE YEARS ENDED MARCH 31,
2004 AND 2003

Revenues

Our Customer Marketing business provides clients
with comprehensive solutions for creating and executing online
direct marketing programs. Our solutions are designed to enable
marketers to drive revenue and deepen customer relationships
with a comprehensive process that includes: collecting and
managing customer information, analyzing the information to
determine optimal segments and offers, and delivering highly
relevant, individualized email messages. Customer Marketing
represented 71% and 72% of revenue in fiscal 2004 and 2003,
respectively.

The Professional Services group provides
expertise to enhance marketing programs and improve results.
Digital Impact offers clients services in each of the following
categories: Strategy, Analysis, Data Management, Solutions
Engineering, Web Development, Creative and Customer Acquisition.
Professional Services represented 29% and 28% of revenue in
fiscal 2004 and 2003, respectively.

Total revenues decreased by 1% to
$43.7 million for the fiscal year ended March 31, 2004
from $44.0 million for the fiscal year ended March 31,
2003. Revenue generated by Customer Marketing activities
decreased 2% for the twelve months ended March 31, 2004
over the twelve months ended March 31, 2003 and represented
71% of net revenues. An approximate increase in email volume to
3.2 billion, which equals 25% growth for the twelve months
ended March 31, 2004 over the twelve months ended
March 31, 2003, was offset by an erosion in pricing over
the period. Revenue generated by Professional Services increased
2% for the twelve months ended March 31, 2004 over the
twelve months ended March 31, 2003 and represented 29% of
net revenues. A decline in Customer Acquisition revenue was
offset by growth in Solutions Engineering revenue from custom
programming.

Annual revenues for fiscal 2005 are expected to
grow modestly. We expect a small decline in the first half year
compared to the first half of fiscal 2004, due to delayed new
business, lower Customer Acquisition

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revenues, price erosion and client attrition. For
the second half we expect modest growth compared to the second
half of fiscal 2004.


Cost of Revenue

Cost of revenue consists primarily of expenses
relating to the delivery of online direct marketing services,
including personnel costs of our services staff, the
amortization of equipment, purchased and licensed technology,
and data center expenses.

Total cost of revenues increased 7% to
$19.5 million for the fiscal year ended March 31, 2004
from $18.3 million for the fiscal year ended March 31,
2003. The increase in cost of revenues was primarily related to
a $798,000 increase in depreciation of hardware and software and
amortization of maintenance contracts related to the expansion
and updating of our data center infrastructure and a $596,000
increase in service personnel costs and consulting expenses,
offset by a $240,000 reduction in data center rent.

Gross margin decreased to 55% for the fiscal year
2004 from 59% for fiscal 2003. The decline in gross margin was
due to a 7% increase in cost of revenues while revenue decreased
by 1%.

Gross margins for Customer Marketing were 59% and
63% for the twelve months ended March 31, 2004 and 2003,
respectively. The decrease in gross margin is primarily the
result of price erosion, partially offset by improvements in
operational efficiency.

Gross margins for Professional Services were 46%
and 48% for the twelve months ended March 31, 2004 and
2003, respectively. The decline is primarily due to a lower mix
of Customer Acquisition revenues.

We expect that total gross margins for fiscal
year 2005 will be in the range of 50% to 55% as we expand our
professional services capabilities in strategic marketing, data
analytics and search engine marketing.

Operating Expenses

Our operating expenses are classified into three
general categories: research and development, sales and
marketing, and general and administrative. We classify all
charges to these operating expense categories based on the
nature of the expenditures. Although each category includes
expenses that are unique to each operating category, some
expenditures, such as compensation, employee benefits,
recruiting costs, travel and entertainment costs, facilities
costs and third-party professional service fees, occur in each
of these categories.

We allocate the facilities costs to each
functional area that uses the facilities based on each
areas relative headcount. These allocated charges include
rent and other facility-related costs, communication charges and
depreciation expense for furniture and equipment.

Total operating expenses also include non-cash
expenses related to stock-based compensation, amortization of
purchased intangibles, goodwill impairment charges and
restructuring charges.

Research and
development.Research and development
expenses consist primarily of personnel and related costs,
consultants and outside contractor costs, and software and
hardware maintenance costs for our development efforts. Research
and development expense decreased by 32% to $5.1 million
for the year ended March 31, 2004 from $7.5 million
for year ended March 31, 2003. The decrease was mainly
attributable to reductions in personnel costs, resulting from
lower headcount driven by restructuring activities. We
capitalized $311,000 and $84,000 for internally developed
software for the fiscal years ended March 31, 2004 and
March 31, 2003, respectively. We expect research and
development expense to decrease in absolute dollars and as a
percentage of revenue for the next fiscal year. Research and
development expense is substantially dependent on the level of
development activity and related staffing.

Sales and marketing.Sales and marketing expenses consist of personnel and related
costs for our direct sales force and marketing staff, and
marketing programs, which include trade shows, advertisements,
promotional activities and media events. Sales and marketing
expenses decreased by 13% to $12.0 million for the fiscal
year ended March 31, 2004 from $13.8 million for the
year ended March 31, 2003. The decrease was mainly
attributable to reduction in personnel costs due to lower
staffing. We expect sales and marketing

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expense to increase modestly for the next fiscal
year largely as a result of higher staffing and commissions on
increased sales.


General and
administrative.General and
administrative expenses consist primarily of personnel and
related costs for general corporate purposes, including
information services, finance, accounting, human resources,
facilities and legal. General and administrative expenses
increased by 1% to $7.3 million for the year ended
March 31, 2004 from $7.2 million for the year ended
March 31, 2003. The increase was primarily due to higher
fees and increased accounting and legal activities. For the next
fiscal year, we expect general and administrative expenses to
increase slightly in absolute dollars and as a percentage of
revenue.

Stock-based
compensation.In connection with the
granting of stock options and restricted stock to our employees
and the assumption of options related to the acquisition of
MineShare, we recorded unearned stock-based compensation. It
represents the total difference between the exercise prices of
the stock options or the purchase price of the restricted stock
and the deemed fair market value of the underlying common stock
for accounting purposes on the date granted. This amount is
included as a component of stockholders equity and is
being amortized on an accelerated basis by charges to operations
over the vesting period of the options or restricted stock,
consistent with the methods described in FASB Interpretation
No. 28.

Stock-based compensation, a non-cash expense,
decreased 77% to $88,000 for the year ended March 31, 2004
from $386,000 for the year ended March 31, 2003. The
decline was primarily due to our use of the accelerated method
of amortization for our employee stock-based compensation
arrangements plus the reversal of balances of unamortized
stock-based compensation as a result of employee terminations.

As of March 31, 2004, $6,000 of total
unearned deferred stock-based compensation remains to be
amortized.

Amortization of
Goodwill.In accordance with
SFAS No. 142, Goodwill and Other Intangible
Assets,goodwill is no longer amortized as of
April 1, 2002 but is annually tested for impairment. The
Company completed its testing in the fourth quarter of fiscal
year 2004 and determined that no impairment existed.

Amortization of Purchased
Intangibles.Amortization of purchased
intangibles consists of the amortization of purchased technology
from our acquisition of MineShare. Amortization of purchased
intangibles was $214,000 and $644,000 for the fiscal years ended
March 31, 2004 and 2003, respectively.

Other income and
(expenses).Other expense decreased to
$73,000 for the fiscal year ended March 31, 2004 from
$207,000 for the fiscal year ended March 31, 2003. The
decrease relates to a decline in interest paid on equipment
leases and long-term debt. The interest expense declined to
$100,000 from $386,000 in fiscal year 2004 and 2003,
respectively, as debt and lease obligations decreased by
$1.3 million.

Income taxes.No
provision for federal and state income taxes was recorded as we
incurred net operating losses from inception through
March 31, 2004. Due to the uncertainty regarding the
ultimate utilization of the net operating loss carryforwards, we
have not recorded any benefit for losses and a valuation
allowance has been recorded for the entire amount of the net
deferred tax asset. The Tax Reform Act of 1986 limits the use of
net operating loss and tax credit carryforwards in certain
situations where changes occur in the stock ownership of a
company. If we should have an ownership change, as defined for
tax purposes, utilization of the carryforwards could be
restricted. In addition, sales of our stock, including shares
sold in the initial public offering, may further restrict our
ability to utilize our net operating loss carryforwards.

COMPARISON OF THE YEARS ENDED MARCH 31,
2003 AND 2002

Revenues

Our Customer Marketing business provides clients
with comprehensive solutions for creating and executing online
direct marketing programs. Our solutions are designed to enable
marketers to drive revenue and deepen customer relationships
with a comprehensive process that includes: collecting and
managing customer information, analyzing the information to
determine ideal segments and offers, and delivering highly

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relevant, individualized email messages. Customer
Marketing represented 72% and 74% of revenue in fiscal 2003 and
2002, respectively.


The Professional Services group provides
expertise to enhance marketing programs and improve results.
Digital Impact offers clients services in each of the following
categories: Strategy, Analysis, Data Management, Solutions
Engineering, Web Development, Creative and Customer Acquisition.
Professional Services represented 28% and 26% of revenue in
fiscal 2003 and 2002, respectively.

Total revenues increased by 13% to
$44.0 million for the fiscal year ended March 31, 2003
from $39.0 million for the fiscal year ended March 31,
2002. The increase was primarily the result of growth in the
client base and email volume.

The increase in the average number of clients
from fiscal 2002 to fiscal 2003 is primarily the result of
retaining most existing clients and the addition of new mid-cap
and Fortune 1000 clients. The higher email volume for the twelve
months ended March 31, 2003 over the twelve months ended
March 31, 2002 was partially offset by an erosion in
pricing over the twelve-month period. Revenue generated by
Customer Marketing activities increased 9% for the twelve months
ended March 31, 2003 over the twelve months ended
March 31, 2002 and represented 72% of net revenues. Revenue
generated by Professional Services increased 22% for the twelve
months ended March 31, 2003 over the twelve months ended
March 31, 2002 and represented 28% of net revenues.

Cost of Revenue

Cost of revenue consists primarily of expenses
relating to the delivery of online direct marketing services,
including personnel costs of our services staff, the
amortization of equipment, purchased and licensed technology,
and data center expenses.

Total cost of revenues decreased 2% to
$18.3 million for the fiscal year ended March 31, 2003
from $18.5 million for the fiscal year ended March 31,
2002.

The decrease in cost of revenue was primarily
related to lower costs for consultants of $485,000, resulting
from reductions in outside staffing in our services and
operations staff, and a $475,000 reduction in data center rent
resulting from lower negotiated rates, offset by an increase in
equipment depreciation of $310,000, as a result of our
investments in our data center infrastructure and a $380,000
increase in personnel costs. Amortization of capitalized
software development costs was $177,000 and $0 for the fiscal
year ended March 31, 2003 and 2002, respectively.

Gross margin increased to 59% for the fiscal year
2003 from 52% for fiscal 2002. The increase was largely due to
efforts to control expenses while revenue grew by 13%.

Operating Expenses

Our operating expenses are classified into three
general categories: research and development, sales and
marketing, and general and administrative. We classify all
charges to these operating expense categories based on the
nature of the expenditures. Although each category includes
expenses that are unique to each operating category, some
expenditures, such as compensation, employee benefits,
recruiting costs, equipment costs, travel and entertainment
costs, facilities costs and third-party professional service
fees, occur in each of these categories.

We allocate the total cost for information
services and facilities to each functional area that uses the
information services and facilities based on each areas
relative headcount. These allocated charges include rent and
other facility-related costs, communication charges and
depreciation expense for furniture and equipment.

Total operating expenses also include non-cash
expenses related to stock-based compensation, amortization of
purchased intangibles, goodwill impairment charges, write-off of
acquired in-process research and development and restructuring
charges and write-off of fixed assets.

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Research and
development.Research and development
expenses consist primarily of personnel and related costs,
consultants and outside contractor costs, and software and
hardware maintenance costs for our development efforts. Research
and development expense decreased by 36% to $7.5 million
for the year ended March 31, 2003 from $11.7 million
for the year ended March 31, 2002. The decrease was mainly
attributable to reductions in personnel costs of
$3.7 million, resulting from a 24 person reduction in
headcount related to restructuring activities and completion of
our IMPACT product, $256,000 reduction in outside consulting
expense related to efforts to control costs and meet development
needs with internal personnel, and a $600,000 lease buyout cost
in 2002 from the closure of Cupertino facility, offset by a
$400,000 increase in depreciation and the amortization of
software maintenance contracts. We capitalized $84,000 and
$120,000 for internally developed software for the fiscal years
ended March 31, 2003 and March 31, 2002, respectively.
Current capitalized balances will be amortized over two years
from the product release dates. A new version of IMPACT and
related reporting products are expected to be released in
mid-2004.

Sales and marketing.Sales and marketing expenses consist of personnel and related
costs for our direct sales force and marketing staff, and
marketing programs, which include trade shows, advertisements,
promotional activities and media events. Sales and marketing
expense decreased by 12% to $13.8 million for the fiscal
year ended March 31, 2003 from $15.7 million for the
year ended March 31, 2002. The decrease was mainly
attributable to a $1.2 million reduction in personnel costs
associated with restructuring activities, a $360,000 reduction
in marketing expenses, and a $260,000 reduction in recruiting
expenses.

General and
administrative.General and
administrative expenses consist primarily of personnel and
related costs for general corporate purposes, including
information services, finance, accounting, human resources,
facilities and legal. General and administrative expenses
decreased by 16% to $7.2 million for the year ended
March 31, 2003 from $8.6 million for the year ended
March 31, 2002. The decrease was primarily due to decreased
personnel costs of $200,000 related to an 8% decline in
headcount, a $540,000 decrease in bad debt expense, a $400,000
reduction in outside consulting expense and a $100,000 decline
in travel and entertainment expense.

Stock-based
compensation.In connection with the
granting of stock options and restricted stock to our employees
and the assumption of options related to the acquisition of
MineShare, we recorded unearned stock-based compensation
totaling approximately $17.4 million, net of forfeitures,
from fiscal 1999 through March 31, 2003. This amount
represents the total difference between the exercise prices of
the stock options or the purchase price of the restricted stock
and the deemed fair market value of the underlying common stock
for accounting purposes on the date granted. This amount is
included as a component of stockholders equity and is
being amortized on an accelerated basis by charges to operations
over the vesting period of the options or restricted stock,
consistent with the methods described in FASB Interpretation
No. 28.

Stock-based compensation, a non-cash expense,
decreased 83% to $386,000 for the year ended March 31, 2003
from $2.3 million for the year ended March 31, 2002.
The decline was primarily due to our use of the accelerated
method of amortization for our employee stock-based compensation
arrangements plus the reversal of balances of unamortized
stock-based compensation as a result of employee terminations.

As of March 31, 2003, approximately $125,000
of total unearned deferred stock-based compensation remains to
be amortized.

Amortization of
Goodwill.In accordance with
SFAS No. 142, Goodwill and Other Intangible
Assets,goodwill is no longer amortized as of
April 1, 2002 but is periodically tested for impairment.
Goodwill amortization expense was approximately
$1.5 million for the twelve months ended March 31,
2002.

Amortization of Purchased
Intangibles.Amortization of purchased
intangibles consists of the amortization of purchased technology
from our July 2000 acquisition of MineShare. Prior to the
quarter ended September 30, 2002, amortization of purchased
intangibles was a component of research and development expense.
These amounts have been reclassified to conform to the current
period presentation. Amortization of purchased intangibles was
$644,000 for the twelve months ended March 31, 2003 and
2002.

Other income and
(expenses).Other income and
(expense) decreased to ($207,000) for the fiscal year ended
March 31, 2003 from $297,000 for the fiscal year ended
March 31, 2002. Other expenses relate

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primarily to interest paid on long-term debt.
Other income relates to interest income on cash, cash
equivalents and short-term investments. The decrease in other
income and (expense) was largely due to lower interest
income on lower average cash and cash equivalents balances
resulting from the use of cash to fund current operations, and
lower prevailing interest rates.


Income taxes.No
provision for federal and state income taxes was recorded as we
incurred net operating losses from inception through
March 31, 2003. Due to the uncertainty regarding the
ultimate utilization of the net operating loss carryforwards, we
have not recorded any benefit for losses and a valuation
allowance has been recorded for the entire amount of the net
deferred tax asset. The Tax Reform Act of 1986 limits the use of
net operating loss and tax credit carryforwards in certain
situations where changes occur in the stock ownership of a
company. If we should have an ownership change, as defined for
tax purposes, utilization of the carryforwards could be
restricted. In addition, sales of our stock, including shares
sold in the initial public offering, may further restrict our
ability to utilize our net operating loss carryforwards.

Liquidity and Capital Resources

Cash and Investments.

As of March 31, 2004, we had
$26.2 million in cash, cash equivalents and short-term
investments and working capital of $29.5 million. In
addition, as of March 31, 2004, we had $1.2 million in
restricted cash, $1.1 million of which is supporting
letters of credit issued against certain contractual lease
obligations.



| |                                     
| | ------------------------------------
| | Cash Flow from Operating Activities.

Our operating activities generated
$3.3 million of cash for the year ended March 31,
2004. The net cash generated resulted from the net loss of
$580,000, offset by non-cash items of $5.7 million, an
increase in accounts receivable of $269,000, an increase in
deferred revenue of $112,000, a decrease in other assets of
$351,000, and a decrease in accounts payable and accrued
liabilities of $2.0 million. Customer payments of
$43.4 million were the principal source of cash from
operating activities. Salaries and other personnel costs of
$30.0 million and rent, communications and other occupancy
costs of $3.3 million comprised 82% of operating cash
consumption in fiscal 2004.

Our operating activities generated
$4.4 million of cash for the year ended March 31,
2003. The net cash generated resulted from the net loss of
$4.0 million, offset by non-cash items of
$7.0 million, decreases in accounts receivable of $324,000,
and an increase in accruals and deferred revenue of
$1.1 million.

Our operating activities used $5.5 million
of cash for the year ended March 31, 2002. The net cash
used in operating activities in fiscal 2002 resulted from the
net loss of $19.7 million, less non-cash items of
$12.0 million, decreases in accounts payable, accrued
liabilities and deferred revenue of $1.5 million and
increases in current and other assets of $1.2 million,
partially offset by a decreases in accounts receivable and
restricted cash totaling $4.2 million and $706,000,
respectively.



| |                                     
| | ------------------------------------
| | Cash Flow from Investing Activities.

Investing activities used $2.6 million of
cash for the year ended March 31, 2004, related to the
acquisition of property and equipment totaling $2.1 million
and the investment of $0.5 million in short-term marketable
securities. Investing activities used $2.9 million of cash
for the year ended March 31, 2003, related to acquisition
of property and equipment totaling $4.4 million, offset by
the maturity of $1.5 million in short term investments. The
cash was used to purchase the equipment and software, including
performance monitoring systems, networking equipment, servers
and database software, to upgrade and increase capacity of our
data center. Investing activities used $4.0 million of cash
for the year ended March 31, 2002, related to the
acquisition of property and equipment totaling $2.3 million
and the investment of $1.7 million in short-term marketable
securities.

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| |                                     
| | ------------------------------------
| | Cash Flow from Financing Activities.

Financing activities generated $1.3 million
of cash during the fiscal year ended March 31, 2004,
attributable primarily to the proceeds from the issuance of
common stock related to the exercise of stock options and shares
issued under the Companys employee stock purchase plan,
offset by principal payments on long-term debt totaling
$1.7 million. Financing activities used $1.8 million
of cash for the year ended March 31, 2003, and consisted
primarily of principal payments on long-term debt totaling
$3.0 million, partially offset by proceeds from the
issuance of common stock resulting from the exercise of stock
options and shares issued under the Companys employee
stock purchase plan. Financing activities used $1.7 million
of cash for the year ended March 31, 2002, and consisted
primarily of principal payments on long-term debt totaling
$2.3 million, partially offset by proceeds from the
issuance of common stock resulting from the exercise of stock
options and shares issued under the Companys employee
stock purchase plan.



| |               
| | --------------
| | Debt Payments.

At March 31, 2004 we had borrowings in the
form of long-term debt, payable in quarterly installments
through October 2005, with an interest rate of 2%. Total debt as
of March 31, 2004 was $238,000.



| |             
| | ------------
| | Commitments.

We are committed to making cash payments in the
future on two types of contracts: long-term debt and
non-cancelable operating leases. We have no off-balance sheet
debt or other such unrecorded obligations and we have not
guaranteed the debt of any other party. Our credit agreements
place restrictions on our ability to pay dividends.



| |                   
| | ------------------
| | Future Cash Needs.

Digital Impact has made certain commercial
commitments that extend beyond our fiscal year ending
March 31, 2004. These commitments include letters of credit
obtained from a financial institution in lieu of a security
deposit for leased office space. The aggregate amount of the
letters of credit is classified as restricted cash.

Below is a schedule of the future payments that
we are obligated to make based on agreements in place as of
March 31, 2004:

|                              |                      |                |       |       |  |      |       |       |  |      |       |       |  |   |       |       |  |   |     |     |  |   |   |   | 
|----------------------------- | -------------------- | -------------- | ----- | ----- |  | ---- | ----- | ----- |  | ---- | ----- | ----- |  | - | ----- | ----- |  | - | --- | --- |  | - | - | - | 
|                              |                      |               
|                              |                      | March 31      
|                              |                      |               
|                              |                      | Total          |       | 2005  |  | 2006 |       | 2007  |  | 2008 |       | 2009 
|                              |                      |                |       |       |  |      |       |       |  |      |       |      
|                              |                      |               
|                              |                      | (In thousands)
|Contractual Obligations:      |                      |                |       |       |  |      |       |       |  |      |       |       |  |   |       |       |  |   |     |     |  |   |   |  
|                              | Purchase obligations |                | $     | 889   |  |      | $     | 499   |  |      | $     | 360   |  |   | $     | 30    |  |   | $   |    |  |   | $ |  | 
|                              | Long-term debt       |                |       | 238   |  |      |       | 158   |  |      |       | 80    |  |   |       |      |  |   |     |    |  |   |   |  | 
|                              | Operating leases     |                |       | 7,910 |  |      |       | 3,086 |  |      |       | 2,296 |  |   |       | 2,324 |  |   |     | 204 |  |   |   |  | 
|                              |                      |                |       |       |  |      |       |       |  |      |       |       |  |   |       |       |  |   |     |     |  |   |   |  
|Total Contractual Obligations |                      | $              | 9,037 |       |  | $    | 3,743 |       |  | $    | 2,736 |       |  | $ | 2,354 |       |  | $ | 204 |     |  | $ |  |  
|                              |                      |                |       |       |  |      |       |       |  |      |       |       |  |   |       |       |  |   |     |     |  |   |   |  

The purchase obligations in the table above
relate to the minimum purchase commitments for internet and
consulting fees, software fees and subscription contracts.

The Company continues to face risks associated
with the execution of its strategy. Our future cash flows and
capital requirements depend on numerous factors, including
market acceptance of our services, competition from new and
existing competitors, the amount of resources we invest in our
data center infrastructure and new product development,
marketing and selling our products and services, our brand
promotions and any future acquisitions or divestitures.

The Companys primary source of liquidity is
$26.2 million in cash and cash equivalents, and short-term
investments. The Company believes it has the necessary financial
resources to fund its working capital needs, capital
expenditures and other business requirements for at least the
next 12 months. The Companys cash

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flow is primarily dependent upon operating
performance, capital expenditures to expand and update the data
center infrastructure, and potential cash usage for corporate
development transactions.




| |                            
| | ---------------------------
| | Indemnification Provisions.

During the ordinary course of business, we have
included indemnification provisions within our contracts.
Pursuant to these agreements, we indemnify, hold harmless, and
agree to reimburse the indemnified party for losses suffered or
incurred by the indemnified party, generally parties with which
we have commercial relations, arising from a breach of
representations, warranties or covenants and infringement of a
3rd parties intellectual property rights. To date, we
have not incurred any costs in connection with such
indemnification clauses.

Recent Accounting Pronouncements

In November 2002, the EITF reached consensus on
Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables. EITF 00-21 provides guidance on how to
account for arrangements that involve the delivery or
performance of multiple products, services and/or rights to use
assets. The provisions of EITF Issue No. 00-21 applies to
revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. The adoption of this standard did not
have a material effect on our financial position or results of
operations.

On March 31, 2004, the FASB issued a
proposed Statement, Share-Based Payment, an amendment of
FASB Statements Nos. 123 and 95, that addresses the
accounting for share-based payment transactions in which an
enterprise receives employee services in exchange for either
equity instruments of the enterprise or, liabilities that are
based on the fair value of the enterprises equity
instruments or that may be settled by the issuance of such
equity instruments. The proposed statement would eliminate the
ability to account for share-based compensation transactions
using Accounting Principles Board, or APB, Opinion No. 25,
Accounting for Stock Issued to Employees, and
generally would require that such transactions be accounted for
using a fair-value-based method and recognized as expenses in
our consolidated statement of income. The proposed standard
would require the modified prospective method be used, which
would require that the fair value of new awards granted from the
beginning of the year of adoption plus unvested awards at the
date of adoption be expensed over the vesting period. In
addition, the proposed statement encourages companies to use the
binomial approach to value stock options, which
differs from the Black-Scholes option pricing model that we
currently use to determine the fair value of our options. The
proposed standard is recommending that the effective date for
public companies be fiscal years beginning after
December 15, 2004. Should this proposed statement be
finalized in its current form, it will have a significant impact
on our consolidated statement of operations as we will be
required to expense the fair value of our stock options rather
than disclosing the impact on our consolidated net loss within
our notes (see Note 2) as is our current practice.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

Interest Rate Risk

Our exposure to market risk for changes in
interest rates relates primarily to the increase or decrease in
the amount of interest income we can earn on our investment
portfolio and on the increase or decrease in the amount of
interest expense we must pay on our outstanding debt
instruments. The risk associated with fluctuating interest
expense is limited, however, to the exposure related to those
debt instruments and credit facilities which are tied to market
rates. We do not plan to use derivative financial instruments in
our investment portfolio. We plan to ensure the safety and
preservation of our invested principal funds by limiting default
risk, market risk and reinvestment risk. We plan to mitigate
default risk by investing in high quality securities.

Foreign Currency Risk

For the period from our inception through
March 31, 2004, we provided our services to clients
primarily in the United States. As a result, our financial
results have not been materially affected by factors such as
changes in foreign currency exchange rates or weak economic
conditions in foreign markets. The majority of

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our sales are currently denominated in
U.S. dollars. We have a subsidiary in the United Kingdom
which, to date, has had minimal operations and minimal foreign
currency sales. The effect of foreign exchange rates
fluctuations on operations were not material for the years ended
March 31, 2004, 2003 and 2002.


As the operations of this subsidiary expand, our
future operating results could be directly impacted by changes
in foreign currency exchange rates or economic conditions in
this region. As of March 31, 2004, we had $140,520 in cash
and cash equivalents denominated in foreign currencies.






|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

Index to Consolidated Financial
Statements

|                                                                                                                     |  |  |    | 
|-------------------------------------------------------------------------------------------------------------------- |  |  | -- | 
|Report of PricewaterhouseCoopers LLP, Independent
    Auditors                                                       |  |  | 25 | 
|Consolidated Balance Sheets as of March 31,
    2004 and 2003                                                        |  |  | 26 | 
|Consolidated Statements of Operations for the
    years ended March 31, 2004, 2003 and 2002                          |  |  | 27 | 
|Consolidated Statements of Comprehensive Loss for
    the years ended March 31, 2004, 2003 and 2002                  |  |  | 28 | 
|Consolidated Statements of Changes in
    Stockholders Equity for the years ended March 31,
    2004, 2003 and 2002 |  |  | 29 | 
|Consolidated Statements of Cash Flows for the
    years ended March 31, 2004, 2003 and 2002                          |  |  | 30 | 
|Notes to the Consolidated Financial Statements                                                                       |  |  | 31 | 
|Schedule II  Valuation and
    Qualifying Accounts                                                                  |  |  | 44 | 

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REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board of Directors and Stockholders

of Digital Impact, Inc.:


In our opinion, the consolidated financial
statements listed in the accompanying index present fairly, in
all material respects, the financial position of Digital Impact,
Inc. and its subsidiaries at March 31, 2004 and 2003, and
the results of their operations and their cash flows for each of
the three years in the period ended March 31, 2004 in
conformity with accounting principles generally accepted in the
United States of America. In addition, in our opinion, the
financial statement schedule listed in the accompanying index
presents fairly, in all material respects, the information set
forth therein when read in conjunction with the related
consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles
used and significant estimates made by management, and
evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our
opinion.

PRICEWATERHOUSECOOPERS LLP

San Jose, California

June 1, 2004


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DIGITAL IMPACT, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except par values)


|                                     |                                                                                                             |                                            |       |          |        |  |       |          |        | 
|------------------------------------ | ----------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | -------- | ------ |  | ----- | -------- | ------ | 
|                                     |                                                                                                             |                                           
|                                     |                                                                                                             | March 31,                                 
|                                     |                                                                                                             |                                           
|                                     |                                                                                                             | 2004                                       |       | 2003    
|                                     |                                                                                                             |                                            |       |         
|ASSETS                               |                                                                                                             |                                            |       |          |        |  |       |         
|Current assets:                      |                                                                                                             |                                            |       |          |        |  |       |         
|                                     | Cash and cash equivalents                                                                                   |                                            | $     | 25,550   |        |  | $     | 23,659   |       
|                                     | Short-term investments                                                                                      |                                            |       | 608      |        |  |       | 108      |       
|                                     | Accounts receivable, net of allowance for
    doubtful accounts of $263 and $345                            |                                            |       | 8,172    |        |  |       | 7,903    |       
|                                     | Prepaid expenses and other current assets                                                                   |                                            |       | 1,385    |        |  |       | 1,377    |       
|                                     |                                                                                                             |                                            |       |          |        |  |       |         
|                                     |                                                                                                             | Total current assets                       |       |          | 35,715 |  |       |          | 33,047 | 
|                                     |                                                                                                             |                                            |       |          |        |  |       |         
|Property and equipment, net          |                                                                                                             |                                            | 6,100 |          |        |  | 8,909 |         
|Restricted cash                      |                                                                                                             |                                            | 1,164 |          |        |  | 1,114 |         
|Goodwill                             |                                                                                                             |                                            | 2,002 |          |        |  | 2,002 |         
|Intangible assets                    |                                                                                                             |                                            |      |          |        |  | 214   |         
|Other assets                         |                                                                                                             |                                            | 380   |          |        |  | 731   |         
|                                     |                                                                                                             |                                            |       |          |        |  |       |         
|                                     |                                                                                                             | Total assets                               |       | $        | 45,361 |  |       | $        | 46,017 | 
|                                     |                                                                                                             |                                            |       |          |        |  |       |         
|                                    
|LIABILITIES AND STOCKHOLDERS EQUITY |                                                                                                             |                                            |       |          |        |  |       |         
|Current liabilities:                 |                                                                                                             |                                            |       |          |        |  |       |         
|                                     | Accounts payable                                                                                            |                                            | $     | 1,100    |        |  | $     | 1,819    |       
|                                     | Accrued payroll                                                                                             |                                            |       | 1,647    |        |  |       | 1,779    |       
|                                     | Accrued pass-through vendor costs                                                                           |                                            |       | 659      |        |  |       | 398      |       
|                                     | Accrued liabilities                                                                                         |                                            |       | 614      |        |  |       | 2,005    |       
|                                     | Deferred revenue                                                                                            |                                            |       | 2,087    |        |  |       | 1,975    |       
|                                     | Current portion of capital lease obligations                                                                |                                            |       |         |        |  |       | 374      |       
|                                     | Current portion of long-term debt                                                                           |                                            |       | 158      |        |  |       | 1,212    |       
|                                     |                                                                                                             |                                            |       |          |        |  |       |         
|                                     |                                                                                                             | Total current liabilities                  |       |          | 6,265  |  |       |          | 9,562  | 
|                                     |                                                                                                             |                                            |       |          |        |  |       |         
|Long-term debt, less current portion |                                                                                                             |                                            | 80    |          |        |  |      |         
|                                     |                                                                                                             |                                            |       |          |        |  |       |         
|                                     |                                                                                                             | Total liabilities                          |       |          | 6,345  |  |       |          | 9,562  | 
|                                     |                                                                                                             |                                            |       |          |        |  |       |         
|Commitments (See Note 4)             |                                                                                                             |                                            |       |          |        |  |       |         
|Stockholders equity:                |                                                                                                             |                                            |       |          |        |  |       |         
|                                     | Preferred stock, $0.001 par value;
    5,000,000 shares authorized; none outstanding                        |                                            |       |         |        |  |       |         |       
|                                     | Common stock, $0.001 par value;
    100,000 shares authorized; 34,089 and 33,593 issued and
    outstanding |                                            |       | 34       |        |  |       | 31       |       
|                                     | Additional paid-in capital                                                                                  |                                            |       | 145,540  |        |  |       | 142,482  |       
|                                     | Accumulated other comprehensive income (loss)                                                               |                                            |       | 51       |        |  |       | (12      | )     
|                                     | Unearned stock-based compensation                                                                           |                                            |       | (6       | )      |  |       | (125     | )     
|                                     | Accumulated deficit                                                                                         |                                            |       | (105,959 | )      |  |       | (105,379 | )     
|                                     | Less treasury stock, at cost, (496 and 454) shares                                                          |                                            |       | (644     | )      |  |       | (542     | )     
|                                     |                                                                                                             |                                            |       |          |        |  |       |         
|                                     | Total stockholders equity                                                                                  |                                            |       | 39,016   |        |  |       | 36,455   |       
|                                     |                                                                                                             |                                            |       |          |        |  |       |         
|                                     |                                                                                                             | Total liabilities and stockholders equity |       | $        | 45,361 |  |       | $        | 46,017 | 
|                                     |                                                                                                             |                                            |       |          |        |  |       |         

The accompanying notes are an integral part of
these consolidated financial statements.

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DIGITAL IMPACT, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except per share
data)


|                                                                             |                                       |                             |        |        |        |      |        |        |        |   |         |        |        | 
|---------------------------------------------------------------------------- | ------------------------------------- | --------------------------- | ------ | ------ | ------ | ---- | ------ | ------ | ------ | - | ------- | ------ | ------ | 
|                                                                             |                                       |                            
|                                                                             |                                       | Fiscal year ended March 31,
|                                                                             |                                       |                            
|                                                                             |                                       | 2004                        |        | 2003   |        | 2002
|                                                                             |                                       |                             |        |        |        |     
|Revenues                                                                     |                                       | $                           | 43,712 |        |        | $    | 44,010 |        |        | $ | 39,038  |       
|Cost of revenues                                                             |                                       |                             | 19,526 |        |        |      | 18,259 |        |        |   | 18,544  |       
|                                                                             |                                       |                             |        |        |        |      |        |        |        |   |         |       
|Gross profit                                                                 |                                       |                             | 24,186 |        |        |      | 25,751 |        |        |   | 20,494  |       
|                                                                             |                                       |                             |        |        |        |      |        |        |        |   |         |       
|Operating expenses:                                                          |                                       |                             |        |        |        |      |        |        |        |   |         |       
|                                                                             | Research and development              |                             |        | 5,080  |        |      |        | 7,481  |        |   |         | 11,668 |       
|                                                                             | Sales and marketing                   |                             |        | 12,031 |        |      |        | 13,800 |        |   |         | 15,728 |       
|                                                                             | General and administrative            |                             |        | 7,280  |        |      |        | 7,207  |        |   |         | 8,610  |       
|                                                                             | Stock-based compensation              |                             |        | 88     |        |      |        | 386    |        |   |         | 2,319  |       
|                                                                             | Amortization of goodwill              |                             |        |       |        |      |        |       |        |   |         | 1,500  |       
|                                                                             | Amortization of purchased intangibles |                             |        | 214    |        |      |        | 644    |        |   |         | 644    |       
|                                                                             |                                       |                             |        |        |        |      |        |        |        |   |         |       
|                                                                             |                                       | Total operating expenses    |        |        | 24,693 |      |        |        | 29,518 |   |         |        | 40,469 | 
|                                                                             |                                       |                             |        |        |        |      |        |        |        |   |         |       
|Loss from operations                                                         |                                       |                             | (507   | )      |        |      | (3,767 | )      |        |   | (19,975 | )     
|Other income and (expenses)                                                  |                                       |                             | (73    | )      |        |      | (207   | )      |        |   | 297     |       
|                                                                             |                                       |                             |        |        |        |      |        |        |        |   |         |       
|Net loss                                                                     |                                       | $                           | (580   | )      |        | $    | (3,974 | )      |        | $ | (19,678 | )     
|                                                                             |                                       |                             |        |        |        |      |        |        |        |   |         |       
|Net loss per common share  basic and
    diluted                            |                                       | $                           | (0.02  | )      |        | $    | (0.13  | )      |        | $ | (0.70   | )     
|                                                                             |                                       |                             |        |        |        |      |        |        |        |   |         |       
|Shares used in net loss per common share
    calculation  basic and diluted |                                       |                             | 32,950 |        |        |      | 30,290 |        |        |   | 27,960  |       
|                                                                             |                                       |                             |        |        |        |      |        |        |        |   |         |       

The accompanying notes are an integral part of
these consolidated financial statements.

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DIGITAL IMPACT, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE
LOSS

(In thousands)


|                                                |                                          |                             |      |      |  |      |        |     |   |  |         |    | 
|----------------------------------------------- | ---------------------------------------- | --------------------------- | ---- | ---- |  | ---- | ------ | --- | - |  | ------- | -- | 
|                                                |                                          |                            
|                                                |                                          | Fiscal year ended March 31,
|                                                |                                          |                            
|                                                |                                          | 2004                        |      | 2003 |  | 2002
|                                                |                                          |                             |      |      |  |     
|Net loss                                        |                                          |                             | (580 | )    |  |      | (3,974 | )   |   |  | (19,678 | ) 
|Other comprehensive income (loss):              |                                          |                             |      |      |  |      |        |     |   |  |         |   
|                                                | Cumulative translation adjustment        |                             |      | 63   |  |      |        | (12 | ) |  |         |   | 
|                                                | Unrealized gains (losses) on investments |                             |      |     |  |      |        |    |   |  |         | 34 | 
|                                                |                                          |                             |      |      |  |      |        |     |   |  |         |   
|Net change in other comprehensive income (loss) |                                          |                             | 63   |      |  |      | (12    | )   |   |  | 34      |   
|                                                |                                          |                             |      |      |  |      |        |     |   |  |         |   
|Comprehensive loss                              |                                          |                             | (517 | )    |  |      | (3,986 | )   |   |  | (19,644 | ) 
|                                                |                                          |                             |      |      |  |      |        |     |   |  |         |   

The accompanying notes are an integral part of
these consolidated financial statements.

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DIGITAL IMPACT, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

(In thousands)


|                                                                                                  |  |              |        |                |  |            |    |               |  |             |      |             |  |              |      |         |  |       |         |   |  |  |     |   |  |  |        |   |  |  |          |   |  |  |         |  
|------------------------------------------------------------------------------------------------- |  | ------------ | ------ | -------------- |  | ---------- | -- | ------------- |  | ----------- | ---- | ----------- |  | ------------ | ---- | ------- |  | ----- | ------- | - |  |  | --- | - |  |  | ------ | - |  |  | -------- | - |  |  | ------- | -
|                                                                                                  |  |              |        |                |  |            |    | Accumulated   |  |             |      |             |  |             
|                                                                                                  |  | Common Stock |        | Treasury Stock |  | Additional |    | Other         |  | Unearned    |      |             |  |             
|                                                                                                  |  |              |        |                |  | Paid-In    |    | Comprehensive |  | Stock-Based |      | Accumulated |  |             
|                                                                                                  |  | Shares       |        | Amount         |  | Shares     |    | Amount        |  | Capital     |      | Income      |  | Compensation |      | Deficit |  | Total
|                                                                                                  |  |              |        |                |  |            |    |               |  |             |      |             |  |              |      |         |  |      
|Balances, March 31, 2001                                                                          |  |              | 27,866 |                |  |            | 27 |               |  |             | (110 | )           |  |              | (147 | )       |  |       | 141,823 |   |  |  | (34 | ) |  |  | (4,387 | ) |  |  | (81,727  | ) |  |  | 55,555  |  
|Issuance of common stock in respect of exercise
    of stock options and ESPP, net of repurchases |  |              | 1,141  |                |  |            | 2  |               |  |             |     |             |  |              |     |         |  |       | 954     |   |  |  |    |   |  |  |       |   |  |  |         |   |  |  | 956     |  
|Issuance of common stock  restricted
    stock award                                             |  |              | 704    |                |  |            | 1  |               |  |             |     |             |  |              |     |         |  |       | 1,619   |   |  |  |    |   |  |  | (1,620 | ) |  |  |         |   |  |  |        |  
|Repurchase of common stock                                                                        |  |              |       |                |  |            |   |               |  |             | (285 | )           |  |              | (297 | )       |  |       |        |   |  |  |    |   |  |  |       |   |  |  |         |   |  |  | (297    | )
|Issuance of common stock to non-employees                                                         |  |              | 50     |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       | 43      |   |  |  |    |   |  |  | (43    | ) |  |  |         |   |  |  |        |  
|Amortization of unearned stock-based compensation                                                 |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       |        |   |  |  |    |   |  |  | 2,319  |   |  |  |         |   |  |  | 2,319   |  
|Cancellations of unvested options and restricted
    stock                                        |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       | (2,562  | ) |  |  |    |   |  |  | 2,562  |   |  |  |         |   |  |  |        |  
|Unrealized gains on marketable securities                                                         |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       |        |   |  |  | 34  |   |  |  |       |   |  |  |         |   |  |  | 34      |  
|Net loss                                                                                          |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       |        |   |  |  |    |   |  |  |       |   |  |  | (19,678  | ) |  |  | (19,678 | )
|                                                                                                  |  |              |        |                |  |            |    |               |  |             |      |             |  |              |      |         |  |       |         |   |  |  |     |   |  |  |        |   |  |  |          |   |  |  |         |  
|Balances, March 31, 2002                                                                          |  |              | 29,761 |                |  |            | 30 |               |  |             | (395 | )           |  |              | (444 | )       |  |       | 141,877 |   |  |  |    |   |  |  | (1,169 | ) |  |  | (101,405 | ) |  |  | 38,889  |  
|Issuance of common stock upon exercise of stock
    options and warrants, net of repurchases      |  |              | 741    |                |  |            | 1  |               |  |             |     |             |  |              |     |         |  |       | 568     |   |  |  |    |   |  |  |       |   |  |  |          |   |  |  | 569     |  
|Issuance of common stock  ESPP                                                                   |  |              | 1,024  |                |  |            |    |               |  |             |     |             |  |              |     |         |  |       | 695     |   |  |  |    |   |  |  |       |   |  |  |          |   |  |  | 695     |  
|Repurchase of restricted stock                                                                    |  |              | (95    | )              |  |            |    |               |  |             | (59  | )           |  |              | (98  | )       |  |       |        |   |  |  |    |   |  |  |       |   |  |  |          |   |  |  | (98     | )
|Non-employee option grant                                                                         |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       | 22      |   |  |  |    |   |  |  |       |   |  |  |          |   |  |  | 22      |  
|Amortization of unearned stock-based compensation                                                 |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       |        |   |  |  |    |   |  |  | 310    |   |  |  |          |   |  |  | 310     |  
|Cancellations of unvested options and restricted
    stock                                        |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       | (680    | ) |  |  |    |   |  |  | 734    |   |  |  |          |   |  |  | 54      |  
|Cumulative translation adjustment                                                                 |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       |        |   |  |  | (12 | ) |  |  |       |   |  |  |          |   |  |  | (12     | )
|Net loss                                                                                          |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       |        |   |  |  |    |   |  |  |       |   |  |  | (3,974   | ) |  |  | (3,974  | )
|                                                                                                  |  |              |        |                |  |            |    |               |  |             |      |             |  |              |      |         |  |       |         |   |  |  |     |   |  |  |        |   |  |  |          |   |  |  |         |  
|Balances, March 31, 2003                                                                          |  |              | 31,431 |                |  |            | 31 |               |  |             | (454 | )           |  |              | (542 | )       |  |       | 142,482 |   |  |  | (12 | ) |  |  | (125   | ) |  |  | (105,379 | ) |  |  | 36,455  |  
|Issuance of common stock upon exercise of stock
    options and warrants, net of repurchases      |  |              | 2,132  |                |  |            | 2  |               |  |             |     |             |  |              |     |         |  |       | 2,341   |   |  |  |    |   |  |  |       |   |  |  |         |   |  |  | 2,343   |  
|Issuance of common stock  ESPP                                                                   |  |              | 521    |                |  |            | 1  |               |  |             |     |             |  |              |     |         |  |       | 748     |   |  |  |    |   |  |  |       |   |  |  |         |   |  |  | 749     |  
|Repurchase of restricted stock                                                                    |  |              |       |                |  |            |   |               |  |             | (40  | )           |  |              | (97  | )       |  |       |        |   |  |  |    |   |  |  |       |   |  |  |         |   |  |  | (97     | )
|Restricted stock grant                                                                            |  |              | 5      |                |  |            |   |               |  |             | (2   | )           |  |              | (5   | )       |  |       | 14      |   |  |  |    |   |  |  |       |   |  |  |         |   |  |  | 9       |  
|Amortization of unearned stock-based compensation                                                 |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       |        |   |  |  |    |   |  |  | 74     |   |  |  |         |   |  |  | 74      |  
|Cancellation of unvested options and restricted
    stock                                         |  |              |        |                |  |            |    |               |  |             |      |             |  |              |      |         |  |       | (45     | ) |  |  |     |   |  |  | 45     |   |  |  |          |   |  |  |        |  
|Cumulative translation adjustment                                                                 |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       |        |   |  |  | 63  |   |  |  |       |   |  |  |         |   |  |  | 63      |  
|Net loss                                                                                          |  |              |       |                |  |            |   |               |  |             |     |             |  |              |     |         |  |       |        |   |  |  |    |   |  |  |       |   |  |  | (580     | ) |  |  | (580    | )
|                                                                                                  |  |              |        |                |  |            |    |               |  |             |      |             |  |              |      |         |  |       |         |   |  |  |     |   |  |  |        |   |  |  |          |   |  |  |         |  
|Balances, March 31, 2004                                                                          |  |              | 34,089 |                |  |            | 34 |               |  |             | (496 | )           |  |              | (644 | )       |  |       | 145,540 |   |  |  | 51  |   |  |  | (6     | ) |  |  | (105,959 | ) |  |  | 39,016  |  
|                                                                                                  |  |              |        |                |  |            |    |               |  |             |      |             |  |              |      |         |  |       |         |   |  |  |     |   |  |  |        |   |  |  |          |   |  |  |         |  

The accompanying notes are an integral part of
these consolidated financial statements.

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##### Table of Contents



DIGITAL IMPACT, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands)


|                                                                                              |                                                                |                                           |        |        |        |      |        |        |       |   |         |        |        |  
|--------------------------------------------------------------------------------------------- | -------------------------------------------------------------- | ----------------------------------------- | ------ | ------ | ------ | ---- | ------ | ------ | ----- | - | ------- | ------ | ------ | -
|                                                                                              |                                                                |                                          
|                                                                                              |                                                                | Fiscal year ended March 31,              
|                                                                                              |                                                                |                                          
|                                                                                              |                                                                | 2004                                      |        | 2003   |        | 2002
|                                                                                              |                                                                |                                           |        |        |        |     
|Cash flows from operations:                                                                   |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Net loss                                                                                      |                                                                | $                                         | (580   | )      |        | $    | (3,974 | )      |       | $ | (19,678 | )     
|Adjustments to reconcile net loss to net cash
    provided by (used in) operating activities: |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|                                                                                              | Depreciation and amortization                                  |                                           |        | 5,266  |        |      |        | 6,556  |       |   |         | 7,905  |       
|                                                                                              | Provision for (recovery of) bad debts                          |                                           |        |       |        |      |        | (36    | )     |   |         | 501    |       
|                                                                                              | Amortization of unearned stock-based compensation              |                                           |        | 88     |        |      |        | 386    |       |   |         | 2,319  |       
|                                                                                              | Loss on write-off of fixed assets and other
    non-cash items |                                           |        | 300    |        |      |        | 64     |       |   |         | 1,265  |       
|                                                                                              | Unrealized loss on cash and cash equivalents                   |                                           |        |       |        |      |        |       |       |   |         | 34     |       
|                                                                                              | Change in operating assets and liabilities:                    |                                           |        |        |        |      |        |        |       |   |         |        |       
|                                                                                              |                                                                | Accounts receivable                       |        |        | (269   | )    |        |        | 324   |   |         |        | 4,207  |  
|                                                                                              |                                                                | Prepaid expenses and other current assets |        |        | 48     |      |        |        | 127   |   |         |        | (953   | )
|                                                                                              |                                                                | Restricted cash                           |        |        | (50    | )    |        |        | 27    |   |         |        | 706    |  
|                                                                                              |                                                                | Other assets                              |        |        | 351    |      |        |        | 134   |   |         |        | (286   | )
|                                                                                              |                                                                | Accounts payable                          |        |        | (719   | )    |        |        | (291  | ) |         |        | (2,028 | )
|                                                                                              |                                                                | Accrued liabilities                       |        |        | (1,262 | )    |        |        | (23   | ) |         |        | 776    |  
|                                                                                              |                                                                | Deferred revenue                          |        |        | 112    |      |        |        | 1,146 |   |         |        | (221   | )
|                                                                                              |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Net cash provided by (used in) operating
    activities                                       |                                                                |                                           | 3,285  |        |        |      | 4,440  |        |       |   | (5,453  | )     
|                                                                                              |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Cash flows from investing activities:                                                         |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|                                                                                              | Purchases of investments in marketable securities              |                                           |        | (500   | )      |      |        |       |       |   |         | (1,651 | )     
|                                                                                              | Maturities of investments in marketable securities             |                                           |        |       |        |      |        | 1,543  |       |   |         |       |       
|                                                                                              | Acquisition of property and equipment                          |                                           |        | (2,145 | )      |      |        | (4,416 | )     |   |         | (2,307 | )     
|                                                                                              |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Net cash used in investing activities                                                         |                                                                |                                           | (2,645 | )      |        |      | (2,873 | )      |       |   | (3,958  | )     
|                                                                                              |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Cash flows from financing activities:                                                         |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|                                                                                              | Principal payments on long-term debt                           |                                           |        | (1,664 | )      |      |        | (2,999 | )     |   |         | (2,349 | )     
|                                                                                              | Proceeds from issuance of common stock                         |                                           |        | 3,092  |        |      |        | 1,264  |       |   |         | 956    |       
|                                                                                              | Purchases of treasury stock                                    |                                           |        | (102   | )      |      |        | (98    | )     |   |         | (297   | )     
|                                                                                              |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Net cash provided by (used in) financing
    activities                                       |                                                                |                                           | 1,326  |        |        |      | (1,833 | )      |       |   | (1,690  | )     
|                                                                                              |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Effect of exchange rates on cash and cash
    equivalents                                     |                                                                |                                           | (75    | )      |        |      | (12    | )      |       |   |        |       
|Net increase (decrease) in cash and cash
    equivalents                                      |                                                                |                                           | 1,891  |        |        |      | (278   | )      |       |   | (11,101 | )     
|Cash and cash equivalents at beginning of year                                                |                                                                |                                           | 23,659 |        |        |      | 23,937 |        |       |   | 35,038  |       
|                                                                                              |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Cash and cash equivalents at end of year                                                      |                                                                | $                                         | 25,550 |        |        | $    | 23,659 |        |       | $ | 23,937  |       
|                                                                                              |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Supplemental disclosure of cash flow information:                                             |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Cash paid for interest                                                                        |                                                                | $                                         | 100    |        |        | $    | 386    |        |       | $ | 520     |       
|Supplemental disclosure of non-cash financing
    activities:                                 |                                                                |                                           |        |        |        |      |        |        |       |   |         |       
|Assets acquired under capital leases                                                          |                                                                |                                           | 316    |        |        |      | 1,404  |        |       |   | 1,102   |       
|Unearned stock-based compensation                                                             |                                                                | $                                         | (31    | )      |        | $    | (658   | )      |       | $ | (899    | )     

The accompanying notes are an integral part of
these consolidated financial statements.

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##### Table of Contents



DIGITAL IMPACT, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|        |            
|------- | -----------
|Note 1. | The Company

Digital Impact, Inc. (the Company or
Digital Impact) was incorporated in California in
October 1997 and reincorporated in Delaware in October 1999.
Digital Impact is a premier provider of online direct marketing
solutions for enterprises. The Companys solutions enable
corporations to create and deliver online direct marketing
programs that drive revenue, influence behavior and deepen
customer relationships. The Companys solutions provide
customer insight and powerful program execution through a
combination of hosted applications, technology infrastructure
and digital marketing services.

Digital Impact derives its revenues from the sale
of solutions that enable businesses to proactively communicate
with their customers online. Primarily, these services have
consisted of the design and execution of online direct marketing
campaigns, the development and execution of Customer Acquisition
programs and additional services provided by the Professional
Services organization.

Digital Impact is organized into two segments:
Customer Marketing and Professional Services. Customer Marketing
consists of creating and executing online direct marketing
programs. Professional Services include several categories of
services designed to improve campaign results.



|        |                                               
|------- | ----------------------------------------------
|Note 2. | Summary of Significant Accounting
    Policies



| |                                    
| | -----------------------------------
| | Basis of presentation and liquidity

The condensed consolidated financial statements
include the accounts of Digital Impact and its wholly owned
subsidiary. All significant intercompany accounts and balances
have been eliminated.

Certain reclassifications have been made to the
prior years consolidated financial statements to conform
to the current years presentation. The reclassifications
had no effect on prior years stockholders equity.

The Company incurred a net loss of approximately
$580,000 for the year ended March 31, 2004 and generated
cash of $3.3 million from operating activities for that
period.

The Company continues to face risks associated
with the execution of its strategy. Future cash flows and
capital requirements depend on numerous factors, including
market acceptance of its services, competition from new and
existing competitors, the amount of resources it invests in its
data center infrastructure and new product development,
marketing and selling its products and services, brand
promotions and any future acquisitions or divestitures.

The Companys primary source of liquidity is
$25.6 million in cash and cash equivalents, and $608,000 in
short-term investments. The Company believes it has the
necessary financial resources to fund its working capital needs,
capital expenditures and other business requirements for at
least the next 12 months.



| |                 
| | ----------------
| | Use of estimates

Preparation of the accompanying financial
statements in conformity with generally accepted accounting
principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts
of revenues and expenses during the reported period. Significant
estimates include those required in the valuation of intangible
assets acquired in business combinations, allowances for
doubtful accounts and sales allowances. Actual results could
differ from those estimates.



| |                             
| | ----------------------------
| | Foreign currency translation

The functional currency for the Companys
U.K. subsidiary is the U.K. Pound. Assets and liabilities are
translated using the exchange rate at the balance sheet date.
Revenues, expenses, gains, and losses are translated using the
exchange rate at the end of the month in which the transaction
occurred. Translation

31



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DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

gains and losses are accumulated as a separate
component of stockholders equity. Net gains and losses
from foreign currency transactions are included in the
Consolidated Statement of Operations and were not significant
during any of the periods presented.



| |                    
| | -------------------
| | Revenue recognition

The Company generates revenue from the sale of
solutions that enable businesses to proactively communicate with
its customers online.

Digital Impact applies the provisions of Staff
Accounting Bulletin 104 Revenue Recognition and
recognizes revenue when persuasive evidence of an arrangement
exists, the service has been delivered, the fee is fixed or
determinable and collection of the resulting receivables is
reasonably assured. Customer Marketing revenues are recognized
upon sending the campaigns. Revenues attributable to one-time
set-up fees for service initiation are deferred and recognized
ratably over the term of the clients service agreement,
typically twelve months. Customer Acquisition revenues are
derived primarily from programs that assist clients in growing
their email lists through the use of third-party list rentals.
Customer Acquisition programs fall into three general
categories: List Rental, ProspectNet and search engine marketing
programs. List Rental programs involve the execution and
delivery of email campaigns to a defined number of individuals
provided by a third-party list rental or email address marketing
service. ProspectNet programs involve the strategic placement of
a Digital Impact client offer on a third-party site for the
purpose of generating new opt-in email addresses for the client.
Search engine marketing involves the expert management of
search, placement, traffic flow, and analytical data for our
clients. Digital Impact contracts with third-party providers to
deliver names of individuals who opt-in to join the
clients email list. Digital Impact is obligated to make
payments to third parties for the cost of services associated
with the execution of List Rental and ProspectNet programs.
Digital Impact accounts for revenues and costs associated with
Customer Acquisition programs in accordance with Emerging Issues
Task Force Issue No. 99-19 (EITF 99-19), Reporting
Revenue Gross as a Principal versus Net as an Agent. The
cost of Customer Acquisition campaigns are recognized in the
period that the programs are executed and are netted against
program revenue. The cost of Customer Acquisition campaigns are
estimated using Company records of outstanding purchase
commitments when final vendor invoices have not been received.

Digital Impact recognizes revenue net of
third-party costs because the majority of client and supplier
contracts have the following characteristics: the supplier, not
the Company, is the primary obligor in the arrangement, the
Company has limited latitude in establishing the price charged
to the client, the Companys credit risk is sometimes
mitigated by receiving prepayment or reduced credit terms from
its clients before ordering from the supplier, the Company does
not maintain any inventory related to Customer Acquisition
programs, the Company does not make changes to any data acquired
from the supplier, and the client approves the supplier
selection and the service specifications.

Digital Impact provides other complementary
services to clients, such as strategy, solutions engineering,
web-page development, creative design and data analytics. These
services are typically billed on an hourly rate. The revenue for
engagements that support the delivery of future products and
services, such as targeted solutions, is deferred at the time of
delivery and recognized pro-rata over the future periods of
usage. The period over which the revenue is recognized varies,
generally between one and twelve months, depending on the term
of the contract or the estimated period of usage. Management
uses their best estimates to determine the appropriate period
for revenue deferral.

The Company assesses the probability of
collection based on a number of factors, including its past
transaction history with the customer and the credit-worthiness
of the customer. New customers and certain existing customers
are subject to a credit review process that evaluates the
customers financial position and ultimately their ability
to pay according to the original terms of the arrangement. Based
on the Companys

32



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

review process, if it is determined from the
outset or during the term of an arrangement that collection of
the resulting receivable is not probable, then revenue is
recognized on a cash-collected basis.



| |                                                      
| | -----------------------------------------------------
| | Cash, cash equivalents and short-term
    investments

The Company considers all highly liquid
investments with an original or remaining maturity of three
months or less at the time of purchase to be cash equivalents.

Short-term investments consist of certificates of
deposit and are classified as current assets because they have a
maturity of less than one year.

Digital Impact classifies short-term investments
as available-for-sale. Accordingly, these investments are
carried at fair value, with unrealized gains and losses reported
as a separate component of stockholders equity. Digital
Impact realizes gains or losses when these investments are sold
using the specific identification method. Digital Impact has not
recognized any material gains of losses from the sale of
short-term investments.

As of March 31, 2004, we had
$1.2 million in restricted cash, $1.1 million of which
represents cash pledged as collateral for letters of credit that
collateralize the Companys operating leases.



| |                                                                   
| | ------------------------------------------------------------------
| | Concentration of credit risk and other risks
    and uncertainties

Financial instruments subjecting the Company to
concentration of credit risk consist primarily of cash and cash
equivalents and trade accounts receivable. The Companys
cash and cash equivalents are maintained at a major
U.S. financial institution. Deposits in this institution
may exceed the amount of insurance provided on such deposits.

The Companys customers are primarily
concentrated in the United States. The Company performs ongoing
credit evaluations and establishes an allowance for doubtful
accounts based upon factors surrounding the credit risk of
customers, historical trends and other information. For the
fiscal year ended March 31, 2004, two customers represented
11% and 12% of revenue. In fiscal year 2003, one customer
represented 14% of revenue. As of March 31, 2004, two
customers represented 10% and 12% of accounts receivable, while
as of March 31, 2003, one customer represented 18% of
accounts receivable. For the fiscal year ended March 31,
2002, one customer represented 11% of revenue, and one customer
represented 17% of accounts receivable.



| |                                 
| | --------------------------------
| | Research and development expense

Research and development expenses consist
primarily of salary and related personnel expense, consulting
fees and other operating expenses related to the research and
development departments. The research and development
departments perform new product development, enhance and
maintain existing products and perform quality assurance. With
the exception of capitalized software development costs,
research and development costs are expensed as incurred.

The Company follows the provisions outlined in
Statement of Position 98-1 Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use
related to the treatment of costs.

The Company capitalizes certain direct costs
incurred in the development of internal use software. For the
fiscal years ended March 31, 2004, 2003 and 2002, the
Company capitalized approximately $311,000, $84,000 and $120,000
in software development costs, respectively. These costs are
being amortized using the straight-line method over the
estimated useful life of the software, generally two years,
beginning when the software is ready for use. These amounts are
included in property and equipment in the accompanying
consolidated balance sheet.

33



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)



| |                  
| | -----------------
| | Long-lived assets

Property and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation and
amortization is computed using the straight-line method over the
shorter of the estimated useful lives of the assets, generally
three to five years, or the lease term, if applicable. Gains and
losses upon asset disposal are taken into Other Income (Expense)
in the year of disposition. Maintenance and repairs are charged
to operations as incurred.

Long-lived assets, such as property and equipment
and purchased intangibles subject to amortization, are reviewed
for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to
estimated discounted future cash flows expected to be generated
by the asset. If the carrying amount of an asset exceeds its
estimated fair value, an impairment charge is recognized by the
amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of are separately
presented in the balance sheet and reported at the lower of the
carrying amount or fair value less costs to sell, and are no
longer depreciated.



| |                                     
| | ------------------------------------
| | Goodwill and other intangible assets

In accordance with Statement of Financial
Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets
(SFAS No. 142), goodwill is no longer
subject to amortization, but rather is subject to at least an
annual assessment for impairment. The company completed its
annual impairment test in March 2004 and determined that no
impairment existed.



| |             
| | ------------
| | Income taxes

Deferred tax assets and liabilities are
determined based on the differences between financial reporting
and tax basis of assets and liabilities, measured at tax rates
that will be in effect when the differences are expected to
reverse. Valuation allowances are established when necessary to
reduce deferred tax assets to the amounts expected to be
realized. As of March 31, 2004, the Company had recorded a
full valuation allowance against its deferred tax assets.



| |                                            
| | -------------------------------------------
| | Accounting for stock-based
    compensation

SFAS No. 123, Accounting for
Stock-Based Compensation (FSAS No. 123),
as amended by SFAS No. 148, permits companies to
measure the compensation cost of stock-based awards based on
either their intrinsic value or their estimated fair value at
the date of grant and recognize the amount over the related
service period. Therefore, as permitted by
SFAS No. 123 and SFAS No. 148, the Company
accounts for its employee stock option plans under the intrinsic
value method, in accordance with the provisions of Accounting
Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees,and
related interpretations. As such, compensation expense related
to the granting of employee stock options is recorded over the
vesting period only if, on the date of grant, the fair value of
the underlying stock exceeds the options exercise price.
Digital Impact has adopted the disclosure-only requirements of
SFAS No. 123, which allows entities to continue to
apply the provisions of APB No. 25 for transactions with
employees and provide pro forma net income and pro forma
earnings per share disclosures for employee stock grants made as
if the fair value based method of accounting in
SFAS No. 123 had been applied to these transactions.

34



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

Had the Company determined compensation expense
of employee stock options based on the estimated fair value of
the stock options at the grant date, consistent with the
guidelines of SFAS 123, the net loss would have been
increased to the pro forma amounts indicated below (in
thousands, except per share amounts):

|                                                                                                   |  |           |        |      |  |      |        |   |  |   |         |  
|-------------------------------------------------------------------------------------------------- |  | --------- | ------ | ---- |  | ---- | ------ | - |  | - | ------- | -
|                                                                                                   |  |          
|                                                                                                   |  | March 31,
|                                                                                                   |  |          
|                                                                                                   |  | 2004      |        | 2003 |  | 2002
|                                                                                                   |  |           |        |      |  |     
|Net loss, as reported                                                                              |  | $         | (580   | )    |  | $    | (3,974 | ) |  | $ | (19,678 | )
|Add: Stock-based employee compensation expense
    included in reported net loss                   |  |           | 94     |      |  |      | 363    |   |  |   | 2,256   |  
|Deduct: total stock-based compensation determined
    under fair value based method for all awards |  |           | (2,123 | )    |  |      | (3,263 | ) |  |   | (5,593  | )
|                                                                                                   |  |           |        |      |  |      |        |   |  |   |         |  
|Pro forma net loss, fair value method for all
    stock-based awards                               |  | $         | (2,609 | )    |  | $    | (6,874 | ) |  | $ | (23,015 | )
|                                                                                                   |  |           |        |      |  |      |        |   |  |   |         |  
|Basic and diluted net loss per share:                                                              |  |           |        |      |  |      |        |   |  |   |         |  
|As reported                                                                                        |  | $         | (0.02  | )    |  | $    | (0.13  | ) |  | $ | (0.70   | )
|Pro forma                                                                                          |  | $         | (0.08  | )    |  | $    | (0.23  | ) |  | $ | (0.82   | )

The fair value for each option granted was
estimated at the date of grant using the Black-Scholes
option-pricing model, assuming no expected dividends and the
following weighted average assumptions:

|                                         |  |                      |      |                        |  |      |      |      |  |      |      |      |  |  |      |   |  |  |      |   |  |  |      |  
|---------------------------------------- |  | -------------------- | ---- | ---------------------- |  | ---- | ---- | ---- |  | ---- | ---- | ---- |  |  | ---- | - |  |  | ---- | - |  |  | ---- | -
|                                         |  |                      |      |                        |  |      |      |     
|                                         |  |                      |      | Employee StockPurchase
|                                         |  | Stock Options        |      | Plan                  
|                                         |  |                      |      |                       
|                                         |  |                      |      |                       
|                                         |  | Year ended March 31, |      | Year ended March 31,  
|                                         |  |                      |      |                       
|                                         |  | 2004                 |      | 2003                   |  | 2002 |      | 2004 |  | 2003 |      | 2002
|                                         |  |                      |      |                        |  |      |      |      |  |      |      |     
|Expected volatility                      |  |                      | 74   | %                      |  |      | 90   | %    |  |      | 115  | %    |  |  | 88   | % |  |  | 90   | % |  |  | 115  | %
|Weighted average risk-free interest rate |  |                      | 2.95 | %                      |  |      | 3.45 | %    |  |      | 4.23 | %    |  |  | 1.28 | % |  |  | 2.11 | % |  |  | 3.39 | %
|Expected life in years                   |  |                      | 4.2  |                        |  |      | 6.5  |      |  |      | 6.5  |      |  |  | 0.75 |   |  |  | 0.75 |   |  |  | 0.75 |  
|Expected dividends                       |  |                      | 0    | %                      |  |      | 0    | %    |  |      | 0    | %    |  |  | 0    | % |  |  | 0    | % |  |  | 0    | %

Based on the above assumptions, the weighted
average fair value per share of options granted at fair market
value for the years ended March 31, 2004, 2003 and 2002,
was $1.37, $1.18 and $0.72, respectively. No options were
granted below fair market value for the fiscal years ended
March 31, 2004, 2003 and 2002.

The pro forma impact of options on the net loss
for the years ended March 31, 2004, 2003 and 2002, may not
be representative of the effects on net income (loss) for future
years, as future years will include the effects of additional
years of stock option grants.



| |                   
| | ------------------
| | Comprehensive loss

Comprehensive loss is defined as the change in
equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner
sources. Other comprehensive loss, a component of
stockholders equity, recorded by the Company for the
fiscal years ended March 31, 2004, 2003 and 2002 was
attributable to unrealized gains and losses on cash equivalents
and the impact of foreign currency translation losses.



| |                          
| | -------------------------
| | Net loss per common share

Basic net loss per share is calculated by
dividing net loss by the weighted average number of vested
common shares outstanding for the period. Diluted net loss per
share is calculated giving effect to all dilutive potential
common shares, including options and preferred stock. A
reconciliation of the numerators and

35



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

denominators used in the basic and diluted net
loss per share amounts follows (amounts in thousands, except per
share data):

|                                                  |                                                                   |                             |        |        |   |      |        |        |   |   |        |         |  
|------------------------------------------------- | ----------------------------------------------------------------- | --------------------------- | ------ | ------ | - | ---- | ------ | ------ | - | - | ------ | ------- | -
|                                                  |                                                                   |                            
|                                                  |                                                                   | Fiscal year ended March 31,
|                                                  |                                                                   |                            
|                                                  |                                                                   | 2004                        |        | 2003   |   | 2002
|                                                  |                                                                   |                             |        |        |   |     
|Numerator:                                        |                                                                   |                             |        |        |   |      |        |        |   |   |        |        
|                                                  | Net loss                                                          |                             | $      | (580   | ) |      | $      | (3,974 | ) |   | $      | (19,678 | )
|                                                  |                                                                   |                             |        |        |   |      |        |        |   |   |        |        
|Denominator:                                      |                                                                   |                             |        |        |   |      |        |        |   |   |        |        
|                                                  | Weighted average common shares outstanding                        |                             |        | 32,950 |   |      |        | 30,300 |   |   |        | 28,315  |  
|                                                  | Weighted average unvested common shares subject
    to repurchase |                             |        |       |   |      |        | (10    | ) |   |        | (355    | )
|                                                  |                                                                   |                             |        |        |   |      |        |        |   |   |        |        
|Denominator for basic and diluted calculation     |                                                                   |                             | 32,950 |        |   |      | 30,290 |        |   |   | 27,960 |        
|                                                  |                                                                   |                             |        |        |   |      |        |        |   |   |        |        
|Net loss per common share  basic and
    diluted |                                                                   | $                           | (0.02  | )      |   | $    | (0.13  | )      |   | $ | (0.70  | )      
|                                                  |                                                                   |                             |        |        |   |      |        |        |   |   |        |        

The following outstanding stock options, shares
subject to repurchase by the Company and warrants have been
excluded from the calculation of diluted net loss per common
share because all such securities are antidilutive for all
periods presented (in thousands):

|                             |  |                             |       |      |  |      |       |  |  |  |       | 
|---------------------------- |  | --------------------------- | ----- | ---- |  | ---- | ----- |  |  |  | ----- | 
|                             |  |                            
|                             |  | Fiscal year ended March 31,
|                             |  |                            
|                             |  | 2004                        |       | 2003 |  | 2002
|                             |  |                             |       |      |  |     
|Options                      |  |                             | 7,323 |      |  |      | 7,935 |  |  |  | 8,410 | 
|Shares subject to repurchase |  |                             |      |      |  |      | 220   |  |  |  | 389   | 



| |                                 
| | --------------------------------
| | Recent accounting pronouncements

In November 2002, the EITF reached consensus on
Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables. EITF 00-21 provides guidance on how to
account for arrangements that involve the delivery or
performance of multiple products, services and/or rights to use
assets. The provisions of EITF Issue No. 00-21 applies to
revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. The adoption of this standard did not
have a material effect on its financial position or results of
operations.

On March 31, 2004, the FASB issued a
proposed Statement, Share-Based Payment, an amendment of
FASB Statements Nos. 123 and 95, that addresses the
accounting for share-based payment transactions in which an
enterprise receives employee services in exchange for either
equity instruments of the enterprise or, liabilities that are
based on the fair value of the enterprises equity
instruments or that may be settled by the issuance of such
equity instruments. The proposed statement would eliminate the
ability to account for share-based compensation transactions
using Accounting Principles Board, or APB, Opinion No. 25,
Accounting for Stock Issued to Employees, and
generally would require that such transactions be accounted for
using a fair-value-based method and recognized as expenses in
our consolidated statement of income. The proposed standard
would require the modified prospective method be used, which
would require that the fair value of new awards granted from the
beginning of the year of adoption plus unvested awards at the
date of adoption be expensed over the vesting period. In
addition, the proposed statement encourages companies to use the
binomial approach to value stock options, which
differs from the Black-Scholes option pricing model that we
currently use to determine the fair value of our options. The
proposed standard is recommending that the effective date for
public companies be fiscal years beginning after
December 15, 2004. Should this proposed statement be
finalized in its current form, it will have a significant impact
on our consolidated statement of operations as we will be
required to expense the fair value of our stock options rather
than disclosing the impact on our consolidated net loss within
our notes as is our current practice.

36



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)



|        |                         
|------- | ------------------------
|Note 3. | Balance Sheet Components



| |                            
| | ---------------------------
| | Property and equipment, net

|                                 |  |                |         |      |  |   |         |  
|-------------------------------- |  | -------------- | ------- | ---- |  | - | ------- | -
|                                 |  |               
|                                 |  | March 31,     
|                                 |  |               
|                                 |  | 2004           |         | 2003
|                                 |  |                |         |     
|                                 |  |               
|                                 |  | (In thousands)
|Furniture and office equipment   |  | $              | 1,335   |      |  | $ | 1,322   |  
|Capitalized software development |  |                | 515     |      |  |   | 204     |  
|Computer equipment and software  |  |                | 22,161  |      |  |   | 22,172  |  
|                                 |  |                |         |      |  |   |         |  
|Total cost                       |  |                | 24,011  |      |  |   | 23,698  |  
|Less accumulated depreciation    |  |                | (17,911 | )    |  |   | (14,789 | )
|                                 |  |                |         |      |  |   |         |  
|                                 |  | $              | 6,100   |      |  | $ | 8,909   |  
|                                 |  |                |         |      |  |   |         |  

Depreciation and amortization expense for
property and equipment was approximately $5.0 million,
$5.7 million, and $5.8 million for the years ended
March 31, 2004, 2003 and 2002, respectively. Amortization
of capitalized software development was approximately $27,000
and $177,000 for the year ended March 31, 2004 and 2003,
respectively.



| |         
| | --------
| | Goodwill

Goodwill consisted of the following: (in
thousands)

|                         |  |           |        |      |  |   |        |  
|------------------------ |  | --------- | ------ | ---- |  | - | ------ | -
|                         |  |          
|                         |  | March 31,
|                         |  |          
|                         |  | 2004      |        | 2003
|                         |  |           |        |     
|Goodwill                 |  | $         | 9,933  |      |  | $ | 9,933  |  
|Accumulated amortization |  |           | (7,931 | )    |  |   | (7,931 | )
|                         |  |           |        |      |  |   |        |  
|                         |  | $         | 2,002  |      |  | $ | 2,002  |  
|                         |  |           |        |      |  |   |        |  

Upon adoption of SFAS No. 142 on
April 1, 2002, the Company ceased amortizing goodwill. The
following adjusts reported net loss and basic and diluted net
loss per share as if the adoption of SFAS No. 142
occurred as of April 2000.

|                                                                  |                       |                       |        |       |   |      |        |       |   |   |         |       |  
|----------------------------------------------------------------- | --------------------- | --------------------- | ------ | ----- | - | ---- | ------ | ----- | - | - | ------- | ----- | -
|                                                                  |                       |                      
|                                                                  |                       | Year ended March 31, 
|                                                                  |                       |                      
|                                                                  |                       | 2004                  |        | 2003  |   | 2002
|                                                                  |                       |                       |        |       |   |     
|                                                                  |                       |                      
|                                                                  |                       | (In thousands, except
|                                                                  |                       | per share amounts)   
|Reported net loss                                                 |                       | $                     | (580   | )     |   | $    | (3,974 | )     |   | $ | (19,678 | )    
|Goodwill amortization                                             |                       |                       |       |       |   |      |       |       |   |   | 1,500   |      
|                                                                  |                       |                       |        |       |   |      |        |       |   |   |         |      
|Adjusted net loss                                                 |                       | $                     | (580   | )     |   | $    | (3,974 | )     |   | $ | (18,178 | )    
|                                                                  |                       |                       |        |       |   |      |        |       |   |   |         |      
|Basic and Diluted net loss per share                              |                       |                       |        |       |   |      |        |       |   |   |         |      
|                                                                  | Reported net loss     |                       | $      | (0.02 | ) |      | $      | (0.13 | ) |   | $       | (0.70 | )
|                                                                  | Goodwill amortization |                       |        |      |   |      |        |      |   |   | $       | 0.05  |  
|                                                                  |                       |                       |        |       |   |      |        |       |   |   |         |      
|                                                                  | Adjusted net loss     |                       | $      | (0.02 | ) |      | $      | (0.13 | ) |   | $       | (0.65 | )
|                                                                  |                       |                       |        |       |   |      |        |       |   |   |         |      
|Shares used in computing basic and diluted net
    loss per share |                       |                       | 32,950 |       |   |      | 30,290 |       |   |   | 27,960  |      

37



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)



| |                  
| | -----------------
| | Intangible assets

Intangible assets consist of the following: (in
thousands)

|                         |  |           |        |      |  |      |        |   |  |   |        |  
|------------------------ |  | --------- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                         |  |          
|                         |  | March 31,
|                         |  |          
|                         |  | 2004      |        | 2003 |  | 2002
|                         |  |           |        |      |  |     
|Intangible assets        |  | $         | 1,930  |      |  | $    | 1,930  |   |  | $ | 1,930  |  
|Accumulated amortization |  |           | (1,930 | )    |  |      | (1,716 | ) |  |   | (1,072 | )
|                         |  |           |        |      |  |      |        |   |  |   |        |  
|                         |  | $         |       |      |  | $    | 214    |   |  | $ | 858    |  
|                         |  |           |        |      |  |      |        |   |  |   |        |  

Amortization expense was $214,000, $644,000 and
$644,000 for the years ended March 31, 2004, 2003 and 2002,
respectively.



|        |                               
|------- | ------------------------------
|Note 4. | Long-Term Debt and Commitments



| |               
| | --------------
| | Long-term debt

In fiscal 2004, the Company signed an agreement
to finance a software purchase. The amount borrowed under the
agreement is $316,000 and bears interest at a rate of
2.0% per year. As of March 31, 2004, $238,000 remained
outstanding.



| |                 
| | ----------------
| | Operating leases

The Company leases its facilities under operating
leases, which expire between 2005 and 2008. Rent expense for the
years ended March 31, 2004, 2003 and 2002 was
$2.8 million, $2.9 million, and $4.5 million,
respectively.

Future minimum debt and lease payments under
noncancelable capital and operating leases, including lease
commitments entered into as of March 31, 2004, are as
follows (in thousands):

|                      |                        |           |     |           |  |   |       |       | 
|--------------------- | ---------------------- | --------- | --- | --------- |  | - | ----- | ----- | 
|                      |                        | Long-term |     | Operating
|Year Ending March 31, |                        | Debt      |     | Leases   
|                      |                        |           |     |          
|2005                  |                        | $         | 158 |           |  | $ | 3,086 |      
|2006                  |                        |           | 80  |           |  |   | 2,296 |      
|2007                  |                        |           |    |           |  |   | 2,324 |      
|2008 and thereafter   |                        |           |    |           |  |   | 204   |      
|                      |                        |           |     |           |  |   |       |      
|                      | Total minimum payments |           | $   | 238       |  |   | $     | 7,910 | 
|                      |                        |           |     |           |  |   |       |      



| |                 
| | ----------------
| | Letter of credit

In 2000, the Company obtained a letter of credit
from a financial institution totaling $1.1 million in lieu
of a security deposit for leased office space which is
collateralized by an amount of $1.1 million of cash which
is classified as restricted cash and held in long-term other
assets. No amounts have been drawn against the letter of credit
at March 31, 2004.



|        |                     
|------- | --------------------
|Note 5. | Stockholders Equity



| |                            
| | ---------------------------
| | Convertible preferred stock

The Company is authorized to issue up to
5,000,000 shares of convertible preferred stock, par value
$0.001 per share. As of March 31, 2004 and 2003, there
were no shares of preferred stock issued or outstanding.

38



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)



| |             
| | ------------
| | Common stock

Each share of common stock has the right to one
vote. The holders of common stock are also entitled to receive
dividends whenever funds are legally available and when declared
by the Board of Directors, subject to the prior rights of
holders of all classes of stock outstanding having priority
rights as to dividends. No dividends have been declared or paid
through March 31, 2004.



| |                   
| | ------------------
| | Stock option plans

The Companys 1998 Stock Plan (the
Plan) provides for the grant of options and other
equity-based incentives covering up to 12,643,000 shares of
the Companys common stock to the Companys employees,
directors, and consultants, plus an annual increase to be added
on January 1 of each year, equal to the lesser of
1,500,000 shares, 5% of outstanding shares on such date or
a lesser amount determined by the Board of Directors. Options
granted under the Plan may be incentive stock options or
non-statutory stock options. Incentive stock options may only be
granted to employees. Although the Board of Directors has the
authority to set the period over which options becomes
exercisable, generally the options will become exercisable for
25% of the option shares one year from the date of grant and
then ratably over the following 36 months, respectively.
The exercise price of incentive stock options and non-statutory
stock options shall be no less than 100% and 85%, respectively,
of the fair market value per share of the Companys common
stock on the grant date.

A summary of the stock option activity for all
plans for the three years ended March 31, 2004 is as
follows:

|                         |  |                       |        |                |  |   |      | 
|------------------------ |  | --------------------- | ------ | -------------- |  | - | ---- | 
|                         |  | Outstanding           |        | Weighted      
|                         |  | number of             |        | average       
|                         |  | options               |        | exercise price
|                         |  |                       |        |               
|                         |  |                      
|                         |  | (Shares in thousands)
|Balances, March 31, 2001 |  |                       | 7,691  |                |  | $ | 5.29 | 
|Options granted          |  |                       | 5,009  |                |  | $ | 0.85 | 
|Options exercised        |  |                       | (641   | )              |  | $ | 0.81 | 
|Options cancelled        |  |                       | (3,649 | )              |  | $ | 5.75 | 
|                         |  |                       |        |                |  |   |      | 
|Balances, March 31, 2002 |  |                       | 8,410  |                |  | $ | 2.78 | 
|Options granted          |  |                       | 1,778  |                |  | $ | 1.54 | 
|Options exercised        |  |                       | (741   | )              |  | $ | 0.75 | 
|Options cancelled        |  |                       | (1,512 | )              |  | $ | 3.42 | 
|                         |  |                       |        |                |  |   |      | 
|Balances, March 31, 2003 |  |                       | 7,935  |                |  | $ | 2.57 | 
|Options granted          |  |                       | 3,478  |                |  | $ | 2.46 | 
|Options exercised        |  |                       | (2,132 | )              |  | $ | 1.10 | 
|Options cancelled        |  |                       | (1,958 | )              |  | $ | 3.28 | 
|                         |  |                       |        |                |  |   |      | 
|Balances, March 31, 2004 |  |                       | 7,323  |                |  | $ | 2.76 | 
|                         |  |                       |        |                |  |   |      | 

At March 31, 2004, 2003 and 2002, there were
4,878,000, 4,694,000 and 2,612,000 shares available for
grant, respectively.



| |                          
| | -------------------------
| | 1999 director option plan

In September 1999, the Company adopted the
1999 Director Option Plan under which 1,500,000 shares
of common stock have been reserved for issuance to non-employee
members of the Companys Board of Directors. As of
March 31, 2004, 130,000 options have been granted under
this plan.

39



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)



| |                                    
| | -----------------------------------
| | Options outstanding and exercisable

The following table summarizes information about
options outstanding and exercisable at March 31, 2004.

|                   |                |                |  |                  |       |                |  |                |     |                |  |   |       |  |  |  |       |  |  |   |       | 
|------------------ | -------------- | -------------- |  | ---------------- | ----- | -------------- |  | -------------- | --- | -------------- |  | - | ----- |  |  |  | ----- |  |  | - | ----- | 
|                   |                |                |  |                  |       |               
|                   |                | Outstanding    |  |                  |       |               
|                   |                |                |  |                 
|                   |                |                |  | Weighted         |       |                |  | Exercisable   
|                   |                |                |  | Average          |       |                |  |               
|                   |                |                |  | Remaining        |       | Weighted       |  |                |     | Weighted      
|Range of Per Share |                | Number of      |  | Contractual Life |       | Average        |  | Number of      |     | Average       
|Exercise Prices    |                | Options        |  | (Years)          |       | Exercise Price |  | Options        |     | Exercise Price
|                   |                |                |  |                  |       |                |  |                |     |               
|                   |                | (In thousands) |  |                  |       |                |  | (In thousands) |     |               
|                   | $0.02  $1.17  |                |  |                  | 1,786 |                |  |                | 7.4 |                |  | $ | 0.72  |  |  |  | 1,333 |  |  | $ | 0.72  | 
|                   | $1.24  $1.70  |                |  |                  | 1,161 |                |  |                | 8.7 |                |  | $ | 1.41  |  |  |  | 382   |  |  | $ | 1.44  | 
|                   | $1.73  $2.35  |                |  |                  | 628   |                |  |                | 8.0 |                |  | $ | 2.01  |  |  |  | 352   |  |  | $ | 1.94  | 
|                   | $2.38  $2.45  |                |  |                  | 479   |                |  |                | 8.8 |                |  | $ | 2.41  |  |  |  | 103   |  |  | $ | 2.41  | 
|                   | $2.48  $2.50  |                |  |                  | 312   |                |  |                | 8.2 |                |  | $ | 2.49  |  |  |  | 122   |  |  | $ | 2.50  | 
|                   | $2.55  $2.55  |                |  |                  | 1,283 |                |  |                | 9.6 |                |  | $ | 2.55  |  |  |  | 149   |  |  | $ | 2.55  | 
|                   | $2.61  $2.75  |                |  |                  | 790   |                |  |                | 9.7 |                |  | $ | 2.68  |  |  |  | 47    |  |  | $ | 2.69  | 
|                   | $2.79  $3.70  |                |  |                  | 109   |                |  |                | 8.1 |                |  | $ | 3.02  |  |  |  | 45    |  |  | $ | 3.26  | 
|                   | $4.63  $7.00  |                |  |                  | 225   |                |  |                | 6.0 |                |  | $ | 6.72  |  |  |  | 212   |  |  | $ | 6.73  | 
|                   | $8.00  $48.88 |                |  |                  | 548   |                |  |                | 6.2 |                |  | $ | 12.53 |  |  |  | 525   |  |  | $ | 12.66 | 
|                   |                |                |  |                  |       |                |  |                |     |                |  |   |       |  |  |  |       |  |  |   |       | 
|                   |                |                |  |                  | 7,323 |                |  |                | 8.3 |                |  | $ | 2.76  |  |  |  | 3,270 |  |  | $ | 3.51  | 
|                   |                |                |  |                  |       |                |  |                |     |                |  |   |       |  |  |  |       |  |  |   |       | 

At March 31, 2004, 2003 and 2002, there were
3,270,000, 4,546,000 and 2,687,000 options outstanding and
exercisable at weighted average exercise prices of $3.51, $2.90
and $3.92, respectively.



| |                        
| | -----------------------
| | Restricted stock grants

In March 2001, the Company issued approximately
548,000 shares of restricted stock with a fair value of
$1.34 per share as part of a retention program designed to
retain key employees. Half of the restricted stock vested on the
date of issuance. The remainder vested on September 16,
2001. As a result, the Company recognized approximately $361,000
of compensation expense in the fiscal year ended March 31,
2001, for the shares that vested immediately, and recorded
unearned stock-based compensation totaling approximately
$375,000 for the shares that vest in September 2001. The
$375,000 of recorded unearned stock-based compensation was
recognized as stock-based compensation expense in the fiscal
year ended March 31, 2002.

In April 2001, the Company issued approximately
797,500 shares of restricted stock with a fair value of
$1.67 per share in exchange for the cancellation of
approximately 737,500 options. The restricted stock was issued
with a purchase price of $0.001 with one-sixth of the stock
vesting on the grant date and the remainder vesting over three
years. The Company recorded unearned stock-based compensation of
approximately $1.3 million which will be recognized over
the vesting period of the restricted stock.

In December 2001, the Company issued
approximately 375,000 restricted stock units with a fair value
of $0.73 per underlying share to an executive officer in
exchange for the cancellation of 375,000 options. Approximately
140,000 restricted stock units were vested on the grant date,
with the remaining units vesting quarterly through February
2004. As a result, the Company recognized approximately $177,000
of compensation expense in the fiscal year ended March 31,
2002 for the restricted stock units that vested in that fiscal
year, and recorded stock-based compensation expense totaling
$98,000 for the restricted stock units that vest quarterly
through February 2004.

40



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)



| |                             
| | ----------------------------
| | Employee stock purchase plan

In September 1999, the Board of Directors adopted
the employee stock purchase plan under which 3.1 million
shares have been reserved for issuance. The number of shares is
subject to an annual increase as defined in the plan document.
The 1999 employee stock purchase plan contains successive
six-month offering periods and the price of stock purchased
under the plan is 85% of the lower of the fair value of the
common stock either at the beginning of the period or at the
end. As of March 31, 2004, the Company had issued
2.4 million shares under the plan at a weighted average
price of $1.45 per share.



|        |                      
|------- | ---------------------
|Note 6. | Restructuring Charges

The restructuring charges for the fiscal years
ended March 31, 2004, 2003 and 2002 have been included in
cost of revenues, research and development, sales and marketing
and general and administrative expenses.



| |                          
| | -------------------------
| | Fiscal 2002 restructuring

In the fourth quarter of fiscal 2002, the
Companys management took certain actions to increase
operational efficiencies and bring costs in line with revenues.
These measures included the involuntary terminations of
approximately 24 employees, as well as the consolidation of some
leased office space. As a consequence, the Company recorded a
$1.2 million charge to operations during the fiscal year
ended March 31, 2002. This charge included approximately
$100,000 for severance-related payments to terminated employees,
approximately $690,000 related to the Companys decision to
exit and reduce certain facilities and approximately $434,000
for the write-off of fixed assets situated in office locations
that were closed or consolidated. As of March 31, 2002, all
restructuring liabilities were paid.

During the year ended March 31, 2002, the
Company recorded a $600,000 loss related to the write-off of
fixed assets that were no longer in use and excess to
requirements.



| |                          
| | -------------------------
| | Fiscal 2003 restructuring

In the fourth fiscal quarter of 2003, the Company
initiated a cost reduction program that resulted in the
involuntary termination of 18 employees and the closure of our
Cupertino facility. The Company recorded a charge of $546,000 to
operations during the fourth fiscal quarter. The charge related
to payments for severance of approximately $131,000, the accrual
of future lease costs (net of estimated sublease income) of
approximately $365,000, and the write-off of fixed assets of
approximately $50,000. As of March 31, 2004, all of these
accrued costs have been paid.



| |                          
| | -------------------------
| | Fiscal 2004 restructuring

In the fourth fiscal quarter of 2004, the Company
initiated a cost reduction resulting in the closure of Santa
Monica office in June 2004 and involuntary termination of 19
employees. The Company recorded a severance charge of $164,000
during the fourth fiscal quarter. As of March 31, 2004,
approximately $70,000 remained in Accrued
Liabilities for future severance payments. It is expected
to be paid by the end of December 2004.



|        |                  
|------- | -----------------
|Note 7. | Segment Reporting

Digital Impact is organized into two segments:
Customer Marketing and Professional Services. These segments
were determined in fiscal 2003 based on the alignment of the
Companys organization structure and selected management
financial reporting with the nature of the service product
offerings.

Customer Marketing provides clients with
comprehensive solutions for creating and executing online direct
marketing programs. Our solutions are designed to enable
marketers to drive revenue and deepen

41



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

customer relationships with a comprehensive
process that includes: collecting and managing customer
information, analyzing the information to determine ideal
segments and offers, and delivering highly relevant,
individualized email messages. Customer Marketing represented
71% and 72% of revenue in fiscal 2004 and 2003, respectively.
The gross margin for Customer Marketing was 59% and 63% for the
twelve months ended March 31, 2004 and 2003, respectively.

Professional Services are utilized by clients to
enhance marketing programs and improve results. Digital Impact
offers clients services in each of the following categories:
Strategy, Analysis, Data Management, Solutions Engineering, Web
Development, Creative and Customer Acquisition. Professional
Services represented 29% and 28% of revenue in fiscal 2004 and
2003, respectively. The gross margin for Professional Services
were 46% and 48% for the twelve months ended March 31, 2004
and 2003, respectively.

The respective revenue and gross profit of each
of these segments is as follows:

|                     |  |                           |        |                           |  |                           |        |           |  |              |        |       |  |           |        |              |  |       |        |  |  |   |        |  |  |   |        |  |  |   |        |  |  |   |        | 
|-------------------- |  | ------------------------- | ------ | ------------------------- |  | ------------------------- | ------ | --------- |  | ------------ | ------ | ----- |  | --------- | ------ | ------------ |  | ----- | ------ |  |  | - | ------ |  |  | - | ------ |  |  | - | ------ |  |  | - | ------ | 
|                     |  |                           |        |                           |  |                          
|                     |  | Year Ended March 31, 2004 |        | Year Ended March 31, 2003 |  | Year Ended March 31, 2002
|                     |  |                           |        |                           |  |                          
|                     |  | Customer                  |        | Professional              |  |                           |        | Customer  |  | Professional |        |       |  | Customer  |        | Professional |  |      
|                     |  | Marketing                 |        | Services                  |  | Total                     |        | Marketing |  | Services     |        | Total |  | Marketing |        | Services     |  | Total
|                     |  |                           |        |                           |  |                           |        |           |  |              |        |       |  |           |        |              |  |      
|Revenue              |  | $                         | 31,244 |                           |  | $                         | 12,468 |           |  | $            | 43,712 |       |  | $         | 31,776 |              |  | $     | 12,234 |  |  | $ | 44,010 |  |  | $ | 29,034 |  |  | $ | 10,004 |  |  | $ | 39,038 | 
|                     |  |                           |        |                           |  |                           |        |           |  |              |        |       |  |           |        |              |  |       |        |  |  |   |        |  |  |   |        |  |  |   |        |  |  |   |        | 
|Segment Gross Profit |  | $                         | 18,403 |                           |  | $                         | 5,783  |           |  | $            | 24,186 |       |  | $         | 19,903 |              |  | $     | 5,848  |  |  | $ | 25,751 |  |  | $ | 16,279 |  |  | $ | 4,215  |  |  | $ | 20,494 | 
|                     |  |                           |        |                           |  |                           |        |           |  |              |        |       |  |           |        |              |  |       |        |  |  |   |        |  |  |   |        |  |  |   |        |  |  |   |        | 

Segment information is presented in accordance
with SFAS 131,Disclosures about Segments of an
Enterprise and Related Information. This standard is based on a
management approach and internal accounting methods. Operating
costs and operating profits are not presented because the
Company does not allocate research and development, sales and
marketing, or general and administrative expenses between
segments in the internal accounting system.



|        |             
|------- | ------------
|Note 8. | Income Taxes

At March 31, 2004, the Company had federal
and state net operating loss carryforwards of approximately
$86.6 million and $40.6 million respectively,
available to offset future regular taxable income, if any. The
Companys net operating loss carryforwards expire on
various dates after the year 2008, if not utilized.

At March 31, 2004, the Company had federal
and state research and development and other credits of
approximately $2.2 million and $1.8 million,
respectively. The federal research and development credit
carryforwards expire beginning after 2013, if not utilized, and
the California state research credit can be carried forward
indefinitely.

The Tax Reform Act of 1986 limits the use of net
operating loss and tax credit carryforward in certain situations
where changes occur in the stock ownership of a company. The
availability of net operating losses to offset future taxable
income may be limited as a result of the acquisition of
Mineshare in 2000. The amount of such limitation, if any, has
not been determined.

42



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##### Table of Contents



DIGITAL IMPACT, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

Temporary items that give rise to significant
portions of deferred tax assets and liabilities at
March 31, 2004 and 2003 are as follows (in thousands):

|                                              |                           |           |         |        |  |   |         |        | 
|--------------------------------------------- | ------------------------- | --------- | ------- | ------ |  | - | ------- | ------ | 
|                                              |                           |          
|                                              |                           | March 31,
|                                              |                           |          
|                                              |                           | 2004      |         | 2003  
|                                              |                           |           |         |       
|Net operating loss carryforwards              |                           | $         | 31,830  |        |  | $ | 31,050  |       
|Research and development credit carryover     |                           |           | 3,401   |        |  |   | 2,707   |       
|Fixed assets                                  |                           |           | (199    | )      |  |   | (198    | )     
|Stock based compensation                      |                           |           | 1,882   |        |  |   | 2,994   |       
|Capitalized research and development expenses |                           |           | 1,158   |        |  |   | 1,326   |       
|Capitalized start-up and other                |                           |           | 701     |        |  |   | 861     |       
|                                              |                           |           |         |        |  |   |         |       
|                                              | Total deferred tax assets |           |         | 38,773 |  |   |         | 38,740 | 
|Less valuation allowance                      |                           |           | (38,773 | )      |  |   | (38,740 | )     
|                                              |                           |           |         |        |  |   |         |       
|Net deferred tax asset                        |                           | $         |        |        |  | $ |        |       
|                                              |                           |           |         |        |  |   |         |       

Due to the uncertainty surrounding the
realization of the favorable tax attributes in future tax
returns, the Company has established a 100% valuation allowance
against its deferred tax asset. The valuation allowance for the
period ended March 31, 2004 increased by $191,000.

The difference between the income tax benefit at
the statutory of 34% and the companys effective tax rate
is due primarily to the valuation allowance established to
offset the deferred tax assets. The provision for income tax is
different than the amount computed using the applicable
statutory federal income tax rate with the difference for the
years summarized below:

Rate reconciliation

|                                         |                      |           |        |      |   |      |        |      |   |  |        |      |   |  |        |      |  
|---------------------------------------- | -------------------- | --------- | ------ | ---- | - | ---- | ------ | ---- | - |  | ------ | ---- | - |  | ------ | ---- | -
|                                         |                      |          
|                                         |                      | March 31,
|                                         |                      |          
|                                         |                      | 2004      |        | 2003 |   | 2002 |        | 2001
|                                         |                      |           |        |      |   |      |        |     
|Federal tax benefit                      |                      |           | 34.00  | %    |   |      | 34.00  | %    |   |  | 34.00  | %    |   |  | 34.00  | %   
|State tax benefit, net of federal        |                      |           | 5.83   |      |   |      | 5.83   |      |   |  | 5.83   |      |   |  | 5.83   |     
|Research and development                 |                      |           |       |      |   |      |       |      |   |  |       |      |   |  | 3.68   |     
|Permanent differences                    |                      |           | (5.08  | )    |   |      | (0.45  | )    |   |  | (2.63  | )    |   |  | (20.72 | )   
|California net operating loss limitation |                      |           | (26.38 | )    |   |      | (4.23  | )    |   |  | (1.45  | )    |   |  | 6.07   |     
|Other                                    |                      |           | (2.69  | )    |   |      | 25.16  |      |   |  | 8.65   |      |   |  | 2.10   |     
|Valuation allowance                      |                      |           | (5.68  | )    |   |      | (60.31 | )    |   |  | (44.40 | )    |   |  | (30.96 | )   
|                                         |                      |           |        |      |   |      |        |      |   |  |        |      |   |  |        |     
|                                         | Total effective rate |           |        | 0.00 | % |      |        | 0.00 | % |  |        | 0.00 | % |  |        | 0.00 | %
|                                         |                      |           |        |      |   |      |        |      |   |  |        |      |   |  |        |     



|        |                           
|------- | --------------------------
|Note 9. | Related Party Transactions

In January 2002, the Company loaned $300,000 to
William Park, our Chief Executive Officer. Mr. Park has
repaid this loan in its entirety in April 2004. The loan was
scheduled to mature on February 1, 2005. Interest,
compounded annually and paid in full upon maturity, accrued at
the rate of 2.74%. As of March 31, 2004, approximately
$4,000 of unpaid interest was outstanding.

43



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##### Table of Contents



Schedule II

Valuation and Qualifying Accounts


|                                 |                                 |                |   |              |  |            |   |             |   |  |   |     |  |  |   |     | 
|-------------------------------- | ------------------------------- | -------------- | - | ------------ |  | ---------- | - | ----------- | - |  | - | --- |  |  | - | --- | 
|                                 |                                 |                |   | Additions    |  |            |   |            
|                                 |                                 |                |   | (Deductions) |  |            |   |            
|                                 |                                 | Balance at     |   | Charged to   |  |            |   |            
|                                 |                                 | Beginning of   |   | Costs and    |  | Deductions |   | Balance at 
|                                 |                                 | Period         |   | Expenses     |  | Write-Offs |   | End of Year
|                                 |                                 |                |   |              |  |            |   |            
|                                 |                                 |               
|                                 |                                 | (In thousands)
|Fiscal year ended March 31, 2004 |                                 |                |   |              |  |            |   |             |   |  |   |     |  |  |   |    
|                                 | Allowance for doubtful accounts |                | $ | 345          |  |            | $ | 0           |   |  | $ | 82  |  |  | $ | 263 | 
|                                 |                                 |                |   |              |  |            |   |             |   |  |   |     |  |  |   |    
|Fiscal year ended March 31, 2003 |                                 |                |   |              |  |            |   |             |   |  |   |     |  |  |   |    
|                                 | Allowance for doubtful accounts |                | $ | 697          |  |            | $ | (36         | ) |  | $ | 316 |  |  | $ | 345 | 
|                                 |                                 |                |   |              |  |            |   |             |   |  |   |     |  |  |   |    
|Fiscal year ended March 31, 2002 |                                 |                |   |              |  |            |   |             |   |  |   |     |  |  |   |    
|                                 | Allowance for doubtful accounts |                | $ | 883          |  |            | $ | 501         |   |  | $ | 687 |  |  | $ | 697 | 
|                                 |                                 |                |   |              |  |            |   |             |   |  |   |     |  |  |   |    

44



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##### Table of Contents








|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure

None






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

(a) Evaluation of disclosure controls and
procedures. Our management evaluated, with the participation
of our Chief Executive Officer and Chief Financial Officer, the
effectiveness of our disclosure controls and procedures as of
the end of the period covered by this report. Based on this
evaluation, our Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and
procedures as of the end of the period covered by this report
are effective to ensure that information we are required to
disclose in reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the Securities and
Exchange Commissions rules and forms.

Our disclosure controls and procedures provide
our Chief Executive Officer and Chief Financial Officer
reasonable assurances that our disclosure controls and
procedures will achieve their objectives. However, company
management, including our Chief Executive Officer and Chief
Financial Officer, does not expect that our disclosure controls
and procedures or our internal controls will prevent all human
error. A control system, no matter how well designed and
implemented, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met.
Furthermore, the design of a control system must reflect the
fact that there are internal resource constraints, and the
benefit of controls must be weighed relative to their
corresponding costs. Because of the limitations in all control
systems, no evaluation of controls can provide complete
assurance that all control issues and instances of error, if
any, within our company are detected. These inherent limitations
include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur due to human error or
mistake. Additionally, controls, no matter how well designed,
could be circumvented by the individual acts of specific persons
within the organization. The design of any system of controls is
also based in part upon certain assumptions about the likelihood
of future events, and there can be no assurance that any design
will succeed in achieving its stated objectives under all
potential future conditions.

(b) Changes in internal control over
financial reporting. There was no change in our internal
control over financial reporting that occurred during the period
covered by this report that has materially affected, or is
reasonably likely to materially affect, our internal control
over financial reporting.




PART III

Certain information required by Part III
is omitted from this Report because the Registrant will file a
definitive proxy statement pursuant to Regulation 14A (the
Proxy Statement) not later than 120 days after
the end of the fiscal year covered by this Report and certain
information included therein is incorporated herein by
reference. Only those sections of the Proxy Statement that
specifically address the items set forth herein are incorporated
by reference.






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

The information concerning the Companys
directors and executive officers required by this Item is
incorporated by reference to the Companys Proxy Statement,
Proposal No. 1  Election of Director
and Executive Officers.

There is no family relationship among any of the
directors or executive officers of Digital Impact.

The information regarding compliance with
Section 16 of the Securities Exchange Act of 1934 is
incorporated by reference to the Companys Proxy Statement,
Beneficial Ownership of Shares 
Section 16(a) Beneficial Ownership Reporting
Compliance.

The information regarding the Companys Code
of Ethics required by this item is incorporated by reference to
the Companys Proxy Statement, Proposal
No. 1  Election of Director.

45



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##### Table of Contents








|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required by this Item is
incorporated by reference to our Proxy Statement,
Executive Compensation (except for the subsection
entitled Report of the Compensation Committee on Executive
Compensation, which is not incorporated herein by
reference).






|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

The information regarding the securities
authorized for issuance under equity compensation plans required
by this item is incorporated by reference to our Proxy
Statement, Equity Compensation Plan Information. The
information regarding the security ownership by certain
beneficial owners required by this Item is incorporated by
reference to our Proxy Statement, Beneficial Ownership of
Shares.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information required by this item is
incorporated by reference to our Proxy Statement,
Indebtedness of Management.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

The information required by this item is
incorporated by reference to our Proxy Statement, Proposal
No. 2  Ratification of Selection of Independent
Auditors.






|         |                                                                     
|-------- | --------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules,
    and Reports on Form 8-K

(a) Documents filed as part of this
Report



| |                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------
| | (1) Financial Statements  all
    consolidated financial statements of the Company as set forth
    under Item 8 of this Report
|
| | (2) Financial Statement
    Schedules  Schedule II  Valuation and
    Qualifying Accounts                                     

(b) Reports on Form 8-K

On January 8, 2004, the Company furnished a
Current Report on Form 8-K with the Securities and Exchange
Commission. The Current Report on Form 8-K includes a copy
of our press release dated January 5, 2004, which
reaffirmed our quarterly financial forecasts for the quarter
ended December 31, 2003.

On January 27, 2004, the Company furnished a
Current Report on Form 8-K with the Securities and Exchange
Commission. The Current Report on Form 8-K includes a copy
of our press release dated January 27, 2004 reporting our
results of operations and financial condition for the quarter
ended December 31, 2003.

(c ) Exhibits

|        |        |             |  |                                                                                                                                                                                                                                                                                                                  
|------- | ------ | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |            
|Number  |        | Description
|        |        |            
|        | 2.1(2) |             |  | Agreement and Plan of Reorganization dated as of
    July 19, 2000, by and among the Registrant, Candlestick
    Acquisition Corp., MineShare, Inc., David Mariani, as the
    Founding Shareholder, David Mariani, as Shareholder
    Representative, and Computershare Investor Services, as Exchange
    Agent
|        | 2.2(2) |             |  | Agreement and Plan of Merger among MineShare,
    Inc. and Candlestick Acquisition Corp. dated as of July 31,
    2000                                                                                                                                                                                           
|        | 3.1(1) |             |  | Form of Amended and Restated Certificate of
    Incorporation of the Registrant                                                                                                                                                                                                                                  
|        | 3.2(1) |             |  | Bylaws of the Registrant                                                                                                                                                                                                                                                                                         
|        | 4.1(1) |             |  | Amended and Restated Investor Rights Agreement                                                                                                                                                                                                                                                                   

46



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##### Table of Contents



|        |          |             |  |                                                                                                                                          
|------- | -------- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |          |            
|Number  |          | Description
|        |          |            
|        | 10.1(3)  |             |  | The Registrants 1998 Stock Plan, as amended
    and restated                                                                            
|        | 10.2(1)  |             |  | The Registrants 1999 Employee Stock
    Purchase Plan                                                                                   
|        | 10.3(8)  |             |  | The Registrants 1999 Director Equity
    Plan, as amended and restated                                                                  
|        | 10.4(1)  |             |  | Employment Agreement between the Registrant and
    David Oppenheimer                                                                    
|        | 10.5(5)  |             |  | Employment Agreement between the Registrant and
    Kevin Johnson                                                                        
|        | 10.6(6)  |             |  | Standard Form Lease between the Registrant
    and Casiopea Venture Corporation                                                          
|        | 10.7(1)  |             |  | Form of Indemnification Agreement between the
    Registrant and each of its directors and executive officers                            
|        | 10.8(4)  |             |  | Form of Retention Agreement with Key Employees                                                                                           
|        | 10.9(6)  |             |  | Retention Agreement between the Registrant and
    William Park dated January 11, 2002                                                   
|        | 10.10(6) |             |  | Retention Agreement between the Registrant and
    Gerardo Capiel dated January 11, 2002                                                 
|        | 10.11(6) |             |  | Promissory Note of William Park dated
    February 7, 2002                                                                               
|        | 10.12(7) |             |  | Amendment to Retention Agreement between the
    Registrant and William Park dated December 23, 2002                                     
|        | 10.13(7) |             |  | Amendment to Retention Agreement between the
    Registrant and Gerardo Capiel dated December 23, 2002                                   
|        | 10.14(9) |             |  | Transition Agreement and Release by and between
    the Registrant and Dave Kleinberg dated February 10, 2003                            
|        | 10.15    |             |  | Master Service Agreement between the Registrant
    and Globix Corporation dated September 25, 2002                                      
|        | 21.1     |             |  | Subsidiaries of the Registrant                                                                                                           
|        | 23.1     |             |  | Consent of PricewaterhouseCoopers LLP (included
    on page 49 of this Report)                                                           
|        | 24.1     |             |  | Power of Attorney (included on page 50 of
    this Report)                                                                               
|        | 31.1     |             |  | Certification of Chief Executive Officer, as
    required by Rule 13a-14(a) or Rule 15d-14(a) of the
    Securities Exchange Act of 1934.
|        | 31.2     |             |  | Certification of Chief Financial Officer, as
    required by Rule 13a-14(a) or Rule 15d-14(a) of the
    Securities Exchange Act of 1934.
|        | 32.1     |             |  | Certification of Chief Executive Officer pursuant
    to Section 906 of the Sarbanes-Oxley Act of 2002.                                  
|        | 32.2     |             |  | Certification of Chief Financial Officer pursuant
    to Section 906 of the Sarbanes-Oxley Act of 2002.                                  




| |     |                                                                                                                                                                                                           
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Incorporated by reference to Digital
    Impacts registration statement on Form S-1 (SEC File
    No. 333-87299) originally filed with the Commission on
    September 17, 1999, as subsequently amended.
|
| | (2) | Incorporated by reference to Digital
    Impacts Report on Form 8-K filed with the Commission
    on August 14, 2000.                                                                                    
|
| | (3) | Incorporated by reference to Digital
    Impacts Registration Statement on Form S-8 (SEC File
    No. 333-67686) filed with the Securities and Exchange
    Commission on August 16, 2001.               
|
| | (4) | Incorporated by reference to Digital
    Impacts Report on Form 10-K filed with the Commission
    on June 13, 2001.                                                                                     
|
| | (5) | Incorporated by reference to Digital
    Impacts Report on Form 10-Q filed with the Commission
    on February 14, 2002.                                                                                 

47



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##### Table of Contents





| |     |                                                                                                                                  
| | --- | ---------------------------------------------------------------------------------------------------------------------------------
| | (6) | Incorporated by reference to Digital
    Impacts Report on Form 10-K filed with the Commission
    on June 7, 2002.             
|
| | (7) | Incorporated by reference to Digital
    Impacts Report on Form 10-Q filed with the Commission
    on February 14, 2003.        
|
| | (8) | Incorporated by reference to Digital
    Impacts Proxy Statement on Schedule 14A filed with
    the Commission on June 24, 2003.
|
| | (9) | Incorporated by reference to Digital
    Impacts Report on Form 10-K filed with the Commission
    on June 13, 2003.            

48



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##### Table of Contents



CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the incorporation by
reference in the Registration Statements on Form S-8
(Nos. 333-106094, 333-110496, 333-101435, 333-83032,
333-67686, 333-44782, 333-43714 and 333-34678) of Digital
Impact, Inc. of our report dated June 1, 2004 relating to
the financial statements and financial statement schedule, which
appears in this Form 10-K.

PRICEWATERHOUSECOOPERS LLP

San Jose, California

June 9, 2004


49



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the Registrant
has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.



| |                                          
| | -----------------------------------------
| | DIGITAL IMPACT, INC.                     
|
| | By: /s/ WILLIAM PARK                     
| |                                          
| | William Park                             
| | President and Chief Executive
    Officer

Dated: June 9, 2004

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each
person whose signature appears below constitutes and appoints
William Park and David Oppenheimer as his or her
attorney-in-fact, each with the power of substitution, for him
or her in any and all capacities, to sign any amendments to this
Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue
hereof.

Pursuant to the requirements of the Securities
Exchange Act of 1934, this Report has been signed below by the
following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

|                                       |  |                                                                                                                            |  |              |  | 
|-------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------- |  | ------------ |  | 
|                                       |  |                                                                                                                            |  |             
|Signature                              |  | Title                                                                                                                      |  | Date        
|                                       |  |                                                                                                                            |  |             
|                                      
|/s/ WILLIAM PARKWilliam Park           |  | President, Chief Executive Officer
    and Director (Principal Executive Officer)                                          |  | June 9, 2004
|                                      
|/s/ DAVID OPPENHEIMERDavid Oppenheimer |  | Senior Vice President, Finance, Chief
    Financial Officer and Treasurer
    (Principal Financial and Accounting Officer) |  | June 9, 2004
|                                      
|/s/ MICHAEL BROWNMichael Brown         |  | Director                                                                                                                   |  | June 9, 2004
|                                      
|/s/ GERARDO CAPIELGerardo Capiel       |  | Chief Technology Officer, Director                                                                                         |  | June 9, 2004
|                                      
|/s/ PETER PERVEREPeter Pervere         |  | Director                                                                                                                   |  | June 9, 2004
|                                      
|/s/ EDWARD J. SPIEGELEdward J. Spiegel |  | Director                                                                                                                   |  | June 9, 2004

50



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##### Table of Contents



EXHIBIT INDEX

|        |          |             |  |                                                                                                                                                                                                                                                                                                                  
|------- | -------- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |          |            
|Number  |          | Description
|        |          |            
|        | 2.1(2)   |             |  | Agreement and Plan of Reorganization dated as of
    July 19, 2000, by and among the Registrant, Candlestick
    Acquisition Corp., MineShare, Inc., David Mariani, as the
    Founding Shareholder, David Mariani, as Shareholder
    Representative, and Computershare Investor Services, as Exchange
    Agent
|        | 2.2(2)   |             |  | Agreement and Plan of Merger among MineShare,
    Inc. and Candlestick Acquisition Corp. dated as of July 31,
    2000                                                                                                                                                                                           
|        | 3.1(1)   |             |  | Form of Amended and Restated Certificate of
    Incorporation of the Registrant                                                                                                                                                                                                                                  
|        | 3.2(1)   |             |  | Bylaws of the Registrant                                                                                                                                                                                                                                                                                         
|        | 4.1(1)   |             |  | Amended and Restated Investor Rights Agreement                                                                                                                                                                                                                                                                   
|        | 10.1(3)  |             |  | The Registrants 1998 Stock Plan, as amended
    and restated                                                                                                                                                                                                                                                    
|        | 10.2(1)  |             |  | The Registrants 1999 Employee Stock
    Purchase Plan                                                                                                                                                                                                                                                           
|        | 10.3(8)  |             |  | The Registrants 1999 Director Equity
    Plan, as amended and restated                                                                                                                                                                                                                                          
|        | 10.4(1)  |             |  | Employment Agreement between the Registrant and
    David Oppenheimer                                                                                                                                                                                                                                            
|        | 10.5(5)  |             |  | Employment Agreement between the Registrant and
    Kevin Johnson                                                                                                                                                                                                                                                
|        | 10.6(6)  |             |  | Standard Form Lease between the Registrant
    and Casiopea Venture Corporation                                                                                                                                                                                                                                  
|        | 10.7(1)  |             |  | Form of Indemnification Agreement between the
    Registrant and each of its directors and executive officers                                                                                                                                                                                                    
|        | 10.8(4)  |             |  | Form of Retention Agreement with Key Employees                                                                                                                                                                                                                                                                   
|        | 10.9(6)  |             |  | Retention Agreement between the Registrant and
    William Park dated January 11, 2002                                                                                                                                                                                                                           
|        | 10.10(6) |             |  | Retention Agreement between the Registrant and
    Gerardo Capiel dated January 11, 2002                                                                                                                                                                                                                         
|        | 10.11(6) |             |  | Promissory Note of William Park dated
    February 7, 2002                                                                                                                                                                                                                                                       
|        | 10.12(7) |             |  | Amendment to Retention Agreement between the
    Registrant and William Park dated December 23, 2002                                                                                                                                                                                                             
|        | 10.13(7) |             |  | Amendment to Retention Agreement between the
    Registrant and Gerardo Capiel dated December 23, 2002                                                                                                                                                                                                           
|        | 10.14(9) |             |  | Transition Agreement and Release by and between
    the Registrant and Dave Kleinberg dated February 10, 2003                                                                                                                                                                                                    
|        | 10.15    |             |  | Master Service Agreement between the Registrant
    and Globix Corporation dated September 25, 2002                                                                                                                                                                                                              
|        | 21.1     |             |  | Subsidiaries of the Registrant                                                                                                                                                                                                                                                                                   
|        | 23.1     |             |  | Consent of PricewaterhouseCoopers LLP (included
    on page 49 of this Report)                                                                                                                                                                                                                                   
|        | 24.1     |             |  | Power of Attorney (included on page 50 of
    this Report)                                                                                                                                                                                                                                                       
|        | 31.1     |             |  | Certification of Chief Executive Officer, as
    required by Rule 13a-14(a) or Rule 15d-14(a) of the
    Securities Exchange Act of 1934.                                                                                                                                                                        
|        | 31.2     |             |  | Certification of Chief Financial Officer, as
    required by Rule 13a-14(a) or Rule 15d-14(a) of the
    Securities Exchange Act of 1934.                                                                                                                                                                        
|        | 32.1     |             |  | Certification of Chief Executive Officer pursuant
    to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                          
|        | 32.2     |             |  | Certification of Chief Financial Officer pursuant
    to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                          




| |     |                                                                                                                                                                                                           
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Incorporated by reference to Digital
    Impacts registration statement on Form S-1 (SEC File
    No. 333-87299) originally filed with the Commission on
    September 17, 1999, as subsequently amended.



---



##### Table of Contents





| |     |                                                                                                                                                                                            
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (2) | Incorporated by reference to Digital
    Impacts Report on Form 8-K filed with the Commission
    on August 14, 2000.                                                                     
|
| | (3) | Incorporated by reference to Digital
    Impacts Registration Statement on Form S-8 (SEC File
    No. 333-67686) filed with the Securities and Exchange
    Commission on August 16, 2001.
|
| | (4) | Incorporated by reference to Digital
    Impacts Report on Form 10-K filed with the Commission
    on June 13, 2001.                                                                      
|
| | (5) | Incorporated by reference to Digital
    Impacts Report on Form 10-Q filed with the Commission
    on February 14, 2002.                                                                  
|
| | (6) | Incorporated by reference to Digital
    Impacts Report on Form 10-K filed with the Commission
    on June 7, 2002.                                                                       
|
| | (7) | Incorporated by reference to Digital
    Impacts Report on Form 10-Q filed with the Commission
    on February 14, 2003.                                                                  
|
| | (8) | Incorporated by reference to Digital
    Impacts Proxy Statement on Schedule 14A filed with
    the Commission on June 24, 2003.                                                          
|
| | (9) | Incorporated by reference to Digital
    Impacts Report on Form 10-K filed with the Commission
    on June 13, 2003.