**SECURITIESAND EXCHANGE COMMISSION**

**WashingtonD.C. 20549**

 

**FORM 10-K**

 

| **Annual Report Pursuant to Section  13 or 15(d)  of the Securities Exchange Act of 1934** |
|--------------------------------------------------------------------------------------------|
|                                                                                       |
| **For the fiscal year ended: December 31, 2002**                                           |
|                                                                                       |
| **Commission File Number:**                                                                |

 

| **E-centives,  Inc.**                                           |
|-----------------------------------------------------------------|
| (Exact name of registrant as specified in  its charter)         |
|                                                            |   |   |
| **Delaware**                                                    |   | **52-1988332** |
| (State or other jurisdiction of  incorporation or organization) |   | (IRS Employer Identification No.) |
|                                                            |   |   |
| **6901 Rockledge Drive, 6th Floor, Bethesda,  MD 20817**        |
| (Address of principal executive offices)                        |
|                                                            |   |   |
| **(240) 333-6100**                                              |
| (Registrant’s telephone number, including  area code)      |

 

Securities registered pursuant to Section 12(b) of theAct:      **NotApplicable**

 

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

 

**Common Stock, par value $0.01 per share**

## **(Title ofclass)**

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months and (2) has been subject to such filingrequirements for the past 90 days.  ýYes  o  No

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form10-K.  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act). Yes oNo ý

 

The aggregate market value of common stock held by non-affiliates ofthe registrant, based upon the closing price of the registrant’s common stockon the SWX Swiss Exchange as of June 28, 2002 is $9,633,963(1).

 

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(1)Assumes an exchange rate of 1.48829 Swiss Francs per oneU.S. Dollar as of June 28, 2002.

 

As of March 24, 2003, there were 37,349,284 shares of the registrant’scommon stock outstanding.

 

 

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**E-centives,Inc.**

**Form10-K**

 

**Tableof Contents**

** **
| PART I         |      |                                                                                              |
|----------------|-----------|---------------------------------------------------------------------------------------------------|
|           | Item 1.   | Business.                                                                                         |
|           | Item 2.   | Properties.                                                                                       |
|           | Item 3.   | Legal  Proceedings.                                                                               |
|           | Item 4.   | Submission  of Matters to a Vote of Security Holders.                                             |
| PART II        |      |                                                                                              |
|           | Item 5.   | Market  for Registrant’s Common Stock and Related Stockholder Matters.                       |
|           | Item 6.   | Selected  Financial Data.                                                                         |
|           | Item 7.   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations.      |
|           | Item  7A. | Quantitative  and Qualitative Disclosures About Market Risk.                                      |
|           | Item 8.   | Financial  Statements and Supplementary Data.                                                     |
|           | Item 9.   | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure.            |
| PART  III      |      |                                                                                              |
|           | Item  10. | Directors  and Executive Officers of the Registrant.                                              |
|           | Item  11. | Executive  Compensation.                                                                          |
|           | Item  12. | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters. |
|           | Item 13.  | Certain  Relationships and Related Transactions.                                                  |
|           | Item  14. | Controls  and Procedures                                                                          |
| PART IV        |      |                                                                                              |
|           | Item 15.  | Exhibits,  Financial Statement Schedules, and Reports on Form 8-K.                                |
| SIGNATURES     |
| CERTIFICATIONS |

 

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**E-centives,Inc.**

 

**PART I**

 

**ITEM 1**- **Business**

 

**CAUTIONARYNOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

Except for anyhistorical information, the matters we discuss in this Annual Report on Form10-K concerning our company contain forward-looking statements.  Any statements in this Form Annual Report on10-K that are not statements of historical fact, are intended to be, and are,“forward-looking statements” under the safe harbor provided by Section 27(a) ofthe Securities Act of 1933.  Withoutlimitation, the words “anticipates,” “believes,” “estimates,” “expects,”“intends,” “plans” and similar expressions are intended to identifyforward-looking statements. The important factors we discuss below and underthe caption ‘‘Management’s Discussion and Analysis of Financial Condition andResults of Operations,’’ as well as other factors identified in our filingswith the SEC and those presented elsewhere by its management from time to time,could cause actual results to differ materially from those indicated by theforward-looking statements made in this Annual Report on Form 10-K.  The Company assumes no obligation to updateany forward-looking information to reflect actual results or changes in thefactors affecting such forward-looking information.

 

**AVAILABLE INFORMATION**

 

Our Internet website address is www.e-centives.com. We make available,free of charge, on or through our website our Annual Reports on Form 10-K, QuarterlyReports on Form 10-Q and Current Reports on Form 8-K, and amendments to thesereports, as soon as reasonably practicable after we electronically file suchmaterial with, or furnish such material to, the Securities and ExchangeCommission.

 

**OVERVIEW**

 

We wereestablished as Imaginex, Inc. on August 2, 1996, through incorporation in theState of Delaware. During October 1996, we amended our articles ofincorporation to change our name to Emaginet, Inc. and again in March 1999 weamended our articles of incorporation to change our name to E-centives, Inc.During March 2001, we expanded our international operations by establishing asubsidiary in the United Kingdom, E-centives Limited.  However, the operations of this subsidiary were terminated inconjunction with our second quarter 2002 restructuring plan that involvedclosing down the operating activities of the Commerce Division.

 

We provideinteractive direct marketing technologies and services for globalmarketers.  We offer a complete suite oftechnologies, including several patented components, which enable businesses toacquire and retain relationships with their audiences.  During 2002, our solutions included the *Interactive Database Marketing System*, the*E-mail Marketing System*, the *PerformOneNetwork*, the *Commerce Engine*andthe *Commerce Network.* With ouracquisition of substantially all of the assets of Consumer Review, Inc. inDecember 2002, we began providing additional advertising and e-commerceservices through our *ConsumerREVIEW.com*division. However, during the second quarter of 2002, we decided to suspendoffering the *Commerce Network*andthe *Commerce Engine,* and in Julyof 2002, we decided to suspend the offerings of the *PerformOne Network*.

 

•                    Our*Interactive Database Marketing System*is a comprehensive solution that offers a suite of e-marketing technologiesincluding e-mail marketing, online promotions and data warehousing.  Our system provides solutions for creating,targeting, publishing, managing and tracking e-mails, coupons and promotionalincentives.  Our system can deploy andmanage promotions, and track individual consumer’s responses to offers formanufacturers, retailers, and websites.

 

•                  Our *E-mail Marketing System* enables companiesto build ongoing, personalized dialogs with their audiences. Our system canimprove effectiveness of e-mail marketing campaigns through segmentation andtargeting and have shown to raise response rates, enabling our clients to boostsales, strengthen brands and build loyalty with their customers.

 

•                  *ConsumerREVIEW.com* manages web communitiesaround common product interests.  Theweb properties are dedicated to meeting the needs of consumers who areresearching products on the web. We focus on creating an online environmentthat fosters communication and consumer-generated reviews of products, byproviding an interface to a large database of product information, forums, andother useful content.

 

•                  Our *PerformOne Network* provided marketers withthe ability to deliver targeted, personalized offers to millions of consumersacross our network of partner sites and via e-mail.

 

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•                  Our *Commerce Engine* provided Internet siteswith leading product search and comparison shopping tools. From dynamice-marketplaces to customized product search applications, these solutionshelped businesses provide their users with the support tools they needed tomake smarter purchase decisions.

 

•                  Our *Commerce Network* enabled merchants todistribute and promote their products to the end users of our Commerce Enginecustomers.  It collected product datafrom merchants, normalized it into appropriate categories, indexed it and madeit available for access through our Commerce Engine customers.

 

Of our totalnet revenue of $7.2 million for the year ended December 31, 2002, we generatedapproximately 11% from agreements with international customers. One of our *Interactive Database Marketing System*customers, Reckitt Benckiser PLC, contributed $4.5 million, or 62%, of ourrevenue for the year ended December 31, 2002. This customer’s initial contract expired in October 2002; and thecustomer subsequently renewed the agreement for an additional year.  Loss of this customer could have a materialadverse effect on our business, financial condition, results of operations andcash flow.

 

**INDUSTRYBACKGROUND**

 

The Internethas emerged as a powerful marketing medium that allows millions of consumersand marketers to conduct business and interact with each other in unprecedentedways.  Early online marketing strategieswere heavily focused on customer acquisition, optimizing the emerging medium’sinherent capacity to build brand awareness, advertise products and services,and promote purchases.  With the exponentialincreases in the volume of sites and the ease with which consumers couldnavigate between them, online marketers turned to customer retention andloyalty-building efforts to differentiate themselves from the competition.

 

The Internetis particularly well suited to direct marketers because of its ability toaccess both broad audiences, as well as precisely defined groups.  As a result, the Internet provides marketerswith opportunities to identify and attract customers, as well as targetspecific types of users and collect data on their preferences.  At the same time, we believe the Internetappeals to consumers because it offers more individual control over marketingmessages.  The growth of the Internethas encouraged both e-commerce and traditional brick and mortar companies tospend more of their marketing budgets via the Internet.  We believe there is a need for a marketinginfrastructure that could satisfy the objectives of both marketers andconsumers, which would enable businesses to acquire and retain customers, yetoperate from a consumer-centric approach that would provide relevance andmeaningful value to the individual user.

 

**OUR PRODUCTS AND SERVICES**

 

We launchedour direct marketing services in November 1998 by delivering e-centives(promotions including such items as digital coupons, sales notices, freeshipping offers, minimum purchase discounts and repeat purchase incentives)through our *PerformOneNetwork* (previously called *PromotionsNetwork)*.  While we wereintroducing our *PerformOne Network*between November 1998 and June 1999, we allowed marketers to use the system atno charge.  We then began generatingrevenue in the third quarter of 1999. In conjunction with the acquisition of the Commerce Division, the *Commerce Engine* and *Commerce Network* began generating revenuein late March 2001.  In July 2001, westarted producing revenue from our *E-mailMarketing System.* With the acquisition of the *Promotions System* from BrightStreet.com inDecember 2001, we began generating revenue by providing services from the *Interactive Database Marketing System*.During the second quarter of 2002 we decided to suspend offering our CommerceDivision’s products and services.  Themajority of the customer agreements for the *CommerceEngine* and *Commerce Network*were terminated by the end of the second quarter of 2002, with the remainingagreements terminating by August 30, 2002. In addition, in July of 2002 wedecided to suspend the offerings our *PerformOneNetwork* by fulfilling our existing contracts and curtailing any newsales efforts. With the acquisition of substantially all of the assets ofConsumer Review, Inc. in December 2002, we began generating revenue fromadvertising fees and e-commerce transaction fees from our *ConsumerREVIEW.com* division.

 

Our currentprimary product offerings are our *InteractiveDatabase Marketing System* and our *E-mailMarketing System*, along with *ConsumerREVIEW.com*’sadvertising and e-commerce services*.*

 

***Interactive DatabaseMarketing System***

 

With theacquisition of substantially all of BrightStreet.com’s assets in December 2001,we combined the *Promotion System*with our E-mail Marketing System, our data warehousing system and our onlinereporting system and began offering our *InteractiveDatabase Marketing System*. This technology and infrastructure, which is primarily targeted atconsumer packaged goods companies, allows companies to establish directconsumer relationships through a set of integrated tools that include targetede-mail marketing, a customer transaction database, a data warehouse, a microsite and survey generator and our patented coupon promotion system.  This system enables companies to acquireconsumers, collect consumers’ brand preference and usage information, segmentconsumers within loyalty categories, communicate with consumers via e-mailmarketing, deliver coupons, track individual usage of each coupon,

 

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aswell as track and report every consumer interaction with the system.  For the years ended December 31, 2002 and2001, we generated 67% and 1% of our revenue, respectively, from our *Interactive Database Marketing System.*Substantiallyall of our 2002 revenue related to our Interactive Database Marketing Systemwas generated from our contract with Reckitt Benckiser PLC.

 

***E-mail MarketingSystem***

 

Our *E-mail Marketing**System*allows companies to build ongoing,personalized dialogs with their audiences by outsourcing their e-mail marketingneeds to us.  It lets businessescost-effectively conduct e-mail marketing without having to acquire or develop theirown e-mail infrastructure and manage the process.  This system consists of list management and hosting, strategy andcreative services, e-mail delivery and management, as well as tracking andanalytical services.  It is designed tohelp build an ongoing, personalized communication with the client’s intendedaudience and maximize effectiveness through segmentation and targeting.  For the years ended December 31, 2002 and2001 we generated 5% and 2% of our revenue, respectively, from our *E-mail Marketing**System.*

 

***ConsumerREVIEW.com***

 

*ConsumerREVIEW.com*is a leading source of user-generated buying advice for outdoor sporting goodsand consumer electronics. Consumers visit to learn, interact, and buy or sellthe products showcased within our network of web communities, including siteslike AudioREVIEW.com and MtbREVIEW.com. Users find the products they areinterested in, read and write reviews, participate in discussions, compareprices, and shop online. ConsumerREVIEW.com business services primarily includeadvertising and e-commerce referrals. For the year ended December 31, 2002, wegenerated 3% of our revenue from ConsumerREVIEW.com, as these web sites wereacquired in early December 2002.

 

***PerformOneNetwork***

 

Our directmarketing system was designed to enable marketers to access a database ofconsumers across the websites of our network partners and by e-mail. Our *PerformOne Network* included a web-basedapplication that enabled consumers to register to receive promotional offers atour network partners’ websites or through our website. Our members provideddemographic information and product category interests in return for targetedoffers. Our system then delivered offers for products and services directly tothe member’s account or through e-mail. *PromoMail,* the primary service we providedour marketers, consisted of targeted e-mails highlighting a marketer’s specificpromotion.  Our application providednetwork partners with the ability to present offers to their users without thecosts and challenges of building and maintaining their own online directmarketing system. For the years ended December 31, 2002, 2001 and 2000, wegenerated 4%, 62% and 100% of our revenue, respectively, from our *PerformOneNetwork.*

 

***CommerceProducts and Services***

 

Through the acquisitionof the Commerce Division in March 2001, we acquired a system that providedproduct search, price comparison and merchandising services.  However, as part of our second quarter 2002restructuring plan, we discontinued offering our commerce products andservices, the *Commerce Engine* and the *CommerceNetwork.* For the years ended December 31, 2002 and 2001 we generated21% and 35% of our revenue, respectively, from our Commerce Division.

 

*Commerce Engine. *The*CommerceEngine* was an application designed to handle the challenges ofbringing consumers and merchants together and promoting transactions betweenthem. It was a platform to collect and organize vast amounts of electronicproduct information from online merchants and publishers of comparative productinformation. We made the *Commerce Engine* available to Internetportals and other website customers who, in turn, provided commerce servicesthrough their sites to end users. We provided and managed all hardware,software and operational aspects of the *Commerce Engine* and the associateddatabases of product libraries and purchasing locations.

 

*Commerce Network.*This system enabled merchants to distribute and promote their products to theend users of our *Commerce Engine* customers. It collected product data from merchants, normalized it into appropriatecategories, indexed it and made it available for access through our *CommerceEngine* customers.

 

**INFORMATION ON OUR OPERATING SEGMENTS**

 

*Basis of Reportable Segments*

 

In accordance with FAS 131, *Disclosuresabout Segments of an Enterprise and Related Information,* starting in2002, with the acquisition of substantially all of the assets of ConsumerReview, Inc., the Company reports its segment information in two reportablesegments: E-centives and ConsumerREVIEW.com.

 

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•                       E-centivesincludes the services of the Interactive Database Marketing System, the E-mailMarketing System, the PerformOne Network, the Commerce Engine and the CommerceNetwork.

 

•                       ConsumerREVIEW.comsells advertising and e-commerce services that are provided through a networkof web communities.

 

FAS 131 requires an enterprise to reportsegment information in the same way that management internally organizes itsbusiness for assessing performance and making decisions regarding allocation ofresources.

 

The chief operating decision maker evaluates the performance of theOperating Segments and allocates resources based on profit or loss and cashgenerated from operations. The accounting policies of the reportable segmentsare the same as those described in Note 2 of the Notes to ConsolidatedFinancial Statements, which begin on page F-6.

 

*Segment Financial Information*

 

For financial information regarding the Company’s reportable segments,including net sales, operating profit, identifiable assets and otherinformation by segment, see Note 11 of the Notes to Consolidated FinancialStatements, which begin on page F-6.

 

**OUR BACKLOG**

 

We include in our backlog only those customer orders for which we havea signed agreement with a defined term for the customer relationship. AtDecember 31, 2002, the quantity of backlog orders was not significant, becausethe majority of our agreements have a short period of time between the signingof the agreement and the providing of the service. However, the few agreementsthat do have backlogs are for our larger agreements for our *Interactive Database Marketing System* andour *E-mail Marketing**System*, which typically have terms ranging from six months to one year.

 

Our backlog was approximately $2.4 million and $5.8 million at December31, 2002 and 2001, respectively. Backorders for both years included contractsfor sales of our *Interactive DatabaseMarketing System* and our *E-mail Marketing**System*,however backorders at December 31, 2001also included orders related to our Commerce Division and our *PerformOne Network*.  The decrease is primarily due to our suspensionof offering the services of the *CommerceNetwork,* the *Commerce Engine*and the *PerformOne Network* during 2002.

 

**RECENTACQUISITION**

 

On December 4,2002, we acquired substantially all of Consumer Review Inc.’s assets andcertain of its liabilities through an Asset Purchase Agreement.  The cost of the acquisition wasapproximately $2.7 million, consisting of 400,000 shares of Series Bconvertible preferred stock valued at approximately $2.1 million, $290,000 incash and about $320,000 in acquisition costs. At closing, the Series B convertible preferred stock was placed intoescrow.  If we experience a change incontrol before the one year anniversary of the closing, each share of theSeries B convertible preferred stock will immediately be converted into tenshares of our common stock and shall be released from escrow. Upon the one yearanniversary of the closing date, provided that a change of control has notoccurred, the conversion rate for each share of the Series B convertiblepreferred stock shall be determined based upon the achievement of contractuallydefined revenue during the calculation period and will be adjusted pursuant tothe schedule below.  The stockconsideration will then be disbursed in accordance with the terms of the EscrowAgreement.

 
| **Revenues during the Calculation Period**     |   | **Conversion Rate** |   |
|------------------------------------------------|--------|---------------------|--------|
| Less than $1,000,000                           |   |  4 to 1        |   |
| More than $1,000,000, but less than $2,000,000 |   |  6 to 1        |   |
| More than $2,000,000, but less than $3,000,000 |   |  8 to 1        |   |
| More than $3,000,000, but less than $4,000,000 |   | 10 to 1             |   |
| More than $4,000,000, but less than $6,000,000 |   | 12 to 1             |   |
| $6,000,000  or more                            |   | 14 to 1             |   |

 

The acquisition was accounted for under the purchase method ofaccounting and, accordingly, the purchase price was allocated to the assetsacquired and liabilities assumed based on their estimated fair values at theacquisition date.  We engaged an independentthird-party appraiser to perform a valuation of the Series Bconvertible preferred stock andintangible assets associated with the acquisition.

 

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**SALES AND MARKETING**

 

We seek toestablish relationships with clients principally through our direct salesforce, as well as working with advertising or promotional agencies to reachtheir clients. During 2002, we maintained sales personnel in major metropolitanareas of Washington, D.C., San Francisco and New York, as well as in the UnitedKingdom and France.  However, our UnitedKingdom office was closed and our French presence was terminated during 2002,as we decided to concentrate our focus on our United States/North Americaoperations.

 

In order tostrengthen our existing relationships with clients, we offer accountmanagement, technology integration and consulting services. We assign accountmanagers with knowledge of on-line direct marketing to clients with the goal ofincreasing the performance of their marketing efforts and overall satisfactionwith our services. Our account managers also provide periodic reports toclients and help formulate strategies to more effectively market their productsand services.

 

We primarilymarket our products and services through conferences and tradeshows.

 

**TECHNOLOGY**

 

*ConsumerREVIEW.com*

 

To meet thedemands of its network of growing web communities and product research sites,Consumer Review, Inc. developed a proprietary, next-generation web architecturebased on Microsoft .NET® enterprise server technology. We acquired thistechnology when we purchased substantially all the assets of Consumer Review,Inc. in December 2002.  Designed forworld-class performance, the system was built for scalability, reliability, andinteroperability with web-enabled enterprise partners. It was developed forsimplified manageability, using open web standards, such as XML.  The web architecture was envisioned in 2000and developed and launched in 2001.

 

Functions:

 

**•**                  Provides product research and drivespurchasing decisions based on the experience of other consumers.

**•**                  Creates enthusiast communities withcommunication on message boards, marketplaces, and photo galleries.

**•**                  Delivers advertising, merchandising,content syndication, e-commerce partnerships, and other valuable services.

 

Components:

 

**•**                  User profiling – registration andlogin for various site services.

**•**                  Workflow, content, account, serviceand syndication management.

**•**                  Network operations on an array ofload balanced, dynamic servers.

 

Microsoft published a case study on ConsumerREVIEW.com as the migrationto Microsoft .NET® began. This study may be viewed at http://www.microsoft.com/servers/evaluation/casestudies/ConsumerRev.aspto learn more.

 

*Promotions System*

 

This system enables companies to create,manage, deliver and track promotional vehicles, such as print-at-home onlinecoupons.  This technology was built tomeet the stringent requirements of Consumer Packaged Goods manufacturers,including standardized bar codes and integration with existing couponclearinghouses, but has benefits that cross many other industries.  Our system’s printable coupons can beindividually tailored with relevant content and different incentive values basedon the respective recipients, enabling manufacturers to target coupons muchmore efficiently and cost-effectively than traditional methods.  In addition, our system has high trackingcapabilities, including individually coded offers that can be cross-referencedagainst specific consumer profiles.  Ourtechnology can also be used to build knowledge about consumers, such as theirprior product purchases and loyalty data, and to get a more accurate measure ofthe actual impact of marketing expenditures on sales.

 

The promotions system consists of thefollowing:

 

**•**                  database servers for storingpromotions, subscribers, content and promotion activity data;

**•**                  data collection and transformationservers for importing and exporting both subscriber and promotion data;

**•**                  application servers for promotion contentmanagement and promotions serving;

**•**                  web servers to support campaignmanagement; subscription management, and promotion activity tracking; and

**•**                  client-side plug-in software thatmanages the subscribers’ identification and printable coupon assembly andprinting.

 

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All promotions are built and managed usingour proprietary web-based *Maestro*campaign management software, which was designed and built to be used either byour account management team or by our customers directly, based upon theservice level model selected by our customers. Once promotions are launched, our application servers, which areclustered for load balancing and fault tolerance, serve the promotions to theusers for viewing and printing.  Thisarchitecture allows us to scale the system, simply by adding hardware asrequired.

 

All of our customers’ subscribers and content for promotions are storedin relational databases.  Thesedatabases are replicated to a stand-by database for fail-over purposes, and alldata is regularly copied to tape for disaster recovery purposes.  We host our promotions system in a datacenter that provides redundant network connectivity and diesel generated backuppower.  In addition we monitor and testour system, and as defects are identified they are addressed with version andprocess controlled upgrades.

 

*E-mail Marketing System*

 

We have developed a proprietary e-mail marketing system that is builtto scale with our customers.  Thissystem enables companies to communicate and build relationships with theirusers via e-mail.  This correspondencecan be single messages or a series of messages that are sequenced to form aconversation to facilitate building a one to one relationship.  The e-mail marketing system consists of thefollowing:

 

**•**                  database servers for storing e-maillists, content and e-mail activity data;

**•**                  data collection and transformationservers for importing and exporting both subscriber and e-mail activity data;

**•**                  application servers for contentmanagement, personalization engine and inbound mail handling;

**•**                  web servers to support campaignmanagement, subscription management,viral marketing and activity tracking; and

**•**                  mail servers for sending andreceiving e-mail.

 

All of our clients’ e-mail listsand content for e-mail campaigns are stored in a relational database prior tothe sending of the e-mail campaigns. This database is constantly being replicated to a stand-by database forfail over purposes and all data is copied to tape nightly for disaster recoverypurposes.

 

Once an e-mail campaign is run,the e-mails are assembled using our applications servers, which are clusteredfor load balancing and fault tolerance. Each e-mail can be individually personalized with relevant content andtargeted offers for the respective recipients. As each message is assembled, it is sent to a farm of outbound mailservers using a load-balancing appliance, which is also fault tolerant.  This architecture allows us to scalehorizontally, simply by adding hardware to the required components.  After an e-mail campaign has been sent, ourdata collection component collects and aggregates all e-mail activity andprovides this to our clients via web based real-time reporting.

 

All e-mail campaigns are builtand managed using our proprietary e-mail Content Manager, which was built to beused both by our account management team, to provide a full service model toour clients, as well as by our clients for a self-service model.

 

We host our systems in a data center that providesredundant network connectivity and diesel generated backup power.  In addition we monitor and test our system,and as defects are identified they are addressed with version and processcontrolled upgrades.

 

*Data Warehousing & Reporting System*

 

We have developed a datawarehousing and reporting system that was developed to scale with ourneeds.  This system enables us tocollect user level activity data from our various marketing applications,including our E-mail Marketing System and our Promotions System, and provideonline reporting and analysis.  Thissystem provides our customers with the results of their marketing campaigns,and enables optimizing decision-making to improve their strategies and tactics.

 

The data warehousing andreporting system consists of the following:

 

**•**                  database servers for storingsubscribers, marketing campaigns and activity data;

**•**                  data collection and transformationservers for collecting subscriber activity data and importing subscribers;

**•**                  reporting servers for aggregatingsubscriber level data into standard and custom reports;

**•**                  web servers for online reportdelivery; and

**•**                  client-side plug-in software forbrowsers that manages the display of reports in both numerical and graphicalformats with the ability to export data into various formats, such as Excel andHTML, for further distribution and analysis.

 

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All of our customers’ data are stored in a relational database.  This database is constantly being replicatedto a stand-by database for fail-over purposes and all data is regularly copiedto tape for disaster recovery purposes. Our reporting servers are fed aggregated data and are load balanced andfault tolerant.  Our architecture allowsus to scale the system, simply by adding hardware to the required components.

 

*PerformOne Network*

 

We developed a proprietary and scalable technology infrastructure thatenabled marketers to create, deliver, redeem and track targeted promotions thatwe call e-centives. The e-centives system principally consisted of database anduser interface servers, as well as a *Campaign Manager* software that managed thecreation and presentation of e-centives.

 

All e-centives were stored in and accessed from our database servers.These databases were developed using standard, high-performance technology andwere designed for rapid identification of target members. Our database serverarchitecture was hardware scalable, which meant that we could add new hardwareservers to increase capacity or improve access times as our membership andnumber of e-centives grew. We implemented the following initiatives to improveperformance and decrease system failures:

 

**•**                  a backup ofmembership and application data was completed daily;

**•**                  individualserver failures were mitigated through the deployment of redundant servers andstorage devices;

**•**                  all databaseservers were upgraded to maximize both processor speed and available memory;and

**•**                  periodicin-house scalability testing and performance tuning of the whole system wereperformed.

 

The user interface servers searched our databases and displayed theindividual member’s e-centives accounts as web pages. These servers controlledthe co-branded web pages of our marketers and partners. The user interfaceservers were deployed in a way to permit uninterrupted service in the event ofa failure of one server. The servers also gathered information used for memberbehavior analysis and tracking.

 

*Commerce Engine and Commerce Network*

 

A proprietary technology infrastructure was developed to scale with ourclient’s needs and to provide turnkey commerce capabilities for companies in abroad range of markets. The flexible platform enabled sites to blend commerceinto their user experience, embedding relevant products and content within arange of applications including web search, online banking, and editorialcontent.

 

The core items that made up the Commerce Engine technology included *Product Finder, Product Merchandiser, Marketplace,Omega*and*Product Spotlight*.  All of these systems used a combination ofdatabases, application servers, and network equipment that provided aninfrastructure for delivering access to the content and services.  The content included product listings,offers and 3rd party related content.

 

**•**                  *Product Finder* included proprietarytechnology that allowed our partners to search through the content of ourdatabase returning relevant results based on the provided search criteria. Aportion of this technology was a result of patented and patent pending technology.

 

**•**                  *Product Merchandiser* used proprietarytechnology to target a subset of our content to individuals based on theindividuals profiles, portal specifications, merchant specifications andobserved aggregated browsing and buying behavior of users of the system.

 

**•**                  *Marketplace* provided a flexible websitebuilding and hosting solution that allowed our partners to customize theirconsumers shopping experience. This technology was accessible to the consumeras a set of web pages that dynamically served up a shopping experience. Anotherportion of the technology was a set of web tools that were used to manage andconfigure that shopping experience.

 

**•**                  *Omega* provided the ability to integrateour product listing content into other companies’ standard web searchexperience.

 

**•**                  The *Product Spotlight* service provided fore-mail delivery of our content personalized to an individual.

 

In addition to these systems described above, there were additionalapplications and web tools that we provided to our partners

 

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to manage andinteract without the system.

 

**•**                  The *Selling System* was a web-based tool thatinteracted with our systems and databases to enable our merchant partners toselectively publish and promote product offers. This content published by eachmerchant was then accessible via Product Merchandiser and Marketplace to eachof our portal partners.

 

**•**                  The *Control Panel* was a web-based tool thatinteracted with our systems and databases. The tool enabled the portal partnerto configure aspects of the various commerce engine systems.

 

**•**                  The *Taxonomy Mapping Tool* was a downloadableapplication that interacted with our databases and servers, which allowed aportal partner to create a custom view on how to navigate through all of ourproduct content.

 

All our content was stored in and accessed from our databaseservers.  Our database serverarchitecture was hardware scalable, which means that we could add new hardwareservers to increase capacity or improve access times as our membership andtraffic grew.

 

We monitor andtest our system and software, and from time to time have identified minordefects. We address such defects by rewriting software code and, if possible,replacing small portions of our proprietary software with commerciallyavailable software components. Any difficulties in implementing new softwaremay result in greater than expected expense and may cause disruptions to ourbusiness.  We spent approximately $2.9 million,$7.9 million, and $4.1 million in 2000, 2001 and 2002, respectively, onresearch and development activities.

 

**COMPETITION**

 

We believethat the market for our solutions to be rapidly evolving and intenselycompetitive. We mainly compete with providers of promotions and data trackingtechnologies and services on the Internet. Some of our current and potentialcompetitors include:

 

**•**                  other providersof marketing technologies and services;

**•**                  traditionaladvertising agencies;

**•**                  outsourcede-mail providers;

**•**                  couponproviders; and

**•**                  promotions destinationsites.

 

As a providerof online direct-marketing solutions, we generally compete with marketing andother promotion programs for a portion of a marketer’s total marketing budget.In addition, within the promotions market, we compete with a variety ofbusinesses.

 

Our primarycompetition can be categorized as follows:

 

**•**                  both online andoffline direct marketing and promotion companies;

**•**                  Internet-basedmarketing technology and services firms; and

**•**                  other companiesthat facilitate the marketing of products and services on the Internet.

 

Current orpotential competitors include vendors that provide:

 

**•**                  e-mail marketingsolutions;

**•**                  rewardsprograms; and

**•**                  coupon andpromotion programs.

 

The failure tocompete successfully would impair our ability to generate revenues and becomeprofitable. Our ability to compete depends on many factors.

 

Factors overwhich we have some level of control:

 

**•**                  ability to enterinto relationships with marketers;

**•**                  ability toprovide simple, cost-effective and reliable solutions;

**•**                  timelydevelopment and marketing of new services; and

**•**                  ability tomanage rapidly changing technologies, frequent new service introductions andevolving industry standards.

 

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Factorsoutside our control include:

 

**•**                  development,introduction and market acceptance of new or enhanced services by ourcompetitors;

**•**                  changes inpricing policies of our competitors;

**•**                  entry of newcompetitors in the market;

**•**                  ability ofmarketers to provide simple, cost-effective and reliable promotions; and

**•**                  market economyimpacts on our clients’ marketing budgets.

 

We expectcompetition to intensify as more competitors enter our markets. Many of ourexisting competitors, as well as a number of potential new competitors, havesignificantly greater financial, technical, marketing and managerial resourcesthan we do. Many of our competitors also generate greater revenue and arebetter known than we are. They may compete more effectively and be moreresponsive to industry and technological change.

 

**INTELLECTUAL PROPERTY RIGHTS**

 

A large partof our success depends on protecting our intellectual property, which is one ofour most important assets. If we do not adequately protect our intellectualproperty, our business, financial condition, results of operations and cashflow could be seriously harmed.

 

We havedeveloped and acquired proprietary technology, including database and interfaceservers, offer creation and presentation software, and software to enablecommunication between marketers’ e-commerce systems and our system. All of ourmarketer clients who desire to use our software enter into a license agreementwith us. In addition, we require employees, contractors and other persons withaccess to our proprietary information to execute confidentiality andnon-compete agreements. We seek to protect our software, documentation andother written materials under trade secret and other intellectual propertylaws, which afford only limited protection. We have not registered anycopyrights in the U.S. or elsewhere related to our software or othertechnology.

 

We haveseveral issued U.S. patents and a number of pending U.S. and foreign patentapplications. Our pending patent applications seek to protect technology we useor may use in our business. We have no issued foreign patents, but we haveseveral pending foreign patent applications. It is possible that no patentswill be issued from the currently pending patent applications.  It is also possible that our patents or anypotential future patents may be found invalid or unenforceable, or otherwise besuccessfully challenged. Also, any patent we have currently or that is issuedto us may not provide us with any competitive advantages. We may not developfuture proprietary products or technologies that are patentable, and thepatents of others may seriously limit or prevent our ability to do business.Some of our acquired patent rights are subject to reversion if certain paymentsare not made (see page 28 regarding the acquisition of substantially all ofBrightStreet.com’s assets for further details).

 

We haveregistered the E-centives trademark in the U.S. We have filed U.S. trademarkregistrations for *PromoCast, PromoCommerce,PromoMail, PromoMail Event,**PromoMailSpotlight*, *BrightStreet*and *BrightStreet.com*, all ofwhich are pending. We have also filed for trademark registration of E-centives,the E-centives logo, *PromoCast,**PromoCommerce,*and *PromoMail* in Switzerland and with theEuropean Union. Through our acquisition of the substantially all the assets ofConsumer Review, Inc., we obtained several additional registered U.S.trademarks, including but not limited to, *CarReview, MTB Review, PC Photo Review, Golf Review, Garden Review, ComputingReview, Videogame Review*and *PhotographyReview*. We currently own several additional U.S. registeredtrademarks related to the ConsumerREVIEW.com business line, and we also claimrights in a number of additional tradenames associated with our businessactivities.

 

We hold rightsto various web domain names including *E-centives.com,**BrightStreet.com*, and*ConsumerREVIEW.com*, as well as severalother review-related domains. Regulatory bodies in the United States and abroadcould establish additional top-level domains, appoint additional domain nameregistrars or modify the requirements for holding domain names. Therelationship between regulations governing domain names and laws protectingtrademarks and similar proprietary rights is unclear. We may be unable toprevent third parties from acquiring domain names that are similar to ordiminish the value of our trademarks and other proprietary rights.

 

We have notregistered any copyrights in the United States or elsewhere related to oursoftware or other technology.

 

Despite ourefforts to protect our proprietary rights, unauthorized parties may attempt tocopy aspects of our products or to obtain and use information that we regard asproprietary. Policing unauthorized use of our products is difficult, and, whilewe are unable to determine the extent to which piracy of our software productsexists, software piracy can be expected to be a persistent problem. Inaddition, the laws of some foreign countries do not protect our proprietaryrights to as great an extent as do the laws of the United States. Our means ofprotecting our proprietary rights may not be adequate, and our competitors mayindependently develop similar

 

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technology,duplicate our products or design around patents issued to us or our otherintellectual property.

 

There has beena substantial amount of litigation in the software industry regardingintellectual property rights. In fact, in 2000, we settled litigation with oneof our competitors regarding our intellectual property (see Item 3 – “LegalProceedings” on page 20).  It ispossible that in the future, other third parties may claim that our current orpotential future products infringe upon their intellectual property. We expectthat software developers will increasingly be subject to infringement claims asthe number of products and competitors in our industry segment grows and thefunctionality of products in different industry segments overlaps. Any claims,with or without merit, could be time-consuming to defend, result in costlylitigation, require us to enter into royalty or licensing agreements or subjectus to an injunction. These agreements, if required, may not be available onterms acceptable to us or at all, which could materially adversely affect ourbusiness, financial condition, results of operations and cash flow. We haverecently filed a patent infringement action against Coupons, Inc., pending inthe United States District Court (District of Maryland). See Item 3 – “LegalProceedings” on page 20 for further details.

 

We integratethird-party software from vendors such as Oracle Corporation into the softwarewe use in our business. The third-party software may not continue to beavailable to us on commercially reasonable terms. We may not be able to renewthese agreements or develop alternative technology. If we cannot maintainlicenses to key third-party software, develop similar technology or licensesimilar technology from another source on a timely or commercially feasiblebasis, our business, financial condition, results of operations and cash flowcould be materially adversely affected.

 

**EMPLOYEES**

 

As of December31, 2002, we had a total of 85 employees, all of whom were based in the UnitedStates. Of these, 32 were sales and marketing, 30 were product development and23 were general and administrative personnel. None of our employees are represented by a labor union, nor have we everexperienced a work stoppage. We believe our employee relations are good.  The table below reflects our employeeheadcount at December 31 for each of the years below:

 

| 1997 |   | 16  |   |
|------|--------|-----|--------|
| 1998 |   | 31  |   |
| 1999 |   | 74  |   |
| 2000 |   | 110 |   |
| 2001 |   | 153 |   |
| 2002 |   | 85  |   |

 

**RECENT DEVELOPEMENTS**

 

*(a) Convertible Promissory Note*

 

In March 2003, we executed a convertiblepromissory note in favor of Friedli Corporate Finance and InVenture, Inc., foran aggregate sum of up to $6 million. The terms of the note includes, among other things, an 8% interest rate,a maturity date three years from the date of issuance, a conversion featurewhich provides that under certain circumstances each note will automaticallyconvert to our common stock, a prepayment premium of up to 30% of the principalamount under each such note, and a one-time final payment charge, in additionto all principal and interest paid, of 30% of the principal amount to be paidat maturity.  We may draw down againstthe available principal of up to $6 million at any time and in any amountduring the first two years of the note term. All principal drawn upon will be secured by substantially all of ourassets.  We intend to use the amountsdrawn upon for working capital and general corporate purposes.

 

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*(b) Termination of employees*

 

During the first quarter of 2003, we made a payment of approximately $122,000,consisting of severance and other employee benefits related to the plannedtermination of 11 employees.

 

**RISK FACTORS**

 

We caution youthat our performance is subject to risks and uncertainties.  There are a variety of important factorslike those that follow that may cause our future business, financialconditions, results of operations and cash flow to differ materially and/oradversely from those projected in any of our forward-looking statements made inthis Annual Report on Form 10-K or otherwise. The following risk factors andother information in this Annual Report on Form 10-K should be carefullyconsidered.  The risks and uncertaintiesdescribed below are not the only ones we face. Additional risks and uncertainties not presently known to us or that wecurrently deem immaterial may also impair our business, financial conditions,results of operations and cash flow.

 

***RisksRelated to Our Business***

 

**We have incurred net losses since inception,expect to incur continuing losses and may never achieve profitability in thefuture.**

 

To date, wehave not been profitable. We did not begin to generate revenues until the thirdquarter of 1999. As of December 31, 2002, we had an accumulated deficit ofapproximately $116.7 million. We incurred net losses in 2002, 2001, and 2000 of$17.1 million, $45.0 million and  $29.9million, respectively. We may continue to incur losses and may never achieveprofitability in the future. We expect to incur lower net losses and negativecash flow during the next year or so, with the overall goal of achievingprofitability for the business.  Weexpect to spend additional financial resources to expand our business duringthe next 12 months until we are able to fund expansion initiatives throughexisting working capital resources.  Wehave quantified the specific amounts of operating expenses and capitalexpenditures we expect to incur, and we currently anticipate spending between$375,000 and $575,000 over the next 12 months on capital expenditures andexpenses associated with expanding our system capacity.  If we cannot achieve operating profitabilityor positive cash flows from our operating activities, we may be unable tosecure additional funding, our stock price may decline and we may be unable tocontinue our operations.

 

**Our future results and the demand for ourservices are uncertain, and we will not become profitable if our services donot achieve market acceptance.**

 

We wereincorporated in August 1996 and launched our online direct marketing system inNovember 1998. We did not charge for our services and did not begin to generaterevenues until the third quarter of 1999. Since then, we have started offering additional services, some throughacquisitions and others through the launching of internally developed services.  Accordingly, our future results areuncertain and our results to date may not be representative of our futureresults.  If our products and servicesdo not achieve market acceptance, our business will not become profitable.

 

Since some ofour services are new, we cannot predict their demand. Demand for our servicesis dependent upon many factors.

 

Factors over which we have some level of control include:

 

**•**                  thenumber of customers we can attract to our solutions;

**•**                  ourability to compete successfully in our market; and

**•**                  oursuccess in promoting our products and services through our sales, marketing andbusiness development personnel.

 

Factors outside our control include:

 

**•**                  uncertaintyabout the value and effectiveness of our marketing solutions;

**•**                  ourcustomers’ ability to sell their products and services to their consumers; and

**•**                  thequality, accuracy and utility of the information provided to us that we provideto marketers regarding member demographics, member activity and promotionalsuccess.

 

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**Ageneral national economic downturn has and may continue to materially adverselyaffect our business, financial condition, results of operations and cash flow.**

 

Economicindicators suggest that the U.S. economy has experienced a general nationaleconomic downturn from 2001 into early 2003. Such downturns typically result in materially adverse effects uponadvertising and marketing expenditures and retail sales.  The repercussions from any such downturn arelikely to have a materially adverse effect on our business, financialconditions, results of operations and cash flow by reducing the demand for ourservices and the amount of any fees we are able to obtain.  The businesses of our clients are likely to be affected by any downturn insuch a manner as to reduce their willingness to make advertising and marketingexpenditures. Consumer demand for goods and services offered by our clients maysimilarly weaken as a result of such downturn. Numerous companies engaged in the provision of goods and services onlinehave recently encountered significantly reduced revenues, lay-offs of personneland often bankruptcy and/or liquidation. The occurrence or continuation of sucha general national economic downturn and any of the resulting effects,including those above, has and may continue to materially adversely affect ourbusiness, financial conditions, results of operations and cash flow.

 

**We may require additional capital to financethe growth of our operations, and if such funds are not available, we may notbe able to fund our planned expansion or continue operations.**

 

We currentlyanticipate that our existing capital, together with our funds from operationsand the proceeds from the our recent $6 million promissory note funding, willbe sufficient to meet our need for working capital, capital expenditures andbusiness expansion into the second quarter of 2004.  Additionally, Friedli Corporate Finance has executed a letter tous confirming its ability to provide us with $20 million in funding (of which$6 million was the recent convertible promissory notes).  See “Recent Developments” on page 12 for afurther discussion on the financing commitment.  Further, we may need to raise additional funds sooner than weexpect. For example, we may need additional financing if we:

 

•                  are unable toincrease our revenues as anticipated;

•                  decide to expandfaster than planned;

•                  develop new orenhanced services or products ahead of schedule;

•                  need to respondto competitive pressures; or

•                  need to acquirecomplementary products, businesses or technologies.

 

We cannot becertain that additional financing will be available on acceptable terms, or atall. Numerous companies engaged in the provision of goods or services onlinehave recently encountered significant difficulty obtaining funding from thepublic capital markets as well as through private transactions.  If we raise additional capital through theissuance of equity securities, the common stock interest of investors holdingshares prior to such issuance would be diluted. In addition, we may raise anynecessary additional capital through the issuance of preferred stock, withrights superior to those of the common stock purchased by investors prior tosuch issuance. If adequate funds are not available on acceptable terms, we maynot be able to fund our expansion, develop or enhance our products or servicesor respond to competitive pressures.

 

**We may not successfully integrate and manage the assets we purchasedfrom Consumer Review, Inc., and the intended benefits of the acquisition maynot be realized, which could have a negative impact and/or have materiallyadversely effect on the market price of shares of our common stock and ourbusiness.**

 

The acquisition of substantially all of the assets of Consumer Review,Inc. poses risks for our ongoing operations and the value of shares of ourcommon stock, including that:

 

•                  we may fail tosuccessfully integrate the acquired products and services into our businessoperations;

•                  we may incurunanticipated expenses related to the integration of the businesses into ourexisting business operations;

•                  we mayexperience difficulties and incur unanticipated expenses related to theassimilation and retention of employees; and

•                  whether or notsuccessfully integrated, the acquired assets may not perform as well as weexpect.

 

If we fail to successfully integrate the acquired assets and/or fail torealize intended benefits of the acquisition due to any of the foregoingreasons, the market price of shares of our common stock could decline and/orour business, financial condition, results of operations and cash flow could bematerially adversely affected.

 

**We may not be able to compete successfullyagainst current and future competitors.**

 

The market toprovide our services is intensely competitive and rapidly changing. We expectcompetition to continue to increase as

 

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a result ofsuch factors as:

 

**•**                  ourmarket’s increasing size;

**•**                  ourmarket opportunity becoming more visible;

**•**                  minimalbarriers to entry; and

**•**                  industryconsolidation.

 

We competewith companies for the dollars that marketers allocate to their marketingbudgets. We compete for these marketing dollars with many online directmarketers in several fields, such as vendors that provide:

 

**•**                  e-mailmarketing solutions;

**•**                  rewardsprograms; and

**•**                  couponand promotions programs.

 

We believe themarket for our Promotions System to be rapidly evolving and intenselycompetitive. In this area, we mainly compete with providers of promotions anddata tracking technologies and services on the Internet. Some of our currentand potential competitors include:

 

**•**                  other providersof marketing technologies and services;

**•**                  traditionaladvertising agencies;

**•**                  couponproviders; and

**•**                  promotionsdestination sites.

 

Many of ourother existing and potential competitors have significantly greater financial,technical, marketing and managerial resources than we do. Many competitors alsogenerate greater revenue and are better known than we are. As a result, theymay compete more effectively than we do and be more responsive to industry andtechnological change than we are. We also compete for marketing dollars withother online marketing and advertising companies as well as offline directmarketing and promotion companies. We operate in an intensely competitiveenvironment with a significant number of existing and potential competitors.

 

Our ability tosuccessfully compete depends on many factors.

 

Factors overwhich we have some level of control include:

 

**•**                  abilityto enter into relationships with marketers;

**•**                  abilityto provide simple, cost-effective and reliable solutions;

**•**                  timelydevelopment and marketing of new services; and

**•**                  abilityto manage rapidly changing technologies, frequent new service introductions andevolving industry standards.

 

Factorsoutside our control include:

 

**•**                  development,introduction and market acceptance of new or enhanced services by ourcompetitors;

**•**                  changesin pricing policies of our competitors;

**•**                  entryof new competitors in the market; and

**•**                  abilityof marketers to provide simple, cost-effective and reliable promotions.

 

The failure tocompete successfully would impair our ability to generate revenues and becomeprofitable.

 

**Our E-centives brand may not achieve thelevel of recognition necessary to attract additional clients, and buildingrecognition of the E-centives brand may require us to expend significant fundson marketing, either of which could materially adversely affect our business,financial condition, results of operations and cash flow.**

 

To besuccessful, we must continue to build and increase market recognition of ourcorporate brand because our market is competitive, with low barriers to entry.We no longer advertise to attract visitors to our website, but rather areattempting to build a brand that businesses identify with online marketing. Webelieve that the recognition of the E-centives brand is critical to our successand the importance of this will increase as more companies enter our market andcompetition for marketers’ attention increases. Building recognition of theE-centives brand may require us to expend significant funds on marketing.  The outcome of our marketing efforts is hardto predict. If we are not successful in our marketing efforts to increase ourbrand awareness, our ability to attract marketing clients could be harmed whichwould cause a materially adverse affect on our business, financial condition, results of 

 

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operations and cash flow.

 

**Our network infrastructure, computing systemsor software may fail or be compromised or damaged, which could harm ourreputation, as well as materially adversely affect our business, financialcondition, results of operations and cash flow.**

 

Theperformance of our hardware and software is critical to our business. Systemfailures that cause an interruption in service or a decrease in responsivenessof our transaction processing or data storage capabilities could impair ourreputation and the attractiveness of our brand. We have experienced periodicsystem interruptions, which may occur from time to time in the future. All suchdisruptions were caused by unique errors in our software code that were allsubsequently corrected and did not have a material adverse effect on ourbusiness. Any significant increase in the frequency or severity of futuredisruptions could have a material adverse effect on our business, financial condition, results of operationsand cash flow.

 

The softwarefor our systems is complex and may contain undetected errors or defects,especially when we implement upgrades to our system. Any errors or defects thatare discovered after our software is released for use could damage ourreputation or result in lost revenues.

 

We regularlymonitor and test our system and software, and from time to time we haveidentified minor defects. We currently address such defects by rewritingsoftware code and, if possible, replacing portions of our proprietary softwarewith commercially available software components. Any difficulties inimplementing this new software may result in greater than expected expense andmay cause disruptions to our business.

 

Cable &Wireless (formerly Exodus Communications) and Metromedia Fiber Network host oursystems and provide us with communications links. The delivery of our servicesis substantially dependent on our ability and the ability of the providers toprotect our computer hardware and network infrastructure against damage from,among other things:

 

•                  human error;

•                  fire andflooding;

•                  power loss;

•                  telecommunicationsfailure; and

•                  online orphysical sabotage.

 

We rely onCable & Wireless and Metromedia Fiber Network for a significant portion ofour Internet access as well as monitoring and managing the power and operatingenvironment for our server and networking equipment. Any interruption in theseservices, or any failure of Cable & Wireless to handle higher volumes ofInternet use, could result in financial losses or impair our reputation. In May2002, MetroMedia Fiber Network filed voluntary petitions for reorganizationunder Chapter 11 of the U.S. Bankruptcy Code. Subsequent to this filing, E-centives made a decision to consolidate allof its colocation equipment within its Cable & Wireless facilities.  As such, E-centives no longer maintains anycolocation assets with Metromedia Fiber Network.

 

**Our system capacity needs are untested andour failure to handle the growth of our database may materially adverselyeffect our business, financial condition, results of operations and cash flowor require us to expend substantial capital.**

 

The capacityof our system has not been tested and we do not yet know the ability of oursystem to manage substantially larger amounts of users and related data. Asubstantial increase in the number of users and a corresponding increase in thenumber of data records could strain our servers and storage capacity, whichcould lead to slower response time or system failures. We may not be able to handleour expected user and transaction levels while maintaining satisfactoryperformance. System failures or slowdowns adversely affect the speed andresponsiveness of our transaction processing. These would have a negativeimpact on the experience for our clients’ users and reduce our system’seffectiveness. Such an increase could require us to expand and upgrade ourtechnology, processing systems and network infrastructure. Any unexpectedupgrades could be disruptive and costly. Our failure to handle the growth ofour databases could lead to system failures, inadequate response times orcorruption of our data, and could materially adversely affect our business,financial condition, results of operations and cash flow. We believe that onaverage, our various systems’ hardware, at peak traffic levels, run atapproximately 80% of capacity. We may be unable to expand and upgrade oursystems and infrastructure to accommodate this growth in a timely manner. Anyfailure to expand or upgrade our systems could damage our reputation and ourbusiness.

 

In addition,if our usage of telecommunications capacity increases, we will need to purchaseadditional networking equipment and rely more heavily on our web hostingproviders to maintain adequate data transmission speeds. The availability ofthese products or services may be limited or their cost may be significant.

 

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**Our business could suffer if Internet usersreduce or block our access to their personal data.**

 

We collectconsumer demographic and purchase preference information from users and alsocollect data regarding the offers viewed and offers clicked-on by such users.Privacy concerns may cause users to resist signing up for our system, providingpersonal information and allowing us to monitor their usage. If users were toreduce the information voluntarily supplied or block access to their data, ourability to improve our database of user information and the value of ourservice would diminish.

 

**Privacy laws may be enacted or applied to us,which could restrict our ability to disclose consumer data with third parties,which could materially adversely affect our business, financial condition,results of operations and cash flow.**

 

We currentlyreport consumer information to our clients about their users. Our clientsreceive detailed and specific information about the activities of their usersfor purposes of targeting marketing messages and promotions to subscribers withcertain demographic or purchase preference criteria. Growing concern aboutprivacy and the collection, distribution and use of personal information, evenin the aggregate, may lead to the enactment and application of federal or statelaws or regulations that would restrict our ability to provide user data tothird parties. In addition, several states have proposed legislation that wouldlimit the uses of user information gathered online. Consequently, any futureregulation that would restrict our ability to provide information regardingusers would have a materially adverseimpact on our business, financialcondition, results of operations and cash flow by restricting our methods ofoperation or imposing additional costs.

 

**If we are not successful in protecting ourintellectual property our business will suffer.**

 

We dependheavily on technology to operate our business. Our success depends onprotecting and enforcing our intellectual property, which is one of our mostimportant assets.  We have developed andacquired proprietary technology including database and interface servers, offercreation and presentation software, and software to enable communicationbetween marketers’ e-commerce systems and our system.

 

Our means ofprotecting our intellectual property may not be adequate. Unauthorized partiesmay attempt to copy aspects of our service or to obtain and use informationthat we regard as proprietary. It is also possible that our patents or anypotential future patents may be found invalid or unenforceable, or otherwise besuccessfully challenged. If any of our current or future patents aresuccessfully challenged by a third party, we could be deprived of our right toprevent others from using the methods covered by such patents. In addition,competitors may be able to devise methods of competing with our business thatare not covered by our patents or other intellectual property. Although,members can access our service over the Internet from anywhere in the world, wecurrently only have operations in the U.S. The laws of some foreign countriesdo not protect our intellectual property rights to as great an extent as do thelaws of the United States. Our competitors may independently develop similartechnology, duplicate our technology or design around any patents that we mayobtain or our other intellectual property. If we do not adequately protect ourintellectual property, our business, financial condition, results of operationsand cash flow could be materially adversely affected.

 

**If we infringe upon the intellectual propertyrights of others our business, financial condition, results of operations andcash flow could be materially adversely affected.**

 

There has beena substantial amount of litigation in the software and Internet industryregarding intellectual property rights. It is possible that, in the future,third parties may claim that our current or potential future technologiesinfringe upon their intellectual property. We expect that software developerswill increasingly be subject to infringement claims as the number of productsand competitors in our industry segment grows. Any such claims, with or withoutmerit, could be time-consuming, result in costly litigation and diversion ofmanagement resources, require us to enter into royalty or licensing agreementsor subject us to an injunction. Royalty or licensing agreements, if required,may not be available on terms acceptable to us or at all, which could seriouslyharm our ability to operate our business and our financial condition maysuffer. For more information on pending intellectual property litigation, seeItem 3 — “Legal Proceedings” on page 20 for further details.

 

**Our liability fordamages due to legal proceedings may be significant.  Our insurance may not be adequate to cover this risk.**

 

Various legalproceedings are pending against us alleging, among other things, breach ofcontract and failure to fulfill certain payment obligations.  In some actions, parties are seekingdamages, including treble damages, that may exceed our insurance coverage.  Some actions involve allegations that arenot insured. If we sustain damages greater than our insurance coverage, or thedamages are not insured, there could be a material adverse effect on ourliquidity, which could hamper our operations. For more information on pending intellectual property litigation, seeItem 3 on page 20 for further details.

 

**We may be subject to claims based on thecontent of promotions we deliver.**

 

The onlinepromotions developed by our clients may not comply with federal, state or locallaws governing the content of 

 

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advertisementsand the sale of products and services. We do not control the content of thepromotions for which we provide promotions technology. Our role in facilitatingthese promotions may expose us to liability based on the content of thepromotions. We also may face liability if the promotional information in thepromotions is defamatory, inaccurate, or infringes on proprietary rights ofothers. Our clients or our employees may make errors or enter inaccurateinformation, and we do not verify the accuracy of information contained in thepromotions or otherwise for compliance with applicable advertising laws. We mayface civil or criminal liability for unlawful advertising or other marketeractivities. We could also face claims based on the content that is accessiblefrom our website through links to other websites.

 

We may not beadequately insured to cover these claims. Any claims could require us to spendsignificant time and money in litigation, even if we ultimately prevail. Inaddition, negative publicity caused by these inaccuracies could damage ourreputation and diminish our brand.

 

**Our business may be affected by seasonalfluctuations in direct marketing spending and Internet use, which could causeour stock price to fluctuate widely and/or materially adversely affect ourbusiness, financial operations, financial results and cash flow.**

 

Our limitedoperating history and rapid growth make it difficult for us to assess theimpact of seasonal factors on our business. We expect seasonal fluctuationswill affect our business. We believe that online direct marketing spending willbe highest in the fourth quarter of each calendar year due to increasedconsumer spending during the holiday period, and lowest during the summermonths of the third quarter. Because the market for Internet direct marketingservices is emerging, we cannot be certain of these seasonal patterns andadditional patterns may develop in the future as the market matures. This couldcause our operating results and stock price to fluctuate widely and/ormaterially adversely affect our business, financial operations, financialresults and cash flow.

 

**If we do not manage our growth, our business,financial condition, results of operations and cash flow could be materiallyadversely affected.**

 

We may not besuccessful in managing our growth.  Wehave gone from 60 employees on June 30, 1999, to 153 employees on December 31,2001, to 85 employees on December 31, 2002. Past growth has placed, and future growth will continue to place, asignificant strain on our management and resources, related to the successfulintegration of personnel.  Theacquisitions and integrations of the BrightStreet.com and ConsumerREVIEW.combusinesses has and will continue to divert management’s attention and place anadditional strain on our management and resources.

 

To manage theexpected growth of our operations, we will need to improve our operational andfinancial systems, procedures and controls. We will also need to manage ourfinance, administrative, client services and operations staff and train andmanage our growing employee base effectively. Our current and plannedpersonnel, systems, procedures and controls may not be adequate to support ourfuture operations. Our business, financial condition, results of operations andcash flow could be materially adversely affected if we do not effectivelymanage our growth.

 

**If we lose the services of any of our keypersonnel, our business and stock price could suffer.**

 

Our successdepends in large part on the contributions of Kamran Amjadi, our Chairman andChief Executive Officer and Mehrdad Akhavan, our President and Chief OperatingOfficer, whose understanding of our services, strategy and relationships wouldbe extremely difficult to duplicate from outside our company. We havemaintained employment agreements with Messrs. Amjadi and Akhavan, although suchagreements are currently under re-negotiation. As such, Messrs. Amjadi andAkhavan are currently operating in their respective capacities without writtenagreement.  While we expect to finalizenew agreements shortly, the loss of the services of any of these key personnelcould have a material adverse effect on our business, financial condition,results of operations and cash flow. We do not maintain “key person” lifeinsurance policies.

 

**If we are unable to attract and retain highlyskilled employees, our business, financial condition, results of operations andcash flow could be materially adversely affected.**

 

Our futuresuccess also depends on our ability to identify, attract, retain and motivatehighly skilled employees, particularly additional technical, sales andmarketing personnel. We face competition in hiring and retaining personnel froma number of sectors, including technology and Internet companies, governmentcontractors and traditional businesses. Many of these companies have greaterfinancial resources than we have to attract and retain qualified personnel. Wehave occasionally encountered and expect to continue to encounter difficultiesin hiring and retaining highly skilled employees, particularly qualifiedsoftware developers and engineers. We seek developers and engineers who haveexperience with the newest software development tools and Internet technologies.We may be unable to retain our highly skilled employees or identify, attract,assimilate or retain other highly qualified employees in the future, which mayin turn materially adversely affect our business, financial operations,financial results and cash flow.

 

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**We have stock-based compensation expenserelating to stock option grants, which will decrease earnings over, at least,the next two years.**

 

Stock-basedcompensation represents an expense associated with the recognition of thedifference between the fair market value of common stock at the time of anoption grant and the option exercise price. Stock compensation is amortizedover the vesting period of the options, generally four years. For the yearended December 31, 2002, the charge relating to stock option grants wasapproximately $360,000.  We estimate thecharge relating to stock option grants will be $234,000 and $54,000 in 2003 and2004 respectively. These charges will dilute earnings for those years and mayhave a negative impact on our stock price.

 

***RisksRelated to Our Industry***

 

**The demand for Internet direct marketingservices is uncertain.**

 

The market foronline direct marketing has only recently begun to develop. Most businesseshave little or no experience using the Internet for direct marketing andpromotion. As a result, many businesses have allocated only a limited portionof their marketing budgets to online direct marketing. In addition, companiesthat have invested a significant portion of their marketing budgets in onlinemarketing may decide after a time to return to more traditional methods if theyfind that online marketing is a less effective method of promoting theirproducts and services than traditional marketing methods. We cannot predict theamount of direct marketing spending on the Internet in general, or demand forour targeted direct marketing services in particular. The demand for onlinemarketing may not develop to a level sufficient to support our continuedoperations or may develop more slowly than we expect.

 

**Many of the clients for ourConsumerREVIEW.com business unit are emerging Internet companies that representcredit risks.**

 

Many of ourConsumerREVIEW.com clients are Internet companies which have significantlosses, negative cash flow and limited access to capital. Many of thesecompanies represent credit risks and could fail. Any financial difficulties ofour clients may result in difficulties in our ability to collect accountsreceivable or lower than expected sales of our products and services. If ourInternet clients continue to have financial difficulties or if suchdifficulties worsen, our business, financial condition, results of operationsand cash flow could be materially adversely affected.

 

***Additional Risks Related to Ownership of OurCommon Stock***

 

**We are, and will continue to be, controlledby our co-founders and board members, who may approve corporate actions withwhich you may disagree.**

 

We are, andwill continue to be, controlled by our co-founders and board members, who mayapprove corporate actions with which you may disagree.  As of December 31, 2002, our co-founders,Messrs. Amjadi, Akhavan and Friedli, owned directly or indirectly, approximately49.2% of our outstanding common stock.  As a result, to the extent that these stockholders exercise theirvoting rights in concert, they may to be able to control most matters requiringstockholder approval, such as electing a majority of the directors andapproving significant corporate matters, including a merger or sale of thebusiness. The interest of these stockholders may at times conflict with theinterests of our other stockholders.

 

**Althoughour common stock is listed on the SWX Swiss Exchange, it is thinly traded.  The market price of our common stock, likethe market prices of stocks of other Internet-related companies, may fluctuatewidely and rapidly.**

 

For the mostpart, trading in our common stock has been low.  Although our common stock has been listed on the SWX SnissExchange since October 3, 2000, there is no assurance that more tradingactivity in the common stock will develop.

 

In addition,the market price of our common stock, like the market prices of stocks of otherInternet-related companies, may fluctuate widely and rapidly.  The market price and trading volume of ourcommon stock, since our initial public offering has been and may continue to behighly volatile.  Factors such asvariations in our revenue, earnings and cash flow and announcements of newservice offerings, technological innovations, strategic alliances and/oracquisitions involving competitors or price reductions by us, our competitorsor providers of alternative services could cause the market price of our commonstock to fluctuate substantially.  Also,broad market fluctuations, including fluctuations of the SWX Swiss Exchange,which result in changes to the market prices of the stocks of many companiesbut are not directly related to the operating performance of those companies,could also adversely affect the market price of our common stock.

 

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**The listing of our shares on the SWX SwissExchange may limit our ability to raise capital and could adversely affect ourstock price.**

 

We are thefirst U.S. company to list solely on the SWX Swiss Exchange. We are not listedon any U.S. exchange. Because we are the first U.S. company to do this, we areuncertain what effect, if any, our listing on only the SWX Swiss Exchange willhave upon our ability to raise additional financing in the U.S. capitalmarkets. If the listing of our shares solely on the SWX Swiss Exchange isreceived by investors with uncertainty, the listing may discourage potentialinvestors and could hinder our ability to raise necessary financing onacceptable terms. In addition, after the expiration of the various lock-upperiods entered into by our current stockholders in connection with our recentacquisition of substantially all of the assets of Consumer Review, Inc., and inconnection with the recent issuance of warrants to certain insider andthird-parties (see Recent Developments on page 12) and the related registeringand listing of such stock, all of the shares of our common stock will beeligible for trading on the SWX Swiss Exchange. If a significant amount of suchshares are offered for sale on the SWX Swiss Exchange after such lock-upperiods expire, it could decrease our stock price, among other things.

 

**Stockholders have experienced substantialdilution in their equity ownership and voting power in our company whether ornot they exercised their basic subscription rights under our 2001 right’soffering, and they may experience further dilution if outstanding options,warrants and convertible preferred stock are exercised and if we offer additionalshares of our common stock for sale in future months.**

 

Stockholderswho did not exercise their basic subscription rights under the rights offeringwill experience substantial dilution of their percentage of equity ownershipinterest and voting power in our company. Even if our stockholders exercised their basic subscription rights infull, they will nevertheless still experience substantial dilution in theirvoting rights and in their proportional interest in our future net earnings dueto the purchase of common stock by standby purchasers.  In addition, stockholders may experiencesubstantial dilution based on the conversion of our newly issued Series Bconvertible preferred stock, the Series A convertible preferred stock that wasissued in conjunction with the rights offering, and/or the exercising ofoutstanding warrants and options.  It isalso possible that it may be necessary or appropriate for us to seek to raiseadditional equity capital in the future and shares of common stock may be offeredfor sale in the future.  In that event,the relative voting power and equity interests of persons who purchased thecommon stock in the rights offering could be reduced.  No assurance can be given that such future sale will not occur,and, if it did, at what price or other terms.

 

**ITEM2****– Properties**

 

We do notcurrently own any real estate. Our headquarters and principal administrative,finance, legal, sales and marketing operations are located in leased officespace in Bethesda, Maryland, a suburb of Washington, D.C. This lease, which wasrenegotiated in 2002, is for approximately 23,500 square feet and is for a termof five years, expiring in September 2005. Our current monthly rent paymentunder this lease is approximately $70,000, with increases of 3% per year. Wehave subleased approximately 10,000 square feet of the office space, with amonthly base rent of approximately $22,000, that increases 4% annually.  The sublease commenced in March 2002 andexpires in September 2005.

 

During 2002,we also maintained offices in Redwood Shores, California, Foster City,California, New York, New York and London, England.  Our offices in Redwood Shores, New York and London were closedprior to December 31, 2002. We do not expect to add any significant additionaloffice space in the foreseeable future.

 

OurConsumerREVIEW.com operating segment is primarily located in the Foster City,California office, while the E-centives operating segment is located throughoutthe our various offices.

 

**ITEM 3****– LegalProceedings**

 

On or aboutFebruary 6, 2003, Marketex Storage Systems, Inc. filed suit against us inCalifornia Superior Court, County of Santa Clara alleging that $53,514 plusinterest, attorney’s fees and costs is due to them.  Their claims were based on different breach of contract andrelated theories for various maintenance and support services.  In March of 2003 we settled the case withMarketex.  The terms of the settlementare that we will pay the full amount due ratably over 9 months. In return,Marketex will waive accrued interest, legal fees and costs.

 

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On or aboutNovember 14, 2002, we filed a joint patent infringement action with BlackDiamond CCT Holding, LLC against Coupons, Inc. in the Federal District Court ofMaryland.  In this suit, we allegeinfringement of two U.S. patents relating to online coupons, rights of which weacquired from BrightStreet.com. Coupons, Inc. has answered our complaint by denying infringement and hasraised affirmative defenses of non-infringement, invalidity, estoppel, lachesand/or estoppels and defenses under 35 U.S.C. section 373. No counter claimswere filed against us by Coupons, Inc.

 

On or aboutOctober 10, 2002, we received a demand letter from Orrick, Herrington & Sutcliffe,LLP, (“Orrick”), a law firm representing Bowne of New York City (“Bowne”), afinancial printing company, demanding payment of $91,527 for financial printingservices allegedly rendered by Bowne.  The demand letter also indicated that if the matter was not amicablyresolved, Bowne would commence legal proceedings.  The parties have now settled this dispute and entered into aformal settlement agreement whereby we have agreed to pay a total of $71,734 inequal installments over six months until July 15, 2003.  Upon our final payment, the agreementprovides for a full release of claims against us.

 

On or aboutAugust 29, 2002, Network Appliance, Inc. (“Network Appliance”) filed suitagainst us in the Superior Court of the State of California, County of SanMateo, alleging that we failed to fulfill certain payment obligations under ouragreement with Network Appliance for the purchase of equipment totaling$66,296.  We timely filed our answer,and on or about October 8, 2002 we were served with (i) Form ofInterrogatories, (ii) Requests for Admissions and (3) Request for Production ofDocuments.  It is our position thatNetwork Appliance had, prior to filing suit, agreed to reduce the amount forthe equipment to approximately 60% of the value cited in the complaint againstus and as such we believe our liability is limited to that amount.  The parties entered into a settlementagreement whereby we agreed to pay Network Appliance $55,000, payable as follows: $27,500 on or before November 1, 2002 and$27,500 on or before December 1, 2002.  All such payments have been made, and Network Appliance in turndismissed its lawsuit with prejudice and released all claims against us.

 

On or aboutApril 1, 2002 the trustee for Debtor, CyberRebate (“Trustee”) filed suitagainst us in the United States Bankruptcy Court, Eastern District of New York(“Bankruptcy Court”) for recovery of $210,000 allegedly paid to us as anavoidable preference under U.S. Bankruptcy laws.  On or about February 20, 2003, the parties agreed to a settlementand entered into a stipulation and order (“Stipulation and Order”) forBankruptcy Court approval, whereby we and the Trustee settled the claim inaccordance with the following:

 

•                  We shall pay atotal of $189,000 (the “Settlement Amount”);

 

•                  Commencing onFebruary 24, 2003, and on the first business day of each successive month thereafter, weshall pay equal monthlyinstallments of $15,750 into escrow until the stipulation and order enteredinto by the parties is finally approved by the Bankruptcy Court, after whichtime all remaining payments shall be made to the Official Committee ofUnsecured Creditors (“OCUC”), with the final payment of $31,500 made no laterthan the first business day of December, 2003;

 

•                  Notwithstandingthe payment schedule set forth above, in the event the Bankruptcy Court entersan Order confirming a plan of liquidation or dismissing the Debtor’s case (the“Triggering Events”), then we shall have until the later of (i) 10 days fromentry of such an Order with respect to any of the Triggering Events, or, (ii)June 1, 2003, to pay to the OCUC an amount equal to the difference between theSettlement Amount and the aggregate amount of payments previously made to theTrustee.

 

In exchangefor such payments, the Trustee shall fully release all claims against us anddismiss the suit against us with prejudice, and we will have a generalunsecured claim against the Debtor’s estate in the amount of $21,000.

 

There were noother material additions to, or changes in status of, any ongoing, threatenedor pending legal proceedings during the year ended December 31, 2002, includingno changes in the status of the settlement with coolsavings.com, Inc.(“coolsavings). The terms of the settlement with coolsavings provide for across-license between coolsavings and us for each of the patents currently indispute.  There are no royalties orother incremental payments involved in the cross-license.  Pursuant to this settlement, we may have tomake payments of up to $1.35 million to coolsavings as follows:

 

•                  $650,000, whichwas paid to coolsavings on September 29, 2000, was due at the signing of thesettlement documents.

 

 

•                  $250,000, whichwas accrued for during 2001, was due if, within one year from the date of entryof the Stipulated Order of Dismissal filed on or about March 3, 2000, CatalinaMarketing Corporation prevailed in a motion for summary judgment in a separatelitigation between it and coolsavings, involving the coolsavings’ patentcurrently in dispute.  However, adispute has arisen between the parties regarding whether this portion of thelicense fee is actually due, despite Catalina Marketing Corporation notprevailing in its motion.  This disputeis based in part on the fact that the we

 

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may be entitled to a license under the coolsavings’ patent at issue asa result of our acquisition of the assets of BrightStreet.com, whichacquisition included the settlement of infringement litigation betweencoolsavings and BrightStreet.com regarding the same coolsavings patent at issuein our settled litigation.  As such, theparties are currently in discussions regarding the resolution of this issue.

 

•                  Up to $450,000if and to the extent the coolsavings’ patent currently in dispute survives thepending reexamination proceedings at the Patent and Trademark Office that wereinitiated by a third party. This component of the settlement arrangement hasnot been accrued for because the possibility of us having to make this paymentcontinues to remain remote.

 

Depending on the amount and timing, an unfavorable resolution of someor all of these matters could materially adversely affect our business,financial condition, results of operations and cash flow in a particularperiod.

 

In addition, from time to time, we are a party to various legalproceedings incidental to our business. None of these proceedings is considered by management to be material tothe conduct of our business, operations or financial condition.

 

**ITEM 4****–Submission of Matters to a Vote of Security Holders**

 

During the quarter endedDecember 31, 2002, there were no matters submitted to a vote of securitiesholders.

 

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**PARTII**

 

**ITEM 5****– Market for Registrant’s Common Stock and RelatedStockholder Matters**

 

**A.****            MarketInformation**

 

Since ourinitial public offering on October 3, 2000, our common stock has traded on theSWX Swiss Exchange under the symbol “ECEN.” The following table reflects the high and low sales prices, in SwissFrancs and U.S. Dollars, reported on the SWX Swiss Exchange for each quarterlisted.  The amounts listed in U.S.Dollars reflect the relevant exchange rate as of the date of such high or lowprice.

 
|                                  |   | **SWISS FRANCS**     |   | **US DOLLARS** |   | **EXCHANGE RATES** |   |
|---------------------------------------|--------|----------------------|--------|----------------|--------|--------------------|--------|
| **PERIOD**                            |   | **HIGH**             |   | **LOW**        |   | **HIGH**           |   | **LOW** |   | **HIGH** |   | **LOW** |   |
| **2000**                              |   |                 |   |           |   |               |   |   |   |   |   |   |   |
| Quarter ended December 31, 2000       |   | CHF 21.80            |   | CHF 11.75      |   | $                  | 12.46  |   | $ | 7.04 |   | 0.57140 |   | 0.59900 |   |
|                                  |   |                 |   |           |   |               |   |   |   |   |   |   |   |
| **2001**                              |   |                 |   |           |   |               |   |   |   |   |   |   |   |
| Quarter ended March 31, 2001     |   | CHF 15.25            |   | CHF  8.50 |   | $                  | 9.35   |   | $ | 4.92 |   | 0.61310 |   | 0.57857 |   |
| Quarter ended June 30, 2001      |   | CHF   8.50 |   | CHF  1.87 |   | $                  | 4.87   |   | $ | 1.05 |   | 0.57346 |   | 0.55921 |   |
| Quarter ended September 30, 2001 |   | CHF   2.57 |   | CHF  0.80 |   | $                  | 1.50   |   | $ | 0.50 |   | 0.58485 |   | 0.61985 |   |
| Quarter ended December 31, 2001  |   | CHF   1.15 |   | CHF  0.85 |   | $                  | 0.71   |   | $ | 0.52 |   | 0.60897 |   | 0.60713 |   |
|                                  |   |                 |   |           |   |               |   |   |   |   |   |   |   |
| **2002**                              |   |                 |   |           |   |               |   |   |   |   |   |   |   |
| Quarter ended March 31, 2002     |   | CHF   1.14 |   | CHF  1.00 |   | $                  | 0.68   |   | $ | 0.60 |   | 0.59531 |   | 0.59577 |   |
| Quarter ended June 30, 2002      |   | CHF   1.14 |   | CHF  0.38 |   | $                  | 0.68   |   | $ | 0.25 |   | 0.59347 |   | 0.66796 |   |
| Quarter ended September 30, 2002 |   | CHF   0.46 |   | CHF  0.22 |   | $                  | 0.32   |   | $ | 0.15 |   | 0.69032 |   | 0.66538 |   |
| Quarter ended December 31, 2002  |   | CHF   1.58 |   | CHF  0.19 |   | $                  | 1.07   |   | $ | 0.13 |   | 0.67912 |   | 0.67195 |   |

 

**B.****            Holders**

 

As of March 24, 2003, the number of holders of our common stock was inexcess of 90 record and beneficial owners.

 

**C.****            Dividends**

 

We have neverdeclared or paid any cash dividends on our common stock. We intend to retainfuture earnings, if any, to finance the expansion of our business, and do notexpect to pay any cash dividends in the foreseeable future. Please see our Item7 — “Management’s Discussion and Analysis of Financial Conditions and Resultsof Operations — Liquidity and Capital Resources” on page 37.

 

Thedeclaration of dividends is within the discretion of our board of directors andsubject to limitations set forth in the Delaware General Corporation Law. Ourcertificate of incorporation provides that if dividends are paid, they must bepaid equally on each share of outstanding common stock. Payment of anydividends on our common stock is subject to the rights of any preferred stockthen outstanding.

 

**D.****            RecentSale/Issuance of Unregistered Securities**

 

*Options*

 

During the year ended December 31, 2002, we granted options to purchasea total of 445,000 shares of common stock under our stock incentive plan tocertain of our employees and directors. During that period, 30 options wereexercised to purchase shares of common stock, and options to purchase 1,400,500shares of common stock were forfeited by employees leaving the company.

 

*Convertible Promissory Note*

 

In March 2003, we executed a convertiblepromissory note in favor of Friedli Corporate Finance and InVenture, Inc., foran aggregate sum of up to $6 million. The terms of the note include, among other things, an 8% interest rate,a maturity date three years from the date of issuance, a conversion featurewhich provides that under certain circumstances the note will automaticallyconvert to our common stock, a prepayment premium of up to 30% of the principalamount under such note, 

 

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and a one-time final payment charge, in addition to all principal andinterest paid, of 30% of the principal amount to be paid at maturity.  We may draw down against the availableprincipal of up to $6 million at any time and in any amount during the firsttwo years of the note term.  Allprincipal drawn upon will be secured by substantially all of our assets.  We intend to use the amounts drawn upon forworking capital and general corporate purposes.

 

*Warrants*

 

On October 8, 2002, our board of directors approved the issuance of6,000,000 warrants (the “Warrants”) to four investors (the “Investors”) asconsideration for a $20 million financing commitment (the “FinancingCommitment”), which was memorialized in a letter to us, by Friedli CorporateFinance, dated September 12, 2002 (the “Commitment Letter”). In the CommitmentLetter, Friedli Corporate Finance, a financial advisor to us, agreed to provideus with the Financing Commitment. The Warrants were issued to the Investors inJanuary 2003 in connection with Friedli Corporate Finance agreeing to providethe Financing Commitment. The Warrants were issued to the Investors in offshoretransactions pursuant to Regulation S promulgated under the Securities Act of1933.

 

The Warrants entitle each Investor to purchase one share of our commonstock, $0.01 par value per share, for an initial exercise price of CHF 0.19 pershare during the exercise period. Pursuant to an amendment to the Warrants, theexercise period will begin three (3) months from January 6, 2003 and end onApril 7, 2008 at 5:00 P.M. Eastern time.

 

Two of the Investors, Peter Friedli and Venturetec, are currentstockholders. Pursuant to the terms of the private placement, each of PeterFriedli and Venturetec received 1,000,000 Warrants. As disclosed in our filingsunder the Securities Exchange Act of 1934, Peter Friedli beneficially owns 3%of New Venturetec AG, the parent of Venturetec, and is the President of bothNew Venturetec AG and Venturetec. Mr. Friedli has also been one of ourdirectors since 1996.

 

In March 2003, Friedli Corporate Finance amended and restated theCommitment Letter to provide for a $14 million financing commitment.

 

*Series B Convertible Preferred Stock*

 

In addition, in connection with our purchase of substantially all ofthe assets of Consumer Review, Inc., we issued into escrow 400,000 shares ofour Series B convertible preferred stock as part of the consideration for theacquisition.  If we experience a changein control before the one year anniversary of the closing, each share of theSeries B convertible preferred stock will immediately be converted into tenshares of our common stock and released from escrow. Upon the one yearanniversary of the closing date, provided that a change of control has notoccurred, the conversion rate for each share of the Series B convertiblepreferred stock shall be determined, based upon the achievement ofcontractually defined revenue during the calculation period, and will beconvertible pursuant to the table in Item 7 on page 28.  It is our current intention to register theSeries B convertible preferred stock within fifteen months of the closing.

 

Venturetec and Pine were debentureholders in Consumer Review, Inc;therefore, as a result of the acquisition Venturetec and Pine received 240,315shares and 4,500 shares, respectively, of our Series B convertible preferredstock.

 

*Rights Offering*

 

On October 19, 2001, we closed a rights offering of common stock forapproximately $24.6 million with subscriptions for 20,000,000 shares.  Each subscriber in the rights offering alsoreceived, for no additional consideration, based upon the number of shares ofcommon stock purchased by such subscriber in the rights offering, a pro-rataportion of 2,000,000 shares of the our Series A convertible preferred stock(convertible on a 10-for-1 basis into 20,000,000 shares of common stock undercertain circumstances).  After deductingexpenses, underwriting discounts and any foreign currency loss, the netproceeds from this transaction were approximately $22.2 million, with $12.6million of the net proceeds received by December 31, 2001. The remaining netproceeds of $9.6 million, which related to promissory notes issued to us aspart of the consideration for the rights offering, were received during thesecond quarter of 2002.

 

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**ITEM 6****– Selected Financial Information**

 

**SELECTED CONSOLIDATEDFINANCIAL DATA**

**(in U.S. Dollars inthousands, except share data)**

 

You shouldread the selected consolidated financial data shown below together with ourconsolidated financial statements and related notes and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andother financial data included elsewhere in this annual report. Our consolidatedstatements of operations data for each of the years ended December 31, 2000,2001 and 2002 and the consolidated balance sheet data as of December 31, 2001and 2002, are derived from our consolidated financial statements that have beenaudited by KPMG LLP, independent certified public accountants, includedelsewhere in this annual report. Our statement of operations data for the yearsended December 31, 1998 and 1999 and the balance sheet data as of December 31,1998, 1999 and 2000 have been derived from our audited financial statements notincluded in this annual report. The results are not necessarily indicative ofthe results that may be expected in future periods and are not comparablebetween prior periods as a result of business combinations consummated inapplicable years.  Results of acquiredbusinesses are included for the period subsequent to their respective dates ofacquisition. 

 

|                                                                                           |   | **Year Ended December 31,** |   |
|------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                                           |   | **1998**                    |   | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
|                                                                                           |   |                        |   |   |   |   |   |   |   |   |   |
| **Consolidated  Statement of Operations Data:**                                                |   |                        |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                        |   | $                           | — |   | $ | 740 |   | $ | 10,230 |   | $ | 5,054 |   | $ | 7,221 |   |
| Cost of revenue                                                                                |   | —                      |   | 1,028 |   | 2,208 |   | 8,395 |   | 4,416 |   |
| Product development,   exclusive of stock-based compensation                                   |   | 1,160                       |   | 2,427 |   | 2,873 |   | 7,933 |   | 4,069 |   |
| General and  administrative,  exclusive of stock-based compensation                            |   | 1,237                       |   | 4,083 |   | 8,765 |   | 12,592 |   | 10,763 |   |
| Sales and marketing,  exclusive of stock-based compensation                                    |   | 2,480                       |   | 7,889 |   | 19,006 |   | 9,997 |   | 3,886 |   |
| Network partner fees                                                                           |   | —                      |   | 730 |   | 6,354 |   | 986 |   | 2 |   |
| Restructuring and  impairment charge                                                           |   | —                      |   | — |   | — |   | 9,876 |   | 1,128 |   |
| Stock-based  compensation:                                                                     |   |                        |   |   |   |   |   |   |   |   |   |
| Product development                                                                            |   | —                      |   | 283 |   | 822 |   | 201 |   | 60 |   |
| General and  administrative                                                                    |   | —                      |   | 297 |   | 333 |   | 362 |   | 106 |   |
| Sales and marketing                                                                            |   | —                      |   | 475 |   | 558 |   | 300 |   | 193 |   |
| Loss from operations                                                                           |   | (4,877                      | )      | (16,472 | ) | (30,689 | ) | (45,588 | ) | (17,402 | ) |
| Interest expense                                                                               |   | —                      |   | — |   | — |   | (4 | ) | (58 | ) |
| Interest income, net                                                                           |   | 310                         |   | 268 |   | 694 |   | 608 |   | 296 |   |
| Other income                                                                                   |   | —                      |   | 34 |   | 50 |   | — |   | — |   |
| Loss before income taxes                                                                       |   | (4,567                      | )      | (16,170 | ) | (29,945 | ) | (44,984 | ) | (17,164 | ) |
| Income taxes                                                                                   |   | —                      |   | — |   | — |   | (19 | ) | 19 |   |
| Net loss                                                                                       |   | (4,567                      | )      | (16,170 | ) | (29,945 | ) | (45,003 | ) | (17,145 | ) |
| Preferred stock dividend  requirements and accretion of convertible redeemable preferred stock |   | (383                        | )      | (383 | ) | (552 | ) | — |   | — |   |
| Net loss applicable to  common shareholders                                                    |   | $                           | (4,950 | ) | $ | (16,553 | ) | $ | (30,497 | ) | $ | (45,003 | ) | $ | (17,145 | ) |
|                                                                                           |   |                        |   |   |   |   |   |   |   |   |   |
| Basic and diluted loss  per common share                                                       |   | $                           | (1.02  | ) | $ | (3.40 | ) | $ | (4.09 | ) | $ | (2.68 | ) | $ | (0.46 | ) |
| Shares used to compute  basic and diluted net loss per common share                            |   | 4,860,000                   |   | 4,869,601 |   | 7,460,272 |   | 16,810,366 |   | 37,349,270 |   |
|                                                                                           |   |                        |   |   |   |   |   |   |   |   |   |
| **Consolidated  Balance Sheet Data:**                                                          |   |                        |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                     |   | 2,377                       |   | 427 |   | 27,062 |   | 8,902 |   | 2,317 |   |
| Working capital                                                                                |   | 2,117                       |   | 872 |   | 26,094 |   | 2,177 |   | 1,279 |   |
| Total assets                                                                                   |   | 3,031                       |   | 5,490 |   | 36,377 |   | 27,829 |   | 12,691 |   |
| Deferred revenue                                                                               |   | —                      |   | 791 |   | 904 |   | 2,524 |   | 1,096 |   |
| Long term obligations                                                                          |   | —                      |   | 2,000 |   | — |   | 7,369 |   | 246 |   |
| Stockholders’ equity                                                                      |   | 2,587                       |   | 995 |   | 30,834 |   | 10,533 |   | 7,105 |   |

 

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**ITEM 7****–Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

*You should read the following discussion ofour financial condition and results of operations together with “SelectedConsolidated Financial Data” and our consolidated financial statements and thenotes to those consolidated financial statements elsewhere in this AnnualReport on Form 10-K beginning on page F-1. In addition to historicalinformation, this discussion contains forward-looking information that involvesrisks and uncertainties. Our actual results could differ materially from those anticipatedby such forward-looking information due to competitive factors, risksassociated with our expansion plans and other factors discussed under “RiskFactors” and elsewhere in this annual report.*

 

**Overview**

 

We provideinteractive direct marketing technologies and services.  Businesses rely on our broad range ofsolutions to acquire and retain customers. We provide online marketing andcommerce capabilities and solutions for companies across a range of industries.With our proprietary technology, we power acquisition and retention solutionsfor companies that do business with millions of Internet users every day.  During 2002, our suite of solutions includedthe *Interactive Database Marketing System*,the *E-mail Marketing System*, the *PerformOneNetwork*, the *Commerce Engine*,the *Commerce Network*, as well asadvertising and e-commerce services provided through *ConsumerREVIEW.com*.

 

We wereestablished on August 2, 1996 as Imaginex, Inc., through incorporation in theState of Delaware.  During October 1996,we amended our articles of incorporation to change our name to Emaginet, Inc.and in March 1999, we again amended our articles of incorporation to change ourname to E-centives, Inc. From inception until June 1999, our principalactivities included:

 

•                  designing anddeveloping our online direct marketing system, including our infrastructure;

•                  developing andprotecting our intellectual property;

•                  establishingrelationships with marketers and high-traffic Internet sites;

•                  expanding thenumber of consumer members and building our database of consumer information;and

•                  securingfinancing for working capital and capital expenditures.

 

We launchedour direct marketing service in November 1998 by delivering E-centives throughour *PerformOne Network*offerings.  Between November 1998 and June 1999, while wewere introducing our direct marketing service, we allowed marketers to use ourdirect marketing system at no charge. We began generating revenue in the third quarter of 1999.  In conjunction with the acquisition of theCommerce Division, our commerce products and services began generating revenuein late March 2001.  In August 2001, westarted producing revenue from our e-mail marketing technology services andthrough the acquisition of BrightStreet.com in December 2001, we begangenerating revenue by providing online promotions management solutions throughour *Interactive Database Marketing System*.During the second quarter of 2002 we decided to suspend offering the *Commerce Network*and the *Commerce Engine,* and in July of 2002 wedecided to suspend the offerings of the *PerformOneNetwork*. With the acquisition of substantially all of theassets of Consumer Review, Inc. in December 2002, we began providing additionaladvertising and e-commerce services from the *ConsumerREVIEW.com*division.

 

Our directmarketing system was designed to enable marketers to access a database ofconsumers across the websites of our network partners and by e-mail. Our *PerformOne Network* included a web-basedapplication that enabled consumers to register to receive promotional offers atour network partners’ websites or through our website. Our members provideddemographic information and product category interests in return for targetedoffers. Our system would then deliver offers for products and services directlyto the member’s account or through e-mail. *PromoMail,* the primary service we providedour marketers, consisted of targeted e-mails highlighting a marketer’s specificpromotion.  Our application providednetwork partners with the ability to present offers to their users

 

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without the costs and challenges of building and maintaining their ownonline direct marketing system. As previously noted, during 2002, we decided toterminate the offerings of our *PerformOneNetwork*.

 

•                  Our *PromoMail*service consisted of targeted e-mails highlighting a marketer’s specificpromotions.  Marketers who contracted touse the *PromoMail*service participated in mailings to a group of members based upon thosemembers’ preferences.  Marketers couldpurchase this service on a fixed fee basis or on a performance basis.  For the fixed fee contracts, participatingmarketers were charged a fixed fee for each member to whom the e-mail was sentand revenue related to the service was recognized upon transmission of thee-mail.  When marketers purchased the *PromoMail*service on a performance basis, revenue was based solely on the actions of ourmembers.  We earned a contractuallyspecified amount based on the number of members who clicked on the offer orother specified link, the number of purchases by our members, or the amount ofsales generated by our members.

 

•                  During the firsttwo quarters of 2001, we entered into several barter transactions (“marketingpartner transactions”) that consisted of the sale of large quantities ofoutbound e-mail to marketing partners, and the purchase of banneradvertisements and outbound e-mail services by E-centives from these samepartners.  We generally entered into acontractual relationship with a marketing partner for delivery of a specifiedquantity of targeted e-mails to our membership database or other databases,offering promotions and special offers on behalf of the marketingpartners.  In addition, we placed orderswith the marketing partner to purchase a specified volume of banneradvertisements, website click-throughs or outbound e-mail.  These marketing activities were designed todrive the marketing partners’ viewers and members to our registration page toregister for the E-centives service.

 

Through the March 2001 acquisition of the Commerce Division, weacquired a comprehensive system that provided product search, price comparisonand merchandising services. Revenue from the *Commerce Engine* and the *Commerce Network* was generated primarilythrough license, support and maintenance fees from Internet portal and otherwebsite destination customers, as well as fees from the participating onlinemerchants.  Contracts consisted of implementationand information service fees from Internet sites and service and monthlytransaction fees from merchants. However, our second quarter 2002 restructuring plan included theelimination of the products and service offerings of our Commerce Division, theclosure of our subsidiary in the United Kingdom, the reduction of 18 positionsand the disposal of non-core assets. Following the acquisition of the Commerce Division, business began todeteriorate.  Less money was being spenton this type of technology, as the returns perhaps did not appear to justifyinvesting in the products and services we offered through the CommerceDivision.  As a result, several of theCommerce Division clients that were up for renewal did not renew theiragreements and a large new customer terminated its contract early.Additionally, with many companies having less discretionary funds due to slowdowns in the capital markets, new customers were not entering into contractsfor our Commerce Division offerings. Therefore, the Commerce Division experienced a significant increase inexpenses without the corresponding increase in revenues. Due to the decline inthe customer base, we concluded that the benefits derived from the CommerceDivision would not be sufficient to support the product offerings and thedecision was made to close the Commerce Division.  The majority of the customer agreements for the *Commerce Engine*and*Commerce Network* services terminated bythe end of the second quarter of 2002, with the remaining agreementsterminating by August 30, 2002.

 

•                  The *CommerceEngine* was available to Internet portals and other website customerswho could, in turn, provide commerce services through their sites to end-users.We provided and managed all hardware, software and operational aspects of the *CommerceEngine* and the associated databases of product libraries andpurchasing locations. The *Commerce Engine* also tracked and, in thecases where merchants have installed our Affiliate Tracking System, confirmedpurchases made by end-users of our customers’ services and generated invoicesfor our merchants to support performance-based marketing arrangements amongmultiple parties.

 

•                  Our *Commerce Network* enabled merchants todistribute and promote their products to the end users of our *CommerceEngine* customers.  Our systemcollected product data from merchants, normalized it into appropriatecategories, indexed it and made it available for access through our *CommerceEngine* customers, and refreshed it regularly to reflect pricingchanges and availability.  Our accountmanagers worked closely with merchants to coordinate their involvement withinthe network, including product data management, merchandising, analysis andrecommendations.  We also providedmerchants with detailed performance reports broken down by site and category,in order to track activity.

 

In August 2001, we began offering e-mail marketing technology servicesto businesses.  These services allowcompanies to outsource their e-mail marketing campaigns to us.  This solution lets businessescost-effectively conduct e-mail marketing without having to acquire or developtheir own e-mail infrastructure and manage the process.  Our e-mail marketing solution consists oflist management and hosting, strategy and creative services, e-mail deliveryand management, and tracking and analysis services.  Our e-mail marketing system is designed to help build an ongoing,personalized dialogue with the client’s intended audience and maximizeeffectiveness through targeting and testing. Revenue is generated by charging fees for list management and hostingservices, strategy and creative services, e-mail delivery and managementservices, as well as tracking and analysis services.

 

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On December 3,2001, we entered into an Asset Purchase Agreement (the “Agreement”) withBrightStreet.com, Inc. (“BrightStreet.com”) whereby we acquired substantiallyall of BrightStreet.com’s assets and certain of its liabilities.  We acquired BrightStreet.com forapproximately $2.2 million, consisting of approximately $1.7 million in cash, aguaranteed warrant to purchase 500,000 shares of our common stock valued atapproximately $185,000, a contingent performance-based warrant to purchase upto 250,000 shares of our common stock and about $369,000 in acquisitioncosts.  In conjunction with theAgreement, we entered into a Patent Assignment Agreement (the “Assignment”)with BrightStreet.com.  Pursuant to theAssignment, BrightStreet.com has agreed to assign to us all rights, title andinterest in and to all the issued and pending BrightStreet.com patents(collectively, the “Patents”), subject to certain pre-existing rights grantedby BrightStreet.com to third parties (“Pre-existing Rights”), provided we makea certain payment to BrightStreet.com by December 3, 2005 (the “Payment”).  If we make such Payment by that date, weshall own all rights title and interest in and to the Patents, subject to thePre-existing Rights.  Until such Paymentis made, we have, subject to the Pre-existing Rights, an exclusive, worldwide,irrevocable, perpetual, transferable, and sub-licensable right and licenseunder the Patents, including the rights to control prosecution of the Patentsand Patent applications and the right to sue for the infringement of thePatents.  Until we take formal title tothe Patents, we may not grant an exclusive sublicense to the Patents to anyunaffiliated third party. In the event we do not make the Payment by December3, 2005, we shall retain a license to the Patents, but the license shall convertto a non-exclusive license, and other rights to the Patents and Patentapplications shall revert to BrightStreet.com or its designee. In exchange forthe rights granted under the Assignment, beginning December 2002, we areobligated to pay BrightStreet.com ten percent of revenues received that aredirectly attributable to (a) the licensing or sale of products or functionalityacquired from BrightStreet.com, (b) licensing or royalty fees received fromenforcement or license of the Patents covered by the Assignment, and (c)licensing or royalty fees received under existing licenses granted byBrightStreet.com to certain third parties. If the total transaction compensation paid, as defined by the Agreement,at any time prior to December 3, 2005 exceeds $4,000,000, the Payment will bedeemed to have been made.  Additionally,we have the right, at any time prior to December 3, 2005, to satisfy thePayment by paying to BrightStreet.com the difference between the $4,000,000 andthe total compensation already paid.

 

With theacquisition of BrightStreet.com’s assets, we started offering online promotionstechnology and infrastructure that is used for powering a variety ofpromotional offerings, including coupons, rebates, sales circulars, surveys,trial offers and loyalty programs.  Thissystem designs, deploys, and manages promotions and tracks individual consumerresponse to offers for manufacturers, retailers, and websites.  It also enables businesses to gain insightsabout their consumer preferences and motivations, and enhance consumerrelationships with rich data modeling and sophisticated targeting.  Revenue consists of fees from the sale oflicenses and related services.

 

On December 4,2002, we acquired substantially all of Consumer Review, Inc.’s assets andcertain of its liabilities through an Asset Purchase Agreement.  The cost of the acquisition wasapproximately $2.7 million, consisting of 400,000 shares of Series Bconvertible preferred stock valued at approximately $2.1 million, $290,000 incash and about $320,000 in acquisition costs. At closing the Series B convertible preferred stock was placed intoescrow.  If we experience a change incontrol before the one year anniversary of the closing, each share of theSeries B convertible preferred stock will immediately be converted into tenshares of our common stock and shall be released from escrow. Upon the one yearanniversary of the closing date, provided that a change of control has notoccurred, the conversion rate for each share of the Series B convertiblepreferred stock shall be determined based upon the achievement of contractuallydefined revenue during the calculation period and will be adjusted pursuant tothe schedule below.  The stockconsideration will then be disbursed in accordance with the terms of the EscrowAgreement.

 

| **Revenues  during the Calculation Period**    |   | **Conversion Rate** |   |
|------------------------------------------------|--------|---------------------|--------|
| Less than $1,000,000                           |   | 4 to 1              |   |
| More than $1,000,000, but less than $2,000,000 |   | 6 to 1              |   |
| More than $2,000,000, but less than $3,000,000 |   | 8 to 1              |   |
| More than $3,000,000, but less than $4,000,000 |   | 10 to 1             |   |
| More than $4,000,000, but less than $6,000,000 |   | 12 to 1             |   |
| $6,000,000 or more                             |   | 14 to 1             |   |

 

ConsumerREVIEW.commanages web communities around common product interests.  The web properties are dedicated to meetingthe needs of consumers who are researching products on the web. It provides aninterface to a large database of product information, forums, and other usefulcontent.  Consumers visit to learn,interact, and buy or sell the products showcased within our network of webcommunities, including sites like AudioREVIEW.com and MtbREVIEW.com. Users findthe products they are interested in, read and write reviews, participate indiscussions, compare prices, and shop online. ConsumerREVIEW.com businessservices primarily include advertising and e-commerce referrals.

 

To date wehave not been profitable, incurring net losses of $17.1 million, $45.0 millionand $29.9 million for the years ended December 31, 2002, 2001 and 2000,respectively. We have undertaken a series of cost-cutting measures to preservecash and we continue to examine ways to manage our human and capital resourcesmore efficiently.  In addition to therestructuring plans noted

 

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below, we have undertaken efforts to reduce marketing and generaloverhead expenses, and are continually looking prudently at all expenditures inorder to reduce our ongoing operating costs.

 

**•**                  In 2001, weimplemented restructuring actions to respond to the global economic downturnand to improve our cost structure by streamlining operations and prioritizingresources in strategic areas of our business. As a result, we recordedrestructuring/impairment charges of $9.9 million to reflect these actions. Thischarge consisted of costs related to the consolidation of excess facilities inour Bethesda, Maryland and Redwood Shores, California locations, severance andother employee benefit costs related to the termination of 63 employees, aswell as a revaluation of the intangible assets associated with the CommerceDivision.

 

•                  In 2002 werecorded a net restructuring/impairment charge of $1.1 million. Approximately$1.3 million of the charge occurred during the second quarter of 2002, inassociation with the termination of our lease for the Redwood Shores facilityand the closure of our Commerce Division. The charge related to the RedwoodShores facility was the net effect of the costs associated with terminating thelease and the reversal of the remaining 2001 accrued restructuring/impairmentbalance related to this facility. The Commerce Division related chargeconsisted of severance and other employee benefit costs for the termination of18 employees, the cost of closing the operations of the United Kingdomsubsidiary, the disposal and write-down of related tangible and intangibleassets, as well as other costs associated with the closure of the CommerceDivision.  During the last two quartersof 2002, we recorded a net restructuring/impairment credit of approximately$181,000. This was the result of a $359,000 credit related to the revised planfor the Bethesda facility, which was partially offset by the costs of scalingback the *PerformOne Network* andan increase in the reserve that was established for the closure of the CommerceDivision.  The revised plan for theBethesda office was due to the execution of a partial lease termination forone-half of the office space in this facility. As a result, we reversed the remaining accrued restructuring/impairmentbalance that was established in 2001 and set up a new reserve for the costsassociated with the new agreement. The costs connected with scaling back the *PerformOne Network* included severance andother employee benefits for the termination of 19 employees.

 

**Critical Accounting Policies**

 

Our criticalaccounting policies are as follows:

 

•                  Revenuerecognition

•                  Estimatingvaluation allowance for doubtful accounts

•                  Impairment oflong-lived and amortizable intangible assets

•                  Restructuringcharge

•                  Impairment ofgoodwill and intangible assets with indefinite useful lives

 

*(a) Revenue Recognition*

 

Revenue is generated by providing promotions marketing services, e-mailmarketing services, advertising services and various other consulting services,as well as licensing our software products. Our current products and services principally include the*Interactive Database Marketing System,*the *E-mail Marketing System,*andadvertising and e-commerce services provided through *ConsumerREVIEW.com*. Although we reduced the offerings of the*PerformOne Network* and eliminated the *Commerce Engine* and the *Commerce Network*, these systemscontributed revenue into the third quarter of 2002.

 

*Interactive Database Marketing System: *For the years endedDecember 31, 2002 and 2001, the *InteractiveDatabase Marketing System* represented 67% and 1%, respectively, ofthe year’s revenue.  Revenue isgenerated by charging fees for system licensing, data hosting, site hosting,database management, account management, strategy and creative services, e-maildelivery and management services, as well as tracking and analyticalservices.  Revenue related to licensingfees is recognized ratably over the license period, one-time service fees forsetting up the customer are recognized ratably over the expected term of thecustomer relationship and all other revenue is recognized when the service isprovided and the amount is determinable. For agreements that also include a performance-based incentive feecomponent that is not finalized until the end of a period of time specified inthe agreement, we recognize the amount that would be due under the formula atinterim reporting dates as if the contract was terminated at that date.  This policy does not involve a considerationof future performance, but does give rise to the possibility that fees earnedby exceeding performance targets early in the measurement period may bereversed due to missing performance targets later in the measurement period.Our only client with a performance-based incentive fee contributedapproximately $1,064,000 in such revenue from the original contract thatexpired in October 2002.  The renewalagreement, which began in November 2002, also

 

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includes performance-based incentive fees that are estimated to beapproximately $265,000, however the terms were not defined in the renewalagreement and are to be defined through an amendment to the agreement. Norevenue associated with these potential performance-based incentive fees hasbeen recognized.

* *

*E-mail Marketing System:*  Revenue is generated by charging fees forlist management and hosting services, strategy and creative services, e-maildelivery and management services, as well as tracking and analytical services.  Revenue related to one-time service fees forsetting up the customer is recognized ratably over the expected term of thecustomer relationship, while all other revenue is recognized when the serviceis provided.  Revenue from our *E-mail Marketing System* represented 5% and2% of our 2002 and 2001, respectively, revenue.

 

*ConsumerREVIEW.com:*  Revenue is predominantly generated throughadvertising and e-commerce fees. Advertising revenue is derived from the sale of advertisements on pagesdelivered to community members of our websites. This revenue is recognized inthe period in which the advertisements are delivered. E-commerce fees arederived from on-line performance-based programs and are earned on either a leadreferral basis or on an affiliate commission basis. We earn revenue fromperformance-based programs when a user of our websites responds to a commercelink by linking to a customer’s websites. For lead referral programs, we chargeour customers on a cost-per-click basis, and recognize the revenue in the monththe click occurs.  For affiliate-commissionsprograms, we recognize our revenue when the commission is earned, which is themonth the transaction occurred. C*onsumerREVIEW.com*represented 3% of our revenue for the year ended December 31, 2002.

 

*PerformOne Network:*The principal service, *PromoMail*,which was purchased by marketers either on a fixed fee basis or on aperformance basis and represented approximately 4% and 30% (excluding marketingpartner transactions as defined below), respectively, of our revenue for theyears ended December 31, 2002 and 2001. For the fixed fee contracts, participating marketers are charged a fixedfee for each member to whom the e-mail is sent, and revenue related to theservice is recognized upon transmission of the e-mail.  When marketers purchase the service on aperformance basis, revenue is based solely on the actions of our members.  We earn a contractually specified amountbased on the number of members who click on the offer or other specified link,the number of purchases by our members, or the amount of sales generated by ourmembers.  Beginning January 1, 2002,revenue for performance related agreements was recognized upon cash receiptsfrom the marketers for the actions of our members or upon notification of theactions for marketers that prepay. Prior to January 1, 2002, revenue was recognized upon notification ofthe actions of our members.  This changein revenue recognition policy was due to the uncertainty in estimating therevenue and, therefore, the collectibility of the revenue.  The change in revenue recognition to a cashreceipts basis did not have a significant impact on revenue.

 

*Commerce Engine:*Revenue was primarily generated through license, support and maintenance feesfrom Internet portal and other website customers.  Revenue was recognized ratably over the expected term of thecustomer relationship.   Revenue fromthe *Commerce Engine* represented4% and 9% of our 2002 and 2001, respectively, revenue.

 

*Commerce Network:*Through this system, we earned a contractually specified amount from merchantsbased on the number of end users who clicked on their specified link or theamount of merchant’s sales generated by the end users.  Beginning January 1, 2002, revenue wasrecognized upon cash receipts from the merchants, and prior to January 1, 2002revenue was recognized when an action by an end user occurred.  This change in revenue recognition policywas due to the uncertainty in estimating the revenue and, therefore, thecollectibility of the revenue. The change in revenue recognition to a cashreceipts basis did not have a significant impact on revenue.  Revenue from the *Commerce Network* represented 16% and 26% of our 2002 and2001, respectively, revenue.

 

*Consulting Services:*Customers may also contract for consulting services, such as assistance withpromotions planning, consumer acquisition and analytics.  Revenue related to these consulting servicesis recognized as the related services are provided.

 

*Marketing Partner Transactions*:Revenue for the first two quarters of 2001 included approximately $1.4 millionin barter revenue (“marketing partner transactions”), which representsexchanges of promotional e-mail deliveries for reciprocal advertising space ortraffic on other websites.  There wereno marketing partner transactions during the third and fourth quarters of 2001or during the year ended December 31, 2002. Revenue and expenses from these marketing partner transactions wererecorded based upon the fair value of the promotional e-mails delivered at asimilar quantity or volume of e-mails delivered in a qualifying past cashtransaction.  Fair value of promotionale-mails delivered was based upon our recent historical experience of cashreceived for similar e-mail deliveries. Such revenue was recognized when the promotional e-mails weredelivered.  Corresponding expenses wererecognized for the advertisements received when our advertisements weredisplayed on the reciprocal websites or properties, which was typically in thesame period as delivery of the promotional e-mails and were included in salesand marketing expense.

 

For the year ended December 31, 2002, one of our *Interactive Database Marketing System*customers, Reckitt Benckiser PLC, contributed $4.5 million, or 62%, ofrevenue.  This customer’s originalagreement expired in October 2002, and the

 

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customersubsequently renewed the agreement for an additional year.  This customer also represented approximately$2.6 million of the $3.0 million accounts receivable balance as of December 31,2002.  We do not believe there is asignificant risk of uncollectibility due to the customer’s payment history andcredit-worthiness.  Substantially all ofthe accounts receivable balance related to this customer was collectedsubsequent to year end.

 

*(b) Estimating valuation allowance fordoubtful accounts*

 

The preparation of financial statements requires us to make estimatesand assumptions that affect the reported amount of assets and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reported period.  We analyze historical bad debts, customerconcentrations, customer credit-worthiness, and current economic trends whenevaluating the adequacy of the allowance for doubtful accounts.  As a result, we recorded bad debt expense ofapproximately $35,000 for the year ended December 31, 2002.  As of December 31, 2002, our accountsreceivable balance was approximately $3.0 million, net of allowance fordoubtful accounts of approximately $75,000. Although approximately $2.6 million of the balance relates to onecustomer, we do not believe there is a significant risk of uncollectibility dueto the customer’s payment history and credit-worthiness. (Substantially all ofthe accounts receivable balance related to this customer was collectedsubsequent to year end.)

 

*(c) Impairment of long-lived and amortizableintangible assets*

 

We perform an on-going analysis of therecoverability of our long-lived and amortizable intangible assets and, for theyear ended December 31, 2002, this was done in accordance with FAS 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets,*which we adopted on January 1, 2002. Based onquantitative and qualitative measures, we assess the need to record impairmentlosses on long-lived and amortizable intangible assets used in operations whenimpairment indicators are present. The impairment conditions evaluated by usmay change from period to period, given that we operate in a volatile businessenvironment.  However, such impairmentconditions considered are the ability to maintain financial performanceobjectives, access to new markets and customers, overall market conditions, aswell as the value of new contracts. During the second quarter of 2002, inconjunction with our plan to close the Commerce Division, we wrote-offapproximately $4.7 million of tangible assets. Because of this plan, we also recorded an impairment charge of $694,000for the full value of the intangible assets associated with the CommerceDivision.  This was subsequent to theimpairment charge of $469,000 that we took during the fourth quarter of 2001that resulted from the revaluation of the Commerce Division.

 

Because the conditions underlying the factorswe use to evaluate our acquisitions change from time to time, we may determinethat it is necessary to take additional material impairment charges in futureperiods, which could have a material adverse impact on our business, financialcondition, results of operations and cash flow.

 

*(d) Estimation of Restructuring Accruals*

 

During 2001, we implemented an expensereduction plan as part of our strategy focused on improving operationalefficiencies and strengthening the financial performance of our business. Theseefforts resulted in the consolidation of excess facilities and the eliminationof redundant positions. As a result of this restructuring plan, we recordedcharges of approximately $9.4 million during 2001. These charges related mainlyto the consolidation of the Redwood Shores, California and Bethesda, Marylandfacilities and workforce reductions of 63 positions. Facility consolidationcosts of approximately $9.0 million included expected losses on subleases,brokerage commissions and other costs. Employee separation costs ofapproximately $431,000 included severance and other benefits.  Duringthe second quarter of 2002, the remaining accrued reserve balance ofapproximately $6.5 million associated with the Redwood Shores facility wasreversed because a new reserve was established to reflect the termination ofthe lease.  In addition, during thethird quarter of 2002, the remaining accrued reserve balance of approximately$1.4 million associated with the Bethesda facility was reversed as a newreserve was established to reflect a partial lease termination. As ofDecember 31, 2002, there was no remaining accrued liability balance related tothe 2001 restructuring charges.

 

During 2002, management approved plans toterminate the lease for the Redwood Shores facility, close the CommerceDivision, terminate one-half of the Bethesda facility lease and scale back theofferings of the *PerformOne Network*.A restructuring/impairment charge of approximately $9.0 million was recorded toreflect these actions. The charge included approximately $2.1 million in costsassociated with terminating the Redwood Shores facility lease,  $5.7 million for the disposal and write-downof tangible and intangible assets and other related expenses associated withclosing the Commerce Division, $1.0 million in costs associated with thepartial lease termination of the Bethesda facility and $215,000 in severanceand other employee benefit costs related to the termination of 37employees.  As of December 31, 2002, thebalance of the accrued restructuring/impairment charges recorded in 2002 wasabout $717,000.

 

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The calculation of the 2001 restructuringaccrual related to consolidation of two of our offices required us to make estimatesconcerning: (1) the expected length of time to sublease the facility; (2) theexpected rental rates on subleases; and (3) the estimated brokerage andrefurbishmnent expenses associated with executing the subleases.  Due to the early termination and partialtermination of the Redwood Shores and Bethesda office leases, respectively,that occurred during 2002, we reversed the associated 2001 reserve balances andestablished new reserves for the actual costs to be incurred in terminating theleases.  The calculation of the 2002restructuring accrual related to closure of the Commerce Division required usto make estimates concerning the liquidation of tangible assets and theexpected costs of terminating the UK office lease.  The expected cost to terminate the UK office lease consists ofmonthly rental through September 30, 2002 and forfeiture of the Company'ssecurity deposit of approximately $102,000. This is based on our best estimate, however, the landlord of the UKoffice facility has not responded to our requests to enter into a terminationagreement.  If the landlord of the UKoffice facility does not agree to a termination agreement, we could face apotential additional liability of approximately $364,000 for rental paymentsthrough September 2004.  If the actualresults differ from the our estimates, or as management’s best estimates changefrom quarter to quarter, based on the latest information, we are required toadjust our restructuring accrual, including recording additional expenses.

 

The policy regarding restructuring accrualswill change effective January 1, 2003, due to the adoption of FAS 146, *Accounting for Costs Associated with Exit or DisposalActivities.*  In July 2002,the FASB issued FAS 146, which requires a liability for a cost associated withan exit or disposal activity be recognized and measured initially at its fairvalue in the period in which the liability is incurred. If fair value cannot bereasonably estimated, the liability shall be recognized initially in the periodin which fair value can be reasonably estimated. The provisions of FAS 146 willbe effective prospectively for exit or disposal activities initiated afterDecember 31, 2002.

 

*(e) Impairment of Goodwill**and intangible assets with indefinite usefullives*

 

We adopted the provisions of FAS 142, *Goodwill and Other Intangible Assets,* asof January 1, 2002. FAS 142 requires that goodwill and intangible assets withindefinite useful lives no longer be amortized, but instead be tested, at leastannually, for impairment.  Wecontinually evaluate whether events and circumstances that have occurred thatindicate that the remaining value of any goodwill and/or intangible assets withindefinite useful lives may not be recoverable. During the second quarter of2002, due to the closure of the Commerce Division, the associated goodwill wasdeemed impaired and the net value of approximately $657,000 was written off.

 

**Related Party Transactions**

 

Peter Friedli, one of our stockholders and directors, serves as theinvestment advisor to both Venturetec and Pine, and also serves as President ofVenturetec and its parent corporation, New Venturetec AG.  Mr. Friedli also has relationships withseveral of our other stockholders; he serves as the investment advisor toInVenture, Inc., Joyce, Ltd., Savetech, Inc., Spring Technology Corp. andUSVentech, Inc.  Mr. Friedli alsoservices as the President of Friedli Corporate Finance, Inc. (“FCF”), a companythat provides us consulting services.

 

In March 2003, we executed a convertible promissory note in favor ofFriedli Corporate Finance and InVenture, Inc., for an aggregate sum of up to $6million.  We may draw down against theavailable principal of up to $6 million at any time and in any amount during thefirst two years of the note term.  Allprincipal drawn upon will be secured by substantially all of our assets.  We intend to use the amounts drawn upon forworking capital and general corporate purposes.

 

On October 8, 2002, our board of directors authorized the issuance of6,000,000 warrants to four investors as consideration for a $20 millionfinancing commitment from Friedli Corporate Finance.  Two of the Investors, Peter Friedli and Venturetec, are ourstockholders and pursuant to the terms of the warrant issuance, each of PeterFriedli and Venturetec received 1,000,000 warrants. As part of this financing,in the first quarter of 2003, we executed a promissory note in favor of FriedliCorporate Finance and InVenture, Inc., for an aggregate sum of up to $6million.

 

Venturetec and Pine were debentureholders in Consumer Review, Inc.  Therefore, as a result of our acquisition ofsubstantially all the assets of Consumer Review, Inc. in December 2002,Venturetec and Pine received 240,315 shares and 4,500 shares, respectively, ofour Series B convertible preferred stock.

 

As part of itsOctober 2001 rights offering, we sold shares of our common stock to Venturetecand Pine. Venturetec and Pine each delivered to us a promissory note asconsideration for the subscription price for the shares of common stock forwhich each company subscribed. Venturetec’s note (which was only partial consideration for the purchaseof the shares; the remainder was paid in cash) was in the principal amount ofCHF 8,500,000 (approximately $5.2 million) and Pine’s note was in the principalamount of CHF 8,687,530 (approximately $5.3 million). However, on January 22,2002, Pine, Venturetec and InVenture, all companies under common control,reallocated their share purchases and/or related promissory notes. The CHF2,500,000 (approximately $1.5 million) in cash originally indicated asoriginating from Venturetec was reallocated as follows:

 

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•                  In a privatesale, InVenture purchased from Pine 1,041,667 shares of common stock, originallypurchased by Pine pursuant to the rights offering, for CHF 2,083,334. As partof this transaction, Pine was credited with paying us CHF 2,083,334(approximately $1.3 million) and delivered to us an amended and restatedsecured promissory note, in the principal amount of CHF 6,604,196(approximately $4.1 million), with 2% interest. We simultaneously returnedPine’s original CHF 8,687,530 promissory note. All of the outstanding principal and interest under the promissory noteswas fully received in April 2002.

 

•                  Venturetec paidus CHF 416,666 (approximately $256,000) and delivered to us an amended andrestated secured promissory note, in the principal amount of CHF 10,583,334(approximately $6.5 million), with 2%. This CHF 10,583,334 reflects an increasein Venturetec’s secured promissory note to CHF 11,000,000 (approximately $6.8million), reflecting Venturetec’s original subscription price for the shares ofour common stock for which it subscribed under the rights offering, minus theCHF 416,666 payment. We simultaneously returned Venturetec’s original CHF8,500,000 promissory note. All of the outstanding principal and interest underthe promissory notes was fully received in April 2002.

 

Also as part of the rights offering, we paid commissions ofapproximately $1,438,000 to Rahn and Bodmer Banquiers, one of the participantsin the rights offering, and $214,000 to Friedli Corporate Finance.

 

In July 1996, we entered into a consulting agreement with FCF, wherebyMr. Friedli provides us with financial consulting services and investorrelations advice. Pursuant to a renewed agreement, FCF is paid $4,000 per monthplus reimbursement of expenses related to Mr. Friedli’s services.  In addition, we engaged FCF to support us inconnection with the 2001 rights offering and reimbursed FCF approximatley$100,000 in expenses for such rights offering support.

 

**Rights Offering**

 

On October 19, 2001, we closed a rights offering of common stock forapproximately $24.6 million with subscriptions for 20,000,000 shares.  Each subscriber in the rights offering alsoreceived, for no additional consideration, based upon the number of shares ofcommon stock purchased by such subscriber in the rights offering, a pro-rataportion of 2,000,000 shares of our Series A convertible preferred stock(convertible on a 10-for-1 basis into 20,000,000 shares of common stock undercertain circumstances).  After deductingexpenses, underwriting discounts and any foreign currency loss, the net proceedsfrom this transaction were approximately $22.2 million, with $12.6 million ofthe net proceeds received by December 31, 2001 and the remaining net proceedsof $9.6 million, which related to promissory notes issued to us as part of theconsideration for the rights offering, was received during the second quarterof 2002.  In connection with theproceeds of the promissory notes, we incurred a foreign currency loss ofapproximately $258,000 in the second quarter of 2002 based upon the differencebetween the currency rates at the time the cash was received and the closing ofthe rights offering.

 

**RecentDevelopments**

 

*Convertible Promissory Note*

 

In March 2003, we executed a convertiblepromissory note in favor of Friedli Corporate Finance and InVenture, Inc., foran aggregate sum of up to $6 million. The terms of the note include, among other things, an 8% interest rate,a maturity date three years from the date of issuance, a conversion featurewhich provides that under certain circumstances the note will automaticallyconvert to our common stock, a prepayment premium of up to 30% of the principalamount under tht note, and a one-time final payment charge, in addition to allprincipal and interest paid, of 30% of the principal amount to be paid atmaturity.  We may draw down against theavailable principal of up to $6 million at any time and in any amount duringthe first two years of the note term. All principal drawn upon will be secured by substantially all of ourassets.  We intend to use the amountsdrawn upon for working capital and general corporate purposes.

 

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**Results of Operations**

 

The followingpresents our financial position and results of operation as of and for theyears ended December 31, 2002, 2001 and 2000.

 

*Years ended December 31, 2002 and 2001.*

 

*Revenue.*  Revenue increased by $2,167,000 to$7,221,000 for the year ended December 31, 2002, compared to $5,054,000 for theyear ended December 31, 2001. The majority of the increase can be attributed tothe addition of new products and services. The *Interactive Database MarketingSystem,* which began generating revenue in late 2001, added$4,820,000 to our 2002 revenue, versus $58,000 for 2001. Our *E-mail Marketing**System,* which began generating revenue inJuly 2001, generated $350,000 in revenue, an increase of $236,000 when comparedto the prior year.  ConsumerREVIEW.com,which we acquired in December 2002, contributed $214,000 in revenue for 2002.

 

The CommerceDivision, which was acquired in March 2001 and closed by the third quarter of 2002,generated $1.5 million in revenue, which was lower by $300,000 when compared to2001. Our *PerformOne Network*experienced a $1,374,000 decrease in revenue, from $1,728,000 to $354,000, thatstemmed from a decline in the number of sales, a decrease in the dollar amountof the average sale, as well as our third quarter 2002 plan to suspend thesystem’s services and focus on our newer product offerings*.* Additionally, $1,371,000 or 27% of the revenue for 2001 wasgenerated through marketing partner transactions that occurred during the firsttwo quarters of 2001.  We did not engagein any marketing partner transaction activity during 2002.

 

Cost of Revenue.  Cost of revenue consistsprimarily of expenses related to providing our services, including relatedpersonnel costs, depreciation of servers, network and hosting charges, andrevenue share payments.  Cost ofrevenue decreased by $3,979,000 to $4,416,000 for the year ended December 31,2002, compared to $8,395,000 for the year ended December 31, 2001.  The decrease is primarily the result of the one-time purchase of $1,300,000 of data andoutbound e-mail services during the first half of 2001, lower revenue shareexpense of $566,000 associated with the lower *PerformOneNetwork* revenue, $334,000in lower network and hostingcharges due to consolidation ofspace and equipment, as well as the 2002 reversal of $174,000 inexpenses due to favorable settlements of liabilities for hosting charges recorded during 2001. In addition, the closure of the CommerceDivision resulted in lower depreciation and personnel related expenses for 2002of approximately $1,000,000, while the acquisition of BrightStreet.com in late2001 did not add a significant amount of expense to 2002.

 

Product Development.  Product development consists primarily of expenses related to thedevelopment and enhancement of our technology and services, including payrolland related expenses for personnel, as well as other associated expenses forour technology department.  We expenseproduct development costs as incurred. Product development expenses decreased by $3,865,000 to $4,068,000 forthe year ended December 31, 2002, compared to $7,933,000 for the year endedDecember 31, 2001.  Product developmentcosts for 2002 included the products and services from the BrightStreet.comacquisition, while 2001 did not include them for the corresponding period;however, costs still decreased year over year. This was the effect of the reduction in product development personneland overall lower costs due to suspending the services of the *PerformOne Network*, closing down the Commerce Division, andother organizational efficiency initiatives.

 

General and Administrative.  Generaland administrative expenses include payroll and related expenses foraccounting, finance, legal, human resources, and administrative personnel, aswell as selected executives.  Inaddition, general and administrative expenses include fees for professionalservices, occupancy related costs, and all other corporate costs, includingdepreciation and amortization.  Generaland administrative expenses decreased by $1,829,000 to $10,763,000 for the yearended December 31, 2002, compared to $12,592,000 for the year ended December31, 2001.  The primary reason for thedecrease was lower rent expense of $1,992,000 due to restructuring plansassociated with the Redwood Shores and the Bethesda offices.  Although the acquisitions of the CommerceDivision, BrightStreet.com and ConsumerREVIEW.com added expenses to 2002, loweramortization and professional fees offset these additional expenses.

 

Sales and Marketing.  Sales and marketing expenses consist primarily of payroll, salescommissions and related expenses for personnel engaged in sales, marketing andcustomer support, as well as advertising and promotional expenditures.  As a result of our cost-cutting efforts,sales and marketing expenses were lower by $6,111,000, decreasing from$9,997,000 for the year ended December 31, 2001 to $3,886,000 for the year endedDecember 31, 2002.  Although sales andmarketing for the year

 

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ended December31, 2002 included a full year’s worth of expenses related to the addition ofthe BrightStreet.com products and services, an overall decrease in advertisingand promotional expenditures during 2002 led to the reduction in costs.  Our efforts resulted in a decrease inprinted publications, on-line media, out-of-home media and broadcast mediaexpenditures of approximately $1,739,000, $1,463,000, $920,000 and $170,000, respectively.In addition, the reduction in the number of sales and marketing personnel,along with the closure of the Commerce Division, contributed to the decrease incosts.

 

Network Partner Fees.  Network partner fees include the fees we payour network partners for members, advertising and exclusivity on the networkpartners’ site.  Network partner feesdecreased by $984,000 to $2,000 in the year ended December 31, 2002, comparedto $986,000 in the year ended December 31, 2001.  This decrease is primarily the result of the termination ofNetwork Partner and Affiliate agreements associated with the *PerformOne Network*.  Such agreements included the Co-BrandingAgreement with Excite, the Website Affiliation agreement with USATODAY.com andthe Affiliate Marketing Agreement with BeFree, which accounted forapproximately $433,000, $225,000 and $197,000, respectively, of the decrease.We do not expect to incur network partner fees in the future.

 

Restructuring and Impairment Charges.  For the year ended December 31, 2002, werecorded a restructuring/impairment charge of $1,128,000, while for the yearended December 31, 2001 we recorded a charge of $9,876,000.

 

In 2001, management took certain actions to better align our costs withrevenues and to position us for profitable growth in the future. In April 2001and July 2001, we eliminated 21 and 25 positions, respectively, incurring atotal charge of approximately $344,000. During December 2001, we announced arestructuring plan that involved scaling back the Commerce Division, whichresulted in a reduction of our workforce by 17 associates, and an assessment ofthe carrying value of the intangible assets associated with the CommerceDivision. Due to the decline in the Commerce Division’s customer base and thereduction in the Commerce Division’s workforce, we concluded that the benefitsderived from the related intangible assets that had been acquired in connectionwith the purchase of the Commerce Division would not generate sufficient cashflow to support its carrying value. Accordingly, we wrote-down the acquiredintangible assets to estimated fair value, a reduction of approximately$469,000.  In addition, we decided toconsolidate and more efficiently use our facilities, leaving approximately 50%of the office space in both the Bethesda, Maryland and the Redwood Shores,California locations unoccupied and available for sub-lease.  As a consequence of this plan, we recorded a$9.0 million charge to operations during the fourth quarter of 2001.

 

During 2002, plans were approved to terminate the lease for the RedwoodShores facility, close the Commerce Division, terminate a portion of theBethesda facility lease and suspend the services of the *PerformOne Network*.  A charge of approximately $9.0 million wasrecorded to reflect these actions. The charge included approximately $2.1million in costs associated with terminating the Redwood Shores facilitylease,  $5.7 million for the disposaland write-down of tangible and intangible assets and other related expensesassociated with closing the Commerce Division, $1.0 million in costs associatedwith the partial lease termination of the Bethesda facility and $215,000 inseverance and other employee benefit costs related to the termination of 37employees.  However, the costs of the2002 restructuring plans were offset by a $6.5 million reversal and a $1.4million reversal of the balances of the accrued restructuring charges that wereestablished in December 2001 in conjunction with our effort to consolidate ourRedwood Shores and Bethesda facilities, respectively.  We had originally planned to leave approximately 50% of bothfacilities unoccupied and available for sub-lease, but subsequently decidedthat, due to the lack of viable sub-lease alternatives, it was more cost effectiveto terminate the entire Redwood Shores lease and do a partial termination ofthe Bethesda lease.

 

Stock-based Compensation.  Stock-based compensation expense consists ofthe difference between the fair value of our common stock and the exerciseprice of certain performance-based options prior to the measurement date andthe difference between the estimated fair value of our common stock and theexercise price of stock options issued to employees recognized ratably over thevesting period.  Stock-based compensationexpenses decreased by $504,000 to $359,000 for the year endedDecember 31,2002, compared to $863,000 for the year ended December 31,2001.  This decrease was attributable tothe reversal of historical stock-based compensation expense incurred forterminated employees in excess of the expense pertaining to options vestedthrough termination. We estimate the charge relating to stock option grantswill be $234,000 and $54,000 in 2003 and 2004, respectively.

 

Interest Income.  Interest income for 2001 consisted only of income on our cashbalances, while interest income for 2002 also included interest from ourpromissory notes.  However, interestincome decreased by $312,000 to $296,000 for the year ended December 31, 2002,compared to $608,000 for the year ended December 31, 2001.  The lower interest income was primarily theresult of earning less interest on our investments due to lower cash balances,in addition to lower interest rates resulting from general economic conditions.

 

Net Loss. Net loss decreased by $27.9 million to $17.1 million for the year endedDecember 31, 2002, compared to $45.0 million for the year ended December 31,2001.  Although revenue only increasedby $2.2 million, our efforts to reduce costs resulted in a decrease in operatingcosts of $26.0 million.

 

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*Years ended December 31, 2001 and 2000.*

 

*Revenue.*  Revenue decreased by $5,176,000 to$5,054,000 for the year ended December 31, 2001, compared to $10,230,000 forthe year ended December 31, 2000.  Whilerevenue for 2001 includes $1.4 million in marketing partner transactions, aswell as approximately $2.0 million in revenue from our commerce relatedservices and other new business lines, lower revenue from our direct marketingservices more than offset these additional sources of revenue.  Fixed fee *PromoMail*revenue decreased by $4.5 million, other*PerformOne Network* related revenue decreased by $2.3 million, andthe ZDNet agreement to deliver monthly e-mails, which generated approximately$1.3 million in revenue in 2000, expired in late 2000 and therefore had norevenue impact in 2001.

 

*Cost of Revenue.* Cost of revenue consists primarily of expenses related to providing ourservices, including related personnel costs, depreciation of servers, networkand hosting charges, and revenue share payments.  Although revenue declined from 2000 to 2001, cost of revenueincreased primarily due to the additional depreciation expense and network andhosting charges associated with the acquisition of the Commerce Division. Costof revenue increased by $6,187,000 to $8,395,000 for the year ended December31, 2001, compared to $2,208,000 for the year ended December 31, 2000.  Approximately $4.3 million or 69% of theincrease can be attributed to the acquisition of the Commerce Division.  Also contributing to the increase is theone-time purchase of $1.3 million of data and e-mail services from Matchlogic,a wholly owned subsidiary of Excite, in connection with a renegotiation of ournetwork partner related agreement with Excite. In addition, the year ended December 31, 2001 had higher depreciationcharges for fixed assets associated with providing our services.  The increase in cost of revenue can also beattributed to the shift from paying our network partners a fixed fee per newmember to revenue share arrangements.

 

*Product Development*.  Product development consists primarily ofexpenses related to the development and enhancement of our technology andservices, including payroll and related expenses for personnel, as well asother associated expenses for our technology department.  We expense product development costs as weincur them.  Product development expensesincreased by $5,060,000 to $7,933,000 for the year ended December 31, 2001, comparedto $2,873,000 for the year ended December 31, 2000.  Approximately $3.5 million or 69% of the increase is the directresult of the acquisition of the Commerce Division, with the remaining portionof the increase due to increased product development personnel costs associatedwith the development and improvement of our systems, including itsinfrastructure and computer software.

 

*General andAdministrative*.  General and administrativeexpenses include payroll and related expenses for accounting, finance, legal,human resources, and administrative personnel, as well as selectedexecutives.  In addition, general andadministrative expenses include fees for professional services, occupancyrelated costs, and all other corporate costs, including depreciation andamortization.  General andadministrative expenses increased by $3,827,000 to $12,592,000 for the yearended December 31, 2001, compared to $8,765,000 for the year ended December 31,2000.  A large portion of the increase,about $2.6 million, is due to higher rent expense, primarily associated withthe increased office space in Bethesda, Maryland and the new office space inRedwood Shores, California.  Theacquisition of the Commerce Division added approximately $1.4 million indepreciation and amortization expense for 2001. Although general andadministrative expenses have increased, primarily due to the acquisition of theCommerce Division, we have taken steps to reduce our ongoing expenditures.

 

*Sales and Marketing*.  Sales and marketing expenses consistprimarily of payroll, sales commissions and related expenses for personnelengaged in sales, marketing and customer support, as well as advertising andpromotional expenditures.  Sales andmarketing expenses decreased by $9,009,000 to $9,997,000 for the year endedDecember 31, 2001, compared to $19,006,000 for the year ended December 31,2000.  Although the year ended December31, 2001 included approximately $1.6 million of expenses related to theCommerce Division, there was an overall decrease in marketing and salesexpenditures when compared to the year ended December 31, 2000.  Broadcast media, on-line media, printedpublication and out-of-home media, expenditures were lower by $2.5 million,$2.4 million, $2.0 million and $1.3 million, respectively.  In addition, 2001 had lower salary relatedcosts, public relation expenditures and commissions than 2000.  These lower costs are primarily the resultof our cost reduction efforts.

 

*Network Partner Fees*.  Network partner fees include the fees we payour network partners for members, advertising and exclusivity on the networkpartners’ site.  Network partner feesdecreased by $5,368,000 to $986,000 in the year ended December 31, 2001,compared to $6,354,000 in the year ended December 31, 2000.  This decrease is primarily the result of thetermination of the Co-Branding Agreement with Excite, which resulted in anapproximate $4.5 million decrease in expense, and a shift from paying ourpartners a fixed fee per new member, to revenue share arrangements that areclassified as cost of revenue.

 

*Restructuring andImpairment Charges.*  During 2001, management took certain actions to better align ourcosts with revenues and to position us for profitable growth in the future. InApril 2001 and July 2001 we eliminated 21 and 25 positions, respectively,

 

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incurring atotal charge of approximately $344,000. During December 2001, we announced arestructuring plan that involved scaling back the Commerce Division, whichresulted in a reduction of our workforce by 17 associates, and an assessment ofthe carrying value of the intangible assets associated with the CommerceDivision. Due to the decline in the Commerce Division’s customer base and thereduction in the Commerce Division’s workforce, we concluded that the benefitsderived from the related intangible assets that had been acquired in connectionwith the purchase of the Commerce Division would not generate sufficient cashflow to support its carrying value. Accordingly, we wrote-down the acquiredintangible assets to their fair value, a reduction of approximately$469,000.  In addition, we decided toconsolidate and more efficiently use our facilities, leaving approximately 50%of the office space in both the Bethesda, Maryland and the Redwood Shores,California locations unoccupied and available for sub-lease.  As a consequence of this plan, we recorded a$9.0 million charge to operations during the fourth quarter of 2001.

 

*Stock-based Compensation.*  Stock-based compensation expense consists ofthe accrual of the difference between the fair value of our common stock andthe exercise price of certain performance-based options prior to themeasurement date and the accrual of the difference between the estimated fair valueof our common stock and the exercise price of stock options issued toemployees.  Stock-based compensationexpenses decreased by $851,000 to $863,000 for the year ended December 31,2001, compared to $1,714,000 for the year ended December 31, 2000.  This decrease can be attributed toperformance-based options that fully vested in 2000 and therefore did notimpact 2001, as well as the reversal of historical stock-based compensationexpense incurred for terminated employees in excess of the expense pertainingto options vested through termination.

 

*Interest Income.*  Net interest income consists of income onour cash balances.  Net interest incomedecreased by $86,000 to $608,000 for the year ended December 31, 2001, comparedto $694,000 for the year ended December 31, 2000.  We earned less interest in 2001 due to lower cash balances andlower interest rates resulting from general economic conditions.

 

*Net Loss*.  Net loss increased by $15.0 million to $45.0million for the year ended December 31, 2001, compared to $30.0 million for theyear ended December 31, 2000.  Thisincrease in net loss is the result of the decrease in revenue of $5.2 million,the increase in cost of revenue of $6.2 million and the restructuring andseverance charges of $9.9 million, offset by lower other operating expenses ofabout $6.3 million.

 

**Liquidity and Capital Resources**

 

Since ourinception through December 31, 2000, we funded our operations primarily fromthe private sale of our convertible preferred stock and common stock, as wellas our initial public offering on the SWX Swiss Exchange.  Through these financing activities, weraised net proceeds of approximately $82.5 million. In late 2001, we closed arights offering in which we received approximately $12.6 million in net proceedsduring 2001, with the remaining net proceeds, associated with promissory notesdelivered as part of the rights offering purchase price consideration, of $9.6million received during the second quarter of 2002.

 

On December31, 2002, we held $2.3 million in cash and cash equivalents.  In addition, we had restricted cash of$745,000 in the form of three certificates of deposit.  Two of the certificates of deposit serve ascollateral for letter of credit commitments to secure our lease paymentobligations for our Bethesda, Maryland and our Foster City, California offices.The third certificate of deposit serves as collateral for a letter of creditcommitment related to our D&O insurance policy.  As we make our monthly payments on this policy, the certificateof deposit is reduced by the corresponding amount and the money is transferredto our operating account.

 

Cash used inoperating activities for the year ended December 31, 2002 was $16.7 million, animprovement of $8.1 million over the $24.8 million for the year ended December31, 2001.  Net cash flows used inoperating activities for both periods primarily reflect our net losses for eachyear.

 

Investingactivities for the year ended December 31, 2002 provided $58,000 in cash, whileinvesting activities for the year ended December 31, 2001 used $4,773,000 incash.  Cash provided by investingactivities for the year ended December 31, 2002 included the conversion intocash of $1.0 million in restricted cash associated with the certificate ofdeposit that was used as collateral for the letter of credit commitment for theRedwood Shores office.  This cash wassubsequently transferred to Inktomi Corporation, in accordance with theamendment to the sublease agreement that provided for an early termination of thesublease. Cash provided by investing activities also reflected $428,000 used topurchase property and equipment, the $255,000 for the letter of creditcommitment related to our D&O insurance policy, as well as acquisitioncosts for ConsumerREVIEW.com and BrightStreet.com of $175,000 and $34,000,respectively. Cash used in investing activities for 2001 included the purchaseof the $1.0 million certificate of deposit used as collateral for the RedwoodShores office, the purchase of $895,000 in property and equipment and cashoutflows related to the acquisition of BrightStreet.com and the CommerceDivision of $1,924,000 and $1,116,000, respectively.  The $467,000 decrease in the purchasing of property and equipmentwas the result of our efforts to preserve cash by closely monitoring ourcapital expenditures.

 

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For the yearended December 31, 2002, net cash provided by financing activities of $10.1million primarily reflected the $10.3 million in proceeds from the notesreceivable from stockholders that were issued in conjunction with our October2001 rights offering. The $11.4 million in net cash provided by financingactivities for the year ended December 31, 2001, included $12.6 million inproceeds from the October 2001 rights offering and the March 2, 2001 payment of$1.2 million in dividends that were declared on our preferred stock in 2000.

 

We believethat our existing cash resources will be sufficient to meet our anticipatedcash needs for working capital and capital expenditures into the second quarterof 2004 based on our capital infusion of up to $6 million, structured in theform of a three-year promissory note that was issued in the first quarter of2003.   Should future revenue beinsufficient to cover our operating costs, we will need to secure additionalfunds to ensure future viability.  Wemay need to raise additional funds sooner to fund our future expansion, todevelop new or enhanced products or services, to respond to competitivepressures or to make acquisitions. We cannot be certain that additionalfinancing will be available to us on acceptable terms, or at all. If adequatefunds are not available, or not available on acceptable terms, we may not beable to expand our business. To the extent that our existing funds are notsufficient to enable us to operate into the second quarter of 2004 and beyond,Friedli Corporate Finance has provided a written commitment to provide us witha capital infusion of up to an additional $14 million for continued operationsand future business expansion purposes, in both sales and marketing and mergerand acquisition activities.  However, noformal terms and conditions have been agreed upon. Based on our current operatingplans, we do not believe that we will require the full capital commitment ofFriedli Corporate Finance to fund continued operations through profitability.

 

**Contractual Obligations and CommercialCommitments**

 

*Lease Obligations:*

 

In association with the acquisition ofBrightStreet.com’s assets, effective November 1, 2001, we entered into aModification, Assignment and Assumption Agreement with Pentech FinancialServices, Inc. (“Pentech”) and BrightStreet.com regarding the Master EquipmentLease (“Lease”) that BrightStreet.com had entered into with Pentech in May2000.  Per the agreement, with theconsent of Pentech, BrightStreet.com assigned the Lease to us with certainmodifications to the terms and conditions of the Lease.  In addition, we agreed to defend, indemnify,save and hold harmless BrightStreet.com from and against any and all claims,demands, costs, and any other damages which BrightStreet.com may sustain as aresult of any failure or delay by us in performing the assumed obligations.

 

We are obligated under non-cancelable capitalleases, for certain computer equipment, that expire during 2004.  In addition, we are obligated undernon-cancelable operating leases, primarily for office space, which expire onvarious dates through 2005.

 

Rent expense under operating leases wasapproximately $1,549,000, $3,541,000 and $955,000 for the years endedDecember 31, 2002, 2001 and 2000, respectively.

 

In February 2002, we signed a SubleaseAgreement to sublease a portion of the sixth floor at the Bethesda, Marylandfacility that commenced on March 1, 2002 and expires on September 30,2005.  For the period of March 2002through November 2002, the rental income was included as part of therestructuring reserve that was established in 2001.  For December 2002, the rental income offset rent expense.

 

As of December 31, 2002, our contractualobligations and commercial commitments, which consist of future minimum leasepayments under non-cancelable leases, are as follows:

 
| **Contractual  Obligations** |   | **less  than 1 year** |      | **1-3  years** |   | **total** |   |
|------------------------------|--------|-----------------------|-----------|----------------|--------|-----------|--------|
| capital lease obligations(1) |   | $                     | 243,552   |           | $      | 248,306   |   | $ | 491,858 |   |
| operating lease obligations  |   | 1,008,371             |      | 1,710,416      |   | 2,718,787 |   |
| Total                        |   | $                     | 1,251,923 |           | $      | 1,958,722 |   | $ | 3,210,645 |   |

 

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(1) Includes approximately $21,300 in interest

 

*Patent Assignment:*

 

On December 3, 2001, in conjunction with the acquisition ofsubstantially all the assets of BrightStreet.com, we entered into a 

 

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PatentAssignment Agreement (the “Assignment”) with BrightStreet.com.  Pursuant to the Assignment, BrightStreet.comhas agreed to assign to us all rights, title and interest in and to all theissued and pending BrightStreet.com patents (collectively, the “Patents”),subject to certain pre-existing rights granted by BrightStreet.com to thirdparties, provided we make a certain payment to BrightStreet.com by December 3,2005 (the “Payment”).

 

In exchange for the rights granted under the Assignment, beginningDecember 2002, we are obligated to pay BrightStreet.com ten percent of revenuesreceived that are directly attributable to (a) the licensing or sale ofproducts or functionality acquired from BrightStreet.com, (b) licensing orroyalty fees received from enforcement or license of the Patents covered by theAssignment, and (c) licensing or royalty fees received under existing licensesgranted by BrightStreet.com to certain third parties.  If the total transaction compensation paid, at any time prior toDecember 3, 2005 exceeds $4,000,000, the Payment will be deemed to have beenmade.  Additionally, we have the right,at any time prior to December 3, 2005, to satisfy the Payment by paying toBrightStreet.com the difference between the $4,000,000 and the totalcompensation already paid.

 

**Recently Enacted Accounting Pronouncements**

 

In August2001, the FASB issued FAS 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*, whichsupercedes both FAS 121 and the accounting and reporting provisions of APBOpinion No. 30, *Reporting the Results ofOperations-Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transactions*,for the disposal of a segment of a business (as previously defined in thatOpinion).  FAS 144 retains thefundamental provisions in FAS 121 for recognizing and measuring impairmentlosses on long-lived assets held for use and long-lived assets to be disposedof by sale, while also resolving significant implementation issues associatedwith FAS 121.  For example, FAS 144 providesguidance on how a long-lived asset that is used as part of a group should beevaluated for impairment, establishes criteria for when a long-lived asset isheld for sale, and prescribes the accounting for a long-lived asset that willbe disposed of other than by sale.  FAS144 retains the basic provisions of APB 30 on how to present discontinuedoperations in the income statement but broadens that presentation to include acomponent of an entity (rather than a segment of a business).  Unlike FAS 121, an impairment assessmentunder FAS 144 will never result in a write-down of goodwill.  Rather, goodwill is evaluated for impairmentunder FAS 142. The provisions of FAS 144 are required to be adopted no laterthan the year beginning after December 15, 2001. We adopted FAS 144 effectiveJanuary 1, 2002, and during the three months ended June 30, 2002 we wrote-offapproximately $4.7 million and $694,000, respectively, of our tangible andintangible assets due to our plan to close the Commerce Division.

 

In July 2002,the FASB issued FAS 146, *Accounting forCosts Associated with Exit or Disposal Activities*, which nullifiesEITF Issue 94-3, *Liability Recognition forCertain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in a Restructuring)*. FAS 146 requiresthat a liability for a cost associated with an exit or disposal activity berecognized when the liability is incurred. If fair value cannot be reasonablyestimated, the liability shall be recognized initially in the period in whichfair value can be reasonably estimated. Under Issue 94-3, a liability for anexit cost was recognized at the date of an entity’s commitment to an exit plan.The provisions of FAS 146 are effective for exit or disposal activities thatare initiated after December 31, 2002.

 

In November 2002, the FASBissued FIN 45, Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness to Others. FIN 45elaborates on the disclosures to be made by a guarantor in its interim andannual financial statements about its obligations under guarantees issued. FIN45 also clarifies that a guarantor is required to recognize, at inception of aguarantee, a liability for the fair value of the obligation undertaken. Theinitial recognition and measurement provisions of FIN 45 are applicable toguarantees issued or modified after December 31, 2002. The disclosurerequirements are effective for financial statements of interim and annualperiods ending after December 31, 2002. The adoption of FIN 45 is not expectedto have a material adverse effect on our business, financial condition, resultsof operations and cash flow.

 

 

We have certain guarantees disclosable under FIN 45:

 
| • | We guarantee the payment of sublease rentals to our Landlord on the  property that we sublet.  The maximum  guarantee on this property is approximately $768,000.                                                                                                                                                                                                |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • | We sometimes indemnify certain of our customers against damages, if  any, they might incur as a result of a claim brought against them related to  patent infringement from the use of our products.  We are unable to estimate the maximum exposure of such  indemnifications due to the inherent uncertainty and the varying nature of  the contractual terms. |

 

In November2002, the EITF reached consensus on Issue 00-21, *Revenue Arrangements with Multiple Deliverables,* on a modelto be used to determine when a revenue arrangement with multiple deliverablesshould be divided into separate units of accounting and, if separation isappropriate, how the arrangement consideration should be allocated to theidentified accounting units. The EITF also reached a consensus that thisguidance should be effective for all revenue arrangements entered into duringfiscal periods beginning after June 15, 2003. We are currently assessing theimpact the guidance would have on our business, financial condition, results ofoperations and cash flow.

 

In December2002, the FASB issued FAS 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure*, whichamended FAS 123 *Accounting for Stock-BasedCompensation*. The new standard provides alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. Additionally, the statement amends thedisclosure requirements of FAS 123 to require prominent disclosures in theannual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults. This statement is effective for financial statements for fiscal yearsending after December 15, 2002. We have elected to continue to follow

 

39

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the intrinsicvalue method in accounting for our stock-based employee compensationarrangement as defined by APB 25, *Accountingfor Stock Issued to Employee*, and as allowed under FAS 123 and havemade the applicable disclosures in Note 2 to the consolidated financialstatements as required by FAS 148.

 

In January2003, the FASB issued FIN 46, *Consolidationof Variable Interest Entities*, an interpretation of AccountingResearch Bulletin 51, *Consolidated FinancialStatements*. FIN 46 explains how to identify variable interestentities and how an enterprise assesses its interests in a variable interestentity to decide whether to consolidate that entity. This Interpretationrequires existing unconsolidated variable interest entities to be consolidatedby their primary beneficiaries if the entities do not effectively disperserisks among parties involved. FIN 46 is effective immediately for variableinterest entities created after January 31, 2003, and to variable interestentities in which an enterprise obtains an interest after that date. TheInterpretation applies in the first fiscal year or interim period beginning afterJune 15, 2003, to variable interest entities in which an enterprise holds avariable interest that it acquired before February 1, 2003. We do notanticipate that the adoption of FIN 46 will have a material adverse effect onour business, financial condition, results of operations and cash flow.

 

**ITEM 7A****– Quantitative and Qualitative Disclosures AboutMarket Risk**

 

The followingdiscussion about our market risk disclosures involves forward-lookingstatements. Actual results could differ materially from those projected inforward-looking statements. We maintain instruments subject to interest rateand foreign currency exchange rate risk. We categorize all of our market risksensitive instruments as non-trading or other instruments.

 

*(a) Interest Rate Sensitivity*

 

We maintain a portfolio of cash equivalents in a variety ofsecurities.  Substantially all amountsare in money market and certificates of deposit, the value of which isgenerally not subject to interest rate changes. We believe that a 10% increaseor decline in interest rates would not be material to our interest income orcash flows.

 

*(b) Foreign Rate Sensitivity*

 

We primarily operate in the United States; although during 2001 weexpanded our operations to include a sales office in London, United Kingdom.However, in conjunction with closing our Commerce Division, we closed ouroffice in London. As a result of this sales office, we were exposed to foreigncurrency rate fluctuations by having sales in foreign currencies. However, wehave recorded insignificant sales in foreign currencies.

 

We were exposed to the impact of foreign currency changes associatedwith the British Pound, for our London subsidiary’s financial instruments,which were limited to cash and cash equivalents. It was the policy of managementto fund foreign operations on a monthly basis, thus minimizing average cash andovernight investments in the Pound. At December 31, 2002, we maintained cashand cash equivalents of approximately £2,000 or approximately $3,000. Webelieve that a 10% increase or decrease in the Pound exchange ratio would notbe material to cash and cash equivalent balances, interest income, or cashflows from consolidated operations.

 

We are also exposed to the impact of foreign currency changesassociated with the Swiss Franc, due to the Swiss Franc promissory notes thatwere issued to us by Pine and Venturetec as partial payment of theirconsideration under the rights offering. In April 2002, we received all of theoutstanding principal and interest under the promissory notes and incurred aforeign currency loss of approximately $258,000 in the second quarter of 2002based upon the difference between the currency rates at the time the cash wasreceived and at the closing of the rights offering.

 

**ITEM 8****– Financial Statements and Supplementary Data**

 

Our financialstatements and supplementary data required by this item are attached as pagesF-1 to F-31 and are listed under Item 14(A)(1) and (2).

 

**ITEM 9****– Changes in and Disagreements with Accountants onAccounting and Financial Disclosures**

 

None.

 

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**PARTIII**

 

**ITEM 10****– Directors and Executive Officers of the Registrant**

 

The followingtable presents information about each of our executive officers, key employeesand directors as of December 31, 2002.

 
| **Name**         |   | **Age** |   | **Position(s) with Company**                                  |
|------------------|--------|---------|--------|---------------------------------------------------------------|
| Kamran  Amjadi   |   | 39      |   | Chairman,  Chief Executive Officer and Director               |
| Mehrdad  Akhavan |   | 39      |   | President,  Chief Operating Officer, Secretary and Director   |
| David  Samuels   |   | 41      |   | Senior  Vice President, Chief Financial Officer and Treasurer |
| Lawrence  Brand  |   | 49      |   | Senior  Vice President of Sales                               |
| Wendy  Roberts   |   | 38      |   | Vice  President of Emerging Markets                           |
| Ira  Becker      |   | 35      |   | Vice  President of Strategic Alliances                        |
| Alex  Sukhenko   |   | 34      |   | Vice  President of Engineering                                |
| John  Hoffman    |   | 43      |   | Vice  President of Network Operations                         |
| Christy  Marble  |   | 35      |   | Vice  President of Client Services                            |
| Peter  Friedli   |   | 45      |   | Director                                                      |

 

*Kamran Amjadi* hasserved as our Chairman and Chief Executive Officer since he co-founded ourbusiness in August 1996. From September 1990 until August 1996, Mr. Amjadi wasthe Executive Vice President and Director of United States Operations for MPTechnologies, a software company. From July 1986 until August 1990, Mr. Amjadiwas a software engineer with the Hewlett-Packard Corporation.

 

*Mehrdad Akhavan* hasserved as our President and Chief Operating Officer since October 1999, havingserved as our Executive Vice President and Secretary since he co-founded ourbusiness in August 1996. Mr. Akhavan was elected to our board of directors inOctober 1996. From November 1994 until August 1996, Mr. Akhavan was Presidentof TechTreK, a children’s computer entertainment and education center. FromJanuary 1991 until November 1994, Mr. Akhavan was President of TridentSoftware, a company he co-founded, which digitized works of art.

 

*David Samuels* joined us as Senior VicePresident, Chief Financial Officer and Treasurer in April of 2001 and overseesall financial and investor-related matters for E-centives. Prior to joiningE-centives, Mr. Samuels served as Vice President of Finance for TeligentInternational where, as a member of the senior management team, he played apivotal role orchestrating the financial management and funding initiatives formultiple joint venture businesses in Europe, Asia, and Latin America. He spentFebruary 1990 to January 2000 with Host Marriott Services Corporation, servingmost recently as Vice President of Finance, Development and Operations for NewMarkets where he functioned in the capacity of a divisional CFO drivingstrategic and business growth initiatives for a $200 million revenue businessunit. He began his financial career as an auditor with KPMG LLP.

 

*Lawrence Brand*joined us in November 1997 as our Vice President of Sales. He became our SeniorVice President of Sales and Business Development in November 1999. FromSeptember 1990 until April 1997, Mr. Brand was the Executive Vice President andGeneral Manager of InterBase Software, a division of Borland International, adeveloper of application, tools and relational databases. From July 1984 untilFebruary 1990, Mr. Brand held various positions with Oracle Corporation,serving most recently as National Director of Financial Services.  Mr. Brand left the company in February 2003.

 

*Wendy Roberts*overseesthe development of new market strategies and became our Vice President ofEmerging Markets in May 2002 and in March 2003 she was promoted to Senior VicePresident, Business Development.  Wendybrings more than 18 years of experience in the areas of new businessdevelopment, management consulting and strategic planning. From 1997 to2001  she served as Senior Partner ationStrategy and served as Vice President of New Business Development and asPartner of Strategy at Agency.com, a leader in the development of DigitalRelationship Management for Fortune 1000 companies. There she developed andgrew vertical market strategies and relationships in the areas ofPharmaceuticals, Financial Services and Insurance, High Technology, Retail andTravel. Through various senior roles in Sales, Marketing, Consulting and ClientManagement areas, Wendy has lead efforts to develop Relationship Managementstrategies for many leading companies.

 

*Ira Becker* joined usin September 1998 as Director of Business Development and was promoted to VicePresident of Strategic Alliances in May 1999. From November 1997 untilSeptember 1998, Mr. Becker was Director of Sales Development at PointCast, anInternet news and information company. From September 1995 until September1997, Mr. Becker was Vice President of Sales of inquiry.com, an Internetresource for information technology professionals. From September 1989 untilSeptember 1995, Mr. Becker was a manager with Ziff-Davis Publishing.

 

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*Alex Sukhenko*, our Vice President ofEngineering, Messaging & Data Warehouse, joined us in March 1999.  From September 1996 to February 1999, Alexserved as District Manager of AT&T Solutions for Advanced Networking Solutionsand prior to AT&T Solutions, Alex served as a consulting manager forNoblestar Systems. Alex has also served as a senior scientist for VectorResearch Inc. He began his career at Eastman Kodak, focusing on processre-engineering for Kodak’s circuit board manufacturing operations.

 

*John Hoffman*oversees our internal and external computer services, security and operation asour Vice President of Network Operations. He became a member or our team when we acquired BrightStreet.com in December 2001. At BrightStreet Inc.’s he oversaw their network infrastructure, where hemanaged more than 24 systems providing scalability and high availabilityarchitectures.  John brings more than 19years of experience in computer operations, software development and security.He has obtained varied development and operational experience both in highsecurity government work and the Internet. Prior to BrightStreet, he heldvarious positions at Lockheed Missile & Space Company, from 1998 to 2000,and at Netcom Online Communications, from 1994 to 1998.

 

*Christy Marble*, ourVice President of Client Services, joined us in July 2000. Christy oversees allclient implementations, managing such processes as account services, businessstrategy, performance analyses and production. She brings to E-centives more than 10 years of experience designing anddelivering results-based online and offline relationship marketing. From 1992until joining us, Christy worked at Claritas, Inc. where she most recentlyserved as Vice President, Financial Industry Practice Management where sheintroduced “best practices solutions” and helped generate additional sales. AsVice President of Client Services for Claritas, she designed and implementedcompany-wide employee training programs and new employee orientation processes.She also produced B2B and B2C marketing plans and oversaw a sales mentoringprocess for all sales channels, including telemarketing and online.

 

*Peter Friedli* co-founded our business inAugust 1996. Mr. Friedli was elected to our board of directors in October 1996.Mr. Friedli has been the principal of Friedli Corporate Finance, Inc., aventure capital firm, since its inception in 1986. Prior to joining FriedliCorporate Finance, Mr. Friedli worked as an international management consultantfor service and industrial companies in Europe and the U.S. Mr. Friedli alsoserves as the President of New Venturetec, Inc., a publicly traded Swissventure capital investment company and currently serves as a director ofVantageMed Corporation, a publicly traded provider of healthcare informationservices.

 

**Board of Directors**

 

Our board of directors currently consists of Kamran Amjadi, MehrdadAkhavan, and Peter Friedli. Kamran Amjadi is the Chairman of our board of directors.

 

*Board Committee: *Our board of directors currently has acompensation committee. The compensation committee determines the salaries andincentive compensation of our officers and provides recommendations for thesalaries and incentive compensation of other employees and consultants. Thecompensation committee also administers our various incentive compensation,stock and benefit plans. The compensation committee consists of Mr. Friedli,the committee’s chairman, and Mr. Amjadi.

 

*Director Compensation: *We do not currentlycompensate our directors who are also employees. Each non-employee directorcurrently is reimbursed for reasonable travel expenses for each board meetingattended. In addition, each non-employee director receives 10,000 stock optionsper year of service, with vesting one year from the date of grant.

 

*Compensation Committee Interlocks and InsiderParticipation: *Noneof our executive officers serves as a member of the board of directors orcompensation committee of any entity that has one or more executive officersserving on our board of directors or compensation committee.

 

**Limitation of Liability and Indemnificationof Directors and Officers**

 

Ourcertificate of incorporation provides that our directors will not be personallyliable to us, or our stockholders, for monetary damages for breach of theirfiduciary duties as a director, except for liability:

 

•                  for any breachof the director’s duty of loyalty to us or our stockholders;

•                  for acts oromissions not in good faith or which involve intentional misconduct or aknowing violation of law;

•                  under aprovision of Delaware law relating to unlawful payment of dividends or unlawfulstock purchase or redemption of stock; or

•                  for anytransaction from which the director derives an improper personal benefit.

 

As a result ofthis provision, we and our stockholders may be unable to obtain monetarydamages from a director for breach of his or her duty of care.

 

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Our bylawsprovide for the indemnification of our directors and officers and any personwho is or was serving at our request as a director, officer, employee, partneror agent of another corporation or of a partnership, joint venture, limitedliability company, trust or other enterprise. This indemnification is providedto the fullest extent authorized by, and subject to the conditions set forthin, the Delaware General Corporation Law. This indemnification will include theright to be paid the expenses by us in advance of any proceeding for whichindemnification may be had in advance of its final disposition.

 

**ITEM 11****– ExecutiveCompensation**

 

The followingtable sets forth the compensation paid to our Chief Executive Officer and ourthree other most highly compensated executive officers who were serving as ourexecutive officers as of December 31, 2002 (collectively, the “Named ExecutiveOfficers”).  We had only four executiveofficers, including the Chief Executive Officer, as of December 31, 2002.

 

**Summary Compensation Table**

 
|                                                        |   |           |       |   |    |   |   | **Long-Term  Compensation**         |   |
|-------------------------------------------------------------|--------|----------------|------------|--------|---------|--------|--------|-------------------------------------|--------|
| **Name and Principal Position(s)**                          |   | **Year**       | ** ** |   |    |   |   | **Securities  Underlying  Options** |   |
| **Annual  Compensation**                                    |
| **Salary  ($)**                                             |   | **Bonus  ($)** |
| Kamran Amjadi                                               |   |           |       |   |    |   |   |                                |   |
| Chairman and Chief Executive Officer                        |   | 2002           |       | $      | 170,000 |   | $      | —                              |   | — |   |
|                                                        |   | 2001           |       | $      | 170,000 |   | $      | —                              |   | — |   |
|                                                        |   | 2000           |       | $      | 170,000 |   | $      | 40,000                              |   | 275,000 |   |
|                                                        |   |           |       |   |    |   |   |                                |   |
| Mehrdad Akhavan                                             |   |           |       |   |    |   |   |                                |   |
| President, Chief Operating Officer, Secretary and  Director |   | 2002           |       | $      | 150,000 |   | $      | —                              |   | — |   |
|                                                        |   | 2001           |       | $      | 150,000 |   | $      | —                              |   | — |   |
|                                                        |   | 2000           |       | $      | 150,000 |   | $      | 40,000                              |   | 275,000 |   |
|                                                        |   |           |       |   |    |   |   |                                |   |
| David Samuels (1)                                           |   |           |       |   |    |   |   |                                |   |
| Chief Financial Officer and Treasurer                       |   | 2002           |       | $      | 170,000 |   | $      | —                              |   | — |   |
|                                                        |   | 2001           |       | $      | 123,958 |   | $      | —                              |   | 100,000 |   |
|                                                        |   |           |       |   |    |   |   |                                |   |
| Lawrence Brand                                              |   |           |       |   |    |   |   |                                |   |
| Senior Vice President of Sales and Business  Development    |   | 2002           |       | $      | 177,083 |   | $      | —                              |   | — |   |
|                                                        |   | 2001           |       | $      | 150,000 |   | $      | 25,000                              |   | — |   |
|                                                        |   | 2000           |       | $      | 150,000 |   | $      | 50,000                              |   | 49,564 |   |

 

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(1)          David Samuels joined E-centives in April 2001as Chief Financial Officer and Treasurer. Accordingly, the 2001 information forMr. Samuels is for the period from April 2001 to December 31, 2001.

 

**Employment Agreements**

 

Kamran Amjadiand Mehrdad Akhavan have been employed by us under employment agreements thatexpired on August 31, 2002. Mr. Amjadi and Mr. Akhavan’s employment agreementsprovided for annual base salaries of $170,000 and $150,000, respectively,subject to increase by the board of directors. Each of Mr. Amjadi and Mr.Akhavan is eligible for an annual bonus of $50,000. Pursuant to suchagreements, we could terminate, without cause, Messrs. Amjadi and Akhavan atany time provided that we are required to pay the full balance of theirsalaries for the term. If we are taken over, sold, or involved in a merger oracquisition of any kind and the same salary is not offered to Messrs. Amjadiand Akhavan for the remaining term of their agreements, then they were entitledto payment of the full balance of their salaries for the term. Pursuant to suchagreements, each of Messrs. Amjadi and Akhavan agreed for a period of one yearfollowing resignation or termination of the agreement not to compete directlywith or be employed by any person or organizations that compete directly withour products or services developed or in development at the time of theirtermination.  We are currentlyrenegotiating Messrs. Amjadi and Akhavan’s employment agreements.  Despite their expiration on August 31, 2002,all parties have continued to operate in accordance with the terms of thoseagreements.  The parties anticipatecompleting negotiations by the end of the second quarter 2003.

 

**Option Grants in LastFiscal Year**

 

No optionswere granted to any of our named executive officers during the fiscal yearended December 31, 2002.

 

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**Fiscal Year-EndOption Values**

 

The followingtable presents information with respect to stock options owned by each of ournamed executive officers at December 31, 2002. 

 
|            |   | **Number  of Securities Underlying  Unexercised Options at  December 31, 2002** |   | **Value  of Unexercised  In-the-Money Options at  December 31, 2002** |   |
|-----------------|--------|---------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------|--------|
| **Name**        |   | **Exercisable**                                                                 |   | **Unexercisable**                                                     |   | **Exercisable** |   | **Unexercisable** | ** ** |
| Kamran Amjadi   |   | 375,000                                                                         |   | —                                                                |   | $ | — |   | $ | — |   |
| Mehrdad Akhavan |   | 375,000                                                                         |   | —                                                                |   | — |   | — |   |
| David Samuels   |   | 43,750                                                                          |   | 56,250                                                                |   | — |   | — |   |
| Lawrence Brand  |   | 190,619                                                                         |   | 30,182                                                                |   | — |   | — |   |
|                 |        |                                                                                 |        |                                                                       |        |  |  |  |  |  |  |

 

**Stock Incentive and Option Plan**

 

Our Amendedand Restated Stock Incentive and Option Plan provides for the grant of options,restricted stock and other stock-based compensation to our employees,consultants and advisors. As of December 31, 2002, there were 21,000,000 sharesof common stock reserved for issuance and there where 2,206,800 options topurchase shares of common stock outstanding at a weighted average exerciseprice of $5.18 per share. Options granted under the plan typically vest overtime, usually ratably over four years from the date of grant, subject toacceleration in the event of a change of control of E-centives. Typically, anoption granted under the plan expires ten years after it is granted. Inaddition, the plan allows for grants of options the vesting of which is tied tothe employee’s performance. As of December 31, 2002, our board of directors hasissued only stock options under the plan. The plan provides for the granting ofboth incentive stock options within the meaning of Section 422 of the InternalRevenue Code of 1986 and non-statutory options.

 

Ourcompensation committee administers our plan. The compensation committee isauthorized to determine:

 

•                  which eligibleindividuals receive option grants or share issuances;

•                  the number ofshares under each option grant or share issuance;

•                  the exerciseprice per share under each option;

•                  the term of eachoption; and

•                  the vestingschedule for individual option grants or share issuances.

 

**401(k) Plan**

 

We have atax-qualified employee savings plan, which covers all of our employees.Eligible employees may defer up to 25% of their pre-tax earnings, subject tothe Internal Revenue Service’s annual contribution limit. Our 401(k) planpermits us to make additional discretionary matching contributions on behalf ofall participants in our 401(k) plan in an amount determined by us. Our 401(k)plan is intended to qualify under Section 401 of the Internal Revenue Code of1986 so that contributions by employees or by us to our 401(k) plan, and incomeearned on plan contributions, are not taxable to employees until withdrawn fromthe plan, and so that

 

44

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contributions by us, if any, will bedeductible by us when made.

 

**ITEM 12****– SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters**

 

The followingtable presents information regarding the beneficial ownership of common stockas of March 15, 2003:

 

•                  each person, orgroup of affiliated persons, who is the beneficial owner of more than fivepercent of our outstanding common stock;

•                  each of ournamed executive officers;

•                  each of ourdirectors; and

•                  all of ourexecutive officers and directors as a group.

 

Unlessotherwise indicated, the address of each person identified is c/o E-centives,Inc., 6901 Rockledge Drive, 6th Floor, Bethesda, Maryland 20817.

 

Holders of ourcommon stock are entitled to one vote for each share held on all matterssubmitted to a stockholder vote. The persons named in this table have solevoting power for all shares of our common stock shown as beneficially owned bythem, subject to community property laws where applicable and except asindicated in the footnotes to this table. Beneficial ownership is determined inaccordance with the rules of the Securities and Exchange Commission. Incomputing the number of shares beneficially owned by a person and thepercentage ownership of that person, shares of common stock subject to optionsand warrants held by that person that are currently exercisable or exercisablewithin 60 days after March 15, 2003 are deemed outstanding. These shares,however, are not deemed outstanding for the purpose of computing the percentageownership of any other person.

 
|                                                             |   | **Shares  Beneficially Owned** |   |
|------------------------------------------------------------------|--------|--------------------------------|--------|
| **Name**                                                         |   | **Number**                     |   | **Percent  of Class** |   |
| Kamran Amjadi(1)                                                 |   | 1,971,000                      |   | 5.2 |   |
|                                                             |   |                           |   |   |   |
| Mehrdad Akhavan(2)                                               |   | 1,035,000                      |   | 2.7 |   |
|                                                             |   |                           |   |   |   |
| Peter Friedli (3)                                                |   | 29,744,341                     |   | 58.4 |   |
| c/o Friedli Corporate Finance AG                                 |   |                           |   |   |   |
| Freigutstrasse 5                                                 |   |                           |   |   |   |
| 8002 Zürich, Switzerland                                    |   |                           |   |   |   |
|                                                             |   |                           |   |   |   |
| Venturetec, Inc.(4)                                              |   | 8,112,743                      |   | 20.3 |   |
| c/o Friedli Corporate Finance AG                                 |   |                           |   |   |   |
| Freigutstrasse 5                                                 |   |                           |   |   |   |
| 8002 Zürich, Switzerland                                    |   |                           |   |   |   |
|                                                             |   |                           |   |   |   |
| New Venture AG (5)                                               |   | 8,112,743                      |   | 20.3 |   |
| c/o Friedli Corporate Finance AG                                 |   |                           |   |   |   |
| Freigutstrasse 5                                                 |   |                           |   |   |   |
| 8002 Zürich, Switzerland                                    |   |                           |   |   |   |
|                                                             |   |                           |   |   |   |
| InVenture, Inc.(6)                                               |   | 11,983,337                     |   | 27.6 |   |
| c/o Friedli Corporate Finance AG                                 |   |                           |   |   |   |
| Freigutstrasse 5                                                 |   |                           |   |   |   |
| 8002 Zürich, Switzerland                                    |   |                           |   |   |   |
|                                                             |   |                           |   |   |   |
| Bank J Vontobel & Co AG(7)                                   |   | 5,030,000                      |   | 12.6 |   |
| Bahnhofstrasse 3                                                 |   |                           |   |   |   |
| 8002 Zurich, Switzerland                                         |   |                           |   |   |   |
|                                                             |   |                           |   |   |   |
| Rahn & Bodmer Banquiers(8)                                   |   | 4,187,535                      |   | 10.6 |   |
| Talstrasse 15, Postfach                                          |   |                           |   |   |   |
| 8002 Zurich, Switzerland                                         |   |                           |   |   |   |
|                                                             |   |                           |   |   |   |
| Credit Suisse First Boston(9)                                    |   | 2,500,000                      |   | 6.3 |   |
|                                                             |   |                           |   |   |   |
| Zurich Lebensversicherungs(10)                                   |   | 2,000,000                      |   | 5.2 |   |
|                                                             |   |                           |   |   |   |
| David Samuels(11)                                                |   | 62,500                         |   |   | * |
|                                                             |   |                           |   |   |   |
| Lawrence Brand(12)                                               |   | 190,619                        |   |   | * |
|                                                             |   |                           |   |   |   |
| All executive officers and directors as a group (5  persons)(13) |   | 33,003,460                     |   | 63.5 |   |

 

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*  Less than 1% of the outstanding shares ofcommon stock.

 

(1)               Includes375,000 shares issuable upon exercise of vested stock options.

 

(2)               Includes375,000 shares issuable upon exercise of vested stock options.

 

(3)               Includes3,749,608 shares of common stock, 40,000 shares issuable upon exercise ofvested stock options, 1,110,000 shares issuable upon exercise of warrants topurchase and 3,550,000 shares issuable on conversion of Series A convertiblepreferred stock held by Mr. Friedli individually, as well as shares of commonstock and common stock underlying warrants and Series A convertible preferredcommon stock held by entities over which Mr. Friedli has control, as follows:InVenture, Inc. — 5,991,667 shares of common stock and 5,991,670 issuable onconversion of Series A convertible preferred shares; Joyce, Ltd. — 235,000shares of common stock; Pine Inc. — 255,000 shares of common stock and 20,000warrant shares; Savetech, Inc. — 165,383 shares of common stock; SpringTechnology Corp. — 177,520 shares of common stock and 200,000 warrant shares;USVentech — 145,750 shares of common stock; and Venturetec, Inc. — 5,404,413shares of common stock,  1,708,330issuable on conversion of Series A convertible preferred shares and 1,000,000issuable on exercise of warrants.  Mr.Friedli has sole voting and investment power with respect to 8,449,608 sharesand shared voting and investment power with respect to 21,294,733 shares. See“Related Party Transactions — Stock Purchases and Related Matters” for adescription of Mr. Friedli’s relationships with these entities.

 

(4)               Includes5,404,413 shares of common stock, 1,708,330 issuable on conversion of Series Aconvertible preferred shares and 1,000,000 issuable on exercise ofwarrants.  Venturetech, Inc. has shoredvoting and investment power with respect to 8,112,743 shares.

 

(5)               Includes5,404,413 shares of common stock, 1,708,330 issuable on conversion of Series Aconvertible preferred shares and 1,000,000 issuable on exercise of warrantsheld by Venturetech, Inc.  NewVenturetec AG may be deemed to control Venturetec, Inc. by virtue of itsownership of 100% of Venturetec, Inc.’s capital stock and its correspondingright to elect Venturetec, Inc.’s directors, and, therefore, our capital stockowned by Venturetec, Inc. may also be deemed to be beneficially owned by NewVenturetec, Inc.  New Venturetech AG hasshared voting and investment power with respect to 8,112,743 shares.

 

(6)               Includes5,991,667 shares of common stock and 5,991,670 issuable on conversion of SeriesA convertible preferred shares. InVenture, Inc. has shared voting andinvestment power with respect to 11,983,337 shares.

 

(7)               Includes2,530,000 shares of common stock and 2,500,000 shares issuable upon conversionof Series A convertible preferred stock.

 

(8)               Includes2,093,765 shares of common stock and 2,093,770 shares issuable upon conversionof Series A convertible preferred stock.

 

(9)               Includes2,500,000 shares issuable upon conversion of warrants.

 

(10)         Includes1,000,000 shares of common stock and 1,000,000 shares issuable upon conversionof Series A convertible preferred stock.

 

(11)         Includes62,500 shares issuable upon exercise of vested stock options.

 

(12)         Includes190,619 shares issuable upon exercise of vested stock options. Since Mr. Brandleft the company in February 2002, all vested stock expire on May 31, 2003.

 

(13)         Includes18,380,341 shares of common stock, 1,043,119 shares issuable upon exercise ofvested stock options, 2,330,000 shares issuable upon exercise of warrants and11,250,000 issuable on conversion of Series A convertible preferred stock.

 

**Securities Authorized for Issuance UnderEquity Compensation Plans**

 

Below isinformation as of December 31, 2002 with respect to compensation plans underwhich equity securities are authorized for issuance. 

 
|                                                        |   | **A**                                                                                                   |   | **B**                                                                                |   | **C**                                                                                                                                                 |       |
|-------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                        |   | **Number of securities to be issued upon exercise of   outstanding options, warrants  and rights** |   | **Weighted-average   exercise price of   outstanding options,  warrants and rights** |   | **Number of securities remaining available for future   issuance under equity compensation plans (excluding securities reflected in  column A)** |       |
| Equity compensation  plans approved by security holders(1)  |   | 2,166,800                                                                                               |   | $                                                                                    | 5.18   |                                                                                                                                                  | 18,793,200 | (2) |
| Equity compensation  plans not approved by security holders |   | —                                                                                                  |   | —                                                                               |   | —                                                                                                                                                |       |
| **Total**                                                   |   | —                                                                                                  |   | —                                                                               |   | —                                                                                                                                                |       |
|                                                             |        |                                                                                                         |        |                                                                                      |        |                                                                                                                                                       |            |  |

 

(1)               Plans approved bystockholders include the Amended and Restated Stock Incentive and Option Plan.

(2)               40,000 options weregranted to Peter Friedli, one of our directors, as compensation for being anonemployee member of our board of directors.

 

46

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**ITEM13****– CertainRelationships and Related Transactions**

 

**StockPurchases and Related Matters**

 

Peter Friedli,one of our stockholders and directors, serves as the investment advisor to bothVenturetec and Pine, and also serves as President of Venturetec and its parentcorporation, New Venturetec AG.  Mr.Friedli also has relationships with several of our other stockholders; heserves as the investment advisor to InVenture, Inc., Joyce, Ltd., Savetech,Inc., Spring Technology Corp. and USVentech, Inc.

 

In March 2003, we executed a convertible promissory note in favor ofFriedli Corporate Finance and InVenture, Inc., for an aggregate sum of up to $6million.  We may draw down against theavailable principal of up to $6 million at any time and in any amount duringthe three year term of the note.  Allprincipal drawn upon will be secured by substantially all of our assets.  We intend to use the amounts drawn forworking capital and general corporate purposes.

 

On October 8,2002, our board of directors authorized the issuance of 6,000,000 warrants tofour investors as consideration for a $20 million financing. Two of theInvestors, Peter Friedli and Venturetec, are our stockholders and pursuant tothe terms of the private placement, each of Peter Friedli and Venturetecreceived 1,000,000 warrants. As part of this financing, in the first quarter of2003, we executed a promissory note in favor of Friedli Corporate Finance andInVenture, for an aggregate sum of up to $6 million.

 

Venturetec andPine were debentureholders in Consumer Review, Inc.  Therefore, as a result of our acquisition of substantially all ofthe assets of Consumer Review, Inc. in December 2002, Venturetec and Pinereceived 240,315 shares and 4,500 shares, respectively, of our Series B convertiblepreferred stock.

 

As part of ourOctober 2001 rights offering, we sold shares of our common stock to Venturetecand Pine. Venturetec and Pine each delivered to us a promissory note dated asof October 19, 2001, with a maturity date of March 31, 2002, as considerationfor the subscription price for the shares of common stock for which eachcompany subscribed under the rights offering. Venturetec’s note (which was only partial consideration for the purchaseof the shares; the remainder was paid in cash) was in the principal amount ofCHF 8,500,000 (approximately $5.2 million) and Pine’s note was in the principalamount of CHF 8,687,530 (approximately $5.3 million). However, on January 22,2002, Pine, Venturetec and InVenture, all companies under common control,reallocated their share purchases and/or related promissory notes associatedwith the rights offering. The CHF 2,500,000 (approximately $1.6 million) incash originally indicated as originating from Venturetec was reallocated asfollows:

 

•                  In a privatesale, InVenture purchased from Pine 1,041,667 shares of common stock,originally purchased by Pine pursuant to the rights offering, for CHF2,083,334. As part of this transaction, Pine was credited with paying us CHF2,083,334 (approximately $1.3 million) and delivered to us an amended andrestated secured promissory note dated as of October 19, 2001, in the principalamount of CHF 6,604,196 (approximately $4.1 million), with 2% interest accruingfrom October 19, 2001 and a maturity date that was extended to May 15, 2002. Wesimultaneously returned Pine’s original CHF 8,687,530 promissory note.  All of the outstanding principal andinterest under the promissory notes was fully received in April 2002.

 

•                  Venturetec paidus CHF 416,666 (approximately $256,000) and delivered to us an amended andrestated secured promissory note dated as of October 19, 2001, in the principalamount of CHF 10,583,334 (approximately $6.5 million), with 2% interestaccruing from October 19, 2001 and a maturity date that was extended to June30, 2002. This CHF 10,583,334 reflects an increase in Venturetec’s securedpromissory note to CHF 11,000,000 (approximately $6.8 million), reflectingVenturetec’s original subscription price for the shares of our common stock forwhich it subscribed under the rights offering, minus the CHF 416,666 payment.We simultaneously returned Venturetec’s original CHF 8,500,000 promissory note.All of the outstanding principal and interest under the promissory notes wasfully received in April 2002.

 

**Loans to Members of Management and Board ofDirectors**

 

We do not haveany outstanding loans to officers or the board of directors.

 

**Other Transactions**

 

In July 1996,we entered into a consulting agreement with Friedli Corporate Finance, wherebyMr. Friedli provides us with financial consulting services and investorrelations advice. During 2001, the agreement was extended for 3 years.  Pursuant to this agreement, FriedliCorporate Finance is paid $4,000 per month plus reimbursement of expensesrelated to Mr. Friedli’s services. Consulting expense under the FriedliCorporate Finance agreement was approximately $63,000, $63,000 and $63,000 forthe years ended December 31, 2000, 2001 and 2002, respectively. In addition,under the original agreement, we granted:

 

47

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•      a preemptive right to purchase any debt or equitysecurities issued by us in a financing transaction;

•      a preemptive right to allocate 10% of the shareoffering in our initial public offering;

•      a veto right on a single capital expenditure of$500,000 or more until our initial public offering; and

•      a seat on our board of directors and itscompensation committee.

 

InOctober 2000, Friedli Corporate Finance permanently waived its rights to purchase shares of common stock in ourinitial public offering and our future offerings.

 

We engaged Friedli Corporate Finance to support us in connection with our 2001rights offering.  In association withthis support, we reimbursed Friedli Corporate Finance approximately $100,000 in expenses.

 

To the extent that our existing funds are not sufficient to enable us to operate into thesecond quarter of 2004 and beyond, in September 2002, Friedli CorporateFinance provided a written commitmentto provide us with a capital infusion of up to $20 million for continuedoperations and future business expansion purposes.  In consideration for the commitment, we issued 6,000,000 warrantsto four investors. Two of the investors, Peter Friedli and Venturetec, Inc.,are current stockholders, and each received 1,000,000 warrants. In March 2003,Friedli Corporate Finance amended and restated its commitment to provide for acapital infusion of up to $14 million, with the $6 million reduction based uponthe convertible promissory note financing.

 

**ITEM 14****– Controlsand Procedures**

 

Within the 90 days prior to the date of this report, we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under theSecurities Exchange Act of 1934).  Basedupon that evaluation, our Chief Executive Officer and our Chief FinancialOfficer concluded that our disclosure controls and procedures are effective intimely alerting them to material information relating to us (including ourconsolidated subsidiaries) required to be included in our periodic SECfilings.  There have been no significantchanges in our internal controls, or in other factors, which couldsignificantly affect these controls subsequent to the date we carried out ourevaluation.

 

Disclosure controls and procedures are Company controls and otherprocedures that are designed to ensure that information required to bedisclosed by us in the reports that we file or submit under the SecuritiesExchange Act of 1934 is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include, without limitation,controls and procedures designed to ensure that information required to bedisclosed by us in the reports that we file under the Securities Exchange Actof 1934 is accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure.

 

48

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**PARTIV**

 

**ITEM 15**** – Exhibits, Financial Statement Schedules andReports on Form 8-K**

 

**a)****Financial Statements and Schedules**

 

The followingfinancial statements required by this item are submitted in a separate sectionbeginning on page F-1 of this report.

 

**INDEX TO FINANCIAL STATEMENTS**

** **

| Independent Auditors’ Report                     |
|-------------------------------------------------------|
| Consolidated Balance Sheets                           |
| Consolidated Statements of Operations                 |
| Consolidated Statements of Stockholders’  Equity |
| Consolidated Statements of Cash Flows                 |
| Notes to Consolidated Financial Statements            |

 

See ScheduleII - Valuation and Qualifying Accounts and Reserves

 

All otherschedules have been omitted because the required information is included in theConsolidated Financial Statements or the notes thereto, or is not applicable orrequired.

** **

**Reports on Form 8-K**

 

On November 27, 2002 we filed a Form 8-K under Item 2 announcing thecontemplated issuance of 6,000,000 warrants as consideration for a $20 millionfinancing commitment from Friedli Corporate Finance.

 

On December 13, 2002 we filed a Form 8-K under Item 2 announcing ouracquisition of substantially all of the assets of Consumer Review, Inc.

** **

**Exhibits**

 

See ExhibitIndex attached.

 

49

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**SIGNATURES**

 

Pursuant tothe requirements of Section 13 or 15(d) of the Securities Act of 1934, theregistrant has duly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized, in the city of Bethesda, State of Maryland, on March31, 2003.

 
|   |   | E-CENTIVES,  INC.                      |
|--------|--------|----------------------------------------|
|   |   |
|   | By:    | /s/ Kamran  Amjadi                     |   |
|   |   | Kamran  Amjadi                         |
|   |   | *Chairman and Chief Executive Officer* |

 

Pursuant tothe requirements of the Securities Act of 1934, this annual report has beensigned by the following persons in the capacities and on the dates indicated.

 
| **Name**              |   | **Title**                             |   | **Date**       |
|-----------------------|--------|---------------------------------------|--------|----------------|
|                  |   |                                  |   |           |
|                  |   |                                  |   |           |
| /s/ Kamran  Amjadi    |   | Chairman and  Chief Executive         |   | March 31, 2003 |
| Kamran  Amjadi        |   | Officer (Principal Executive Officer) |   |           |
|                  |   | and Director                          |   |           |
|                  |   |                                  |   |           |
|                  |   |                                  |   |           |
| /s/ Mehrdad  Akhavan  |   | President,  Chief Operating           |   | March 31, 2003 |
| Mehrdad  Akhavan      |   | Officer, Secretary and Director       |   |           |
|                  |   |                                  |   |           |
|                  |   |                                  |   |           |
| /s/ David A.  Samuels |   | Chief  Financial Officer (Principal   |   | March 31, 2003 |
| David A. Samuels      |   | Financial and Accounting Officer)     |   |           |
|                  |   |                                  |   |           |
| /s/ Peter  Friedli    |   |                                  |   | March 31, 2003 |
| Peter  Friedli        |   | Director                              |   |           |

 

50

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**CERTIFICATION  PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002**

 

I, Kamran Amjadi,certify that:

 

1)              Ihave reviewed this annual report on Form 10-K of E-centives, Inc.;

 

2)              Basedon my knowledge, this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report;

 

3)              Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this annual report;

 

4)              Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

b)             Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”);

 

c)              Presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5)              Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)              Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             Anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6)              Theregistrant’s other certifying officers and I have indicated in this annualreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  March 31, 2003 |   |                                 |              |
|----------------------------|--------|--------------------------------------|-------------------|
|                       | By:    |                                 | /s/ Kamran Amjadi |   |
|                       |   | Kamran Amjadi                        |              |
|                       |   | Chairman and Chief Executive Officer |              |
|                            |        |                                      |                   |  |

 

51

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**CERTIFICATIONPURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002**

 

I, David A. Samuels, certifythat:

 

1)              Ihave reviewed this annual report on Form 10-K of E-centives, Inc.;

 

2)              Basedon my knowledge, this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report;

 

3)              Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this annual report;

 

4)              Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

b)             Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”);

 

c)              Presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5)              Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)              Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             Anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6)              Theregistrant’s other certifying officers and I have indicated in this annualreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  March 31, 2003 |   |                    |                 |
|----------------------------|--------|-------------------------|----------------------|
|                       | By:    |                    | /s/ David A. Samuels |   |
|                       |   | David A. Samuels        |                 |
|                       |   | Chief Financial Officer |                 |
|                            |        |                         |                      |  |

 

52

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INDEPENDENTAUDITORS’ REPORT

 

The Board ofDirectors and Stockholders

E-centives,Inc.:

 

We haveaudited the accompanying consolidated balance sheets of E-centives, Inc. andsubsidiary as of December 31, 2002 and 2001, and the related consolidatedstatements of operations, stockholders’ equity and comprehensive loss and cashflows for each of the years in the three-year period ended December 31, 2002.These consolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we planand perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of E-centives, Inc.and subsidiary as of December 31, 2002 and 2001 and the results of theiroperations and their cash flows for each of the years in the three-year periodended December 31, 2002, in conformity with accounting principles generallyaccepted in the United States of America.

 

As discussed in Notes 2 and 7 to the consolidated financial statements,effective January 1, 2002, the Company adopted the provisions of Statement ofFinancial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”.

 
| /s/ KPMG LLP      |   |
|-------------------|--------|
| McLean,  Virginia |
| March 27,  2003   |

 

F-1

----

 

**E-CENTIVES, INC.**

 

**CONSOLIDATED BALANCE SHEETS**

** **
|                                                                                                                                                                                                                             |   | **December 31, 2002** |       | **December 31, 2001** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|------------|-----------------------|--------|
|                                                                                                                                                                                                                             |   |                  |       |                  |   |
| **ASSETS**                                                                                                                                                                                                                       |   |                  |       |                  |   |
|                                                                                                                                                                                                                             |   |                  |       |                  |   |
| Current assets:                                                                                                                                                                                                                  |   |                  |       |                  |   |
| Cash and cash equivalents                                                                                                                                                                                                        |   | $                     | 2,317,354  |                  | $      | 8,902,259 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $75,108 and $148,127 at December 31, 2002 and 2001, respectively                                                                                                 |   | 2,973,129             |       | 2,162,114             |   |
| Other receivables                                                                                                                                                                                                                |   | 140,169               |       | 612,710               |   |
| Prepaid expenses                                                                                                                                                                                                                 |   | 297,888               |       | 336,834               |   |
| Restricted cash                                                                                                                                                                                                                  |   | 635,049               |       | 89,916                |   |
| Deferred financing fee                                                                                                                                                                                                           |   | 240,000               |       | —                |   |
| Other                                                                                                                                                                                                                            |   | 16,203                |       | —                |   |
| Total current assets                                                                                                                                                                                                             |   | 6,619,792             |       | 12,103,833            |   |
| Property and equipment, net                                                                                                                                                                                                      |   | 2,281,155             |       | 11,154,158            |   |
| Goodwill, net                                                                                                                                                                                                                    |   | —                |       | 656,764               |   |
| Other intangible assets, net                                                                                                                                                                                                     |   | 3,185,213             |       | 2,446,191             |   |
| Restricted cash                                                                                                                                                                                                                  |   | 110,000               |       | 1,366,945             |   |
| Deferred financing fee                                                                                                                                                                                                           |   | 480,000               |       | —                |   |
| Other assets                                                                                                                                                                                                                     |   | 14,790                |       | 100,772               |   |
| Total assets                                                                                                                                                                                                                     |   | $                     | 12,690,950 |                  | $      | 27,828,663 |   |
|                                                                                                                                                                                                                             |   |                  |       |                  |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                    |   |                  |       |                  |   |
|                                                                                                                                                                                                                             |   |                  |       |                  |   |
| Current liabilities:                                                                                                                                                                                                             |   |                  |       |                  |   |
| Accounts payable                                                                                                                                                                                                                 |   | $                     | 1,957,590  |                  | $      | 1,992,776 |   |
| Accrued expenses                                                                                                                                                                                                                 |   | 1,254,773             |       | 2,718,781             |   |
| Accrued restructuring costs                                                                                                                                                                                                      |   | 717,079               |       | 2,170,206             |   |
| Deferred revenue                                                                                                                                                                                                                 |   | 1,095,613             |       | 2,523,729             |   |
| Current portion of capital leases                                                                                                                                                                                                |   | 224,914               |       | 208,331               |   |
| Other liabilities                                                                                                                                                                                                                |   | 90,552                |       | 312,627               |   |
| Total current liabilities                                                                                                                                                                                                        |   | 5,340,521             |       | 9,926,450             |   |
| Capital leases, net of current portion                                                                                                                                                                                           |   | 245,614               |       | 476,457               |   |
| Accrued restructuring costs, net of current portion                                                                                                                                                                              |   | —                |       | 6,892,744             |   |
| Total liabilities                                                                                                                                                                                                                |   | 5,586,135             |       | 17,295,651            |   |
| Commitments and contingencies                                                                                                                                                                                                    |   |                  |       |                  |   |
| Stockholders’ equity:                                                                                                                                                                                                       |   |                  |       |                  |   |
| Series A convertible preferred stock (voting), $.01  par value, 9,600,000 shares of preferred stock authorized, 2,000,000 shares  issued and outstanding at December 31, 2002 and 2001 (liquidation  preference—Note 12).   |   | 20,000                |       | 20,000                |   |
| Series B convertible preferred stock (voting), $.01  par value, 400,000 shares of preferred stock authorized, 400,000 and 0 shares  issued and outstanding at December 31, 2002 and 2001 (liquidation  preference—Note 12). |   | 4,000                 |       | —                |   |
| Common stock, $.01 par value, 120,000,000 shares  authorized 37,349,284  and 37,732,009  shares issued and outstanding at December 31, 2002 and 2001, respectively.                                                         |   | 373,493               |       | 373,493               |   |
| Additional paid-in capital                                                                                                                                                                                                       |   | 123,452,566           |       | 120,337,200           |   |
| Notes receivable from stockholders                                                                                                                                                                                               |   | —                |       | (10,576,941           | )      |
| Accumulated other comprehensive gain (loss)                                                                                                                                                                                      |   | 3,386                 |       | (16,997               | )      |
| Accumulated deficit                                                                                                                                                                                                              |   | (116,748,630          | )          | (99,603,743           | )      |
| Total stockholders’ equity                                                                                                                                                                                                  |   | 7,104,815             |       | 10,533,012            |   |
| Total liabilities and stockholders’ equity                                                                                                                                                                                  |   | $                     | 12,690,950 |                  | $      | 27,828,663 |   |

 

See accompanying notes to consolidated financial statements.

 

F-2

----

 

**E-CENTIVES, INC.**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
|                                                                                          |   | **Year ended December 31,** |        |
|-----------------------------------------------------------------------------------------------|--------|-----------------------------|-------------|
|                                                                                          |   | **2002**                    |        | **2001** |   | **2000** |   |
|                                                                                          |   |                        |        |   |   |   |   |
| Revenue                                                                                       |   | $                           | 7,220,798   |   | $ | 5,053,624 |   | $ | 10,230,035 |   |
| Operating expenses:                                                                           |   |                        |        |   |   |   |   |
| Cost of revenue                                                                               |   | 4,415,722                   |        | 8,395,162 |   | 2,207,855 |   |
| Product development, exclusive of stock-based  compensation                                   |   | 4,068,402                   |        | 7,933,192 |   | 2,872,572 |   |
| General and administrative, exclusive of  stock-based compensation                            |   | 10,763,390                  |        | 12,591,620 |   | 8,764,830 |   |
| Sales and marketing, exclusive of stock-based  compensation                                   |   | 3,885,839                   |        | 9,997,131 |   | 19,005,844 |   |
| Network partner fees                                                                          |   | 2,271                       |        | 985,593 |   | 6,353,937 |   |
| Restructuring and impairment charges                                                          |   | 1,128,400                   |        | 9,876,123 |   | — |   |
| Stock-based compensation:                                                                     |   |                        |        |   |   |   |   |
| Product development                                                                           |   | 60,409                      |        | 200,822 |   | 822,052 |   |
| General and administrative                                                                    |   | 105,825                     |        | 362,365 |   | 333,215 |   |
| Sales and marketing                                                                           |   | 193,282                     |        | 299,932 |   | 558,382 |   |
| Loss from operations                                                                          |   | (17,402,742                 | )           | (45,588,316 | ) | (30,688,652 | ) |
| Interest expense                                                                              |   | (58,078                     | )           | (3,630 | ) | — |   |
| Interest income                                                                               |   | 296,457                     |        | 607,957 |   | 693,312 |   |
| Other income                                                                                  |   | —                      |        | — |   | 50,000 |   |
| Loss before income taxes                                                                      |   | (17,164,363                 | )           | (44,983,989 | ) | (29,945,340 | ) |
| Income taxes                                                                                  |   | 19,476                      |        | (19,476 | ) | — |   |
| Net loss                                                                                      |   | (17,144,887                 | )           | (45,003,465 | ) | (29,945,340 | ) |
| Preferred stock dividend requirement and accretion  of convertible redeemable preferred stock |   | —                      |        | — |   | (551,773 | ) |
| Net loss applicable to common stockholders                                                    |   | $                           | (17,144,887 | ) | $ | (45,003,465 | ) | $ | (30,497,113 | ) |
|                                                                                          |   |                        |        |   |   |   |   |
| Basic and diluted net loss per common share                                                   |   | $                           | (0.46       | ) | $ | (2.68 | ) | $ | (4.09 | ) |
| Shares used to compute basic and diluted net loss  per common share                           |   | 37,349,270                  |        | 16,810,366 |   | 7,460,272 |   |

 

See accompanying notes to consolidated financial statements.

 

F-3

----

 

**E-CENTIVES, INC.**

 

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY****AND COMPREHENSIVE LOSS**

** **
|                                                                                      |   | **Series A  Convertible  Preferred Stock** |   | **Series B  Convertible  Preferred Stock** |   |       |      |                             |      |       |                           | **Notes  receivable  from  stockholders** |       |        |    | **Accumulated********other  comprehensive  loss** |   |        |        |    |   |
|-------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|------------|-----------|----------------------------------|-----------|------------|--------------------------------|-------------------------------------------|------------|-------------|---------|---------------------------------------------------|--------|-------------|-------------|---------|--------|
|                                                                                      |   |                                       |   |                                       |   |       |      | **Additional  paid-in  capital** |      |       |                           |                                      |       |        |    | **Total  stockholders  equity**                   |   |
|                                                                                      |   |                                       |   | **Common Stock**                           |   |       |      | **Comprehensive  loss**          |      |       | **Accumulated********deficit** |                                      |       |
|                                                                                      |   | **Shares**                                 |   | **Amount**                                 |   | **Shares** |      | **Amount**                       |      | **Shares** |                           | **Amount**                                |       |        |    |                                              |   |        |        |
| Balance, December 31, 1999                                                                |   | 1,700,000                                  |   | $                                          | 17,000 |       | 2,500,000 |                             | $         | 25,000     |                           | 4,874,375                                 |       | $           | 48,744  |                                              | $      | 24,323,640  |        | $       | — |   | $ | — |   | $ | — |   | $ | (23,419,250 | ) | $ | 995,134 |   |
|                                                                                      |   |                                       |   |                                       |   |       |      |                             |      |       |                           |                                      |       |        |    |                                              |   |        |        |    |   |   |   |   |   |
| Issuance of warrants related to convertibleredeemable preferred stock                     |   |                                       |   |                                       |   |       |      |                             |      |       |                           |                                      |       |        |    |                                              |   |        |        |    |   |   |   |   |   |
|                                                                                      | — |                                       | — |                                       | — |       | —    |                             | —    |       | —                         |                                      | 773,068    |        | —  |                                              | — |        | —      |    | — |   | 773,068 |   |
| Issuance of common stock in connection withinitial public offering, net of offering costs |   |                                       |   |                                       |   |       |      |                             |      |       |                           |                                      |       |        |    |                                              |   |        |        |    |   |   |   |   |   |
|                                                                                      | — |                                       | — |                                       | — |       | —    |                             | 3,700,000 |       | 37,000                         |                                      | 36,667,896 |        | —  |                                              | — |        | —      |    | — |   | 36,704,896 |   |
| Exercise of stock options                                                                 |   | —                                     |   | —                                     |   | —     |      | —                           |      | 65,625     |                           | 656                                       |       | 144,031     |    | —                                            |   | —      |        | —  |   | — |   | 144,687 |   |
| Conversion of Series A preferred stock to common  stock                                   |   | (1,700,000                                 | )      | (17,000                                    | )      | —     |      | —                           |      | 1,700,000  |                           | 17,000                                    |       | —      |    | —                                            |   | —      |        | —  |   | — |   | — |   |
| Conversion of Series B preferred stock to common  stock                                   |   | —                                     |   | —                                     |   | (2,500,000 | )         | (25,000                          | )         | 2,500,000  |                           | 25,000                                    |       | —      |    | —                                            |   | —      |        | —  |   | — |   | — |   |
| Conversion of Series C convertible redeemable  preferred stock to common stock            |   | —                                     |   | —                                     |   | —     |      | —                           |      | 2,328,434  |                           | 23,284                                    |       | 21,925,436  |    | —                                            |   | —      |        | —  |   | — |   | 21,948,720 |   |
| Stock-based compensation                                                                  |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | 1,713,649   |    | —                                            |   | —      |        | —  |   | — |   | 1,713,649 |   |
| Accretion of convertible redeemable preferred stock  to redemption value                  |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | (264,898    | )       | —                                            |   | —      |        | —  |   | — |   | (264,898 | ) |
| Declaration of dividends                                                                  |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | —      |    | —                                            |   | —      |        | —  |   | (1,235,688 | ) | (1,235,688 | ) |
| Net loss                                                                                  |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | —      |    | —                                            |   | (29,945,340 | )           | —  |   | (29,945,340 | ) | (29,945,340 | ) |
| Comprehensive loss                                                                        |   |                                       |   |                                       |   |       |      |                             |      |       |                           |                                      |       |        |    |                                              |   | (29,945,340 | )           |    |   |   |   |   |   |
| Balance, December 31, 2000                                                                |   | —                                     |   | —                                     |   | —     |      | —                           |      | 15,168,434 |                           | 151,684                                   |       | 85,282,822  |    | —                                            |   |        |        | —  |   | (54,600,278 | ) | 30,834,228 |   |
|                                                                                      |   |                                       |   |                                       |   |       |      |                             |      |       |                           |                                      |       |        |    |                                              |   |        |        |    |   |   |   |   |   |
| Rights offering                                                                           |   | 2,000,000                                  |   | 20,000                                     |   | —     |      | —                           |      | 20,000,000 |                           | 200,000                                   |       | 22,222,571  |    | (10,576,941                                       | )      | —      |        | —  |   | — |   | 11,865,630 |   |
| Exercise of stock options                                                                 |   | —                                     |   | —                                     |   | —     |      | —                           |      | 11,875     |                           | 119                                       |       | 28,006      |    | —                                            |   | —      |        | —  |   | — |   | 28,125 |   |
| Acquisition of Commerce Division                                                          |   | —                                     |   | —                                     |   | —     |      | —                           |      | 2,168,945  |                           | 21,690                                    |       | 11,755,682  |    | —                                            |   | —      |        | —  |   | — |   | 11,777,372 |   |
| Acquisition of BrightStreet.com                                                           |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | 185,000     |    | —                                            |   | —      |        | —  |   | — |   | 185,000 |   |
| Stock-based compensation                                                                  |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | 863,119     |    | —                                            |   | —      |        | —  |   | — |   | 863,119 |   |
| Foreign currency translation adjustment                                                   |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | —      |    | —                                            |   | (16,997     | )           | (16,997 | )      | — |   | (16,997 | ) |
| Net loss                                                                                  |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | —      |    | —                                            |   | (45,003,465 | )           | —  |   | (45,003,465 | ) | (45,003,465 | ) |
| Comprehensive loss                                                                        |   |                                       |   |                                       |   |       |      |                             |      |       |                           |                                      |       |        |    |                                              |   | (45,020,462 | )           |    |   |   |   |   |   |
| Balance, December 31, 2001                                                                |   | 2,000,000                                  |   | 20,000                                     |   | —     |      | —                           |      | 37,349,254 |                           | 373,493                                   |       | 120,337,200 |    | (10,576,941                                       | )      |        |        | (16,997 | )      | (99,603,743 | ) | 10,533,012 |   |
|                                                                                      |   |                                       |   |                                       |   |       |      |                             |      |       |                           |                                      |       |        |    |                                              |   |        |        |    |   |   |   |   |   |
| Rights offering                                                                           |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | (27,855     | )       | 10,576,941                                        |   | —      |        | —  |   | — |   | 10,549,086 |   |
| Exercise of stock options                                                                 |   | —                                     |   | —                                     |   | —     |      | —                           |      | 30         |                           | —                                    |       | 105         |    | —                                            |   | —      |        | —  |   | — |   | 105 |   |
| Issuance of Warrants                                                                      |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | 720,000     |    | —                                            |   | —      |        | —  |   | — |   | 720,000 |   |
| Acquisition of Consumer Review.com                                                        |   | —                                     |   | —                                     |   | 400,000    |      | 4,000                            |      | —     |                           | —                                    |       | 2,063,600   |    | —                                            |   | —      |        | —  |   | — |   | 2,067,600 |   |
| Stock-based compensation                                                                  |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | 359,516     |    | —                                            |   | —      |        | —  |   | — |   | 359,516 |   |
| Foreign currency translation adjustment                                                   |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | —      |    | —                                            |   | 20,383      |        | 20,383  |   | — |   | 20,383 |   |
| Net loss                                                                                  |   | —                                     |   | —                                     |   | —     |      | —                           |      | —     |                           | —                                    |       | —      |    | —                                            |   | (17,144,887 | )           | —  |   | (17,144,887 | ) | (17,144,887 | ) |
| Comprehensive loss                                                                        |   |                                       |   |                                       |   |       |      |                             |      |       |                           |                                      |       |        |    |                                              |   | $           | (17,124,504 | )       |   |   |   |   |   |   |
| Balance, December 31, 2002                                                                |   | 2,000,000                                  |   | $                                          | 20,000 |       | 400,000   |                             | $         | 4,000      |                           | 37,349,284                                |       | $           | 373,493 |                                              | $      | 123,452,566 |        | $       | — |   |   |   | $ | 3,386 |   | $ | (116,748,630 | ) | $ | 7,104,815 |   |
|                                                                                           |        |                                            |        |                                            |        |            |           |                                  |           |            |                                |                                           |            |             |         |                                                   |        |             |             |         |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidated financial statements.

 

F-4

----

 

**E-CENTIVES, INC.**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
|                                                                         |   | **Year ended December 31,** |        |
|------------------------------------------------------------------------------|--------|-----------------------------|-------------|
|                                                                         |   | **2002**                    |        | **2001** |   | **2000** |   |
| Cash flows from operating activites:                                         |   |                        |        |   |   |   |   |   |   |   |
| Net loss                                                                     |   | $                           | (17,144,887 | ) | $ | (45,003,465 | ) | $ | (29,945,340 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |   |                        |        |   |   |   |   |
| Depreciation and amortization                                                |   | 5,274,070                   |        | 6,182,141 |   | 2,093,804 |   |
| Stock-based compensation                                                     |   | 359,516                     |        | 863,119 |   | 1,713,649 |   |
| Provision for doubtful accounts                                              |   | 35,263                      |        | 493,168 |   | 489,973 |   |
| Non-cash restructuring and impairment charge                                 |   | (5,744,200                  | )           | 469,397 |   | — |   |
| Change in prior year restructuring accrual                                   |   | (7,841,182                  | )           | — |   | — |   |
| Foreign currency loss on notes receivable                                    |   | 258,230                     |        | — |   | — |   |
| (Increase) decrease in:                                                      |   |                        |        |   |   |   |   |
| Accounts receivable                                                          |   | (425,369                    | )           | 481,335 |   | (2,703,909 | ) |
| Prepaid expenses and other assets                                            |   | (43,022                     | )           | 1,002,351 |   | (1,049,519 | ) |
| Other receivable                                                             |   | 534,397                     |        | 146,613 |   | — |   |
| Increase (decrease) in:                                                      |   |                        |        |   |   |   |   |
| Accounts payable                                                             |   | (35,187                     | )           | (447,594 | ) | 1,079,024 |   |
| Deferred revenue                                                             |   | (1,428,114                  | )           | 795,724 |   | 113,191 |   |
| Accrued expenses and other liabilities                                       |   | (2,014,053                  | )           | 10,248,497 |   | 619,297 |   |
| Net cash used in operating activities                                        |   | (16,726,138                 | )           | (24,768,714 | ) | (27,589,830 | ) |
| Cash flows from investing activities:                                        |   |                        |        |   |   |   |   |
| Sale (purchase) of short-term investments                                    |   | —                      |        | 114,491 |   | (5,472 | ) |
| Decrease (increase) in restricted cash                                       |   | 711,812                     |        | (913,877 | ) | (542,984 | ) |
| Acquisition of property and equipment                                        |   | (428,254                    | )           | (895,323 | ) | (2,502,944 | ) |
| Decrease (increase) in security deposits                                     |   | (15,641                     | )           | (37,855 | ) | (29,991 | ) |
| Acquisition of Commerce Division                                             |   | —                      |        | (1,115,955 | ) | — |   |
| Acquisition of BrightStreet.com                                              |   | (34,254                     | )           | (1,924,380 | ) | — |   |
| Acquisition of ConsumerREVIEW.com                                            |   | (175,302                    | )           | — |   | — |   |
| Net cash provided by (used in) investing activities                          |   | 58,361                      |        | (4,772,899 | ) | (3,081,391 | ) |
| Cash flows from financing activities:                                        |   |                        |        |   |   |   |   |
| Payments on obligations under capital lease                                  |   | (208,331                    | )           | (16,621 | ) | — |   |
| Proceeds from rights offering                                                |   | (27,855                     | )           | 12,606,016 |   | — |   |
| Proceeds from notes receivable                                               |   | 10,318,953                  |        | — |   | — |   |
| Payment of dividends                                                         |   | —                      |        | (1,235,688 | ) | — |   |
| Issuance of common stock                                                     |   | —                      |        | — |   | 36,704,896 |   |
| Issuance of Series C convertible redeemable  preferred stock                 |   | —                      |        | — |   | 20,456,891 |   |
| Exercise of stock options                                                    |   | 105                         |        | 28,125 |   | 144,687 |   |
| Net cash provided by financing activities                                    |   | 10,082,872                  |        | 11,381,832 |   | 57,306,474 |   |
| Net (decrease) increase in cash and cash  equivalents                        |   | (6,584,905                  | )           | (18,159,781 | ) | 26,635,253 |   |
| Cash and cash equivalents, beginning of period                               |   | 8,902,259                   |        | 27,062,040 |   | 426,787 |   |
| Cash and cash equivalents, end of period                                     |   | $                           | 2,317,354   |   | $ | 8,902,259 |   | $ | 27,062,040 |   |
|                                                                         |   |                        |        |   |   |   |   |
| Supplemental disclosure of cash flow information:                            |   |                        |        |   |   |   |   |
| Cash paid for interest                                                       |   | $                           | 58,078      |   | $ | 3,630 |   | — |   |

 

Supplemental disclosure ofnon-cash investing and financing activities:

In October 2002, the Company's board of directors approved the issuanceof 6,000,000 warrants valued at $720,000.

In conjunction with the acquisition of ConsumerREVIEW.com in December2002, the Company issued 400,000 shares of series B preferred stock, valued at$2,067,600.

In conjunction with the acquisition of BrightStreet.com, Inc. inDecember 2001, the Company issued warrants, valued at $185,000, for thepurchase of 500,000 shares of common stock and a contingent performance-basedwarrant to purchase up to 250,000 shares of the Company’s common stock.

In conjunction with the acquisition of the Commerce Division in March2001, the Company issued 2,168,945 shares of common stock, valued at$11,755,682, and a contingent performance-based warrant to purchase 1,860,577shares of the Company’s common stock. The right to exercise the warrant expired on March 27, 2002.

In conjunction with the issuance of Series C convertible redeemablepreferred stock in 2000, the Company issued warrants,valued at $773,068, forthe purchase of 119,485 shares of common stock.

In September 2000, the Company declared dividends of $1,235,688 onSeries A convertible preferred stock.

Each share of Series A and Series B convertible preferred stock andSeries C convertible redeemable preferred stock issued prior to October 10,2000, automatically converted into one share of common stock subsequent to theclosing of the Company's initial public offering on October 10, 2000.

In February 2000, the long-term debt was converted into 196,078 sharesof Series C convertible redeemable preferred stock at $10.20 per share.

 

See accompanying notes to consolidated financial statements.

 

F-5

----

 

**E-centives, Inc. andSubsidiary**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**(1) Organization**

 

E-centives, Inc. (“E-centives” or the “Company”) wasestablished as Imaginex, Inc. on August 2, 1996, through incorporation in theState of Delaware. During October 1996, the Company amended its articles ofincorporation to change its name to Emaginet, Inc. and again, in March 1999,the Company amended its articles of incorporation to change its name to E-centives,Inc. During March 2001, the Company expanded its international operations byestablishing a subsidiary in the United Kingdom, E-centives Limited.  However, the operations of this subsidiarywere terminated in conjunction with the Company’s second quarter 2002restructuring plan that involved closing down the operating activities of theCommerce Division.

 

E-centivesprovides interactive direct marketing technologies and services for globalmarketers.  The Company offers acomplete suite of technologies, including several patented components, whichenable businesses to acquire and retain relationships with their audiences, aswell as advertising and e-commerce services.

 

During thesecond quarter of 2002, the Company approved plans to close its Commerce Divisionand discontinue offering the services provided by its Commerce Engineand Commerce Network systems.  TheCompany continued to provide these services through August 30, 2002.  In addition, in July 2002, the Companyreduced its workforce due to its decision to close down its PerformOne Networksystem.  Accordingly, the Company’sprincipal products are the Interactive Database Marketing System, the E-mailMarketing System and advertising and e-commerce related services throughConsumerREVIEW.com.

 

The Companyoperates in a highly competitive environment and inherent in the Company’sbusiness are various risks and uncertainties including its limited operatinghistory and unproven business model. The Company’s success may depend in partupon the continuance of the Internet as a communications medium, prospectiveproduct and service development efforts, and the acceptance of the Company’sofferings by the marketplace.

 

One of our *Interactive Database Marketing System*customers, Reckitt Benckiser PLC, contributed $4.5 million, or 62%, of theCompany’s revenue for the year ended December 31, 2002.  This customer’s initial contract expired inOctober 2002; and the customer subsequently renewed the agreement for an additionalyear.  Loss of this customer could havea material adverse effect on the Company’s business, financial condition,results of operations and cash flow.

 

The Company’smanagement believes that its existing cash resources will be sufficient to meetits anticipated cash needs for working capital and capital expenditures intothe second quarter of 2004 based on the capital infusion of up to $6 million,structured in the form of a three-year convertible promissory note that wasissued during the first quarter of 2003. Should future revenue be insufficient to cover the Company’s operatingcosts, the Company will need to secure additional funds to ensure futureviability.  The Company may need toraise additional funds sooner than anticipated to fund its future expansion, todevelop new or enhanced products or services, to respond to competitivepressures or to make acquisitions. To the extent that the Company’s existingfunds and funds from the promissory note are not sufficient to enable theCompany to operate into the second quarter of 2004 and beyond, FriedliCorporate Finance has provided a written commitment to provide the Company witha capital infusion of up to $20 million, of which $6 million was the recentconvertible promissory note for continued operations and future businessexpansion purposes of the Company, in both sales and marketing and merger andacquisition activities. However, no formal terms and conditions have beenagreed upon other than the terms of the $6 million promissory note. Based onthe Company’s current operating plans, the Company does not believe that itwill require the full capital commitment of Friedli Corporate Finance to fundcontinued operations through profitability. The Company currently believes that it will only require use ofapproximately $6 million of the capital commitment of Friedli Corporate Financefor the twelve month period subsequent to the second quarter of 2003.

 

**(2) Summary of Significant AccountingPolicies**

 

*(a) Basis of Presentation*

 

The accompanying consolidated financial statements include the accountsof the Company and its subsidiary. All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

*(b) Use of Estimates*

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amount ofassets and liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues and

 

F-6

----

 

expenses during the reporting period. Actual results may differ fromthose estimates.

 

Estimates are used in accounting for, amongthings, allowance for uncollectable receivables, recoverability of long-livedassets, intangible assets, and investments, depreciation and amortization,goodwill, employee benefits, restructuring accruals, taxes and contingencies.Estimates and assumptions are reviewed periodically and the effects ofrevisions are reflected in the consolidated financial statement in the periodthey are determined to be necessary.

 

*(c) Reclassification*

 

Certain amounts in prior years’ consolidatedfinancial statements have been reclassified to conform to the current yearpresentation

 

(d) *Cash and Cash Equivalents andShort-Term Investments*

 

All highly liquid investments with maturities of three months or lesswhen purchased are considered cash equivalents. Those investments withmaturities less than twelve months at the balance sheet date are consideredshort-term investments. Cash and cash equivalents consist of cash on depositwith banks and money market funds stated at cost, which approximates fairvalue. In accordance with FAS 115, *Accounting for Certain Investments in Debt and EquitySecurities,* the Company classifies all short-term investments asavailable-for-sale. Accordingly, these investments are carried at fair value.The fair value of such securities approximates cost and there were no materialunrealized gains or losses at December 31, 2002 or 2001.

 

*(e) Property and Equipment*

 

Property and equipment are stated at cost and equipment under capitalleases are stated at the present value of minimum lease payments. Depreciationis calculated using the straight-line method over the estimated useful lives ofthe assets, which range from three to seven years. Equipment under capitalleases and leasehold improvements are capitalized and amortized using thestraight-line method over the shorter of their estimated useful life or theterm of the respective lease (see Note 6).

 

Expenditures for maintenance and repairs are charged to expense asincurred. Expenditures for major renewals and betterments that extend theuseful lives of property and equipment are capitalized and depreciated over theremaining useful lives of the asset. When assets are retired or sold, the costand related accumulated depreciation are removed from the accounts and anyresulting gain or loss is recognized in the results of operations.

 

*(f) Long-Lived and Amortizable IntangibleAssets*

 

Effective January 1, 2002, the Company adopted the provisions of FAS144, *Accounting for the Impairment orDisposal of Long-Lived Assets*, which supercedes both FAS 121 and theaccounting and reporting provisions of APB Opinion 30, *Reporting the Results of Operations-Reporting theEffects of Disposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions, for the disposal of a segmentof a busin*ess (as previously defined in that Opinion).  The Company assesses the recoverability oflong-lived assets, including amortizable intangible assets, whenever adverseevents or changes in circumstances or business climate indicate that thecarrying value of the asset may not be recoverable. If the future undiscountedcash flows expected to result from the use of the related assets are less thanthe carrying value of such assets, an impairment has been incurred and a lossis recognized to reduce the carrying value of the long-lived assets to fairvalue. In connection with the restructuring plans adopted during 2001, certainassets were deemed to be impaired. Accordingly, the Company recorded animpairment charge of approximately $469,000 during 2001 (see Note 8).

 

In accordance with the amortization provisions of FAS 142, the Companyamortizes intangible assets with definite useful lives over their respectiveestimated useful lives to their estimated residual values, and reviews them forimpairment in accordance with FAS 144.

 

Long-lived and amortizable intangible assets at December 31, 2002,consisted of technology and tradenames, which were acquired in connection withthe BrightStreet.com and ConsumerREVIEW.com acquisitions, while at December 31,2001 long-lived and amortizable intangible assets consisted of a customer list,which was acquired in connection with the purchase of the Commerce Division.

 

As of December 31, 2002, the Company had the following long-lived andamortizable intangible assets:

 

F-7

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|                                  |   | **Amount** |      | **Amortization** |      |
|---------------------------------------|--------|------------|-----------|------------------|-----------|
| **Amortizable****Intangible assets:** |   |       |      |             |      |
| Technology                            |   | $          | 3,875,306 |             | $         | (803,083 | ) |
| Tradenames                            |   | 116,218    |      | $                | (3,228    | ) |
| Total amortizable intangible assets   |   | $          | 3,991,524 |             | $         | (806,311 | ) |
|                                  |   |       |      |             |      |
| **Aggregate Amortizaton Expense:**    |   |       |      |             |      |
| For the year ended December 31, 2002  |   |       |      | $                | 1,020,283 |   |
|                                  |   |       |      |             |      |
| **Estimated Amortizaton Expense:**    |   |       |      |             |      |
| For the year ended December 31, 2003  |   |       |      | $                | 1,330,508 |   |
| For the year ended December 31, 2004  |   |       |      | $                | 1,272,555 |   |
| For the year ended December 31, 2005  |   |       |      | $                | 582,150   |   |

 

Had the amortization provisions of FAS 142 been applied as of January1, 2001 for all of the Company’s acquisitions, it would not have had a materialadverse effect on the Company’s net loss and loss per common share for the yearended December 31, 2001.

 

*(g) Goodwill*

 

Goodwill represents the excess of costs over fair value of tangible andseparately identifiable intangible assets of businesses acquired.  The Company adopted the provisions of FAS142, *Goodwill and Other Intangible Assets*,as of January 1, 2002.  Goodwill andintangible assets acquired in a purchase business combination that aredetermined to have an indefinite useful life are not amortized, but insteadtested for impairment at least annually in accordance with the provisions ofFAS 142.  At December 31, 2001 goodwillrelated to employee workforce that was recorded in connection with the purchaseof the Commerce Division.  During thesecond quarter of 2002, due to the closure of the Commerce Division, the goodwillwas deemed impaired and the net value of approximately $657,000 was writtenoff.

 

*(h) Deferred Revenue*

 

Deferred revenue represents billings or collections on contracts inadvance of performance of services and is amortized into revenue as the relatedservice is performed based upon the applicable revenue recognition methodology.

 

*(i) Revenue Recognition*

 

Revenue is generated by providing promotions marketing services, e-mailmarketing services and various other consulting services, as well as licensingthe Company’s software products.  TheCompany’s current products are principally the*Interactive Database Marketing System* and the *E-mail Marketing System*, as well asadvertising and e-commerce services provided through ConsumerREVIEW.com.  Although the Company reduced the offeringsof the*PerformOne Network* andeliminated the *Commerce Engine*and the *Commerce Network,*theseproducts contributed revenue during the years ended December 31, 2002 and 2001.In addition, the offerings of the *PerformOneNetwork*contributed revenue during the year ended December 31, 2000.

 

The Company’s *Interactive DatabaseMarketing System*, which represented 67% of the Company’s 2002revenue, is a solution targeted at consumer packaged goods companies thatallows businesses to establish direct consumer relationships through a set ofintegrated tools that include targeted e-mail marketing, a customer transactiondatabase, a data warehouse, a micro site and survey generator and a patentedcoupon promotion system.  It isprimarily the combination of the Company's Promotions System and E-mailMarketing System. Revenue is generated by charging fees for system licensing,data hosting, site hosting, database management, account management, strategyservices, creative services, e-mail delivery and management services, as wellas tracking and analytical services. Revenue related to licensing fees is recognized ratably over the licenseperiod, one-time service fees for setting up the customer is recognized ratablyover the expected term of the customer relationship and all other revenue isrecognized when the service is provided and the revenue is determinable.  For agreements that also include aperformance-based incentive fee component that is not finalized until aspecified date, the Company recognizes the amount that would be due under theformula at interim reporting dates as if the contract was terminated at thatdate.  This policy does not involve aconsideration of future performance, but does give rise to the possibility thatfees earned by exceeding performance targets early in the measurement periodmay be reversed due to missing performance targets later in the measurementperiod.  The Company’s only client witha performance-based incentive fee contributed approximately $1,064,000 in suchrevenue from the original contract that expired in October 2002.  The renewal agreement, which began inNovember 2002, also includes performance-based incentive fees that areestimated to be approximately $265,000, however the terms were not defined inthe renewal agreement and are to be defined through an amendment to theagreement.  Accordingly, no revenuerelated to this potential performance-based incentive fee has been recognized.

 

The Company’s *E-mail MarketingSystem*, which represented 5% of the 2002 revenue, allows businessesto conduct e-mail marketing without having to acquire or develop their owne-mail infrastructure.  Revenue isgenerated by charging fees for list management and hosting services, strategyand creative services, e-mail delivery and management services, as well astracking and

 

F-8

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analyticalservices.  Revenue related to one-timeservice fees for setting up the customer is recognized ratably over theexpected term of the customer relationship, while all other revenue isrecognized when the service is provided.

 

*ConsumerREVIEW.com,*which was acquired in December 2002, manages web communities around commonproduct interests.  The web propertiesare dedicated to meeting the needs of consumers who are researching products onthe web. Revenue is predominantly generated through advertising and e-commercefees.  Advertising revenue is derivedfrom the sale of advertisements on pages delivered to community members of theCompany’s websites. This revenue is recognized in the period in which theadvertisements are delivered. E-commerce fees are derived from on-lineperformance-based programs and are earned on either a lead referral basis or onan affiliate commission basis. Revenue is earned from performance-basedprograms when a user of the Company’s websites responds to a commerce link bylinking to a customer’s websites. For lead referral programs, customers arecharged on a cost-per-click basis, and revenue is recognized in the month theclick occurs.  For affiliate-commissionsprograms, revenue is recognized when the commission is earned, which is themonth the transaction occurred.  *ConsumerREVIEW.com* represented 3% of thecompany’s total revenue for 2002.

 

*PromoMail*, theprincipal offering of the *PerformOne Network*,was a service that consisted of targeted e-mails highlighting specifice-centives.  Marketers purchased thisservice on a fixed fee basis or on a performance basis.  For the fixed fee contracts, participatingmarketers were charged a fixed fee for each member to whom the e-mail was sentand revenue related to the service was recognized upon transmission of thee-mail.  When marketers purchased theservice on a performance basis, revenue was based solely on the actions of theCompany’s members.  The Company earned acontractually specified amount based on the number of members who clicked onthe offer or other specified link, the number of purchases by the Company’smembers, or the amount of sales generated by the Company’s members.  Beginning January 1, 2002, revenue forperformance related agreements was being recognized upon cash receipts from themarketers for the actions of the Company’s members or upon notification of theactions for marketers that prepay. Prior to January 1, 2002, revenue was recognized upon notification ofthe actions of the Company’s members. This change in revenue recognition policy was due to the uncertainty inestimating the revenue and, therefore, the collectibility of the revenue.  Due to the Company’s focus on their newproduct offerings and their decision to scale back the offerings of the *PerformOne Network*, *PromoMail* only represented 4% of therevenue for 2002.

 

The *Commerce Engine,*whichthe Company stopped offering during the second quarter of 2002, providedInternet portals and other website customers with an infrastructure to enabletheir end users to make purchase decisions for goods and services. The *Commerce Engine* provided a completecommerce experience for online consumers, enabling them to search for products,compare features and prices among products, and locate and purchase theseproducts through participating online merchants.  Revenue, which was recognized ratably over the expected term ofthe customer relationship, was primarily generated through license, support andmaintenance fees.  Revenue from the *Commerce Engine* represented 16% of theCompany’s total revenue for 2002.

 

The *Commerce Network,*whichthe Company stopped offering during the second quarter of 2002, enabled merchantsto distribute and promote their products to the end users of the Company’s *Commerce Engine* customers.  The system collected product data frommerchants, normalized it into appropriate categories, indexed it and made itavailable for access through the *CommerceEngine*.  Revenue wasprimarily based on the actions of the end users of the *Commerce Engine*. The Company earned acontractually specified amount based on the number of end users who clicked onthe specified link or the amount of sales generated by the end users.  Beginning January 1, 2002, revenue wasrecognized upon cash receipts from the merchants, and prior to January 1, 2002revenue was recognized when an action occurred by an end user.  This change in revenue recognition policywas due to the uncertainty in estimating the revenue and, therefore, thecollectibility of the revenue.  Revenuefrom the *Commerce Network*represented 4% of the Company’s total revenue for 2002.

 

Customers may also contract for consulting services, such as assistancewith promotions planning, consumer acquisition and analytics.  Revenue related to these services isrecognized as the related services are provided.

 

Revenue for the first two quarters of 2001 included barter revenue(“marketing partner transactions”), which represented exchanges of promotionale-mail deliveries for reciprocal advertising space or traffic on otherwebsites.  There were no marketingpartner transactions during the third and fourth quarters of 2001 or during2002.  Revenue and expenses frommarketing partner transactions were recorded based upon the fair value of thepromotional e-mails delivered at a similar quantity or volume of e-mailsdelivered in a qualifying past cash transaction.  Fair value of promotional e-mails delivered was based upon theCompany’s recent historical experience of cash received for similar e-maildeliveries.  Such revenue was recognizedwhen the promotional e-mails were delivered. Corresponding expenses were recognized for the advertisements receivedwhen the advertisements were displayed on the reciprocal websites orproperties, which was typically in the same period as delivery of thepromotional e-mails and were included in sales and marketing expense.

 

For the year ended December 31, 2002, one of the Company’s *Interactive Database Marketing System*customers contributed $4.5 million of revenue. This customer’s original agreement expired in October 2002, however, thecustomer subsequently renewed the agreement for an additional year.  This customer also represented approximately$2.6 million of the $3.0 million

 

F-9

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accountsreceivable balance as of December 31, 2002. The Company does not believe there is a significant risk ofuncollectibility due to the customer’s payment history and credit-worthiness.(Substantially all of the accounts receivable balance related to this customerwas received subsequent to year end.)

 

*(j) Cost of Revenue*

 

Cost of revenue consists primarily of expenses related to providing theCompany’s services, including related personnel costs associated with providingits services, depreciation of servers, network and hosting charges, and revenueshare payments. During the third quarter of 2002, there was a reversal of$174,000 in expenses due to favorable settlements of liabilities for networkand hosting costs that were incurred in the prior year.

 

*(k) Product Development Costs*

 

Product development consists primarily of expenses related to thedevelopment and enhancement of the Company’s technology and services, includingpayroll and related expenses for personnel, as well as other associatedexpenses for the Company’s technology department.  The Company expenses product development costs as they incur them.

 

Development costs related to the software product marketed by theCompany are accounted for in accordance with FAS 86, *Accounting for the Costs of ComputerSoftware to be Sold, Leased or Otherwise Marketed*. Under thisstandard, capitalization of software development costs begins upon the establishmentof technological feasibility, subject to net realizable value considerations.To date, the period between achieving technological feasibility and the generalavailability of such software has been short; therefore, software developmentcosts qualifying for capitalization have been insignificant. Accordingly, theCompany has not capitalized any software development costs and has charged allsuch costs to product development expense.

 

*(l) Sales and Marketing Costs*

 

Sales and marketing expenses consist primarily of payroll, salescommissions and related expenses for personnel engaged in sales, marketing andcustomer support, as well as advertising and promotional expenditures.  Such costs are expensed as incurred.

 

*(m) Advertising Costs*

 

Advertising costs are expensed as incurred. Advertising expense wasapproximately $47,000, $4,309,000 and $12,537,000 during 2002, 2001, and 2000,respectively.

 

*(n) Stock-Based Compensation*

 

At December 31, 2002, the Company had one stock-based employeecompensation plan, which is described more fully in Note 12c. As permittedunder FAS 148, *Accounting for Stock-BasedCompensation—Transition and Disclosure*, which amended FAS 123, *Accounting for Stock-Based Compensation*,the Company has elected to continue to follow the intrinsic value method inaccounting for its stock-based employee compensation arrangement as defined byAPB 25, *Accounting for Stock Issued toEmployees*, and related interpretations including FASB InterpretationNo. 44, *Accounting for Certain Transactionsinvolving Stock Compensation an interpretation of APB Opinion No. 25. *The following table illustratesthe effect on net income and earnings per share if the company had applied thefair value recognition provisions of FAS 123 to stock-based employee compensation.

 
|                                                                                                                                                     |   | **Year ended December 31,** |        |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|-------------|
|                                                                                                                                                     |   | **2002**                    |        | **2001** |   | **2000** |   |
|                                                                                                                                                     |   |                        |        |   |   |   |   |
| Net loss, as reported                                                                                                                                    |   | $                           | (17,144,887 | ) | $ | (45,003,465 | ) | $ | (30,497,113 | ) |
| Add:  Total stock-based employee compensation  expense included in reported net loss, net of related tax effects                                    |   | 359,516                     |        | 863,119 |   | 1,713,649 |   |
| Deduct:   Total stock-based employee compensation  expense as determined under fair value based   method for all awards, net of related tax effects |   | (1,301,288                  | )      | (2,437,069 | )  | (2,892,355 | ) |
| Pro forma net income                                                                                                                                     |   | $                           | (18,086,659 | ) | $ | (46,577,415 | ) | $ | (31,675,819 | )  |
|                                                                                                                                                     |   |                        |        |   |   |   |   |
| Basic and diluted net loss per share:                                                                                                                    |   |                        |        |   |   |   |   |
| As reported                                                                                                                                              |   | $                           | (0.46       | ) | $ | (2.68 | ) | $ | (4.09 | ) |
| Pro forma                                                                                                                                                |   |                        | (0.48       | ) | (2.77 | ) | (4.25 | ) |

 

 

F-10

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*(o) Income Taxes*

 

The Company uses the asset and liability method of accounting forincome taxes. Under the asset and liability method, deferred tax assets andliabilities are recognized for future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases and operating and tax losscarryforwards. Deferred tax assets and liabilities are measured using enactedtax rates expected to apply to taxable income in the years in which thosetemporary differences are expected to be recovered or settled. The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome in the period that includes the enactment date.  The Company records a valuation allowance toreduce the deferred tax assets to the amount that is more likely than not to berecognized.

 

*(p) Net Income (Loss) Per Share*

 

The Company computes net income (loss) applicable to commonstockholders in accordance with FAS 128, *Earnings Per Share,*and SAB 98. Under the provisions ofFAS 128 and SAB 98, basic net income (loss) available per share is computed bydividing the net income (loss) available to common stockholders for the periodby the weighted average number of common shares outstanding during the period.Diluted net income (loss) available per share is computed by dividing the netincome (loss) for the period by the weighted average number of common anddilutive common equivalent shares outstanding during the period. As the Companyhad a net loss in each of the periods presented, basic and diluted net income(loss) available per share is the same.

 

*(q) Fair Value of Financial Instruments*

 

The Company considers the carrying value of the Company’s financialinstruments, which include cash equivalents, restricted cash, accountsreceivable, accounts payable, and accrued expenses to approximate fair value atDecember 31, 2002 and 2001 because of the relatively short period of timebetween origination of the instruments and their expected realization orsettlement.

 

*(r) Concentration of Credit Risk*

 

Financial instruments, which potentially subject the Company toconcentrations of credit risk, consist of cash and cash equivalents, restrictedcash and accounts receivable. The Company maintains its cash and cashequivalents and restricted cash with high quality financial institutions. Attimes, these accounts may exceed federally insured limits. The Company has notexperienced any losses in such bank accounts.

 

There has been a significant slowdown in the Internet sector in theUnited States, particularly with respect to retail Internet companies.  Many retail Internet companies haddifficulties raising capital, borrowing money and otherwise funding theiroperating losses, and some have gone out of business.  Some of the Company’s marketer clients are retail Internetcompanies, many of which have significant losses, negative cash flow andlimited access to capital.  Theseclients are experiencing even greater cash flow problems due to this slowdown.Therefore, many of the Company’s clients could fail.  As a result of the difficulties of some of the Company’s clients,the Company has had to expend additional effort to collect its accountsreceivable, and in certain cases had to settle for less than the total amountowed.  In the year ended December 31,2002, the Company incurred charges related to bad debt of approximately$35,000.  While the Company believesthat its allowance for doubtful accounts as of December 31, 2002 is adequate tocover any difficulties with the collection of its accounts receivable balance,there can be no assurance that the allowance will be adequate to cover anyreceivables later deemed to be uncollectible.

 

The Company believes it is not exposed to significant credit riskrelated to cash and cash equivalents and short-term investments.

 

There was one customer that accounted for 84% of the Company’s accountsreceivable at December 31, 2002 and one customer that accounted for 69% of theCompany’s accounts receivable at December 31, 2001. For the year ended December31, 2002 one customer accounted for 62% of revenue, while for the years endedDecember 31, 2001 and 2000, not one customer accounted for more than 10% ofrevenue.  Substantially all of theaccounts receivable that accounted for 84% of the balance at December 31, 2002,was subsequently received in February 2003.

 

*(s) Retirement Plan*

 

The Company sponsors a defined contribution retirement plan establishedunder the provisions of Internal Revenue Code 

 

F-11

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401(k).Eligible employees may defer up to 25% of their pre-tax earnings, subject tothe Internal Revenue Service’s annual contribution limit.  The 401(k) plan permits the Company to makeadditional discretionary matching contributions on behalf of all participantsin the 401(k) plan in an amount determined by the Company; however, nocontributions have been made for the years presented.

 

*(t) Foreign Currency Translation*

 

The functional currency of the Company’s international operation is thelocal currency. Accordingly, all assets and liabilities of the subsidiary aretranslated using exchange rates in effect at the end of the period, and revenueand costs are translated using weighted average exchange rates for the period.The related translation adjustments are reported in accumulated othercomprehensive income (loss) in stockholders’ equity. For the years endedDecember 31, 2002 and 2001, the Company recorded a foreign currency translationgain and loss of approximately $20,000 and $17,000, respectively.  There were no gains or losses resulting fromforeign currency translations in 2000.

 

Transaction gains and losses arising from transactions denominated in acurrency other than the functional currency of the entity involved are includedin the consolidated statement of operations. For the years ended December 31,2002 and 2001, the Company recorded a foreign currency transaction loss andgain of approximately $258,000 and $43,000, respectively. There were no gainsor losses resulting from foreign currency transactions in 2000.

 

*(u) Comprehensive Income (Loss)*

 

Effective January 1, 1998, the Company adopted the provisions of FAS130, *ReportingComprehensive Income.*FAS 130 established standards for reportingcomprehensive income and its components in financial statements. Othercomprehensive income (loss) recorded by the Company is comprised of foreigncurrency translation adjustments.

 

*(v) Recent Accounting Pronouncements*

 

In July 2002, the FASB issued FAS 146, *Accounting for Costs Associated with Exit or DisposalActivities*, which nullifies EITF Issue 94-3, *Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring)*. FAS 146 requires that aliability for a cost associated with an exit or disposal activity be recognizedwhen the liability is incurred. If fair value cannot be reasonably estimated,the liability shall be recognized initially in the period in which fair valuecan be reasonably estimated. Under Issue 94-3, a liability for an exit cost wasrecognized at the date of an entity’s commitment to an exit plan. Theprovisions of FAS 146 are effective for exit or disposal activities that areinitiated after December 31, 2002.

 

In November 2002, the FASB issued FIN 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness to Others. FIN 45 elaborates on thedisclosures to be made by a guarantor in its interim and annual financial statementsabout its obligations under guarantees issued. FIN 45 also clarifies that aguarantor is required to recognize, at inception of a guarantee, a liabilityfor the fair value of the obligation undertaken. The initial recognition andmeasurement provisions of FIN 45 are applicable to guarantees issued ormodified after December 31, 2002. The disclosure requirements are effective forfinancial statements of interim and annual periods ending after December 15,2002. The adoption of FIN 45 is not expected to have a material adverse effecton the Company’s business, financial condition, results of operations and cashflow. The Company has certain guarantees disclosable under FIN 45:

 

•    The Company guarantees the payment ofsublease rentals to its Landlord on the property that it sublets. The maximumguarantee on this property is approximately $768,000.

•    The Company sometimes indemnifies certain ofits customers against damages, if any, they might incur as a result of a claimbrought against them related to patent infringement from the use of theCompany’s products. The Company is unable to estimate the maximum exposure ofsuch indemnifications due to the inherent uncertainty and the varying nature ofthe contractual terms.

 

In November 2002, the EITF reached consensus on Issue 00-21, *Revenue Arrangements with Multiple Deliverables*on a model to be used to determine when a revenue arrangement with multipledeliverables should be divided into separate units of accounting and, ifseparation is appropriate, how the arrangement consideration should beallocated to the identified accounting units. The EITF also reached a consensusthat this guidance should be effective for all revenue arrangements enteredinto during fiscal periods beginning after June 15, 2003. The Company iscurrently assessing the impact the guidance would have on its business,financial condition, results of operations or cash flow.

 

In December 2002, the FASB issued FAS 148, *Accounting for Stock-Based Compensation — Transition and Disclosure*,which amended FAS 123 *Accounting forStock-Based Compensation*. The new standard provides alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation. Additionally, the statement amendsthe disclosure requirements of FAS 123 to require prominent disclosures in theannual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults. This statement is effective for financial statements for fiscal yearsending after December 15, 2002 and the applicable required disclosures havebeen made in the consolidated financial statements. The Company has

 

F-12

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elected tocontinue to follow the intrinsic value method in accounting for its stock-basedemployee compensation arrangement as defined by APB 25, *Accounting for Stock Issued to Employee* asallowed under FAS 123 (see Note 12c).

 

In January 2003, the FASB FIN 46, *Consolidationof Variable Interest Entities*, an interpretation of AccountingResearch Bulletin 51, *Consolidated FinancialStatements*. FIN 46 explains how to identify variable interestentities and how an enterprise assesses its interests in a variable interestentity to decide whether to consolidate that entity. This Interpretationrequires existing unconsolidated variable interest entities to be consolidatedby their primary beneficiaries if the entities do not effectively disperserisks among parties involved. FIN 46 is effective immediately for variableinterest entities created after January 31, 2003, and to variable interestentities in which an enterprise obtains an interest after that date. TheInterpretation applies in the first fiscal year or interim period beginningafter June 15, 2003, to variable interest entities in which an enterprise holdsa variable interest that it acquired before February 1, 2003. The Company doesnot anticipate that the adoption of FIN 46 will have a material adverse effecton its business, financial condition, results of operations or cash flow.

 

**(3) Equity Offerings**

 

*(a) Initial PublicOffering*

 

On October 3, 2000, the Company completed itsinitial public offering (“IPO”) in which it sold 3,700,000 shares of its commonstock to investors in Switzerland, resulting in proceeds to the Company ofapproximately $36.7 million, after deducting underwriters’ commissions andother offering-related expenses. In connection with the IPO, 1,700,000 sharesof Series A convertible preferred stock, 2,500,000 shares of Series Bconvertible preferred stock, and 2,328,434 shares of Series C convertibleredeemable preferred stock were converted to common stock on a one-for-onebasis.

 

*(b) Rights Offering*

 

On October 19, 2001, the Company closed a rights offering of commonstock for approximately $24.6 million with subscriptions for 20,000,000shares.  Each subscriber in the rightsoffering also received, for no additional consideration, based upon the numberof shares of common stock purchased by such subscriber in the rights offering,a pro-rata portion of 2,000,000 shares of the Company’s Series A convertiblepreferred stock, convertible on a 10-for-1 basis into 20,000,000 shares ofcommon stock under certain circumstances (see Note 12a).  After deducting expenses, underwritingdiscounts and any foreign currency loss, the net proceeds from this transactionwere approximately $22.2 million, with $12.6 million of the net proceedsreceived by December 31, 2001 and the remaining net proceeds of $9.6 million,which related to promissory notes issued to the Company as part of theconsideration for the rights offering, was received during the second quarterof 2002 (see Note 12b).

 

*(c) Series BConvertible Preferred Stock*

 

During December 2002, the Company issued 400,000 shares of Series Bconvertible preferred stock as part of the Company’s acquisition ofsubstantially all of the assets of Consumer Review, Inc. See Notes 4c and 12a.

 

*(d) Warrants*

 

In March 2001, as part of the purchase price for the Commerce Division,the Company issued to Inktomi Corporation a warrant to purchase 1,860,577shares of the Company’s common stock upon the achievement of revenue targetsfor the Commerce Division at the end of 12 months following the closing of thisacquisition. Because the revenue targets were not met, the warrants were notearned. See Note 4a.

 

In December 2001, as part of the purchase price for substantially allof BrightStreet.com’s assets, the Company issued a guaranteed warrant topurchase 500,000 shares of the Company’s common stock and a contingentperformance-based warrant to purchase up to 250,000 shares of the Company’scommon stock. The guaranteed warrant is exercisable from June 3, 2002 throughDecember 3, 2005 at an exercise price of $0.5696 per share.  The performance-based warrant isexercisable, in whole or in part, beginning June 4, 2003 until December 3, 2005based upon the achievement of certain performance targets at an exercise priceof $2.44 per share. See Note 4b.

* *

On October 8, 2002 the Company's board of directors authorized theissuance of 6,000,000 warrants (the "Warrants") to four investors(the "Investors") as consideration for a $20 million financingcommitment (the "Financing Commitment"), which was memorialized in aletter to the Company, by Friedli Corporate Finance, dated September 12, 2002(the "Commitment Letter").  Inthe Commitment Letter, Friedli Corporate Finance, a financial advisor to theCompany, agreed to provide the Company with the Financing Commitment. TheWarrants were issued to the Investors in January 2003 in connection withFriedli Corporate Finance agreeing to provide the Financing Commitment.  The Warrants were issued to the Investors inoffshore transactions pursuant to Regulation S promulgated under the SecuritiesAct of 1933.  The Warrants entitle eachInvestor to purchase one share of the Company's common stock, $0.01 per valueper share, for an initial exercise price of CHF 0.19 per share during the exerciseperiod.  Pursuant to an amendment to theWarrants, the exercise period will begin three (3) months from January 6, 2003and end on April 7, 2008 at 5:00 P.M. Eastern time.  The fair value of these warrants, using the Black-Scholes pricingmodel on the date they were granted, is estimated to be approximately $720,000.

 

**(4) Acquisitions**

 

*(a) CommerceDivision*

 

On March 28, 2001, the Company acquired the Commerce Division ofInktomi Corporation (“Commerce Division”) in a purchase business combinationfor approximately $12.9 million, consisting of 2,168,945 shares of theCompany’s common stock valued at approximately $11.8 million and about $1.1million in acquisition costs.  A totalof 2,551,700 shares of the Company’s common stock, or 14.4% of the Company’soutstanding common stock, were issued with 40% placed into escrow.  Thirty eight

 

F-13

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percent of the escrow shares, or 382,755,were to be released based upon the achievement of contractually defined revenueand performance targets for the Commerce Division.  However, the targets were not met, so the shares were releasedfrom escrow and returned to E-centives. The remaining 637,925 of escrow shares were held in satisfaction of anypotential indemnity claims and were released to Inktomi in June 2002.  As part of the purchase price, the Companyalso issued to Inktomi Corporation a warrant to purchase an additional1,860,577 shares of the Company’s common stock upon the achievement ofadditional revenue targets for the Commerce Division at the end of 12 monthsfollowing the closing of this acquisition. Because the revenue targets were notmet, the warrants were not earned.

 

In connection with the acquisition, theCompany entered into a license agreement and reseller agreement with InktomiCorporation.  Under the terms of thelicense agreement, Inktomi Corporation will perpetually license certainsoftware and technology to the Company to be used in the acquiredbusiness.  Pursuant to the reselleragreement, Inktomi Corporation will resell certain products of the acquiredbusiness for a period of twelve months from the closing.  During 2002, the reseller agreement wasterminated.

 

The acquisition was accounted for under the purchase method ofaccounting and, accordingly, the purchase price was allocated to the assetsacquired and liabilities assumed based on their estimated fair values at theacquisition date.  The Company engagedan independent third-party appraiser to perform a valuation of the tangible andintangible assets associated with the acquisition.  The Company is amortizing the identifiable intangible assets on astraight-line basis over 2-3 years. Based upon the valuation, the total purchase price of $12,893,326 wasallocated as follows:

 

| Current assets                |   | $         | 984,542    |   |
|-------------------------------|--------|-----------|------------|--------|
| Fixed assets, net             |   | 5,657,205 |       |
| Internally developed software |   | 5,549,168 |       |
| Intangible assets             |   | 1,626,433 |       |
| Deferred revenue              |   | (924,022  | )          |
| Total consideration           |   | $         | 12,893,326 |   |

 

Following the acquisition of the CommerceDivision, the Commerce Division business began to deteriorate.  Less money was being spent on this type oftechnology by businesses, as the returns perhaps did not appear to justifyinvesting in the products and services offered through the Commerce Division.  As a result, several of the CommerceDivision clients that were up for renewal did not renew their agreements and alarge new customer terminated its contract early. Additionally, with manycompanies having less discretionary funds due to slow downs in the capitalmarkets, new customers were not entering into contracts for the CommerceDivision offerings.  Therefore, theCommerce Division experienced a significant increase in expenses without thecorresponding increase in revenues. Due to the decline in the customer base,the Company concluded that the benefits derived from the Commerce Divisionwould not be sufficient to support the product offerings and the decision wasmade to close the Commerce Division during the second quarter of 2002.

 

*(b) BrightStreet.com*

 

On December 3, 2001, the Company entered into an Asset PurchaseAgreement (the “Agreement”) with BrightStreet.com, Inc. (“BrightStreet.com”),whereby the Company acquired substantially all of BrightStreet.com’s assets andcertain of its liabilities.  The Companyacquired BrightStreet.com for approximately $2.2 million, consisting ofapproximately $1.7 million in cash, a guaranteed warrant to purchase 500,000shares of the Company’s common stock valued at approximately $185,000, acontingent performance-based warrant to purchase up to 250,000 shares of theCompany’s common stock and approximately $369,000 in acquisition costs.  The cash payments consisted of approximately$843,000 in cash advances to fund BrightStreet.com’s working capital under theterms of a Management Services Agreement and an $825,000 payment atclosing.  The guaranteed warrant isexercisable from June 3, 2002 through December 3, 2005 at an exercise price of$0.5696 per share.  Theperformance-based warrant is exercisable, in whole or in part, beginning June4, 2003 until December 3, 2005 based upon the achievement of certainperformance targets at an exercise price of $2.44 per share.

 

In conjunction with the Agreement, the Company entered into a PatentAssignment Agreement (the “Assignment”) with BrightStreet.com.  Pursuant to the Assignment, BrightStreet.comhas agreed to assign to the Company all rights, title and interest in and toall the issued and pending BrightStreet.com patents (collectively, the“Patents”), subject to certain pre-existing rights granted by BrightStreet.comto third parties (“Pre-existing Rights”), provided the Company makes a certainpayment to BrightStreet.com by December 3, 2005 (the “Payment”).  If the Company makes such Payment by thatdate, the Company shall own all rights, title and interest in and to the Patents,subject to the Pre-existing Rights. Until such Payment is made, the Company has, subject to the Pre-existingRights, an exclusive, worldwide, irrevocable, perpetual, transferable, andsub-licensable right and license under the Patents, including the rights tocontrol prosecution of the Patents and Patent applications and the right to suefor the infringement of the Patents. Until the Company takes formal title to the Patents, it may not grant anexclusive sublicense to the Patents to any unaffiliated third party. In theevent the Company does not make the Payment by December 3, 2005, the Companyshall retain a license to the Patents, but the license shall convert to anon-exclusive license, and other rights to the Patents and Patent applicationsshall revert to BrightStreet.com or its designee.

 

F-14

----

 

In exchange for the rights granted under the Assignment, beginningDecember 2002, the Company is obligated to pay BrightStreet.com ten percent ofrevenues received that are directly attributable to (a) the licensing or saleof products or functionality acquired from BrightStreet.com, (b) licensing orroyalty fees received from enforcement or license of the Patents covered by theAssignment, and (c) licensing or royalty fees received under existing licensesgranted by BrightStreet.com to certain third parties.  If the total transaction compensation paid, as defined by theAssignment, at any time prior to December 3, 2005 exceeds $4,000,000, thePayment will be deemed to have been made. Additionally, the Company has the right, at any time prior to December3, 2005, to satisfy the Payment by paying to BrightStreet.com the differencebetween the $4,000,000 and the total compensation already paid. Any transactioncompensation payments will be accounted for as an addition to the purchaseprice when they are earned.  Through theyear ended December 31, 2002, no royalty payment was accrued for.

 

The BrightStreet.com acquisition was accounted for under the purchasemethod of accounting and, accordingly, the purchase price was allocated to theassets acquired and liabilities assumed based on their estimated fair values atthe acquisition date.  The Company isamortizing the identifiable intangible assets on a straight-line basis overthree years.  The total purchase priceof $2,221,901 was allocated as follows:

 

| Fixed assets, net         |   | $         | 742,301   |   |
|---------------------------|--------|-----------|-----------|--------|
| Accounts receivable       |   | 136,827   |      |
| Licensed technology       |   | 2,086,305 |      |
| Capital lease obligations |   | (695,479  | )         |
| Other liabilities         |   | (48,053   | )         |
| Total consideration       |   | $         | 2,221,901 |   |

 

*(c)ConsumerREVIEW.com*

 

On December 4, 2002, the Company acquired substantially all of ConsumerReview Inc.’s assets and certain of its liabilities through an Asset PurchaseAgreement.  The cost of the acquisitionwas approximately $2.7 million, consisting of 400,000 shares of Series Bconvertible preferred stock valued at approximately $2.1 million, $290,000 incash and about $320,000 in acquisition costs. At closing, the Series B convertible preferred stock was placed intoescrow.  If the Company experiences achange in control, as defined in the Asset Purchase Agreement, before the oneyear anniversary of the closing, each share of the Series B convertiblepreferred stock will immediately be converted into ten shares of the Company’scommon stock and shall be released from escrow. Upon the one year anniversaryof the closing date, provided that a change of control has not occurred, theconversion rate for each share of the Series B convertible preferred stockshall be determined based upon the achievement of contractually defined revenueduring the calculation period and will be adjusted pursuant to the schedulebelow.  The stock consideration willthen be disbursed in accordance with the terms of the Escrow Agreement.

 

| **Revenues  during the Calculation Period**    |   | **Conversion Rate** |   |
|------------------------------------------------|--------|---------------------|--------|
| Less than $1,000,000                           |   | 4 to 1              |   |
| More than $1,000,000, but less than $2,000,000 |   | 6 to 1              |   |
| More than $2,000,000, but less than $3,000,000 |   | 8 to 1              |   |
| More than $3,000,000, but less than $4,000,000 |   | 10 to 1             |   |
| More than $4,000,000, but less than $6,000,000 |   | 12 to 1             |   |
| $6,000,000 or more                             |   | 14 to 1             |   |

 

The acquisition was accounted for under the purchase method ofaccounting and, accordingly, the purchase price was preliminarily allocated to theassets acquired and liabilities assumed based on their estimated fair values atthe acquisition date.  The Companyengaged a third-party appraiser to perform a valuation of the Series Bconvertible preferred stock and the intangible assets.  The total purchase price of $2,677,902 waspreliminarily allocated as follows:  

 

| Cash                     |   | $         | 352,097   |   |
|--------------------------|--------|-----------|-----------|--------|
| Fixed assets, net        |   | 231,834   |      |
| Accounts receivable, net |   | 284,082   |      |
| Technology               |   | 1,789,001 |      |
| Tradenames               |   | 116,218   |      |
| Other liabilities        |   | (95,330   | )         |
| Total consideration      |   | $         | 2,677,902 |   |

 

The Company is amortizing Intangible Assets over their expected livesof 3 years.

 

F-15

----

 

*(d) Pro Forma Financial Information(unaudited)*

 

The following unaudited pro forma results of operations for the yearsended December 31, 2002 and 2001 are presented as though ConsumerReview.com,BrightStreet.com and the Commerce Division had been acquired as of thebeginning of each period presented, after giving effect to purchase accountingadjustments relating to amortization of intangible assets and other acquisitionrelated adjustments. The pro forma results of operations are not necessarilyindicative of the combined results that would have occurred had theacquisitions been consummated at the beginning of the periods, nor are theynecessarily indicative of future operating results.

 

|                                                |   | **Year Ended December 31,** |        |
|-----------------------------------------------------|--------|-----------------------------|-------------|
|                                                |   | **2002**                    |        | **2001** | ** ** |
|                                                |   |                        |        |   |   |
| Revenue                                             |   | $                           | 8,847,000   |   | $ | 14,817,000 |   |
| Net loss                                            |   | $                           | (18,475,000 | ) | $ | (62,275,000 | ) |
| Net loss applicable to common stockholders          |   | $                           | (18,475,000 | ) | $ | (62,275,000 | ) |
| Weighted average shares of common stock outstanding |   | 37,349,270                  |        | 17,342,259 |   |
| Basic and diluted net loss per common share         |   | $                           | (0.49       | ) | $ | (3.59 | ) |

 

**(5) Letters of Credit**

 

*(a) Bethesda,Maryland Office*

 

As part of the amended and modified lease agreement dated June 29, 2000for the Company’s headquarters office space lease in Bethesda, Maryland, theCompany was required to have an irrevocable letter of credit as a securitydeposit throughout the lease term of five years.  In the event that the letter of credit was drawn upon, theCompany established a certificate of deposit for an equivalent amount, whichserved as collateral for the letter of credit. The $449,579 letter of credit, which was reduced from the first yearvalue of $542,984 on June 29, 2001, was to be reduced by 20% on the first dayof each subsequent lease year.  However,in accordance with a September 25, 2002 partial lease termination agreement,which provided for early termination of half of the office space, a new letterof credit was established with a provision that permits a partial draw by thelandlord of $309,579 any time after January 1, 2003 as partial considerationfor the new agreement.  Per the newagreement, in April 2003, the required security deposit for the remainingoffice space will be reduced to approximately $70,000, therefore the letter ofcredit and the associated certificate of deposit will also be reduced to thatamount.

 

*(b) Foster City,California Office*

 

In November 2002, the Company entered into a sublease agreement foroffice space in Foster City, California. As part of the sublease agreement, the Company is required to have anirrevocable letter of credit in the amount of $40,000 as a security depositthroughout the lease term and has therefore established a certificate ofdeposit for this amount.

 

*(c) D&OInsurance*

 

In October 2002, the Company established a $280,247 certificate ofdeposit to serve as collateral for a letter of credit commitment related to itsD&O insurance policy.  As theCompany makes its monthly payments on the policy, the certificate of deposit isreduced by the corresponding amount and the money is transferred to itsoperating account. As of December 31, 2002, the remaining amount was $255,470.

 

**(6) Property and Equipment**

 

Property and equipment consists of the following:

 

|                           |   |            |   | **December 31,** |      |
|--------------------------------|--------|-----------------|--------|------------------|-----------|
|                           |   | **useful life** |   | **2002**         |      | **2001** |   |
| Computer equipment             |   | 3 years         |   | $                | 7,169,246 |   | $ | 15,953,315 |   |
| Furniture and equipment        |   | 5-7 years       |   | 195,562          |      | 1,181,338 |   |
| Leasehold improvements         |   | 5 years         |   | 23,072           |      | 405,818 |   |
|                           |   |            |   | 7,387,880        |      | 17,540,471 |   |
| Less: accumulated depreciation |   |            |   | (5,106,725       | )         | (6,386,313 | ) |
|                           |   |            |   | $                | 2,281,155 |   | $ | 11,154,158 |   |

 

F-16

----

 

**(7) Intangible Assets and Goodwill**

 

In conjunctionwith the acquisition of substantially all the assets of Consumer Review, Inc.in December 2002, the Company recorded approximately $1,789,000 and $116,000for technology and tradenames, respectively. The intangible assets were recorded at their estimated fair value on thedate of the acquisition and are being amortized on a straight-line basis overthree years.

 

In associationwith the acquisition of substantially all of BrightStreet.com’s assets inDecember 2001, the Company acquired licensed technology. The intangible assetwas recorded at its estimated fair value on the date of the acquisition and isbeing amortized on a straight-line basis over three years.

 

Intangibleassets consisting of an assembled work force and a customer list, were acquiredin connection with the purchase of the Commerce Division in March 2001.  The intangible assets were recorded at theirestimated fair value on the date of the acquisition and were being amortized ona straight-line basis over three and two years, respectively.   The Company adopted the provisions of FAS142 as of January 1, 2002 and as a result, during the first quarter of 2002,reclassified approximately $1,000,000 of intangible assets, approximately$657,000 net of accumulated amortization, associated with employee workforcefrom intangible assets to goodwill and therefore no longer amortized theassembled workforce.  During the secondquarter of 2002, due to the closure of the Commerce Division, the associatedvalues of the goodwill for the assembled workforce and the customer listintangible asset were deemed impaired and the net values of approximately$657,000 and $37,000, respectively, were written off.

 

The Companyacquired a patent for “Electronic couponing method and apparatus” in April 1999from SellectSoft, a software developer, for $3,000,000. The patent wasamortized on a straight-line basis over three years and was fully amortized bythe end of the first quarter of 2002. In conjunction with the Company’s decision to scale back the PerformOneNetwork, in the third quarter of 2002 the patent, which had a net value of $0,was written off.

 

Intangibleassets consist of the following:

 

|                           |   | **December 31,** |      |
|--------------------------------|--------|------------------|-----------|
|                           |   | **2002**         |      | **2001** |   |
| Technology                     |   | $                | 3,875,306 |   | $ | 2,194,807 |   |
| Tradenames                     |   | 116,218          |      | -- |   |
| Goodwill                       |   | --               |      | 1,000,745 |   |
| Customer list                  |   | --               |      | 156,290 |   |
| Patent                         |   | --               |      | 3,000,000 |   |
|                           |   | 3,991,524        |      | 6,351,842 |   |
| Less: accumulated amortization |   | (806,311         | )         | (3,248,887 | ) |
|                           |   | $                | 3,185,213 |   | $ | 3,102,955 |   |

 

**(8) Restructuring and Impairment Charges**

 

During the third quarter of 2002, the Companysigned a partial lease termination agreement, approved a plan to reduce theworkforce associated with closing down of its PerformOne Network and evaluatedits existing reserve established for the closure of the Commerce Division. A netrestructuring/impairment charge of approximately $1.2 million was recorded toreflect these actions. The charge included the costs associated withterminating half of the office space lease for the Bethesda, Maryland facility,the costs of severance and other employee benefits related to the terminationof 19 employees, as well as an increase in the reserve associated withterminating the office lease in the UK. The Company expects the cost to terminate the UK office lease to consistof monthly rental through September 30, 2002 and forfeiture of the Company'ssecurity deposit of approximately $102,000. This is based on the Company’s best estimate, however, the landlord ofthe UK office facility has not responded to requests to enter into atermination agreement.  If the landlordof the UK office facility does not agree to a termination agreement, theCompany could face a potential additional liability of approximately $364,000for rental payments through September 2004. As noted below, in the fourth quarter of 2001, the Company recorded arestructuring charge that included consolidation of excess space associatedwith the Bethesda facility.  Due to thepartial lease termination agreement for this facility, the approximately $1.4million remaining balance of the associated 2001 reserve was reversed.

 

During the second quarter of 2002, theCompany’s management approved plans to terminate the lease for the RedwoodShores, California facility and to close the Commerce Division. The $7.8million restructuring/ impairment charge that reflected these actions consistedof the costs associated with terminating the Redwood Shores lease, the costs ofseverance and other employee benefits related to the reduction in workforce of18 employees, the costs connected with terminating the UK office lease, as wellas the costs associated with closing down the Commerce Division and thedisposal and write-down of related tangible and intangible assets.  As discussed below, in the fourth quarter of2001, the Company recorded a restructuring charge for the consolidation of

 

F-17

----

 

excess space related to the Redwood Shores facility.  As a result of the early termination of thelease for this facility, the approximately $6.5 million remaining balance ofthe related 2001 reserve was reversed.

 

The reversals of the remaining balances ofthe 2001 reserves established for the Bethesda and Redwood Shores offices,combined with the new charges for the second and third quarters of 2002, resultedin a net restructuring/impairment charge of approximately $1.1 million for theyear ended December 31, 2002.

 

The following table shows the balance, as ofDecember 31, 2002, of the accrued restructuring/impairment charges recorded in2002.

 
|                         |   | **Total** |       | **Termination of  facility leases** |    | **Employee  severance and  other benefit  related costs** |   | **Revaluation of intangible assets** |     | **Disposal of  tangible assets** |     | **Other** |   |
|------------------------------|--------|-----------|------------|-------------------------------------|---------|-----------------------------------------------------------|--------|--------------------------------------|----------|----------------------------------|----------|-----------|--------|
| Balance at January 1, 2002   |   | $         | —     |                                | $       | —                                                    |   | $                                    | —   |                             | $        | —    |   | $ | — |   | $ | — |   |
| Restructuring charges, net   |   | $         | 8,969,582  |                                | $       | 2,614,213                                                 |   | $                                    | 211,223  |                             | $        | 694,174   |   | $ | 5,054,306 |   | $ | 395,666 |   |
| Cash (payments)/receipts     |   | $         | (2,508,303 | )                                   | $       | (2,158,695                                                | )      | $                                    | (200,115 | )                                | $        | —    |   | $ | 180,408 |   | $ | (329,901 | ) |
| Non-cash charges             |   | $         | (5,744,200 | )                                   | 295,045 |                                                      | $      | —                               |     | $                                | (694,174 | )         | $      | (5,279,306 | ) | $ | (65,765 | ) |
| Balance at December 31, 2002 |   | $         | 717,079    |                                | $       | 750,563                                                   |   | $                                    | 11,108   |                             | $        | —    |   | $ | (44,592 | )(1) | $ | — |   |
|                              |        |           |            |                                     |         |                                                           |        |                                      |          |                                  |          |           |        |  |  |  |  |  |  |  |

 

----

(1)               Balance representsa receivable for tangible assets that are being sold.

 

In 2001, the Company’s management approvedrestructuring actions to respond to the global economic downturn and to improvethe Company’s cost structure by streamlining operations and prioritizingresources in strategic growth areas of the Company’s business. The Companyrecorded a restructuring/impairment charge of approximately $9.9 millionrelated to these actions. This charge was comprised of the costs related to theconsolidation of excess facilities, severance and other employee benefit costsrelated to the termination of 63 employees, as well as a revaluation of theintangible assets associated with the Commerce Division.  During 2002, as a result of the earlytermination of the Redwood Shores office lease and the partial termination ofthe Bethesda office lease, the remaining balances of the reserves associatedwith these offices, of approximately $6.5 million and $1.4 million,respectively, were reversed and new reserves were established.

 

As of December 31, 2002, the balance for theaccrued restructuring/impairment charge recorded in 2001 consisted of thefollowing:

 

|                         |   | **Total**  |   | **Facility  consolidation** |   | **Employee   severance and   other benefit   related costs** |   | **Revaluation of intangible  assets** |   |
|------------------------------|--------|------------|--------|-----------------------------|--------|--------------------------------------------------------------|--------|---------------------------------------|--------|
| Balance at January 1, 2001   |   | $          | — |                        | $      | —                                                       |   | $                                     | — |   | $ | — |   |
| Restructuring charges, net   |   | 9,876,123  |   | 8,975,976                   |   | 430,750                                                      |   | 469,397                               |   |
| Cash payments                |   | (343,776   | )      | —                      |   | (343,776                                                     | )      | —                                |   |
| Non-cash charges             |   | (469,397   | )      | —                      |   | —                                                       |   | (469,397                              | )      |
| Balance at December 31, 2001 |   | 9,062,950  |   | 8,975,976                   |   | 86,974                                                       |   | —                                |   |
| Cash payments, net           |   | (1,221,768 | )      | (1,134,794                  | )      | (86,974                                                      | )      | —                                |   |
| Non-cash charges             |   | —     |   | —                      |   | —                                                       |   | —                                |   |
| Adjustment to reserve        |   | (7,841,182 | )      | (7,841,182                  | )      | —                                                       |   | —                                |   |
| Balance at December 31, 2002 |   | $          | — |                        | $      | —                                                       |   | $                                     | — |   | $ | — |   |

 

 

 

F-18

----

**(9) Income Taxes**

 

The Companyhas incurred operating losses since its inception and has recognized no UScurrent or deferred incometax provision or benefit.  Thecomponents of income tax expense (benefit) attributable to operations are asfollows:

 

|              |   | **Year ended December 31,** |    |
|-------------------|--------|-----------------------------|---------|
|              |   | **2002**                    |    | **2001** |   |
| Current           |   |                        |    |   |   |
| Federal           |   |                        | —  |   |   | — |   |
| State             |   | —                      |    | — |   |
| Foreign           |   | (19,476                     | )       | 19,476 |   |
| Total current     |   | (19,476                     | )       | 19,476 |   |
| Deferred          |   |                        |    |   |   |
| Federal           |   | —                      |    | — |   |
| State             |   | —                      |    | — |   |
| Foreign           |   | —                      |    | — |   |
| Total deferred    |   | —                      |    | — |   |
| Total tax expense |   |                        | (19,476 | ) |   | 19,476 |   |

 

The provisionfor income taxes is different from that which would be obtained by applying thestatutory US federalincome tax rate to pretax loss before income taxes.  The items causing this difference are as follows:

 
|                                                     |   | **Year Ended December 31,** |      |        |
|----------------------------------------------------------|--------|-----------------------------|-----------|-------------|
|                                                     |   | **2002**                    |      | **2001**    |   |
| Expected tax (expense) benefit at federal statutory rate |   |                        | 5,835,883 |        |   | 15,294,556 |   |
| State tax, net of federal                                |   | 642,643                     |      | 1,136,850   |   |
| Stock-based compensation, not deductible                 |   | (122,235                    | )         | (259,800    | ) |
| Foreign tax rate differential                            |   | (43,238                     | )         | 16,102      |   |
| Other, net                                               |   | 13,368                      |      | (230,151    | ) |
| Increase in valuation allowance                          |   | (6,306,945                  | )         | (15,977,033 | ) |
| Tax (expense) benefit                                    |   |                        | 19,476    |        |   | (19,476 | ) |

 

Temporarydifferences and carryforwards that give rise to deferred tax assets andliabilities are as follows:

 
|                                                           |   | **Year Ended December 31,** |       |
|----------------------------------------------------------------|--------|-----------------------------|------------|
| **Deferred tax assets:**                                       |   | **2002**                    |       | **2001** |   |
|                                                           |   |                        |       |   |   |
| Net operating loss and general business credits  carryforwards |   |                        | 38,472,698 |   |   | 29,241,385 |   |
| Restructuring Reserve                                          |   | 276,536                     |       | 3,401,895 |   |
| Start-up and organizational costs                              |   | 1,087,450                   |       | 1,812,416 |   |
| Intangible Assets                                              |   | 860,749                     |       | 1,165,338 |   |
| Accrued Expenses                                               |   | 166,381                     |       | 135,682 |   |
| Deferred Compensation                                          |   | 139,700                     |       | 210,054 |   |
| Allowance for Bad Debts                                        |   | 28,466                      |       | 56,140 |   |
| Property and equipment                                         |   | 540,488                     |       | 11,813 |   |
| Total Deferred Tax assets                                      |   | 41,572,468                  |       | 36,034,723 |   |
| Valuation Allowance                                            |   | (41,572,468                 | )          | (36,034,723 | ) |
|                                                           |   |                        | —     |   |   | — |   |

 

In assessingthe realizability of deferred tax assets, management considers whether it ismore likely than not that some portion or the entire amount of deferred taxassets will not be realized.  Theultimate realization of the deferred tax asset is dependent upon the generationof future taxable income during the periods in which temporary differencesbecome deductible and credit carryforwards are available.  Management considers scheduled reversal ofdeferred tax liabilities, projected future taxable income, and tax planningstrategies which can be implemented by the Company in making thisassessment.  Based upon the lack ofhistorical taxable income, scheduled reversal of deferred tax liabilities,projections for future taxable income and uncertainty regarding ultimaterealization of the tax benefits regarding the deferred tax assets, the Companyhas established a valuation allowance of $41,572,000 and $36,035,000 as ofDecember 31, 2002 and December 31, 2001, respectively.  The net change in the valuation allowancefor the years ended December 31, 2002 and December 31, 2001 was anincrease of $5,537,745 and $15,977,033 respectively. The federal net operatingloss is $101,002,000 as of December 31, 2002. The Federal net operating loss carryforwardperiod expires commencing in 2011 through the year 2022. Further, as a resultof certain financing and capital transactions, an annual limitation on thefuture utilization of a portion of the net operating loss may occur.  As a result, the net operating losscarryforward may not be fully utilized before expiration.

 

F-19

----

 

**(10) Commitments and Contingencies**

 

*(a) Leases*

 

In association with the acquisition of BrightStreet.com’s assets,effective November 1, 2001, the Company entered into a Modification, Assignmentand Assumption Agreement with Pentech Financial Services, Inc. (“Pentech”) andBrightStreet.com regarding the Master Equipment Lease (“Lease”) thatBrightStreet.com had entered into with Pentech in May 2000 for computerequipment.  Per the agreement, with theconsent of Pentech, BrightStreet.com assigned the Lease to the Company withcertain modifications to the terms and conditions of the Lease.  In addition, the Company agreed to defend,indemnify, save and hold harmless BrightStreet.com from and against any and allclaims, demands, costs, and any other damages which BrightStreet.com maysustain as a result of any failure or delay by the Company in performing theassumed obligations.

 

The Company is obligated under non-cancelablecapital leases, for certain computer equipment, that expire during 2004.  In addition, the Company is obligated undernon-cancelable operating leases, primarily for office space, which expire onvarious dates through 2005.

 

Amounts related to assets under non-cancelable capital leases that havebeen capitalized as property and equipment as of December 31, 2002 are asfollows:

 
| Computer equipment             |   | $        | 407,412 |   |
|--------------------------------|--------|----------|---------|--------|
| Less: accumulated depreciation |   | (147,121 | )       |
|                           |   | $        | 260,291 |   |

 

Rent expense under operating leases was approximately $1,549,000,$3,541,000 and $955,000 for the years ended December 31, 2002, 2001 and2000, respectively.

 

In February 2002, the Company signed a Sublease Agreement to sublease aportion of the sixth floor at the Bethesda, Maryland facility that commenced onMarch 1, 2002 and expires on September 30, 2005.

 

As of December 31, 2002, future minimum lease payments and futuresublease rental income under non-cancelable leases are as follows:

 
| **Year Ending December 31,**                                   |   | **Capital Leases** |    | **Operating Leases** |      | **Rental Income** |   |
|----------------------------------------------------------------|--------|--------------------|---------|----------------------|-----------|-------------------|--------|
| 2003                                                           |   | $                  | 243,552 |                 | $         | 1,008,371         |   | $ | 269,402 |   |
| 2004                                                           |   | 248,306            |    | 1,096,895            |      | 280,179           |   |
| 2005                                                           |   | —             |    | 613,521              |      | 218,069           |   |
| Total                                                          |   | 491,858            |    | $                    | 2,718,787 |              | $      | 767,650 |   |
| Less: amount representing interest (rates approximating  8.3%) |   | (21,330            | )       |                 |      |              |   |
| Present value of net minimum lease payments                    |   | 470,528            |    |                 |      |              |   |
| Less: current installments                                     |   | (224,914           | )       |                 |      |              |   |
| Obligation under capital leases, excluding current portion     |   | $                  | 245,614 |                 |      |              |   |   |

 

*(b) Partner Payments*

 

The Company compensates its network partners for members acquiredthrough their websites by paying a fee for new members, by paying a percentageof the revenue the Company generates from the delivery of E–centives to suchnew members, by paying both or by paying the higher of the two methods.

 

On March 31, 2001, the Company terminated its Co-Branding Agreementwith Excite@Home (“Excite”), dated as of February 16, 2000 and amended December30, 2000.  The termination agreementrelieved the Company of all of its future obligations, including makingpayments of up to $13 million to Excite over the next two years.  In connection with the TerminationAgreement, the Company also purchased $1.3 million worth of data and e-mailservices from Matchlogic, a wholly owned subsidiary of Excite.  Effective April 1, 2001, the Company enteredinto a new one-year agreement with Excite, whereby Excite provided the Companywith access to e-mail and other subscriber information, and in exchange forthis information, the Company was to pay Excite a percentage of the revenuegenerated from these subscribers. However, this restructured agreement resulted in no revenue sharepayments to Excite.  As of November 5,2001, this agreement was terminated, as Excite filed for bankruptcy protection.

 

During June 2001, the Company entered into an Online Services Agreementwith Classmates.com, an online reunion destination site with 20 millionmembers.  The strategic alliance allowsClassmates.com members to receive E-centives’ targeted

 

F-20

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special offersand promotions based upon their self-described interests and will provide theCompany with access to e-mail and other subscriber information.  In exchange for this information, theCompany pays Classmates.com a percentage of the revenue generated from thesesubscribers.

 

Due to the closing down of the PerformOne Network, as of December 31,2002, the Company had no agreements with network partners and has no futurefixed commitments relating to these agreements.

 

*(c) Litigation*

 

The Company is subject to legal proceedings and claims which arise inthe ordinary course of business.  Otherthan the matters described below, as of December 31, 2002, management is notaware of any asserted or pending litigation or claims against the Company thatwould have a material adverse effect on the Company's financial condition,results of operations or liquidity.

 

On or about April 1, 2002 the trustee for Debtor, CyberRebate(“Trustee”) filed suit against E-centives in the United States BankruptcyCourt, Eastern District of New York (“Bankruptcy Court”) for recovery of$210,000 allegedly paid to E-centives as an avoidable preference under U.S.Bankruptcy laws.  On or about February20, 2003, the parties agreed to a settlement and entered into a stipulation andorder for Bankruptcy Court approval, whereby E-centives and the Trustee settledthe claim whereby the Company will pay a total of $189,000 in 2003, whichamount is accrued for.  In exchange forsuch payments, the Trustee shall fully release all claims against E-centivesand dismiss the suit against E-centives with prejudice, and E-centives willhave a general unsecured claim against the Debtor’s estate in the amount of$21,000.

 

F-21

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There were no other material additions to, or changes in status of, anyongoing, threatened or pending legal proceedings during the year ended December31, 2002, including no changes in the status of the settlement withcoolsavings.com, Inc. (“coolsavings”). The terms of the settlement with coolsavings provide for a cross-licensebetween the Company and coolsavings for each of the patents currently indispute.  There are no royalties orother incremental payments involved in the cross-license.  Pursuant to this settlement, the Company mayhave to make payments of up to $1.35 million to coolsavings as follows:

 

•                  $650,000, whichwas paid to coolsavings on September 29, 2000, was due at the signing of thesettlement documents.

 

•                  $250,000, whichwas accrued for during 2001, was due if, within one year from the date of entryof the Stipulated Order of Dismissal filed on or about March 3, 2000, CatalinaMarketing Corporation prevailed in a motion for summary judgment in a separatelitigation between it and coolsavings, involving the coolsavings’ patentcurrently in dispute. However, a dispute has arisen between the partiesregarding whether this portion of the license fee is actually due, despiteCatalina Marketing Corporation not prevailing in its motion.  This dispute is based in part on the factthat the Company may be entitled to a license under the coolsavings’ patent atissue as a result of the Company’s acquisition of the assets ofBrightStreet.com, which acquisition included the settlement of infringementlitigation between coolsavings and BrightStreet.com regarding the samecoolsavings patent at issue in the Company’s settled litigation.  As such, the parties are currently indiscussions regarding the resolution of this issue.

 

•                  Up to $450,000if and to the extent the coolsavings’ patent currently in dispute survives thepending reexamination proceedings at the Patent and Trademark Office that wereinitiated by a third party.  Thiscomponent of the settlement arrangement has not been accrued for because thepossibility of the Company having to make this payment continues to remainremote.

 

*(d) Employment Agreements*

 

The Company has employment agreements with certain officers andemployees. The Company also has bonus agreements with certain officers andemployees as defined in the agreements.

 

**(11) Segment Reporting**

 

*Segment Description*

 

Starting in 2002, with the acquisition ofsubstantially all of the assets of Consumer Review, Inc., the Company has tworeportable operating segments: E-centives and ConsumerREVIEW.com. E-centivesincludes the services of the *InteractiveDatabase Marketing System*, the *E-mailMarketing System*, the *PerformOneNetwork*, the *Commerce Engine*and the *Commerce Network*, whileConsumerREVIEW.com sells advertising and e-commerce services that are providedthrough its network of web communities.

 

Information as to the operations of thesegments of the Company for 2002 is set forth below based on the nature of theproducts and services offered. The Company’s chief operating decision makerevaluates performance based primarily on operating profit. The accountingpolicies of the operating segments are the same as those described in thesummary of significant accounting.

 

The asset, other unallocated amounts,represent corporate assets that consist of cash and equivalents, as well asrestricted cash.

 

F-22

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**Asof and for the year ended December 31, 2002**

 
| **2002**                      |   | **E-centives** |      | **ConsumerReview.com** |   | **Segment  Totals** |   | **Other  Unallocated  Amounts** |      | **Consolidated  Total** |   |
|-------------------------------|--------|----------------|-----------|------------------------|--------|---------------------|--------|---------------------------------|-----------|-------------------------|--------|
| Operating revenue             |   | $              | 7,006,835 |                   | $      | 213,963             |   | $                               | 7,220,798 |                    | $      | — |   | $ | 7,220,798 |   |
| Operating loss                |   | (17,367,368    | )         | (35,374                | )      | (17,402,742         | )      | —                          |      | (17,402,742             | )      |
| Depreciation and amortization |   | 5,205,381      |      | 68,689                 |   | 5,274,070           |   | —                          |      | 5,274,070               |   |
| Assets                        |   | 7,134,390      |      | 2,494,157              |   | 9,628,547           |   | 3,062,403                       |      | 12,690,950              |   |
| Capital expenditures          |   | 410,934        |      | 17,320                 |   | 428,254             |   | —                          |      | 428,254                 |   |
|                               |        |                |           |                        |        |                     |        |                                 |           |                         |        |  |  |  |  |  |

 

**(12) Stockholders’ Equity**

 

*(a) Preferred Stock*

 

On November 30, 2001, the Company’s proposalto amend and restate its Articles of Incorporation to authorize 10,000,000shares of preferred stock was approved by a majority of the stockholders.

 

As of December 31, 2002, there were 2,000,000shares of Series A convertible preferred stock issued.  As part of the Company’s October 2001 rightsoffering of 20,000,000 shares of common stock, additional securities wereissued to each of the stockholders who purchased shares, in an amountproportional to their participation in the rights offering.  The additional securities consisted of 2,000,000shares of Series A convertible preferred stock, convertible into 20,000,000shares of common stock upon certain circumstances.  The Company did not receive any additional consideration for suchSeries A convertible preferred stock beyond such consideration received for theshares of common stock purchased in the rights offering.

 

*Voting:*

The holders of Series A convertiblepreferred stock shall vote with the holders of common stock on allmatters submitted to the stockholders. Each share of Series A convertiblepreferred stock shall entitle the holder thereof to a number of votesequal to the number of shares of common stock into which it is thenconvertible.

 

*Dividends:*

No dividends will be paid on the Series A convertible preferred stock.

 

*Voluntary Conversion:*

Each share of Series A convertiblepreferred stock will be convertible into the Company’s common stock,beginning one year after issuance, at the option of the holder.   The number of shares calculated will be tencommon shares for one preferred share held at the time of conversion.

 

*Mandatory Conversion:*

The Series A convertible preferredstock shall automatically convert into shares of the Company’s common stock (ata ten for one basis) at the conversion price then in effect upon the earlier tooccur of:  (1) the date when the averagetrading price of the Company’s common stock for 15 consecutive trading days isequal to or greater than CHF 6.00; (2) the consummation by the Company of apublic offering of equity securities with proceeds in excess of CHF 40,000,000million or equivalent in USD; (3) change of control; or (4) two years from thedate of issuance.

 

*Liquidation:*

Upon any liquidation, dissolution or winding up of the Company, eachholder of Series A convertible preferredstock shall be entitled to receive, prior to any distribution with respect tothe Company’s common stock and Series B convertible preferred stock, an amountequal to: all cash available for distribution to all classes of stockholders,calculated as if the Series A convertiblepreferred stock had been converted into common stock immediately priorto the liquidation, up to but not to exceed CHF 25.00 per share of such commonstock. Seven percent of the total amount of cash available for distribution toall classes of stockholders shall, however, be distributed to the Company’smanagement (pursuant to a formula to be determined by the board of the Company)prior to the calculation of the liquidation preference in favor of the Series convertible A preferred stockholders.

 

As of December 31, 2002, there were 400,000shares of Series B convertible preferred stock authorized.  As part of the Company’s acquisition ofsubstantially all of the assets of Consumer Review, Inc. in December 2002,400,000 shares of Series B convertible preferred stock were issued.

 

F-23

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*Voting:*

The holders of Series B convertible preferred stock shall vote with theholders of common stock on all matters submitted to the stockholders.  Within the first twelve months of issuance,each holder of shares of Series B convertible preferred stock shall be entitledto one vote for each share of Series B convertible preferred stock heldimmediately after the close of business on the record date fixed for such meetingor the effective date of such written consent. After the first twelve months from issuance, each holder of shares ofSeries B convertible preferred stock shall be entitled to such number of votesas shall be equal to the whole number of shares of common stock into which suchholder’s aggregate number of shares of Series B convertible preferred stock areconvertible (pursuant to the conversion table below) immediately after theclose of business on the record date fixed for such meeting or the effectivedate of such written consent.

 

*Dividends:*

No dividends will be paid on the Series B convertible preferred stock.

 

*Voluntary Conversion:*

Each share of Series B convertible preferred stock will be convertibleinto the Company’s common stock, beginning one year after the closing date ofthe Consumer Review, Inc. acquisition, based upon the achievement ofcontractually defined revenue during the calculation period and will beadjusted pursuant to the schedule below.

 

| **Revenues during the Calculation Period**     |   | **Conversion Rate** |   |
|------------------------------------------------|--------|---------------------|--------|
| Less than $1,000,000                           |   | 4 to 1              |   |
| More than $1,000,000, but less than $2,000,000 |   | 6 to 1              |   |
| More than $2,000,000, but less than $3,000,000 |   | 8 to 1              |   |
| More than $3,000,000, but less than $4,000,000 |   | 10 to 1             |   |
| More than $4,000,000, but less than $6,000,000 |   | 12 to 1             |   |
| $6,000,000 or more                             |   | 14 to 1             |   |

 

*Mandatory Conversion:*

Each share of Series B convertible preferred stock shall automaticallybe converted into shares of common stock at the conversion rate (as definedabove) upon the earlier to occur of: (i) the consummation by the Company of apublic offering of equity securities with proceeds in excess of CHF 20,000,000or equivalent in United States Dollars, (ii) an Acquisition, Asset Transfer orother Liquidation (as defined below) or (iii) thirty months from the date ofissuance, provided the Series B preferred convertible stock shall automaticallyconvert into shares of the Company’s common stock (at a ten for one basis) atthe conversion price then in effect if the Company experiences a change incontrol before the one year anniversary of the closing date of theConsumerREVIEW.com acquisition.

 

*Liquidation:*

Upon any voluntary or involuntary liquidation, dissolution or windingup of the Company (“Liquidation”), before any distribution or payment shall bemade to the holders of the common stock and any other stock of the Company thatis not by its terms expressly senior in right of payment to the Series Bconvertible preferred stock, but following any distribution or payment to theholders of the Series A convertible preferred stock (which is expressly seniorto the Series B convertible preferred stock), the holders of Series Bconvertible preferred stock shall be entitled to be paid out of the assets ofthe Company with respect to each share of Series B convertible preferred stockheld, an amount equal to the product of (i) (a) if the Liquidation is not asale, conversion or other transfer of the Company’s stock, the average of thehigh and low closing prices of the Company’s common stock on the day prior tothe date of such Liquidation, as such prices are reported by the SWX SwissExchange, after applying the CHF-USD exchange rates, as determined by 5 p.m.,Swiss time on such date, by swissfirst Bank AG or (b) if the Liquidation is asale, conversion or other transfer of the Company’s stock, the purchase priceor other valuation of the Company’s common stock pursuant to such Liquidation,and (ii) the number of shares of common stock into which a share of Series Bconvertible preferred stock would be convertible pursuant to the conversiontable above if the conversion had occurred immediately prior to suchLiquidation, as appropriately adjusted for any future stock splits, stockcombinations, or similar transactions affecting the Series B convertible preferredstock.  If, upon any Liquidation, theassets of the Company shall be insufficient to make payment in full to allholders of Series B convertible preferred stock, then such assets shall bedistributed among the holders of Series B convertible preferred stock at thetime outstanding, ratably in proportion to the full amounts to which they wouldotherwise be respectively entitled. After payment in full to the holders ofSeries B convertible preferred stock of the aggregate liquidation preference asaforesaid, the holders of the Series B convertible preferred stock shall, assuch, have no right or claim to any of the remaining assets of the Company.

 

The following events shall be considered a Liquidation: any merger,consolidation, business combination, reorganization, reclassification orrecapitalization of the Company in which the Company is not the survivingentity or in which the stockholders of all classes and series of stock of theCompany immediately prior to such transaction own capital stock representingless than fifty percent of the Company’s voting power of all classes and seriesof stock immediately after such 

 

F-24

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transaction(an “Acquisition”); or a sale, lease or other disposition of all orsubstantially all of the assets of the Company (an “Asset Transfer”).

 

*(b) Notes receivable from Stockholders*

 

As part of its October 2001 rights offering, the Company sold shares ofits common stock to Venturetec, Inc. and Pine, Inc. Peter Friedli, one of theCompany’s stockholders and directors, who serves as the investment advisor toboth Venturetec and Pine, and who also serves as President of Venturetec andits parent corporation, New Venturetec AG. Venturetec and Pine each delivered to the Company a promissory notedated as of October 19, 2001, with a maturity date of March 31, 2002, asconsideration for the subscription price for the shares of common stock forwhich each company subscribed under the rights offering.  Venturetec’s note (which was only partialconsideration for the purchase of the shares; the remainder was paid in cash)was in the principal amount of CHF 8,500,000 (approximately $5.2 million) andPine’s note was in the principal amount of CHF 8,687,530 (approximately $5.3million).

 

On January 22, 2002, Pine, Venturetec and InVenture, all companiesunder common control, reallocated their share purchases and/or relatedpromissory notes associated with the rights offering. The CHF 2,500,000(approximately $1.5 million) in cash originally indicated as originating fromVenturetec was reallocated as follows:

 

•                  In a privatesale, InVenture purchased from Pine 1,041,667 shares of common stock,originally purchased by Pine pursuant to the rights offering, for CHF2,083,334. As part of this transaction, Pine was credited with paying theCompany CHF 2,083,334 (approximately $1.3 million) and delivered to the Companyan amended and restated secured promissory note dated as of October 19, 2001,in the principal amount of CHF 6,604,196 (approximately $4.1 million), with 2%interest accruing from October 19, 2001 and a maturity date that was extendedto May 15, 2002. The Company simultaneously returned Pine’s original CHF8,687,530 promissory note.

 

•                  Venturetec paidthe Company CHF 416,666 (approximately $256,000) and delivered to the Companyan amended and restated secured promissory note dated as of October 19, 2001,in the principal amount of CHF 10,583,334 (approximately $6.5 million), with 2%interest accruing from October 19, 2001 and a maturity date that was extendedto June 30, 2002. This CHF 10,583,334 reflects an increase in Venturetec’ssecured promissory note to CHF 11,000,000 (approximately $6.8 million),reflecting Venturetec’s original subscription price for the shares of the Company’scommon stock for which it subscribed under the rights offering, minus the CHF416,666 payment. The Company simultaneously returned Venturetec’s original CHF8,500,000 promissory note.

 

All of the outstanding principal and interest under the promissorynotes issued by Pine and Venturetec were fully received by the Company in April2002.  In connection with the proceedsof the promissory notes, the Company incurred a foreign currency loss ofapproximately $258,000 in the second quarter of 2002 based upon the differencebetween the currency rates at the time the cash was received and the closing ofthe rights offering.

 

*(c) Stock Incentiveand Option Plan*

 

The Company’s Amended and Restated Stock Incentive and Option Planprovides for the grant of options, restricted stock and other stock-basedcompensation to its employees, consultants and advisors. As of December 31,2002, there were 21,000,000 shares of common stock reserved for issuance andthere were 2,206,800 options topurchase shares of common stock outstanding at a weighted average exerciseprice of $5.18 per share. Options granted under the plan typically vest overtime, usually ratably over four years from the date of grant, with some subjectto acceleration in the event of a change of control of E-centives. Typically,an option granted under the plan expires ten years after it is granted. Inaddition, the plan allows for grants of options the vesting of which is tied tothe employee’s performance. As of the December 31, 2002 the board of directorshas issued only stock options under the plan. The plan provides for the granting of both incentive stock optionswithin the meaning of Section 422 of the Internal Revenue Code of 1986 andnon-statutory options.

 

During 1997 and 1998, 100,018 performance-based option grants were madeto certain key employees at an exercise price of $2.50. During 1999, 160,400additional performance-based option grants were made to certain key employees,with an exercise price of $2.50 for 50,000 of these options and $3.50 for theremaining 110,400 options. During 2002, 200,000 performance-based option grantspriced at $0.50 were made, while 25,000 performance-based options priced at$3.40 were granted in 2001 and no performance-based option grants were made in2000.  Compensation expense related tothese options of $733,137 and ($302,304) was recorded in 2001 and 2000,respectively.  The credit for 2000reflects the reversal of historical stock-based compensation expense, relatedto terminated employees, that was recorded in excess of the expense pertainingto their options vested through termination. There was no compensation expense related to performance based optionsfor 2002, as the options issued in 2002 had an exercise price in excess of thestock price at December 31, 2002 and all options issued prior to 2002 werefully vested.

 

As allowed by FAS 123, the Company applies the intrinsic value-basedmethod of accounting prescribed by APB 25 and related interpretations inaccounting for its employee stock options, rather than the alternative fairvalue accounting method.

 

F-25

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Under thismethod, compensation expense is recorded on the date of grant only if thecurrent market price of the underlying stock exceeded the exercise price.  In 2002, 2001 and 2000, the Company recordedequity-based compensation expense of $359,516, $1,165,423 and $980,512,respectively relating to options to purchase 960,800 shares granted in 1999 and1,517,564 shares granted in 2000 equal to the difference between the fair valueof the Company’s common stock on the grant date and the exercise price of theoptions. Additionally, the Company expects to incur approximately $289,000 ofcompensation expense during the period 2003 through 2004 relating to theseoptions. The expense will be recognized ratably over the vesting period of theoptions, which is generally 4 years. Had compensation expense for the Company’sstock option plan been determined based upon the fair value methodology underFAS 123, the Company’s net loss would have increased to these pro formaamounts:

 

|                                                                                                                                                   |   | **Year ended December 31,** |        |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|-------------|
|                                                                                                                                                   |   | **2002**                    |        | **2001** |   | **2000** |   |
|                                                                                                                                                   |   |                        |        |   |   |   |   |
| Net loss, as reported                                                                                                                                  |   | $                           | (17,144,887 | ) | $ | (45,003,465 | ) | $ | (30,497,113 | ) |
| Add:  Total  stock-based employee compensation  expense included in reported net loss, net of related tax effects                                 |   |                        | 359,516     |   |   | 863,119 |   |   | 1,713,649 |   |
| Deduct:  Total  stock-based employee compensation expense as determined under fair value  based method for all awards, net of related tax effects |   | (1,301,288                  | )           | (2,437,069 | ) | (2,892,355 | ) |
| Pro forma net income                                                                                                                                   |   | $                           | (18,086,659 | ) | $ | (46,577,415 | ) | $ | (31,675,819 | ) |
|                                                                                                                                                   |   |                        |        |   |   |   |   |
| Basic and diluted net loss per share:                                                                                                                  |   |                        |        |   |   |   |   |
| As reported                                                                                                                                            |   | $                           | (0.46       | ) | $ | (2.68 | ) | $ | (4.09 | ) |
| Pro forma                                                                                                                                              |   |                        | (0.48       | ) | (2.77 | ) | (4.25 | ) |

 

The fair value of these options was estimated at the date of grantusing the Black-Scholes option pricing model on the date of grant using thefollowing assumptions:

 

|                      |   | **Year ended December 31,** |   |
|---------------------------|--------|-----------------------------|--------|
|                      |   | **2002**                    |   | **2001** |   | **2000** |   |
| Risk-free interest rates  |   | 3.0                         | %      | 5.0 | % | 5.0 | % |
| Expected lives (in years) |   | 5                           |   | 5 |   | 5 |   |
| Dividend yield            |   | —                      |   | — |   | — |   |
| Expected volatility(1)    |   | 147                         | %      | 100 | % | 100 | % |

 

----

(1)               0%expected volatility was used for all options granted prior to the initialpublic offering on October 3, 2000.

 

The weighted-average fair value of stock options granted during 2002,2001 and 2000 was $0.44, $3.02 and $5.78, respectively.

 

 

A summary of the Company’s stock option activity and weighted averageexercise price is as follows:

 

|                       |   | **Number of  shares** |   | **Weighted  average  exercise price** |   |
|----------------------------|--------|-----------------------|--------|---------------------------------------|--------|
| Balance, January 1, 2000   |   | 1,751,036             |   | $                                     | 2.77   |   |
| Granted                    |   | 1,570,064             |   | 8.28                                  |   |
| Exercised                  |   | (65,625               | )      | 2.11                                  |   |
| Canceled                   |   | (440,625              | )      | 2.98                                  |   |
| Balance, December 31, 2000 |   | 2,814,850             |   | 5.82                                  |   |
| Granted                    |   | 1,596,250             |   | 3.93                                  |   |
| Exercised                  |   | (11,875               | )      | 2.37                                  |   |
| Canceled                   |   | (1,236,895            | )      | 4.66                                  |   |
| Balance, December 31, 2001 |   | 3,162,330             |   | 5.34                                  |   |
| Granted                    |   | 445,000               |   | 0.49                                  |   |
| Exercised                  |   | (30                   | )      | 3.50                                  |   |
| Canceled                   |   | (1,400,500            | )      | 4.05                                  |   |
| Balance, December 31, 2002 |   | 2,206,800             |   | $                                     | 5.18   |   |

 

F-26

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The following table summarizes information concerning currentlyoutstanding and exercisable options at December 31, 2002:

 

|                          |   | **Options outstanding**               |   |
|-------------------------------|--------|---------------------------------------|--------|
| **Range of exercise  prices** |   | **Number  outstanding  at  12/31/02** |   | **Weighted  average  remaining  contractual  life** |   | **Options  exercisable  at  12/31/02** |   |
| $  0.13                  | – | $  0.50                          |   | 400,000 |   | 9.4 years |   | 5,000 |   |
| $  0.53                  | – | $  1.00                          |   | 166,500 |   | 9.0 years |   | 32,125 |   |
| $  1.27                  | – | $  1.50                          |   | 8,000 |   | 8.6 years |   | 2,000 |   |
|                          |   | $  2.50                          |   | 519,235 |   | 5.9 years |   | 503,361 |   |
| $  3.40                  | – | $  3.86                          |   | 316,565 |   | 7.3 years |   | 229,869 |   |
| $  5.11                  | – | $  5.85                          |   | 93,000 |   | 8.2 years |   | 23,250 |   |
| $  6.11                  | – | $  6.72                          |   | 130,000 |   | 7.5 years |   | 64,000 |   |
| $  8.02                  | – | $  8.85                          |   | 7,000 |   | 8.0 years |   | 2,625 |   |
|                          |   | $  9.37                          |   | 12,000 |   | 8.0 years |   | 6,000 |   |
| $11.01                        | – | $11.56                                |   | 4,500 |   | 7.8 years |   | 2,250 |   |
| $12.18                        | – | $13.00                                |   | 550,000 |   | 7.5 years |   | 550,000 |   |
|                          |   |                                  |   | 2,206,800 |   | 7.6 years |   | 1,420,480 |   |

 

*(d) Warrants*

 

The Company has issued warrants to purchase common shares in connectionwith several equity issuances:  the 1997grant was in connection with the issuance of Series A convertible preferredstock, the 1999 grant was in connection with the issuance of Series Bconvertible preferred stock, and the 2000 grant was in connection with theissuance of Series C convertible redeemable preferred stock.  The warrants granted in 2001 were inconjunction with the acquisition of the Commerce Division and BrightStreet.com,with rights to purchase common shares of 1,860,577 and 750,000,respectively.  The warrants for 2002were issued in consideration of a financing commitment (see Note 3d).

 

The warrant issued to Inktomi Corporation as part of the CommerceDivision acquisition was a contingent performance-based warrant that Inktomiwas eligible to exercise based upon the achievement of revenue targets for theCommerce Division at the end of 12 months following the closing of theacquisition.  Since revenue did not meetdid not meet the contractually defined revenue target, the right to exercisethe earn-out warrant expired during 2002.

 

The warrants issued in conjunction with the BrightStreet.comacquisition consist of a guaranteed warrant to purchase 500,000 shares of theCompany’s common stock and a contingent performance-based warrant to purchaseup to 250,000 shares of the Company’s common stock.  The performance-based warrant is based upon the achievement of arevenue target of $7 million for BrightStreet.com during the 18 monthsfollowing the closing of the acquisition.

 

The following table sets forth the warrants outstanding, theirunderlying common shares and their weighted average exercise price per share:

 

|                       |   | **Shares** |   | **Price** |   |
|----------------------------|--------|------------|--------|-----------|--------|
| Balance, January 1, 2000   |   | 480,000    |   | $         | 4.73   |   |
| Granted                    |   | 127,485    |   | 9.94      |   |
| Exercised                  |   | —     |   | —    |   |
| Balance, December 31, 2000 |   | 607,485    |   | 5.82      |   |
| Granted                    |   | 2,610,577  |   | 4.27      |   |
| Exercised                  |   | —     |   | —    |   |
| Balance, December 31, 2001 |   | 3,218,062  |   | 4.56      |   |
| Granted                    |   | 6,000,000  |   | 0.13      |   |
| Exercised                  |   | —     |   | —    |   |
| Expired                    |   | (1,860,577 | )      | 5.51      |   |
| Balance, December 31, 2002 |   | 7,357,485  |   | $         | 0.71   |   |

 

 

488,000 of the warrants granted through December 31, 2000 expire onDecember 31, 2003, with the remaining 119,485 expiring on February 18,2005.  The 1,860,577 warrants granted toInktomi during 2001 expired on March 28, 2002 and the two warrants totaling750,000, granted to BrightStreet.com during 2001, expire on December 3, 2005.The warrants issued during 2002 expire on April 7, 2008.

 

F-27

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*(e) Authorized Capital*

 

On November 7, 2001, the Company’s board of directors unanimouslyapproved, subject to stockholder approval, (i) an amendment of the Company’sRestated Certificate of Incorporation, as amended (“Restated Certificate ofIncorporation”), to increase the total authorized capital stock from 50,000,000shares to 130,000,000 shares in connection with an increase in the authorizedcommon stock from 40,000,000 shares to 120,000,000 shares (this amendment willnot effect a change to the 10,000,000 shares of authorized preferred stock);and (ii) an amendment to the Company’s Amended and Restated Stock Option andIncentive Plan, as amended (the “Stock Option Plan”), to increase the maximumnumber of shares available for issuance from 5,000,000 to 21,000,000. OnNovember 30, 2001, holders of a majority of the outstanding shares of theCompany’s common stock executed a written stockholder consent approving theamendment of the Company’s Restated Certificate of Incorporation and theamendment to the Company’s Stock Option Plan. Under applicable federalsecurities laws, the amendments is not effective until at least 20 days afterthis information statement is sent or given to the Company’s stockholders.

 

**(13) Related Party Transaction**

 

Peter Friedli,one of the Company’s stockholders and directors, serves as the investmentadvisor to both Venturetec and Pine, and also serves as President of Venturetecand its parent corporation, New Venturetec AG. Mr. Friedli also has relationships with several of the Company’s otherstockholders; he serves as the investment advisor to InVenture, Inc., Joyce,Ltd., Savetech, Inc., Spring Technology Corp. and USVentech, Inc.  Mr. Friedli also services as the Presidentof Friedli Corporate Finance, Inc. (“FCF”), a consulting company that isutilized by the Company.

 

On October 8,2002, the Company's board of directors authorized the issuance of 6,000,000warrants (the "Warrants") to four investors (the"Investors") as consideration for a $20 million financing commitment(the "Financing Commitment"), which was memorialized in a letter tothe Company, by Friedli Corporate Finance, dated September 12, 2002 (the"Commitment Letter").  In theCommitment Letter, Friedli Corporate Finance, a financial advisor to theCompany, agreed to provide the Company with the Financing Commitment. TheWarrants were issued to the Investors in January 2003 in connection withFriedli Corporate Finance agreeing to provide the Financing Commitment.  The Warrants were issued to the Investors inoffshore transactions pursuant to Regulation S promulgated under the SecuritiesAct of 1933.  The Warrants entitle eachInvestor to purchase one share of the Company's common stock, $0.01 per valueper share, for an initial exercise price of CHF 0.19 per share during theexercise period.  Pursuant to anamendment to the Warrants, the exercise period will begin three (3) months fromJanuary 6, 2003 and end on April 7, 2008 at 5:00 P.M. Eastern time.  The fair value of these warrants, using theBlack-Scholes pricing model on the date they were granted, is estimated to beapproximately $720,000.

 

In March 2003,Friedli Corporate Finance amended and restated the Commitment Letter to providefor a $14 million Financing Commitment.

 

Venturetec andPine were debentureholders in Consumer Review, Inc.  Therefore, as a result of the Company’s acquisition ofsubstantially all of the assets of Consumer Review, Inc. in December 2002,Venturetec and Pine received 240,315 shares and 4,500 shares, respectively, ofthe Company’s Series B convertible preferred stock.

 

In July 1996,the Company entered into a consulting agreement with FCF, which wassubsequently renewed in 2001.  Under theagreement, FCF provides services to the Company in the form of consultation,advice and other assistance upon the Company’s request. Such services mayinclude, but are not limited to, (a) providing general business, financial andinvestment advice to the Company during the term of the agreement, and (b)serving as liaison between FCF clients/investors and the Company bydisseminating information to such investors on behalf of the Company.Consulting expense under the FCF agreement was approximately $63,000 for theeach of the years ended December 31, 2002, 2001 and 2000.  In addition, the Company engaged FCF tosupport the Company in connection with the October 2001 rights offering.  In association with this support, theCompany agreed to extend the consulting agreement with FCF for 3 years and toreimburse FCF up to $100,000 in expenses for such rights offering support.

 

During 1999,the Company issued a convertible long-term debt instrument for $1,000,000 to aninvestment group controlled by FCF. This instrument was converted into common stock upon consummation of theIPO in October 2000.

 

As part of itsOctober 2001 rights offering, the Company sold shares of its common stock toVenturetec and Pine. Venturetec and Pine each delivered a promissory note asconsideration for the subscription price for the shares of common stock forwhich each company subscribed. Venturetec’s note (which was only partial consideration for the purchaseof the shares; the remainder was paid in cash) was in the principal amount ofCHF 8,500,000 (approximately $5.2 million) and Pine’s note was in the principalamount of CHF 8,687,530 (approximately $5.3 million). However, on January 22,2002, Pine, Venturetec and InVenture, all companies under common control,reallocated their share purchases and/or related promissory notes. The CHF2,500,000 (approximately $1.5 million) in cash originally indicated asoriginating from Venturetec was reallocated as follows:

 

•                  In a privatesale, InVenture purchased from Pine 1,041,667 shares of common stock,originally purchased by Pine pursuant to the rights offering, for CHF2,083,334. As part of this transaction, Pine was credited with paying CHF2,083,334 (approximately $1.3 million) and delivered an amended and restatedsecured promissory note, in the principal amount of CHF 6,604,196(approximately $4.1 million), with 2% interest. The Company simultaneouslyreturned Pine’s original CHF 8,687,530 promissory note.  All of the outstanding principal andinterest under the promissory notes was fully received by in April 2002.

 

•                  Venturetec paidus CHF 416,666 (approximately $256,000) and delivered an amended and restatedsecured promissory note, in the principal amount of CHF 10,583,334(approximately $6.5 million), with 2%. This CHF 10,583,334 reflects an increasein Venturetec’s secured promissory note to CHF 11,000,000 (approximately $6.8million), reflecting Venturetec’s original subscription price for the shares ofcommon stock for which it subscribed under the rights offering, minus the CHF416,666 payment. The Company simultaneously returned Venturetec’s original CHF8,500,000 promissory note. All of the outstanding principal and interest underthe promissory notes was fully received by in April 2002.

 

Also as part of the rights offering, the Company paid commissions ofapproximately $1,438,000 to Rahn and Bodmer Banquiers, one of the participantsin the rights offering, and $214,000 to Friedli Corporate Finance.

 

F-28

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**(14) Basic and Diluted Net Loss Per Share**

 

The Companycomputes net income (loss) per share in accordance FAS 128, *Earnings PerShare,* which requires certain disclosures relating to thecalculation of earnings (loss) per common share. The following represents areconciliation of the numerators and denominators of the basic and dilutedearnings per common share computations for net income (loss).

 
|                                                |   | **Year ended December 31,** |        |
|-----------------------------------------------------|--------|-----------------------------|-------------|
|                                                |   | **2002**                    |        | **2001** |   | **2000** |   |
| Net loss                                            |   | $                           | (17,144,887 | ) | $ | (45,003,465 | ) | $ | (29,945,340 | ) |
| Preferred stock dividend requirements               |   | —                      |        | — |   | (551,773 | ) |
| Net loss applicable to common stockholders          |   | $                           | (17,144,887 | ) | $ | (45,003,465 | ) | $ | (30,497,113 | ) |
| Weighted average shares of common stock outstanding |   | 37,349,270                  |        | 16,810,366 |   | 7,460,272 |   |
| Basic and diluted net loss per common share         |   | $                           | (0.46       | ) | $ | (2.68 | ) | $ | (4.09 | ) |

 

Diluted netloss applicable to common stockholders excludes convertible preferred stock,stock options, and warrants due to their antidilutive effect.

 

**(15) Selected Quarterly Financial Data(unaudited)**

 

The followingtables contain unaudited Statement of Operations information for each quarterof 2002, 2001 and 2000. The Company believes that the following informationreflects all normal recurring adjustments necessary for a fair presentation ofthe information for the periods presented. The operating results for anyquarter are not necessarily indicative of results for any future period.

 
|                                        |   | **2002**               |      |
|---------------------------------------------|--------|------------------------|-----------|
|                                        |   | **1****st****Quarter** |      | **2nd Quarter** |   | **3rd Quarter** |   | **4th Quarter** |   |
| Revenues                                    |   | $                      | 1,343,138 |   | $ | 1,919,718 |   | $ | 2,645,321 |   | $ | 1,312,621 |   |
| Operating loss                              |   | (6,639,926             | )         | (7,260,093 | ) | (616,878 | ) | (2,885,845 | ) |
| Loss before income tax                      |   | (6,520,556             | )         | (7,152,186 | ) | (593,825 | ) | (2,897,796 | ) |
| Net loss applicable to common stockholders  |   | (6,529,413             | )         | (7,162,389 | ) | (608,352 | ) | (2,844,733 | ) |
| Basic and diluted net loss per common share |   | $                      | (0.17     | ) | $ | (0.19 | ) | $ | (0.02 | ) | $ | (0.08 | ) |

 
|                                        |   | **2001**               |      |
|---------------------------------------------|--------|------------------------|-----------|
|                                        |   | **1****st****Quarter** |      | **2nd Quarter** |   | **3rd Quarter** |   | **4th Quarter** |   |
| Revenues                                    |   | $                      | 1,802,575 |   | $ | 1,403,293 |   | $ | 735,086 |   | $ | 1,112,670 |   |
| Operating loss                              |   | (7,786,645             | )         | (11,158,778 | ) | (8,065,224 | ) | (18,577,669 | ) |
| Loss before income tax                      |   | (7,456,198             | )         | (10,997,034 | ) | (8,004,793 | ) | (18,525,964 | ) |
| Net loss applicable to common stockholders  |   | (7,456,198             | )         | (10,997,034 | ) | (8,004,793 | ) | (18,545,440 | ) |
| Basic and diluted net loss per common share |   | $                      | (0.49     | ) | $ | (0.63 | ) | $ | (0.46 | ) | $ | (1.07 | ) |

 
|                                        |   | **2000**               |      |
|---------------------------------------------|--------|------------------------|-----------|
|                                        |   | **1****st****Quarter** |      | **2nd Quarter** |   | **3rd Quarter** |   | **4th Quarter** |   |
| Revenues                                    |   | $                      | 1,042,150 |   | $ | 2,161,416 |   | $ | 2,424,909 |   | $ | 4,601,560 |   |
| Operating loss                              |   | (6,562,743             | )         | (8,330,604 | ) | (8,994,421 | ) | (6,800,884 | ) |
| Loss before income tax                      |   | (6,445,446             | )         | (8,183,997 | ) | (8,913,903 | ) | (6,401,994 | ) |
| Net loss applicable to common stockholders  |   | (6,594,051             | )         | (8,385,581 | ) | (9,115,487 | ) | (6,401,994 | ) |
| Basic and diluted net loss per common share |   | $                      | (1.35     | ) | $ | (1.72 | ) | $ | (1.81 | ) | $ | (0.43 | ) |

 

**(16) Subsequent Events**

 

*(a) Convertible Promissory Notes*

 

In March 2003, the Company executed a convertible promissory note infavor of Friedli Corporate Finance and InVenture, Inc., for an aggregate sum ofup to $6 million.  The terms of the noteinclude, among other things, an 8% interest rate, a maturity date three yearsfrom the date of issuance, a conversion feature which provides that undercertain circumstances each note

 

F-29

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willautomatically convert to the Company’s common stock, a prepayment premium of upto 30% of the principal amount under the note, and a one-time final paymentcharge, in addition to all principal and interest paid, of 30% of the principalamount to be paid at maturity.  TheCompany may draw down against the available principal of up to $6 million atany time and in any amount during the three year term of the note.  All principal drawn upon will be secured bysubstantially all of the Company’s assets. The Company intends to use amounts drawn upon for working capital andgeneral corporate purposes.

 

*(b) Commitment Letter*

 

On March 2003, Friedli Corporate Finance amended and restated theCommitment Letter dated September 12, 2002, to provide for a $14 millionFinancing Commitment.

 

*(c) Termination of employees*

 

During the first quarter of 2003 the Company made a payment ofapproximately $122,000 consisting of severance and other employee benefitsrelated to the planned termination of 11 employees.

 

F-30

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**INDEPENDENT AUDITORS’REPORT**

 

The Board ofDirectors and Stockholders

E-centives,Inc.:

 

Under date ofMarch 27, 2003, we reported on the consolidated balance sheets of E-centives,Inc. and subsidiary as of December 31, 2002 and 2001 and the relatedconsolidated statements of operations, stockholders’ equity and comprehensiveloss and cash flows for each of the years in the three-year period endedDecember 31, 2002 which are included in this Annual Report on Form 10-K. Inconnection with our audits of the aforementioned consolidated financialstatements, we also audited the related consolidated financial statementschedule. This consolidated financial statement schedule is the responsibilityof the Company’s management. Our responsibility is to express an opinion onthis consolidated financial statement schedule based on our audits.

 

In ouropinion, such consolidated financial statement schedule, when considered inrelation to the basic consolidated financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

 

As discussed in Notes 2 and 7 to the consolidated financial statements,effective January 1, 2002, the Company adopted the provisions of Statement ofFinancial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”.

 
| /s/ KPMG LLP      |   |
|-------------------|--------|
| McLean,  Virginia |   |
| March 27,  2003   |   |

 

F-31

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# **SCHEDULE II**

 

**E-CENTIVES, INC.**

 

**VALUATION ANDQUALIFYING ACCOUNTS AND RESERVES**

**Years Ended December31, 2002, 2001 and 2000**

 
| **Column A**                              |   | **Column B**                          |       | **Column C**                        |   | **Column D**  |   | **Column E**                    |       |
|-------------------------------------------|--------|---------------------------------------|------------|-------------------------------------|--------|---------------|--------|---------------------------------|------------|
| **Description**                           |   | **Balance at   Beginning  of Period** |       | **Charged to  Costs and  Expenses** |   | **Cash Paid** |   | **Charged  to Other  Accounts** |       | **Deductions** |   | **Balance  at End of  Period** |   |
| Year ended December 31, 2002:             |   |                                  |       |                                |   |          |   |                            |       |   |   |   |   |
| Allowance for doubtful accounts           |   | $                                     | 148,127    |                                | $      | 35,263        |   | $                               | —     |   | $ | 35,314 | (1) | $ | (143,596 | )(4) | $ | 75,108 |   |
| Valuation allowance on deferred tax asset |   | $                                     | 36,034,723 |                                | $      | 5,537,745     |   | $                               | —     |   | $ | — |   | $ | — |   | $ | 41,572,468 |   |
| Accrued restructuring charge              |   | $                                     | 9,062,950  |                                | $      | 1,128,400     |   | $                               | (3,730,071 | ) | $ | (5,744,200 | )(2) | $ | — |   | $ | 717,079 |   |
|                                      |   |                                  |       |                                |   |          |   |                            |       |   |   |   |   |
| Year ended December 31, 2001:             |   |                                  |       |                                |   |          |   |                            |       |   |   |   |   |
| Allowance for doubtful accounts           |   | $                                     | 252,016    |                                | $      | 493,168       |   | $                               | —     |   | $ | (210,000 | (3) | $ | (387,057 | )(4) | $ | 148,127 |   |
| Valuation allowance on deferred tax asset |   | $                                     | 20,057,690 |                                | $      | 15,977,033    |   | $                               | —     |   | $ | — |   | $ | — |   | $ | 36,034,723 |   |
| Accrued restructuring charge              |   | $                                     | —     |                                | $      | 9,406,726     |   | $                               | (343,776   | ) | $ | — |   | $ | — |   | $ | 9,062,950 |   |
|                                      |   |                                  |       |                                |   |          |   |                            |       |   |   |   |   |
| Year ended December 31, 2000:             |   |                                  |       |                                |   |          |   |                            |       |   |   |   |   |
| Allowance for doubtful accounts           |   | $                                     | 27,125     |                                | $      | 489,973       |   | $                               | —     |   | $ | — |   | $ | (265,082 | )(4) | $ | 252,016 |   |
| Valuation allowance on deferred tax asset |   | $                                     | 9,213,245  |                                | $      | 10,844,445    |   | $                               | —     |   | $ | — |   | $ | — |   | $ | 20,057,690 |   |

 

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(1) allowance for doubtful accounts recordedin connection with the acquisition of substantially all of the assets ofConsumer Review, Inc.

(2) fixedassets, intangible assets, deferred rent, prepaid expenses and other assets.

(3) deferredrevenue

(4) accountsreceivable

 

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**INDEX TO EXHIBITS**

** **
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                              |
|---------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                 |   | Asset  Purchase Agreement, dated January 18, 2001, by and between E-centives, Inc.  and Inktomi Corporation (incorporated herein by reference to Exhibit 2.1 to  the Current Report on Form 8-K filed by E-centives on April 11, 2001).                                      |
| 2.2                 |   | Asset  Purchase Agreement, dated December 3, 2001, by and between E-centives, Inc.  and BrightStreet.com, Inc. (incorporated herein by reference to Exhibit 2.1  to the Current Report on Form 8-K filed by E-centives on December 18, 2001).                                |
| 2.3                 |   | Amended and  Restated Asset Purchase Agreement, dated December 26, 2001, by and between  E-centives, Inc. and BrightStreet.com, Inc. (incorporated herein by reference  to Exhibit 2.1 to the Amended Current Report on Form 8-K/A filed by  E-centives on January 3, 2002). |
| 2.4                 |   | Asset  Purchase Agreement, dated November 08, 2002, by and between E-centives, Inc.  and Consumer Review, Inc. (incorporated herein by reference to Exhibit 2.1 to  the Amended Current Report on Form 8-K filed by E-centives on December 13,  2002).                       |
| 3.1(1)              |   | Restated  Certificate of Incorporation of E-centives, Inc.                                                                                                                                                                                                                   |
| 3.3(1)              |   | Amended and  Restated Bylaws of E-centives, Inc.                                                                                                                                                                                                                             |
| 4.1(1)              |   | Specimen  certificate representing the Common Stock.                                                                                                                                                                                                                         |
| 4.2(1)              |   | Registration  Rights Agreement, dated February 18, 2000, by and among E-centives, Inc. and  certain stockholders named therein.                                                                                                                                              |
| 4.3(1)              |   | Common Stock  Purchase Warrant, dated as of March 28, 2001, between E-centives, Inc. and  Inktomi Corporation.                                                                                                                                                               |
| 4.4(1)              |   | Warrant to  Purchase Common Stock, dated as of December 3, 2001, between E-centives, Inc.  and BrightStreet.com, Inc.                                                                                                                                                        |
| 4.5(1)              |   | Warrant to  Purchase 500,000 shares of Common Stock, dated as of December 3, 2001,  between E-centives, Inc. and BrightStreet.com, Inc.                                                                                                                                      |
| 10.1(1)             |   | 1996 Stock  Incentive Plan.                                                                                                                                                                                                                                                  |
| 10.2(1)             |   | E-centives —  Excite@Home Co-Branding Agreement, dated February 16, 2000, by and between  E-centives, Inc. and At Home Corporation.                                                                                                                                     |
| 10.3(1)             |   | Technology  and Marketing Agreement, dated May 13, 1999, by and between E-centives, Inc.  and ZDNet, as amended.                                                                                                                                                             |
| 10.4(1)             |   | Internet  Data Center Services Agreement, dated March 23, 1998, by and between  E-centives, Inc. and Exodus Communications, Inc.                                                                                                                                             |
| 10.5(1)             |   | Employment  Agreement for Kamran Amjadi, dated May 8, 1998, as amended.                                                                                                                                                                                                      |
| 10.6(1)             |   | Employment  Agreement for Mehrdad Akhavan, dated May 8, 1998, as amended.                                                                                                                                                                                                    |
| 10.7(1)             |   | Lease  Agreement, dated September 23, 1997, by and between E-centives, Inc. and  Democracy Associates Limited Partnership, as amended and modified on June 29,  2000.                                                                                                        |
| 10.8                |   | Amended and  Restated Stock Option and Incentive Plan (incorporate herein by reference to  Exhibit 99.2 to the E-centives’ Registration Statement on Form S-8  (Registration No. 333-58244))                                                                            |
| 10.9                |   | Technology  License Agreement, dated March 28, 20001, between E-centives and Inktomi  Corporation (incorporated herein by reference to Exhibit 10.1 to the Current  Report on Form 8-K filed by E-centives on April 11, 2001)                                                |
| 10.10               |   | Sublease  Agreement, dated April 1, 2001, by and between E-centives, Inc. and Inktomi  Corporation, as amended on August 28, 2001.                                                                                                                                           |
| 10.11               |   | E-centives  Marketplace Agreement, dated June 27, 2001, by and between E-centives, Inc.  and Vizzavi Europe Limited.                                                                                                                                                         |
| 10.12               |   | Modification,  Assignment and Assumption Agreement, dated November 1, 2001, by and among  E-centives, Inc., BrightStreet.com, Inc. and Pentech Financial Services, Inc.                                                                                                      |
| 10.13               |   | Internet  Service Master Services Agreement, effective as of December 4, 2001, between  E-centives, Inc. and SiteSmith Inc.                                                                                                                                                  |
| 10.14               |   | Convertible  Promissory Note dated as of March 18, 2003 by E-centives, Inc. to the order  of Friedli Corporate Finance, Inc. and/or InVenture Inc.                                                                                                                           |
| 23.1                |   | Consent of  KPMG LLP.                                                                                                                                                                                                                                                        |
| 99.1                |   | Certification  of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes -  Oxley Act of 2002.                                                                                                                                                                  |
| 99.2                |   | Certification  of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes -  Oxley Act of 2002.                                                                                                                                                                  |

 

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(1)               Incorporatedby reference to the Registrant’s Registration Statement on Form S-1(Registration No. 333-42574).

 

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