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Form 10-Q for APTIMUS INC

17-May-2004

Quarterly Report

Certain statements in this filing constitute forward-looking statements withinthe meaning of Section 21E of the Securities Exchange Act of 1934.Forward-looking statements can often be identified by terminology such as may,will, should, expect, plan, intend, expect, anticipate, believe, estimate,predict, potential or continue, the negative of such terms or other comparableterminology. Such forward-looking statements involve known and unknown risks,uncertainties and other factors that may cause the actual results, performanceor achievements of Aptimus, Inc. ("Aptimus", "we", "us" or the "Company"), ordevelopments in the Company's industry, to differ materially from theanticipated results, performance or achievements expressed or implied by suchforward-looking statements. Important factors currently known to management thatcould cause actual results to differ materially from those in forward-lookingstatements include, without limitation, fluctuation of the Company's operatingresults, the ability to compete successfully, the ability of the Company tomaintain current client and distribution publisher relationships and attract newones, and the sufficiency of remaining cash and short-term investments to fundongoing operations.

Although we believe the expectations reflected in our forward-looking statementsare reasonable, we cannot guarantee future results, levels of activity,performance or achievements or other future events. Moreover, neither we noranyone else assumes responsibility for the accuracy and completeness offorward-looking statements. We are under no duty to update any of ourforward-looking statements after the date of this filing. You should not placeundue reliance on forward-looking statements.

OVERVIEW

Aptimus is a performance-based advertising network that distributesadvertisements for direct marketing advertisers across a network of third-partywebsites and company-owned and licensed email lists. For advertisers, theAptimus Network offers a high volume, high quality, Internet-based distributionchannel to present their advertisements across a broad audience of users onwebsites and email lists. Advertisers pay Aptimus only for the results thatAptimus delivers. Aptimus' then shares a portion of the amounts it bills itsadvertiser clients with the third-party website owners or "publishers" and emaillist owners on whose web properties and email lists Aptimus distributes theadvertisements. While this "revenue share" approach is Aptimus' primary paymentmodel, it will as an alternative occasionally pay website owners either a fixedfee for each completed user transaction or a fee for each impression of anadvertisement served on the website. Advertisers pay Aptimus for the followingactions:

(1) when a user opens an advertisement served by Aptimus with a "click" of the cursor on the user's computer screen (a "cost per click" pricing model);

(2) when a user opens an advertisement served by Aptimus, expresses his or her interest in the advertisement by providing certain information desired by the advertiser such as the user's name and email address, and then submits that information to Aptimus or the advertiser directly by "clicking" the submit button on the computer screen (a "cost per lead" pricing model);

(3) when a user opens an advertisement and orders the advertised product or service by providing the desired information such as a name, postal address and payment, and then submits the order to Aptimus or the advertiser directly by "clicking" the submit button on the computer screen (a "cost per acquisition" pricing model);

(4) when an advertisement is displayed on a user's computer screen (a "cost per impression" pricing model), and;

(5) any combination of the pricing models described in (1) - (4) above.

As a result, advertisers can refine their offers and payment models to achievetheir specific objectives. For website publishers and email list owners, theAptimus Network generates high revenues per impression while promotingcompelling offers from recognized brand advertisers in graphical formats thatcomplement the publishers' sites and add value

for their customers. At the core of the Aptimus Network is a proprietary,patent-pending technology and direct marketing approach called Dynamic RevenueOptimization(TM), which determines through computer-based logic on a real-timebasis the best advertisements for promotion on each individual website and ineach email sent. The technology is designed to prioritize advertisements by acombination of their popularity with users and the lead or impression fee thecompany is paid by the advertiser. New advertisements are randomly inserted inthe rotation of advertisements served by the company to insure their exposureand potential in our system. The system also tests, in real time, multipleversions of the same advertisement as well as multiple formats in which the adsare displayed on a page, and the system then adjusts to insure the best versionsof advertisement and format are used. In this way, our technology systemgenerates higher user response for our advertisers and higher revenues for ourpublishers and us than would be the case without use of our system. TheCompany's primary offer presentation formats include cross-marketing promotionsat the point of registration or other transactional activity on websites, onlineadvertising programs, and email marketing campaigns.

We derive our revenues primarily from contracts for the delivery of clicks,leads and orders from the Aptimus network of sites and opt-in email lists. Wereceive revenue when we deliver either the required click-through, leadinformation, or order information to an advertiser in connection with an offerpresented via our network. Pricing is based on a cost per click, lead,impression or order basis and varies depending on the type of offer and type ofinformation collected. The services we deliver are primarily sold undershort-term agreements that are subject to cancellation. Revenues are recognizedin the period in which the click-through, lead, impression or order informationis delivered, provided we have no further performance obligation.

For the three months ended March 31, 2004 and 2003 our ten largest advertiserclients accounted for 63.2% and 62.5% of our net revenues, respectively. Duringthe quarter ended March 31, 2004 Advertising.com accounted for 19.4% of ourrevenues. During the quarter ended March 31, 2003 Blue Dolphin, Inc. accountedfor 14.7% of our revenues and Kraft Foods, Inc. through List Services, Inc.accounted for 13.6% of our revenues. The percentage of revenue represented byour ten largest clients when compared to the same quarter of 2003 has remainedrelatively consistent. We expect our revenues to be composed of a similar mix oflarge and small advertiser clients in the immediate future.

Our business has been operating at a loss and generating negative cash flowsfrom operations since inception. As of March 31, 2004, we had an accumulateddeficit of approximately $63.1 million. With the reductions in continuingoperating expenses that have been made and growth in revenues, we anticipateachieving positive earnings and cash flows during the year ending December 31,2004. However, there are still many challenges to achieving this goal and theachievement is by no means assured.

On March 30, 2004, $305,000 in convertible notes payable issued to certaininvestors were, by election of the holders, converted to 381,250 shares ofunregistered common stock pursuant to the terms of that certain Convertible NotePurchase Agreement, dated as of July 1, 2003, by and between the company andcertain investors. On March 31, 2004, we filed a draft registration statement onForm S-1 with the Securities and Exchange Commission (SEC) covering 776,690shares of unregistered common stock issued in the December 2003 privateinvestment, 381,250 shares of unregistered common stock issued upon theconversion of notes payable, and 182,729 shares of unregistered common stockissuable pursuant to outstanding warrants. The draft registration statement iscurrently under review by the SEC.

RESULTS OF OPERATIONS

Revenues

We currently derive our revenues primarily from network activities, whichinclude both lead generation activities through a network of publishers ande-mail mailings. Clients generally pay us on a performance or results basis,based on a cost per click, cost per lead, cost per acquisition, or percentage ofsales. Our revenues increased by $895,000, or 98%, to $1.8 million in thequarter ended March 31, 2004 from $911,000 in the same quarter of 2003. We sawsequential growth in all sides of our business, while our email marketingrevenues, which increased substantially from the fourth quarter of 2003, wereactually lower than in the first quarter of 2003. Our revenues came mostly fromour core base of continuity type clients, which seek new customers year-roundand generally have ongoing programs with Aptimus. Our revenues from campaigntype clients, whose programs are for limited time periods due to promotional,

budgetary or other reasons, grew from the fourth and first quarter of 2003, butwere still less than 5% of revenues in the first quarter of 2004.

Sales and Marketing

Sales and marketing expenses consist primarily of marketing and operationalpersonnel costs, bad debts, and outside sales costs. Sales and marketingexpenses increased by $89,000 to $437,000, or 24% of revenues, in the quarterended March 31, 2004 from $348,000, or 38% of revenues, in the same quarter of2003. The increase in sales and marketing expenses was a result of hiringadditional employees, increases in sales commissions due to increased sales andto pay reductions that were in effect in the first quarter of 2003. The amountof wages reduced in the last quarter of 2002 and the first quarter of 2003 werepaid to employees in the first quarter of 2004. It is expected that sales andmarketing expenses will increase slightly in the remaining quarters of the yeardue to increased sales commissions on higher revenues and the hiring ofadditional employees.

Connectivity and Network Costs

Connectivity and network costs consist of expenses associated with themaintenance and usage of our network as well as email delivery costs. Such costsinclude email delivery costs, Internet connection charges, hosting facilitycosts and personnel costs. Connectivity and network costs decreased by $103,000to $176,000, or 10% of revenues, in the quarter ended March 31, 2003 from$279,000, or 31% of revenues, in the same quarter of 2003. This decrease wasprimarily the result of decreases in connectivity and email delivery costs,which were offset by increases in labor costs, maintenance agreement costs andaddress verification costs. As a percentage of the total change in this accountthese factors accounted for 76%, 62%, (21%), (12%) and (7%), respectively. Thedecrease in connectivity resulted from moving our network production environmentin-house. In the first six months of 2003 the network production environment washosted by EDS Corporation. Similarly the decrease in email delivery costs was aresult of moving the remaining email programs in-house. In 2003 a third partyperformed the majority of the email delivery. The increase in labor relatedcosts is a result of pay reductions, which were in place in the first quarter of2003. The amount of wages reduced in the last quarter of 2002 and the firstquarter of 2003 were paid to employees in the first quarter of 2004. Theincrease maintenance is related to additional maintenance contracts on hardwareand software. Address verification costs are campaign related and vary frommonth to month depending on the number of offers requiring this service.Connectivity and network costs for the remaining quarters of 2004 are expectedto increase slightly compared to the first quarter of 2004 as a result of anincrease in backup capabilities and an increase in the amount of space rented athosting facilities.

Publisher fees

Publisher fees consist of fees owed to network distribution publishers andopt-in email list owners based on revenue generating activities created inconjunction with these publishers. Publisher fees increased by $459,000 to$679,000, or 38% of revenues, in the quarter ended March 31, 2004 from $220,000,or 24% of revenues, in the same quarter of 2003. Publisher fees have increasedprimarily as a result of the increase in total revenue. Publisher fees haveincreased on a percentage of revenue basis, as a result of the growth in networkrevenues. The effective rate at which we share revenues for email based revenueis lower than that of network based revenues as a result of our ownership of alarge portion of the names mailed to and that we deduct the cost of deliveringthe emails before calculating the fees due publishers for email based revenues.Publisher fees are expected to increase in the future as revenues increase.

Research and Development

Research and development expenses primarily consist of personnel costs relatedto maintaining and enhancing the features, content and functionality of our Websites, network and related systems. Research and development expenses increasedby $19,000 to $152,000, or 8% of revenues, in the quarter ended March 31, 2004from $133,000, or 15% of revenues, in the same quarter of 2003. This increase inresearch and development expense was primarily due to increases in labor costs.The increase in labor related costs is a result of pay reductions, which were inplace in the first quarter of 2003. The amount of wages reduced in the lastquarter of 2002 and the first quarter of 2003 were paid to employees in thefirst quarter of 2004. Research and development expense for the remainingquarters of 2004 are expected to be similar to the first quarter of 2004.

General and Administrative

General and administrative expenses primarily consist of management, financialand administrative personnel expenses and related costs and professional servicefees. General and administrative expenses decreased by $10,000 to $339,000, or19% of revenues, in the quarter ended March 31, 2004 from $349,000, or 38% ofrevenues, in the same quarter of 2003. General and administrative expense willbe higher in the second quarter of 2004 as a result of repayment of payreductions to senior executives. The amount of wages reduced in the last quarterof 2002 and the first quarter of 2003 will be paid to senior executives in thesecond quarter of 2004. The increase expected as a result of this will be around$50,000. Total general and administrative expenses for the third and fourthquarter of 2004 are expected to be similar to the first quarter of 2004.

Depreciation and Amortization

Depreciation and amortization expenses consist of depreciation on leased andowned computer equipment, software, office equipment and furniture andamortization on intellectual property and purchased email lists. Depreciationand amortization expenses decreased by $59,000 to $66,000, or 4% of revenues, inthe quarter ended March 31, 2004 compared to $125,000, or 14% of revenues, inthe same quarter of 2003. The continued decrease in depreciation andamortization is a result of the many assets becoming fully depreciated.Depreciation and amortization is expected to continue to increase slightly inthe second quarter of 2004 and then to be similar to the first quarter of 2004in the third and fourth quarters of 2004.

Equity-Based Compensation

Equity-based compensation expenses consist of amortization of unearnedcompensation recognized in connection with stock options and stock grantsgranted to employees and directors at prices below the fair market value of ourcommon stock. Unearned compensation is recorded based on the intrinsic valuewhen we issue stock options to employees and directors at an exercise pricebelow the estimated fair market value of our common stock at the date of grant.Unearned compensation is also recorded based on the fair value of the optionsgranted as calculated using the Black-Scholes option pricing model when optionsor warrants are issued to advisors and other service providers. Unearnedcompensation is amortized over the vesting period of the option or warrant.Equity-based compensation expenses decreased by $1,000 to zero, in the quarterended March 31, 2004 compared to $1,000, or less than 1% of revenues, in thesame quarter of 2003. The decrease results from issuing stock option grants withstrike prices equal to the fair market value on the date of grant. All stockoption grants that had been issued with strike prices below fair market valueare fully vested. Any future equity-based compensation would result from grantof options to third parties or new grants to employees with strike prices belowthe fair value on the date of grant, of which there are none contemplated atthis time.

Loss (gain) on disposal of long-term assets

Loss (gain) on disposal of long-term assets consists of gains and losses ondisposals of assets and impairments on long-term investments. Some software andcomputer hardware were retired in the first quarter, however the assets werefully depreciated and no gain or loss was recorded.

Interest Expense

Interest expense in the current year results from capital equipment leases andconvertible notes payable. Interest expense totaled $27,000 in the quarter endedMarch 31, 2004 and $3,000 in the same quarter of 2003. Interest expense isexpected to be decrease in the second quarter and third quarter and be zero inthe fourth quarter of 2004.

Interest Income

Interest income results from earnings on the Company's available cash reserves.Interest income totaled $5,000 in the quarter ended March 31, 2004 and $1,000 inthe same quarter of 2003. The increase in interest income is primarily a resultof the proceeds from the sale of common stock in December 2003. Interest incomeis expected to decrease slightly as cash is used in operations.

Income Taxes

No provision for federal income taxes has been recorded for any of the periodspresented due to the Company's current loss position.

LIQUIDITY AND CAPITAL RESOURCES

Since we began operating as an independent company in July 1997, we havefinanced our operations primarily through the issuance of equity securities. Netproceeds from the issuance of stock through March 31, 2004 totaled $67.1million. As of March 31, 2004, we had approximately $1.8 million in cash andcash equivalents, providing working capital of $2.3 million. No off-balancesheet assets or liabilities existed at March 31, 2004.

Net cash used in operating activities was $458,000 and $211,000 in the threemonths ended March 31, 2004 and 2003, respectively. Cash used in operationduring the three months ended March 31, 2004 and 2003 consisted of:

                                                      Three months ended March 31,                                                    ---------------------------------                                                         2004              2003                                                    ---------------    --------------  Cash received from customers................       $  1,298           $    948  Cash paid to employees and vendors..........         (1,751)            (1,157)  Interest received...........................              5                  1  Interest paid...............................            (10)                (3)                                                    ---------------    --------------  Net cash used in operations.................       $   (458)          $   (211)                                                    ===============    ==============

Net cash provided by (used in) investing activities was $(133,000) and $24,000in the three months ended March 31, 2004 and 2003, respectively. In the threemonths ended March 31, 2004, $133,000 was used for the purchase of additionalsoftware, equipment and intangible assets. In the three months ended March 31,2003, $51,000 was received from the maturity of a certificate of deposit. Inaddition to the maturity of the certificate of deposit, $8,000 was received fromthe sale of long-term assets and $35,000 was used for the purchase of additionalequipment and intangible assets.

Net cash used in financing activities was $19,000 and $21,000 in the threemonths ended March 31, 2004 and 2003, respectively. In the three months endedMarch 31, 2004, net cash used in financing activities resulted from $28,000 inprincipal payments made on capital leases offset by $9,000 in receipts for theCompany's common stock resulting from the exercise of stock options. In thethree months ended March 31, 2003, net cash used in financing activitiesresulted from $21,000 in principal payments made on capital leases.

We believe our current cash and cash equivalents will be sufficient to meet ouranticipated cash needs for working capital and capital expenditures for theforeseeable future. Financial results have been improving and we expect to beEBITDA profitable in the quarter ending June 30, 2004 and thereafter. Assumingoperations continue as expected we expect to generate positive cash flows in thenear future. We do not currently anticipate a need for significant capitalexpenditures. However, there are still many challenges to achieving this goaland the achievement is by no means assured. Should our goal of achievingpositive cash flow not be met we may need to raise additional capital to meetour long-term operating requirements.

Our cash requirements depend on several factors, including the level ofexpenditures on advertising and brand awareness, the rate of market acceptanceof our services and the extent to which we use cash for acquisitions andstrategic investments. Unanticipated expenses, poor financial results orunanticipated opportunities requiring financial commitments could give rise toearlier financing requirements. If we raise additional funds through theissuance of equity or convertible debt securities, the percentage ownership ofour shareholders would be reduced, and these securities might have rights,preferences or privileges senior to those of our common stock. Additionalfinancing may not be available on terms favorable to us, or at all. Thedelisting from the Nasdaq SmallCap Market may make raising additional capitalmore difficult. If adequate funds are not available or are not available onacceptable terms, our ability to fund our expansion, take advantage of businessopportunities, develop or enhance services or products or otherwise respond tocompetitive pressures would be significantly limited, and we might need tosignificantly restrict our operations.

The following table summarizes the contractual obligations and commercialcommitments entered into by the Company.

                                                            Payments Due by Period                                                                                           ----------------------                               Contractual Obligations            Total       2004         2005   2006          2007         2008       2009-----------------------            -----       ----         ----   ----          ----         ----       ----Capital lease obligations......   $   86      $   86     $   --    $  --       $    --       $   --     $   --Operating leases...............    1,006         155        219      232           250          100        50    Total Contractual CashObligations....................   $1,092      $  241     $  219    $ 232       $   250       $  100     $  50

CRITICAL ACCOUNTING POLICIES

Our significant accounting policies are described in Note 2 to the financialstatements included in Item 8 of the Annual Report on Form 10-K, filed with theSEC on March 30, 2004. We believe those areas subject to the greatest level ofuncertainty are the allowance for doubtful accounts and depreciation of fixedand intangible assets.

Allowance for Doubtful AccountsThe estimate of allowance for doubtful accounts is comprised of two parts, aspecific account analysis and a general reserve. Accounts where specificinformation indicates a potential loss may exist are reviewed and a specificreserve against amounts due is recorded. As additional information becomesavailable such specific account reserves are updated. Additionally, a generalreserve is applied to the aging categories based on historical collection andwrite-off experience. As trends in historical collection and write-offs change,the percentages applied against the aging categories are updated. Except werespecific information indicates otherwise, the following rates were appliedagainst the total balance due from the client when they had an amount in theapplicable ageing category as of the date the reserve analysis was performed:

                                                            As of March 31,-------------------------------------------------------------------------------                                                        2004               2003-------------------------------------------------------------------------------Current                                                  0%                  0%

Past due 1-30 days                                       0%                  0%

Past due 31-60 days                                     25%                 25%

Past due 61-90 days                                     50%                 50%

Past due greater than 90 days                          100%                100%

Additional metrics related to the allowance for doubtful accounts are as follow:

                                                            As of March 31,-------------------------------------------------------------------------------                                                        2004               2003-------------------------------------------------------------------------------Reserve balance                                       $72,000           $58,000

% Of overall AR reserved                                  5.1%             10.4%

Days sales outstanding                                     72                51

Over the past year both accounts receivable and the allowance have increased.The allowance has been increased at a slower rate then accounts receivable,which has resulted in a decrease in the overall percentage reserved. This trendresults from the recovery form the economic downturn that occurred in 2001. Wedo not expect to see this trend continue but rather expect our overall reservebalance will stabilize around 5-7% range as the economy stabilizes. Any increasein the rates used to calculate the reserve would result in the recognition ofadditional bad debts expense and reduce the net accounts receivable balance.

Depreciation of Fixed and Intangible Assets

Property and equipment are stated at cost less accumulated depreciation and aredepreciated using the straight-line method over their estimated useful lives.Leasehold improvements are amortized on a straight-line method over theirestimated useful lives or the term of the related lease, whichever is shorter.Equipment under capital leases, which all contain bargain purchase options, isrecorded at the present value of minimum lease payments and is amortized usingthe straight-line method over the estimated useful lives of the related assets.The estimated useful lives are as follows:

         Office furniture and equipment                    Five years         Computer hardware and software                    Three years         Leasehold improvements                            Three to Five years

         Email names                                       Two years         Aptimus patents and trademarks                    Three years

Changes in circumstances such as technological advances or changes to theCompany's business model can result in the actual useful lives differing fromthe Company's estimates. In the event the Company determines that the usefullife of a capital asset should be shortened the Company would depreciate the netbook value in excess of the estimated salvage value, over its remaining usefullife thereby increasing depreciation expense. Long-lived assets, including fixedassets and intangible assets other than goodwill, are reviewed for impairmentwhenever events or changes in circumstances indicate the carrying amount of theasset may not be recoverable. A review for impairment involves developing anestimate of undiscounted cash flow and comparing this estimate to the carryingvalue of the asset. The estimate of cash flow is based on, among other things,certain assumptions about expected future operating performance. The Company'sestimates of undiscounted cash flow may differ from actual cash flow due to,among other things, technological changes, economic conditions, changes to ourbusiness model or changes in our operating performance.

RECENT ACCOUNTING PRONOUNCEMENTS

None

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