<PAGE> 1
FILED PURSUANT TO RULE 424(b)(1)
REGISTRATION NO. 333-53341
PROSPECTUS
(TOWNE SERVICES, INC. LOGO)
4,000,000 SHARES
TOWNE SERVICES, INC.
COMMON STOCK
This is an initial public offering of 4,000,000 shares of common stock of
Towne Services, Inc. Towne Services is offering 3,850,000 of these shares and
one selling shareholder identified in this prospectus is offering 150,000 of
these shares. Towne Services will not receive any proceeds from the sale of
shares by this selling shareholder.
There is currently no public market for the common stock. The Nasdaq
National Market has approved the common stock for listing under the symbol
"TWNE." The market price of the shares after this offering may be higher or
lower than the public offering price.
INVESTING IN THE COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING
ON PAGE 9 OF THIS PROSPECTUS.
<TABLE>
<CAPTION>
PER SHARE TOTAL
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<S> <C> <C>
Public Offering Price.......................... $8.00 $32,000,000
Underwriting Discount.......................... $0.56 $ 2,240,000
Proceeds to Towne Services..................... $7.44 $28,644,000
Proceeds to the Selling Shareholder............ $7.44 $ 1,116,000
</TABLE>
In addition, six other selling shareholders identified in this prospectus
have granted the underwriters an over-allotment option which allows the
underwriters to purchase 600,000 additional shares. These shares will be
purchased directly from these six selling shareholders. Towne Services will not
receive any of the proceeds from the sale of these shares.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
WHEAT FIRST UNION
J.C. BRADFORD&CO.
STEPHENS INC.
July 30, 1998
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Prospectus Summary.......................................... 3
Risk Factors................................................ 9
Use of Proceeds............................................. 14
Dividend Policy............................................. 14
Dilution.................................................... 15
Capitalization.............................................. 16
Selected Financial Data..................................... 17
Management's Discussion and Analysis of
Financial Condition and Results of Operations............. 19
Business.................................................... 27
Management.................................................. 38
Principal and Selling Shareholders.......................... 46
Certain Transactions........................................ 48
Description of Capital Stock................................ 49
Shares Eligible for Future Sale............................. 53
Underwriting................................................ 55
Legal Matters............................................... 56
Experts..................................................... 56
Additional Information...................................... 57
Index to Financial Statements............................... F-1
</TABLE>
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Throughout this prospectus, we refer to Towne Services as either "Towne
Services," "Towne" or the "Company."
Unless otherwise stated, all information in this prospectus assumes that
the underwriters will not exercise their over-allotment option to purchase any
of the 600,000 shares subject to that option.
In addition, we have adjusted the common stock share numbers presented in
this prospectus to reflect (a) a 100-for-1 split of the common stock which
occurred in January 1997 and (b) the conversion of 15,000 shares of preferred
stock into 1,217,903 shares of common stock upon completion of this offering.
------------------------
This prospectus contains certain "forward-looking statements" concerning
Towne Services' operations, performance and financial condition, including its
future economic performance, plans and objectives and the likelihood of success
in developing and expanding its business. These statements are based upon a
number of assumptions and estimates which are subject to significant
uncertainties, many of which are beyond the control of Towne Services. The words
"may," "would," "could," "will," "expect," "anticipate," "believe," "intend,"
"plan," "estimate" and similar expressions are meant to identify such
forward-looking statements. Actual results may differ materially from those
expressed or implied by such forward-looking statements. Factors that could
cause actual results to differ materially include, but are not limited to, those
set forth in "Risk Factors."
------------------------
Towne Services' principal executive offices are located at 3295 River
Exchange Drive, Suite 350, Norcross, Georgia 30092, and its telephone number is
(770) 734-2680.
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[Fold-out of inside front cover]
TOWNE SERVICES, INC. A Closer Look.
[Color graphic of flowchart depicting Towne's automated processing system.]
[Two color maps depicting Towne's customer locations as of June 30, 1997
and June 30, 1998. States where Towne's customers are located are
highlighted in green.]
<PAGE> 4
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
It is not complete and does not contain all of the information that you should
consider before investing in the common stock. You should read the entire
prospectus carefully, including the "Risk Factors" section and the financial
statements and notes to the financial statements before making any decision to
invest in the common stock.
TOWNE SERVICES
Towne Services designs, develops and markets products and services that
convert the in-house credit transactions of small businesses into automated
"virtual credit card" accounts which are processed electronically. Usually,
in-house credit transactions are completed without a credit card or cash, are
recorded and processed manually and then billed to the customer at a later date.
To automate this process, Towne Services offers two main electronic processing
systems, TOWNE CREDIT(SM) and TOWNE FINANCE(SM), which process small business'
in-house credit transactions in much the same way as credit card transactions
are processed.
The TOWNE CREDIT system electronically processes in-house consumer credit
transactions of small and medium size retail merchants. The TOWNE FINANCE
system, a commercial version of TOWNE CREDIT, is an automated asset management
and financing system that processes business-to-business credit transactions for
small commercial businesses. Through the use of Towne's products and services,
small businesses can automate certain manual processes, accelerate cash flow,
provide better customer service, reduce paperwork and shift many other
administrative burdens to Towne Services. In addition, Towne provides
complementing products and services to banks that enable them to generate
interest-bearing revolving credit accounts by financing the accounts receivable
of these small businesses. Through the use of Towne's products, banks can
monitor customers' accounts receivable and generate detailed status reports, and
may attract new business customers who, in turn, may become customers of Towne
Services.
HOW TOWNE SERVICES' PRODUCTS WORK
Towne designed its products and services to be simple to use, fast and
reliable. A typical Towne Services transaction begins when a store clerk enters
transaction information into a point of sale terminal or computer. The business
owner or manager later transmits this information to Towne Services
electronically. Towne processes the information, creates transaction reports for
the business, transmits the accounts receivable information to the business'
bank and invoices the business' customers directly. The bank then advances funds
to the business against these accounts. Towne Services tracks payments made on
these accounts and provides frequent updates to the business and its bank.
Towne's electronic processing systems enable businesses to offer in-house
credit to their customers at costs comparable to traditional credit card
transactions. As with credit card transactions, the business pays a discount fee
to the bank on each transaction. In addition, the business' customer pays
interest and fees to the bank for amounts owed by the customer for purchases
made on in-house credit. Towne Services generates recurring revenue by
collecting a portion of the discount fee and, on occasion, interest paid on
these accounts and by charging monthly transaction processing fees. Towne
Services also generates revenue by charging its business and bank customers
initial set-up fees.
TOWNE SERVICES' MARKET
A variety of small and medium size retail merchants use the TOWNE CREDIT
system, including hardware stores, clothing stores, florists, auto parts stores,
pharmacies and private clubs. Towne Services markets the TOWNE FINANCE products
and services to small commercial businesses, such as furniture manufacturers,
equipment distributors, plumbing suppliers and other industry supply stores.
Towne Services believes there are
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more than 5 million small and medium size retail merchants and 12 million small
commercial businesses in the United States. Many of these small businesses
extend in-house credit and process these credit transactions manually. Towne's
processing systems allow small businesses to automate these in-house accounts
and provide a convenient service to customers who prefer to purchase items on
credit. Towne Services believes that the market for its electronic processing
products and services is largely untapped, as most electronic payment processing
companies focus on larger businesses and on credit and debit card transactions,
which may be less convenient and are subject to terms established by the credit
card company or debit card issuer.
TOWNE SERVICES' STRATEGIES
Towne Services has grown significantly since the release of TOWNE CREDIT in
June 1997. The total number of sales people, bank contracts and business
customers for TOWNE CREDIT and TOWNE FINANCE as of the end of each of the last
12 months follows:
<TABLE>
<CAPTION>
1997 1998
---------------------------------------- ----------------------------------------
JULY AUG. SEPT. OCT. NOV. DEC. JAN. FEB. MARCH APRIL MAY JUNE
---- ---- ----- ---- ---- ---- ---- ---- ----- ----- --- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Sales people................ 8 9 13 14 11 15 16 17 33 45 54 61
Bank contracts.............. 34 41 41 58 65 74 85 97 122 130 152 177
Business customers.......... 38 49 59 69 81 96 117 135 161 189 225 279
</TABLE>
Towne's goal is to continue to grow significantly to become one of the
leading providers of electronic processing products and services for the
in-house credit transactions of small and medium size businesses in the United
States. Towne Services plans to attain this goal by implementing the following
key business strategies:
Expand Direct Sales and Marketing Efforts Nationwide
Since the release of TOWNE CREDIT, Towne Services has expanded its
direct sales and marketing force from 7 persons located in 3 states to 61
persons located in 25 states. Towne intends to continue aggressively hiring
sales and marketing personnel nationwide to strengthen its direct marketing
efforts, increase its customer base and expand into new markets. Towne
Services recently retained a marketing firm to help develop new marketing
materials and expand its advertising efforts across the country. Towne also
plans to increase its participation in conventions, seminars and trade
programs which cater to small and medium size businesses and the banks that
service these businesses across the United States.
Continue to Leverage Bank Relationships
The executive officers and directors of Towne Services have an average
of over 15 years experience in the electronic processing and financial
services industries, and 7 members of its board of directors either run
banks or run companies that have banks as customers. Towne's management
leverages this experience and these contacts to develop relationships with
banks and banking organizations. These banks market Towne's products and
services to small businesses in their communities. Through these
relationships, Towne Services believes it attracts business customers that
would be difficult to reach through traditional marketing methods. In
addition, Towne intends to provide new products and services, such as a
lease financing and processing system currently being developed, that may
allow banks to attract new customers for both the banks and Towne Services.
Towne Services plans to sign additional agreements with existing bank
customers to offer its new products and services and to leverage these
relationships to develop new bank customers in its current and future
markets.
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Enter New Relationships For Marketing and Product Enhancements
Towne Services has established marketing and other business
relationships that enhance its products and services and its channels of
distribution. Towne has agreements with several companies whose products
and services complement the TOWNE CREDIT and TOWNE FINANCE systems,
including Datamatx Inc., Wallace and de Mayo P.C. and Cash Management
Services, Inc., which provide statement processing services, collections
services and lockbox management services. Towne Services also has
agreements with entities that have banks as their customers, such as
Phoenix International Ltd., Inc. and The Bankers Bank of Kentucky, under
which these other companies and organizations encourage their bank
customers to use Towne's systems. Towne intends to enter more relationships
with companies that can expand the number of its products and services,
complement its existing and future systems and provide access to large
groups of banks and small businesses.
Maximize Electronic Link to Customers
When a business customer installs TOWNE CREDIT or TOWNE FINANCE, it
establishes an electronic link with Towne Services. Towne intends to
maximize this electronic distribution channel by developing and
implementing multiple products and services that the customer can access
through this channel to help automate its operations, run its business more
efficiently and provide better service for its customers. Towne Services
plans to use this electronic connection to cross-market both existing and
new products and services to its customers, which should allow it to
develop and maintain long-term customer relationships.
Acquire Complementary Companies and Products
Towne Services intends to acquire providers of complementary products
and services that may enhance and expand its operations, product and
service offerings, market share or geographic presence. For example, Towne
Services recently acquired some of the assets and liabilities of Credit
Collection Solutions, Inc., a company that has developed computer software
for processing payments and tracking collections. For more information on
this acquisition, please see "Business -- Acquisitions of Complementary
Companies and Products."
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THIS OFFERING
Common stock offered by Towne Services..... 3,850,000 shares
Common stock offered by one selling
shareholder.............................. 150,000 shares
Total shares to be sold in this offering... 4,000,000 shares
Common stock offered by other selling
shareholders if the underwriters exercise
the over-allotment option................ 600,000 shares
Common stock to be outstanding
after this offering...................... 18,673,734 shares
Offering price per share................... $8.00
Estimated net proceeds to Towne Services
(after deducting expenses
related to this offering)................ $27,444,000
Use of proceeds............................ Towne Services expects to use the
proceeds to enhance its sales and
marketing efforts, expand its
products and services, pay off
certain debts and for general
corporate purposes, including
acquisitions.
Towne Services will not receive any
of the proceeds from any shares
sold by the selling shareholders.
Dividend policy............................ Towne Services does not plan to pay
cash dividends in the near future.
Nasdaq National Market symbol.............. TWNE
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SUMMARY FINANCIAL DATA
<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED
INCEPTION DECEMBER 31, MARCH 31,
PERIOD ENDED ------------------------------------- ------------------------------------------
DECEMBER 31, PRO FORMA PRO FORMA
1995(1) 1996 1997 1997(2) 1997 1998 1998(2)
------------ ---------- ----------- ---------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
DATA:
Revenues..................... $ 6,000 $ 105,285 $ 722,364 $ 952,029 $ 96,663 $ 547,954 $ 597,237
Costs of processing,
servicing and support...... 2,250 219,621 832,102 883,851 102,684 374,128 400,688
Research and development..... 0 51,871 332,470 402,761 11,231 74,024 90,599
Sales and marketing.......... 3,739 118,163 839,323 839,323 94,337 485,562 485,562
Stock compensation expense... 0 10,020 0 0 0 5,971,590(3) 5,971,590
General and administrative... 18,410 358,606 1,139,642 1,644,747 170,416 1,347,282 1,408,061
---------- ---------- ----------- ---------- ---------- ------------ ------------
Total costs and expenses..... 24,399 758,281 3,143,537 3,770,682 378,668 8,252,586 8,356,500
---------- ---------- ----------- ---------- ---------- ------------ ------------
Operating loss............... (18,399) (652,996) (2,421,173) (2,818,653) (282,005) (7,704,632) (7,759,263)
Financing costs for stock
issued to nonemployees..... 0 0 0 0 0 323,000(4) 323,000
---------- ---------- ----------- ---------- ---------- ------------ ------------
Net loss..................... (18,625) (662,307) (2,516,101) (2,977,418) (300,420) (8,091,921) (8,165,727)
========== ========== =========== ========== ========== ============ ============
Dividends on preferred stock(5) 0 0 0 0 0 (5,108,000) (5,108,000)
Accretion of warrants with
redemption feature(5)...... 0 0 0 0 0 (211,000) (211,000)
Net loss attributable to
common shareholders........ (18,625) (662,307) (2,516,101) (2,977,418) (300,420) (13,410,921) (13,484,727)
========== ========== =========== ========== ========== ============ ============
Net loss per common
share(6)................... $ (0.00) $ (0.10) $ (0.26) $ (0.31) $ (0.04) $ (1.11) $ (1.12)
========== ========== =========== ========== ========== ============ ============
Weighted average common
shares outstanding(6)...... 5,000,000 6,337,356 9,600,592 9,600,592 8,006,626 12,077,352 12,077,352
========== ========== =========== ========== ========== ============ ============
OTHER OPERATING DATA AT
END OF PERIOD:
Number of sales people....... 0 2 15 -- 2 33 --
Number of bank
contracts(7)............... 0 17 74 -- 27 122 --
Number of business
customers.................. 0 11 96 -- 24 161 --
</TABLE>
<TABLE>
<CAPTION>
AT MARCH 31, 1998
------------------------------------------
ACTUAL PRO FORMA(8) AS ADJUSTED(9)
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<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital............................................. $3,159,039 $2,709,090 $29,106,129
Total assets................................................ 5,523,501 6,023,501 31,470,591
Long-term debt, net of discounts............................ 1,289,162 1,289,162 28,559
Shareholders' equity........................................ 2,398,101 2,398,101 30,071,794
</TABLE>
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- ---------------
(1) Towne Services was incorporated on October 23, 1995. The inception period is
from that date to December 31, 1995 (the "Inception Period").
(2) The pro forma statements of operations data give effect to Towne's
acquisition of some of the assets and liabilities of Credit Collection
Solutions, Inc. as if this purchase had occurred at the beginning of the
periods presented. The pro forma financial information does not necessarily
represent what Towne's results of operations would have been if this
purchase had actually occurred on these dates. See "Selected Financial Data"
and the pro forma financial information included elsewhere in this
prospectus.
(3) During the three months ended March 31, 1998, Towne Services sold shares of
common stock and issued options to acquire common stock to employees,
officers and directors at what management believed to be the fair market
value of the common stock at that time. Towne Services retained an
independent appraiser who subsequently valued the common stock at a higher
price. Based upon outside sales to third parties, the independent valuation
and the anticipated offering price, Towne Services recorded a one time
non-cash compensation charge for the additional value. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(4) During the three months ended March 31, 1998, Towne Services sold shares of
common stock to nonemployees at what management believed to be the fair
market value of the common stock at that time. Towne Services retained an
independent appraiser who subsequently valued the common stock at a higher
price. Based upon outside sales to third parties, the independent valuation
and the anticipated offering price, Towne Services recorded a one time
financing cost for the additional value. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
(5) Dividends have been recorded with respect to convertible preferred stock
issued on March 13, 1998 for the difference between the estimated fair
market value of the common stock on that date and the conversion price of
the preferred stock. Accretion has been recorded with respect to warrants
with a redemption feature which were issued on December 18, 1997 based upon
the estimated fair market value of the common stock issuable upon exercise
of the warrants. See notes (3) and (4) above and Note 9 of notes to Towne
Services' financial statements.
(6) See Note 2 of notes to Towne Services' financial statements for a
description of the method used to determine the share calculations.
(7) Number of bank contracts includes each TOWNE CREDIT and TOWNE FINANCE
processing agreement executed with a bank. In some cases, Towne Services
enters into an agreement with a bank that has several branches or with a
bank holding company that is the parent of several different banks. The
numbers presented above do not reflect the number of branches operated by
the bank or the number of banks owned by a bank holding company, unless the
branches or subsidiary banks have entered into separate written agreements
with Towne Services.
(8) Derived from the March 31, 1998 unaudited financial statements of Towne
Services and of Credit Collection Solutions, Inc. appearing elsewhere in
this prospectus.
(9) Adjusted to reflect the sale of 3,850,000 shares of common stock by Towne
Services, the application of the estimated net proceeds from this offering
and the exercise of an outstanding warrant. See "Use of Proceeds."
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RISK FACTORS
An investment in the shares of common stock involves a high degree of risk.
You should carefully consider the following factors and other information in
this prospectus before deciding to invest in any shares of common stock.
LIMITED OPERATING HISTORY AND PRIOR LOSSES
Towne Services released its TOWNE CREDIT product and related services in
June 1997. From its incorporation on October 23, 1995 through June 1997, Towne's
activities consisted of raising capital, hiring personnel and performing
research and development. Accordingly, Towne Services has only a limited
operating history. Towne Services has incurred significant losses since it began
operations. Towne Services had net losses of approximately $19,000 for the
period from October 23 to December 31, 1995, $660,000 in 1996 and $2.5 million
in 1997. For the three months ended March 31, 1998, Towne Services had a net
loss of approximately $8.1 million. Towne Services expects that it will continue
to incur net losses until it is able to attain sufficient revenues to support
its business and it can provide no assurances as to when, if ever, this may
occur.
You should evaluate Towne Services in light of the risks, expenses and
difficulties frequently encountered by companies in their early stages of
development and in relatively new and changing markets. Towne's products and
services are relatively new. Businesses and banks may not accept these products
and services quickly or at all. Although Towne Services has experienced growth
in revenues in recent periods, its costs and expenses have also increased
substantially. Accordingly, there can be no assurance that it will continue to
sustain its revenue growth, control costs or become profitable. Towne's ability
to achieve and maintain profitability depends on a number of factors, including
gaining market acceptance for its current and future products and services,
increasing revenues while reducing costs, implementing its business strategies
and many things outside its control. There can be no assurance that Towne
Services will be successful in the future.
DEPENDENCE ON INCREASED SALES AND MARKETING FORCES AND ENTERING NEW MARKETING
RELATIONSHIPS
An integral part of Towne's strategy is to continue aggressively hiring
sales and marketing personnel and enter into new marketing relationships to gain
access to large groups of potential bank and business customers. Competition for
experienced sales and marketing personnel is intense. Towne Services may not be
able to retain existing personnel or to locate and attract additional qualified
personnel in the future. In addition, Towne has relationships with various
companies and organizations for the marketing, support and endorsement of its
products and services. For example, Towne Services has agreements with Phoenix
International Ltd., Inc. and The Bankers Bank of Kentucky for these entities to
market Towne's processing systems to their existing and future customer base of
banks across the country. The loss of any of these key marketing relationships
or the failure to enter into new marketing relationships could prevent or delay
Towne's growth and could have a material adverse effect on its business,
financial condition and operating results. See "Business -- Towne Services'
Strategies" and "-- Sales and Marketing."
DEPENDENCE ON ABILITY TO GROW AND MANAGE GROWTH
Towne Services has grown rapidly since the release of Towne Credit in June
1997, and much of this growth has occurred in the last few months. For example,
the number of Towne Services customers and contracts has more than doubled since
January 1, 1998, and Towne Services has had to recruit and hire more personnel,
modify its processing systems and otherwise expand its operations to accommodate
its growth. Towne Services may not be successful in continuing its growth or
managing its growth. Further, Towne's growth has placed, and will continue to
place, significant demands on all aspects of its business, including its systems
and personnel. There can be no assurance that Towne Services will be able to
fund its growth, manage costs, adapt its operating systems, respond to changing
business conditions or otherwise achieve or accommodate growth. See
"Business -- Towne Services' Strategies" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
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FLUCTUATIONS IN OPERATING RESULTS; FACTORS BEYOND TOWNE SERVICES' CONTROL
Towne Services' operating results have varied in the past and are likely to
vary significantly in the future, in large part because the market for its
products and services is emerging and because its processing volume differs
substantially from customer to customer. Towne's future success depends on a
number of factors, many of which are unpredictable and beyond its control. These
factors include: whether or not the market accepts current and future products
and services; whether new competitors emerge or existing competitors gain market
share faster than Towne Services; whether new technologies are developed which
make Towne's systems outdated or obsolete; whether costs of doing business
increase as a result of higher wages, sales commissions, taxes and other
operating costs; whether seasonal trends in consumer purchasing impact the
volume of transactions processed; whether the accounting principles which govern
the manner in which Towne currently accounts for stock options granted to its
personnel change; general economic factors and the impact of potential
acquisitions to Towne's operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business -- Employees." Due
to all of these factors, historical results cannot be relied upon to indicate
future results and it is likely that in some future period Towne's results of
operations will fall below market expectations. This would likely cause the
price of the common stock to drop substantially.
HIGHLY COMPETITIVE INDUSTRY
The electronic transaction processing industry is intensely competitive.
Increased competition is likely from both existing competitors and new entrants
into Towne's existing or future markets. Towne Services believes there are low
barriers to entry in its markets. Competitors may offer new products and
services, change prices, improve customer service and hire additional personnel,
all of which may result in greater competition and lower market share for Towne
Services. Further, competitors may be able to adapt more quickly to new
technologies and changes in customer requirements and may also be able to devote
greater resources to marketing. Many competitors have longer operating
histories, greater name recognition, larger customer bases and substantially
greater resources than Towne Services.
ACQUISITION RISKS
Towne Services recently acquired some of the assets and liabilities of
Credit Collection Solutions, Inc., a provider of payment collections software.
An inability to acquire and integrate additional businesses, products or
services may negatively affect the financial results of Towne Services and its
ability to grow. There can be no assurance that Towne Services will be able to
identify and acquire suitable candidates on good terms, arrange adequate
financing, complete any transaction or successfully integrate the acquired
business. Future acquisitions may also distract management and result in
dilution to current shareholders, additional debt, loss of key employees,
integration costs, expenses related to goodwill and other intangible assets, and
unforeseen liabilities, all of which could have a material adverse effect on
Towne Services. In addition, Towne Services competes with other electronic
processing companies for acquisition candidates.
RISK OF POSSIBLE SYSTEM FAILURE
Towne's operations depend on its ability to protect its network
infrastructure and equipment against damage from human error, natural disasters,
power and telecommunications failures, intentional acts of vandalism and similar
events. Despite precautions taken by Towne Services, the occurrence of human
error, a natural disaster or other unanticipated problems could halt its
services, damage network equipment and result in substantial expense to repair
or replace damaged equipment. In addition, the failure of its telecommunications
providers to supply the necessary services could also interrupt Towne's
business. The inability to supply services to its customers could negatively
affect Towne Services' business, financial condition and results of operations
and may also harm its reputation.
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CHANGES IN TECHNOLOGY
Other companies may develop new technologies or introduce new products that
are more effective than Towne's products and services. This may make the
products and services offered by Towne Services obsolete or less attractive to
potential customers.
DEPENDENCE ON KEY PERSONNEL
Towne Services believes that its ability to successfully implement its
growth strategies and to operate its business depends on the continued
employment of its senior managers and sales and marketing personnel. Towne
Services maintains key man life insurance on some of its executive officers, but
if members of management become unable or unwilling to continue in their present
positions, its business, financial condition and results of operations could be
negatively affected. See "Management."
RELIANCE ON SIGNIFICANT NEW CUSTOMERS
Towne Services has relied upon and expects to continue to rely upon fees
from significant new customers for a substantial portion of its revenues. The
amount of revenues derived from any given customer during a given period of time
may vary significantly, and Towne Services expects that the identity of
customers accounting for large portions of revenues will change from quarter to
quarter and year to year. The inability of Towne Services to sell its products
and services to a significant number of new customers would have a material
adverse effect on its business, financial condition and results of operations.
See "Business -- Customers."
LOSS OF CUSTOMERS
Customer attrition is a normal part of the electronic processing business.
Towne Services has experienced and will experience losses of small business
customers due to attrition. Towne's written agreements with its customers
generally provide that either party may terminate the agreement upon 30 to 60
days' notice for any reason. Consolidation in the financial services industry in
the United States may result in fewer potential bank customers. In addition,
Towne Services may elect not to process or continue processing for customers
that experience financial difficulties or other problems.
TAX ISSUES
At March 31, 1998, Towne Services had net operating loss carryforwards
("NOLs") of approximately $4.8 million which will expire if not utilized by 2011
and 2012. Due to changes in its ownership structure as of October 1, 1997,
Towne's use of approximately $2.5 million of these NOLs will be limited to
approximately $550,000 in any given year to offset future taxes. If Towne's
taxable income in future years is less than the NOLs it is permitted to use,
some NOLs will not be realized. NOLs generated after October 1, 1997 may be
further limited as a result of future sales of common stock by Towne Services.
At March 31, 1998, Towne Services had available NOLs of approximately $4.8
million. Once these NOLs are utilized or expire, the projected effective tax
rate will increase, which will adversely affect Towne's operating results and
financial condition. In addition, Towne Services may become subject to state
taxation of fees charged for its transaction processing products and services,
which would decrease its profits, if any, and may have a negative impact on its
financial condition and results of operations.
CONCENTRATION OF STOCK OWNERSHIP
Following this offering, assuming exercise of the underwriters'
over-allotment option, Towne's senior officers and directors will beneficially
own approximately 43.8% of the outstanding common stock. Accordingly, they will
control Towne Services and will have the power to elect a majority of the
directors, appoint management and approve actions requiring the approval of a
majority of its shareholders. The interests of senior management could conflict
with the interests of the other shareholders of Towne Services. See "Management"
and "Principal and Selling Shareholders."
11
<PAGE> 13
SUBSTANTIAL DISCRETION OF MANAGEMENT CONCERNING USE OF PROCEEDS
Towne Services expects to use approximately $11.0 million of the net
proceeds of this offering for specific, identified purposes, with the remaining
net proceeds to be used for working capital and general corporate purposes
including possible acquisitions. Accordingly, management will have substantial
discretion in spending a large part of the net proceeds to be received by Towne
Services. See "Use of Proceeds."
PRODUCT RISKS
Towne Services may be liable if the use of any of its products causes
damage to its customers' businesses. Towne Services also may be required to
recall certain of its products if they become damaged or unable to perform their
intended functions. Towne Services has not experienced any product recalls or
product liability judgments or claims. However, a product recall or product
liability judgment against Towne Services could negatively affect its business,
financial condition and results of operations.
TRADEMARKS AND OTHER PROPRIETARY RIGHTS
Towne Services believes that its technologies, trademarks and other
proprietary rights are important to its success. Towne Services attempts to
protect itself through a combination of copyright law, trademark and trade
secret laws, employee and third party confidentiality agreements and other
methods. However, unauthorized parties may attempt to copy aspects of its
technology, products and services or to otherwise obtain and use information
that Towne Services regards as proprietary, despite its efforts to protect them.
Third parties may claim that Towne Services' current or future products and
services infringe the patent, copyright or trademark rights of such third
parties. No assurance can be given that, if such actions or claims are brought,
Towne Services will ultimately prevail. Any such claims, whether with or without
merit, could be costly and time consuming, cause delays in introducing new or
improved products and services, require Towne Services to enter royalty or
licensing agreements or discontinue using the challenged technology and
otherwise could have a material adverse effect on its business, financial
condition and results of operations. See "Business -- Trademarks and Other
Proprietary Rights."
NO PRIOR PUBLIC MARKET; VOLATILITY OF STOCK PRICE
Before this offering, there has not been a market for Towne Services'
common stock. The common stock will be listed on the Nasdaq National Market, but
Towne cannot guarantee that an active trading market will develop for the common
stock. Because the initial public offering price for the common stock was
determined by negotiation between Towne Services and the underwriters, it may
not reflect the market price of the common stock after this offering. Four
members of Towne's management team have agreed to sell 384,286 shares of common
stock at the offering price if the underwriters' exercise their over-allotment
option. Investors may not be able to resell their shares at or above the initial
public offering price. The completion of the offering and the establishment of a
trading market for the common stock may also make it easier for members of
senior management to sell more shares of their common stock in the future. Sales
by members of senior management of a large number of shares in the market after
this offering, or the perception that such sales may occur, could cause the
market price of the common stock to drop. See "-- Shares Eligible for Future
Sale; Possible Adverse Effect on Market Price," "Principal and Selling
Shareholders" and "Underwriting."
IMMEDIATE AND SUBSTANTIAL DILUTION
The initial public offering price per share will exceed the net tangible
book value per share. Accordingly, purchasers of common stock sold in this
offering will experience immediate and substantial dilution of $6.40 per share
in their investment, while the value of shares held by current shareholders will
increase. See "Dilution."
12
<PAGE> 14
SHARES ELIGIBLE FOR FUTURE SALE; POSSIBLE ADVERSE EFFECT ON MARKET PRICE
A substantial number of outstanding shares of common stock, as well as
shares of common stock issuable on exercise of stock options and warrants
granted or to be granted by Towne Services, are or will be eligible for future
sale in the public market at prescribed times pursuant to Rule 144 or Rule 701
under the Securities Act of 1933. Sales of a large number of shares in the
market after this offering, or the perception that such sales may occur, could
cause the market price of the common stock to drop. These factors could also
make it more difficult for Towne Services to raise additional funds in the
future through the sale of common stock.
There will be 18,673,734 shares of common stock outstanding immediately
after this offering. Of these shares, the 4,000,000 shares sold in this offering
will be freely tradable without restriction or further registration under the
Securities Act of 1933, except for any shares purchased by "affiliates" of Towne
Services, as defined in Rule 144. The remaining 14,673,734 shares of common
stock outstanding will be "restricted securities" within the meaning of Rule
144. In connection with this offering, Towne's directors, executive officers and
some of its shareholders have agreed that, with certain exceptions, they will
not sell any shares of common stock without the consent of Wheat First
Securities, Inc. for 180 days after the date of this prospectus. After this 180
day period, these shares may be sold in the future without registration under
the Securities Act of 1933 to the extent permitted by Rule 144 as an exemption
from registration under the Securities Act of 1933. In addition, Towne's chief
executive officer and some of its shareholders have registration rights allowing
them to cause Towne Services to register their shares for sale under certain
circumstances. See "Management -- Employment Agreements," "Certain
Transactions," "Underwriting" and "Shares Eligible for Future Sale."
ANTI-TAKEOVER PROVISIONS; EMPLOYMENT AGREEMENTS
Some provisions of Towne's Articles of Incorporation and Bylaws could make
it more difficult for a third party to acquire control of Towne Services, even
if such change in control would be beneficial to shareholders. See "Description
of Capital Stock." Some of Towne's executive officers have employment agreements
that contain change in control provisions. These provisions may discourage or
prevent a tender offer, proxy contest or other attempted takeover. See
"Management -- Employment Agreements."
13
<PAGE> 15
USE OF PROCEEDS
The net proceeds to Towne Services from the sale of 3,850,000 shares of
common stock offered by it in this offering are estimated to be approximately
$27.4 million after deducting underwriting discounts and other estimated
offering expenses payable by the Company. Towne Services will not receive any
proceeds from any sale of shares offered by the selling shareholders. See
"Principal and Selling Shareholders."
Towne Services intends to use a total of approximately $11.0 million of the
net proceeds of this offering as follows: (i) approximately $4.0 million to
enhance its sales and marketing efforts, including hiring additional sales and
marketing personnel; (ii) approximately $5.0 million to upgrade, enhance and
expand its products and services; (iii) approximately $1.5 million to repay the
indebtedness outstanding under the Company's loan facility with Sirrom
Investments, Inc. (the "Sirrom Loan Facility"); and (iv) approximately $510,000
to repay the indebtedness outstanding under the Company's loan from Citizens
Bank (the "Citizens Loan"). The Sirrom Loan Facility matures on December 18,
2002, bears interest at 14% per year and was obtained to provide working capital
for Towne Services. The Citizens Loan matures on September 3, 1998, bears
interest at 8.5% per year and was obtained to finance the Company's purchase of
assets and liabilities from Credit Collection Solutions, Inc. on June 11, 1998.
See "Business -- Acquisitions of Complementary Companies and Products."
Towne Services intends to use the balance of the net proceeds, expected to
be approximately $16.4 million, for working capital and general corporate
purposes, including possible acquisitions. Towne Services continues to evaluate
potential strategic acquisitions of providers of complementary technologies and
services and plans to carry on discussions with potential acquisition
candidates. Other than the acquisition of assets from Credit Collection
Solutions, the Company is not currently a party to any written agreements or
commitments with respect to any such acquisitions. There can be no assurance
that any acquisitions will be consummated on terms favorable to the Company, if
at all. Pending application of the net proceeds as described above, Towne
Services intends to invest the net proceeds in short-term, interest-bearing
investment grade securities. See "Risk Factors -- Ability to Grow and Manage
Growth," "Business -- Towne Services' Strategies" and "-- Acquisitions of
Complementary Companies and Products."
DIVIDEND POLICY
Towne Services has not paid cash dividends in the past and does not
anticipate paying any cash dividends on its common stock in the foreseeable
future. Towne Services intends to retain its earnings, if any, to finance the
expansion of its business and for general corporate purposes, including future
acquisitions. Unless waived in writing by the lenders, the Sirrom Loan Facility
restricts the declaration and payment of dividends. In addition, the terms of
the Series A Preferred Stock prevent the payment of dividends on the common
stock unless full cumulative dividends have been paid on the Series A Preferred
Stock. Any payment of future dividends on the common stock will be at the
discretion of the Company's board of directors and will depend upon, among other
things, the Company's earnings, financial condition, capital requirements, level
of indebtedness, contractual restrictions with respect to the payment of
dividends and other factors that the Company's board of directors deems
relevant. See "Description of Capital Stock."
14
<PAGE> 16
DILUTION
The net tangible book value of Towne Services at March 31, 1998 was $2.1
million, or $0.16 per share. Net tangible book value per share represents the
amount by which the Company's net tangible assets exceed its total liabilities
divided by the fully diluted number of shares of common stock outstanding. After
giving effect to the sale of 3,850,000 shares of common stock offered by the
Company in this offering and the application of the estimated net proceeds as
set forth under "Use of Proceeds," the Company's pro forma net tangible book
value as of March 31, 1998 would have been $29.8 million, or $1.60 per share.
This represents an immediate increase of $1.44 in net tangible book value per
share to existing shareholders and an immediate dilution of $6.40 in net
tangible book value per share to persons purchasing shares in this offering. The
following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price............................... $8.00
Net tangible book value before this offering.............. $0.16
Increase attributable to the sale of shares offered
hereby................................................. 1.44
Pro forma net tangible book value after this offering....... 1.60
-----
Dilution in net tangible book value to new investors........ $6.40
=====
</TABLE>
The following table sets forth the number of shares of common stock
purchased from the Company, the total consideration paid and the average price
per share paid by existing shareholders and to be paid by the new investors
purchasing shares of common stock offered hereby.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
-------------------- --------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing shareholders........................ 14,823,734 79.4% $ 7,509,848 19.6% $ 0.51
New investors................................ 3,850,000 20.6 30,800,000 80.4 8.00
---------- ----- ----------- -----
Total.............................. 18,673,734 100.0% 38,309,848 100.0%
========== ===== =========== =====
</TABLE>
The sale of 150,000 shares by one selling shareholder in this offering will
reduce the number of shares of common stock held by existing investors to
14,673,734, or 78.6%, and will increase the number of shares to be held by new
investors to 4,000,000, or 21.4%, of the total number of shares to be
outstanding after this offering. If the underwriters exercise their
over-allotment option in full, sales by the other six selling shareholders in
this offering will reduce the number of shares of common stock held by existing
shareholders to 14,073,734, or 75.4%, and will increase the number of shares to
be held by new investors to 4,600,000, or 24.6%, of the total number of shares
of common stock to be outstanding after this offering. See "Principal and
Selling Shareholders" and "Description of Capital Stock."
The above table assumes that 1,217,903 shares of common stock will be
issued upon conversion of the Series A Preferred Stock outstanding upon
completion of this offering (assuming a conversion date of August 1, 1998) and
that warrants for 308,982 shares of common stock will be exercised on or before
completion of this offering. The table also includes 76,000 shares issued in
April 1998 from the exercise of stock options granted under the Company's 1996
Stock Option Plan. At March 31, 1998 there were outstanding options and warrants
to purchase 3,339,361 shares of common stock at a weighted average exercise
price of $0.60 per share which are not included in the above table. See
"Management -- Stock Option Plans" and Note 6 of the notes to Towne Services'
financial statements.
15
<PAGE> 17
CAPITALIZATION
The following table sets forth the Company's capitalization at March 31,
1998 (i) on a historical basis and (ii) as adjusted to give effect to the sale
by the Company of 3,850,000 shares of common stock offered hereby and the
application of the estimated net proceeds therefrom. See "Selected Financial
Data" and "Use of Proceeds." This table should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the Company's financial statements and the related notes thereto
and the other financial information appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1998
---------------------------
ACTUAL AS ADJUSTED
----------- ------------
<S> <C> <C>
Long-term debt, including current maturities, net of
original issue discount................................... $ 1,331,129 $ 70,526
----------- ------------
Warrants with redemption feature............................ 466,000 0
----------- ------------
Shareholders' equity:
Preferred stock, 20,000,000 shares authorized; 15,000
shares of Series A issued and outstanding, actual; and
none outstanding, as adjusted(1)....................... 1,508,000 0
Common stock, 50,000,000 shares authorized; 13,220,849
shares issued and outstanding, actual; and 18,597,734
shares issued and outstanding, as adjusted(2).......... 17,457,055 46,878,145
Warrants outstanding...................................... 41,000 41,000
Accumulated deficit....................................... (16,607,954) (16,847,351)
----------- ------------
Total shareholders' equity........................ 2,398,101 30,071,794
----------- ------------
Total capitalization.............................. $ 4,195,230 $ 30,142,320
=========== ============
</TABLE>
- ---------------
(1) The 15,000 shares of Series A Preferred Stock outstanding immediately prior
to this offering automatically convert into 1,217,903 shares of common stock
upon completion of this offering (assuming a conversion date of August 1,
1998). See "Description of Capital Stock." The issuance of such shares of
common stock upon completion of this offering is reflected in the as
adjusted column.
(2) Excludes 3,339,361 shares of common stock subject to options and warrants
outstanding at March 31, 1998 with a weighted average exercise price of
$0.60 per share and assumes that warrants for 308,982 shares of common stock
will be exercised on or before completion of this offering. See
"Management -- Stock Option Plans" and Notes 5 and 6 of notes to the
Company's financial statements.
16
<PAGE> 18
SELECTED FINANCIAL DATA
The following selected financial data is qualified by reference to, and
should be read in conjunction with, Towne Services' financial statements and the
related notes thereto and other financial information included elsewhere in this
prospectus, as well as "Management's Discussion and Analysis of Financial
Condition and Results of Operations." The selected financial data of the Company
as of December 31, 1996 and 1997, for its Inception Period ended December 31,
1995 and for the years ended December 31, 1996 and 1997 were derived from Towne
Services' financial statements that have been audited by Arthur Andersen LLP,
independent public accountants. The selected financial data as of December 31,
1995 and March 31, 1998 and for the three months ended March 31, 1997 and 1998
were derived from unaudited financial statements which, in the opinion of
management, include all adjustments, consisting only of normal recurring
accruals, necessary for a fair presentation of the Company's financial condition
and results of operations. These results may not be indicative of future
results.
The pro forma statements of operations data for the year ended December 31,
1997 and for the three months ended March 31, 1998 and the pro forma balance
sheet data at March 31, 1998 give effect to the acquisition of certain assets of
Credit Collection Solutions, Inc. as if this purchase had occurred at the
beginning of the periods presented (for the statements of operations data) and
at March 31, 1998 (for the balance sheet data). The pro forma financial
information does not necessarily represent what the Company's results of
operations would have been if this transaction had in fact occurred on these
dates, nor does it indicate the future financial position or results of future
operations of the Company. The pro forma adjustments are based on currently
available information and certain assumptions that management believes are
reasonable. See the pro forma financial information included elsewhere in this
prospectus.
<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED
INCEPTION DECEMBER 31, MARCH 31,
PERIOD ENDED ------------------------------------- --------------------------------------
DECEMBER 31, PRO FORMA PRO FORMA
1995(1) 1996 1997 1997 1997 1998 1998
------------ --------- ----------- ----------- --------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
DATA:
Revenues..................... $ 6,000 $ 105,285 $ 722,364 $ 952,029 $ 96,663 $ 547,954 $ 597,237
Costs of processing,
servicing and support...... 2,250 219,621 832,102 883,851 102,684 374,128 400,688
Research and development..... 0 51,871 332,470 402,761 11,231 74,024 90,599
Sales and marketing.......... 3,739 118,163 839,323 839,323 94,337 485,562 485,562
Stock compensation expense... 0 10,020 0 0 0 5,971,590(2) 5,971,590
General and administrative... 18,410 358,606 1,139,642 1,644,747 170,416 1,347,282 1,408,061
--------- --------- ----------- ----------- --------- ------------ -----------
Total costs and expenses..... 24,399 758,281 3,143,537 3,770,682 378,668 8,252,586 8,356,500
--------- --------- ----------- ----------- --------- ------------ -----------
Operating loss............... (18,399) (652,996) (2,421,173) (2,818,653) (282,005) (7,704,632) (7,759,263)
--------- --------- ----------- ----------- --------- ------------ -----------
Interest expense (income),
net........................ (131) 5,802 95,946 159,783 19,063 64,289 83,464
Other expense (income)....... 357 3,509 (1,018) (1,018) (648) 0 0
Financing costs for stock
issued to nonemployees..... 0 0 0 0 0 323,000(3) 323,000
--------- --------- ----------- ----------- --------- ------------ -----------
Total other expenses......... 226 9,311 94,928 158,765 18,415 387,289 406,464
--------- --------- ----------- ----------- --------- ------------ -----------
Net loss..................... (18,625) (662,307) (2,516,101) (2,977,418) (300,420) (8,091,921) (8,165,727)
========= ========= =========== =========== ========= ============ ===========
Preferred stock
dividends(4)............... 0 0 0 0 0 (5,108,000) (5,108,000)
Accretion of warrants with
redemption feature(4)...... 0 0 0 0 0 (211,000) (211,000)
Net loss attributable to
common shareholders........ (18,625) (662,307) (2,516,101) (2,977,418) (300,420) (13,410,921) (13,484,727)
========= ========= =========== =========== ========= ============ ===========
Net loss per common
share(5)................... $ (0.00) $ (0.10) $ (0.26) $ (0.31) $ (0.04) $ (1.11) $ (1.12)
========= ========= =========== =========== ========= ============ ===========
Weighted average common
shares outstanding(5)...... 5,000,000 6,337,356 9,600,592 9,600,592 8,006,626 12,077,352 12,077,352
========= ========= =========== =========== ========= ============ ===========
</TABLE>
17
<PAGE> 19
<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED
INCEPTION DECEMBER 31, MARCH 31,
PERIOD ENDED ------------------------------- ---------------------------------------
DECEMBER 31, PRO FORMA PRO FORMA
1995(1) 1996 1997 1997 1997 1998 1998
------------ ------- -------- ---------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
OTHER OPERATING DATA AT END OF
PERIOD:
Number of sales people......... 0 2 15 -- 2 33 --
Number of bank contracts(6).... 0 17 74 -- 27 122 --
Number of business customers... 0 11 96 -- 24 161 --
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31, AT MARCH 31, 1998
------------------------------- --------------------------------------------
1995 1996 1997 ACTUAL PROFORMA AS ADJUSTED(7)
------- -------- ---------- ---------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital........................... $17,517 $ 1,677 $2,025,165 $3,159,039 $2,709,090 $29,106,129
Total assets.............................. 28,226 366,806 3,586,432 5,523,501 6,023,501 31,470,591
Long-term debt............................ 30,000 90,000 1,289,666 1,289,162 1,289,162 28,559
Shareholders'(deficit) equity............. (2,875) 119,092 1,261,663 2,398,101 2,398,101 30,071,794
</TABLE>
- ---------------
(1) The Company was incorporated on October 23, 1995. The Inception Period is
from that date to December 31, 1995.
(2) During the three months ended March 31, 1998, the Company sold shares of
common stock and issued options to acquire common stock to employees,
officers and directors at what management believed to be the fair market
value of the common stock at that time. The Company retained an independent
appraiser who subsequently valued the common stock at a higher price. Based
upon third party sales, the independent valuation and the anticipated
offering price, the Company recorded a one time non-cash compensation charge
for the additional value. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
(3) During the three months ended March 31, 1998, the Company sold shares of
common stock to nonemployees at what management believed to be the fair
market value of the common stock at that time. The Company retained an
independent appraiser who subsequently valued the common stock at a higher
price. Based upon third party sales, the independent valuation and the
anticipated offering price, the Company recorded a one time financing cost
for the additional value. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
(4) Dividends have been recorded with respect to convertible preferred stock
issued on March 13, 1998 for the difference between the estimated fair
market value of the common stock on that date and the conversion price of
the preferred stock. Accretion has been recorded with respect to warrants
with a redemption feature which were issued on December 18, 1997 based upon
the estimated fair market value of the common stock issuable upon exercise
of the warrants. See notes (2) and (3) above and Note 9 of notes to Towne
Services' financial statements.
(5) See Note 2 of notes to Towne Services' financial statements for a
description of the method used to determine the share calculations.
(6) Number of bank contracts includes each TOWNE CREDIT and TOWNE FINANCE
processing agreement executed with a bank. In some cases, Towne Services
enters into an agreement with a bank that has several branches or with a
bank holding company that is the parent of several different banks. The
numbers presented above do not reflect the number of branches operated by
the bank or the number of banks owned by the bank holding company unless the
branches or subsidiary banks have entered into separate written agreements
with Towne Services.
(7) Adjusted to reflect the sale of 3,850,000 shares of common stock by Towne
Services, the application of the estimated net proceeds from this offering
and the exercise of an outstanding warrant. See "Use of Proceeds".
18
<PAGE> 20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with Towne Services'
financial statements and the related notes thereto included elsewhere in this
prospectus. This discussion contains forward-looking statements that involve
risks and uncertainties. The Company's actual results may differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including, but not limited to, those set forth under "Risk Factors" and
elsewhere in this prospectus.
OVERVIEW
Towne Services designs, develops and markets products and services that
convert the in-house credit transactions of small businesses into automated
"virtual credit card" accounts which are processed electronically. Usually,
in-house transactions are completed without a credit card or cash, are recorded
and processed manually and then billed to the customer at a later date. Through
the use of Towne's products and services, small businesses can automate certain
manual processes, accelerate cash flow, provide better customer service, reduce
paperwork and shift many other administrative burdens to Towne Services. In
addition, Towne Services provides complementing products and services to banks
that enable them to generate interest-bearing revolving credit accounts by
financing the accounts receivable of these small businesses. Through the use of
Towne's products, banks can monitor customers' accounts receivable and generate
detailed status reports, and may attract new business customers who, in turn,
may become customers of Towne Services.
During the Inception Period, the Company's activities primarily related to
raising capital, recruiting personnel, researching and developing new products
including TOWNE CREDIT, purchasing operating assets and establishing a market
for its products. During 1996 and 1997 and the three months ended March 31,
1998, the Company invested the majority of its resources in researching and
developing its products, expanding its marketing activities, building community
bank and merchant sales channels and developing its general and administrative
infrastructure.
The Company's revenues currently are generated through initial set-up fees,
discount fees and monthly transaction processing fees. Set-up fees include
charges for installation, implementation and training of the Company's bank and
business customers. Towne Services recognizes revenues related to its set-up
fees upon execution of the related contract or, if appropriate, upon settlement
of any contract contingencies. Set-up fees charged to each bank vary depending
on the asset size of the bank and the number of its branches. The Company also
charges set-up fees to its business customers based either upon a flat rate or
upon the expected transaction volume.
As with credit card transactions, the Company's business customer pays a
discount fee to its bank equal to a percentage of the value of each transaction
processed. In addition, the business' customer pays to the bank interest and
fees for amounts owed on account. Towne Services generates recurring revenue by
collecting a portion of the discount fee and, on occasion, interest paid on
these accounts, as well as by charging monthly transaction processing fees.
Monthly transaction processing fees include charges for electronic processing,
statement rendering and mailing, settling payments, recording account changes
and new accounts, leasing and selling point of sale terminals and collecting
debts.
Management believes the prices charged for both the initial set-up fees and
the recurring transaction fees are based upon the relative fair value of the
related services provided. Accordingly, Towne recognizes these fees as the
related services are provided.
Costs of processing, servicing and support include installation costs for
the Company's products and costs related to customer service, information
systems personnel and installation services.
Research and development expenses consist of salary and related personnel
costs, including costs for employee benefits, computer equipment and support
services, used in product and technology development. The Company believes that
its research and development expenditures, which aid in the design of new
products and product enhancements to respond to changes in customer demand, are
essential for obtaining and retaining a leadership position in its marketplace.
Most research and development expenditures are
19
<PAGE> 21
expensed as incurred; however, the Company has capitalized certain development
costs under Statement of Financial Accounting Standards ("SFAS") No. 86 when the
products reached technological feasibility.
Sales and marketing expenses consist primarily of salaries and commissions,
travel expenses, advertising, trade show expenses, personnel recruiting costs
and costs of marketing materials. These expenses also include the costs incurred
to develop the Company's indirect marketing channels.
General and administrative expenses consist primarily of salaries and other
personnel costs for the Company's executive, administrative, finance and human
resources personnel, costs of support services and professional services fees.
No provision for federal or state income taxes has been recorded because
the Company has experienced cumulative net losses since inception.
Towne Services had net losses of approximately $19,000, $660,000 and $2.5
million for its Inception Period and for the subsequent years ended December 31,
1996 and 1997, respectively. For the three months ended March 31, 1998, the
Company had a net loss of approximately $8.1 million. As of December 31, 1997,
the Company had an accumulated deficit of $3.2 million. As of March 31, 1998,
this accumulated deficit was $16.6 million. These losses resulted from
significant costs incurred in the development and sale of the Company's products
and services and the establishment of distribution channels.
The Company's business has grown rapidly with total revenues increasing
from $6,000 in the Inception Period to $105,000 in 1996, $722,000 in 1997 and
$548,000 in the first quarter of 1998. However, the Company has experienced net
losses in each of these periods and expects to continue to incur losses for the
foreseeable future. The number of Towne Services employees increased from 1 at
December 31, 1995 to 70 at March 31, 1998. The Company currently intends to
expand its sales and marketing operations, to invest more in product research
and development, to pursue strategic acquisitions and to improve its internal
operating and financial infrastructure, all of which will increase its operating
expenses.
Because of the Company's limited operating history, management believes
that period-to-period comparisons of its operating results are not meaningful.
Although the Company has experienced significant revenue growth recently, there
can be no assurance that such growth rates are sustainable, and they should not
be relied upon as indicators of future performance. The Company's prospects must
be considered in light of the risks, expenses and difficulties frequently
encountered by companies in the early stage of development and relatively new
and changing markets. There can be no assurance that the Company will be
successful in addressing such risks and difficulties or that it will achieve
profitability in the future. See "Risk Factors -- Limited Operating History and
Prior Losses", "Fluctuations in Operating Results; Factors Beyond Towne
Services' Control" and "Dependence on Ability to Grow and Manage Growth."
20
<PAGE> 22
RESULTS OF OPERATIONS
The following table sets forth certain historical operating information for
Towne Services, in dollars and as a percentage of total revenues, for the
periods indicated.
<TABLE>
<CAPTION>
INCEPTION THREE MONTHS ENDED
PERIOD ENDED YEARS ENDED DECEMBER 31, MARCH 31,
DECEMBER 31, ------------------------- --------------------------
1995 1996 1997 1997 1998
------------ --------- ----------- --------- ------------
<S> <C> <C> <C> <C> <C>
Revenues..................... $ 6,000 $ 105,285 $ 722,364 $ 96,663 $ 547,954
Costs of processing,
servicing and support...... 2,250 219,621 832,102 102,684 374,128
Research and development..... 0 51,871 332,470 11,231 74,024
Sales and marketing.......... 3,739 118,163 839,323 94,337 485,562
Stock compensation expense... 0 10,020 0 0 5,971,590
General and administrative... 18,410 358,606 1,139,642 170,416 1,347,282
-------- --------- ----------- --------- ------------
Total costs and expenses..... 24,399 758,281 3,143,537 378,668 8,252,586
-------- --------- ----------- --------- ------------
Operating loss............... (18,399) (652,996) (2,421,173) (282,005) (7,704,632)
-------- --------- ----------- --------- ------------
Interest (income) expense,
net........................ (131) 5,802 95,946 19,063 64,289
Other expense (income)....... 357 3,509 (1,018) (648) 0
Financing costs for stock
issued to nonemployees..... 0 0 0 0 323,000
-------- --------- ----------- --------- ------------
Total other expenses......... 226 9,311 94,928 18,415 387,289
-------- --------- ----------- --------- ------------
Net loss..................... $(18,625) $(662,307) $(2,516,101) $(300,420) $ (8,091,921)
======== ========= =========== ========= ============
Net loss attributable to
common shareholders........ $(18,625) $(662,307) $(2,516,101) $(300,420) $(13,410,921)
======== ========= =========== ========= ============
</TABLE>
<TABLE>
<CAPTION>
INCEPTION THREE MONTHS ENDED
PERIOD ENDED YEARS ENDED DECEMBER 31, MARCH 31,
DECEMBER 31, ------------------------- --------------------------
1995 1996 1997 1997 1998
------------ --------- ----------- --------- ------------
<S> <C> <C> <C> <C> <C>
Revenues..................... 100% 100% 100% 100% 100%
Costs of processing,
servicing and support...... 38 209 115 106 68
Research and development..... 0 49 46 12 14
Sales and marketing.......... 62 112 116 98 89
Stock compensation expense... 0 10 0 0 1,090
General and administrative... 307 340 158 176 246
-------- --------- ----------- --------- ------------
Total costs and expenses..... 407 720 435 392 1,506
-------- --------- ----------- --------- ------------
Operating loss............... (307) (620) (335) (292) (1,406)
-------- --------- ----------- --------- ------------
Interest (income) expense,
net........................ (2) 6 13 20 12
Other expense (income)....... 6 3 0 (1) 0
Finance costs for stock
issued to nonemployees..... 0 0 0 0 59
-------- --------- ----------- --------- ------------
Total other expenses......... 4 9 13 19 71
-------- --------- ----------- --------- ------------
Net loss..................... (311)% (629)% (348)% (311)% (1,477)%
======== ========= =========== ========= ============
Net loss attributable to
common shareholders........ (311)% (629)% (348)% (311)% (2,447)%
======== ========= =========== ========= ============
</TABLE>
COMPARISON OF THREE MONTHS ENDED MARCH 31, 1997 AND MARCH 31, 1998
Revenues. The Company's revenues increased from $97,000 for the first
quarter ended March 31, 1997 to $548,000 for the first quarter ended March 31,
1998. During these two periods, set-up fees accounted for approximately 50% and
68% of total revenues, respectively. Recurring revenues accounted for
approximately 4% and 35% of total revenues, respectively, during these two
periods. The increase in revenues during these
21
<PAGE> 23
periods resulted primarily from an increase in the number of customers and
higher set-up and transaction processing fees charged to new customers. The
increase in recurring revenues as a percentage of total revenues resulted
primarily from an increase in the monthly transaction processing fees that
generate recurring revenues.
Costs of Processing, Servicing and Support. Costs of processing, servicing
and support increased from $103,000 for the three months ended March 31, 1997 to
$374,000 for the three months ended March 31, 1998. These costs were
approximately 106% and 68% of total revenues, respectively, for these two
periods. The dollar amount of costs of processing, servicing and support
increased as a result of the addition of new customers, additional servicing and
increased support functions required to support the Company's growth. Towne
Services anticipates that these costs will continue to increase as new customers
are added. If the Company is successful in establishing operating leverage, it
anticipates that at some future point these costs will begin to decrease on a
per customer and per transaction basis.
Research and Development. The Company increased its research and
development expenses from $11,000 for the three months ended March 31, 1997 to
$74,000 for the three months ended March 31, 1998. Research and development
expenses represented approximately 12% and 14% of total revenues, respectively,
during these two periods. Towne Services expects that the dollar amount of
research and development expenses will continue to increase as the Company
recruits and hires additional experienced programmers and develops new products
and services. The Company does not expect to incur significant costs to make its
products Year 2000 compliant because it believes its products are currently
designed to properly function through and beyond the year 2000.
Sales and Marketing. Sales and marketing expenses increased from $94,000
for the three months ended March 31, 1997 to $486,000 for the three months ended
March 31, 1998. Sales and marketing expenses were approximately 97% and 89% of
total revenues, respectively, during these two periods. The increase in the
dollar amount of these expenses is primarily the result of a significant
increase in the number of sales personnel in remote locations, related travel
expenses and increased costs for marketing materials used to recruit potential
bank and business customers. Towne Services anticipates that sales and marketing
expenses will continue to increase as it continues to expand its direct sales
and marketing force and hires additional personnel to promote its indirect sales
channels.
Stock Compensation Expense. Stock compensation expense was $6.0 million
for the three months ended March 31, 1998. During the three months ended March
31, 1998, Towne Services sold shares of common stock and issued options to
acquire common stock at what management believed to be the fair market value of
the common stock at that time. The Company retained an independent appraiser who
subsequently valued the common stock at a higher price. Based upon outside sales
to third parties, the independent valuation and the anticipated offering price,
the Company recorded a one time non-cash charge for the additional value.
General and Administrative. General and administrative expenses increased
from $170,000 for the three months ended March 31, 1997 to $1.3 million for the
three months ended March 31, 1998. These costs represented approximately 176%
and 246% of total revenues, respectively, for these two periods. The increase in
the dollar amount of these expenses was primarily the result of increases in the
number of administrative and operational employees and the costs associated with
executive and administrative expenses related to the Company's growth. Towne
Services anticipates that these expenses will continue to increase in the near
future as it upgrades internal and financial reporting systems to enhance
management's ability to obtain and analyze information about its operations.
Also, the Company anticipates additional costs related to being a public
company, including annual and other public reporting costs, directors' and
officers' liability insurance, investor relations programs and professional
services fees.
Interest (Income) Expense, Net. Interest expense increased from $19,000
for the three months ended March 31, 1997 to $64,000 for the three months ended
March 31, 1998. Interest expense increased due primarily to borrowings under the
Sirrom Loan Facility obtained in late 1997.
22
<PAGE> 24
Income Taxes. As of March 31, 1998, Towne Services had NOLs of
approximately $4.8 million for federal tax purposes which will expire if not
utilized by 2011 and 2012. The Company has not recognized any benefit from the
future use of such NOLs because management's assumptions of future profitable
operations contain risks that do not provide sufficient assurance to recognize
such tax benefits currently.
COMPARISON OF INCEPTION PERIOD AND YEARS ENDED DECEMBER 31, 1996 AND DECEMBER
31, 1997
Revenues. The Company's revenues increased from $6,000 for the Inception
Period to $105,000 in 1996 and $722,000 in 1997. Set-up fees accounted for
approximately 0%, 44% and 53% of the Company's total revenues in the Inception
Period, 1996 and 1997, respectively. Recurring revenues accounted for
approximately 4%, 5% and 18% of total revenues in the Inception Period, 1996 and
1997, respectively. The increases in the dollar amount of revenues during these
periods resulted primarily from an increase in the number of customers and
higher set-up and transaction processing fees charged to new customers. The
increases in recurring revenues as a percentage of revenues resulted primarily
from an increase in the monthly transaction processing revenues that generate
recurring revenues.
Costs of Processing, Servicing and Support. Costs of processing, servicing
and support increased from $2,000 for the Inception Period to $220,000 in 1996
and $832,000 in 1997. The costs were approximately 38%, 209% and 115% of total
revenues, respectively, for these three periods. The dollar amount of costs of
processing, servicing and support increased as a result of the addition of new
customers, additional servicing and increased support functions required to
support the Company's growth.
Research and Development. The Company increased its research and
development expenses from $0 during the Inception Period to $52,000 in 1996 and
$332,000 in 1997. Research and development expenses represented approximately
0%, 49% and 46% of total revenues, respectively, during these three periods.
These increases in dollar amounts were due primarily to the continued
development of TOWNE CREDIT and TOWNE FINANCE.
Sales and Marketing. Sales and marketing expenses increased from $4,000 in
the Inception Period to $118,000 in 1996 and $839,000 in 1997. Sales and
marketing expenses were approximately 62%, 112% and 116% of total revenues,
respectively, during these three periods. These increases in dollar amounts were
primarily the result of a significant increase in the number of sales personnel
in remote locations, related travel expenses and increased costs for marketing
materials used to recruit potential bank and business customers.
General and Administrative. General and administrative expenses increased
from $18,000 in the Inception Period to $359,000 in 1996 to $1.1 million in
1997. These costs were approximately 307%, 340% and 158% of total revenues,
respectively, for these three periods. These increases in dollar amounts were
primarily the result of increases in the number of administrative and
operational employees, and the costs associated with administrative expenses and
building infrastructure to support the Company's growth.
Interest (Income) Expense, net. Interest expense increased from $0 for the
Inception Period to $6,000 in 1996 and $96,000 in 1997. Interest expense
increased from 1996 to 1997 primarily as a result of the Sirrom Loan Facility
which was obtained in late 1997.
Income Taxes. As of December 31, 1997, Towne Services had NOLs of
approximately $3.0 million for federal tax purposes which will expire if not
utilized by 2011 and 2012. The Company has not recognized any benefit from the
future use of such NOLs because management's assumptions of future profitable
operations contain risks that do not provide sufficient assurance to recognize
such tax benefits currently.
23
<PAGE> 25
SELECTED QUARTERLY RESULTS OF OPERATIONS
The following tables set forth unaudited statements of operations data for
the nine quarters ended March 31, 1998, as well as such data expressed as a
percentage of the Company's total revenues for the periods indicated. This data
has been derived from unaudited interim financial statements that, in the
opinion of management, include all adjustments (consisting primarily of
recurring accruals) necessary for a fair presentation of such information when
read in conjunction with Towne Services' financial statements and the related
notes thereto appearing elsewhere in this prospectus. The operating results for
any quarter are not necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------------------------------------
MARCH JUNE SEPTEMBER DECEMBER MARCH JUNE SEPTEMBER DECEMBER MARCH
1996 1996 1996 1996 1997 1997 1997 1997 1998
----- ----- --------- -------- ----- ----- --------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues...................... $ 6 $ 19 $ 29 $ 51 $ 97 $ 88 $ 198 $ 340 $ 548
Costs of processing, servicing
and support................. 17 32 41 130 103 150 222 357 374
Research and development...... 0 2 0 50 11 34 114 173 74
Sales and marketing........... 15 34 31 38 94 118 207 421 486
Stock compensation expense.... 0 0 0 10 0 0 0 0 5,972
General and administrative.... 24 74 70 190 170 181 268 521 1,347
---- ----- ----- ----- ----- ----- ----- ------- --------
Total costs and expenses...... 56 142 142 418 378 483 811 1,472 8,253
---- ----- ----- ----- ----- ----- ----- ------- --------
Operating loss................ (50) (123) (113) (367) (282) (395) (613) (1,132) (7,705)
---- ----- ----- ----- ----- ----- ----- ------- --------
Interest (income) expense,
net......................... 0 2 2 2 19 26 29 22 64
Other expense (income)........ 0 0 0 3 (1) 0 0 0 0
Financing costs for stock
issued to nonemployees...... 0 0 0 0 0 0 0 0 323
---- ----- ----- ----- ----- ----- ----- ------- --------
Total other expenses.......... 0 2 2 5 18 26 29 22 387
---- ----- ----- ----- ----- ----- ----- ------- --------
Net loss...................... $(50) $(125) $(115) $(372) $(300) $(421) $(642) $(1,154) $ (8,092)
==== ===== ===== ===== ===== ===== ===== ======= ========
Net loss attributable to
common shareholders......... $(50) $(125) $(115) $(372) $(300) $(421) $(642) $(1,154) $(13,411)
==== ===== ===== ===== ===== ===== ===== ======= ========
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------------------------------------
MARCH JUNE SEPTEMBER DECEMBER MARCH JUNE SEPTEMBER DECEMBER MARCH
1996 1996 1996 1996 1997 1997 1997 1997 1998
----- ----- --------- -------- ----- ----- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues...................... 100% 100% 100% 100% 100% 100% 100% 100% 100%
Costs of processing, servicing
and support................. 283 168 141 255 106 170 112 105 68
Research and development...... 0 11 0 98 12 39 58 51 14
Sales and marketing........... 250 179 107 75 97 134 105 124 89
Stock compensation expense.... 0 0 0 20 0 0 0 0 1,090
General and administrative.... 400 389 241 372 176 206 135 153 246
---- ----- ----- ----- ----- ----- ----- ------- --------
Total costs and expenses...... 933 747 490 819 391 549 410 433 1,506
---- ----- ----- ----- ----- ----- ----- ------- --------
Operating loss................ (833) (647) (390) (719) (291) (449) (310) (333) (1,406)
---- ----- ----- ----- ----- ----- ----- ------- --------
Interest (income) expense,
net......................... 0 11 7 4 20 30 15 6 12
Other expense (income)........ 0 0 0 6 (1) 0 0 0 0
Financing costs for stock
issued to nonemployees...... 0 0 0 0 0 0 0 0 59
---- ----- ----- ----- ----- ----- ----- ------- --------
Total other expenses.......... 0 11 7 10 19 30 15 6 71
---- ----- ----- ----- ----- ----- ----- ------- --------
Net loss...................... (833)% (658)% (397)% (729)% (310)% (479)% (324)% (339)% (1,477)%
==== ===== ===== ===== ===== ===== ===== ======= ========
Net loss attributable to
common shareholders......... (833)% (658)% (397)% (729)% (310)% (479)% (324)% (339)% (2,447)%
==== ===== ===== ===== ===== ===== ===== ======= ========
</TABLE>
24
<PAGE> 26
During the Company's short history, its operating results have varied
significantly and are likely to fluctuate significantly in the future as a
result of a combination of factors. These factors include: whether or not the
market accepts current and future products and services; whether new competitors
emerge or existing competitors gain market share faster than Towne Services;
whether new technologies are developed which make Towne's systems outdated or
obsolete; whether costs of doing business increase as a result of higher wages,
sales commissions, taxes and other operating costs; whether seasonal trends in
consumer purchasing impact the volume of transactions processed; general
economic factors and the impact of potential acquisitions to Towne's operations.
In addition, the amount of revenues associated with particular set-up fees can
vary significantly based upon the number of products used by customers for any
particular period. Towne Services establishes its expenditure levels for product
development, sales and marketing and other operating expenses based, in large
part, on its anticipated revenues. As a result, if revenues fall below
expectations, operating results and net income are likely to be adversely and
disproportionately affected because only a portion of the Company's expenses
vary with its revenues.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, Towne Services has financed its operations primarily
through sales of its equity securities in private placements and through
borrowings under the Sirrom Loan Facility. Through December 1997, the Company
received aggregate net proceeds of $4.3 million from the sale of its common
stock. In March 1998, the Company received net proceeds of $1.5 million from the
sale of its Series A Preferred Stock in a private placement.
On December 18, 1997, Towne Services entered into the Sirrom Loan Facility
under which it borrowed $1.5 million for general working capital purposes. At
March 31, 1998, $1.5 million remained outstanding under the Sirrom Loan
Facility. At March 31, 1998, the Company also had two lines of credit under
which it could borrow up to a total of $750,000 and no amounts were outstanding
under these credit facilities. These lines of credit were obtained for working
capital purposes, and one of them was guaranteed by various officers and
directors of the Company. On June 5, 1998, Towne Services entered into the
Citizens Loan under which it borrowed $500,000 to purchase some of the assets
and liabilities of Credit Collection Solutions, Inc. The terms of the Sirrom
Loan Facility, the lines of credit and the Citizens Loan require the Company to
satisfy certain covenants and place certain restrictions on the Company's
ability to declare and pay dividends, incur additional debt and enter into
agreements for mergers, acquisitions or sales of substantial assets. The Sirrom
Loan Facility matures on December 18, 2002 and accrues interest at 14% per year.
The first line of credit is for $500,000, matures on July 10, 2000, is secured
by certain lease contracts on point of sale terminals and accrues interest at
the lender's prime rate plus 1/2%. The second line of credit was for $250,000,
matured on June 4, 1998 and accrued interest at the lender's prime rate. The
Citizens Loan matures on September 3, 1998 and accrues interest at 8.5% per
year. Towne Services plans to terminate the Sirrom Loan Facility, the lines of
credit and the Citizens Loan after completion of this offering. The Company
currently is negotiating with certain other financial institutions to establish
a credit facility for future working capital and acquisition financing, but
there can be no assurance that such negotiations will be successful.
Net cash used in operating activities was approximately $2.1 million for
the year ended December 31, 1997 and $1.5 million for the quarter ended March
31, 1998. Net cash used in operating activities during 1997 represents a $2.5
million net loss partially offset by a $600,000 increase in accounts payable and
accrued expenses, $120,000 of growth in accounts receivable and a $260,000
increase in prepaid expenses and other assets. Net cash used in operating
activities for the quarter ended March 31, 1998 represents a net loss of $8.1
million partially offset by a $600,000 increase in accounts payable and accrued
expenses, $240,000 of growth in accounts receivable and a $150,000 increase in
prepaid expenses and other assets.
Cash provided by financing activities of $5.0 million in 1997 and another
$2.7 million in the first quarter of 1998 consisted primarily of the proceeds
from the issuance of securities and a five year note payable for $1.5 million.
Purchase of computer equipment used in conducting the Company's business
represented the primary component of cash used in investing activities.
25
<PAGE> 27
As of March 31, 1998, the Company had $3.5 million in cash and cash
equivalents. The net proceeds from this offering remaining after deducting (i)
underwriting discounts, (ii) estimated offering expenses, and (iii) the
repayment of the indebtedness outstanding under the Sirrom Loan Facility and the
Citizens Loan are expected to total approximately $25.4 million. Towne Services
believes that such remaining net proceeds, together with existing cash and cash
equivalents and cash generated from operations, will be sufficient to fund its
anticipated operating costs and to meet its anticipated working capital and
liquidity needs for the next 12 months. The Company currently intends to use
such remaining net proceeds for working capital and general corporate purposes,
including enhancing its sales and marketing efforts, expanding its products and
services and for possible acquisitions. However, no assurance can be made with
respect to the actual timing and amount of the expenditures and any
acquisitions. In addition, no assurance can be given that the Company will
complete any acquisitions on terms favorable to the Company, if at all, or that
additional sources of financing will not be required during these time periods
or thereafter. The Company's estimates are forward looking statements that are
subject to risks and uncertainties. Actual results and working capital needs
could differ materially from those estimated due to a number of factors,
including the factors discussed under "Risk Factors."
EFFECTS OF ACCOUNTING STANDARDS
SFAS No. 121, "Accounting for Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" issued by the Financial Accounting
Standards Board ("FASB") requires the Company to review for impairment, and
potentially write down, the carrying values of long-lived assets and certain
identifiable intangibles to be held and used by the Company. The Company adopted
SFAS No. 121, effective January 1, 1996, with no material impact on its
financial statements. The Company periodically reviews the values assigned to
long-lived assets, such as property and equipment, to determine if any
impairments are other than temporary. Management believes that the long-lived
assets in the accompanying financial statements are appropriately valued.
SFAS No. 123, "Accounting for Stock Based Compensation" establishes a fair
value based method for financial accounting and reporting stock-based employee
compensation plans or similar equity instruments. Companies may elect to
continue to measure compensation cost for those plans using the method of
accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees." Entities electing to remain with the
accounting in APB No. 25 must make pro forma disclosures of net income and, if
presented, earning per share, as if the fair value-based method of accounting
defined in SFAS No. 123 had been applied. The Company has elected to account for
its stock-based compensation plan under APB No. 25 but has computed, for pro
forma disclosure purposes, the value of all options granted during 1996, 1997
and the first quarter of 1998 using the minimum value option pricing model as
prescribed by SFAS No. 123. See Note 5 of notes to Towne Services' financial
statements. Towne currently employs all of its employees pursuant to a
co-employment agreement under which a third party provides certain benefits to
and pays the wages of these employees. See "Business -- Employees." The FASB is
currently deliberating the definition of "employee" under APB No. 25 in
connection with employee leasing and co-employment agreements. In the event that
the FASB issues a final statement concluding that personnel under co-employment
relationships are not employees of the business for which they perform services
for purposes of APB No. 25, the Company would have to change its accounting for
stock options issued to its employees to account for such options at their fair
value as required for options granted to non-employees under SFAS No. 123. Such
a change in accounting may have a material adverse effect on the operating
results of the Company. See Note 7 of notes to Towne Services' financial
statements.
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share." SFAS
No. 128 establishes standards for computing and presenting earnings per share.
The Company adopted the new guidelines for the calculation and presentation of
earnings per share, and all prior periods have been restated. Basic loss per
share is based on the weighted average number of shares outstanding. Diluted
loss per share is based on the weighted average number of shares outstanding and
the dilutive effect of common stock equivalent shares issuable upon the exercise
of stock options and warrants (using the treasury stock method). See Note 2 of
notes to Towne Services' financial statements for a reconciliation of net loss
attributable to common shareholders under SFAS No. 128.
26
<PAGE> 28
BUSINESS
GENERAL
Towne Services designs, develops and markets products and services that
convert the in-house credit transactions of small businesses into automated
"virtual credit card" accounts which are processed electronically. Usually,
in-house credit transactions are completed without a credit card or cash, are
recorded and processed manually and then billed to the customer at a later date.
To automate this process, Towne Services offers two main electronic processing
systems, TOWNE CREDIT(SM) and TOWNE FINANCE(SM), which process small business'
in-house credit transactions in much the same way as credit card transactions
are processed.
The TOWNE CREDIT system electronically processes in-house consumer credit
transactions of small and medium size retail merchants. The TOWNE FINANCE
system, a commercial version of TOWNE CREDIT, is an automated asset management
and financing system that processes business-to-business credit transactions for
small commercial businesses. Through the use of Towne's products and services,
small businesses can automate certain manual processes, accelerate cash flow,
provide better customer service, reduce paperwork and shift many other
administrative burdens to Towne Services. In addition, Towne provides
complementing products and services to banks that enable them to generate
interest-bearing revolving credit accounts by financing the accounts receivable
of these small businesses. Through the use of Towne's products, banks can
monitor customers' accounts receivable and generate detailed status reports and
may attract new business customers who, in turn, may become customers of Towne
Services.
Towne's electronic processing systems enable businesses to offer in-house
credit to their customers at costs comparable to traditional credit card
transactions. As with credit card transactions, the business pays a discount fee
to the bank on each transaction. In addition, the business' customer pays
interest and fees to the bank for amounts owed by the customer for purchases
made on in-house credit. The discount fees and interest create a pool of funds
from which Towne Services collects its transaction fees, thereby generating
recurring revenue. The remaining amounts generate fee income for the bank. Towne
Services also generates non-recurring revenue by charging its business and bank
customers initial set-up fees.
TOWNE SERVICES' MARKET
Towne Services provides its products and services to retail merchants and
small commercial businesses that extend in-house credit to their customers and
to the banks these businesses use. The electronic payments processing industry
generally has not offered Towne's target customers a way to process their
in-house credit transactions electronically, focusing instead on credit and
debit card transactions. Maintaining and processing manual in-house charge
accounts can be time consuming and costly -- the business owner usually records
data by hand, updates books and records, purchases supplies for rendering
invoices, prepares and mails statements and collects payment. These businesses
often must wait weeks or even months to receive their money. Historically, banks
have not provided accounts receivable financing due to their inability to
control the assets securing the business' loan, the costly administrative
burdens and the lack of timely information.
A variety of small and medium size retail merchants use the TOWNE CREDIT
system, including hardware stores, clothing stores, florists, auto parts stores,
pharmacies and private clubs. Towne Services markets the TOWNE FINANCE products
and services to small commercial businesses, such as furniture manufacturers,
equipment distributors, plumbing suppliers and other industry supply stores.
Towne Services believes there are more than 5 million small and medium size
retail merchants and 12 million small commercial businesses in the United
States. Many of these small businesses extend in-house credit and process these
credit transactions manually. Towne's processing systems allow small businesses
to automate these in-house accounts and provide a convenient service to
customers who prefer to purchase items on credit.
Towne Services believes that most community banks desire to establish and
maintain close relationships with members of the communities in which they do
business, including the small businesses. Towne Services believes that the
market for its electronic processing products and services is largely untapped,
as most electronic payment processing companies focus on larger businesses and
on credit and debit card transactions which may be less convenient and are
subject to terms established by the credit card company or debit card
27
<PAGE> 29
issuer. In addition, the Company believes its TOWNE CREDIT and TOWNE FINANCE
systems are well-designed to help banks that service small businesses provide
accounts receivable financing and other bank products and programs that may
attract new business and generate a new source of fee income for the bank.
TOWNE SERVICES' STRATEGIES
Towne Services has grown significantly since the release of TOWNE CREDIT in
June 1997. The total number of sales people, bank contracts and business
customers for TOWNE CREDIT and TOWNE FINANCE as of the end of each of the last
12 months follows:
<TABLE>
<CAPTION>
1997 1998
---------------------------------------- ----------------------------------------
JULY AUG. SEPT. OCT. NOV. DEC. JAN. FEB. MARCH APRIL MAY JUNE
---- ---- ----- ---- ---- ---- ---- ---- ----- ----- --- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Sales people................. 8 9 13 14 11 15 16 17 33 45 54 61
Bank contracts............... 34 41 41 58 65 74 85 97 122 130 152 177
Business customers........... 38 49 59 69 81 96 117 135 161 189 225 279
</TABLE>
Towne's goal is to continue to grow significantly to become one of the
leading providers of electronic processing products and services for the
in-house credit transactions of small and medium size businesses in the United
States. Towne Services plans to attain this goal by implementing the following
key business strategies:
Expand Direct Sales and Marketing Efforts Nationwide
Since the release of TOWNE CREDIT, Towne Services has expanded its direct
sales and marketing force from 7 persons in 3 states to 61 persons located in 25
states. Of this total, 30 persons are dedicated to developing bank customer
relationships and 31 are focused on developing small business customers. Towne
intends to continue aggressively hiring sales and marketing personnel nationwide
to strengthen its direct marketing efforts, increase its customer base and
expand into new markets. Towne Services recently retained a marketing firm to
help develop new marketing materials and expand its advertising efforts across
the country. Towne also plans to increase its participation in conventions,
seminars and trade programs which cater to small and medium size businesses and
the banks that service these businesses across the United States.
Continue to Leverage Bank Relationships
The executive officers and directors of Towne Services have an average of
over 15 years experience in the electronic processing and financial services
industries, and 7 members of its board of directors either run banks or run
companies that have banks as customers. Towne's management leverages these
expertise and contacts to develop relationships with banks and banking
organizations. These banks market Towne's products and services to small
businesses in their communities. Through these relationships, Towne Services
believes it attracts business customers that would be difficult to reach through
traditional marketing methods. In addition, Towne intends to provide new
products and services, such as a lease financing and processing system currently
being developed, that may allow banks to attract new customers for both the
banks and Towne Services. Towne Services plans to sign additional agreements
with existing bank customers to offer its new products and services and to
leverage these relationships to develop new bank customers in its current and
future markets.
Enter New Relationships For Marketing and Product Enhancements
Towne Services has established marketing and other business relationships
that enhance its products and services and its channels of distribution. Towne
has agreements with several companies whose products and services complement the
TOWNE CREDIT and TOWNE FINANCE systems, including Datamatx Inc., Wallace and de
Mayo P.C. and Cash Management Services, Inc., which provide statement processing
services, collection services and lockbox management services. Towne Services
also has agreements with entities that have banks as their customers, such as
Phoenix International Ltd., Inc. and The Bankers Bank of Kentucky,
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under which these other companies and organizations encourage their bank
customers to use Towne's systems. Towne intends to enter more relationships with
companies that can expand the number of its products and services, complement
its existing and future systems and provide access to large groups of banks and
small businesses.
Maximize Electronic Link to Customers
When a business customer installs TOWNE CREDIT and TOWNE FINANCE, it
establishes an electronic link with Towne Services. Towne intends to maximize
this electronic distribution channel by developing and implementing multiple
products and services that the customer can access through its connection to
Towne Services to help automate its operations, run its business more
efficiently and provide better service for its customers. Towne Services plans
to use this electronic connection to cross-market both existing and new products
and services to its customers, which should allow it to develop and maintain
long-term customer relationships.
Acquire Complementary Companies and Products
Towne Services intends to acquire providers of complementary products and
services that may enhance and expand its operations, product and service
offerings, market share or geographic presence. For example, Towne Services
recently acquired some of the assets and liabilities of Credit Collection
Solutions, Inc., a company that has developed computer software for processing
payments and tracking collections. For more information on this acquisition,
please see "-- Acquisitions of Complementary Companies and Products."
PRODUCTS AND SERVICES
Towne Services designs its products and services to be simple to use, fast
and reliable. Towne's automated processing systems, TOWNE CREDIT and TOWNE
FINANCE, process in-house credit transactions for small businesses in much the
same way as credit card transactions are processed.
TOWNE CREDIT
TOWNE CREDIT is an automated transaction processing system designed for
consumer-based credit transactions conducted by small businesses. The system
uses remote point of sale terminals and communications networks to capture and
transmit transaction data and generate a "virtual credit card" account funded by
a business' bank. A typical in-house credit transaction for Towne Services'
business customers is processed through TOWNE CREDIT as follows:
Step 1: The participating business sells goods or services on an
in-house account. No money changes hands and no credit cards are used.
Step 2: The business enters sales information at the point of sale
into an electronic cash register or computer terminal loaded with Towne
Services' proprietary computer software.
Step 3: The business owner closes out its daily transactions and
electronically transmits transaction data to Towne Services through the
computer system across telecommunications lines.
Step 4: Towne Services processes the data, calculates receivables,
performs other accounting functions and transmits reports to the business
and its community bank upon request by the next business day.
Step 5: The community bank retrieves the sales and payment
information and advances funds to the business' bank account based upon
pre-set lending terms.
Step 6: Towne Services bills the business' customer, collects and
processes the customer's payment and transmits payment information to the
bank for credit to the business' bank account.
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Steps 1 and 2. When a customer makes a purchase on account, a store clerk
records the transaction on a point of sale terminal provided by Towne Services.
The PC-based terminal stores names and addresses of customers, account balances
and payment activity, which the business owner can retrieve quickly at the point
of sale. The business can use this terminal instead of the traditional cash
register, as it will record and store information from cash sales and credit and
debit card transactions. Businesses that do not want a new terminal can have the
TOWNE CREDIT software loaded on an existing computer. The TOWNE CREDIT system
captures the transaction data, including dollar amount and customer information,
for use in billing, tracking inventory and generating sales and tax reports.
The bank leases the TOWNE CREDIT point of sale terminal from Towne Services
and provides it to the business. The Company customizes and regularly updates
the software that drives the terminals and provides terminal maintenance
services for its customers.
Steps 3 and 4. On a daily basis, the business owner or manager transmits
the sales activity by batch to the Company's computer processing center in
Norcross, Georgia, across an ordinary telephone line or Internet connection.
Towne's customer communication software enables it to support a wide range of
business customers, including those in rural areas that might otherwise have
difficulty in transmitting data because of unstable land line communications.
Towne Services' communications and computer processing systems are flexible
and scalable, meaning that it can add more processing capacity, increase
processing speed and support numerous customer operating systems and data
protocols. The Company's electronic processing network is capable of
simultaneously managing batches of transactions from multiple businesses and
data from numerous days' transactions from a single business. Towne's system
provides for the redundant capture of transaction data at both the point of sale
terminal and at its communications network center. This data capture redundancy
helps to protect the business and the Company against potential loss of data.
Towne's systems process data from purchase transactions, calculate
receivables, post these transactions and perform other accounting functions
automatically. Towne Services can program its systems to generate daily
customized receivables, ledger and other reports used by its customers to manage
their businesses. The Company's network systems then transmit reports to
businesses and their banks by the business day following receipt of transaction
data.
Steps 5 and 6. The community bank that serves the business usually offers
a line of credit, in which case the bank funds the prior day's sales at
discounts similar to those in major credit card transactions. Through a graphic
interface with the Company's communications server, the bank has daily access to
the information it needs to finance the business' accounts receivable. If no
line of credit is in place, the business' funds are deposited at the bank as
they are collected by the Company. TOWNE CREDIT works with the bank's current
loan processing systems and creates the general ledger account entries necessary
for the bank to account for the line of credit loans to the business. Towne
Services assumes no credit risk from business customers in these transactions.
With TOWNE CREDIT, many administrative burdens of running a small business
are outsourced to Towne Services. The Company generates and prints statements
and sends them to the business' customers. Towne Services maintains an automated
lock box through which payments can be received. The lock box gives the business
the benefit of controlled remittance processing and allows the bank to control
the payments associated with the accounts, thus applying them to the outstanding
loan balance. If a customer chooses to pay the business directly when he or she
receives the bill, the business owner can record that payment in the point of
sale terminal to be processed electronically on the Company's system. The system
allows businesses to quickly track account balances and payment history and
verify customer transaction information by checking the receivables reports
generated or, if needed, by dialing into Towne's processing network to verify or
update information.
Towne Services also settles payments for its customers. Settlement involves
managing a record of each business transaction and transferring funds received
to the business' community bank for credit to its bank
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account. The Company transmits, upon request, transaction information directly
to the bank and arranges for funds to be transferred from its automated lock box
via Automated Clearing House (ACH) or Fedwire transfer to the community bank.
Funds are then transferred to the business' bank account via the bank's internal
deposit system. Settlement payments made to the business' bank account reflect a
discount from the full transaction price, which generally includes the Company's
processing fees.
TOWNE CREDIT enables businesses to streamline front desk and back office
procedures. Through TOWNE CREDIT, businesses receive accelerated funding for
in-house charge accounts and eliminate costly and inefficient manual processing.
Sales also may be enhanced by the business' ability to offer finance options,
such as sales on account, to its customers. The bank that serves the business
generates fee income in the form of transaction discounts and may profit from
interest-bearing consumer credit accounts. If the bank elects not to fund the
business' accounts receivable, the system still functions as an automated
billing and collection system, and the bank generates fee income. In both cases,
the TOWNE CREDIT processing system provides the Company with fee income.
TOWNE FINANCE
The Company's automated asset management and financing software system,
TOWNE FINANCE, is a commercial version of TOWNE CREDIT that addresses
business-to-business credit transactions. TOWNE FINANCE facilitates accounts
receivable financing for small commercial businesses by allowing these
businesses and their community banks to better manage and control assets that
fluctuate in value. TOWNE FINANCE transaction processing occurs in much the same
way as TOWNE CREDIT processing, but on a larger and more sophisticated basis.
For example, a furniture manufacturer may need additional working capital
to purchase raw materials and cover the incremental costs associated with
payroll and general overhead. The furniture manufacturer's traditional payment
terms can limit cash flow. By the time it invoices customers and receives
payment, many expenses associated with the finished product have been incurred.
With TOWNE FINANCE, the manufacturer has the ability to convert the invoices to
needed cash to finance its ongoing operations. TOWNE FINANCE enables financial
institutions to offer these businesses the same convenient services available to
its TOWNE CREDIT customers.
TOWNE FINANCE facilitates the process through which a bank can loan money
to a small commercial business. Using TOWNE FINANCE, banks can assign percentage
values to specific assets of its small business customers, such as accounts
receivable, inventory, real estate, furniture, fixtures and equipment. By
assigning these values, banks can develop a risk-based formula for lending to
their business customers. TOWNE FINANCE tracks the accounts receivable,
maintains a parallel aging of the accounts and allows the bank to control
advances and pay downs based on daily activity of new sales and account
payments. The system supports discretionary lines of credit as well as automatic
daily funding of eligible assets. TOWNE FINANCE works with the banks' current
loan processing systems and creates the general ledger account entries necessary
for community banks to account for these asset-based accounts receivable loans.
Once a bank customer agrees to use TOWNE FINANCE, the bank must approve a
credit line for the customer. After credit is established, the Company loads
historical invoice data onto its host computer. The bank will advance funds to a
customer at a discount to their aggregate value. The bank specifies a set of
standards at the processing level and assigns a loan officer to monitor the
credit as it would any other loan. Towne Services then takes over the statement
rendering and remittance processing functions for the bank much like it does for
TOWNE CREDIT. Access to an automated lock box allows the bank to control the
payments associated with the accounts and apply the payments to the outstanding
loan balance. After payments are received, Towne Services processes the payments
and transmits funds electronically to the customers' operating account at the
bank.
The bank provides a line of credit that is controlled using TOWNE FINANCE
daily processing and reporting functions. The bank retains all credit and
funding responsibility and the Company provides a specialized sales force, back
room processing and monitoring services. Towne Services assumes no credit risk
from the business' customers.
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TOWNE FINANCE allows community banks to provide a profitable and cost
effective accounts receivable financing program for its small commercial
customers. Community banks using TOWNE FINANCE gain interest-bearing loans on
funds (net of all processing expenses) and strengthen relationships with
business customers that experienced cash flow problems or that might have
otherwise turned to non-traditional lenders. Many non-traditional accounts
receivable lenders, however, are unable to process efficiently an accounts
receivable program based upon the small size of these small commercial customers
invoices. Therefore, Towne Services fills an underserved niche in the
marketplace.
Supporting Services and New Products
The Company provides an array of value-added services in connection with
its TOWNE CREDIT and TOWNE FINANCE processing systems, including marketing
programs and materials and collection services. Towne Services plans to design
and develop new and improved products and services to help its customers
automate their businesses and provide better service to their clients.
Marketing Programs and Materials. The Company's primary marketing tool is
its direct sales force. However, the Company also offers a number of services
designed to allow community banks to target businesses in their communities.
Towne Services provides advertising, marketing brochures and inserts and direct
mail to increase market penetration for its bank customers.
Collection Services. Towne's processing systems help its customers
identify delinquent accounts. Towne Services maintains an agreement with Wallace
and de Mayo, a national collections company, that enables its customers to have
on-line access to professional debt collection services. Towne Services
maintains an electronic interface with Wallace and de Mayo so account
information is readily delivered to assist in collecting past due amounts.
New Product Development. Towne Services plans to design and develop new
and improved products and services that small business customers can access
through their electronic connection to the Company to help automate their
businesses and provide better service to their clients. For instance, the
Company has recently commenced testing on an enhanced version of an automated
processing system that offers community banks the opportunity to set up formal
lease programs with local dealers, distributors and manufacturers of leased
products. This system, TOWNE LEASE(SM), is designed to provide documentation,
statement rendering and remittance processing for merchants and community banks
who desire to offer product leasing to their customers. The community bank will
be able to electronically transmit lease contract information to Towne Services
for entry into its host processing system. During the term of a lease, Towne
Services performs all servicing aspects of the lease. The community bank
accesses lease information and receives general ledger postings. Like TOWNE
CREDIT and TOWNE FINANCE, TOWNE LEASE is a technology designed to allow the
community bank to access, process and download their financial data from the
Company's computer network system.
ACQUISITIONS OF COMPLEMENTARY COMPANIES AND PRODUCTS
Towne Services intends to pursue acquisitions of providers of complementary
products and services that may enhance and expand its operations, product and
service offerings, market share and geographic presence. For example, on June
11, 1998 Towne Services acquired certain assets and liabilities of Credit
Collection Solutions, Inc. Credit Collection has developed computer software for
processing payments and tracking collections including Collection Works, an
operating system developed to address the debt collection needs of banks and
collection agencies. Pursuant to this acquisition, the Company agreed to assume
liabilities of approximately $510,000 and to issue up to 100,000 shares of its
common stock if certain financial results are achieved from the acquired assets
including Collection Works. Following the acquisition, Towne Services hired
Credit Collections' majority shareholder and president, who is experienced in
credit collection solutions. Towne Services' management believes this
acquisition advances its growth strategies by adding a complementary technology
solution and enhancing its customer base.
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SALES AND MARKETING
Towne Services employs a direct sales force of 61 persons located in 25
states. Towne's direct sales force develops relationships with banks and small
business customers. The Company employs two distinct sales forces to market its
products and services. The bank sales force focuses on developing relationships
with banks through which TOWNE CREDIT and TOWNE FINANCE are marketed to business
customers. The Company's business representatives call on small business
customers of banks that have contracted with Towne Services, as well as other
merchants who might use its products.
Towne Services has leveraged its board members' and senior managers'
expertise and contacts to develop relationships with community banks and banking
organizations. The Company has over 170 agreements with community banks located
in 18 states who work directly with Towne Services' sales force to market TOWNE
CREDIT and TOWNE FINANCE to the banks' customers. Through these relationships
with the community banks, Towne Services believes it attracts businesses that
would be difficult to reach through traditional marketing methods. Towne
Services believes that endorsements by local community bankers are the most
effective sales tools to reach small businesses. Banks often have long standing
relationships with the small business owners and provide immediate credibility
and access for Towne's products and services. Towne Services believes that its
relationships with the community banks enable it to attract small business
customers that would be difficult and expensive to reach when employing
traditional marketing methods.
Through its community bank contacts, Towne Services personnel arrange a
meeting with the bank's lending officers to introduce its products and services
and explain their potential benefits to the bank. At this meeting, Towne
Services distributes questionnaires to bank employees to gather information on
potential businesses that might be interested in TOWNE CREDIT or TOWNE FINANCE.
The bank then arranges a meeting with targeted local business owners to
introduce Towne Services and demonstrate its products. Towne Services provides
sales personnel, speakers, slide and video presentations and demonstration
equipment at these meetings. Towne's small business sales people are responsible
for follow up sales and service. During the weeks following the bank meeting,
the small business sales representatives will contact other attendees and
attempt to arrange one-on-one meetings with them.
Towne Services also markets TOWNE CREDIT and TOWNE FINANCE through several
companies that have merchants and community banks across the United States as
their customers or members. Towne Services has established strategic
relationships with companies such as Phoenix International Ltd., Inc. and The
Bankers Bank of Kentucky to cross-market its products and services to their
customers. In addition, Towne Services has agreements with Datamatx Inc.,
Wallace and de Mayo P.C. and Cash Management Services, Inc. to incorporate their
products into Towne's systems. These alliances enable Towne Services to reach
and provide services to large groups of community banks and small businesses in
new geographic markets. Towne Services will continue to pursue additional
alliances with companies and organizations that will provide the Company access
to large groups of banks and small businesses nationwide such as bankers banks,
trade associations and merchant franchise operations.
RECRUITING AND TRAINING
In June 1997, when TOWNE CREDIT was first released, Towne Services had 7
sales and marketing personnel. By December 31, 1997, the Company had more than
doubled its sales and marketing force to 15 persons. As of June 30, 1998, the
sales force had increased to 61 persons located in 25 states. Towne Services
hires sales personnel who are experienced in marketing products and services to
community banks and small businesses. Towne Services has an experienced in-house
recruiter who focuses full time on hiring sales personnel. In recruiting
experienced sales personnel, Towne Services focuses on hiring persons who have
established relationships with banks and small businesses in a particular
market.
Towne Services has developed a four-week training program for members of
its sales force led by Towne's training and sales managers. The first week
includes three days of instruction on point of sale systems and the Company's
policies and procedures, followed by two days of assisting on sales calls with
selected members of the bank and small business sales forces. During the second
week, the training focuses on more specific aspects of TOWNE CREDIT and TOWNE
FINANCE, such as installation and training, pricing models and a review of
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sales manuals. The two weeks of classes emphasize customer service and
presentation and communication skills. The sales representatives also spend an
additional two days during the second week participating in sales. Once the
representatives complete the training class, they are paired with a bank or
business sales representative for two weeks of training in the field working
with more experienced sales representatives. After satisfactory completion of
the four weeks of training, new members of the Company's sales force get
assigned to a territory.
TECHNOLOGY
The Company's electronic processing systems involve communicating data to
and from remote customer locations and Towne Services' computer processing
center. Towne Services uses its proprietary technologies together with third
party telecommunications networks to transmit and process transaction data for
its customers. Transactions are interactively processed and returned to the
sending system. Towne Services' systems can use telephone lines, internet
connections, satellite linkages and bank automated teller machine communication
lines to transport transaction data. This system architecture allows Towne
Services to access customers located across the country.
The Company designed its communications systems to support a large number
of telecommunications lines and high volumes of data traffic. This configuration
is scalable, allowing Towne Services to add new servers and new communications
lines as needed without having to rebuild its communications system. The
Company's communications servers process multiple data protocols. This allows
Towne Services to service a wide range of customers without requiring them to
change the communications systems they currently use.
Towne Services' communications and processing system servers can manage
data traffic across multiple time zones as well as balance both client/server
and on-line batch mode processing loads. This "cluster processing" uses multiple
servers that work in tandem. A bank of pentium-based processors work in a shared
network environment to co-process reporting jobs. The host processing system is
scalable which means the Company can add new servers to the processing pool to
increase throughput with minimal downtime.
Towne Services designed its systems using software and hardware capable of
interacting with the variety of operating platforms used by its customers,
including client/server and mainframe operating systems. Towne Services has
developed software to support a wide range of operating systems used by its
customers, including UNIX, RED HAT LINUX, MAC OS8, Windows NT and DOS based
systems. Towne Services' transaction reporting software is not hardware
dependent, which allows Towne Services to change its equipment to take advantage
of the most recent technologies in its operations. This could include a complete
change-over of operating systems and/or hardware.
The Company's computer processing system stores data redundantly (at both
the customer terminal location and at the Company's processing center) and in a
secure environment. Potential service interruptions are minimized by hosting the
client's data on multiple servers and locations so that no single hardware
failure would result in service interruption. In addition, the Company keeps
mirror servers on location, creates daily digital backup tapes and stores them
in fireproof safes and maintains a full "hot-site" backup processing center at
another location from its main processing center. The Company believes that its
system configuration and disaster recovery measures adequately protect it
against system failures that may occur due to destruction of its processing
center, natural disasters, bomb threats or other loss or impairment of its
network capabilities. See "Risk Factors -- Risk of Possible System Failure."
Towne Services designed its products and services to be simple to use, fast
and reliable. The Company dedicates significant resources to developing new
proprietary technologies to enhance services for its customers. The Company
believes its continuing investment in technology will allow it to remain
competitive in the industry.
CUSTOMERS
Many small businesses offer in-house credit as a means to better serve
their customers. Many community banks seek new ways to provide better services
for their customers while generating income for the bank. The
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electronic transaction processing industry generally has not offered these
businesses or banks a way to process their in-house credit transactions
electronically or provide accounts receivable financing, focusing instead on
credit and debit card transactions and on larger businesses.
The Company provides processing services to a diverse customer base of over
270 small and medium size retail merchants and small commercial businesses
located in 18 states. A variety of small and medium size retail merchants use
the TOWNE CREDIT system, including hardware stores, clothing stores, florists,
auto parts stores, pharmacies and private clubs. TOWNE CREDIT merchant customers
typically have $1 million or less in annual revenues. TOWNE FINANCE products and
services are marketed to small commercial businesses with $5 million or less in
revenues, such as furniture manufacturers, equipment distributors, plumbing
suppliers and agricultural supply stores.
The Company has executed over 170 contracts with banks in 18 states. Most
of the Company's current bank customers have asset sizes of $2 billion or less.
These bank customers market Towne's products and services to small businesses in
their communities. There are approximately 11,000 financial institutions in the
United States that the Company considers to be potential bank customers. Towne
Services believes that most of these community banks desire to establish
long-term relationships with these businesses and that TOWNE CREDIT and TOWNE
FINANCE are well-designed to help these banks obtain that goal.
The majority of the Company's contracts with its customers are cancelable
at will or on short notice or provide for renewal at frequent periodic
intervals, and, accordingly, the Company may have to rebid or modify such
contracts on a frequent basis. No single small business customer accounted for
more than 1% of the total revenues of the Company in 1997 or in the three months
ended March 31, 1998. No single bank customer accounted for more than 5% of the
total revenues of the Company in 1997. One bank customer accounted for
approximately 22% of the Company's total revenues for the three months ended
March 31, 1998 due to a comparatively large one time set-up fee. The Company
anticipates that one or more new customers will continue to account for large
portions of the revenues generated for the particular quarter in which the
underlying bank contract is signed. Towne Services believes that the identity of
bank customers accounting for large portions of revenues will change from
quarter to quarter and year to year.
CUSTOMER SERVICES
Towne's products are supported by two levels of customer service. First,
each customer bank provides first line customer service support to the merchants
on accounting and loan related issues. Second, Towne Services provides a help
desk for technical support for its network systems and terminals.
The Company is committed to providing superior service for its current
customer base. The Company provides many service features to its merchants,
including toll-free customer service and terminal support during business hours
and on an emergency basis. In addition, Towne Services provides emergency
48-hour hardware replacement, turnkey installation and training for new
merchants and flexible reporting capabilities, both in frequency and format.
Towne Services attempts to establish long-term relationships through the
continued support and interaction of professional account managers.
Towne Services maintains a staff of trained client service representatives.
This staff trains customers on the use of Towne's processing system and hardware
at the customer location. Customer service representatives provide technical
support for all of the Company's products and services through a call-in support
center available during normal business hours. After hours, customers can reach
the Company's technical support personnel by pager. These customer service
representatives respond to inquires about the Company's products and services
and assist merchants in resolving terminal, network and communication problems.
COMPETITION
Towne Services is aware of other companies who have successfully marketed
business-to-business software and marketing support to banks that allows the
banks to track and finance the in-house charge accounts of its customers similar
to a factoring operation. Most of these competitors do not offer a point of sale
system, but rather require merchants to forward paper invoices to the banks
where bank personnel input the
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invoices onto the software purchased by the banks. One such company has a system
similar to TOWNE FINANCE but does not market the system to banks, acting instead
as the lender itself.
The electronic transaction processing industry is intensely competitive.
Increased competition is likely from both existing competitors and new entrants
into its existing or future markets. The Company believes there are low barriers
to entry in its markets. Towne Services may not be able to compete successfully
as other companies develop new products and services, change prices, improve
customer service and hire additional personnel. Competitors may offer new
products and services resulting in greater competition and lower market share
for the Company. Many of the Company's competitors have longer operating
histories, greater name recognition, larger customer bases and substantially
greater resources than the Company. Competitors may be able to adapt more
quickly to new technologies and changes in customer requirements and may also be
able to devote greater resources to marketing.
TRADEMARKS AND OTHER PROPRIETARY RIGHTS
The Company attempts to protect itself through a combination of copyright
law, trademark and trade secret laws, employee and third party confidentiality
agreements and other methods. However, unauthorized parties may attempt to copy
aspects of the Company's technology, products and services or to otherwise
obtain and use information that the Company regards as proprietary, despite the
Company's efforts to protect them. Third parties may claim that the Company's
current or future products and services infringe the patent, copyright or
trademark rights of such third parties. No assurance can be given that, if such
actions or claims are brought, the Company will ultimately prevail. Any such
claims, whether with or without merit, could be costly and time consuming, cause
delays in introducing new or improved products and services, require Towne
Services to enter royalty or licensing agreements or discontinue using the
challenged technology and otherwise could have a material adverse effect on the
Company's business and financial results.
EMPLOYEES
At June 30, 1998, the Company had 107 full-time employees, of which 66 were
in sales and marketing, 29 were in operations and 12 were corporate and general
administrative employees. Of these employees, 53 were based in Norcross,
Georgia, and 54 were based in 24 other states. Towne Services employs all of its
employees pursuant to a co-employment agreement with Vincam Human Resources,
Inc. ("Vincam"). Pursuant to this agreement, Vincam (which is not an affiliate
of Towne Services) assumes certain employer's rights as to Towne Services
employees, including the obligation to pay wages, and Towne Services retains
supervision and control over the employees as necessary to conduct its business.
Vincam also provides certain benefits to the employees, such as group health
insurance and a 401(k) plan. Towne Services pays Vincam a management fee and
reimburses it for the employees' salaries and benefits. For Towne, the primary
purposes of this agreement are to reduce certain human resources-related costs
which Vincam can provide more efficiently due to economies of scale and to allow
Towne to provide its employees with benefits similar to those offered by much
larger companies. Towne believes that the individuals who are subject to the
Vincam agreement constitute common law employees of Towne and has received a
legal opinion from its legal counsel to that effect. As a result of Vincam's
obligation to pay the wages of Towne's employees, however, Towne believes that
for federal income tax withholding purposes the individuals subject to the
agreement with Vincam are treated as Vincam's employees. Towne Services does not
anticipate any material disruption in its business in the event of termination
of the agreement with Vincam. None of the Company's employees is represented by
a collective bargaining agreement nor has the Company ever experienced any work
stoppage. Management believes that the Company's relationship with its employees
is satisfactory.
SEASONALITY
The electronic transaction processing industry in general is prone to
seasonal fluctuations in purchase activity. Although the Company generally
experiences seasonality in its business, fluctuations are less pronounced than
in the industry, due in part to the Company's diverse customer base. The Company
expects its revenues will be higher in the third and fourth calendar quarters
and lower in the first calendar quarter of each year. The decline in retail
activity following the holiday season results in lower first quarter revenues.
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PROPERTY AND FACILITIES
The Company leases its principal executive offices in Norcross, Georgia and
does not maintain offices or facilities at other locations. The Company believes
that its current facilities will be adequate to support its operations for the
next 12 months.
LEGAL PROCEEDINGS
The Company may be involved from time to time in legal proceedings arising
in the normal course of its business. The Company is not a party to any pending
legal proceedings which it believes are material.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of Towne Services and their ages and
positions as of May 1, 1998, are as follows.
<TABLE>
<CAPTION>
NAME AGE CLASS(1) POSITION
- ---- --- -------- --------
<S> <C> <C> <C>
Drew W. Edwards........................ 33 III Chief Executive Officer and Chairman of
the Board of Directors
Henry M. Baroco........................ 54 II President, Chief Operating Officer and
Director
Bruce F. Lowthers, Jr.................. 33 -- Senior Vice President and Chief
Financial Officer
Cleve B. Shultz........................ 30 -- Executive Vice President and Secretary
G. Lynn Boggs.......................... 42 III Director
Frank W. Brown......................... 44 I Director
John W. Collins........................ 50 III Director
J. Stanley Mackin...................... 65 I Director
Joe M. Rodgers......................... 64 II Director
J. Daniel Speight, Jr.................. 41 I Director
Glenn W. Sturm......................... 44 II Director
J. Stephen Turner...................... 51 II Director
Bahram Yusefzadeh...................... 52 I Director
</TABLE>
- ---------------
(1) Class I term expires in 1999; Class II term expires in 2000; and Class III
term expires in 2001.
BIOGRAPHICAL INFORMATION
Drew W. Edwards is a co-founder of Towne Services and has been Chief
Executive Officer and Chairman of the Board of Directors since its formation.
From 1990 until forming Towne Services, Mr. Edwards served in various marketing
and management positions with The Bankers Bank in Atlanta, Georgia, most
recently as its Senior Vice President and Director of Sales and Marketing. The
Bankers Bank is a leading provider of correspondent banking services in the
southeastern United States. From 1987 to 1990, Mr. Edwards worked for the
Federal Reserve Bank of Atlanta.
Henry M. Baroco has been President, Chief Operating Officer and a director
of Towne Services since 1996. Mr. Baroco has over 30 years of experience with
various credit, leasing and lending organizations. Before joining Towne
Services, Mr. Baroco had been Senior Vice President and General Manager of the
vendor finance division of CIT Industrial Finance since September 1995. From
November 1993 to September 1995, he served as Senior Vice President of Sales and
Marketing for Norwest Equipment Finance. From April 1991 to November 1993, Mr.
Baroco was Senior Vice President and General Manager of Sales and Marketing for
LB Credit Corporation. Mr. Baroco also worked in various capacities for GE
Capital -- Vendor Financial Services for over 18 years.
Bruce F. Lowthers, Jr. has been Senior Vice President and Chief Financial
Officer of Towne Services since November 1997. Prior to joining Towne Services,
Mr. Lowthers had been Chief Financial Officer and Treasurer of Quest Group
International, Inc., a telecommunications company, since September 1994. From
June 1992 to September 1994, he was an audit manager with Ernst & Young, LLP.
Mr. Lowthers is a certified public accountant.
Cleve B. Shultz has been Executive Vice President of Towne Services since
April 1998. He served as the Company's Senior Vice President from January 1996
to April 1998. Prior to joining the Company, Mr. Shultz had been Vice
President-Marketing at The Bankers Bank in Georgia since August 1993. Before
joining The
38
<PAGE> 40
Bankers Bank, Mr. Shultz served as campaign director for Representative John
Linder's successful 1992 campaign for the U.S. House of Representatives, 4th
Congressional District of Georgia.
G. Lynn Boggs is a co-founder of Towne Services and has been a director
since its formation. Mr. Boggs has been Senior Vice President and branch manager
of Vining-Sparks Investment Banking Group, L.P., a fixed income broker-dealer to
financial institutions in Nashville, Tennessee, since June 1996. Mr. Boggs has
been in the securities industry for the past 12 years. From October 1994 to June
1996, he was Senior Vice President-Investments at PaineWebber, Inc. in
Nashville, Tennessee. From March 1993 to October 1994, he was Senior Vice
President -- Investments for Prudential Securities in Nashville. From 1989 to
March 1993, he was Senior Vice President of Vining-Sparks.
Frank W. Brown has been a director of Towne Services since March 1998. Mr.
Brown has been a principal with Brown, Burke Capital Partners, Inc. since 1991.
Brown, Burke Capital Partners provides financial advisory services to
community-oriented financial institutions and middle market corporations in
connection with mergers and acquisitions and financing. He is also the Managing
Member of Capital Appreciation Management Company, L.L.C., which is the managing
general partner of Capital Appreciation Partners, L.P., an Atlanta-based
merchant banking fund and a shareholder of Towne Services. From 1977 to 1991,
Mr. Brown worked in various corporate finance and investment banking positions
with Bankers Trust Company, The First Boston Corporation and The
Robinson-Humphrey Company.
John W. Collins has been a director of Towne Services since its formation.
Mr. Collins is currently the Chairman of the Board of Directors and Chief
Executive Officer of The InterCept Group, Inc., a publicly-traded provider of
fully-integrated electronic commerce products and services for community
financial institutions. Mr. Collins has over 25 years of experience in multiple
areas of electronic commerce for community financial institutions. Prior to
co-founding The InterCept Group in 1996, he had served as a director and
executive officer of several of its predecessor companies and subsidiaries since
1986.
J. Stanley Mackin has been a director of Towne Services since June 1998.
Mr. Mackin has been the Chairman of the Board of Directors of Regions Financial
Corporation since 1990 and served as its Chief Executive Officer from August
1990 to January 1998. Prior to joining Regions Financial as its President and
Chief Operating Officer in January 1990, Mr. Mackin had worked for Regions Bank
since 1966. He served as Chairman and Chief Executive Officer of Regions Bank
from 1986 to 1990, as President and Chief Executive Officer from 1983 to 1986,
and as head of the commercial loan division from 1971 to 1983.
Joe M. Rodgers has been a director of Towne Services since May 1998. He has
been Chairman of The JMR Group, a private investment company specializing in
merchant and investment banking, since February 1993. Mr. Rodgers served as
Chairman of the Board of Directors and Chief Executive Officer of Berlitz
International, Inc., a foreign language services company, from December 1991
until February 1993. From 1985 to 1989, Mr. Rodgers served as United States
Ambassador to France. Mr. Rodgers is also a director of AMR Corporation/American
Airlines, Inc.; American Constructors, Inc.; Gaylord Entertainment Company;
Gryphon Holdings, Inc.; Lafarge Corporation; SunTrust Bank, Nashville, N.A.;
Thomas Nelson, Inc.; Tractor Supply Company; and Willis Corroon Group, PLC.
J. Daniel Speight, Jr. has been a director of Towne Services since its
formation. Mr. Speight is the President, Chief Executive Officer and a director
of FLAG Financial Corporation, a bank holding company. He served as Chief
Executive Officer and a director of Middle Georgia Bankshares, Inc. from 1989
until its merger with FLAG Financial in March 1998. He has been President, Chief
Executive Officer and a director of Citizens Bank, a subsidiary of FLAG
Financial in Vienna, Georgia, since 1984. Mr. Speight is currently a director
(past chairman) of The Bankers Bank and a member of the State Bar of Georgia. He
is past Chairman of the Georgia Bankers Association Community Banking Committee,
past President of The Community Bankers Association of Georgia and past director
of the Independent Bankers Association of America.
Glenn W. Sturm has been a director of Towne Services since 1996. Mr. Sturm
has been a partner in the law firm of Nelson Mullins Riley & Scarborough, L.L.P.
since 1992, where he serves as Corporate Chairman and as a member of the
executive committee. Since 1996, Mr. Sturm has been a director of Phoenix
39
<PAGE> 41
International Ltd., Inc., a publicly-held provider of client/server retail
banking software to financial institutions in the United States and abroad. He
has also been a director of The InterCept Group since 1997.
J. Stephen Turner has been a director of Towne Services since 1997. He has
been the Chairman of the Board of Directors and Chief Executive Officer of FNB
Financial Corp., a bank holding company, since 1990. Mr. Turner is also a
director of Farmers National Bank in Scottsville, Kentucky. He has also been the
President and Chief Executive Officer of Allen Realty Corporation in Nashville,
Tennessee since 1988.
Bahram Yusefzadeh has been a director of Towne Services since 1997. Mr.
Yusefzadeh has been Chairman of the Board of Directors and Chief Executive
Officer of Phoenix International Ltd., Inc. since its formation in 1993. Mr.
Yusefzadeh has over 28 years of experience in the banking software industry. He
was a co-founder of Nu-Comp Systems, Inc., where he developed the Liberty
Banking System and served as Nu-Comp's President and Chief Executive Officer
from 1969 to 1986. Mr. Yusefzadeh also served as Chairman of the Board of
Directors of Broadway & Seymour, Inc. during 1986 and in various executive
capacities for The Kirchman Corporation from 1986 to 1992.
DIRECTOR COMPENSATION
Upon initial election to the board of directors, each non-employee director
receives options to acquire 30,000 shares of common stock, all of which vest
immediately. The Board of Directors recently approved a grant of 20,000 options
to all nonemployee directors, all of which vest immediately. Directors may be
reimbursed for out-of-pocket expenses incurred in attending meetings of the
board of directors or its committees and for other expenses incurred in their
capacity as directors. Directors do not receive cash fees for their services as
directors.
EXECUTIVE COMPENSATION
The following table summarizes the compensation paid or accrued by the
Company for services rendered during the year ended December 31, 1997 by the
Company's Chief Executive Officer and President, who were the only executive
officers whose total salary and bonus exceeded $100,000 (together, the "Named
Executive Officers") during such year. The Company did not grant any stock
appreciation rights or make any long-term incentive plan payouts during the
year.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
-------------------------------------------
OTHER
ANNUAL
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION
- --------------------------- ---- -------- -------- ------------
<S> <C> <C> <C> <C>
Drew W. Edwards..................................... 1997 $100,000 $100,000(1) $5,400(2)
Chief Executive Officer
Henry M. Baroco..................................... 1997 100,000 50,000 5,400(2)
President and Chief
Operating Officer
</TABLE>
- ---------------
(1) Mr. Edwards has voluntarily deferred receipt of his 1997 bonus amount until
completion of this offering.
(2) Represents automobile lease payments made by the Company.
EMPLOYMENT AGREEMENTS
Edwards and Baroco. Mr. Edwards and the Company entered into an employment
agreement effective as of October 15, 1995, pursuant to which he serves as the
Company's Chairman and Chief Executive Officer and currently receives a base
salary of $150,000 per year. Mr. Baroco and the Company entered into an
employment agreement effective as of January 15, 1997, pursuant to which he
serves as the Company's President and Chief Operating Officer and currently
receives a base salary of $150,000 per year. In addition, each of Mr. Edwards
and Mr. Baroco are entitled to incentive compensation as determined by the Board
of
40
<PAGE> 42
Directors or a committee thereof based upon achievement of targeted levels of
performance and other criteria established by the Board of Directors. Each of
Mr. Edwards and Mr. Baroco may participate in the Company's stock option plans
and also receive health insurance, civic and social club dues, an automobile
allowance or use of an automobile owned or leased by the Company and other
benefits. Mr. Edwards' and Mr. Baroco's base salaries may be increased
periodically by the Board of Directors or its compensation committee. Mr.
Edwards' and Mr. Baroco's employment agreements have terms of three years and
two years, respectively, and the agreements renew daily until either party fixes
the remaining term at three years or two years, as the case may be, by giving
written notice. The Company can terminate each agreement upon the death or
disability of the executive or for cause, and each executive may terminate his
employment for any reason after any occurrence of a change in control. If either
of Mr. Edwards' or Mr. Baroco's employment is terminated after a change in
control (i) by the Company without cause or otherwise in breach of his
agreement, or (ii) by Mr. Edwards or Mr. Baroco for any reason, the Company must
pay him all accrued compensation and bonus amounts and one-twelfth of his annual
base salary and bonus amounts for each of the 36 consecutive 30-day periods
following Mr. Edward's termination and 24 consecutive 30-day periods in the case
of Mr. Baroco. In addition, the Company would be required to continue life,
disability and health insurance for the executive until his death, and the
executive's outstanding options to purchase common stock would vest and become
immediately exercisable. Pursuant to Mr. Edwards' employment agreement, the
Company also granted to him piggyback and, if his employment is terminated for
any reason, demand registration rights with respect to the shares of common
stock then owned by him. See "Shares Eligible for Future Sale."
Lowthers and Shultz. Mr. Lowthers and the Company entered into an
employment agreement effective as of October 15, 1997, as amended on May 18,
1998, pursuant to which he serves as the Company's Chief Financial Officer and
receives a base salary of not less than $125,000 per year. Mr. Shultz and the
Company entered into an employment agreement effective as of May 19, 1998,
pursuant to which he serves as the Company's Executive Vice President and
receives a base salary of not less than $90,000 per year. Each agreement has a
term of one year, and the agreements renew daily until either party fixes the
remaining term at one year by giving written notice. The Company can terminate
each agreement upon the death or disability of the executive or for cause. Each
executive may terminate his employment if the Company breaches his employment
agreement or, in the case of Mr. Lowthers, if he is relocated outside of
Atlanta, Georgia metropolitan area without his consent. If either Mr. Lowthers'
or Mr. Shultz's employment is terminated by the Company prior to a change in
control or prior to completion of its initial public offering for any reason
other than the Company's material breach of his employment agreement, the
Company may repurchase all of the shares of common stock and options owned by
him at the prices paid by him or their then current fair market value, whichever
is greater.
MANAGEMENT BONUS PLAN
Under the Company's 1998 Management Bonus Plan, a bonus pool of $550,000
will be created if the Company meets its 1998 revenue and income goals, as
adjusted from time to time by the Board of Directors. All non-commission
employees are eligible for a percentage of the pool based on their seniority
level, length of employment and overall performance. If the 1998 revenue goal is
exceeded, the bonus pool will increase by $0.078 for every $1.00 beyond the
budgeted revenue goal, provided that the corresponding margins are in line with
the budget. If the bonuses are paid, the Company's executive officers will
receive the following percentages of the total bonus pool: Mr. Edwards, 20%; Mr.
Baroco, 20%; Mr. Lowthers, 15%; and Mr. Shultz, 12%. Bonuses are payable as
follows: 12.5% of the pool is payable following the end of each quarter if the
Company meets its goals for that quarter, and the remaining 50% of the pool is
payable following the end of the fiscal year if the Company has met its goals
for the entire year.
41
<PAGE> 43
OPTION GRANTS
The following table sets forth information concerning each grant of stock
options to the Company's executive officers during the year ended December 31,
1997:
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
----------------------------------------------------- VALUE AT ASSUMED
PERCENT ANNUAL RATES OF
NUMBER OF OF TOTAL STOCK PRICE
SECURITIES OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OR OPTION TERM(1)
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION ---------------------
NAME GRANTED FISCAL YEAR ($/SH) DATE 5%($) 10%($)
- ---- ---------- ------------ ----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Drew W. Edwards................. 59,523 5.8% 0.60(2) 1/24/07 22,460 56,919
Henry M. Baroco................. 59,523 5.8% 0.60(2) 1/24/07 22,460 56,919
Bruce F. Lowthers, Jr........... 300,000 29.4% 1.00(3) 11/03/07 188,668 478,123
Cleve B. Shultz................. 59,523 5.8% 0.60(2) 1/24/07 22,460 56,919
</TABLE>
- ---------------
(1) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can
be no assurance that the actual stock price appreciation over the term will
be at the assumed 5% and 10% levels or at any other defined level. Unless
the market price of the common stock appreciates over the option term, no
value will be realized from the option grants made to the executive
officers.
(2) Options were granted at the fair market value of the common stock on the
date of grant as determined by the board of directors, and vested
immediately.
(3) Options were granted at the fair market value of the common stock on the
date of grant as determined by the board of directors, and vest ratably over
three years beginning with the date of the grant.
The following table sets forth certain information regarding the exercise
of options and the number of options held by the Company's executive officers,
as of December 31, 1997:
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
SECURITIES UNDERLYING IN-THE-MONEY
OPTIONS(#) OPTIONS($)(1)
--------------------------- ---------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Drew W. Edwards.................................. 230,923 100,000 1,725,970 750,000
Henry M. Baroco.................................. 800,923 385,000 6,109,970 2,939,500
Bruce F. Lowthers, Jr............................ 75,000 225,000 525,000 1,575,000
Cleve B. Shultz.................................. 230,923 100,000 1,725,970 750,000
</TABLE>
- ---------------
(1) Based upon the price of the common stock to be sold in this offering, which
is $8.00 per share.
STOCK OPTION PLANS
1998 Stock Option Plan
The board of directors has approved the Company's 1998 Stock Option Plan,
effective as of May 19, 1998 (the "1998 Plan"). The purpose of the 1998 Plan is
to advance the interests of the Company, its subsidiaries and its shareholders
by affording certain employees and directors of the Company, as well as key
consultants and advisors to the Company or any subsidiary, an opportunity to
acquire or increase their proprietary interests in the Company. The objective of
the issuance of stock options and grants of restricted stock under the 1998 Plan
is to promote the growth and profitability of the Company and its subsidiaries
because the optionees and grantees will be provided with an additional incentive
to achieve the Company's objectives through participation in its success and
growth and by encouraging their continued association with or service to the
Company.
42
<PAGE> 44
Awards under the 1998 Plan are granted by the compensation committee of the
board of directors (the "Compensation Committee"), which at all times shall be
composed of at least two independent directors. Awards issued under the 1998
Plan may include incentive stock options ("ISOs") and/or non-qualified stock
options ("NQSOs") and/or grants of restricted stock. The Compensation Committee
will administer the 1998 Plan and generally has discretion to determine the
terms of an option grant, including the number of option shares, option price,
term, vesting schedule, the post-termination exercise period and whether the
grant will be an ISO or NQSO. Notwithstanding this discretion: (i) the number of
shares subject to options granted to any individual in any fiscal year may not
exceed 500,000 shares (subject to certain adjustments); (ii) if an option is
intended to be an ISO and is granted to a shareholder holding more than 10% of
the combined voting power of all classes of the Company's stock or the stock of
its parent or subsidiary on the date of the grant of the option, the option
price per share of common stock may not be less than 110% of the fair market
value of such share at the time of grant; and (iii) the term of an ISO may not
exceed 10 years, or 5 years if granted to a shareholder owning more than 10% of
the total combined voting power of all classes of stock on the date of the grant
of the option.
The maximum number of shares of common stock that currently may be subject
to outstanding options, determined immediately after the grant of any option, is
2,000,000 shares (subject to certain adjustments). The 1998 Plan provides that
the number of shares of common stock available for issuance thereunder shall be
automatically increased on the first trading day of each calendar year beginning
January 1, 1999 by the lesser of (i) three percent of the number of shares
outstanding on the preceding trading day or (ii) 500,000 shares (subject to
certain adjustments). Shares of common stock that are attributable to awards
which have expired, terminated or been canceled or forfeited during any calendar
year are available for issuance or use in connection with future awards during
such calendar year.
The Company's shareholders have approved the 1998 Plan, which will remain
in effect until terminated by the board of directors. The 1998 Plan may be
amended by the board of directors without the consent of the shareholders of the
Company, except that any amendment, although effective when made, will be
subject to shareholder approval within one year after approval by the board of
directors if the amendment increases the total number of shares issuable
pursuant to ISOs (other than the permitted annual increase), changes the class
of employees eligible to receive ISOs that may participate in the 1998 Plan, or
otherwise materially increases the benefits accruing to recipients of ISOs.
The Omnibus Budget Reconciliation Act of 1993 added Section 162(m) to the
Internal Revenue Code of 1986, as amended. Section 162(m) generally disallows a
public company's tax deduction for compensation to the chief executive officer
and four other most highly compensated executive officers in excess of $1
million in any tax year beginning on or after January 1, 1994. Compensation that
qualifies as "performance-based compensation" is excluded from the $1 million
deductibility cap and therefore remains fully deductible by the company that
pays it. The Company intends that options granted with an exercise price at
least equal to 100% of fair market value of the underlying stock at the date of
grant will qualify as such "performance-based compensation," although other
awards under the Stock Option Plan may not so qualify.
1996 Stock Option Plan
In November 1996, the Company adopted its 1996 Stock Option Plan (the "1996
Plan"). As of June 15, 1998, options to acquire 2,090,000 shares had been
authorized for issuance under the 1996 Plan, and options to acquire 1,728,400
shares were outstanding. All of such options were issued at the fair market
value of the common stock as determined by the board of directors based on the
Company's financial condition and prospects at such time and recent sales of the
securities of the Company. Effective May 19, 1998, the board of directors
determined that the Company will not issue any additional options under the 1996
Plan.
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<PAGE> 45
COMMITTEES OF THE BOARD OF DIRECTORS
The board of directors has established an Audit Committee, a Compensation
Committee and an Executive Committee. The Compensation Committee consists of
Messrs. Boggs, Brown, Speight, Sturm, Turner and Yusefzadeh. The Audit Committee
consists of Messrs. Rodgers, Speight and Turner, and the Executive Committee
consists of Messrs. Boggs, Brown, Collins, Edwards, Sturm and Yusefzadeh.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Thomas A. Bryan, who served as the chairman of the Compensation Committee
during 1997, served without compensation as the Treasurer and Secretary of the
Company from its inception in October 1995 until 1996.
On December 11, 1996, the Company entered into a $250,000 line of credit
with Citizens Bank, Vienna, Georgia, to fund its working capital needs. J.
Daniel Speight, Jr., a director of the Company, is the president and chief
executive officer of Citizens Bank. The interest rate for any borrowings under
the line of credit was 9.25% per year, but no money was drawn on this line of
credit. The following directors and officers personally guaranteed this line of
credit: Drew W. Edwards, Henry M. Baroco, Cleve B. Shultz, Thomas M. Bryan, G.
Lynn Boggs, John W. Collins and Glenn W. Sturm. In consideration of their
guaranties, the Company issued each of these directors and officers options to
acquire 71,400 shares of common stock at an exercise price of $0.50 per share.
This loan matured in December 1997 and was not renewed. On June 5, 1998, the
Company entered into the Citizens Loan under which it borrowed $500,000 to fund
its acquisition of assets and liabilities from Credit Collection Solutions. The
Citizens Loan matures on September 3, 1998 and accrues interest at a fixed rate
of 8.5% per year. The Company has from time to time obtained financing from
Citizens Bank for the purchase of specific furniture and equipment. The total
amount borrowed under these term loans was $90,000, and interest rates for these
loans range from 9.25% to 12.0% per year. As of March 31, 1998, $73,000 remained
outstanding under these term loans. See "Use of Proceeds."
On June 3, 1997, the Company entered into a $250,000 line of credit with
First Federal Savings Bank of LaGrange, Georgia, to fund its working capital
needs. Mr. Speight is the president and chief executive officer and a director
of FLAG Financial Corporation, the holding company for First Federal Savings
Bank of LaGrange. The interest rate for this loan was the lender's prime rate,
and there have been no borrowings under this line of credit. Messrs. Edwards,
Baroco, Shultz, Bryan, Boggs, Collins and Sturm personally guaranteed this loan.
In consideration of their guaranties, the Company issued each of these directors
and officers options to acquire 59,523 shares of common stock at an exercise
price of $0.60 per share. FLAG Financial Corporation is the bank holding company
for several customer banks of the Company. These bank customers have not
generated a material amount of revenues for the Company in prior periods but the
Company anticipates that these customer banks will generate revenues for the
Company in 1998 in excess of 5% of the Company's revenues for 1997.
On March 13, 1998, the Company entered into a Stock Purchase Agreement with
Capital Appreciation Partners, L.P. under which Capital Appreciation Partners
purchased 15,000 shares of the Series A Preferred Stock for $1.5 million. Frank
W. Brown is the Managing Member of Capital Appreciation Management Company,
L.L.C., the general partner of Capital Appreciation Partners, and became a
director of the Company as a result of the stock purchase. Pursuant to the Stock
Purchase Agreement, Messrs. Edwards, Baroco, Boggs, Bryan and Shultz agreed,
with certain exceptions, not to sell any of the shares of common stock in the
Company without first offering the right to sell stock on the same terms to
Capital Appreciation Partners. These co-sale rights terminate upon completion of
an underwritten initial public offering of the Company's common stock in which
gross proceeds to the Company exceed $20 million and the product obtained by
multiplying (x) the public offering price per share times (y) the number of
shares of common stock to be outstanding after the offering, including the
common stock issuable upon conversion of the Series A Preferred Stock but
excluding warrants and options, exceeds $80 million. Capital Appreciation
Partners also has certain registration rights with respect to the shares of
common stock issuable upon conversion of the Series A Preferred Stock. See
"Shares Eligible For Future Sale." In addition, Brown Burke
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<PAGE> 46
Capital Partners, of which Mr. Brown is a partner, purchased 100,000 shares of
common stock from the Company at a price of $1.00 per share in October 1997 and
50,000 shares of common stock upon the exercise of options at an exercise price
of $1.25 per share in March 1998.
The Company and Phoenix International Ltd., Inc. entered into a General
Marketing Agent Agreement, dated as of June 5, 1998, under which Phoenix
International agrees to market Towne's products and services to Phoenix
International's bank customers. Bahram Yusefzadeh, a director and member of the
Compensation Committee of Towne Services, is the Chairman of the Board and Chief
Executive Officer of Phoenix International and Glenn W. Sturm is a director of
both companies and serves on Towne's Compensation Committee.
From November 1, 1995 through May 1, 1996, the Company borrowed $45,000
from each of Mr. Boggs, a director and principal shareholder, and Mr. Bryan, a
principal shareholder. The Company executed promissory notes and loan agreements
to evidence these loans. Each of these loans accrued interest at the rate of 7%
per year, and had principal payments due on October 31, 1998, 1999 and 2000.
Messrs. Boggs and Bryan agreed to subordinate the Company's obligations under
these loans to its obligations to other creditors of the Company. As of December
1997, these loans have been paid in full.
On March 31, 1997, the Company loaned $450,000 to J. Stephen Turner, a
director, to fund the purchase of 450,000 shares of common stock. Interest
accrued at 6.0% per year until May 31, 1997 and 8.0% per year thereafter until
paid. Mr. Turner pledged the shares of common stock received upon this purchase
as collateral for the loan. Mr. Turner paid this note in full prior to May 31,
1997.
45
<PAGE> 47
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's common stock as of July 1, 1998 and as adjusted to
reflect the sale of the common stock offered hereby with respect to: (i) each of
the Company's directors and executive officers; (ii) each person known by the
Company to own beneficially more than 5% of the common stock; (iii) each selling
shareholder; and (iv) all directors and executive officers of the Company as a
group. Unless otherwise indicated, each of the holders listed below has sole
voting power and investment power over the shares beneficially owned, and each
person known by the Company to beneficially own more than 5% of the common stock
has an address in care of the Company's principal office.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED PRIOR TO SHARES BENEFICIALLY
OFFERING(1) NUMBER OF OWNED AFTER OFFERING(1)
---------------------- SHARES ------------------------
NAME NUMBER PERCENTAGE OFFERED(2) NUMBER PERCENTAGE
- ---- --------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
DIRECTORS AND EXECUTIVE OFFICERS
Drew W. Edwards(3)......................... 2,010,490 14.7% 95,239 1,915,251 10.0%
Henry M. Baroco(4)......................... 1,426,133 10.0 82,857 1,343,276 6.8
Bruce F. Lowthers, Jr.(5) ................. 279,033 2.1 279,033 1.5
Cleve B. Shultz(6)......................... 627,935 4.6 38,095 589,840 3.1
G. Lynn Boggs(7)........................... 1,725,923 12.8 168,095 1,557,828 8.3
Frank W. Brown(8).......................... 1,367,903 9.4 1,367,903 7.3
John W. Collins(9)......................... 512,623 3.8 512,623 2.7
J. Stanley Mackin(10)...................... 50,000 * 50,000 *
Joe M. Rodgers(11)......................... 271,648 2.0 271,648 1.5
J. Daniel Speight, Jr.(12)................. 431,700 3.2 47,619 384,081 2.0
Glenn W. Sturm(13)......................... 360,923 2.7 360,923 1.9
J. Stephen Turner(14)...................... 552,500 4.1 552,500 3.0
Bahram Yusefzadeh(15)...................... 102,500 * 102,500 *
All directors and executive officers as a
group (13 persons)....................... 9,719,311 56.6 9,287,406 43.8
OTHER PRINCIPAL AND SELLING SHAREHOLDERS
Thomas A. Bryan(16)........................ 1,695,923 12.6 168,095 1,527,828 8.1
FLAG Financial Corporation(17)............. 361,700 2.7 47,619 314,081 1.7
Sirrom Investments, Inc.(18)............... 308,982 2.3 150,000 158,982 *
Capital Appreciation Partners, L.P.(19).... 1,217,903 9.2 1,217,903 6.5
</TABLE>
- ---------------
* Less than 1%.
(1) The percentage of shares beneficially owned includes common stock of which
such person has the right to acquire beneficial ownership within 60 days of
July 1, 1998, including but not limited to by exercise of an option;
however, such common stock is not deemed outstanding for the purpose of
computing the percentage owned by any other person.
(2) Other than the 150,000 shares to be sold by Sirrom Investments, Inc. in
this offering, shares will be offered by selling shareholders only if and
to the extent that the underwriters exercise their over-allotment option.
See "Underwriting."
(3) Includes currently exercisable options to purchase 400,923 shares of common
stock.
(4) Includes currently exercisable options to purchase 970,923 shares of common
stock.
(5) Includes currently exercisable options to purchase 120,000 shares of common
stock.
(6) Includes currently exercisable options to purchase 315,923 shares of common
stock.
(7) Includes currently exercisable options to purchase 200,923 shares of common
stock.
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<PAGE> 48
(8) Includes (i) 150,000 shares of common stock held by Brown, Burke Capital
Partners, Inc. of which Mr. Brown is a principal, and (ii) 1,217,903 shares
of common stock issuable upon conversion of the Series A Preferred Stock
held by Capital Appreciation Partners, L.P. Mr. Brown is the managing
member of Capital Appreciation Management Company, L.L.C., the managing
general partner of Capital Appreciation Partners, L.P. See note (10) below
and "Description of Capital Stock."
(9) Includes (i) 331,700 shares of common stock held by Mr. Collins, (ii)
50,000 shares of common stock held by The InterCept Group, Inc., of which
Mr. Collins is Chief Executive Officer, Chairman of the Board and a
significant shareholder, and (iii) options to acquire 130,923 shares of
common stock held by Mr. Collins. Mr. Collins disclaims beneficial
ownership with respect to the shares held by The InterCept Group, Inc.
(10) Includes options to acquire 50,000 shares of common stock.
(11) Includes (i) options to acquire 50,000 shares of common stock, (ii) 200,000
shares of common stock held by Rodgers Capital Group, L.P., of which Mr.
Rodgers is a partner, and (iii) warrants to acquire 21,648 shares of common
stock.
(12) Includes (i) 361,700 shares of common stock held by FLAG Financial
Corporation, of which Mr. Speight is Chief Executive Officer, President and
a director (47,619 of these shares are to be sold in this offering if the
underwriters' over-allotment option is exercised) and (ii) options to
acquire 70,000 shares of common stock.
(13) Includes currently exercisable options to purchase 130,923 shares of common
stock.
(14) Includes currently exercisable options to purchase 52,500 shares of common
stock.
(15) Includes 50,000 shares owned by the Yusefzadeh Family Limited Partnership,
for which Mr. Yusefzadeh is the general partner, and 38,400 shares owned by
Mr. Yusefzadeh's children.
(16) Includes 24,000 shares owned by Mr. Bryan's minor children and currently
exercisable options to purchase 130,923 shares of common stock. Mr. Bryan's
address is 5615 Cross Gate Drive, Atlanta, Georgia 30327. Mr. Bryan is a
co-founder of the Company and served as a director of the Company from 1995
to 1998.
(17) FLAG Financial Corporation's address is 101 North Greenwood Street, P.O.
Box 3007, LaGrange, Georgia 30240.
(18) Sirrom Investments, Inc.'s address is 500 Church Street, Suite 200,
Nashville, Tennessee 37219.
(19) Represents shares issuable upon conversion of Series A Preferred Stock,
including 17,903 shares issuable as payment of estimated dividends owed
with respect to the Series A Preferred Stock through July 31, 1998. Capital
Appreciation Partners, L.P.'s address is One Buckhead Plaza, Suite 1585,
3060 Peachtree Road, Atlanta, Georgia 30305.
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CERTAIN TRANSACTIONS
LOAN FACILITIES
On December 18, 1997, the Company entered into the Sirrom Loan Facility and
issued a Stock Purchase Warrant (the "Sirrom Warrant") to Sirrom Investments,
Inc. Pursuant to the Sirrom Warrant, Messrs. Edwards, Baroco and Shultz agreed,
with certain exceptions, not to sell any of their shares of common stock in the
Company without first offering Sirrom Investments the right to sell stock on the
same terms. These co-sale rights terminate upon completion of an underwritten
initial public offering of the Company's common stock in which gross proceeds to
the Company are $15 million or more and the common stock is traded on a U.S.
securities exchange.
CERTAIN ISSUANCES OF STOCK AND WARRANTS
On October 21, 1997, the Company issued warrants to purchase a total of
75,000 shares of common stock at an exercise price of $1.00 per share to Joe M.
Rodgers, a director of the Company, and three other individuals who are
principals of Rodgers Capital Group, L.P. in consideration of professional
services provided by these individuals to the Company in connection with certain
marketing efforts. As part of such issuance, Mr. Rodgers received a warrant to
purchase 21,648 shares of common stock. Rodgers Capital Group also purchased
200,000 shares of common stock from the Company in October 1997 at a price of
$1.00 per share. In addition, the Company paid Rodgers Capital a total of
$220,000 as compensation for services provided by Rodgers Capital during 1997 in
connection with obtaining equity investments for the Company.
MANAGEMENT LOANS
On September 8, 1997, the Company loaned its President and Chief Operating
Officer, Henry M. Baroco, $78,990 pursuant to a full recourse promissory note to
fund the exercise of options to acquire 263,300 shares of its common stock. This
note accrues interest at the rate of 8.5% per year and matures on the earlier of
(i) September 8, 1998 or (ii) the date that Mr. Baroco sells the common stock
purchased with proceeds of the note. Mr. Baroco pledged the shares of common
stock received upon this exercise and other personal assets as collateral for
the loan.
On April 1, 1998, the Company loaned its Chief Financial Officer, Bruce F.
Lowthers, Jr., $75,000 pursuant to a full recourse promissory note to fund the
exercise of options to acquire 75,000 shares of its common stock. This note
accrues interest at the rate of 8.75% per year and matures on the earlier of (i)
December 31, 1999 or (ii) the date on which Mr. Lowthers sells the common stock
purchased with proceeds of the note. Mr. Lowthers pledged the shares of common
stock received upon this exercise and other personal assets as collateral for
the loan.
OTHER TRANSACTIONS AND RELATIONSHIPS
During the year ended December 31, 1997, the Company incurred costs of
$37,000 for rent on office space leased from ProVesa, Inc., a subsidiary of The
InterCept Group. Mr. Collins, a director of Towne Services, is the Chief
Executive Officer and Chairman of the Board of Directors of The InterCept Group.
The Company also paid approximately $25,000 for utilities and accounting
services provided by The InterCept Group. On June 23, 1998, Towne and the
InterCept Group entered into a Strategic Marketing and Processing Agreement
under which the parties agree to jointly offer certain on-line services to
Towne's business customers.
Certain transactions between the Company and its officers, directors and
principal shareholders may be on terms more favorable to such persons than they
could obtain in a transaction with an unaffiliated party. The Company has
adopted a policy requiring that all material transactions between the Company
and its officers, directors and other affiliates be on terms no less favorable
to the Company than could be obtained from unaffiliated third parties and must
be approved by both a majority of the board and a majority of the disinterested
directors. See "Management -- Compensation Committee Interlocks and Insider
Participation."
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<PAGE> 50
DESCRIPTION OF CAPITAL STOCK
The following description of the capital stock of the Company is only a
summary and is subject to the provisions of the Articles of Incorporation and
Bylaws, which are included as exhibits to the Registration Statement of which
this prospectus forms a part, and the provisions of applicable law.
AUTHORIZED AND OUTSTANDING CAPITAL STOCK
Under its Articles of Incorporation, Towne Services is authorized to issue
50,000,000 shares of common stock without par value. Towne Services also has
authority, exercisable through its board of directors, to issue 20,000,000
shares of preferred stock without par value. The rights of the holders of the
common stock are subject to the rights of the holders of the Company's Series A
Convertible Preferred Stock (discussed below) and such other rights as the board
of directors may hereafter confer on the holders of preferred stock.
Accordingly, such rights conferred on holders of any additional preferred stock
that may be issued in the future may adversely affect the rights of holders of
the common stock. As of July 1, 1998, there were 13,296,849 shares of common
stock outstanding and 15,000 shares of Series A Preferred Stock outstanding. All
of the outstanding shares of Series A Preferred Stock automatically convert into
common stock upon the effective date of this offering. See "Use of Proceeds."
COMMON STOCK
Under the Articles of Incorporation, holders of common stock are entitled
to receive such dividends as may be legally declared by the board of directors.
Each shareholder is entitled to one vote per share on all matters to be voted
upon. Shareholders are not entitled to cumulate votes for the election of
directors. Holders of common stock do not have preemptive, redemption or
conversion rights and, upon liquidation, dissolution or winding up of the
Company, will be entitled to share ratably in the net assets of the Company
available for distribution to common shareholders. All shares outstanding prior
to this offering are, and all shares to be issued in this offering will be,
validly issued, fully paid and non-assessable.
PREFERRED STOCK
The Articles of Incorporation authorize the board of directors to issue,
without further action or vote by the holders of the common stock, shares of
preferred stock in one or more series and to fix any preferences, conversion and
other rights, voting powers, restrictions, limitations, qualifications and terms
and conditions of redemption as shall be set forth in resolutions adopted by the
board of directors. Articles of Amendment must be filed with the Georgia
Secretary of State prior to the issuance of any shares of preferred stock of the
applicable series. Any preferred stock so issued may rank senior to the common
stock with respect to the payment of dividends or amounts upon liquidation,
dissolution or winding-up, or both. In addition, any such shares of preferred
stock may have class or series voting rights. Issuances of preferred stock,
while providing the Company with flexibility in connection with general
corporate purposes, may have an adverse effect on the rights of holders of
common stock. In addition, the issuance of preferred stock could have the effect
of making it more difficult for a third party to acquire a majority of the
outstanding voting stock of the Company or the effect of decreasing the market
price of the common stock. The Company has no present plan to issue any
additional shares of preferred stock.
Series A Preferred Stock
On March 13, 1998, the Company filed Articles of Amendment to its Articles
of Incorporation for the designation of 25,000 shares of Series A Convertible
Preferred Stock and issued 15,000 shares of such stock. The stated value of the
Series A Preferred Stock is $100 per share.
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<PAGE> 51
The holders of outstanding shares of Series A Preferred Stock are entitled
to receive cumulative cash dividends and cumulative dividends payable in kind in
the form of additional shares of Series A Preferred Stock ("PIK dividends") as
follows:
(i) For the period from the date of issuance through March 31, 1999,
PIK dividends at a quarterly rate of $1.00 per share;
(ii) For the period April 1, 1999 through March 31, 2000, PIK
dividends at a quarterly rate of $2.00 per share;
(iii) For the period April 1, 2000 through March 31, 2002, cash
dividends at a quarterly rate of $4.00 per share; and
(iv) From and after April 1, 2002 (so long as the Series A Preferred
Stock remains outstanding), cash dividends at a quarterly rate of $6.00 per
share.
Dividends are payable quarterly, except that PIK dividends through March
31, 2000 accrue and will not be paid until conversion of the Series A Preferred
Stock or the liquidation, dissolution or winding up of Towne Services. Dividends
are cumulative from the date of issue. The Company may not declare or pay cash
dividends on any other series of preferred stock that is junior to the Series A
Preferred Stock, or on common stock, nor may it redeem, purchase or otherwise
acquire any of such stock, unless full cumulative dividends have been declared
and paid on the Series A Preferred Stock. In the event of any liquidation or
dissolution of the Company, the holders of shares of Series A Preferred Stock
are entitled to receive out of assets of the Company available for distribution
to shareholders, before any distributions are made to holders of common stock,
liquidating distributions in the amount of $100 per share, plus accrued and
unpaid dividends.
The holders of the Series A Preferred Stock are entitled to vote on all
matters upon which holders of common stock have the right to vote. They are
entitled to a number of votes equal to the largest number of full shares of
common stock into which such shares of Series A Preferred Stock could be
converted. The holders of Series A Preferred Stock and common stock vote
together as a single class on all matters, unless otherwise provided. The
holders of Series A Preferred Stock have the exclusive right, voting separately
as a class, to elect one director of the Company, for as long as 10% of the
authorized number of shares of Series A Preferred Stock are outstanding.
The outstanding shares of Series A Preferred Stock are convertible into
common stock at the option of the holder at any time and automatically convert
upon completion of an initial public offering. The conversion price is $1.25 per
share, subject to adjustment in certain circumstances. If the Company has not
completed an initial public offering by December 31, 1998, the conversion price
will be reduced by $0.04 each month thereafter, until either the conversion
price equals $1.00 or the Company completes an initial public offering. All PIK
dividends accrued and unpaid on shares of Series A Preferred Stock surrendered
for conversion shall be paid in Series A Preferred Stock upon conversion or, at
the holder's election, may be converted into common stock. Cash dividends
accrued and unpaid on shares of Series A Preferred Stock surrendered for
conversion shall be converted into common stock.
The holders of Series A Preferred Stock must approve by majority vote (i)
the redemption, purchase or other acquisition for value of any shares of
preferred or common stock, or (ii) the authorization or issuance of any
additional shares of Series A Preferred Stock, except dividends, or any other
equity security senior to or on parity with the Series A Preferred Stock. The
holders of shares of Series A Preferred Stock have no preemptive or other rights
to subscribe for any other shares or securities, nor do they have any redemption
rights.
CLASSIFIED BOARD OF DIRECTORS
The Articles of Incorporation provide that the board of directors shall
consist of not less than 5 nor more than 12 members. The board of directors is
divided into three classes of directors serving staggered three-year terms. As a
result, approximately one-third of the board of directors is elected at each
annual meeting of shareholders. The classification of directors, together with
other provisions in the Articles of Incorporation and
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Bylaws that limit the removal of directors and permit the remaining directors to
fill any vacancies on the board of directors, has the effect of making it more
difficult for shareholders to change the composition of the board of directors.
As a result, at least two annual meetings of shareholders may be required for
the shareholders to change a majority of the directors, whether or not such
change in the board of directors would be beneficial to the Company and its
shareholders and whether or not a majority of the Company's shareholders
believes that such a change would be desirable. The Company believes, however,
that the longer time required to elect a majority of a classified board of
directors will help to ensure the continuity and stability of the Company's
management and policies. Currently, the terms of Class I directors expire in
1999, the terms of Class II directors expire in 2000 and the terms of Class III
directors expire in 2001.
REMOVAL OF DIRECTORS AND FILLING VACANCIES
The Bylaws provide that, unless the Board of Directors otherwise
determines, any vacancies, including vacancies resulting from an increase in the
number of directors, will be filled by the affirmative vote of holders of a
majority of the remaining directors, even if less than a quorum. A director may
be removed only with cause by the vote of the holders of 66 2/3% of the shares
entitled to vote for the election of directors at a meeting of shareholders
called for the purpose of removing such director.
ADVANCE NOTICE PROVISIONS FOR SHAREHOLDER NOMINATIONS AND SHAREHOLDER PROPOSALS
The Bylaws provide that with respect to an annual meeting of shareholders,
nominations of persons for election to the board of directors and the proposal
of business to be considered by shareholders may be made only (i) by or at the
direction of the board of directors, the Chairman of the board of directors or
the President, or (ii) by a shareholder who has complied with the advance notice
procedures set forth in the Bylaws.
The purpose of requiring shareholders to give the Company advance notice of
nominations and other business is to afford the board of directors a meaningful
opportunity to consider the qualifications of the proposed nominees or the
advisability of the other proposed business and, to the extent deemed necessary
or desirable by the board of directors, to inform shareholders and make
recommendations about such qualifications or business, as well as to provide a
more orderly procedure for conducting meetings of shareholders. Although the
Bylaws do not give the board of directors any power to disapprove timely
shareholder nominations for the election of directors or proposals for action,
they may have the effect of precluding a contest for the election of directors
or the consideration of shareholder proposals if the proper procedures are not
followed and of discouraging or deterring a third party from conducting a
solicitation of proxies to elect its own slate of directors or to approve its
own proposal.
SPECIAL MEETINGS
Under the Bylaws, provided that the Company has more than 100 beneficial
owners (as defined by the Georgia Business Corporation Code (the "Georgia
Code")) of its shares, special meetings of the shareholders may be called by
shareholders only if such shareholders hold outstanding shares representing a
majority of all votes entitled to be cast on any issue proposed to be considered
at any such special meeting. If the Company has less than 100 beneficial owners,
the holders of shares representing 25% or more of the votes entitled to be cast
may call a special meeting.
LIMITATION OF LIABILITY AND INDEMNIFICATION
The Articles of Incorporation eliminate, subject to certain exceptions, the
personal liability of a director to the Company or its shareholders for monetary
damage for breaches of such director's duty of care or other duties as a
director. The Articles do not provide for the elimination of or any limitation
on the personal liability of a director for (i) any appropriation, in violation
of the director's duties, of any business opportunity of the Company, (ii) acts
or omissions that involve intentional misconduct or a knowing violation of law,
(iii) unlawful corporate distributions, or (iv) any transactions from which the
director derived an improper personal benefit. The Articles of Incorporation of
the Company further provide that if the Georgia Code is
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<PAGE> 53
amended to authorize corporate action further eliminating or limiting the
personal liability of directors, then the liability of a director of the Company
shall be eliminated or limited to the fullest extent permitted by the Georgia
Code, as amended, without further action by the shareholders. These provisions
of the Articles of Incorporation will limit the remedies available to a
shareholder in the event of breaches of any director's duties to such
shareholder or the Company.
The Bylaws require the Company to indemnify and hold harmless any director
who was or is a party, or is threatened to be made a party, to any threatened,
pending or completed action, suit or proceeding whether civil, criminal,
administrative or investigative (including any action or suit by or in the right
of the Company) because he or she is or was a director, officer, employee or
agent of the Company, against expenses (including, but not limited to,
attorney's fees and disbursements, court costs and expert witness fees),
judgments, fines, penalties, and amounts paid in settlement incurred by him or
her in connection with the action, suit or proceeding. Indemnification would be
disallowed under any circumstances where indemnification may not be authorized
by action of the board of directors, the shareholders, or otherwise.
The Company has entered into separate indemnification agreements with each
of its directors and executive officers whereby the Company agreed, among other
things, to provide for indemnification and advancement of expenses in a manner
and subject to terms and conditions similar to those set forth in the Bylaws.
These agreements also provide that the Company shall purchase and maintain
liability insurance for the benefit of its directors and executive officers.
These agreements may not be abrogated by action of the shareholders. There is no
pending litigation or proceeding involving a director, officer, employee or
other agent of the Company as to which indemnification is being sought, nor is
the Company aware of any pending or threatened litigation that may result in
claims for indemnification by any director, officer, employee or other agent.
ANTI-TAKEOVER PROVISIONS AND GEORGIA LAW
Board and Shareholder Action Required for Certain Transactions. The
Articles of Incorporation require the affirmative vote of at least 66 2/3% of
the directors for the following actions by the Company to be submitted to a vote
of the shareholders: (i) a sale of all or substantially all of the assets of the
Company; (ii) a liquidation or dissolution of the Company; (iii) the merger,
consolidation or reorganization of the Company, unless the shareholders of the
Company immediately prior to such transaction will own at least a majority of
the combined voting power of the Company resulting from such merger,
consolidation or reorganization; or (iv) any increase in the number of directors
above 12 directors. In addition, the affirmative vote of 66 2/3% of the holders
of the common stock is required for shareholder approval of any such actions.
Issuance of Preferred Stock. The board of directors has the power to issue
an additional 19,985,000 shares of Preferred Stock, in one or more classes or
series and with such rights and preferences as determined by the board of
directors, all without shareholder approval. Because the board of directors has
the power to establish the preferences and rights of each class or series of
Preferred Stock, it may afford the holders of any series of Preferred Stock
preferences, powers and rights, voting or otherwise, senior to the rights of
holders of common stock. The board of directors has no present plans to issue
any additional shares of Preferred Stock.
Georgia Anti-Takeover Statutes. The Georgia Code generally restricts a
company from entering into certain business combinations with an interested
shareholder (which is defined as any person or entity that is the beneficial
owner of at least 10% of the company's voting stock) or its affiliates for a
period of five years after the date on which such shareholder became an
interested shareholder, unless (i) the transaction is approved by the board of
directors of the company prior to the date such person became an interested
shareholder, (ii) the interested shareholder acquires 90% of the company's
voting stock in the same transaction in which it exceeds 10%, or (iii)
subsequent to becoming an interested shareholder, such shareholder acquires 90%
of the company's voting stock and the business combination is approved by the
holders of a majority of the voting stock entitled to vote thereon (the
"Business Combination Statute"). The Georgia Code provides that the Business
Combination Statute will not apply unless the bylaws of the corporation
specifically provide that the Business Combination Statute is applicable to the
corporation. The
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<PAGE> 54
Company has not elected to be covered by such statute, but it could do so by
action of the board of directors at any time.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is First Union
National Bank.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have outstanding
18,673,734 shares of common stock and immediately exercisable options and
warrants to purchase 2,195,411 additional shares of common stock. The 4,000,000
shares sold in this offering (4,600,000 shares if the underwriters'
over-allotment option is exercised in full) will be freely tradable without
restriction by persons other than affiliates of the Company, as defined in Rule
144. The remaining 14,673,734 outstanding shares of common stock will be
"restricted" securities within the meaning of Rule 144 and may not be sold in
the absence of registration under the Securities Act of 1933 unless an exemption
from registration is available, such as the exemptions contained in Rule 144 and
Rule 701. Upon the completion of this offering, 115,000 of these restricted
shares will be eligible for immediate sale in the public market without
restriction pursuant to Rule 144(k) and an additional 11,372,933 shares will
become eligible for sale, subject to the provisions of Rule 144 or Rule 701,
commencing 90 days after the date of this prospectus. When the lock-up
agreements between the underwriters and the directors, executive officers and
certain shareholders of the Company expire 180 days after the date of this
prospectus (or earlier with the written consent of Wheat First Securities,
Inc.), 11,596,915 of the restricted shares will be eligible for immediate sale
in the public market, subject to the provisions of Rule 144 or 701, and the
remaining 3,076,819 restricted shares which are currently outstanding will
become available for public sale, subject to the provisions of Rule 144 or 701,
at various times thereafter. The lock-up agreements provide that the directors,
executive officers and certain shareholders of the Company will not offer, sell,
contract to sell, loan, pledge or otherwise dispose of or grant any options,
rights or warrants to purchase with respect to, or otherwise transfer or reduce
any risk of ownership of, directly or indirectly, any shares of common stock of
the Company, or any securities that are convertible into or exchangeable or
exercisable for common stock owned by them, with certain exceptions, for a
period of 180 days after the date of this prospectus without the written consent
of Wheat First Securities, Inc. on behalf of the underwriters.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned his or her shares of
common stock for at least one year (including the prior holding period of any
prior owner other than an affiliate) is entitled to sell within any three-month
period that number of shares which does not exceed the greater of 1% of the
outstanding shares of common stock and the average weekly trading volume during
the four calendar weeks preceding each such sale. Sales under Rule 144 are also
subject to certain manner of sale provisions, notice requirements and the
availability of current public information about the Company. A person (or
persons whose shares are aggregated) who has not been an affiliate of the
Company for at least three months and who has beneficially owned shares for at
least two years (including the holding period of any prior owner other than an
affiliate) would be entitled to sell such shares under Rule 144(k) without
regard to the limitations described above. Rule 144 defines "affiliate" of a
company as a person that directly, or indirectly through one or more
intermediaries, controls, is controlled by or is under common control with such
company. Affiliates of a company generally include its directors, executive
officers and principal shareholders.
Under Rule 701, subject to certain limitations, securities issued to
employees, directors, officers, consultants and advisors pursuant to a written
compensatory benefit plan by an issuer that is not subject to the reporting
requirements of the Securities Exchange Act of 1934 may be resold pursuant to
Rule 144 by persons other than affiliates without compliance with the provisions
of Rule 144 other than the manner of sale provisions. Affiliates may sell
securities issued pursuant to Rule 701 subject to all of the provisions of Rule
144 except the holding period requirement.
The Company intends to register all of the 3,728,400 shares of common stock
issuable upon the exercise of options granted or to be granted under its stock
option plans. Upon such registration, such shares will be
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<PAGE> 55
eligible for resale in the public market without restriction by persons who are
not affiliates of the Company and, to the extent they are held by affiliates,
pursuant to Rule 144 without observance of the holding period requirement.
Towne Services has granted its chief executive officer, Drew W. Edwards,
piggyback registration rights and, after termination of his employment for any
reason, demand registration rights with regard to all shares of common stock
then owned by him. Towne Services also has granted piggyback and demand
registration rights to Capital Appreciation Partners, L.P. with regard to
1,217,903 shares of common stock that are issuable upon the conversion of Series
A Preferred Stock purchased by it in March 1998; however, Capital Appreciation
Partners, L.P. has agreed not to exercise its registration rights before March
14, 1999. In connection with a $1.5 million loan to Towne Services by Sirrom
Investments, Inc. in 1997, Towne Services granted piggyback registration rights
to Sirrom Investments with regard to 308,982 shares of common stock (158,982
shares following completion of this offering) issuable upon the exercise of a
warrant granted by the Company to Sirrom Investments. In general, the demand
registration rights require Towne Services to register the shares of common
stock subject to the registration rights upon request of the holder if the
Company has completed an initial public offering. The piggyback registration
rights held by Mr. Edwards and Capital Appreciation Partners permit them to sell
the shares of common stock subject to the registration rights in any
registration by Towne Services of any shares of its common stock, subject to
certain exceptions. The piggyback registration rights held by Sirrom Investments
allow the holder to sell shares of common stock in any registration by Towne
Services using a registration statement on Form S-3 or similar form. Generally,
the registration rights held by Capital Appreciation Partners and Sirrom
Investments are terminated when the shares of common stock subject to those
rights are eligible to be resold pursuant to Rule 144 with no volume
restriction. The Company generally is required to bear the expenses relating to
the sale of the shareholders' shares of common stock under these registration
rights, except for underwriting discounts and commissions and in certain cases
the fees and expenses of the shareholders' counsel and filing fees related to
the registration statement. The Company also is obligated to indemnify the
shareholders whose shares are included in any of the Company's registrations
against certain losses and liabilities, including liabilities under the
Securities Act of 1933 and state securities laws.
Prior to this offering, there has been no public market for the common
stock, and no prediction can be made as to the effect, if any, that the sale of
shares or the availability of shares for sale will have on the market price
prevailing from time to time. Nevertheless, sales of substantial amounts of
common stock in the public market, or the perception that substantial amounts of
common stock are available for sale, could adversely affect prevailing market
prices and the ability of the Company to raise equity capital in the future.
54
<PAGE> 56
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement among the
Company, the selling shareholders and Wheat First Union, a division of Wheat
First Securities, Inc., J.C. Bradford & Co. and Stephens Inc., as
representatives of the underwriters (the "Representatives"), the underwriters
have severally agreed to purchase from the Company and one selling shareholder,
and the Company and one selling shareholder have agreed to sell to each of the
underwriters, the respective number of shares of common stock set forth opposite
their names below:
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
- ----------- ---------
<S> <C>
Wheat First Securities, Inc. ............................... 1,397,600
J.C. Bradford & Co. ........................................ 1,397,600
Stephens Inc................................................ 698,800
William Blair & Company, L.L.C. ............................ 46,000
Fifth Third/The Ohio Company................................ 46,000
First Albany Corporation.................................... 46,000
Interstate/Johnson Lane Corporation......................... 46,000
Legg Mason Wood Walker, Incorporated........................ 46,000
McDonald & Co. Securities, Inc. ............................ 46,000
Morgan Keegan & Company, Inc. .............................. 46,000
Raymond James & Associates Inc. ............................ 46,000
The Robinson-Humphrey Company, LLC.......................... 46,000
SunTrust Equitable Securities Corporation................... 46,000
Volpe Brown Whelan & Company, LLC........................... 46,000
---------
Total............................................. 4,000,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the
underwriters thereunder are subject to approval of certain legal matters by
counsel and to various other conditions. The nature of the underwriters'
obligations is such that they are committed to purchase and pay for all the
above shares of common stock if any are purchased.
The underwriters propose to offer the shares of common stock directly to
the public at the public offering price set forth on the cover page of this
prospectus and to selected dealers at such price less a concession not in excess
of $0.33 per share of common stock. The underwriters may allow, and such
selected dealers may reallow, a concession not in excess of $0.10 per share of
common stock to certain brokers and dealers. After the initial offering to the
public, the price to public, concessions and reallowances to dealers may be
changed by the Representatives.
Six of the selling shareholders have granted to the underwriters an option,
exercisable during the 30-day period after the date of this prospectus, to
purchase up to an additional 600,000 shares of common stock to cover
over-allotments, if any, at the public offering price, less the underwriting
discount, as set forth on the cover page of this prospectus. To the extent that
the underwriters exercise this option, each of the underwriters will be
committed, subject to certain conditions, to purchase such additional shares in
approximately the same proportion as set forth in the above table. The
underwriters may purchase such shares only to cover over-allotments made in
connection with this offering.
The executive officers, directors and certain shareholders of the Company
have agreed generally with the Representatives not to offer, sell, contract to
sell or otherwise dispose of, directly or indirectly, or announce an offering
of, any common stock of the Company, with certain exceptions, for a period of
180 days after the date hereof without the written consent of Wheat First
Securities, Inc.
The Company and the selling shareholders have agreed to indemnify the
underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, or to contribute to payments that the underwriters may
be required to make in respect thereof.
55
<PAGE> 57
The Representatives have informed the Company and the selling shareholders
that the underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
Prior to this offering, there has been no public market for the common
stock. Consequently, the initial public offering price was determined through
negotiations between the Company and the Representatives. Among the factors that
were considered in making such determination were prevailing market conditions,
the Company's financial and operating history and condition, its prospects and
prospects for the industry in general, the management of the Company and the
market prices of securities for companies in business similar to that of the
Company.
Upon purchase by the underwriters of the shares of common stock being
offered pursuant to this prospectus, Towne Services has agreed to issue warrants
to purchase up to the following number of shares of common stock at an exercise
price equal to 110% of the initial public offering price to the following
underwriters: Wheat First Securities, Inc. -- 30,000 shares; and J.C. Bradford &
Co. -- 20,000 shares. The warrant exercise price has been determined by
negotiation between the Company and Wheat First Securities, Inc. and J.C.
Bradford & Co. These warrants may not be exercised for two years from the date
of issuance and expire, if not sooner exercised, on the fifth anniversary of the
date of issuance. In addition, these warrants may not be sold, transferred,
assigned, hypothecated or otherwise disposed of for a period of at least two
years from the date of issuance of such warrants except certain affiliates of
Wheat First Securities, Inc. and J.C. Bradford & Co., without the prior written
consent of the Company. If these warrants are issued, Wheat First Securities,
Inc. and J.C. Bradford & Co. will have, at nominal cost, the opportunity to
profit from an increase in the market price of the common stock. To the extent
these warrants are exercised, the value of the common stock may be diluted.
In connection with this offering, certain underwriters and selling group
members (if any) and their respective affiliates may engage in transactions that
stabilize, maintain or otherwise affect the market price of the common stock.
Such transactions may include stabilization transactions effected in accordance
with Rule 104 of Regulation M of the Securities and Exchange Commission (the
"Commission"), pursuant to which such persons may bid for or purchase common
stock for the purpose of stabilizing its market price. The underwriters also may
create a short position for the account of the underwriters by selling more
common stock in connection with this offering than they are committed to
purchase from the Company and in such case may purchase common stock in the open
market following completion of this offering to cover all or a portion of such
short position. The underwriters may also cover all or a portion of such short
position, up to 600,000 shares of common stock, by exercising the underwriters
over-allotment option. In addition, Wheat First Securities, Inc., on behalf of
the underwriters, may impose penalty bids under contractual arrangements with
the underwriters whereby it may reclaim from an underwriter (or dealer
participating in this offering), for the account of the other underwriters, the
selling concession with respect to the common stock that is distributed in this
offering but subsequently purchased for the account of the underwriters in the
open market. Any of the transactions described in this paragraph may result in
the maintenance of the price of the common stock at a level above that which
might otherwise prevail in the open market. None of the transactions described
in this paragraph is required, and if any is undertaken, it may be discontinued
at any time.
LEGAL MATTERS
The validity of the shares of common stock offered hereby is being passed
upon for the Company by Nelson Mullins Riley & Scarborough, L.L.P., Atlanta,
Georgia. At May 1, 1998, members of Nelson Mullins Riley & Scarborough, L.L.P.
beneficially owned an aggregate of 467,723 shares of common stock. Certain legal
matters related to this offering will be passed upon for the underwriters by
Alston & Bird LLP, Atlanta, Georgia.
EXPERTS
The financial statements included in this prospectus, to the extent and for
the periods indicated in their reports, have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their reports with respect
thereto, and contain information derived from and make reference to a report
prepared by Smerkovitz and Associates, an independent appraiser. These financial
statements and the information derived
56
<PAGE> 58
from the report referenced therein are included herein in reliance upon the
authority of said firms as experts in giving such reports. The legal opinion
relating to Towne's statement of belief that the personnel performing services
for Towne are its employees under common law referenced elsewhere in this
prospectus was provided by its legal counsel, Nelson Mullins Riley &
Scarborough, L.L.P., Atlanta, Georgia.
ADDITIONAL INFORMATION
The Company has filed with the Commission through the Electronic Data
Gathering and Retrieval ("EDGAR") system a registration statement on Form S-1
(together with all amendments, exhibits and schedules thereto, the "Registration
Statement") under the Securities Act of 1933 with respect to the securities
offered by this prospectus. This prospectus does not contain all of the
information set forth in such Registration Statement, certain parts of which
have been omitted in accordance with the rules and regulations of the
Commission. Statements contained in this prospectus as to the contents of any
contract or other document referred to are necessarily summaries, and in each
instance reference is made to the copy of such contract or other document filed
as an exhibit to the Registration Statement of which this prospectus forms a
part. For further information, reference is made to such registration statement,
including the exhibits thereto, which may be inspected without charge at the
Commission's principal office at 450 Fifth Street, N.W., Room 1024, Washington,
D.C. 20549; and at the following Regional Offices of the Commission, except that
copies of the exhibits may not be available at certain of the Regional Offices:
Chicago Regional Office, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661; and New York Regional Office, 7 World Trade Center, Suite 1300, New York,
New York 10048. Copies of all or any part of such material may be obtained from
the Commission at 450 Fifth Street, N.W. Room 1024, Washington, D.C. 20549, upon
payment of certain fees prescribed by the Commission. The Commission maintains a
World Wide Web site on the Internet at http://www.sec.gov that contains reports,
proxies, information statements, and registration statements and other
information filed with the Commission through the EDGAR system.
The Company is not presently a reporting company and does not file reports
or other information with the Commission. Upon the later of the filing of a
registration statement on Form 8-A and the effective date of the Registration
Statement, however, the Company will become subject to the additional reporting
requirements of the Securities Exchange Act of 1934 and in accordance therewith
will file reports, proxy statements and other information with the Commission.
In addition, after the completion of this offering, the Company intends to
furnish its shareholders with annual reports containing audited financial
statements and with quarterly reports containing unaudited summary financial
information for each of the first three quarters of each fiscal year.
57
<PAGE> 59
TOWNE SERVICES, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
TOWNE SERVICES, INC.
Report of Independent Public Accountants.................... F-2
Balance Sheets as of December 31, 1996 and 1997 and March
31, 1998 (unaudited)...................................... F-3
Statements of Operations for the Period from Inception
(October 23, 1995) to December 31, 1995, for the Years
Ended December 31, 1996 and 1997 and for the three months
ended March 31, 1997 and 1998 (unaudited)................. F-4
Statements of Shareholders' Equity for the Period from
Inception (October 23, 1995) to December 31, 1995, for the
Years Ended December 31, 1996 and 1997 and for the three
months ended March 31, 1998............................... F-5
Statements of Cash Flows for the Period from Inception
(October 23, 1995) to December 31, 1995, for the Years
Ended December 31, 1996 and 1997 and for the three months
ended March 31, 1997 and 1998 (unaudited)................. F-6
Notes to Financial Statements............................... F-7
CREDIT COLLECTION SOLUTIONS, INC.
Report of Independent Public Accountants.................... F-19
Balance Sheets as of December 31, 1997 and March 31, 1998
(unaudited)............................................... F-20
Statements of Operations for the Year Ended December 31,
1997 and for the three months ended March 31, 1997 and
1998 (unaudited).......................................... F-21
Statements of Shareholders' Deficit for the Year Ended
December 31, 1997 and for the three months ended March 31,
1998 (unaudited).......................................... F-22
Statements of Cash Flows for the Year Ended December 31,
1997 and for the three months ended March 31, 1997 and
1998 (unaudited).......................................... F-23
Notes to Financial Statements............................... F-24
PRO FORMA FINANCIAL INFORMATION
Unaudited Pro Forma Financial Information................... F-28
Unaudited Pro Forma Balance Sheet as of March 31, 1998...... F-29
Unaudited Pro Forma Statements of Operations................ F-30
</TABLE>
F-1
<PAGE> 60
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Towne Services, Inc.:
We have audited the accompanying balance sheets of TOWNE SERVICES, INC. (a
Georgia corporation) as of December 31, 1996 and 1997 and the related statements
of operations, shareholders' equity, and cash flows for the period from
inception (October 23, 1995) to December 31, 1995 and for each of the two years
in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Towne Services, Inc. as of
December 31, 1996 and 1997 and the results of its operations and its cash flows
for the period from inception (October 23, 1995) to December 31, 1995 and for
each of the two years in the period ended December 31, 1997 in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
May 21, 1998
F-2
<PAGE> 61
TOWNE SERVICES, INC.
BALANCE SHEETS
DECEMBER 31, 1996 AND 1997 AND MARCH 31, 1998
<TABLE>
<CAPTION>
PRO FORMA
SHAREHOLDERS'
EQUITY AT
MARCH 31, MARCH 31,
1996 1997 1998 1998
--------- ----------- ------------ -------------
(NOTE 9)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................. $ 151,082 $ 2,536,439 $ 3,500,010
Accounts receivable, net of allowance for
uncollectible accounts of $0, $25,000,
and $70,000 in 1996, 1997, and 1998,
respectively........................... 1,596 121,566 359,007
Note receivable........................... 0 78,990 78,990
Stock subscriptions receivable............ 0 0 427,500
Other..................................... 6,713 68,273 163,770
--------- ----------- ------------
Total current assets.............. 159,391 2,805,268 4,529,277
PROPERTY AND EQUIPMENT, net................. 138,916 489,849 687,363
DEBT ISSUANCE COSTS, net.................... 64,124 288,815 304,361
OTHER ASSETS................................ 4,375 2,500 2,500
--------- ----------- ------------
$ 366,806 $ 3,586,432 $ 5,523,501
========= =========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................... $ 40,101 $ 297,937 $ 125,505
Accrued liabilities....................... 14,187 215,109 296,469
Accrued compensation...................... 80,323 220,300 906,297
Current portion of long-term debt......... 0 46,757 41,967
Deferred revenue.......................... 23,103 0 0
--------- ----------- ------------
Total current liabilities......... 157,714 780,103 1,370,238
--------- ----------- ------------
LONG-TERM DEBT, net of discount of $0,
$249,500, and $239,397 in 1996, 1997, and
1998, respectively........................ 90,000 1,289,666 1,289,162
--------- ----------- ------------
COMMITMENTS AND CONTINGENCIES (NOTE 7)
WARRANTS WITH REDEMPTION FEATURE (NOTE 5)... 0 255,000 466,000
--------- ----------- ------------
SHAREHOLDERS' EQUITY:
Preferred stock, $0 par value; 20,000,000
shares authorized, 0, 0, and 15,000
shares issued and outstanding in 1996,
1997, and 1998, respectively (Note
9)..................................... 0 0 1,508,000
Common stock, $0 par value; 50,000,000
shares authorized, 7,905,700,
11,706,766, and 13,220,849 shares
issued and outstanding in 1996, 1997,
and 1998, respectively................. 800,024 4,417,696 17,457,055 19,431,055
Warrants outstanding...................... 0 41,000 41,000 41,000
Accumulated deficit....................... (680,932) (3,197,033) (16,607,954) (16,607,954)
--------- ----------- ------------ ------------
Total shareholders' equity........ 119,092 1,261,663 2,398,101 $ 2,864,101
--------- ----------- ------------ ============
$ 366,806 $ 3,586,432 $ 5,523,501
========= =========== ============
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-3
<PAGE> 62
TOWNE SERVICES, INC.
STATEMENTS OF OPERATIONS
FOR THE PERIOD FROM INCEPTION (OCTOBER 23, 1995) TO DECEMBER 31, 1995,
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1997,
AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998
<TABLE>
<CAPTION>
FOR THE PERIOD
FROM
INCEPTION FOR THE THREE
(OCTOBER 23, FOR THE YEARS ENDED MONTHS ENDED
1995) TO DECEMBER 31, MARCH 31,
DECEMBER 31, ------------------------ -------------------------
1995 1996 1997 1997 1998
-------------- ---------- ----------- ---------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES......................... $ 6,000 $ 105,285 $ 722,364 $ 96,663 $ 547,954
---------- ---------- ----------- ---------- ------------
COSTS AND EXPENSES:
Costs of processing, servicing,
and support................. 2,250 219,621 832,102 102,684 374,128
Research and development....... 0 51,871 332,470 11,231 74,024
Sales and marketing............ 3,739 118,163 839,323 94,337 485,562
Stock compensation expense..... 0 10,020 0 0 5,971,590
General and administrative..... 18,410 358,606 1,139,642 170,416 1,347,282
---------- ---------- ----------- ---------- ------------
Total costs and
expenses............. 24,399 758,281 3,143,537 378,668 8,252,586
---------- ---------- ----------- ---------- ------------
OPERATING LOSS................... (18,399) (652,996) (2,421,173) (282,005) (7,704,632)
---------- ---------- ----------- ---------- ------------
OTHER EXPENSES:
Interest (income) expense,
net......................... (131) 5,802 95,946 19,063 64,289
Other expense (income)......... 357 3,509 (1,018) (648) 0
Financing costs for stock
issued to nonemployees...... 0 0 0 0 323,000
---------- ---------- ----------- ---------- ------------
Total other expenses... 226 9,311 94,928 18,415 387,289
---------- ---------- ----------- ---------- ------------
NET LOSS......................... $ (18,625) $ (662,307) $(2,516,101) $ (300,420) $ (8,091,921)
========== ========== =========== ========== ============
PREFERRED STOCK DIVIDENDS........ 0 0 0 0 (5,108,000)
ACCRETION OF WARRANTS WITH
REDEMPTION FEATURE............. 0 0 0 0 (211,000)
NET LOSS ATTRIBUTABLE TO COMMON
SHAREHOLDERS:
Basic.......................... $ (18,625) $ (662,307) $(2,516,101) $ (300,420) $(13,410,921)
========== ========== =========== ========== ============
Diluted........................ $ (18,625) $ (662,307) $(2,516,101) $ (300,420) $(13,410,921)
========== ========== =========== ========== ============
NET LOSS PER COMMON SHARE:
Basic.......................... $ (0.0) $ (0.10) $ (0.26) $ (0.04) $ (1.11)
========== ========== =========== ========== ============
Diluted........................ $ (0.0) $ (0.10) $ (0.26) $ (0.04) $ (1.11)
========== ========== =========== ========== ============
Weighted average common shares
outstanding................. 5,000,000 6,337,356 9,600,592 8,006,626 12,077,352
========== ========== =========== ========== ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE> 63
TOWNE SERVICES, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE PERIOD FROM INCEPTION (OCTOBER 23, 1995) TO DECEMBER 31, 1995,
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1997,
AND FOR THE THREE MONTHS ENDED MARCH 31, 1998
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK TOTAL
------------------- ------------------------ WARRANTS ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT OUTSTANDING DEFICIT EQUITY
------ ---------- ---------- ----------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, October 23, 1995......... 0 0 0 $ 0 $ 0 $ 0 $ 0
Issuance of common stock.......... 0 0 5,000,000 15,750 0 0 15,750
Net loss.......................... 0 0 0 0 0 (18,625) (18,625)
------ ---------- ---------- ----------- ------- ------------ -----------
BALANCE, December 31, 1995........ 0 0 5,000,000 15,750 0 (18,625) (2,875)
Issuance of common stock.......... 0 0 2,905,700 720,150 0 0 720,150
Fair value of stock options
granted (Note 3)................ 0 0 0 64,124 0 0 64,124
Net loss.......................... 0 0 0 0 0 (662,307) (662,307)
------ ---------- ---------- ----------- ------- ------------ -----------
BALANCE, December 31, 1996........ 0 0 7,905,700 800,024 0 (680,932) 119,092
Issuance of common stock.......... 0 0 3,537,766 3,471,099 0 0 3,471,099
Issuance of warrants.............. 0 0 0 0 41,000 0 41,000
Exercise of stock options......... 0 0 263,300 78,990 0 0 78,990
Fair value of stock options
granted (Note 3)................ 0 0 0 67,583 0 0 67,583
Net loss.......................... 0 0 0 0 0 (2,516,101) (2,516,101)
------ ---------- ---------- ----------- ------- ------------ -----------
BALANCE, December 31, 1997........ 0 0 11,706,766 4,417,696 41,000 (3,197,033) 1,261,663
Issuance of preferred stock (Note
9).............................. 15,000 1,500,000 0 0 0 0 1,500,000
Issuance of common stock.......... 0 0 1,019,083 5,345,609 0 0 5,345,609
Stock subscription receivable
(Note 9)........................ 0 0 495,000 427,500 0 0 427,500
Compensation expense for stock
options granted or amended (Note
9).............................. 0 0 0 2,166,250 0 0 2,166,250
Preferred stock dividend (Note
9).............................. 0 0 0 5,100,000 0 (5,100,000) 0
Accretion of preferred stock with
discounted conversion feature... 0 8,000 0 0 0 (8,000) 0
Accretion of warrants with
redemption feature.............. 0 0 0 0 0 (211,000) (211,000)
Net loss.......................... 0 0 0 0 0 (8,091,921) (8,091,921)
------ ---------- ---------- ----------- ------- ------------ -----------
BALANCE, March 31, 1998
(unaudited)..................... 15,000 $1,508,000 13,220,849 $17,457,055 $41,000 $(16,607,954) $ 2,398,101
====== ========== ========== =========== ======= ============ ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE> 64
TOWNE SERVICES, INC.
STATEMENTS OF CASH FLOWS
FOR THE PERIOD FROM INCEPTION (OCTOBER 23, 1995) TO DECEMBER 31, 1995,
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1997,
AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998
<TABLE>
<CAPTION>
FOR THE PERIOD FOR THE THREE MONTHS
FROM INCEPTION FOR THE YEARS ENDED ENDED
(OCTOBER 23, 1995) DECEMBER 31, MARCH 31,
TO DECEMBER 31, ----------------------- -----------------------
1995 1996 1997 1997 1998
------------------ --------- ----------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss......................................... $(18,625) $(662,307) $(2,516,101) $(300,420) $(8,091,921)
-------- --------- ----------- --------- -----------
Adjustments to reconcile net loss to net cash
used in operating activities:
Compensation expense recognized for stock
option grants................................ 0 10,020 0 0 5,971,590
Financing costs for stock issued to
nonemployees................................. 0 0 0 0 323,000
Issuance of warrants........................... 0 0 41,000 0 0
Loss on disposal of property and equipment..... 0 7,234 0 0 0
Depreciation and amortization.................. 393 12,895 103,629 6,555 39,980
Amortization of deferred financing fees........ 0 0 39,423 17,488 20,896
Amortization of debt discount.................. 0 0 5,500 0 10,103
Changes in operating assets and liabilities:
Accounts receivable.......................... 0 (1,596) (119,970) (480,209) (237,441)
Prepaid expenses............................. 0 (6,713) (64,553) 2,464 (95,497)
Other assets................................. (2,500) (2,000) (194,656) 4,375 (50,842)
Accounts payable............................. 615 39,487 257,836 116,997 (172,432)
Accrued liabilities.......................... 487 94,022 340,899 (57,010) 767,357
Deferred revenue............................. 0 23,103 (23,103) (8,942) 0
-------- --------- ----------- --------- -----------
Total adjustments.......................... (1,005) 176,452 365,005 (398,282) 6,576,714
-------- --------- ----------- --------- -----------
Net cash used in operating activities...... (19,630) (485,855) (2,130,096) (698,702) (1,515,207)
-------- --------- ----------- --------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Note receivable due from shareholder............. 0 0 (78,990) 0 0
Purchases of property and equipment, net......... (7,500) (151,813) (451,569) (72,427) (223,094)
-------- --------- ----------- --------- -----------
Net cash used in investing activities...... (7,500) (151,813) (530,559) (72,427) (223,094)
-------- --------- ----------- --------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options.......... 0 0 78,990 0 0
Repayment of debt................................ 0 0 (318,702) 0 (15,397)
Proceeds from Sirrom Capital..................... 0 0 1,500,000 0 0
Proceeds from long-term borrowings............... 30,000 60,000 314,625 76,287 0
Proceeds from issuance of preferred stock........ 0 0 0 0 1,500,000
Proceeds from issuance of common stock........... 15,750 710,130 3,471,099 947,027 1,217,269
-------- --------- ----------- --------- -----------
Net cash provided by financing
activities............................... 45,750 770,130 5,046,012 1,023,314 2,701,872
-------- --------- ----------- --------- -----------
NET INCREASE IN CASH............................... 18,620 132,462 2,385,357 252,185 963,571
CASH AND CASH EQUIVALENTS, beginning of year....... 0 18,620 151,082 151,082 2,536,439
-------- --------- ----------- --------- -----------
CASH AND CASH EQUIVALENTS, end of year............. $ 18,620 $ 151,082 $ 2,536,439 $ 403,627 $ 3,500,010
======== ========= =========== ========= ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for income taxes......................... $ 0 $ 0 $ 0 $ 0 $ 0
======== ========= =========== ========= ===========
Cash paid for interest............................. $ 0 $ 0 $ 15,900 $ 5,430 $ 42,083
======== ========= =========== ========= ===========
Fair value of stock options granted (Note 3)....... $ 0 $ 64,124 $ 67,583 $ 0 $ 0
======== ========= =========== ========= ===========
Stock subscription receivable (Note 9)............. $ 0 $ 0 $ 0 $ 0 $ 427,500
======== ========= =========== ========= ===========
</TABLE>
The accompanying notes are and integral part of these statements.
F-6
<PAGE> 65
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND BACKGROUND
Towne Services, Inc. ("Towne Services" or the "Company") designs, develops
and markets products and services that convert the in-house credit transactions
of small businesses into automated "virtual credit card" accounts which are
processed electronically. Usually in-house credit transactions are completed
without a credit card or cash, are recorded and processed manually and then
billed to the customer at a later date. To automate this process, Towne Services
offers two main electronic processing systems, TOWNE CREDIT(SM) and TOWNE
FINANCE(SM), which process small business' in-house credit transactions in much
the same way as credit card transactions are processed.
The TOWNE CREDIT system electronically processes in-house consumer credit
transactions of small and medium size retail merchants. The TOWNE FINANCE
system, a commercial version of TOWNE CREDIT, is an automated asset management
and financing system that processes business-to-business credit transactions for
small commercial businesses. Through the use of Towne's products and services,
small businesses can automate certain manual processes, accelerate cash flow,
provide better customer service, reduce paperwork and shift many other
administrative burdens to Towne Services. In addition, Towne provides
complementing products and services to banks that enable them to generate
interest-bearing revolving credit accounts by financing the accounts receivable
of these small businesses. Through the use of Towne's products, banks can
monitor customers' accounts receivable and generate detailed status reports, and
may attract new business customers who, in turn, may become customers of Towne
Services.
Incorporated on October 23, 1995, Towne Services had no significant
operations until it released its TOWNE CREDIT product and related services in
June 1997. Accordingly, the Company has only a limited operating history. The
Company has incurred significant losses in each quarter since it commenced
operations. Towne Services had net losses of $18,625, $662,307 and $2,516,101
for its inception period and for the subsequent years ended December 31, 1996
and 1997, respectively. For the three months ended March 31, 1998, the Company
had a net loss of $8,091,921. The Company expects that it will continue to incur
net losses until it is able to attain sufficient revenues to support its
business. The Company can provide no assurances as to when, if ever, this may
occur.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying financial statements and footnote data as of March 31,
1998 and for the three months ended March 31, 1997 and 1998 are unaudited. In
the opinion of the management of the Company, these financial statements reflect
all adjustments, consisting only of normal recurring adjustments necessary for a
fair presentation of the financial statements. The results of operations for the
three months ended March 31, 1998 are not necessarily indicative of the results
that may be expected for the full year.
F-7
<PAGE> 66
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
REVENUE RECOGNITION
The Company functions as a service bureau whereby customers process
transactions utilizing the Company's software on an outsourced basis. The
Company's revenues are generated primarily through initial set-up fees and
recurring monthly transaction processing fees. Management believes the prices
charged for both the initial set-up fee and the recurring transaction fees are
based upon the relative fair value of the related services provided.
Accordingly, the Company recognizes the initial set-up and recurring transaction
fees as the related services are provided. Revenues related to the initial
set-up fee are recognized upon execution of the related contract or, if
appropriate, upon settlement of any contract contingencies. Transaction fees are
recognized on a monthly basis as earned. The Company also leases point of sale
terminal equipment to certain customers under month-to-month operating leases.
Such operating lease revenues are recognized on a monthly basis as earned.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Major property additions,
replacements, and betterments are capitalized, while maintenance and repairs
which do not extend the useful lives of these assets are expensed as incurred.
Depreciation is provided using the straight-line method for financial reporting.
The detail of property and equipment at December 31, 1996 and 1997 is as
follows:
<TABLE>
<CAPTION>
USEFUL
1996 1997 LIVES
-------- --------- -----------
<S> <C> <C> <C>
Furniture and fixtures.......................... $ 20,335 $ 114,841 Seven years
Computers and equipment......................... 103,220 237,734 Five years
Point-of-sale equipment......................... 25,879 193,843 Three years
Leasehold improvements.......................... 1,752 9,337 Five years
Software development costs...................... 0 47,000 Three years
-------- ---------
151,186 602,755
Less accumulated depreciation................... (12,270) (112,906)
-------- ---------
$138,916 $ 489,849
======== =========
</TABLE>
LONG-LIVED ASSETS
The Company periodically reviews the values assigned to long-lived assets,
such as property and equipment, to determine whether any impairments are other
than temporary. Management believes that the long-lived assets in the
accompanying balance sheets are appropriately valued.
OFFICERS' LIFE INSURANCE
The Company carries life insurance policies on four key executives. The
aggregate face value of these policies is $1,250,000, and the Company is
entitled to receive any proceeds as the beneficiary. The Company had no cash
surrender value in these policies at December 31, 1996 and 1997.
DEFERRED REVENUE
Deferred revenue on the accompanying balance sheets represents initial
set-up fees related to certain contracts entered into during 1996 which included
clauses to guarantee reimbursement to the customer if the
F-8
<PAGE> 67
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
revenues earned by the customer under the contract during the first 12 months of
the contract term do not exceed the initial set-up fee. Set-up fees related to
such contracts were recognized at the end of the 12-month guarantee period. The
Company discontinued offering this guarantee during 1996 and has no such clauses
in contracts entered into subsequent to 1996.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist of salary related personnel
costs, including costs for employee benefits, computer equipment and support
services used in products necessary to deliver the Company's services. The
Company's policy is to capitalize research and development costs upon
establishing technological feasibility, subject to a periodic assessment of
recoverability based on expected future revenues. The Company had capitalized
approximately $0, $47,000 and $59,500 of software development costs at December
31, 1996 and 1997 and March 31, 1998, respectively.
NET LOSS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," effective
for fiscal years ending after December 15, 1997. The Company adopted the new
guidelines for the calculation and presentation of earnings per share, and all
prior periods have been restated. Basic loss per share is based on the weighted
average number of shares outstanding. Diluted loss per share is based on the
weighted average number of shares outstanding and the dilutive effect of common
stock equivalent shares issuable upon the exercise of stock options and warrants
(using the treasury stock method). A reconciliation of net loss attributable to
common shareholders for the three months ended March 31, 1998 is as follows:
<TABLE>
<CAPTION>
<S> <C>
Net loss as reported........................................ $ (8,091,921)
Dividends on convertible preferred shares................... (5,108,000)
Accretion of warrants with redemption feature............... (211,000)
------------
Net loss attributable to common shareholders................ $(13,410,921)
============
</TABLE>
INCOME TAXES
The Company is a C corporation for income tax reporting purposes, and
accounts for income taxes under the provisions of SFAS No. 109, "Accounting for
Income Taxes," which requires the use of an asset and liability method of
accounting for deferred income taxes. Under SFAS No. 109, deferred tax assets or
liabilities at the end of each period are determined using the tax rate expected
to apply to taxable income in the period in which the deferred tax asset or
liability is expected to be settled or realized.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The book values of cash, trade accounts receivable, trade accounts payable,
and other financial instruments approximate their fair values principally
because of the short-term maturities of these instruments. The fair value of the
Company's long-term debt is estimated based on the current rates offered to the
Company for debt of similar terms and maturities.
RISK OF POSSIBLE SYSTEM FAILURE
The Company's operations depend on its ability to protect its network
infrastructure and equipment against damages from human error, natural
disasters, power and telecommunications failures, intentional acts of vandalism
and similar events. Despite precautions taken by the Company, the occurrence of
human error, a natural disaster or other unanticipated problems could halt the
Company's services, damage network
F-9
<PAGE> 68
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
equipment and result in substantial expense for the Company to repair or replace
damaged equipment. In addition, the failure of the Company's telecommunications
providers to supply the necessary services could also interrupt the Company's
services. The inability of the Company to supply services to its customers could
negatively affect the Company's business and financial results and may also harm
the Company's reputation.
LOSS OF CUSTOMERS
Customer attrition is a normal part of the electronic processing business.
The Company has and will experience losses of small business customers due to
attrition. Towne Services' written agreements with its customers generally
provide that either party may terminate the agreement upon 30 to 60 days' notice
for any reason. Consolidation in the financial services industry in the United
States may result in fewer potential bank customers. In addition, the Company
may elect not to process or continue processing for customers that experience
financial difficulties or other problems.
PRODUCT RISKS
Towne Services may be liable if the use of any of its products causes
damage to its customers' businesses. Towne Services also may be required to
recall certain of its products if they become damaged or unable to perform their
intended functions. Towne Services has not experienced any product recalls or
product liability judgments or claims. however, a product recall or product
liability judgment against Towne Services could negatively affect its business
and financial results.
TRADEMARKS AND OTHER PROPRIETARY RIGHTS
Towne Services believes that its technologies, trademarks and other
proprietary rights are important to its success. The Company attempts to protect
itself through a combination of copyright law, trademark and trade secret laws,
employee and third party confidentiality agreements and other methods. However,
unauthorized parties may attempt to copy aspects of the Company's technology,
products and services or to otherwise obtain and use information that the
Company regards as proprietary, despite the Company's efforts to protect them.
Third parties may claim that the Company's current or future products and
services infringe the patent, copyright or trademark rights of such third
parties. No assurance can be given that, if such actions or claims are brought,
the Company will ultimately prevail. Any such claims, whether with or without
merit, could be costly and time consuming, cause delays in introducing new or
improved products and services, require Towne Services to enter royalty or
licensing agreements or discontinue using the challenged technology and
otherwise could have a material adverse effect on the Company's business and
financial results.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income," which establishes standards for
reporting and presentation of comprehensive income and its components in a full
set of general purpose financial statements. This statement is effective for
periods beginning after December 15, 1997. The Company adopted SFAS No. 130
January 1, 1998. The adoption of SFAS 130 did not have a material impact on the
Company's financial statements as comprehensive income did not differ from the
reported net loss for all periods presented.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. This statement is
effective for financial statements for periods beginning after December 15,
1997. The adoption of SFAS No. 131 will not have a material impact on the
Company's financial statements.
F-10
<PAGE> 69
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1997
------- ----------
<S> <C> <C>
Promissory notes to two shareholders, interest at 7%, repaid
in December 1997.......................................... $90,000 $ 0
Note payable to Sirrom Investments, Inc. ("Sirrom") (the
"Sirrom Note"), interest at 14%, $1,500,000 due December
2002, secured by certain assets of the Company and all
shares of the Company's principal shareholders............ 0 1,500,000
Notes payable to Citizens Bank, interest ranging from 9.25%
to 12%, payable monthly through 2000, secured by
equipment................................................. 0 85,923
------- ----------
90,000 1,585,923
Less current portion...................................... 0 (46,757)
------- ----------
90,000 1,539,166
Less original issue discount.............................. 0 (249,500)
------- ----------
$90,000 $1,289,666
======= ==========
</TABLE>
At December 31, 1997, aggregate maturities of long-term debt are as
follows:
<TABLE>
<S> <C>
1998........................................................ $ 46,757
1999........................................................ 24,880
2000........................................................ 14,286
2001........................................................ 1,500,000
----------
$1,585,923
==========
</TABLE>
The Sirrom Note was issued in December 1997 for $1,500,000. As discussed in
Note 5, warrants to purchase up to 1,052,522 shares at $.01 per share were
issued with the Sirrom Note. The value of these warrants was determined to be
approximately $255,000 based on the relative fair value of the warrants to the
note. A corresponding amount of the loan proceeds has been allocated to the
warrants and has been accounted for as debt discount and warrants with
redemption feature on the accompanying balance sheet.
LINES OF CREDIT
The Company has a line of credit agreement with Georgia Bank & Trust which
allows the Company to borrow up to $500,000. This line of credit bears interest
at prime plus 1/2% (9.0% at December 31, 1997) and is secured by certain of the
Company's assets. Interest is payable monthly, and the line of credit matures in
July 2000. At December 31, 1997, $0 was outstanding and $500,000 was available
under this line of credit.
The Company has another $250,000 line of credit with First Federal Savings
Bank of LaGrange. This line of credit matures in June 1998, bears interest at a
variable rate based on prime rate, as defined (8.5% at December 31, 1997), and
is payable monthly. At December 31, 1997, $0 was outstanding and $250,000 was
available under this line of credit. This agreement is guaranteed by seven of
the Company's shareholders. In return for their guarantees, these shareholders
were each granted options to purchase 59,523 shares of common stock outside the
stock option plan with immediate vesting and an exercise price of $.60 per
share. In relation to these options, the Company recorded debt issuance costs of
$67,583, which are included in other assets on the accompanying balance sheet.
The value of the debt issuance costs was determined using the minimum value
method as prescribed under SFAS 123, using an expected life of 5 years and the
risk-free interest rate at the date of grant. This amount is being amortized to
interest expense over the life of the credit
F-11
<PAGE> 70
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
agreement. As of December 31, 1997, none of these options had been exercised.
See Note 6 where these options are included in the stock option activity tables.
During 1996, the Company entered into a line of credit agreement with
Citizens Bank, a company related through common ownership which allowed the
Company to borrow up to $250,000. The agreement was guaranteed by seven of the
Company's shareholders. In return for their guarantees, the seven shareholders
were each granted options to purchase 71,400 shares of common stock outside the
stock option plan with immediate vesting and an exercise price of $.50 per
share. In relation to these options, the Company recorded debt issuance costs of
$64,124 at December 31, 1996, which are included in other assets on the
accompanying balance sheet. The value of the debt issuance costs was determined
using the minimum value method as prescribed under SFAS 123, using an expected
life of 5 years and the risk-free interest rate at the date of grant. The line
of credit expired on December 11, 1997. As of December 31, 1997, none of these
options had been exercised. See Note 6 where these options are included in the
stock option activity tables.
4. INCOME TAXES
The following is a reconciliation of income taxes at the federal statutory
rate with income taxes recorded by the Company for the period from inception
(October 23, 1995) to December 31, 1995 and for the years ended December 31,
1996 and 1997:
<TABLE>
<CAPTION>
1995 1996 1997
------- -------- ---------
<S> <C> <C> <C>
Income tax benefit computed at the federal statutory
rate................................................. $ 2,794 $225,184 $ 843,568
State income tax benefit, net of federal income tax
benefit.............................................. 931 30,220 96,136
Other, net............................................. (123) (2,784) (15,931)
Change in valuation allowance.......................... (3,602) (252,620) (923,773)
------- -------- ---------
$ 0 $ 0 $ 0
======= ======== =========
</TABLE>
Deferred income tax assets and liabilities for 1996 and 1997 reflect the
impact of temporary differences between the amounts of assets and liabilities
for financial reporting and income tax reporting purposes. Temporary differences
that give rise to deferred tax assets and liabilities at December 31, 1996 and
1997 are as follows:
<TABLE>
<CAPTION>
1996 1997
-------- -----------
<S> <C> <C>
Deferred tax assets:
Deferred compensation..................................... $ 30,523 $ 38,000
Accounts receivable reserves.............................. 0 7,980
Other..................................................... 10,837 16,068
Net operating loss carryforwards.......................... 211,129 1,134,584
-------- -----------
Deferred tax assets............................... 252,489 1,196,632
Deferred tax liability:
Depreciation.............................................. (131) (20,501)
-------- -----------
252,358 1,176,131
Valuation allowance......................................... (252,358) (1,176,131)
-------- -----------
Net deferred tax asset................................. $ 0 $ 0
======== ===========
</TABLE>
Due to the Company's current year operating loss position and projected
losses for the fiscal year ending December 31, 1998, no benefit for income taxes
for the year ended December 31, 1997 has been provided in the accompanying
financial statements.
F-12
<PAGE> 71
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
At March 31, 1998, the Company has net operating loss carryforwards
("NOLs") of approximately $4.8 million which will expire if not utilized by 2011
and 2012. Due to changes in the Company's ownership structure, the Company's use
of its NOLs as of October 1, 1997 of approximately $2.5 million will be limited
to approximately $550,000 in any given year to offset future taxes. If the
Company does not realize taxable income in excess of the limitation in future
years, certain NOLs will be unrealizable. NOLs generated after October 1, 1997
may be further limited as a result of any future sales of stock by the Company.
At March 31, 1998, the Company had available net operating loss
carry-forwards of approximately $4.8 million. Once these net operating loss
carry forwards are utilized or expire, the Company's projected effective tax
rate will increase which will adversely affect the Company's operating results
and financial condition.
5. WARRANTS WITH REDEMPTION FEATURE
In connection with the issuance of the Sirrom Note (Note 3), the Company
issued warrants to purchase 308,982 shares of common stock at a price of $0.01
per share. In the event that the Sirrom Note remains outstanding on January 1,
2000, Sirrom will receive an additional 240,142 shares of common stock; if the
Sirrom Note remains outstanding on January 1, 2001, Sirrom will receive an
additional 247,725 shares of common stock, and if the Sirrom Note remains
outstanding on January 1, 2002, Sirrom will receive an additional 255,673 shares
of common stock, all at an exercise price of $0.01 per share. As discussed in
Note 3, the value assigned to these warrants was $255,000.
Sirrom has the option to require the Company to redeem the warrants for a
period of 30 days after maturity of the Sirrom Note in December 2002, at a
purchase price equal to fair market value, as defined. Upon completion of an
initial public offering by the Company, the redemption right terminates.
Accordingly, in periods prior to an initial public offering, the Company has
accounted for the warrants as temporary equity under EITF 88-9, "Put Warrants."
The excess of the redemption value over the carrying value is being accrued by
periodic charges to retained earnings over the redemption period. This accrual
amounted to $211,000 for the three months ended March 31, 1998. Upon the
completion of an initial public offering, the value of the warrants will be
transferred to permanent equity.
6. SHAREHOLDERS' EQUITY
COMMON STOCK
During 1996 the Company issued 2,872,300 shares of common stock at prices
ranging from approximately $.04 to $.30 per share. In addition, the Company
granted 33,400 shares to an employee in the form of a bonus. The Company
recorded compensation expense related to these shares at $.30 per share which
represented management's estimate of the fair value of the common stock on the
date of issuance.
In January 1997, the Company effected a 100-for-1 stock split. All
references in the accompanying financial statements to number of shares and per
share amounts of the Company's common stock have been retroactively restated to
reflect the increased number of shares outstanding of common stock.
In an attempt to raise a minimum of $500,000 to serve as bridge financing
for the Company, the Company offered to sell shares of common stock for $1.00
per share to accredited investors as defined by Rule 501(a) under the federal
Securities Act of 1933. The private placement began in late March 1997 and ended
October 17, 1997. Through this private placement and certain other issuances of
common stock, the Company raised $3,471,000.
The Company and its shareholders entered into an Amended and Restated
Shareholders' Agreement dated April 28, 1997. Pursuant to this agreement,
shareholders are significantly restricted from transferring their shares.
Shareholders are allowed to transfer shares only in accordance with the
agreement and to a limited class of permitted transferees and the board of
directors has sole discretion to determine whether a
F-13
<PAGE> 72
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
proposed recipient is permitted. Furthermore, no party shareholder may transfer
common stock prior to an initial public offering of the Company's common stock
without first offering the Company a right to purchase their shares and
obtaining the agreement of the purchasing party to abide by the terms of the
Shareholders' Agreement. If the Company elects not to purchase the shares
offered, the selling shareholder must offer all other party shareholders the
right to purchase these shares.
OPTIONS
The Company has a stock option plan for key employees of the Company (the
"Plan") which provides for the issuance of options to purchase up to 2,090,000
shares of the Company's common stock. Options are granted at an exercise price
which is not less than fair value as determined by a committee appointed by the
board of directors and generally vest over a period not to exceed five years.
Options granted under the Plan generally expire ten years from the date of
grant. At December 31, 1997, options to purchase 603,100 shares of common stock
were available for future grant under the Plan.
In September 1996, the board of directors granted options to purchase
1,118,300 shares of common stock outside the Plan to the president of the
Company. These options vested immediately and have an exercise price of $.30 per
share. No compensation expense was recorded for these options, as the option
price was made at the estimated fair market value of the common stock at the
date of grant.
In September 1997, the board of directors granted options to purchase
100,000 shares of common stock outside the Plan to a member of the board of
directors. These options vested immediately and have an exercise price of $1.00
per share. No compensation expense was recorded for these options, as the option
price was established at the estimated fair market value of the common stock at
the date of grant.
Stock option activity for the years ended December 31, 1996 and 1997 and
for the three months ended March 31, 1998 is as follows:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER AVERAGE
OF SHARES EXERCISE
SUBJECT TO PRICE
OPTIONS PER SHARE
---------- ---------
<S> <C> <C>
Options outstanding at December 31, 1995.................... 0 $0.00
Granted................................................... 2,601,500 0.42
Canceled.................................................. 0 0.00
Exercised................................................. 0 0.00
---------
Options outstanding at December 31, 1996.................... 2,601,500 0.42
Granted................................................... 1,020,161 0.83
Canceled.................................................. 0 0.00
Exercised................................................. (263,300) 0.30
---------
Options outstanding at December 31, 1997.................... 3,358,361 0.55
Granted................................................... 401,000 1.25
Canceled.................................................. 0 0.00
Exercised................................................. (495,000) 0.86
---------
Options Outstanding at March 31, 1998....................... 3,264,361 0.59
=========
Exercisable at December 31, 1997.......................... 2,157,361
---------
Exercisable at March 31, 1998............................. 2,118,611
=========
</TABLE>
F-14
<PAGE> 73
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth the range of exercise prices, number of
shares, weighted average exercise price, and remaining contractual lives by
groups of similar price and grant date at March 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------- --------------------
WEIGHTED
AVERAGE
WEIGHTED REMAINING WEIGHTED
RANGE OF NUMBER AVERAGE CONTRACTUAL NUMBER AVERAGE
EXERCISE PRICES OF SHARES PRICE LIFE OF SHARES PRICE
--------------- --------- -------- ----------- --------- --------
<S> <C> <C> <C> <C> <C>
$0.30-$0.55.......................... 2,138,200 $0.42 6.77 1,515,700 $0.42
$0.60................................ 436,661 0.60 9.02 421,661 0.60
$1.00-$1.25.......................... 689,500 1.10 9.66 181,250 1.18
--------- ---------
Total................................ 3,264,361 0.59 7.70 2,118,611 0.52
========= =========
</TABLE>
During 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which defines a fair value-based method of accounting for an
employee stock option plan or similar equity instrument. However, it also allows
an entity to continue to measure compensation cost for those plans using the
method of accounting prescribed by Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees." Entities electing to remain
with the accounting in APB No. 25 must make pro forma disclosures of net income
and, if presented, earnings per share as if the fair value-based method of
accounting defined in the statement had been applied.
The Company has elected to account for its stock-based compensation plan
under APB No. 25; however, the Company has computed for pro forma disclosure
purposes the value of all options granted during 1996 and 1997 using the minimum
value option pricing model as prescribed by SFAS No. 123 using the following
weighted average assumptions for grants in 1996 and 1997:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Risk-free interest rate..................................... 5.9%-6.7% 6.3%-6.7%
Expected dividend yield..................................... 0.0% 0.0%
Expected lives.............................................. 5 years 5 years
Expected volatility......................................... 0.0% 0.0%
</TABLE>
The total value of the options granted during the years ended December 31,
1996, and 1997 were computed as approximately $199,000 and $356,000,
respectively, which would be amortized over the vesting period of the options.
If the Company had accounted for these options in accordance with SFAS No. 123,
the Company's reported pro forma net loss and pro forma net loss per share for
the years ended December 31, 1996 and 1997 would have increased to the following
pro forma amounts:
<TABLE>
<CAPTION>
1996 1997
--------- -----------
<S> <C> <C>
Net loss:
As reported.............................................. $(662,307) $(2,516,101)
Pro forma................................................ (669,307) (2,548,527)
Basic:
As reported.............................................. $ (.10) $ (.26)
Pro forma................................................ (.11) (.27)
Diluted:
As reported.............................................. (.10) (.26)
Pro forma................................................ (.11) (.27)
</TABLE>
WARRANTS
In October 1997, the Company issued warrants to certain principals of
Rodgers Capital Corporation in connection with services performed by Rodgers
Capital Corporation to assist the Company in securing a
F-15
<PAGE> 74
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
marketing agreement with a third party. These warrants allow the holders to
purchase 75,000 shares of common stock for $1.00 per share. The warrants vest
immediately and expire in 2002. As the warrants were granted for services to
nonemployees, the Company has recorded $41,000, the estimated fair value of
these warrants at the date of issuance using the Black-Scholes option valuation
model, as warrants outstanding on the accompanying balance sheet. To calculate
the estimated fair value of the warrants, the Company used the following
assumptions:
<TABLE>
<S> <C>
Risk-free interest rate..................................... 6.06%
Volatility.................................................. 55%
Life of warrant............................................. 5 years
Dividend rate............................................... 0
</TABLE>
7. COMMITMENTS AND CONTINGENCIES
LEASES
During the period from inception (October 23, 1995) to December 31, 1995
and for the years ended December 31, 1996 and 1997, the Company incurred
approximately $0, $10,000, and $37,000, respectively, in rent expense for leased
office space from ProVesa, Inc., a subsidiary of The InterCept Group, Inc.
("InterCept"), a company related to the Company through common ownership. The
Company was also allocated costs for utilities and accounting services from
ProVesa, Inc. based on usage by the Company. In February 1998, the Company began
leasing office space under a noncancelable operating lease agreement with a
nonrelated third party expiring in January 2003. Future minimum rental payments
for this noncancelable lease are as follows:
<TABLE>
<S> <C>
1998........................................................ $168,885
1999........................................................ 184,205
2000........................................................ 184,205
2001........................................................ 184,205
2002........................................................ 184,205
Thereafter.................................................. 15,350
--------
$921,055
========
</TABLE>
CO-EMPLOYMENT ARRANGEMENT
Effective March 16, 1998, the Company began a co-employment arrangement
involving all its personnel with an independent company. Under the co-employment
agreement, the Company pays a percentage of compensation per co-employee (in
addition to compensation costs) to the independent company to cover payroll
processing, unemployment insurance and workers' compensation. Management of the
Company believes that the individuals who are subject to the co-employment
arrangement constitute common law employees of the Company and has received a
legal opinion from its outside legal counsel to that effect. However, the
Financial Accounting Standards Board ("FASB") is currently deliberating the
definition of "employee" under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25). In the event that the FASB
issues a final statement concluding that personnel under such co-employment
relationships are not employees of the Company for purposes of APB 25, the
Company would have to change its accounting for stock options issued to such
employees to account for such options at their fair value as required for
options granted to non-employees under FASB Statement No. 123. Such a change in
accounting may have a material adverse effect on the operating results of the
Company.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with certain executive
officers of the Company. The agreements, which are substantially similar,
provide for compensation to the officers in the form of annual base salaries and
bonuses based on earnings of the Company. The employment agreements also provide
for severance benefits upon the occurrence of certain events, including a change
in control, as defined.
F-16
<PAGE> 75
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. RELATED-PARTY TRANSACTIONS
In September 1997, the Company loaned the president of the Company $78,990
to exercise stock options. The full recourse loan is secured by the underlying
common stock and personal assets of the president, bears interest at 8.5% per
annum, and is due in full in September 1998.
On April 1, 1998, the Company loaned its Chief Financial Officer, Bruce F.
Lowthers, Jr., $75,000 pursuant to a full recourse promissory note to fund the
exercise of options to acquire 75,000 shares of its common stock. This note
accrues interest at the rate of 8.75% per year and matures on the earlier of (i)
December 31, 1999 or (ii) the date on which Mr. Lowthers sells the common stock
purchased with proceeds of the note. Mr. Lowthers pledged the shares of common
stock received upon this exercise and other personal assets as collateral for
the loan.
During the years ended December 31, 1996 and 1997, the Company incurred
fees of approximately $37,000 and $55,000, respectively, for legal services to a
law firm in which a director and shareholder of the Company is a partner. As of
December 31, 1996 and 1997, approximately $18,000 and $42,000, respectively, of
such fees are included in accounts payable in the accompanying balance sheets.
During the years ended December 31, 1996 and 1997, the Company incurred
costs of approximately $4,000, and $15,000, respectively, for communication
services from InterCept Communications Technologies, L.L.C., a subsidiary of
InterCept.
In October 1997, Rodgers Capital Group purchased 200,000 shares of common
stock from the Company at a price of $1.00 per share. In addition, the Company
paid Rodgers Capital a total of $220,000 as compensation for services provided
by Rodgers Capital during 1997 in connection with obtaining equity investments
for the Company.
9. SUBSEQUENT EVENTS
PREFERRED STOCK
In January 1998, the Company authorized 20,000,000 shares of Series A
Preferred Stock ("Preferred Stock") with a stated value of $100 per share. The
board of directors has the authority to issue these shares and to establish
dividends, voting and conversion rights, redemption provisions, liquidation
preferences, and other rights and restrictions. In March 1998, the Company sold
15,000 shares of Preferred Stock to Capital Appreciation Partners, L.P. for
$1,500,000. The shares are convertible into common stock at a price of $1.25 per
share and automatically convert into common stock upon the completion of an
initial public offering.
The Company recorded $5.1 million as a preferred stock dividend for the
difference between the estimated fair market value of the common stock at the
date of issuance and the conversion price as discussed below.
The holders of the preferred shares receive quarterly paid in kind
dividends of $1 per share for the year ending March 31, 1999 and quarterly paid
in kind dividends of $2 per share for the year ending March 31, 2000. For the
two years ending March 31, 2002, the holders receive quarterly cash dividends of
$4 per share, and beginning April 1, 2002, the holders receive quarterly cash
dividends of $6 per share. The difference between the fair value of the
preferred stock at the date of issuance and the fair value if the ultimate
dividend rate was in effect for all periods will be accrued to preferred stock
using the effective interest method over the period preceding the perpetual
dividend. Dividends are to be paid in cash or with shares of common stock valued
at a price of $1.25, at the option of the holders of the preferred stock.
Pro forma shareholders' equity at March 31, 1998 assumes the conversion of
preferred stock into 1,217,903 shares of common stock upon completion of an
initial public offering (assuming an August 1, 1998 conversion date).
COMMON STOCK TRANSACTIONS
During the three months ended March 31, 1998, the Company sold shares of
common stock and issued options to acquire common stock at what management
believed to be the fair market value of the common stock at that time. The
Company retained an independent appraiser (Smerkovitz & Associates) who
F-17
<PAGE> 76
TOWNE SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
subsequently valued the common stock at a higher price. The Company has
subsequently increased the fair market value of its common stock based on the
anticipated public offering.
In February 1998, the Company sold 76,000 shares of common stock to third
parties at $1.25 per share. The Company recorded $323,000 as financing costs for
stock issued to nonemployees for the difference between the sale price to these
third parties and the estimated fair market value on the date of sale.
STOCK SALE TO EMPLOYEES
In February 1998, the board of directors authorized the sale of the
Company's common stock to all employees of the Company for approximately $1.19
per share. The stock sale was available through March 6, 1997, and 943,083
shares were purchased by employees. The Company recorded $3,805,340 as
compensation expense for the difference between the sales price to employees and
the estimated fair market value at the date of sale.
STOCK OPTIONS
The Company granted options to purchase 111,000 and 60,000 shares of common
stock under the Plan at $1.25 per share to key employees in January 1998 and
February 1998, respectively. These options vest 20% per year beginning upon the
first anniversary of the date of grant. The Company will record $726,750
($145,350 per year) of compensation expense over the five year vesting period of
the Options for the difference between the exercise price and the estimated fair
market value on the date of grant.
In February 1998, the board of directors approved an amendment to the
vesting period for options to purchase 397,500 shares of common stock granted
during 1996 and 1997 to nonemployee directors from a five year vesting period to
immediate vesting. As of the date of the amendment, options to purchase 150,000
of these shares were already vested. As this change in vesting period created a
new measurement date, the Company recorded compensation expense of $1,188,750
for the difference between the original exercise price and the estimated fair
market value on the date the options were amended.
In February 1998, the board of directors granted options to purchase 20,000
shares of common stock to each nonemployee director, and options to purchase
30,000 shares of common stock to a new nonemployee director. These options vest
immediately and have an exercise price of $1.25. The Company has recorded
$977,500 as compensation expense for the difference between the exercise price
and the estimated fair market value on the date of grant.
In May 1998, the board of directors granted options to certain board
members and key employees to purchase 595,000 shares of common stock. These
options vest immediately and have an option price of $7.20 per share. Options to
purchase 170,000 shares expire in May 2003 and the remaining options to purchase
425,000 shares expire in May 2008. All of these options vest immediately. The
Company did not record any compensation expense related to these grants as the
option price represented the estimated fair value of the Company's common stock
at the date of grant.
STOCK SUBSCRIPTIONS RECEIVABLE
In March 1998, options for the purchase of 495,000 shares of common stock
were exercised for $427,500 by various option holders. As the cash was not
received until April 1998, the amount has been recorded as subscriptions
receivable on the accompanying balance sheet at March 31, 1998.
INITIAL PUBLIC OFFERING
In the second quarter of 1998, the Company plans to sell approximately
4,000,000 shares of common stock at an estimated initial public offering price
of $8 -- $10 per share in an initial public offering. There can be no assurance,
however, that the initial public offering will be completed at a per share price
within the estimated range or completed at all.
F-18
<PAGE> 77
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Credit Collection Solutions, Inc.:
We have audited the accompanying balance sheet of CREDIT COLLECTION
SOLUTIONS, INC. (a Georgia corporation) as of December 31, 1997 and the related
statements of operations, shareholders' deficit, and cash flows for the year
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Credit Collection Solutions,
Inc. as of December 31, 1997 and the results of its operations and its cash
flows for the year then ended in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
June 8, 1998
F-19
<PAGE> 78
CREDIT COLLECTION SOLUTIONS, INC.
BALANCE SHEETS
DECEMBER 31, 1997 AND MARCH 31, 1998
<TABLE>
<CAPTION>
1997 1998
--------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 215 $ 144
Accounts receivable, net of allowance for doubtful
accounts of $10,000 at December 31, 1997 and March 31,
1998, respectively..................................... 74,320 59,907
--------- ---------
Total current assets.............................. 74,535 60,051
PROPERTY AND EQUIPMENT, net................................. 14,568 10,927
--------- ---------
$ 89,103 $ 70,978
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable.......................................... $ 21,392 $ 17,268
Accrued liabilities....................................... 26,891 42,241
Payroll taxes payable..................................... 39,899 46,468
Note payable.............................................. 85,000 85,000
Wages payable............................................. 1,471 44,353
Due to shareholders....................................... 153,028 163,119
Due to employees.......................................... 32,675 24,984
Due to related party...................................... 213,489 213,518
--------- ---------
Total current liabilities......................... 573,845 636,951
--------- ---------
COMMITMENTS AND CONTINGENCIES (Note 6)
SHAREHOLDERS' DEFICIT:
Common stock, $10 par value; 100,000 shares authorized,
10,000 shares issued and outstanding................... 100,000 100,000
Accumulated deficit....................................... (584,742) (665,973)
--------- ---------
Total shareholders' deficit....................... (484,742) (565,973)
--------- ---------
$ 89,103 $ 70,978
========= =========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-20
<PAGE> 79
CREDIT COLLECTION SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998
<TABLE>
<CAPTION>
MARCH 31
DECEMBER 31, -------------------
1997 1997 1998
------------ -------- --------
(UNAUDITED)
<S> <C> <C> <C>
REVENUES.................................................... $ 229,665 $ 58,338 $ 49,283
--------- -------- --------
COSTS AND EXPENSES:
Costs of processing, servicing, and support............... 51,749 3,006 26,560
Research and development.................................. 70,291 16,695 16,575
General and administrative................................ 457,305 90,151 78,829
--------- -------- --------
Total costs and expenses.......................... 579,345 109,852 121,964
--------- -------- --------
OPERATING LOSS.............................................. (349,680) (51,514) (72,681)
INTEREST EXPENSE............................................ 21,337 1,019 8,550
--------- -------- --------
NET LOSS.................................................... $(371,017) $(52,533) $(81,231)
========= ======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-21
<PAGE> 80
CREDIT COLLECTION SOLUTIONS, INC.
STATEMENTS OF SHAREHOLDERS' DEFICIT
FOR THE YEAR ENDED DECEMBER 31, 1997
AND FOR THE THREE MONTHS ENDED MARCH 31, 1998
<TABLE>
<CAPTION>
COMMON STOCK TOTAL
----------------- ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT DEFICIT DEFICIT
------ -------- ----------- -------------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1996.......................... 10,000 $100,000 $(213,725) $(113,725)
Net loss.......................................... 0 0 (371,017) (371,017)
------ -------- --------- ---------
BALANCE, December 31, 1997.......................... 10,000 100,000 (584,742) (484,742)
Net loss.......................................... 0 0 (81,231) (81,231)
------ -------- --------- ---------
BALANCE, March 31, 1998 (unaudited)................. 10,000 $100,000 $(665,973) $(565,973)
====== ======== ========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
F-22
<PAGE> 81
CREDIT COLLECTION SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1997
AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998
<TABLE>
<CAPTION>
MARCH 31,
DECEMBER 31, -------------------
1997 1997 1998
------------ -------- --------
(UNAUDITED)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(371,017) $(52,533) $(81,231)
--------- -------- --------
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.......................... 14,566 3,641 3,641
Changes in operating assets and liabilities:
Accounts receivable.................................. (36,276) (51,266) 14,413
Accounts payable..................................... 20,547 30,712 (4,124)
Payroll taxes payable................................ 39,899 5,036 6,569
Related-party payable................................ 41,465 45,493 29
Accrued liabilities.................................. 26,891 6,179 15,350
Wages payable........................................ 1,471 0 42,882
Due to employees..................................... 32,675 0 (7,691)
Due to shareholders.................................. 143,028 11,350 10,091
--------- -------- --------
Total adjustments................................. 284,266 51,145 81,160
--------- -------- --------
Net cash used in operating activities............. (86,751) (1,388) (71)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of debt............................ 85,000 0 0
--------- -------- --------
NET DECREASE IN CASH........................................ (1,751) (1,388) (71)
CASH AND CASH EQUIVALENTS, beginning of period.............. 1,966 1,966 215
--------- -------- --------
CASH AND CASH EQUIVALENTS, end of period.................... $ 215 $ 578 $ 144
========= ======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-23
<PAGE> 82
CREDIT COLLECTION SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND MARCH 31, 1997 AND 1998
1. ORGANIZATION AND BACKGROUND
Credit Collection Solutions, Inc. (the "Company") was formed in November
1994 to provide information, training, and support for the collection and
finance industry. The Company's product, Collection Works, is a PC-based
software package which was specifically developed to operate in the local area
network environment for the purpose of debt collection. The product focuses
primarily on collection agencies and bank users but is also adapted to serve the
large company or business that does in-house debt collecting.
The Company's products and services are sold throughout the United States
and Asia.
In June 1998, Towne Services, Inc. ("Towne Services") purchased certain
assets of the Company for approximately $510,000 cash and, subject to certain
earn-out agreements, the issuance of up to 100,000 shares of Towne Services
common stock to the shareholders of the Company. The $510,000 cash was used to
extinguish existing obligations of the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying financial statements and footnote data as of March 31,
1998 and for the three months ended March 31, 1997 and 1998 are unaudited. In
the opinion of the Company's management, these financial statements reflect all
adjustments consisting only of normal recurring adjustments necessary for a fair
presentation of the financial statements. The results of operations for the
three months ended March 31, 1998 are not necessarily indicative of the results
that may be expected for the full year.
REVENUE RECOGNITION
The Company's revenue is generated through sales of its software program
and through providing maintenance and support services. Revenue from software
licenses and system sales is recognized as products are shipped, provided that
no significant postcontract support obligations remain and the collection of the
related receivable is probable. Revenue from maintenance and support is
recognized as the service is provided.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Major property additions,
replacements, and betterments are capitalized, while maintenance and repairs
which do not extend the useful lives of these assets are expensed as
F-24
<PAGE> 83
CREDIT COLLECTION SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
incurred. Depreciation is provided using the straight-line method for financial
reporting. The detail of property and equipment at December 31, 1997 is as
follows:
<TABLE>
<CAPTION>
USEFUL
LIVES
-----------
<S> <C> <C>
Computers and equipment..................................... $12,100 Three years
Software development costs.................................. 31,600 Three years
-------
43,700
Less accumulated depreciation............................... (29,132)
-------
$14,568
=======
</TABLE>
LONG-LIVED ASSETS
The Company periodically reviews the values assigned to long-lived assets,
such as property and equipment, to determine whether any impairments are other
than temporary. Management believes that the long-lived assets in the
accompanying balance sheets are appropriately valued.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist of salary-related personnel costs
and support services used in products necessary to deliver the Company's
product. The Company's policy is to capitalize research and development costs
upon establishing technological feasibility, subject to a periodic assessment of
recoverability based on expected future revenues. The Company capitalized
$31,600 of software development costs at December 31, 1997.
INCOME TAXES
The Company is a C corporation for income tax reporting purposes and
accounts for income taxes under the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," which
requires the use of an asset and liability method of accounting for deferred
income taxes. Under SFAS No. 109, deferred tax assets or liabilities at the end
of each period are determined using the tax rate expected to apply to taxable
income in the period in which the deferred tax asset or liability is expected to
be settled or realized.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The book values of cash, trade accounts receivable, trade accounts payable,
and other financial instruments approximate their fair values principally
because of the short-term maturities of these instruments. The fair value of the
Company's long-term debt is estimated based on the current rates offered to the
Company for debt of similar terms and maturities.
CONCENTRATION OF CUSTOMERS
For the year ended December 31, 1997, the Company had two customers which
accounted for approximately 18% and 13% of the Company's revenues. The loss of
one or both of these customers could have an adverse effect on the Company's
performance and operations.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting and
presentation of comprehensive income and its components in a full set of
general-purpose financial statements. This statement is effective for periods
F-25
<PAGE> 84
CREDIT COLLECTION SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
beginning after December 15, 1997. The Company adopted SFAS No. 130, January 1,
1998. The adoption of SFAS No. 130 did not have a material impact on the
Company's financial statements, as comprehensive income did not differ from the
reported net loss for all periods presented.
3. NOTE PAYABLE
In April 1997, the Company signed a note payable to a third party for
$85,000. This note bears interest at 16% and is due in 36 monthly installments
of approximately $3,000, including interest, beginning May 1997. As of December
31, 1997, the Company has not made any payments on this note payable. Per the
provisions of the note payable, the note is due on demand upon any default.
Accordingly, the note payable has been recorded as a current liability. Accrued
interest of $10,200 on the note is included in accrued liabilities.
4. INCOME TAXES
The following is a reconciliation of income taxes at the federal statutory
rate with income taxes recorded by the Company for the year ended December 31,
1997:
<TABLE>
<S> <C>
Income tax benefit computed at the federal statutory rate... $126,146
State income tax benefit, net of federal income tax
benefit................................................... 14,840
Other, net.................................................. 6,500
Change in valuation allowance............................... (147,486)
--------
$ 0
========
</TABLE>
Deferred income tax assets and liabilities for 1997 reflect the impact of
temporary differences between the amounts of assets and liabilities for
financial reporting and income tax reporting purposes. Temporary differences
that give rise to deferred tax assets and liabilities at December 31, 1997 are
as follows:
<TABLE>
<S> <C>
Deferred tax assets:
Accounts receivable reserves.............................. $ 3,800
Payroll taxes payable..................................... 15,162
Net operating loss carryforwards.......................... 175,411
---------
Deferred tax assets............................... 194,373
Valuation allowance......................................... (194,373)
---------
Net deferred tax asset............................ $ 0
=========
</TABLE>
Due to the Company's current year operating loss position and projected
losses for the fiscal year ending December 31, 1998, no benefit for income taxes
for the year ended December 31, 1997 has been provided in the accompanying
financial statements.
The Company has net operating loss carryforwards ("NOLs") of approximately
$460,000 which will expire if not utilized by 2011 and 2012.
5. RELATED-PARTY TRANSACTIONS
The Company has $213,489 payable to Southern Computer Works, Inc., a
company related through common ownership, for services and payments made on the
Company's behalf. In 1998, the Company used computer equipment which was leased
from an outside party to Southern Computer Works. The lease payments of $1,872
were paid by Southern Computer Works and reimbursed by the Company and have been
included as rent expense in the accompanying statement of operations. The
Company is not obligated to continue to use this equipment in the future.
F-26
<PAGE> 85
CREDIT COLLECTION SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company has received $185,703 of advances from shareholders and
employees of the Company for operating expenses. These advances consist of
personal credit cards and other notes with varying rates of interest from 16% to
23.9%. Of these advances, $10,000 do not bear any interest. All amounts are due
on demand.
The Company utilizes office space owned by one of its shareholders at no
charge. This shareholder does not make any mortgage payments on the building on
the Company's behalf. Payments for utilities are made by Southern Computer Works
and are included in due to related party.
6. COMMITMENTS AND CONTINGENCIES
The Company does not maintain insurance coverage for risk areas such as
workers' compensation, property/casualty, and general liability. Management is
not aware of any incurred or outstanding claims as of December 31, 1997 or March
31, 1998 which would impact the operations of the Company.
F-27
<PAGE> 86
UNAUDITED PRO FORMA FINANCIAL INFORMATION
The accompanying unaudited pro forma balance sheet as of March 31, 1998,
gives effect to the acquisition of certain assets of Credit Collection
Solutions, Inc. as if the purchase had occurred on that date. The accompanying
unaudited pro forma statements of operations for the year ended December 31,
1997 and the three months ended March 31, 1998 have been prepared to reflect
adjustments to Towne Services' historical results of operations to give effect
to the purchase as if it had occurred at the beginning of the respective
periods. The pro forma adjustments are based upon available information and
certain assumptions that management believes to be reasonable. Final purchase
adjustments may differ from the pro forma adjustments herein.
The accompanying pro forma statements are not necessarily indicative of the
results of operations which would have been attained had the purchase been
consummated on the dates indicated or which may be attained in the future. These
pro forma statements should be read in conjunction with the historical financial
statements of Towne Services and related notes thereto, which are included
elsewhere in this prospectus.
F-28
<PAGE> 87
UNAUDITED PRO FORMA BALANCE SHEET
AS OF MARCH 31, 1998
<TABLE>
<CAPTION>
HISTORICAL
HISTORICAL CREDIT PRO
TOWNE COLLECTION FORMA
SERVICES(A) SOLUTIONS(A) ADJUSTMENTS PRO FORMA
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................... $ 3,500,010 $ 144 $ (10,000)(d) $ 3,490,154
Accounts receivable, net of allowance for
uncollectible accounts........................... 359,007 59,907 0 418,914
Note receivable.................................... 78,990 0 0 78,990
Stock subscriptions receivable..................... 427,500 0 0 427,500
Other.............................................. 163,770 0 0 163,770
----------- --------- --------- -----------
Total current assets........................ 4,529,277 60,051 (10,000) 4,579,328
PROPERTY AND EQUIPMENT, net.......................... 687,363 10,927 0 698,290
DEBT ISSUANCE COSTS, net............................. 304,361 0 0 304,361
INTANGIBLES, NET..................................... 0 0 439,022(b) 439,022
OTHER ASSETS......................................... 2,500 0 0 2,500
----------- --------- --------- -----------
$ 5,523,501 $ 70,978 $ 429,022 $ 6,023,501
=========== ========= ========= ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................... $ 125,505 $ 17,268 (17,268)(b) $ 125,505
Accrued liabilities................................ 296,469 42,241 (42,241)(b) 296,469
Accrued compensation............................... 906,297 44,353 (44,353)(b) 906,297
Current portion of long-term debt.................. 41,967 85,000 500,000(d) 541,967
(85,000)(b)
Payroll taxes payable.............................. 0 46,468 (46,468)(b) 0
Due to shareholders................................ 0 163,119 (163,119)(b) 0
Due to employees................................... 0 24,984 (24,984)(b) 0
Due to related party............................... 0 213,518 (213,518)(b) 0
----------- --------- --------- -----------
Total current liabilities................... 1,370,238 636,951 (136,951) 1,870,238
----------- --------- --------- -----------
LONG-TERM DEBT, net of discount...................... 1,289,162 0 0 1,289,162
----------- --------- --------- -----------
WARRANTS WITH REDEMPTION FEATURE..................... 466,000 0 0 466,000
----------- --------- --------- -----------
SHAREHOLDERS' EQUITY:
Preferred stock.................................... 1,508,000 0 0 1,508,000
Common stock....................................... 17,457,055 100,000 (100,000)(c) 17,457,055
Warrants outstanding............................... 41,000 0 0 41,000
Accumulated deficit................................ (16,607,954) (665,973) 665,973(c) (16,607,954)
----------- --------- --------- -----------
Total shareholders' equity (deficit)........ 2,398,101 (565,973) 565,973 2,398,101
----------- --------- --------- -----------
$ 5,523,501 $ 70,978 $ 429,022 $ 6,023,501
=========== ========= ========= ===========
</TABLE>
- ---------------
(a) Derived from the March 31, 1998 unaudited financial statements of Towne
Services and of Credit Collection Solutions, Inc. appearing elsewhere in
this prospectus.
(b) Reflects the allocation of the purchase price to tangible and intangible
assets based on the estimated fair value of such assets. The $510,000 cash
was paid directly to creditors of Credit Collection Solutions, Inc. Towne
Services did not assume any liabilities of Credit Collection Solutions. In
addition to $510,000 cash, Towne Services, Inc. will issue up to 100,000
shares of its common stock to the shareholders of Credit Collection
Solutions, Inc. based upon certain earn-out agreements. These shares will be
recorded as part of the purchase price based upon the fair value of the
shares on the date of issuance. If these shares are issued, future earnings
will be decreased based upon the amortization of additional goodwill.
<TABLE>
<S> <C>
Total consideration......................................... $510,000
Fair value of assets acquired............................... 70,978
--------
Excess of purchase price over fair value of assets
acquired.................................................. 439,022
</TABLE>
The excess of the purchase price over the fair value of assets acquired has
been allocated to goodwill, which will be amortized over a 5 year life.
Towne Services is currently in the process of obtaining a purchase price
valuation. Based on this valuation, a portion of the goodwill may be
expensed as in-process research & development costs; however, this amount
has not yet been determined.
(c) Reflects elimination of Credit Collection Solutions, Inc. equity accounts.
(d) Reflects financing of acquisition with $10,000 cash and a $500,000 90-day
note payable to a bank at the prime rate. It is the intent of Towne Services
to repay this note and accrued interest with the proceeds from the offering.
F-29
<PAGE> 88
UNAUDITED PRO FORMA STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
--------------------------------------------------------------
HISTORICAL
CREDIT
HISTORICAL COLLECTION PRO FORMA
TOWNE SERVICES(A) SOLUTIONS(A) ADJUSTMENTS PRO FORMA
----------------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Revenues.................................... $ 722,364 $ 229,665 $ 0 $ 952,029
Costs and expenses
Costs of processing, servicing, and
support.............................. 832,102 51,749 0 883,851
Research and development................ 332,470 70,291 0 402,761
Sales and marketing..................... 839,323 0 0 839,323
General and administrative.............. 1,139,642 457,305 87,800(c) 1,644,747
(40,000)(d)
------------ --------- ----------- ------------
Total costs and expenses.................... 3,143,537 579,345 47,800 3,770,682
------------ --------- ----------- ------------
Operating loss.............................. (2,421,173) (349,680) (47,800) (2,818,653)
Interest expense, net....................... 95,946 21,337 42,500(b) 159,783
Other income................................ (1,018) 0 0 (1,018)
------------ --------- ----------- ------------
Net loss.................................... $ (2,516,101) $(371,017) $ (90,300) $ (2,977,418)
============ ========= =========== ============
Net loss attributable to common
shareholders......................... (2,516,101) (2,977,418)
============ ============
Net loss per common share............... (0.26) (0.31)
============ ============
Weighted average common shares
outstanding.......................... 9,600,592 9,600,592
============ ============
</TABLE>
<TABLE>
<CAPTION>
THREE MONTH PERIOD ENDED MARCH 31, 1998
--------------------------------------------------------------
HISTORICAL
CREDIT
HISTORICAL COLLECTION PRO FORMA
TOWNE SERVICES(A) SOLUTIONS(A) ADJUSTMENTS PRO FORMA
----------------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Revenues.................................... $ 547,954 $ 49,283 $ 0 $ 597,237
Costs and expenses
Costs of processing, servicing, and
support.............................. 374,128 26,560 0 400,688
Research and development................ 74,024 16,575 0 90,599
Sales and marketing..................... 485,562 0 0 485,562
Stock compensation expense.............. 5,971,590 0 0 5,971,590
General and administrative.............. 1,347,282 78,829 21,950(c) 1,408,061
(40,000)(d)
------------ --------- ----------- ------------
Total costs and expenses.................... 8,252,586 121,964 18,050 8,356,500
------------ --------- ----------- ------------
Operating loss.............................. (7,704,632) (72,681) 18,050 (7,759,263)
Interest expense, net....................... 64,289 8,550 10,625(b) 83,464
Financing costs for stock issued to
nonemployees.............................. 323,000 0 0 323,000
------------ --------- ----------- ------------
Net loss.................................... $ (8,091,921) $ (81,231) $ 7,425 $ (8,165,727)
============ ========= =========== ============
Dividends on preferred stock............ (5,108,000) (5,108,000)
Accretion of warrants with redemption
feature.............................. (211,000) (211,000)
Net loss attributable to common
shareholders......................... (13,410,921) (13,484,727)
============ ============
Net loss per common share............... $ (1.11) $ (1.12)
============ ============
Weighted average common shares
outstanding.......................... 12,077,352 12,077,352
============ ============
</TABLE>
- ---------------
(a) Derived from the financial statements of Towne Services and of Credit
Collection Solutions, Inc. appearing elsewhere in this prospectus.
(b) Reflects interest expense on note payable to bank.
(c) Reflects amortization of intangibles over five years.
(d) Reflects reduction in duplicate general and administrative expenses for
utilities and equipment rentals as Credit Collection Solutions, Inc. vacated
existing office space.
F-30
<PAGE> 89
[Top half inside back cover]
Photograph: Business representative executing transaction with a customer.
Photograph: Business representative talking to a customer.
Photograph: Two children, customers of a small business.
Supporting text: Towne Credit(SM)
Towne Credit electronically processes the in-house consumer credit
transactions of small and medium size retail merchants. This product links
banks with business owners to provide electronic billing, collections and
funding of daily accounts receivables, essentially converting them to credit
card transactions.
[Bottom half of inside back cover]
Photograph: Dentist working with a patient.
Photograph: Business representative assisting a customer.
Photograph: Business representative entering transaction information into
a computer.
Supporting text: Towne Finance(SM)
Towne Finance, the commercial version of TOWNE CREDIT, is an automated
asset management and financing system that processes "business to business"
credit transactions for small commercial businesses, with both products,
businesses increase cash flow and are relieved of administrative burdens such as
sending statements and collecting payments.
<PAGE> 90
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PROSPECTIVE INVESTORS MAY RELY ONLY ON THE INFORMATION CONTAINED IN THIS
PROSPECTUS. NEITHER TOWNE SERVICES, INC., THE SELLING SHAREHOLDERS NOR ANY
UNDERWRITER HAS AUTHORIZED ANYONE TO PROVIDE PROSPECTIVE INVESTORS WITH
INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS PROSPECTUS. THIS PROSPECTUS IS
NOT AN OFFER TO SELL NOR IS IT SEEKING AN OFFER TO BUY THESE SECURITIES IN ANY
JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. THE INFORMATION CONTAINED
IN THIS PROSPECTUS IS CORRECT ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS
OF THE TIME OF THE DELIVERY OF THIS PROSPECTUS OR ANY SALE OF THESE SECURITIES.
NO ACTION IS BEING TAKEN IN ANY JURISDICTION OUTSIDE THE UNITED STATES TO
PERMIT A PUBLIC OFFERING OF THE COMMON STOCK OR POSSESSION OR DISTRIBUTION OF
THIS PROSPECTUS IN ANY SUCH JURISDICTION. PERSONS WHO COME INTO POSSESSION OF
THIS PROSPECTUS IN JURISDICTIONS OUTSIDE THE UNITED STATES ARE REQUIRED TO
INFORM THEMSELVES ABOUT AND TO OBSERVE ANY RESTRICTIONS AS TO THIS OFFERING AND
THE DISTRIBUTION OF THIS PROSPECTUS APPLICABLE IN THAT JURISDICTION.
UNTIL AUGUST 24, 1998, ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE
SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO
DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER
A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................ 3
Risk Factors.............................. 9
Use of Proceeds........................... 14
Dividend Policy........................... 14
Dilution.................................. 15
Capitalization............................ 16
Selected Financial Data................... 17
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.............................. 19
Business.................................. 27
Management................................ 38
Principal and Selling Shareholders........ 46
Certain Transactions...................... 48
Description of Capital Stock.............. 49
Shares Eligible for Future Sale........... 53
Underwriting.............................. 55
Legal Matters............................. 56
Experts................................... 56
Additional Information.................... 57
Index to Financial Statements............. F-1
</TABLE>
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4,000,000 SHARES
TOWNE SERVICES, INC.
(TOWNE SERVICES, INC. LOGO)
COMMON STOCK
--------------------
PROSPECTUS
--------------------
WHEAT FIRST UNION
J.C. BRADFORD&CO.
STEPHENS INC.
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