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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998.
Or
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO
__________, 19__.
Commission file number : 000-24695
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----------------
TOWNE SERVICES, INC.
(Exact name of registrant as specified in its charter)
Georgia 62-1618121
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3295 River Exchange Drive, Suite 350, Norcross, Georgia 30092
(Address of principal executive offices and zip code)
(770) 734-2680
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days (1) Yes X No ; (2) Yes No X .
--- --- --- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date. 18,674,381 shares
outstanding at September 9, 1998.
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TOWNE SERVICES, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets as of
June 30, 1998 and December 31, 1997 3
Statements of Operations for the Three Months and Six
Months ended June 30, 1998 and 1997 4
Statements of Cash Flows for the Six Months ended
June 30, 1998 and 1997 5
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
PART II OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities 17
Item 3. Defaults upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 19
Exhibit Index 20
</TABLE>
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TOWNE SERVICES, INC
BALANCE SHEETS
DECEMBER 31, 1997 AND JUNE 30, 1998
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
-------------------------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,536,439 $ 1,847,328
Accounts receivable, net of allowance
for uncollectible accounts of $25,000 and $70,000
in 1997 and 1998, respectively 121,566 671,847
Note receivable 78,990 160,667
Stock subscriptions receivable -- 50,000
Other 68,273 134,835
-------------------------------
Total current assets 2,805,268 2,864,677
-------------------------------
PROPERTY AND EQUIPMENT, net 489,849 961,176
DEBT ISSUANCE COSTS, net 288,815 318,401
OTHER ASSETS 2,500 278,254
-------------------------------
$ 3,586,432 $ 4,422,508
===============================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 297,937 $ 167,679
Accrued liabilities 215,109 130,580
Accrued compensation 220,300 957,000
Current portion of long-term debt 46,757 596,324
Deferred revenue -- --
-------------------------------
Total current liabilities 780,103 1,851,583
-------------------------------
LONG TERM DEBT, net of discount of $249,500 and
$229,296 in 1997 and 1998, respectively 1,289,666 1,374,707
COMMITMENTS AND CONTINGENCIES
WARRANTS WITH REDEMPTION FEATURE 255,000 750,000
SHAREHOLDERS' EQUITY:
Preferred stock, no par value; 20,000,000 shares authorized, 0 and 15,000
shares issued and outstanding in 1997
and 1998, respectively -- 1,508,000
Common stock, no par value; 50,000,000 shares authorized,
11,706,766 and 13,296,849 issued and outstanding in 1997
and 1998, respectively 4,417,696 17,569,393
Warrants outstanding 41,000 41,000
Accumulated deficit (3,197,033) (18,672,174)
-------------------------------
Total shareholders' equity 1,261,663 446,218
-------------------------------
$ 3,586,432 $ 4,422,508
===============================
</TABLE>
The accompanying notes are an integral part of these balance sheets.
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TOWNE SERVICES, INC
STATEMENTS OF OPERATION
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1997 AND 1998
<TABLE>
<CAPTION>
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
1997 1998 1997 1998
---------------------------------------------------------------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES $ 88,317 $ 873,581 $ 184,979 $ 1,421,535
COSTS AND EXPENSES:
Costs of processing, servicing, and support 150,064 403,707 253,365 777,835
Research and development 33,683 101,987 45,000 176,011
Purchased in process development -- 200,000 -- 200,000
Sales and marketing 118,309 1,139,866 212,183 1,625,428
Stock compensation expense -- 36,338 -- 6,007,928
General and administrative 181,315 704,908 350,799 2,052,190
---------------------------------------------------------------------
Total costs and expenses 483,371 2,586,806 861,347 10,839,392
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OPERATING LOSS (395,054) (1,713,225) (676,368) (9,417,857)
---------------------------------------------------------------------
OTHER EXPENSES:
Interest (income) expense, net 26,414 66,743 44,843 131,032
Other expense (income) -- 252 -- 252
Financing costs for stock issued to nonemployees -- -- -- 323,000
---------------------------------------------------------------------
Total other expenses 26,414 66,995 44,843 454,284
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NET LOSS $ (421,468) $ (1,780,220) $ (721,211) $ (9,872,141)
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PREFERRED STOCK DIVIDENDS -- -- -- (5,108,000)
ACCRETION OF WARRANTS WITH REDEMPTION -- (284,000) -- (495,000)
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS:
---------------------------------------------------------------------
Basic $ (421,468) $ (2,064,220) $ (721,211) $(15,475,141)
=====================================================================
Diluted $ (421,468) $ (2,064,220) $ (721,211) $(15,475,141)
=====================================================================
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
PER COMMON SHARE:
Basic $ (0.05) $ (0.16) $ (0.08) $ (1.19)
=====================================================================
Diluted $ (0.05) $ (0.16) $ (0.08) $ (1.19)
=====================================================================
Weighted Average Common Shares Outstanding 9,101,116 13,296,849 8,624,509 12,962,002
=====================================================================
</TABLE>
The accompanying notes are an integral part of these statements.
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TOWNE SERVICES, INC.
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
1997 1998
-----------------------------
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $ (721,211) $(9,872,141)
Adjustments to reconcile net loss to net cash
used in operating activities:
Compensation expense recognized for stock
option grants -- 5,971,590
Financing costs for stock issued to nonemployees -- 323,000
Purchase in process development -- 200,000
Issuance of warrants -- --
Loss on disposal of property and equipment -- --
Depreciation and amortization 23,917 91,840
Amortization of debt financing fees 24,043 6,856
Amortization of debt discount -- 24,962
Changes in operating assets and liabilities, net of assets acquired: -- --
Accounts receivable (24,243) (490,374)
Prepaid & other assets (50,666) (153,993)
Stock subscriptions receivable -- 377,500
Accounts payable 39,771 (130,258)
Accrued liabilities 8,599 601,468
Accrued compensation 315 50,703
Deferred revenue (13,103) --
-----------------------------
Total Adjustments 8,633 6,873,294
-----------------------------
Net cash used in operating activities (712,578) (2,998,847)
-----------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Note receivable due from shareholder -- (81,677)
Purchase of Credit Collection Solutions, Inc. -- (510,000)
Purchase of property and equipment, net (29,396) (520,911)
-----------------------------
Net cash used in investing activities (29,396) (1,112,588)
-----------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 882,903 --
Repayment of debt (45,405) (36,132)
Proceeds from Sirrom Capital -- --
Proceeds from long-term borrowings -- 628,849
Proceeds from issuance of preferred stock -- 1,500,000
Proceeds from issuance of common stock 669,286 1,329,607
-----------------------------
Net cash provided by financing activities 1,506,784 3,422,324
-----------------------------
NET INCREASE IN CASH 764,810 (689,111)
CASH AND CASH EQUIVALENTS, beginning of year 151,082 2,536,439
=============================
CASH AND CASH EQUIVALENTS, end of year $ 915,892 $ 1,847,328
=============================
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for income taxes $ -- $ --
=============================
Cash paid for interest $ 5,672 $ 44,539
=============================
Stock subscriptions receivable $ -- $ 50,000
=============================
</TABLE>
The accompanying notes are an integral part of these statements.
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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 the Company'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, the Company
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 the Company'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.
2. BASIS OF PRESENTATION
UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying financial statements and footnote data as of June 30, 1998 and
for the three and six months ended June 30, 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. Certain information and footnote
disclosures usually found in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted. The
results of operations for the three and six months ended June 30, 1998 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1998.
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3. INITIAL PUBLIC OFFERING
On July 30, 1998 the Company's initial public offering (the "Initial Public
Offering") was declared effective by the Securities and Exchange Commission. In
the Initial Public Offering, the Company sold 4,000,000 shares of common stock
at $8 per share.
4. 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 on 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.
5. ACQUISITION
In June 1998, the Company acquired certain assets and liabilities of Credit
Collection Solutions, Inc. ("CCS") for approximately $510,000 and the issuance
of up to 100,000 shares of the Company's common stock if certain financial
results are achieved. CCS is a developer of computer software for processing
payments and tracking collections. In connection with the acquisition, the
Company recorded a pre-tax charge of $200,000 for purchased in process
development, which had not reached technical feasibility and had no alternative
future use.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operation
The following discussion should be read in conjunction with Towne Services'
financial statements and the related notes thereto included elsewhere in this
quarterly report. This discussion contains statements which constitute
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These statements appear in a number of places in this quarterly
report and include all statements that are not historical statements of fact
regarding the intent, anticipation, belief or
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current expectations of the Company, its directors or its officers with respect
to, among other things: (i) the Company's financing plans; (ii) trends affecting
the Company's financial condition or results of operations; (iii) the Company's
growth strategy and operating strategy (including, but not limited to, the
Company's development and implementation of its products and services); and (iv)
the declaration and payment of dividends. The words "may," "would," "could,"
"will," "expect," "estimate," "anticipate," "believe," "intend," "plan," and
similar expressions and variations thereof are intended to identify
forward-looking statements. Investors are cautioned that any such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties, many of which are beyond the Company's ability to
control. Actual results may differ materially from these forward-looking
statements as a result of many factors, including the Company's limited
operating history; the inability to achieve or maintain profitability; the
inability to attract and retain sales and marketing personnel or enter new
marketing alliances; inability to obtain, continue and manage growth or execute
agreements with new customers; market acceptance of new products and
enhancements; increased competition; possible system failures; rapid changes in
technology, and the other factors discussed in the Company's registration
statement on Form S-1 (No. 333-53341) as declared effective on July 30, 1998,
including the "Risk Factors" section contained therein.
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
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. 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 six months ended June 30, 1997 and 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. 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, the Company recognizes these fees as the related services are
provided. Set-up fees include charges for installation, implementation and
training of the
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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.
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 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.
Towne Services had net losses of approximately $421,000 and $1.8 million for the
three months ended June 30, 1997 and 1998, respectively. For the six months
ended June 30, 1997 and 1998, the Company had net losses of approximately
$721,000 and $9.9 million, respectively. As of December 31, 1997, the Company
had an accumulated deficit of $3.2 million. As of June 30, 1998, this
accumulated deficit was $18.7 million. Approximately $12 million of this
accumulated deficit resulted from one-time non-cash charges.
The Company's business has grown rapidly with total revenues increasing from
$185,000 at June 30, 1997 to $1.4 million at June 30, 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 4 at June 30, 1997 to 107 at June 30, 1998. The Company currently
intends to expand its sales and marketing operations, to invest more in
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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.
Results of Operations
Comparison of the Three Months Ended June 30, 1997 and June 30, 1998
Revenues. The Company's revenues increased from $88,000 for the three
months ended June 30, 1997 to $874,000 for the three months ended June 30, 1998.
During these two periods, set-up fees accounted for approximately 23% and 74% of
total revenues, respectively. Recurring revenues accounted for approximately 76%
and 25% of total revenues, respectively. The increase in revenues during these
periods resulted primarily from an increase in the number of customers and
higher set-up fee and transactions processing fees charged to new customers. The
increase in set-up fee revenues as a percentage of total revenues resulted
primarily from an increase in the number of customers and higher set-up fees
charged to new customers.
Costs of Processing, Servicing and Support. Cost of processing,
servicing and support increased from $150,000 for the three months ended June
30, 1997 to $404,000 for the three months ended June 30, 1998. These costs were
approximately 170% and 46% 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 and additional services
and support functions required for the Company's growth. Towne Services
anticipates that these costs will continue to increase as new customers are
added. Costs of processing, servicing and support decreased as a percentage of
revenue as a result of substantially increased revenues and improved operating
efficiencies.
Research and Development. The Company increased its research and
development expenses from $34,000 for the three months ended June 30, 1997 to
$102,000 for the three months ended June 30, 1998. Research and development
expenses represented approximately 38% and 12% 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.
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Purchased In Process Development. In connection with the acquisition of
Credit Collection Solutions, Inc. in June 1998, the Company recorded a pre-tax
charge of $200,000 for purchased in process development, which had not yet
reached technological feasibility and had no alternative future use.
Sales and Marketing. Sales and marketing expenses increased from
$118,000 for the three months ended June 30, 1997 to $1.1 million for the three
months ended June 30, 1998. Sales and marketing expenses were approximately 134%
and 130% of total revenues, respectively, during these two periods. The increase
in sales and marketing expenses during the second quarter of 1998 is primarily
the result of significant increases 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. In the first quarter of 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. In the second
quarter of 1998, the Company recorded $36,000 of stock compensation expense
based upon the vesting schedules of certain of those options.
General and Administrative. General and administrative expenses
increased from $181,000 for the three months ended June 30, 1997 to $705,000 for
the three months ended June 30, 1998. These costs represented approximately 205%
and 81% 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 the dollar amount of 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 $26,000
for the three months ended June 30, 1997 to $67,000 for the three months ended
June 30, 1998. Interest expense increased due primarily to borrowings under a
$1.5 million working capital loan from Sirrom Investments, Inc. (the "Sirrom
Loan Facility") obtained in late 1997, and borrowings under term loans from
Citizens Bank (the "Citizens Loan") obtained early in the second quarter of
1998.
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Income Taxes. For the three months ended June 30, 1998, Towne Services
had a net operating loss ("NOL") of approximately $1.8 million for federal tax
purposes that will expire if not utilized by 2011 and 2012. The Company has not
recognized any benefit from the future use of such NOL because management's
assumptions of future profitable operations contain risks that do not provide
sufficient assurance to recognize such tax benefits currently.
Comparison of the Six Months Ended June 30, 1997 and June 30, 1998
Revenues. The Company's revenues increased from $185,000 for the second
quarter ended June 30, 1997 to $1.4 million for the second quarter ended June
30, 1998. During these two periods, set-up fees accounted for approximately 37%
and 72% of total revenues, respectively. Recurring revenues accounted for
approximately 62% and 27% of total revenues, respectively. The increase in
revenues during these periods resulted primarily from an increase in the number
of customers and higher set-up fee and transactions processing fees charged to
new customers. The increase in set-up fee revenues as a percentage of total
revenues resulted primarily from an increase in the number of customers and
higher set-up fees charged to new customers.
Costs of Processing, Servicing and Support. Cost of processing,
servicing and support increased from $253,000 for the six months ended June 30,
1997 to $778,000 for the six months ended June 30, 1998. These costs were
approximately 137% and 55% 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 and additional services
and support functions required for the Company's growth. Towne Services
anticipates that these costs will continue to increase as new customers are
added. Costs of processing, servicing and support decreased as a percentage of
revenue as a result of substantially increased revenues and improved operating
efficiencies.
Research and Development. The Company increased its research and
development expenses from $45,000 for the six months ended June 30, 1997 to
$176,000 for the six months ended June 30, 1998. Research and development
expenses represented approximately 24% and 12% 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.
Purchased in Process Development. In connection with the acquisition of
Credit Collection Solutions, Inc. in June 1998, the Company recorded a pre-tax
charge of $200,000 for purchased in process development, which had not yet
reached technological feasibility and had no alternative future use.
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Sales and Marketing. Sales and marketing expenses increased from
$212,000 for the six months ended June 30, 1997 to $1.6 million for the six
months ended June 30, 1998. Sales and marketing expenses were approximately 115%
and 114% of total revenues, respectively, during these two periods. The increase
in sales and marketing expenses during the second quarter of 1998 is primarily
the result of significant increases 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. In the first quarter of 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. Stock compensation
expense was $6.0 million for the six months ended June 30, 1998.
General and Administrative. General and administrative expenses
increased from $351,000 for the six months ended June 30, 1997 to $$2.1 million
for the six months ended June 30, 1998. These costs represented approximately
190% and 144% 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 the dollar amount of 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 $45,000
for the six months ended June 30, 1997 to $131,000 for the six months ended June
30, 1998. Interest expense increased due primarily to borrowings under a $1.5
million working capital loan from Sirrom Investments, Inc. (the "Sirrom Loan
Facility") obtained in late 1997, and borrowings under term loans from Citizens
Bank (the "Citizens Loan") obtained early in the second quarter of 1998.
Income Taxes. For the six months ended June 30, 1998, Towne Services
had a net operating loss ("NOL") of approximately $9.9 million for federal tax
purposes that will expire if not utilized by 2011 and 2012. The Company has not
recognized any benefit from the future use of such NOL because management's
assumptions of future profitable operations contain risks that do not provide
sufficient assurance to recognize such tax benefits currently.
During the Company's short history, its operating results have varied
significantly and are likely to
13
<PAGE> 14
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 June 30,
1998, $1.5 million remained outstanding under the Sirrom Loan. In the second
quarter of 1998, Towne Services borrowed $644,000 from Citizens Bank, of which
$500,000 was used to purchase certain assets and liabilities of Credit
Collection Solutions, Inc. and $144,000 to finance the purchase of new office
equipment for the Company's new office space. Towne Services paid off and
terminated the Sirrom Loan Facility, the lines of credit and the Citizens Loan
after completion of the Initial Public Offering. The Sirrom Loan Facility will
mature on December 18, 2002 and accrued interest at 14% per year. The Citizens
Loan in the amount of $500,000 matured on September 3, 1998 and accrued interest
at 8.5% per year and the Citizens Loan in the amount of $144,000 will mature in
April 2000 and accrues interest at 11.94% per year. At June 30, 1998, the
Company also had a line of credit under which it could borrow up to a total of
$500,000 and no amounts were outstanding under this credit facility. This line
of credit was obtained for working capital purposes and matures on July 10,
2000, was secured by certain lease contracts on point of sale terminals and
accrued interest at the lender's prime rate plus 1/2%. 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 $713,000 for the six
months ended June 30, 1997 and $3.0 million for the six months ended June 30,
1998. Net cash used in operating
14
<PAGE> 15
activities during the six months ended June 30, 1997 represents a $721,000 net
loss partially offset by a $49,000 increase in accounts payable and accrued
expenses, a $24,000 growth in accounts receivable and a $51,000 increase in
prepaid expenses and other assets. Net cash used in operating activities during
the six months ended June 30, 1998 represents a $9.9 million net loss partially
offset by a $471,000 increase in accounts payable and accrued expenses, a
$490,000 growth in accounts receivable, a $154,000 increase in prepaid expenses
and other assets and a $378,000 decrease in stock subscriptions receivable.
Net cash used in investing activities was approximately $29,000 for the six
months ended June 30, 1997 and $1.1 million for the six months ended June 30,
1998. Net cash used in investing activities during the six months ended June 30,
1997 represents $29,000 for the purchase of computer equipment used in
conducting the Company's business. Net cash used in investing activities during
the six months ended June 30, 1998 represents an increase of $82,000 in notes
due from shareholders, $510,000 to acquire certain assets and liabilities of
Credit Collection Solutions, Inc. and $521,000 for the purchase of computer
equipment and other capital equipment used in conducting the Company's business.
Net cash provided by financing activities was $1.5 million in the first six
months of 1997 and $3.4 million in the first six months of 1998 and consisted
primarily of $1.2 million of proceeds from the issuance of securities, a five
year note payable for $1.5 million, a three year note payable for $144,000 and a
short term note payable for $500,000.
Effects of the Year 2000 and Accounting Standards
The Company's business and customer relationships rely on computer software
programs, internal operating systems and telephone and other network
communications connections. If any of these programs, systems or network
connections are not programmed to recognize and properly process dates after
December 31, 1999 (the "Year 2000" issue), significant system failures or errors
may result which could have a material adverse effect on the business, financial
condition, or results of operations of both the effected customers and the
Company. Towne Services has conducted tests on its proprietary point of sale
terminals, network connections and transaction processing software and believes
that its TOWNE CREDIT and TOWNE FINANCE products and network connections it
maintains are able to process dates after December 31, 1999. For its internal
accounting and operating systems and network communications, the Company uses
software and other products provided by third parties and has received
warranties or other assurances that most of these products are programmed to
address the Year 2000 issue. The Company plans to conduct a limited review of
its internal systems and to continue to test its network connections to help
insure that these programs and systems are adequately programmed to address the
Year 2000 issue. Towne Services intends to modify or replace any products or
systems that are unable to properly function as a result of the Year 2000 issue
and currently believes it will be able to do so without incurring costs or
delays which would have a material adverse effect on its financial condition.
15
<PAGE> 16
The Company supplies point of sale terminals and other products needed to run
its processing systems to its customers and Towne Services has not tested any
other products or systems used in its customers' businesses. If the Company's
customers do not successfully address Year 2000 issues in their operations and,
as a result, experience temporary or permanent interruptions in their
businesses, the Company may lose revenues from these customers, which could have
a material adverse effect on its business, financial condition and results of
operations. Towne Services believes that many financial institutions and small
businesses (including customers of the Company) are still in the preliminary
stages of analyzing their systems for Year 2000 issues. It is impossible to
estimate the potential expenses involved or delays which may result from the
failure of these institutions and third parties to resolve their Year 2000
issues in a timely manner and there can be no assurance that such expenses,
failures or delays will not have a material adverse effect on the Company's
business, financial condition or results of operations.
In June 1997, the issued FASB 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 on 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.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at its fair value. SFAS No. 133
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special accounting
for qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. A company may also implement SFAS No. 133 as of
the beginning of any fiscal quarter after issuance (that is, fiscal quarters
beginning June 16, 1988 and thereafter). SFAS No. 133 cannot be applied
retroactively; it must be applied to (a) derivative instruments and (b) certain
derivative instruments embedded in hybrid contracts that were issued, acquired,
or substantively modified after December 31, 1997. The adoption of SFAS No. 133
will not have a material impact on the Company's financial statements.
16
<PAGE> 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None
a) Exhibits
<TABLE>
<CAPTION>
Exhibit Description
No. -----------
---
<S> <C>
2.1 Asset Purchase Agreement by and between Towne Services, Inc.,
Credit Collection Solutions, Inc., Burton W. Crapps and Robert M.
Ragsdale dated as of June 11, 1998 (incorporated by reference to
Exhibit 2.1 of the Company's Registration Statement on Form S-1
(No. 333-53341) as declared effective by the SEC on July 30, 1998
(the "Registration Statement").
3.1 Amended and Restated Articles of Incorporation, as filed with the
Secretary of the State of Georgia on July 29, 1998 (incorporated
by reference to Exhibit 3.1 of the Registration Statement).
3.2 Amended and Restated Bylaws, effective May 19, 1998 (incorporated
by reference to Exhibit 3.2 of the Registration Statement)
4.1 See Exhibits 3.1 and 3.2 for provisions of the Amended and
Restated Articles of Incorporation and Amended and Restated Bylaws
defining the rights of the holders of Common Stock of the Company.
10.1 1998 Stock Option Plan (including Form of Stock Option Agreement)
incorporated by reference to Exhibit 10.2 of the Registration
Statement
10.2 Amended and Restated Employment Agreement by and between Towne
Services, Inc. and Bruce Lowthers dated as of May 18, 1998
incorporated
</TABLE>
17
<PAGE> 18
<TABLE>
<S> <C>
by reference to Exhibit 10.7 of the Registration Statement
10.3 Employment Agreement by and between Towne Services, Inc. and Cleve
Schultz dated as of May 19, 1998 incorporated by reference to
Exhibit 10.8 of the Registration Statement
10.4 Promissory note dated April 1, 1998 issued to Towne Services, Inc.
by Bruce F. Lowthers, Jr. incorporated by reference to Exhibit
10.18 to the Registration Statement
27 Financial Data Schedule (for SEC used only)
</TABLE>
b) Reports on Form 8-K - There were no reports filed on Form 8-K
during the six month period ended June 30, 1998.
18
<PAGE> 19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOWNE SERVICES, INC.
September 9, 1998 /s/ Drew W. Edwards
- ----------------- -----------------------------
Date Drew W. Edwards
Chairman of the Board and Chief Executive Officer
(principal executive officer)
September 9, 1998 /s/ Bruce F. Lowthers, Jr.
- ----------------- -------------------------------------------------
Date Bruce F. Lowthers, Jr.
Chief Financial Officer
(principal financial and accounting officer)
19
<PAGE> 20
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description Page
------ ----------- ----
<S> <C> <C>
2.1 Asset Purchase Agreement by and between Towne Services, Inc.,
Credit Collection Solutions, Inc., Burton W. Crapps and Robert M.
Ragsdale dated as of June 11, 1998 (incorporated by reference to
Exhibit 2.1 of the Company's Registration Statement on Form S-1
(No. 333-53341) as declared effective by the SEC on July 30, 1998
(the "Registration Statement").
3.1 Amended and Restated Articles of Incorporation, as filed with the
Secretary of the State of Georgia on July 29, 1998 (incorporated
by reference to Exhibit 3.1 of the Registration Statement).
3.2 Amended and Restated Bylaws, effective May 19, 1998 (incorporated
by reference to Exhibit 3.2 of the Registration Statement)
4.1 See Exhibits 3.1 and 3.2 for provisions of the Amended and
Restated Articles of Incorporation and Amended and Restated Bylaws
defining the rights of the holders of Common Stock of the Company.
10.1 1998 Stock Option Plan (including Form of Stock Option Agreement)
incorporated by reference to Exhibit 10.2 of the Registration
Statement
10.2 Amended and Restated Employment Agreement by and between Towne
Services, Inc. and Bruce Lowthers dated as of May 18, 1998
incorporated by reference to Exhibit 10.7 of the Registration
Statement
10.3 Employment Agreement by and between Towne Services, Inc. and Cleve
Schultz dated as of May 19, 1998 incorporated by reference to
Exhibit 10.8 of the Registration Statement
10.4 Promissory note dated April 1, 1998 issued to Towne Services, Inc.
by Bruce F. Lowthers, Jr. incorporated by reference to Exhibit
10.18 to the Registration Statement
27 Financial Data Schedule (for SEC use only)
</TABLE>
20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS FROM FORM 10-Q FOR THE SIX MONTHS ENDED JUNE 30, 1998 (FOR SEC USE
ONLY) AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 1,847,328
<SECURITIES> 0
<RECEIVABLES> 902,514
<ALLOWANCES> (70,000)
<INVENTORY> 0
<CURRENT-ASSETS> 2,864,677
<PP&E> 1,156,203
<DEPRECIATION> (195,027)
<TOTAL-ASSETS> 4,422,508
<CURRENT-LIABILITIES> 1,851,583
<BONDS> 0
0
1,508,000
<COMMON> 17,569,393
<OTHER-SE> (18,672,174)
<TOTAL-LIABILITY-AND-EQUITY> 4,442,508
<SALES> 1,421,535
<TOTAL-REVENUES> 1,421,535
<CGS> 777,835
<TOTAL-COSTS> 10,839,392
<OTHER-EXPENSES> 252
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 131,032
<INCOME-PRETAX> (9,872,141)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,872,141)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,872,141)
<EPS-PRIMARY> (1.19)
<EPS-DILUTED> (1.19)
</TABLE>
