<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 7, 1998
REGISTRATION NO. 333-59613
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
PRE-EFFECTIVE AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
EXCHANGE APPLICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 7373 04-3338916
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBERS) IDENTIFICATION NO.)
</TABLE>
89 SOUTH STREET
BOSTON, MASSACHUSETTS 02111
(617) 737-2244
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
ANDREW J. FRAWLEY
CHAIRMAN OF THE BOARD, PRESIDENT
AND CHIEF EXECUTIVE OFFICER
EXCHANGE APPLICATIONS, INC.
89 SOUTH STREET
BOSTON, MASSACHUSETTS 02111
(617) 737-2244
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
------------------------
with copies to:
<TABLE>
<S> <C>
NEIL W. TOWNSEND, ESQ. DAVID C. CHAPIN, ESQ.
BINGHAM DANA LLP ROPES & GRAY
150 FEDERAL STREET ONE INTERNATIONAL PLACE
BOSTON, MASSACHUSETTS 02110 BOSTON, MASSACHUSETTS 02110
(617) 951-8000 (617) 951-7000
FACSIMILE NO. (617) 951-8736 FACSIMILE NO. (617) 951-7050
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier registration statement for the same
offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
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<CAPTION>
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AMOUNT PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF TO BE OFFERING PRICE AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED(1) PER SHARE(2) PRICE(2) REGISTRATION FEE(3)
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<S> <C> <C> <C> <C>
Common Stock, $0.001 par value
per share...................... 3,450,000 $10.00 $34,500,000 $9,591
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</TABLE>
(1) Includes 450,000 shares subject to the Underwriters' over-allotment option.
See "Underwriting."
(2) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457 under the Securities Act of 1933, as amended.
(3) The Company previously paid a fee of $16,284 in connection with its initial
filing and thus no additional fee has been submitted herewith.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
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<PAGE> 2
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY
NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION
STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO
SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE
BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION
OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE
SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION
DECEMBER 7, 1998
3,000,000 SHARES
[EXCHANGE APPLICATIONS LOGO]
COMMON STOCK
----------------------
Of the 3,000,000 shares of Common Stock offered hereby, 2,000,000 are being
sold by Exchange Applications, Inc. (the "Company") and 1,000,000 are being sold
by a stockholder of the Company (together with certain other stockholders, the
"Selling Stockholders"). See "Principal and Selling Stockholders". The Company
will not receive any of the proceeds from the sale of shares by the Selling
Stockholders.
Prior to this Offering, there has been no public market for the Common
Stock of the Company. It is currently estimated that the initial public offering
price per share will be between $8.00 and $10.00. For factors considered in
determining the initial public offering price, see "Underwriting".
The Company's Common Stock has been approved for quotation on the Nasdaq
National Market under the symbol "EXAP".
----------------------
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 6.
----------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
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UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO PROCEEDS TO SELLING
PUBLIC COMMISSIONS(1) COMPANY(2) STOCKHOLDERS
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<S> <C> <C> <C> <C>
Per Share............. $ $ $ $
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Total(3).............. $ $ $ $
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</TABLE>
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933. See "Underwriting".
(2) Before deducting estimated expenses of $1,000,000 payable by the Company.
(3) The Selling Stockholders have granted the Underwriters an option for 30 days
to purchase up to an additional 450,000 shares at the initial public
offering price per share, less the underwriting discount, solely to cover
over-allotments. The Company will not receive any proceeds from the sale of
shares by the Selling Stockholders. If such option is exercised in full, the
total initial public offering price, underwriting discount and proceeds to
the Selling Stockholders will be $ , $ and $ ,
respectively. See "Principal and Selling Stockholders" and "Underwriting".
----------------------
The shares offered hereby are offered by the several Underwriters, subject
to prior sale, when, as and if delivered to and accepted by them, and subject to
their right to reject any order in whole or in part. It is expected that
delivery of certificates for such shares of Common Stock will be made at the
offices of BT Alex. Brown Incorporated, Baltimore, Maryland, on or about
, 1998.
BT ALEX. BROWN
HAMBRECHT & QUIST
ADAMS, HARKNESS & HILL, INC.
The date of this Prospectus is , 1998.
<PAGE> 3
CONTINUOUS CUSTOMER MANAGEMENT
OPTIMIZING CUSTOMER VALUE THROUGH PROCESS,
APPLICATIONS & TECHNOLOGY
[ART WORK]
[This graphic is a series of diagrams showing the VALEX architecture interfacing
with customer databases and customer touchpoints surrounded by figures depicting
the functional benefits of VALEX.]
Continuous Customer Management ("CCM") is Exchange Applications' enterprise-wide
offering for customer optimization. The CCM solution, including the Company's
VALEX software and related consulting and integration services, is designed to
enable businesses to:
- Analyze enterprise-wide databases of customer information for opportunity
identification investment
- Conduct customer planning to prioritize for opportunity identification
investment
- Perform campaign management to execute targeted, real-time and
event-triggered customer communications
- Select the most effective methods of customer interaction
- Perform measurement and analysis to continuously evaluate and refine
marketing campaigns to maximize customer profitability
Exchange Applications, VALEX, Continuous Customer Management, CCM, Value
Exchange Optimization, Metrics Repository and the Exchange Applications logo are
trademarks of the Company. All other trademarks or tradenames referred to in
this Prospectus are the property of their respective owners.
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH
SECURITIES AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THE OFFERING.
FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING".
<PAGE> 4
OPTIMIZING CUSTOMER VALUE MANAGING CUSTOMER RELATIONSHIPS OVER TIME
THROUGH CONTINUOUS CUSTOMER
MANAGEMENT Exchange Applications' Continuous Customer
Management solution is designed to enable
businesses to maximize the profitability of
their customer relationships. Full potential is
achieved by allocating marketing investments to
most effectively aquire new customers, expand
[ART WORK] the profitability of existing customers and
[This graphic is a retain customers longer.
representation of the three
aspects of the Company's
Continuous Customer Management [ART WORK]
offering. The graphic is a
dramatization of the use of
VALEX to acquire new customers,
expand purchasing of existing
customers and retain customers Businesses use VALEX to run campaigns
longer thereby optimizing disigned to maximize profitability by focusing
customer value.] on key elements of a customer relationship. In
the "ACQUIRE" cycle, a prospect is contacted
via direct mail, resulting in the acquisition
of a new customer. In the "EXPAND" cycle,
VALEX identifies high potential cross-
selling opportunities to expand customer
relationships with additional product sales.
In the "RETAIN" cycle, VALEX automatically
executes a statistical model, notifying a
customer-care organization that the
customer is at risk of leaving, and enables
that customer to be contacted and encouraged
to stay. Customer optimization is achieved by
simultaneously executing hundreds of these
campaigns and continuously monitoring customers
to maximize their profitability across the
enterprise.
<PAGE> 5
PROSPECTUS SUMMARY
The following summary should be read in conjunction with, and is qualified
in its entirety by, the more detailed information and the Consolidated Financial
Statements and Notes thereto appearing elsewhere in this Prospectus. Except as
otherwise noted, all information in this Prospectus, including share and per
share information, assumes: (i) the mandatory conversion into Common Stock of
all outstanding shares of Series B Convertible Preferred Stock and Series C
Convertible Preferred Stock (the "Convertible Preferred Stock") upon the
consummation of the Offering; (ii) the redemption of all outstanding shares of
Series A Redeemable Preferred Stock (the "Series A Preferred Stock") upon
consummation of the Offering; (iii) no exercise of stock options after September
30, 1998; (iv) no exercise of the Underwriters' over-allotment option; and (v)
the amendment and restatement of the Company's Certificate of Incorporation and
By-laws immediately prior to the consummation of the Offering. See "Description
of Capital Stock" and "Underwriting".
THE COMPANY
Exchange Applications, Inc. (the "Company") is a leading provider of open,
enterprise customer optimization software and solutions that are designed to
enable businesses to maximize profitability and revenue growth from new and
existing customers through marketing automation and enterprise-wide customer
management. The Company's Continuous Customer Management ("CCM") solution,
including its VALEX software and related consulting and integration services, is
designed to enable businesses to profitably retain and expand existing customer
relationships and acquire new customers by: (i) analyzing enterprise-wide
databases of customer information to identify profitable growth opportunities;
(ii) planning and prioritizing investments in high potential customers; (iii)
creating targeted, real-time and event-triggered marketing campaigns and other
customer communications; (iv) selecting the most effective channels for customer
communications, such as direct mail, call centers, sales forces and the
Internet; and (v) continuously evaluating the impact of these marketing
campaigns and other communications on profitability. CCM allows businesses to
measure the value of these campaigns against their associated costs, and to use
this information to make investment decisions that maximize customer
profitability. The Company has deployed CCM and VALEX across multiple
industries, with installations in over 45 businesses in North America and
Europe. Its customers include Bell Atlantic, Federal Express, Fleet Bank,
NatWest Bank (U.K.) and US West. The Company's products and services are
distributed through its direct sales force, through re-seller relationships with
IBM, NCR and others, and through co-marketing arrangements with companies such
as Compaq, Ernst & Young, KPMG Peat Marwick, PricewaterhouseCoopers, SAS
Institute and Sun Microsystems.
While enterprise resource planning ("ERP"), supply chain management and
other software applications aimed at reducing costs have generally been
successful, businesses have begun to invest in a new class of applications
designed to increase profitability through revenue growth. Many of these new
applications are aimed at enabling businesses to increase revenue by acquiring
new customers and retaining and expanding relationships with existing customers.
These applications facilitate cross-selling and the marketing of bundled
products, new service offerings and differentiated service relationships. The
success of these efforts depends on the ability of businesses to allocate
resources based not only on functional area and product profitability, but also
on current and potential customer profitability. The Company believes there are
significant opportunities in many industries for solutions that realign
businesses' existing marketing and customer management capabilities with new
technologies and processes that utilize complete economic profiles of customers
to optimize customer relationships across the enterprise.
The Company believes that CCM and VALEX represent a fundamentally new
approach to customer optimization. VALEX is designed to enable businesses to
maximize profitability by: (i) providing a complete view of the relationship
between a business and its customers;
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<PAGE> 6
(ii) leveraging a range of data mining, reporting and modeling products to
identify high-value customers; (iii) providing powerful marketing automation and
campaign management software that lets end users define and execute targeted
customer communication streams; and (iv) integrating with customer interaction
software ("CIS") and data warehouses to perform enterprise-wide customer
management. Through its consulting and integration services, the Company
provides assistance in adopting the CCM solution across business functions and
in rapidly implementing the core VALEX modules. The Company also provides
Metrics Repository, a custom software application that leverages VALEX to track
the success or failure of marketing campaigns across customer segments and
across the enterprise.
The Company's objective is to be the leading provider of open, enterprise
customer optimization software and solutions globally. Key elements of the
Company's strategy include extending VALEX, developing additional customer
optimization solutions, expanding vertical industry focus, broadening
distribution channels and building alliances, and increasing direct sales
globally.
The Company commenced operations in November 1994 and was incorporated in
Delaware in November 1996. See "Historical Background of the Company." Unless
the context otherwise requires, references in this Prospectus to the Company
refer to Exchange Applications, Inc. and its subsidiaries. The Company's
principal executive offices are located at 89 South Street, Boston,
Massachusetts 02111, and its telephone number is (617) 737-2244.
THE OFFERING
Common Stock offered by the
Company............................ 2,000,000 shares
Common Stock offered by the Selling
Stockholders..................... 1,000,000 shares
Common Stock outstanding after the
Offering(1)...................... 9,827,190 shares
Nasdaq National Market symbol...... "EXAP"
Use of Proceeds.................... For redemption of Series A Preferred
Stock, reduction of indebtedness and for
general corporate purposes, including
working capital and potential
acquisitions.
- ---------------
(1) Based on the number of shares of Common Stock outstanding on November 11,
1998. Excludes (i) 2,421,908 shares of Common Stock issuable upon exercise
of options outstanding at November 11, 1998 with exercise prices ranging
from $0.65 to $10.00 per share and with a weighted average exercise price of
$3.82 per share; and (ii) 3,442,300 additional shares reserved for future
grants or issuances under the Company's stock option and stock purchase
plans. See "Management -- "Stock Option Plans" and "Other Stock Plans", and
Note 13 of Notes to Consolidated Financial Statements.
4
<PAGE> 7
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------- -----------------
1995(1) 1996(1) 1997 1997 1998
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenues............................ $1,693 $ 6,034 $12,669 $ 8,149 $17,166
Gross profit.............................. 681 1,939 5,735 3,284 11,938
Loss from operations...................... (507) (1,411) (2,624) (1,786) (1,125)
Net loss.................................. (554) (1,606) (2,599) (1,750) (1,077)
Net loss applicable to common
stockholders............................ (554) (1,606) (3,283) (2,375) (1,257)
Pro forma basic and diluted net loss per
share(2)(3)............................. $ (0.48) $ (0.15)
Pro forma basic and diluted weighted
average common shares
outstanding(2)(3)....................... 5,391 7,420
Supplemental pro forma basic and diluted
net loss per share(4)................... $ (0.47) $ (0.14)
Supplemental pro forma basic and diluted
weighted average common shares
outstanding(4).......................... 5,586 7,616
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1998
--------------------------------------
PRO FORMA
PRO AS ADJUSTED
ACTUAL FORMA(3) (3)(5)
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<S> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents, and marketable securities..... $ 1,988 $ 1,988 $15,517
Working capital....................................... 3,113 3,113 16,891
Total assets.......................................... 12,012 12,012 25,541
Long-term debt, net of current portion................ 177 177 --
Redeemable preferred stock............................ 7,268 1,635 --
Stockholders' equity (deficit)........................ (1,764) 3,869 19,459
</TABLE>
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(1) The Consolidated Statement of Operations Data for the years ended December
31, 1995 and 1996 include the operations of the Company on a carve-out basis
prior to November 15, 1996. During this period, the Company operated as a
separate and substantially independent division of Grant & Partners, Inc.
and Grant & Partners Limited Partnership, and focused on developing VALEX
and providing integration and consulting services. See "Historical
Background of the Company" and Note 1 of Notes to Consolidated Financial
Statements.
(2) Computed on the basis described in Note 2(c) of the Notes to Consolidated
Financial Statements.
(3) Reflects the reclassification of the Series A Preferred Stock to $1,634,000
of additional paid-in capital, the conversion of all outstanding shares of
the Series B Convertible Preferred Stock, at a redemption value of
$3,999,000, into 2,655,556 shares of Common Stock and the conversion of all
outstanding shares of Series C Convertible Preferred Stock, at $0.001 par
value per share, to 1,223,954 shares of Common Stock upon the closing of
this Offering.
(4) Computed on the basis described in Note 2(c) of the Notes to Consolidated
Financial Statements, adjusted for the increase in the number of shares of
Common Stock issued pursuant to this Offering sufficient to generate
proceeds in the amount of $1,635,000 to redeem the Series A Preferred Stock.
(5) Adjusted to reflect the sale of 2,000,000 shares of Common Stock offered by
the Company at an assumed initial public offering price of $9.00 per share,
after deducting underwriting discounts and commissions and estimated
offering expenses payable by the Company, the redemption of the Series A
Preferred Stock for $1,635,000 and the repayment of existing indebtedness in
the amount of $426,000 in respect of capital leases.
5
<PAGE> 8
RISK FACTORS
In addition to the other information in this Prospectus, prospective
investors should carefully consider the following factors in evaluating the
Company and its business before purchasing the shares of Common Stock offered by
this Prospectus. This Prospectus contains forward-looking statements and the
Company's actual results could differ materially from those anticipated in these
forward-looking statements as a result of numerous factors, including those set
forth in the following risk factors, and elsewhere in this Prospectus.
Limited Operating History; History of Losses. The Company began operations
in 1994, was incorporated in 1996 and first achieved profitability for the
quarter ended September 30, 1998. The Company began commercial shipment of its
initial VALEX product in July 1996 and, since such time, has transitioned its
primary business focus from providing services to selling software products. As
a result, the Company and its operations are subject to all of the risks
inherent in the establishment of a new business enterprise. The Company's
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in their early stage of development,
particularly in new and rapidly evolving markets. To address these risks, the
Company must, among other things, respond to competitive developments, continue
to upgrade its products and continue to attract, retain and motivate qualified
personnel. There can be no assurance that the Company will be successful in
addressing such risks, that the Company's revenues will continue to grow, or
that the Company will be able to maintain profitability on a quarterly or annual
basis. See "-- Dependence Upon Key Personnel", "-- Rapid Technological Change
and New Products" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations".
Potential for Significant Fluctuations in Quarterly Results. The Company's
quarterly revenues, expenses and operating results have varied significantly in
the past and are likely to vary significantly from quarter to quarter in the
future. Because purchase of the Company's products and services generally
involves a significant commitment of capital (ranging from approximately
$100,000 to $3,000,000 in 1997), the length of the sales cycle is unpredictable
and subject to a number of factors over which the Company has little or no
control, including customers' budgetary constraints, timing of budget cycles and
concerns about the introduction of new products by the Company or its
competitors. As a result of these and other factors, the timing of significant
orders may be delayed. A substantial portion of the Company's revenues in any
quarter are typically derived from a limited number of non-recurring license
sales and, like many software companies, the Company tends to record a
significant portion of its software license fee revenues in the last month of a
quarter. In addition, the amount of revenues associated with a particular
license can vary significantly based upon the size of the customer databases and
other factors, including the number of users of the software. The Company may
experience from time to time large, individual license sales which can cause
substantial variations in quarterly license revenues. Moreover, small delays in
customer orders can cause significant variability in the Company's license
revenues and results of operations for any particular period. The Company
establishes its expenditure levels for product development, sales and marketing
and other operating activities based, in large part, on its expected future
revenues. As a result, if revenues fall below expectations, operating results
are likely to be adversely and disproportionately affected because only a small
portion of the Company's expenses vary with its revenues.
Quarterly fluctuations also result from factors such as increased
competition, the timing of new releases of the Company's software products and
market acceptance of such releases, changes in pricing policies of the Company
or its competitors, changes in operating expenses, foreign currency exchange
rate fluctuations and general economic factors. Based upon these and all of the
factors described above, the Company believes that its quarterly revenues,
expenses and operating results are likely to vary significantly in the future,
that period-to-period comparisons of its results of operations are not
necessarily meaningful and that, as a result, such comparisons should not be
relied upon as indications of future performance. Moreover, although the
Company's revenues have increased in recent periods, there can be no assurance
that revenues will continue to grow at past
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rates, if at all, or that the Company will achieve and sustain profitability on
a quarterly or annual basis. As a result, the Company's operating results may
fall below market analysts' expectations in some future quarters, which would
have a material adverse effect on the market price of the Common Stock. See
"Selected Consolidated Financial Data" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations".
Product Concentration; Dependence on Emerging Market for Customer
Optimization Software and Services. The Company currently derives all of its
revenues from VALEX licenses and services related to its Continuous Customer
Management ("CCM") solution. The Company expects that VALEX-related revenues,
including CCM services and maintenance contracts, will continue to account for a
majority of the Company's revenues for the foreseeable future. As a result, the
Company's future operating results are dependent upon continued market
acceptance of VALEX and CCM and enhancements thereto. There can be no assurance
that VALEX and CCM will achieve continued market acceptance. A decline in demand
or market acceptance as a result of competition, technological change or other
factors would have a material adverse effect on the Company's business,
operating results and financial condition.
Although demand for VALEX and similar products has grown in recent years,
the market for customer optimization software applications is still emerging and
there can be no assurance that it will continue to grow or that, even if the
market does grow, businesses will continue to adopt VALEX and CCM. The Company
has spent, and intends to continue to spend, considerable resources educating
potential customers about customer optimization software and services in general
and about the features and functions of VALEX and CCM in particular. However,
there can be no assurance that such expenditures will enable VALEX and CCM to
achieve any additional degree of market acceptance. If the market for VALEX and
CCM fails to grow or grows more slowly than the Company currently anticipates,
the Company's business, operating results and financial condition would be
materially adversely affected.
Customer Concentration; Dependence on Certain Industries. In fiscal 1997
and for the nine months ended September 30, 1998, the Company's top five
customers accounted for 74.9% and 39.0% of total revenues, respectively. There
can be no assurance that these or other customers of the Company will continue
to purchase the Company's products or services. The Company's failure to retain
certain of its existing customers, or to add new customers that make significant
purchases of the Company's products and services, would have a material adverse
effect on the Company's business, financial condition and results of operations.
A substantial portion of the Company's revenues has been derived from sales
to telecommunications companies and financial institutions (principally retail
banks, credit card issuers and mutual fund companies). There can be no assurance
that the Company will continue to be successful in these vertical markets, or
will be successful in achieving significant market acceptance or penetration in
additional vertical markets targeted by the Company. Failure to have continued
success in these vertical markets or to penetrate additional vertical markets
would have a material adverse effect on the Company's future growth, financial
condition and results of operations.
Management of Growth. The Company's business has grown rapidly, with total
revenues increasing from $1.7 million in 1995 to $6.0 million in 1996, to $12.7
million in 1997 and to $17.1 million for the first nine months of 1998. The
Company's recent expansion has resulted in substantial growth in the number of
its employees (from 47 at December 31, 1996 to 90 at December 31, 1997 and to
142 at September 30, 1998), the scope of its operating and financial systems and
the geographic distribution of its operations and customers. This recent rapid
growth has placed, and if sustained will continue to place, a significant strain
on the Company's management and operations. Accordingly, the Company's future
operating results will depend on the ability of its officers and other key
employees to continue to implement and improve its operational, customer support
and financial control systems, and to expand, train and manage its employee
base. There can be no assurance that the Company will be able to manage any
future expansion
7
<PAGE> 10
successfully, and any inability to do so would have a material adverse effect on
the Company's business, operating results and financial condition.
Dependence Upon Key Personnel. The Company's future operating results
depend in significant part upon the continued services of a relatively small
number of key technical and senior management personnel, including Andrew J.
Frawley, its Chairman, President and Chief Executive Officer, David G.
McFarlane, its Executive Vice President, Worldwide Sales and Services, and
Michael D. McGonagle, its Vice President, Product Development, none of whom is
bound by an employment agreement. The Company's future success also depends on
its continuing ability to attract and retain other highly qualified technical,
sales and managerial personnel. Competition for such personnel is intense, and
the Company has at times in the past experienced difficulty in recruiting
qualified personnel. There can be no assurance that the Company will retain its
key technical, sales and managerial employees or that it will be successful in
attracting, assimilating and retaining other highly qualified technical, sales
and managerial personnel in the future. The loss of any member of the Company's
key technical, sales and senior management personnel or the inability to attract
and retain additional qualified personnel could have a material adverse effect
on the Company's business, operating results and financial condition. The
Company currently maintains key-man life insurance coverage with respect to
Andrew J. Frawley in the amount of $2,500,000. The Company currently does not
have and does not contemplate securing any other key-man life insurance coverage
for any of its other employees. See "Business -- Employees" and "Management".
Absence of History as an Independent Company. Until November 15, 1996, the
Company operated as a division of two entities, Grant & Partners, Inc. ("GPI")
and Grant & Partners Limited Partnership ("GPLP"), during which time the Company
did not have an operating history as an independent company. The accompanying
consolidated financial statements prior to the formation of the Company
represent the financial results of the Exchange Applications division as
included in the consolidated financial statements of GPI from January 1, 1995 to
March 27, 1995 and of GPLP from March 28, 1995 to November 14, 1996. On November
15, 1996, the Company entered into an assignment and assumption agreement
pursuant to which GPLP sold the Exchange Applications division to the Company in
exchange for 2,300,000 shares of preferred stock of the Company. General
corporate overhead costs related to corporate headquarters and shared
administrative support during the period prior to November 15, 1996 were
allocated by GPI and GPLP to the Exchange Applications division based on a
number of factors, including, for example, personnel and space utilized.
Management believes these allocations were reasonable and the costs of the
services charged to the Company were not materially different from costs that
would have been incurred by the Company if the Company had performed these
functions as a standalone entity. However, the financial statements included
herein for the period from January 1, 1995 through November 15, 1996 may not
necessarily reflect the results of operations, financial position and cash flows
for the periods in which the Company operated as a division of GPI and GPLP that
would have resulted had the Company been operated as a separate entity. See
"Historical Background of the Company".
Rapid Technological Change and New Products. The market for the Company's
software products is characterized by rapid technological advances, evolving
industry standards in computer hardware and software technology, changes in
customer requirements and frequent new product introductions and enhancements.
The Company's future success will depend upon its ability to continue to enhance
its current product line and to develop and introduce new products that keep
pace with technological developments, satisfy increasingly sophisticated
customer requirements and achieve market acceptance. There can be no assurance
that the Company will be successful in developing and marketing, on a timely and
cost-effective basis, fully functional product enhancements or new products that
respond to technological advances by others, or that its new products will
achieve market acceptance. Failure to successfully develop and market product
enhancements or new products could have a material adverse effect on the
Company's business, operating results and financial condition.
8
<PAGE> 11
As a result of the complexities inherent in client/server computing
environments and the broad functionality and performance demanded by customers
for customer optimization software products, major new products and product
enhancements can require long development and testing periods. The Company has
on occasion experienced delays in the scheduled introduction of new and enhanced
products. In addition, software programs as complex as those offered by the
Company may contain undetected errors or "bugs" when first introduced or as new
versions are released that, despite testing by the Company, are discovered only
after a product has been installed and used by customers. To date the Company's
business has not been materially adversely affected by delays or the release of
products containing errors. There can be no assurance, however, that errors will
not be found in future releases of the Company's software, or that any such
errors will not impair the market acceptance of these products and adversely
affect the Company's business, operating results and financial condition.
While the Company generally takes steps to avoid the interruptions of sales
often associated with the pending availability of new products, customers may
delay their purchasing decisions in anticipation of the general availability of
new or enhanced VALEX products, which could have a material adverse effect on
the Company's business and operating results. Moreover, significant delays in
the general availability of such new releases, significant problems in the
installation or implementation of such new releases, or customer dissatisfaction
with such new releases, could have a material adverse effect on the Company's
business, operating results and financial condition. See "Business -- Products"
and "Product Development".
Competition. The market for customer optimization software and related
services is highly competitive. There can be no assurance that the Company will
maintain its competitive position against current and potential competitors,
especially those with significantly greater financial, marketing, service,
support, technical and other resources. Current and potential competitors fall
into the following categories: (i) database marketing vendors, such as Acxiom,
Experian (a division of Great Universal Stores), Harland and Harte-Hanks, which
provide a combination of service bureau capabilities and software; (ii) small
independent software companies that are creating or are attempting to create
offerings similar to the VALEX product; (iii) enterprise resource planning
("ERP") and customer interaction software ("CIS") vendors such as Baan, Oracle,
SAP, Siebel and Vantive, that may broaden their product lines to include
applications with competitive functionality; and (iv) internal corporate
technology departments that attempt to build their own systems. The Company
believes that many of these competitors are focusing significant resources on
increasing the functionality of their products and services. Ultimately,
competitors may be able to offer products and services with functionality
comparable or superior to that of VALEX. Many of the Company's competitors have
longer operating histories, significantly greater financial, technical,
marketing and other resources, greater name recognition, and larger customer
bases than the Company. As a result, they may be able to adapt more quickly to
new or emerging technologies and changes in customer requirements and to devote
greater resources to the promotion and sale of their products and services than
the Company. If these companies were to introduce products and services that
effectively competed with the Company's products and services, they could be in
a position to substantially lower the price of their customer optimization
products and services or to bundle such products and services with their other
products and services, which could give them competitive advantages over the
Company. In order to be successful in the future, the Company must continue to
respond promptly and effectively to the challenges of technological change and
competitors' innovations. There can be no assurance that the Company will be
able to compete successfully with existing or new competitors. Increased
competition may result in price reductions, reduced gross margins and loss of
market share, any of which would materially and adversely affect the Company's
business, operating results and financial condition. See
"Business -- Competition".
Increasing Reliance on Indirect Distribution Channels. Although direct
sales to date have accounted for a majority of the Company's software revenues,
the Company expects that it will increasingly distribute its products to end
users through various indirect distribution channels,
9
<PAGE> 12
including re-seller agreements with IBM, NCR and others and co-marketing
arrangements with companies such as Compaq, Ernst & Young, KPMG Peat Marwick,
PricewaterhouseCoopers, SAS Institute and Sun Microsystems. The Company's
relationships with many of these organizations have been established within the
last twelve months, and the Company is unable to predict the extent to which
these channel partners will be successful in distributing the Company's
products. The Company relies on the marketing and sales efforts of these
organizations, many of whom also market and sell competitive products or are
able, under the terms of their agreements, to market and sell competitive
products. One of the Company's channel partners accounted for approximately 18%
of the Company's consolidated revenues for the nine months ended September 30,
1998. The loss of one or more of the Company's relationships with these
organizations, without replacement, as a result of competitive products offered
by other companies or products developed internally by these organizations,
could have a material adverse effect on the Company's business, operating
results and financial condition. The Company's future performance will also
depend, in part, on its ability to attract organizations that will be able to
market and support the Company's products effectively, especially in markets in
which the Company has not previously distributed its products. None of the
agreements governing the re-seller or co-marketing relationships with these
organizations includes any commitments on the part of these organizations to
effect any minimum number of sales of VALEX, or otherwise to provide the Company
with business. There can be no assurance that revenues arising from the
Company's relationships with these organizations that accounted for significant
revenues in past periods will continue, or if continued will reach or exceed
historical levels. See "Business -- Sales and Marketing".
Intellectual Property Rights; Use of Licensed Technology. The Company
relies primarily on a combination of copyright, trademark and trade secret laws,
confidentiality procedures and contractual provisions to protect its proprietary
rights. In addition, the Company generally licenses VALEX to end users in object
code (machine-readable) format, and the Company's license agreements generally
allow the use of VALEX solely by the customer for internal purposes without the
right to sublicense or transfer VALEX. The Company believes that the foregoing
measures afford only limited protection. Certain customers have required the
Company to maintain a source code escrow account with a third-party software
escrow agent, and a failure by the Company to perform its obligations under any
of the license and maintenance agreements, or the insolvency of the Company,
could conceivably cause the release of the Company's source code to such
customers. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or to
obtain and use information that the Company regards as proprietary. Policing
unauthorized use of the Company's products is difficult, and while the Company
is unable to determine the extent to which piracy of its software products
exists, software piracy can be expected to be a problem. In addition, the laws
of some foreign countries do not protect the Company's proprietary rights to the
same extent as the laws of the United States. Furthermore, there can be no
assurance that the Company's competitors will not independently develop
technology similar to that of the Company. The Company may increasingly be
subject to claims of intellectual property infringement as the number of
products and competitors in the Company's industry segment grows and the
functionality of products in different industry segments overlaps. Although the
Company is not aware that any of its products infringe upon the proprietary
rights of third parties, there can be no assurance that third parties will not
claim infringement by the Company with respect to current or future products.
Any such claims, with or without merit, could be time-consuming to address,
result in costly litigation, cause product shipment delays or require the
Company to enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, might not be available on terms acceptable to the
Company or at all, which could have a material adverse effect upon the Company's
business, operating results and financial condition.
The Company has in the past and may in the future re-sell certain software
that it licenses from third parties. There can be no assurance that these third
party software licenses will continue to be available to the Company on
commercially reasonable terms. The loss of or inability to maintain or obtain
any of these software licenses could result in delays or reductions in product
shipments until
10
<PAGE> 13
equivalent software can be identified, licensed and integrated, which could
materially adversely affect the Company's business, operating results and
financial condition. See "Business -- Products" and "-- Proprietary Rights and
Licenses".
International Operations. The Company derived approximately 34% of its
total revenues from sales outside the United States in the nine months ended
September 30, 1998. The Company opened sales offices in the United Kingdom in
July 1997 and in Australia in April 1998, and believes that continued growth and
profitability will require expansion of its sales in international markets. In
order to successfully expand international sales, the Company must establish
additional foreign operations and hire additional personnel. To the extent that
the Company is unable to do so in a timely and effective manner, any growth in
international sales will be limited, and the Company's business, operating
results and financial condition could be materially adversely affected. In
addition, even if international operations are successfully expanded, there can
be no assurance that the Company will be able to maintain or increase
international market demand for its products.
The Company's international operations are subject to the risks inherent in
any international business activities, including, in particular, management of
an organization spread over various countries, longer accounts receivable
payment cycles in certain countries, compliance with a variety of foreign laws
and regulations, unexpected changes in regulatory requirements, overlap of
different tax structures, foreign currency exchange rate fluctuations and
general economic conditions. Other risks associated with international
operations include import and export licensing requirements, trade restrictions
and changes in tariff rates. The Company's revenues from international
operations have been denominated in foreign currencies which historically have
been stable in relation to U.S. dollars. The Company has made substantial sales
to international customers in Canada, Denmark, Germany, the Netherlands, Sweden
and the United Kingdom. As a result, the Company has not adopted a policy of
hedging foreign currency risks. There can be no assurance that these foreign
currencies, and other foreign currencies as the Company expands its
international operations, will continue to be stable. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business -- Sales and Marketing".
Control by Existing Stockholders. Upon completion of the Offering, the
current officers, directors and principal stockholders will beneficially own
approximately 61.4% of the Company's outstanding Common Stock (56.7% if the
Underwriters' over-allotment option is exercised in full). Consequently, such
persons, as a group, will be able to control the outcome of all matters
submitted for stockholder action, including the election of members to the
Company's Board of Directors and the approval of significant change in control
transactions, and will effectively control the management and affairs of the
Company, which may have the effect of delaying or preventing a change in control
of the Company. While the Company intends to increase the size of its Board of
Directors from four to six members, representatives of the existing stockholders
will nonetheless constitute three of the six directors and will therefore have
significant influence in directing the actions of the Board of Directors. The
Company has not identified candidates for the two additional positions on the
Board of Directors that the Company intends to establish. See "Management" and
"Principal and Selling Stockholders".
Product Liability. While the Company's license agreements with its
customers typically contain provisions designed to limit the Company's exposure
to potential product liability claims, it is possible that such limitation of
liability provisions may not be effective under the laws of certain
jurisdictions. Although the Company has not experienced any product liability
claims to date, there can be no assurance that the Company will not be subject
to such claims in the future. A successful product liability claim brought
against the Company could have a material adverse effect on the Company's
business, operating results and financial condition. Moreover, defending such a
suit, regardless of its merits, could entail substantial expense and require the
time and attention of key management personnel, either of which could have a
material adverse effect on the Company's business, operating results and
financial condition. See "Business -- Products -- VALEX" and "-- Product
Development".
11
<PAGE> 14
Year 2000 Compliance. Many currently installed computer systems and
software products are coded to accept only two-digit entries in the date code
field. Beginning in the year 2000, these date code fields will need to accept
four-digit entries to distinguish 21st century dates from 20th century dates. As
a result, computer systems and software used by many companies may need to be
upgraded to comply with such "Year 2000" requirements. Significant uncertainty
exists in the software industry concerning the potential effects associated with
the failure to comply with such requirements. While the Company believes that
its material operating systems are Year 2000 compliant, any failure of
third-party equipment or software comprising any part of the Company's systems
to operate properly with regard to Year 2000 and thereafter could require the
Company to incur unanticipated expenses to address associated problems, which
could have a material adverse effect on the Company's business, operating
results and financial condition.
The Company believes, based on an internal assessment, that the current
versions of its software products are Year 2000 compliant. However, the
Company's products are generally integrated with the enterprise systems and CIS
products of its customers developed by other vendors. Year 2000 problems in
these systems and products might significantly limit the ability of the
Company's customers to realize the intended benefits offered by VALEX and CCM.
The Company has no plan to ascertain whether the internal systems and products
of its customers are Year 2000 compliant. The Company may in the future be
subject to claims based on Year 2000 problems in others' products or issues
arising from the integration of multiple products within an overall system.
Although the Company has not been involved in any litigation or proceeding to
date involving its products or services related to Year 2000 issues, there can
be no assurance that the Company will not in the future be required to defend
its products or services or to negotiate resolutions of claims based on Year
2000 issues. The costs of defending and resolving Year 2000-related disputes,
and any liabilities of the Company for Year 2000-related damages, including
consequential damages, could have a material adverse effect on the Company's
business, operating results and financial condition.
Year 2000 issues may affect the purchasing patterns of customers and
potential customers in a variety of ways. Many companies are expending
significant resources to replace or remedy their current hardware and software
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to purchase software products such as those offered by the Company.
The Company does not believe that there is any practical way to ascertain the
extent of, and has no plan to address problems associated with, any such
reduction in purchasing resources of its customers. Any such reduction could,
however, have a material adverse effect on the Company's business, operating
results and financial condition. The Year 2000 problem is pervasive and complex,
as virtually every computer operation will be affected in some way.
Consequently, no assurance can be given that Year 2000 compliance can be
achieved without significant additional costs. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Impact of Year 2000
Issue".
No Prior Market for the Common Stock; Possible Volatility of Share
Price. Prior to the Offering, there has been no public market for the Common
Stock, and there can be no assurance that an active trading market will develop
upon completion of the Offering or, if it does develop, that such market will be
sustained. The initial public offering price of the Common Stock has been
determined by negotiation among the Company, the Selling Stockholders and the
representatives of the Underwriters, and may not be representative of the price
that will prevail in the open market. See "Underwriting" for a discussion of the
factors considered in determining the initial public offering price.
The market price of the Common Stock after the Offering may be affected
significantly by factors such as quarterly variations in the Company's results
of operations, the announcement of new products or product enhancements by the
Company or its competitors, technological innovation by the Company or its
competitors and general market conditions or market conditions specific to
particular industries. In particular, the stock prices for many companies in the
technology and emerging growth sectors have experienced wide fluctuations which
have often been unrelated to the
12
<PAGE> 15
operating performance of such companies. Such fluctuations may adversely affect
the market price of the Common Stock.
Anti-Takeover Provisions. The Company's Amended and Restated Certificate
of Incorporation (the "Charter"), and Amended and Restated By-laws (the
"By-laws"), contain certain provisions that may have the effect of discouraging,
delaying or preventing a change in control of the Company or unsolicited
acquisition proposals that a stockholder might consider favorable. Such
provisions include authorizing the issuance of "blank check" preferred stock;
providing for a Board of Directors with staggered, three-year terms; requiring
super-majority voting to effect certain amendments to the Charter and By-laws;
limiting the persons who may call special meetings of stockholders; prohibiting
stockholder action by written consent; and establishing advance notice
requirements for nominations for election to the Board of Directors or for
proposing matters that can be acted upon at stockholders meetings. Certain
provisions of Delaware law and the Company's 1996 Stock Incentive Plan (the
"1996 Plan") and 1998 Stock Incentive Plan (the "1998 Plan") may also have the
effect of discouraging, delaying or preventing a change in control of the
Company or unsolicited acquisition proposals. See "Management -- Stock Incentive
Plans" and "Description of Capital Stock -- Certain Anti-Takeover, Limited
Liability and Indemnification Provisions".
Shares Eligible for Future Sale; Registration Rights. Sales of substantial
amounts of Common Stock in the public market, or the perception that such sales
may occur, could adversely affect the prevailing market price of the Common
Stock or the ability of the Company to raise capital through a public offering
of its equity securities. Upon completion of the Offering, the Company will have
outstanding 9,827,190 shares of Common Stock (not including shares issuable upon
exercise of outstanding stock options). Under agreements entered into between
the representatives of the Underwriters and certain of the Company's
stockholders, including each of the Company's officers, directors, principal
stockholders and certain of their respective affiliates (the "Lock-Up
Agreements") who beneficially hold, in the aggregate, more than 6,450,000 shares
of Common Stock (which includes 77,714 shares acquired in 1998 upon the exercise
of stock options) prior to the Offering, no shares held by such holders will be
eligible for sale in the public market for a period of 180 days following the
date of this Prospectus. The Company intends to file a registration statement
under the Securities Act of 1933, as amended (the "Securities Act"), covering
the sale of Common Stock reserved for issuance under the Company's Stock Plans.
As of November 11, 1998, there were options outstanding under the 1996 Plan to
purchase an aggregate of 2,421,908 shares and no other options outstanding; all
shares acquired upon exercise of the options within 180 days of the Offering are
or will be subject to Lock-Up Agreements. Following the expiration of the
180-day term of the Lock-Up Agreements, 6,011,459 shares, including the
3,000,000 shares offered hereby and approximately 532,587 shares subject to
options that will be exercisable on or before the end of such term, will be
eligible for sale in the public market subject, in some cases, to the
requirements of Rule 144 or Rule 701 under the Securities Act. BT Alex. Brown
Incorporated in its sole discretion and at any time without notice, may release
all or any portion of the securities subject to the Lock-Up Agreements. Any such
decision to release securities would likely be based upon individual stockholder
circumstances, prevailing market conditions and other relevant factors. Any such
release could have a material adverse effect upon the price of the Common Stock.
See "Underwriting".
After the Offering, holders of 6,018,565 shares of Common Stock will be
entitled to certain demand and piggy-back registration rights with respect to
such shares. If the Company were required to register the shares held by such
holders pursuant to the exercise of their demand or piggy-back registration
rights, such sales could have an adverse effect upon the Company's ability to
raise needed capital. See "Shares Eligible for Future Sale".
Immediate Substantial Dilution. The initial public offering price is
substantially higher than the book value per share of the outstanding Common
Stock. As a result, investors purchasing Common Stock in the Offering will incur
immediate substantial dilution. In addition, the Company has issued options to
acquire Common Stock at prices significantly below the initial public offering
price. To the extent such outstanding options are exercised, there will be
further dilution. See "Dilution" and "Shares Eligible for Future Sale".
13
<PAGE> 16
HISTORICAL BACKGROUND OF THE COMPANY
The Company commenced operations in 1994 and was incorporated in Delaware
on November 7, 1996. Prior to November 15, 1996, the Company operated as a
division of two entities, Grant & Partners, Inc. ("GPI") and Grant & Partners
Limited Partnership ("GPLP"). GPI was incorporated in June 1993 and was
primarily engaged in providing management consulting services. In November 1994,
GPI segregated its operations into two business segments: a management
consulting practice and a software applications development practice and
designated management and financial resources to the development of VALEX. On
March 28, 1995, GPI entered into a limited partnership agreement with Cyrk, Inc.
("Cyrk") to form GPLP to provide marketing and customer management services for
companies in a wide range of industries including retailing, transportation,
banking and manufacturing. GPI, as the general partner of GPLP, contributed all
of its assets and liabilities to GPLP for a 50% limited partnership interest.
Cyrk purchased the remaining 50% limited partnership interest in GPLP. GPLP
operated as two separate divisions: (i) the Exchange Applications division,
which focused on marketing program design and execution, customer database
construction and software application development; and (ii) the Exchange
Partners division, which focused on providing a variety of management consulting
services for marketing organizations.
On November 15, 1996, the Company and GPLP entered into an assignment and
assumption agreement whereby GPLP sold the Exchange Applications division to the
Company in exchange for 2,300,000 shares of preferred stock of the Company. In
addition, the Company issued 2,484,375 shares of common stock to certain
employees. The Preferred Stock held by GPLP contained voting rights equal to two
votes for each share of common stock into which the preferred stock would
convert. As a result, GPLP held approximately 70% of the voting rights of the
Company.
The consolidated financial statements prior to November 15, 1996 represent
the financial results of the Exchange Applications division as included in the
consolidated financial statements of GPI from January 1, 1995 to March 27, 1995
and of GPLP from March 28, 1995 to November 14, 1996.
14
<PAGE> 17
USE OF PROCEEDS
Based on an assumed initial public offering price of $9.00 per share, the
Company will receive approximately $15.6 million from the sale of shares of
Common Stock to be sold by the Company pursuant to the Offering after deducting
the underwriting discount and estimated offering expenses payable by the
Company.
The principal purposes of the Offering are to increase the Company's equity
capital, to create a public market for the Common Stock, to facilitate future
access by the Company to public equity markets to provide increased visibility
of the Company in a marketplace where many of its competitors are publicly held
companies.
The Company currently intends to use a portion of the net proceeds of the
Offering to redeem the Series A Preferred Stock for $1,635,000 and to repay
indebtedness in the amount of $426,000 in respect of capitalized leases that
mature at various dates through 2001 and that bear interest ranging from 12% to
14.5% per annum. The remainder of the net proceeds of the Offering will be used
for working capital and general corporate purposes, including financing accounts
receivable.
The Company intends to seek acquisitions of businesses, products and
technologies that are complementary to those of the Company, and a portion of
the net proceeds may also be used for such acquisitions. While the Company
engages from time to time in discussions with respect to potential acquisitions,
the Company has no plans, commitments or agreements with respect to any such
acquisitions as of the date of this Prospectus, and there can be no assurances
that any acquisitions will be made.
Pending such uses, the net proceeds will be invested in government
securities and other short-term, investment-grade, interest-bearing instruments.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock and does not intend to pay any cash dividends on its Common Stock in the
foreseeable future. Future dividends, if any, will be determined by the Board of
Directors. The Company's revolving note agreement prohibits the payment of any
cash dividends on its Common Stock. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
15
<PAGE> 18
CAPITALIZATION
The following table sets forth the capitalization of the Company at
September 30, 1998 (i) on an actual basis, (ii) on a pro forma basis to reflect
the reclassification of Series A Preferred Stock to $1,634,000 of additional
paid-in capital, and the conversion of all outstanding shares of Series B
Convertible Preferred Stock and Series C Convertible Preferred Stock to a total
of 3,879,510 shares of Common Stock upon the closing of this Offering and (iii)
on a pro forma as adjusted basis to give effect to the sale of 2,000,000 shares
of Common Stock offered by the Company at an assumed initial public offering
price of $9.00 per share after deducting the underwriting discount and estimated
offering expenses payable by the Company, the redemption of the Series A
Preferred Stock for $1,635,000 and the repayment of existing indebtedness in the
amount of $426,000 in respect of capital leases. This information should be read
in conjunction with the Company's Consolidated Financial Statements and the
related Notes thereto appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1998
------------------------------------
PRO FORMA AS
ACTUAL PRO FORMA ADJUSTED
------ --------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Long-term debt, net of current portion................. $ 177 $ 177 $ --
------- ------- -------
Redeemable Preferred Stock:
Series A Preferred Stock............................. 3,269 1,635 --
Series B Convertible Preferred Stock................. 3,999 -- --
------- ------- -------
Total Redeemable Preferred Stock............. 7,268 1,635 --
Stockholders' equity (deficit):
Preferred Stock, $.001 par value; 10,000,000 shares
authorized........................................ -- -- --
Series C Convertible Preferred Stock, $.001 par
value; 1,223,954 shares designated, issued and
outstanding, actual; 1,223,954 authorized, none
issued, pro forma and pro forma as adjusted....... 1 -- --
Common Stock, $.001 par value, 30,000,000 shares
authorized, pro forma and pro forma as adjusted
4,312,685 shares issued, actual, 8,192,195 shares
issued, pro forma; 10,192,195 shares issued, pro
forma as adjusted(1).............................. 4 8 10
Additional paid-in capital............................. 5,428 11,058 26,646
Accumulated deficit.................................... (6,707) (6,707) (6,707)
Due from officer....................................... (125) (125) (125)
Deferred compensation.................................. (439) (439) (439)
Cumulative translation adjustment...................... 68 68 68
Unrealized gain on marketable securities............... 6 6 6
Treasury stock, 365,005 shares at cost................. -- -- --
------- ------- -------
Total stockholders' equity (deficit)......... (1,764) 3,869 19,459
------- ------- -------
Total capitalization......................... $ 5,681 $ 5,681 $19,459
======= ======= =======
</TABLE>
- ---------------
(1) Excludes 2,421,908 shares of Common Stock issuable pursuant to stock options
outstanding at November 11, 1998 (of which 321,466 options are exercisable
as of November 11, 1998). See "Management -- Stock Plans" and Note 13 of
Notes to Consolidated Financial Statements.
16
<PAGE> 19
DILUTION
The pro forma net tangible book value of the Company as of September 30,
1998 was $3,869,000, or $0.49 per share of Common Stock, after giving effect to
the automatic conversion of all outstanding shares of Convertible Preferred
Stock and the reclassification of the Series A Preferred Stock to $1,634,000 of
additional paid-in capital. Pro forma net tangible book value per share is
determined by dividing the pro forma net tangible book value of the Company
(total tangible assets less total liabilities) by the total pro forma number of
shares of Common Stock outstanding, including shares of Common Stock resulting
from the conversion of the Convertible Preferred Stock. After giving effect to
the sale of the 2,000,000 shares of Common Stock offered by the Company hereby
at an assumed initial public offering price of $9.00 per share, and after
deducting estimated underwriting discounts and commissions and offering expenses
payable by the Company (resulting in estimated net proceeds of $15.6 million),
the adjusted pro forma net tangible book value of the Company as of September
30, 1998, would have been $19,459,000, or $1.98 per share. This represents an
immediate increase in the pro forma net tangible book value of $1.49 per share
to existing stockholders and an immediate dilution of $7.02 per share to new
investors. The following table illustrates the per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $9.00
Pro forma net tangible book value per share as of
September 30, 1998..................................... $ .49
Pro forma increase attributable to new investors.......... 1.49
-----
Pro forma net tangible book value per share after the
Offering.................................................. 1.98
-----
Pro forma dilution per share to new investors(1)............ $7.02
=====
</TABLE>
The following table summarizes, on a pro forma basis as of September 30,
1998, the difference between the number of shares of Common Stock purchased from
the Company, the total consideration paid to the Company and the average price
per share paid by the existing stockholders and by the new investors (at an
assumed initial public offering price of $9.00 per share before deduction of
estimated underwriting discounts and commissions and offering expenses):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION(1)
--------------------- ---------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------ ------- ------ ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders(1)..... 7,827,190 79.6% $11,334,000 38.6% $1.45
New investors(1)............. 2,000,000 20.4% 18,000,000 61.4 9.00
---------- ----- ----------- ----- -----
Total.............. 9,827,190 100.0% $29,334,000 100.0%
========== ===== =========== =====
</TABLE>
- ---------------
(1) The foregoing table assumes no exercise of the Underwriters' over-allotment
option and no exercise of stock options outstanding at September 30, 1998.
As of November 11, 1998, the Company had 5,564,208 shares of Common Stock
reserved for issuance under the Company's stock plans of which 2,421,908
shares were subject to outstanding stock options at a weighted average
exercise price of $3.82 per share.
17
<PAGE> 20
SELECTED CONSOLIDATED FINANCIAL DATA
The following historical selected consolidated financial data of the
Company is qualified by reference to and should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included elsewhere herein.
The selected consolidated financial data set forth below for each of the fiscal
years ended December 31, 1995, 1996 and 1997 and the nine months ended September
30, 1998 are derived from consolidated financial statements of the Company
audited by Arthur Andersen LLP, independent public accountants, which are
included elsewhere in this Prospectus. The selected consolidated financial data
for the nine months ended September 30, 1997 are derived from the unaudited
consolidated financial statements of the Company, which are included elsewhere
in this Prospectus. The selected consolidated financial data for the period from
inception (November 1, 1994) through December 31, 1994 are derived from the
unaudited consolidated financial statements of the Company, which are not
included in this Prospectus. The unaudited consolidated financial statements
include all adjustments (consisting only of normal recurring adjustments) which
the Company considers necessary for a fair presentation. The results of
operations for the nine months ended September 30, 1998 are not necessarily
indicative of results to be expected for any future period. The data should be
read in conjunction with the Consolidated Financial Statements and the Notes
thereto and with Management's Discussion and Analysis of Financial Condition and
Results of Operations appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION NINE MONTHS
(NOVEMBER 1, YEAR ENDED ENDED
1994) THROUGH DECEMBER 31, SEPTEMBER 30,
DECEMBER 31, --------------------------- -----------------
1994(1) 1995(1) 1996(1) 1997 1997 1998
------------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Software license fees............................. $ -- $ -- $ 1,500 $ 5,765 $ 3,409 $ 9,774
Services and maintenance.......................... -- 1,693 4,534 6,904 4,740 7,392
------ ------ ------- ------- ------- -------
Total revenues.............................. -- 1,693 6,034 12,669 8,149 17,166
Cost of revenues:
Software license fees............................. -- -- 890 1,707 1,312 186
Services and maintenance.......................... -- 1,012 3,205 5,227 3,553 5,042
------ ------ ------- ------- ------- -------
Total cost of revenues...................... -- 1,012 4,095 6,934 4,865 5,228
------ ------ ------- ------- ------- -------
Gross profit........................................ -- 681 1,939 5,735 3,284 11,938
Operating expenses:
Sales and marketing............................... -- 128 1,007 3,602 2,139 6,769
Research and development.......................... -- 708 1,325 2,599 1,678 4,154
General and administrative........................ 7 352 1,018 2,158 1,253 2,140
------ ------ ------- ------- ------- -------
Total operating expenses.................... 7 1,188 3,350 8,359 5,070 13,063
------ ------ ------- ------- ------- -------
Loss from operations................................ (7) (507) (1,411) (2,624) (1,786) (1,125)
Interest income (expense), net...................... -- (47) (195) 25 36 48
------ ------ ------- ------- ------- -------
Net loss............................................ (7) (554) (1,606) (2,599) (1,750) (1,077)
Accretion of discount and dividends on preferred
stock............................................. -- -- -- (684) (625) (180)
------ ------ ------- ------- ------- -------
Net loss applicable to common stockholders.......... $ (7) $ (554) $(1,606) $(3,283) $(2,375) $(1,257)
====== ====== ======= ======= ======= =======
Basic and diluted net loss per share applicable to
common stockholders............................... $(0.01) $(0.46) $ (1.33) $ (1.12) $ (0.86) $ (0.35)
====== ====== ======= ======= ======= =======
Basic and diluted weighted average common shares
outstanding....................................... 1,200 1,200 1,205 2,920 2,759 3,641
====== ====== ======= ======= ======= =======
Pro forma basic and diluted net loss per share(2)
(3)............................................... $ (0.48) $ (0.15)
======= =======
Pro forma basic and diluted weighted average common
shares outstanding(2) (3)......................... 5,391 7,420
======= =======
Supplemental pro forma basic and diluted net loss
per share(4)...................................... $ (0.47) $ (0.14)
======= =======
Supplemental pro forma basic and diluted weighted
average common shares outstanding(4).............. 5,586 7,616
======= =======
</TABLE>
18
<PAGE> 21
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
1998
AS OF DECEMBER 31, ----------------------
------------------------------------- PRO
1994(1) 1995(1) 1996 1997 ACTUAL FORMA(2)
------- ------- ------- ------- ------ --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents, and marketable
securities................................. $ -- $ 500 $ 361 $ 5,475 $ 1,988 $ 1,988
Working capital (deficit).................... (120) (1,224) (853) 5,249 3,113 3,113
Total assets................................. 113 2,514 4,189 11,400 12,012 12,012
Long-term debt, net of current portion....... -- 38 2,368 237 177 177
Redeemable preferred stock................... -- -- -- 7,088 7,268 1,635
Stockholders' equity (deficit)............... (7) (560) (1,295) (728) (1,764) 3,869
</TABLE>
- ---------------
(1) The Consolidated Balance Sheet Data as of December 31, 1994 and 1995 and
consolidated statement of operations data for the period from inception to
December 31, 1994, and for the years ended December 31, 1995 and 1996
include the operations of the Company on a carve-out basis prior to November
15, 1996. During this period, the Company operated as a separate and
substantially independent division of Grant & Partners, Inc. and Grant &
Partners Limited Partnership, and focused on developing VALEX and providing
integration and consulting services. See "Historical Background of the
Company" and Note 1 of Notes to Consolidated Financial Statements.
(2) Gives effect to the reclassification of Series A Preferred Stock to
$1,634,000 to additional paid-in capital, the conversion of all outstanding
shares of the Series B Convertible Preferred Stock, at a redemption value of
$3,999,000, into 2,655,556 shares of Common Stock, and the conversion of all
outstanding shares of Series C Convertible Preferred Stock, at $.001 par
value per share, into 1,223,954 shares of Common Stock upon the closing of
the Offering.
(3) Computed on the basis described in Note 2(c) of Notes to Consolidated
Financial Statements.
(4) Computed on the basis described in Note 2(c) of the Notes to Consolidated
Financial Statements, adjusted for the increase in the number of shares of
Common Stock issued pursuant to this Offering sufficient to generate
proceeds in the amount of $1,635,000 to redeem the Series A Preferred Stock.
19
<PAGE> 22
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and 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
The Company is a leading provider of open, enterprise customer optimization
software and solutions that are designed to enable businesses to maximize
profitability and revenue growth from new and existing customers through
marketing automation and enterprise-wide customer management. The Company's
Continuous Customer Management ("CCM") offering is principally comprised of
VALEX, the Company's open enterprise software application, and the Company's
proprietary consulting and integration services.
The Company was incorporated in November 1996. Prior to incorporation, the
Company operated as a separate division of two entities, Grant & Partners, Inc.
("GPI") and Grant & Partners Limited Partnership ("GPLP"). See Note 1 to Notes
to Consolidated Financial Statements. The Company's activities during its early
stages of operation focused on the development of software solutions to provide
CCM support to businesses. In 1995, the Company began providing professional
services in the areas of marketing program design and execution and data
warehousing. In March 1997, the Company ceased providing marketing program
design services. The Company's development efforts culminated in the
introduction to the market in July 1996 of VALEX, the Company's marketing
automation software product. Since the introduction of VALEX, the Company has
continued to focus significant resources on the development of additional
functionality and features of the VALEX software. The Company also has continued
to expand its marketing activities, build the Exchange Applications identity,
develop the competencies of the professional services group, build international
sales and distribution channels and develop its general and administrative
infrastructure. The Company has shifted its primary business focus from
providing services to selling software products. However, the Company believes
that continuing to provide superior professional services will be critical to
maximizing its opportunities for future revenues.
The financial results of the Company while it operated as a separate
division of GPI and GPLP for the period from inception (November 1, 1994) to
November 14, 1996 have been included on a carve-out basis in the Company's
Consolidated Financial Statements.
The Company generates revenue from software licenses, professional service
arrangements and software maintenance agreements. The Company recognizes
software license fee revenues upon execution of a license agreement and delivery
of the software, provided that the fee is fixed or determinable and deemed
collectible by management. If acceptance of the software by the licensee is
required, revenues are only recognized upon satisfaction of the foregoing
conditions and acceptance of the software. Revenues from professional service
arrangements are recognized on either a time and materials or
percentage-of-completion basis as the services are performed, provided that
amounts due from customers are fixed or determinable and deemed collectible by
management. Revenues related to software maintenance agreements are recognized
ratably over the term of the maintenance period. Amounts collected or billed
prior to satisfying the above revenue recognition criteria are reflected as
deferred revenue or as customer deposits.
Pricing for a VALEX software license is based on the number of customer
records included in a business' data warehouse and certain other factors,
including the number of users of the software. Professional services are
generally priced on a time and materials or fixed-fee basis. Annual maintenance,
which is typically purchased in conjunction with the licensing of VALEX, is a
separate
20
<PAGE> 23
component that is offered for a fee generally equal to 20% of the license fee at
the time of execution of the maintenance contract and upon each renewal.
Maintenance contracts typically include telephone support and rights to
unspecified product updates and maintenance releases. The Company recommends
that its customers enter into and renew their maintenance contracts and, to
date, all customers have done so. As the Company continues to develop additional
features and enhanced functionality in unspecified future product updates, the
Company believes that most of its customers will continue to renew their
maintenance contracts. As the Company effects more sales of its software
products through its re-seller relationships, the Company plans to have the
re-sellers provide certain of the consulting and maintenance services associated
with these sales. By using the services resources of the re-sellers, the Company
plans to allocate its own professional services resources to direct-sale
customers, to the projects that require unique expertise or familiarity with the
VALEX product and to other profitable opportunities.
Licenses originate principally from the Company's direct sales force. Sales
and marketing personnel from indirect sales channels, including re-sellers and
co-marketers, provide the Company with valuable introductions to potential
customers, work with the Company's sales force to complete sales and, in some
cases, effect sales of the Company's products virtually independently. The
Company expects that a significant portion of its revenues over the next several
quarters will be made with some participation from one or more of the Company's
re-sellers or co-marketers.
Because the Company has only recently begun to sell its products,
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 predictive of future performance. In addition, the timing of
license revenues is difficult to predict because of the length and variability
of the Company's sales cycle. 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, particularly in new and rapidly
evolving markets. There can be no assurance that the Company will be successful
in addressing such risks and difficulties or that it will achieve profitability.
See "Risk Factors -- Limited Operating History; History of Losses".
RECENT ACCOUNTING PRONOUNCEMENT
SOP 97-2, "Software Revenue Recognition", was issued in October 1997 and
supercedes the guidance of SOP 91-1 for recognizing revenue from software
arrangements. The Company adopted the provisions of SOP 97-2 for the year ended
December 31, 1997, and the Company believes its revenue recognition policies and
practices comply with the requirements of SOP 97-2. However, SOP 97-2 includes
restrictive provisions regarding specific terms of software arrangements which,
if present, require deferral of revenue recognition beyond the point of delivery
of the software. Future competitive conditions could necessitate changes in the
Company's business practices and the contract terms of its software
arrangements. Such changes might require deferral of revenue recognition, which
could materially adversely affect periodic operating results.
21
<PAGE> 24
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of total revenues represented by certain items from the Company's Consolidated
Statements of Operations.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- ------------------
1995 1996 1997 1997 1998
----- ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
Revenues:
Software license fees....................... --% 24.9% 45.5% 41.8% 56.9%
Services and maintenance.................... 100.0 75.1 54.5 58.2 43.1
----- ----- ----- ----- -----
Total revenues...................... 100.0 100.0 100.0 100.0 100.0
Cost of revenues:
Software license fees....................... -- 14.8 13.5 16.1 1.1
Services and maintenance.................... 59.8 53.1 41.2 43.6 29.4
----- ----- ----- ----- -----
Total cost of revenues.............. 59.8 67.9 54.7 59.7 30.5
----- ----- ----- ----- -----
Gross margin.................................. 40.2 32.1 45.3 40.3 69.5
Operating expenses:
Sales and marketing......................... 7.5 16.7 28.5 26.2 39.4
Research and development.................... 41.8 21.9 20.5 20.6 24.2
General and administrative.................. 20.8 16.9 17.0 15.4 12.5
----- ----- ----- ----- -----
Total operating expenses............ 70.1 55.5 66.0 62.2 76.1
----- ----- ----- ----- -----
Loss from operations.......................... (29.9) (23.4) (20.7) (21.9) (6.6)
Interest income (expense), net................ (2.8) (3.2) 0.2 0.4 0.3
----- ----- ----- ----- -----
Net loss...................................... (32.7)% (26.6)% (20.5)% (21.5)% (6.3)%
===== ===== ===== ===== =====
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
Revenues
The Company's total revenues increased 111% from $8.1 million in the nine
months ended September 30, 1997 to $17.2 million in the nine months ended
September 30, 1998. A number of factors contributed to the increase in total
revenues, including an increase in the Company's sales force, sales resulting
from the establishment of key strategic re-seller and co-marketing relationships
in late 1997 and the first six months of 1998, increased international sales
resulting from the opening of a U.K. sales office during July 1997 and the
growing contribution of maintenance revenues from the larger installed base of
the Company's products.
Software license fee revenues increased 187% from $3.4 million, or 41.8% of
total revenues, in the nine months ended September 30, 1997 to $9.8 million, or
56.9% of total revenues, in the nine months ended September 30, 1998. The
significant increase in software license fee revenues was attributable primarily
to the growing market awareness and acceptance of the Company's products,
particularly in the telecommunications industry, $3.1 million in incremental
software license fee revenues from direct sales to customers in North America,
$2.8 million in incremental software license fee revenues from direct sales to
customers outside North America, and $486,000 in incremental software license
fee revenues from strategic re-seller relationships.
Services and maintenance revenues increased 56% from $4.7 million, or 58.2%
of total revenues, in the nine months ended September 30, 1997 to $7.4 million,
or 43.1% of total revenues, in the nine months ended September 30, 1998. The
growth of services and maintenance revenues resulted from $1.6 million in
incremental professional services revenues associated with the growing sales of
the Company's software products and increased training revenues, and $1.0
million in incremental maintenance revenues from the larger installed base of
software license customers.
22
<PAGE> 25
The decrease in services and maintenance revenues as a percentage of total
revenues was primarily attributable to market acceptance of VALEX and increases
in sales of VALEX by re-sellers and co-marketers that provided certain of the
related services.
The recent growth in the Company's revenue and the broadening of its
customer base has resulted in a decrease in the concentration of revenues from
its top customers. For the nine months ended September 30, 1998, the Company's
top five customers accounted for 39.0% of total revenues, while for the nine
months ended September 30, 1997, the Company's top five customers accounted for
83.1% of total revenues. The three largest customers during the nine months
ended September 30, 1998 represented 18.1%, 7.3% and 4.7% of total revenues,
while the three largest customers during the nine months ended September 30,
1997 represented 30.6%, 29.5% and 9.3%. In the nine-month period ended September
30, 1998, revenues from the largest customer were comprised of sales through a
single re-seller to multiple end-user businesses.
Substantially all of the Company's revenues for the nine months ended
September 30, 1997 were from sales to customers in North America; however,
operations outside North America were significantly expanded in late 1997 and
1998 and represent an increasing source of the Company's revenues. Revenues from
customers outside North America were $4.1 million for the nine months ended
September 30, 1998, representing approximately 23.9% of total revenues.
Cost of Revenues
Total cost of revenues consists of costs associated with software license
fees and costs associated with services and maintenance. Total cost of revenues
as a percentage of total revenues declined from 59.7% in the nine months ended
September 30, 1997 to 30.5% in the nine months ended September 30, 1998.
Cost of software license fees consists primarily of royalty payments made
to third parties for licensed intellectual property included in the Company's
VALEX product, and costs associated with software packaging and distribution.
Cost of software license fees for the nine months ended September 30, 1997 also
included amortization of software development costs capitalized under Statement
of Financial Accounting Standards No. 86 ("SFAS 86"). Cost of software license
fees as a percentage of total revenues decreased from 16.1% to 1.1% for the nine
months ended September 30, 1997 and 1998, respectively. Cost of software license
fees as a percentage of software license fee revenues decreased from 38.4% to
1.9% for the nine months ended September 30, 1997 and 1998, respectively. This
decrease was primarily due to the full amortization of all capitalized software
development costs as of December 31, 1997. The Company's primary royalty
obligation for licensed intellectual property, which required the Company to pay
royalties to a third party on the first $10 million of revenues from VALEX
sales, was fully paid during the second quarter of 1998. No further royalties
will be paid to this third party and other current royalty obligations are not
material to the Company's financial results. If the effect of the SFAS 86
amortization and royalties for licensed software were not included, gross margin
on software license fee revenues would have been 99.8% for the nine months ended
September 30, 1997, versus 99.0% for the nine months ended September 30, 1998.
As the Company adds additional components to its software products, the Company
may choose to license software from third parties. The cost of such licenses may
increase the cost of software license fees.
Cost of services and maintenance consists primarily of personnel, facility
and system costs incurred in providing professional consulting services,
training, and customer support services. Cost of services and maintenance
revenues as a percentage of total revenues was 43.6% and 29.4% during the nine
months ended September 30, 1997 and 1998, respectively. Cost of services and
maintenance as a percentage of services and maintenance revenues was 75.0% and
68.2% for the nine months ended September 30, 1997 and 1998, respectively. The
decrease was attributable primarily to the increased contribution of higher
margin maintenance revenues from the Company's increased installed base of VALEX
customers. As the Company effects more sales of its software products
23
<PAGE> 26
through its re-seller relationships, the Company plans to have the re-sellers
provide certain of the consulting and maintenance services associated with these
sales. By using the services resources of the re-sellers, the Company plans to
allocate its own professional services resources to direct-sale customers, to
the projects that require unique expertise or familiarity with the VALEX product
and to other more profitable opportunities.
Overall gross margin increased from 40.3% for the nine months ended
September 30, 1997 to 69.5% for the nine months ended September 30, 1998 due
primarily to the completion of amortization of software development costs,
increased sales of VALEX and the expiration of the Company's royalty obligations
for licensed intellectual property. If software license fee revenues continue to
grow and maintenance revenues increase as a percentage of total services and
maintenance revenues, the Company expects that overall gross margin will remain
constant or increase slightly in future periods.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries for sales and marketing personnel, commissions, travel and promotional
expenses. Sales and marketing expenses increased from $2.1 million, or 26.2% of
total revenues, for the nine months ended September 30, 1997, to $6.8 million,
or 39.4% of total revenues, for the nine months ended September 30, 1998. This
increase was primarily due to the hiring of 27 additional sales and marketing
employees. While the Company expects sales and marketing expenses to continue to
grow in absolute dollars, the Company expects these expenses to remain
approximately the same as a percentage of total revenues due to increased
contribution from its indirect sales channels.
Research and Development. Research and development expenses consist
primarily of employee salary and benefits, consultant costs, and equipment and
purchased software depreciation costs associated with new product development,
enhancement of existing products and quality assurance activities. Research and
development expenses increased from $1.7 million, or 20.6% of total revenues, in
the nine months ended September 30, 1997 to $4.2 million, or 24.2% of total
revenues, in the nine months ended September 30, 1998. This increase reflects
the hiring of 17 additional employees and additional investments in the
Company's VALEX product. Software development costs were expensed as incurred in
the nine months ended September 30, 1998, since software development costs were
primarily related to product enhancements and product maintenance. The Company
anticipates that annual research and development expenses will increase in
absolute dollars but decrease on a percentage basis as the Company continues to
commit substantial resources to enhancing existing product functionality and to
developing new products.
General and Administrative. General and administrative expenses consist
primarily of salaries and related costs, outside professional fees, provision
for bad debts, and equipment and software depreciation costs associated with the
finance, legal, human resources, information systems, and administrative
functions of the Company. General and administrative expenses increased from
$1.3 million, or 15.4% of total revenues, for the nine months ended September
30, 1997 to $2.1 million, or 12.5% of total revenues, for the nine months ended
September 30, 1998. Expenses increased in absolute dollars as the Company added
nine employees to its finance, information systems, and human resource
departments between September 30, 1997 and September 30, 1998, but declined as a
percentage of total revenues, due primarily to economies of scale. The Company
expects general and administrative expenses to continue to grow in absolute
dollars but to decrease on a percentage basis as the Company implements
additional management information systems, continues its international expansion
and incurs costs incident to being a publicly-held company.
Provision for Income Taxes
No provision for federal or state income taxes has been recorded as the
Company incurred net operating losses for all periods presented. The Company has
recorded a full valuation allowance
24
<PAGE> 27
against the deferred tax asset generated as a result of these net operating loss
carryforwards as the Company believes it is more likely than not that these
assets will not be realized.
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
Revenues
The Company's total revenues increased 256% from $1.7 million in 1995 to
$6.0 million in 1996, reflecting significant software license fee revenues
related to the commercial introduction of the Company's VALEX product in July
1996. The Company's total revenues increased 110% to $12.7 million in 1997 as
the Company sold its products and services to a greater number of customers and
expanded its business outside North America.
Software license fee revenues increased from zero in 1995 to $1.5 million,
or 24.9% of total revenues, in 1996 and grew 284% to $5.8 million, or 45.5% of
total revenues, in 1997. The increase in software license fee revenues from 1995
to 1996 reflected license fee revenues related to the commercial introduction of
the Company's VALEX product in July 1996. The increase in software license fee
revenues in from 1996 to 1997, both in absolute dollars and as a percentage of
total revenues, reflected increased market awareness and acceptance of the
Company's VALEX product, $2.6 million in incremental software license fee
revenues from strategic re-seller relationships, $1.0 million in incremental
software license fee revenues from direct sales to customers in North America
and $598,000 in incremental software license fee revenues from direct sales to
customers outside North America.
Services and maintenance revenues increased 168% from $1.7 million, or
100.0% of revenues, in 1995 to $4.5 million, or 75.1% of total revenues in 1996,
and grew 52% to $6.9 million, or 54.5% of total revenues, in 1997. The increase
in services and maintenance revenues from 1995 to 1996 was primarily due to $2.8
million in incremental professional services revenues associated with VALEX. The
increase in services and maintenance revenues from 1996 to 1997 was primarily
due to $1.7 million in incremental professional services revenues and an
incremental $627,000 in maintenance revenues. The Company expects services and
maintenance revenues to decline as a percentage of total revenues as the parties
with whom the Company has undertaken re-seller and co-marketing relationships
perform more of the professional services associated with the Company's software
licenses sold through these channels. However, the Company expects services and
maintenance revenues to increase in absolute dollars as the installed base of
the Company's products continues to increase.
In 1997, the Company's top five customers accounted for 74.9% of total
revenues, while the Company's three largest customers accounted for 33.0%, 23.1%
and 7.6%, respectively, of the Company's total revenues during this same period.
In 1997, revenues from the largest customer were comprised of sales through a
single re-seller to multiple end-user businesses. In 1996, the Company's top
five customers accounted for 57.7% of total revenues, while the Company's three
largest customers accounted for 20.5%, 10.7% and 10.2%, respectively, of the
Company's total revenues during this same period. In 1995, the Company's top
five customers accounted for 87.8% of total revenues, while the Company's three
largest customers accounted for 37.7%, 17.3% and 13.0%, respectively, of the
Company's total revenues during this same period. In 1995 and 1996, the
Company's revenues consisted primarily of the sale and delivery of the Company's
professional services in the area of customer optimization and data warehousing.
Cost of Revenues
Total cost of revenues, as a percentage of total revenues, increased from
59.8% in 1995 to 67.9% in 1996, and then declined to 54.7% in 1997. The increase
in 1996 reflected six months of amortization of software development costs
previously capitalized in accordance with the guidelines of SFAS 86, which
amortization began in July 1996 upon general release of the Company's VALEX
product. The decline in the total cost of revenues as a percentage of total
revenues in 1997 reflected
25
<PAGE> 28
the increasing contribution of higher-margin software license sales of VALEX,
which was first shipped in July 1996.
Cost of software license fees as a percentage of total revenues was 14.8%
in 1996 and 13.4% in 1997. There were no revenues derived from software license
fees prior to 1996. The cost of software license fees as a percentage of
software license fee revenues decreased from 59.3% in 1996 to 29.6% in 1997 due
primarily to increased software license sales volume in 1997. This increase
offset the incremental $499,000 of amortization of capitalized software
development costs in 1997 versus 1996, as well as the incremental $342,000 in
royalties paid to a third party for intellectual property included in VALEX. If
the effect of SFAS 86 amortization and royalties for licensed intellectual
property were not included, gross margin on software license fee revenues would
have been 95.7% and 99.3% for 1996 and 1997, respectively. With the balance of
capitalized software development costs fully amortized at the end of 1997 and
the primary royalty obligations for licensed intellectual property fully paid as
of the second quarter of 1998, the cost of software license fee revenues
consists principally of the cost of the software media and other incidental
costs.
Cost of services and maintenance as a percentage of total revenues was
59.8%, 53.1% and 41.3% in 1995, 1996 and 1997, respectively. Cost of services
and maintenance as a percentage of services and maintenance revenues was 59.8%,
70.7% and 75.7% in 1995, 1996 and 1997, respectively. The increasing cost was
due to the costs of building a service organization infrastructure and the
increased use, at higher cost, of subcontracted labor on certain engagements.
The Company expects to continue to use subcontractors for the delivery of
professional services from time to time.
Overall gross margin decreased from 40.2% in 1995 to 32.1% in 1996 as a
result of the Company's investments in its services infrastructure in
anticipation of increased VALEX sales and the inclusion of six months of SFAS 86
amortization. In 1997, gross margin increased to 45.3% of total revenues as the
Company's contribution of higher-margin software license fees increased from
24.9% of total revenues in 1996 to 45.5% in 1997. In addition, the Company began
to realize productive returns from the services infrastructure established in
1996.
Operating Expenses
Sales and Marketing. Sales and marketing expenses were $128,000, $1.0
million, and $3.6 million, representing 7.5%, 16.7% and 28.5% of total revenues,
in 1995, 1996 and 1997, respectively. These increases were due primarily to the
increase in the Company's sales and marketing personnel and overall
infrastructure to support VALEX and expand internationally. The Company's
international expansion included the opening of its first international sales
office in the U.K. in July 1997. The Company expects to continue to expand its
direct sales force and marketing staff, increase its international presence, and
continue to develop its indirect sales channels and increase promotional
activity.
Research and Development. Research and development expenses were $708,000,
$1.3 million, and $2.6 million, representing 41.8%, 21.9%, and 20.5% of total
revenues, in 1995, 1996 and 1997, respectively. The increase in absolute dollars
was attributable primarily to the hiring of additional technical personnel
engaged in software development activities. The decline in research and
development expenses on a percentage basis was due primarily to the greater
growth in revenues.
General and Administrative. General and administrative expenses were
$352,000, $1.0 million and $2.2 million, representing 20.8%, 16.9% and 17.0% of
total revenues, in 1995, 1996 and 1997, respectively. General and administrative
expenses grew in absolute dollars as the Company added personnel to all
administrative areas, but declined on a percentage basis due primarily to
economies of scale.
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<PAGE> 29
Interest Income (Expense), Net
Interest expense, net increased from $47,000 in 1995 to $195,000 in 1996 as
a result of interest charges on the Company's demand note payable to related
parties as well as finance charges related to the Company's capital lease
obligations. The Company reported net interest income of $25,000 in 1997 as a
result of the elimination of the related party demand notes payable concurrent
with the March 1997 venture capital financing transaction, as well as the
related interest income generated from the proceeds of the March 1997 and
December 1997 financing transactions.
Provision for Income Taxes
No provision for federal or state income taxes has been recorded as the
Company incurred net operating losses for all periods presented. The Company has
recorded a full valuation allowance against the deferred tax asset generated as
a result of these net operating loss carryforwards, as the Company currently
believes it is more likely than not that these assets will not be realized.
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<PAGE> 30
SELECTED QUARTERLY RESULTS OF OPERATIONS
The following tables present unaudited quarterly consolidated statement of
operations data for each quarter in the seven quarters ended September 30, 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
consolidated financial statements that have been prepared on the same basis as
the audited consolidated financial statements and include all adjustments
(consisting only of normal recurring adjustments) that the Company considers
necessary for a fair presentation of such information. The Company believes
quarter-to-quarter comparisons of its financial results should not be relied
upon as an indication of future performance, and operating results may fluctuate
from quarter to quarter in the future.
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30,
1997 1997 1997 1997 1998 1998 1998
--------- -------- --------- -------- --------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
DATA:
Revenues:
Software license fees................. $ 472 $1,321 $1,616 $2,356 $2,711 $3,105 $3,958
Services and maintenance.............. 1,657 1,372 1,711 2,164 2,080 2,522 2,790
------ ------ ------ ------ ------ ------ ------
Total revenues.................. 2,129 2,693 3,327 4,520 4,791 5,627 6,748
Cost of revenues:
Software license fees................. 430 433 449 395 84 45 57
Services and maintenance.............. 1,237 1,059 1,257 1,674 1,635 1,667 1,740
------ ------ ------ ------ ------ ------ ------
Total cost of revenues.......... 1,667 1,492 1,706 2,069 1,719 1,712 1,797
------ ------ ------ ------ ------ ------ ------
Gross profit............................ 462 1,201 1,621 2,451 3,072 3,915 4,951
Operating expenses:
Sales and marketing................... 568 700 871 1,463 1,735 2,428 2,606
Research and development.............. 453 578 647 921 1,207 1,509 1,438
General and administrative............ 391 428 434 905 571 713 856
------ ------ ------ ------ ------ ------ ------
Total operating expenses........ 1,412 1,706 1,952 3,289 3,513 4,650 4,900
------ ------ ------ ------ ------ ------ ------
Income (loss) from operations........... (950) (505) (331) (838) (441) (735) 51
Interest income (expense), net.......... (33) 29 40 (11) 23 6 19
------ ------ ------ ------ ------ ------ ------
Net income (loss)....................... $ (983) $ (476) $ (291) $ (849) $ (418) $ (729) $ 70
====== ====== ====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30,
1997 1997 1997 1997 1998 1998 1998
--------- -------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
Software license fees................. 22.2% 49.1% 48.6% 52.1% 56.6% 55.2% 58.7%
Services and maintenance.............. 77.8 50.9 51.4 47.9 43.4 44.8 41.3
------ ------ ------ ------ ------ ------ ------
Total revenues.................. 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenues:
Software license fees................. 20.2 16.1 13.5 8.7 1.8 0.8 0.8
Services and maintenance.............. 58.1 39.3 37.8 37.0 34.1 29.6 25.8
------ ------ ------ ------ ------ ------ ------
Total cost of revenues.......... 78.3 55.4 51.3 45.7 35.9 30.4 26.6
------ ------ ------ ------ ------ ------ ------
Gross margin............................ 21.7 44.6 48.7 54.3 64.1 69.6 73.4
Operating expenses:
Sales and marketing................... 26.7 26.0 26.2 32.4 36.2 43.2 38.6
Research and development.............. 21.3 21.5 19.4 20.4 25.2 26.8 21.3
General and administrative............ 18.4 15.9 13.0 20.0 11.9 12.7 12.7
------ ------ ------ ------ ------ ------ ------
Total operating expenses........ 66.3 63.4 58.7 72.8 73.3 82.7 72.6
------ ------ ------ ------ ------ ------ ------
Income (loss) from operations........... (44.6) (18.8) (10.0) (18.5) (9.2) (13.1) 0.7
Interest income (expense), net.......... (1.6) 1.1 1.2 (0.2) 0.5 0.1 0.3
------ ------ ------ ------ ------ ------ ------
Net income (loss)....................... (46.1)% (17.7)% (8.8)% (18.7)% (8.7)% (13.0)% 1.0%
====== ====== ====== ====== ====== ====== ======
</TABLE>
The Company's revenues have increased in all quarters presented as a result
of increased market acceptance of the VALEX product, the continued growth of
indirect channel revenues, and expansion of international sales resources. Cost
of revenues on a percentage basis decreased throughout the quarters presented as
a result of an increase in software license fees in the Company's revenue mix,
the completion of the amortization of capitalized software development
28
<PAGE> 31
costs in the fourth quarter of 1997 and the completion of software royalty
obligations in the second quarter of 1998. No assurances can be given that the
shift in revenue mix will continue. Gross profit for any quarter will be
affected by the revenue mix in that quarter.
Operating expenses have increased in each of the quarters presented. Sales
and marketing expenses have increased as a result of increased sales and
marketing personnel and increased commissions associated with higher revenues.
Research and development expenses generally have increased as a result of
continued enhancements to the VALEX technology. General and administrative
expenses have increased primarily due to additional personnel, professional fees
and facilities and other infrastructure costs. General and administrative
expenses in the quarter ended December 31, 1997 included one-time charges
associated with the decision to relocate the Company's executive offices, as
well as noncash compensation expense associated with the Company's 1996 Stock
Incentive Plan.
The Company's quarterly and annual operating results have varied
significantly in the past and are expected to do so in the future. Accordingly,
the Company believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
predictors of future performance. See "Risk Factors -- Potential for Significant
Fluctuations in Quarterly Results".
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations primarily
through the sale of equity securities in private placements and the issuance of
notes payable to related parties. In March 1997, the Company received $3,888,000
in net cash proceeds from the sale of its Series B Preferred Stock; and in
December 1997, the Company received $3,987,000 in net cash proceeds from the
sale of its Series C Preferred Stock. In addition, in December 1997, the Company
entered into a $2,000,000 revolving note agreement with Fleet National Bank. The
note bears interest at the bank's prime rate plus 0.75% per annum, payable
monthly in arrears, expires on May 31, 1999 and is secured by substantially all
assets of the Company. Under the revolving note agreement, the Company is
required to comply with certain restrictive covenants, including (i) maintaining
a ratio of debt to tangible net worth of not more than 1.00 to 1.00 at the end
of each fiscal quarter, (ii) maintaining a minimum tangible net worth of at
least $5,500,000, subject to certain adjustments, (iii) maintaining minimum net
income of $1.00 for each fiscal quarter, and (iv) maintaining a current assets
to current liabilities ratio of not less than 1.50 to 1.00 as at the end of each
fiscal quarter. In addition, the Company is prohibited from paying any cash
dividends on its Common Stock under the revolving note agreement. As of
September 30, 1998, the Company was in compliance with all covenants under the
revolving note agreement.
As of September 30, 1998, the Company had $2.0 million of cash, cash
equivalents and short-term investments. The Company believes that the net
proceeds of this Offering, along with its existing balance of cash, cash
equivalents and short-term investments, will be sufficient to meet the Company's
working capital and anticipated capital expenditure needs for at least the next
12 months. Thereafter, the Company may require additional sources of funds to
continue to support its business. There can be no assurance that such capital,
if needed, will be available or will be available on terms acceptable to the
Company.
Cash provided by financing activities of $6.7 million in 1997 consisted
primarily of the proceeds from the issuance of Convertible Preferred Stock and
has been invested in short-term investments. Purchases of computer equipment
used in conducting the Company's business represented the primary component of
cash used in investing activities.
Cash and cash equivalents for the nine months ended September 30, 1998
decreased $3.5 million from the December 31, 1997 ending balance. Net cash used
for operations of approximately $2.0 million for the nine months ended September
30, 1998 resulted primarily from a net loss before depreciation expense of
$582,000 and an approximately $1.4 million increase in non-cash working
29
<PAGE> 32
capital. The increase in non-cash working capital was primarily attributable to
an increase in accounts receivable associated with increased license and
services revenue over the nine-month period, partially offset by an increase in
accounts payable and deferred revenue. Net cash used in investing activities for
the nine months ended September 30, 1998 was a result of property and equipment
purchases related to the increase in headcount, the move to new operating
facilities and the acquisition of computer hardware and software for development
and internal operating systems. Net cash used in financing activities of
$152,000 consisted of approximately $203,000 for the repayment of capital lease
obligations, offset by cash inflow of $51,000 from the exercise of stock options
under the 1996 Plan.
The Company had net operating loss carryforwards of approximately $1.7
million at September 30, 1998 to reduce future income taxes, if any. These
carryforwards expire through 2018 and are subject to review and possible
adjustment by the Internal Revenue Service. The Tax Reform Act of 1986 contains
provisions that may limit the amount of net operating loss and credit
carryforwards that the Company may utilize in any one year in the event of
certain cumulative changes in ownership over a three-year period in excess of
50% as defined. The Company believes that it has experienced a change in
ownership in excess of 50%. The Company does not believe that this change will
significantly impact the Company's ability to utilize its net operating loss
carryforwards.
The Company currently has sales offices in the United Kingdom and
Australia, in addition to the United States. The Company's revenues from
international operations have been denominated in foreign currencies which
historically have been stable in relation to U.S. dollars. As a result, the gain
or loss from foreign currency transactions has not been material to the
Company's operating results. As of September 30, 1998, the material assets and
liabilities denominated in foreign currencies include accounts receivable,
accounts payable and cash and cash equivalents. Due to the stability of the
foreign economies where these assets and liabilities are denominated, the
Company has not adopted a policy of hedging foreign currency risks. While it is
anticipated that foreign transactions will continue to be denominated in local
currencies, the Company expects to use hedging instruments to offset potential
currency exposures arising as the Company's international operations expand into
less stable economic environments.
The Company currently intends to use the net proceeds of the Offering to
redeem the Series A Preferred Stock for $1,635,000, repay existing indebtedness
in the amount of $426,000 in respect of capitalized leases and for working
capital and general corporate purposes, including financing accounts receivable
as well as for potential acquisitions of businesses, products and technologies
that are complementary to those of the Company. Although the Company has not
identified any specific businesses, products or technologies that it may
acquire, or entered into any current agreements or negotiations with respect to
any such transactions, the Company from time to time evaluates such
opportunities. Pending such uses, the net proceeds will be invested in
government securities and other short-term, investment-grade, interest-bearing
instruments.
IMPACT OF YEAR 2000 ISSUE
The Year 2000 issue results from computer programs written using two digits
rather than four to define the applicable year. Any of the Company's computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
The Company has attempted to make an assessment, where practicable, with
regard to whether its own internal information systems are Year 2000 compliant.
Since June 1998, the Company has upgraded its accounting, telecommunications and
customer care systems, at an aggregate cost of approximately $400,000, with
systems that are warranted by the vendors to be Year 2000 compliant. To the
extent the Company purchases additional systems, the Company plans to require
that such
30
<PAGE> 33
systems are warranted by the vendors to be Year 2000 compliant. The Company
plans to seek assurances from its existing vendors whose systems are not
warranted to be Year 2000 compliant that such systems are Year 2000 compliant.
The Company recently hired a manager of management information systems, whose
responsibilities include oversight of Year 2000 compliance. The Company does not
separately track the internal costs incurred for Year 2000 projects, which are
principally the related payroll costs for its information systems personnel.
Although the Company does not believe that any additional Year 2000
compliance-related costs will be significant, there can be no assurance that
costs incurred to address unanticipated issues would not have a material adverse
effect on the Company's business, operating results and financial conditions.
Any failure of third-party equipment or software comprising any part of the
Company's systems to operate properly with regard to Year 2000 and thereafter
could require the Company to incur unanticipated expenses to address associated
problems, which could have a material adverse effect on the Company's business,
operating results and financial condition. The Company has received assurances
that all material embedded systems included in the Company's products are Year
2000 compliant.
The Company believes, based on an internal assessment, that the current
versions of its software products are Year 2000 compliant. However, the
Company's products are generally integrated with the enterprise systems and CIS
products of its customers developed by other vendors. Year 2000 problems in
these systems and products might significantly limit the ability of the
Company's customers to realize the intended benefits offered by VALEX and CCM.
The Company has no plan to ascertain whether the internal systems and products
of its customers are Year 2000 compliant. The Company may in the future be
subject to claims based on Year 2000 problems in others' products or issues
arising from the integration of multiple products within an overall system.
Although the Company has not been involved in any litigation or proceeding to
date involving its products or services related to Year 2000 issues, there can
be no assurance that the Company will not in the future be required to defend
its products or services or to negotiate resolutions of claims based on Year
2000 issues. The costs of defending and resolving Year 2000-related disputes,
and any liabilities of the Company for Year 2000-related damages, including
consequential damages, could have a material adverse effect on the Company's
business, operating results and financial condition.
The Company does not have any specific contingency plans if any Year 2000
problems develop with respect to the Company's embedded systems or systems
acquired from vendors. Contingency plans will be developed if it appears the
Company or its key vendors will not be Year 2000 compliant, and such
noncompliance is expected to have a material adverse impact on the Company's
operations. The cost of developing and implementing such plans may itself be
material.
Year 2000 issues may affect the purchasing patterns of customers and
potential customers in a variety of ways. Many companies are expending
significant resources to replace or remedy their current hardware and software
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to purchase software products such as those offered by the Company.
The Company does not believe that there is any practical way to ascertain the
extent of, and has no plan to address problems associated with such a reduction
in purchasing resources of its customers. Any such reduction could, however,
result in a material adverse effect on the Company's business, operating results
and financial condition. The Year 2000 problem is pervasive and complex, as
virtually every computer operation will be affected in some way. Consequently,
no assurance can be given that Year 2000 compliance can be achieved without
significant additional costs.
31
<PAGE> 34
BUSINESS
INTRODUCTION
Exchange Applications, Inc. (the "Company") is a leading provider of open,
enterprise customer optimization software and solutions that are designed to
enable businesses to maximize profitability and revenue growth from new and
existing customers through marketing automation and enterprise-wide customer
management. The Company's Continuous Customer Management ("CCM") solution,
including its VALEX software and related consulting and integration services, is
designed to enable businesses to profitably retain and expand existing customer
relationships and acquire new customers by: (i) analyzing enterprise-wide
databases of customer information to identify profitable growth opportunities;
(ii) planning and prioritizing investments in high potential customers; (iii)
creating targeted, real-time and event-triggered marketing campaigns and other
customer communications; (iv) selecting the most effective channels for customer
communications, such as direct mail, call centers, sales forces and the
Internet; and (v) continuously evaluating the impact of these marketing
campaigns and other communications on profitability. CCM allows businesses to
measure the value of marketing campaigns and other customer communications
against their associated costs and to use this information to make investment
decisions that maximize customer profitability.
The principal components of the Company's CCM offering are VALEX, its open
enterprise software application, and the Company's proprietary consulting and
integration services. The Company has deployed CCM and VALEX across multiple
industries, with installations in over 45 businesses in North America and
Europe. Its customers include Bell Atlantic, Federal Express, Fleet Bank,
NatWest Bank (U.K.) and US West. The Company's products and services are
distributed through its direct sales force, through re-seller relationships with
IBM, NCR and others, and through co-marketing arrangements with companies such
as Compaq, Ernst & Young, KPMG Peat Marwick, PricewaterhouseCoopers, SAS
Institute and Sun Microsystems.
BACKGROUND
Today's increasingly competitive business environment has forced many
businesses to reduce costs in order to improve overall profitability. Enterprise
resource planning ("ERP") and supply chain management software and other
technologies have played a key role in helping businesses cut costs through the
automation of business and administrative functions such as accounting,
purchasing and inventory control, and human resources. While applications aimed
at cost reduction have generally been successful, businesses have realized that
these initiatives are only part of the solution to improve profitability and
have begun to invest in a new class of applications designed to increase
profitability through revenue growth. In the face of growing business
challenges, such as the high cost of attracting new customers, the proliferation
of customer purchasing options, increased customer sophistication and decreased
customer loyalty, revenue growth initiatives have become significantly more
difficult and more important to execute successfully.
Many of these new applications are aimed at enabling businesses to grow
revenue by acquiring new customers and retaining and expanding relationships
with existing customers. These applications facilitate cross-selling and the
marketing of bundled products, new service offerings and differentiated service
relationships. To maximize the profitability of these efforts, businesses need
to allocate resources based not only on functional area and product
profitability, but also on current or potential customer profitability. To
enable this focus on customers, businesses need: (i) an investment allocation
methodology to identify profitable customer opportunities; (ii) the ability to
access and analyze large amounts of customer information; (iii) marketing
automation and campaign management applications to design and implement
effective marketing campaigns; (iv) technologies to manage interactions with
customers; and (v) the ability to evaluate the effectiveness of investments on
current and potential customer profitability.
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<PAGE> 35
To this end, businesses have begun over the past several years to realign
existing marketing and customer management capabilities with new technologies
and processes that are designed to optimize customer relationships across the
enterprise. This evolution can be summarized in three phases, as follows:
Phase 1 -- Traditional Approach. With traditional approaches, businesses
develop marketing campaigns that solicit broad customer segments with infrequent
and static offers. To manage these campaigns, businesses typically use
proprietary software provided by third-party commercial service bureaus to
access customer information maintained in large external databases. These
solutions have provided valuable information to businesses, but have had
significant limitations:
- Limited ability to develop and refine marketing campaigns. Traditional
approaches are severely limited in the number and complexity of marketing
campaigns that can be supported without manual intervention, increasing
cycle time and cost and forcing businesses to run less targeted and less
timely campaigns.
- Inability to access the complete customer relationship. Traditional
approaches use fixed data structures that store only a limited amount of
information about each customer, forcing businesses to make decisions
based on a limited portion of available customer information.
- Limited ability to measure performance. Most traditional solutions use
response rates and other basic metrics which do not provide the necessary
information required to effectively measure campaign performance or to
allocate marketing resources to those campaigns and other communications
with the most positive impact on customer profitability.
- Poor integration with other applications. Many traditional solutions are
limited by closed architectures and therefore require time-consuming,
manual processes to be integrated with analytical tools, such as online
analytical processing ("OLAP") and data mining tools, or customer
touchpoint applications.
Phase 2 -- Marketing Automation and Campaign Management. Recognizing the
competitive value of more active management of customer relationships,
businesses are transitioning from traditional approaches to more automated
marketing environments that enable businesses to target refined customer
segments, implement more customized offers on a timely basis, and measure the
effectiveness of offers with metrics such as return on investment. Central to
this approach are data warehouses which contain a more complete view of the
customer relationship, tools that predict customer behavior and software
applications that automate the design and execution of marketing campaigns.
Through marketing automation and campaign management, businesses benefit from
more timely access to, and robust analysis of, customer information, more
frequent and targeted campaigns, and more comprehensive measurement of the
effectiveness of investments. This results in increased return on investment,
reduced customer acquisition costs and reduced marketing cycle time.
Phase 3 -- Enterprise-Wide Customer Management. Marketing automation and
campaign management solutions alone provide significant value. However, their
lack of integration with customer interaction software ("CIS") products, such as
sales force automation, call center, customer service, help desk and Internet
products, and other customer-related aspects of the business limits the ability
to plan and optimize customer relationships across the enterprise. In addition,
most CIS, marketing automation and campaign management solutions collectively
fail to provide a common customer management methodology. Enterprise-wide
customer management solutions integrate marketing automation and campaign
management software with data warehouses and CIS products in an environment in
which all aspects of the customer relationship are considered. This results in
more consistent messages to customers, greater penetration of potential
high-profit customers and the ability to employ lower cost communication
channels to optimize customer profitability.
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<PAGE> 36
THE CUSTOMER OPTIMIZATION OPPORTUNITY
The Company believes that customer optimization software and solutions
represent a significant opportunity across many industries. Businesses are
adopting these technologies at different rates based on their access to customer
information, their level of database marketing sophistication, the marginal
economic impact of changes in the behavior of their customers and the degree of
competitiveness within their industry. The Company believes that the demand for
these technologies will grow rapidly as additional industries increasingly
recognize enterprise-wide customer management as a competitive requirement.
Significant opportunities exist for solutions that enable businesses to
transition from the traditional service bureau approach to marketing automation
and campaign management solutions and to enterprise-wide customer management
environments. These transitions require highly-automated marketing and campaign
management solutions that integrate people, processes and technology across the
enterprise to insure adherence to a common customer management methodology.
According to an April 1998 GartnerGroup report titled "Defining and
Refining the Size of the DBM Market," overall spending on service bureaus,
marketing automation and campaign management, which Gartner collectively refers
to as database marketing, will be $1.3 billion in 1998, growing at an annual
rate of 35% over the next several years. Independent research analysts have
reported that marketing automation and campaign management efforts represent a
major area of focus for businesses today and note that many businesses are
shifting to such solutions. In an August 1996 GartnerGroup report titled
"Database Marketing, Part I: An Introduction," Gartner states that "database
marketing appeared in almost every industry as a high-payback, data-intensive
application with potentially significant returns".
THE EXCHANGE APPLICATIONS SOLUTION
The Company believes that its Continuous Customer Management solution,
implemented through its VALEX software and proprietary consulting and
integration services, represents a fundamentally new approach to customer
optimization that addresses the opportunities described above. CCM delivers
customer optimization solutions that are designed to allow a business to
maximize the profitability and revenue growth from new and existing customers
through marketing automation and campaign management that can evolve to
enterprise-wide customer management.
VALEX is designed to enable businesses to optimize customer value by: (i)
providing a complete view of the relationship between a business and its
customers; (ii) leveraging a range of data mining, reporting and modeling
products to identify high-value customers; (iii) providing powerful marketing
automation and campaign management software that lets end-users define and
execute targeted customer communication streams; and (iv) integrating with CIS
products and data warehouses to perform enterprise-wide customer management.
VALEX further enhances the value of information stored in data warehouses by
allowing non-technical marketing professionals to design, execute and
continuously evaluate and refine targeted marketing campaigns.
The Company's consulting and integration services include: (i) development
of processes that allow organizations to adopt the CCM solution across business
functions, including Value Exchange Optimization ("VEO"), a methodology for
allocating marketing investments based on expected return; (ii) Metrics
Repository, a custom software application that allows VALEX to track the success
or failure of marketing campaigns across business segments and across the
enterprise; and (iii) VALEX Rapid Implementation, designed to quickly implement
the core VALEX modules, allowing access to data warehouse environments and
campaign execution in a matter of weeks.
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<PAGE> 37
Through CCM and VALEX, businesses gain an understanding of the economics of
customer relationships, measure customer value and provide incentives through
campaigns that influence and optimize customer behavior. The Exchange
Applications solution offers the following key benefits:
Improved Profitability and Revenue Growth. VALEX and CCM are designed to
enable businesses to retain and increase the value of existing customers and
acquire new customers by focusing investment resources on those customers with
the greatest current and potential value. Through the use of the Company's
solution, businesses have achieved increased retention rates, lower acquisition
costs, more efficient cross-selling and better customer satisfaction due to more
relevant, less intrusive communications.
Comprehensive Solution. The Company's products and services are designed
to provide a complete solution for customer optimization. The Company believes
that its combined offering of software, proprietary methodologies and consulting
services help businesses implement marketing automation and campaign management
software and improve customer profitability quickly and with little risk.
Enterprise-wide Customer View. VALEX is designed to enable organizations
to access and use all types of information stored in data warehouses. Businesses
are therefore not restricted in the scope or type of information used to design
customer optimization strategies.
Increased Marketing Velocity. VALEX creates continuous, fully-automated
marketing campaigns, allowing multiple end users to develop customized
communications triggered by customer characteristics (e.g., age, income, buying
behavior), specific events (e.g., changes in spending patterns, births of
children, changes in economic status) or dates (e.g., birth dates, contract
renewal dates). VALEX is designed to allow businesses to reduce dramatically the
cycle time from planning through design, execution and measurement of campaigns,
to better respond to competitive and market pressures and to quickly evaluate
new campaigns.
Open, Extensible Architecture. VALEX is designed to be open, easy-to-use
and scaleable across a wide variety of computing environments. The VALEX
architecture conforms to many current industry standards (OLE, COM, DCOM, CORBA,
ODBC) and can be integrated with existing hardware and software environments
allowing businesses to leverage their investments in CIS products and data
warehouse technologies.
STRATEGY
The Company's objective is to be the leading provider of customer
optimization software and solutions globally. The Company's strategy for
achieving this objective includes:
Extend VALEX. The Company has developed unique technical solutions that
enable businesses to optimize customer relationships. The Company is currently
developing product extensions that will enhance the ability of its existing
products and services to directly integrate with data mining products and link
communications to customers with changes in their behavior. Further, the Company
is developing a local campaign management product to enable satellite offices
and remote users to design and execute independent campaigns while coordinating
with the central marketing function. The Company may also acquire businesses or
technologies that would provide the Company with extended product or service
offerings across the various aspects of a CCM implementation and/or specialized
knowledge or tailored software for selected vertical industries.
Develop Additional Customer Optimization Solutions. The Company intends to
develop additional products to provide automation and business intelligence to
improve a business's ability to perform enterprise-wide customer management. The
Company's future products and services will be designed to optimize and control
communications across CIS environments and enhance business planning and
forecasting solutions based on customer and channel economics.
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Expand Vertical Industry Focus. The Company currently targets the
telecommunications and financial services industries as well as other database
marketing intensive businesses that seek to develop customized marketing
campaigns. The Company intends to expand its focus to other industries as the
demand for its customer optimization solution grows. The Company's experience
has been that the rate of adoption of its solutions is driven by competitiveness
within a given industry, the level of database marketing sophistication, access
to customer information and the marginal economic impact of changes in customer
behavior. The Company is currently considering sales efforts focused on the
retail/catalog, energy/utility and insurance industries.
Broaden Distribution Channels and Build Alliances. The Company will
continue to develop indirect distribution channels. The Company maintains global
re-seller agreements for VALEX with IBM, NCR and others to leverage these
partners' extensive marketing and distribution channels. The Company also has
co-marketing relationships with companies such as Compaq, Ernst & Young, KPMG
Peat Marwick, PricewaterhouseCoopers, SAS Institute and Sun Microsystems,
enabling it to utilize their extensive customer relationships and, in certain
cases, their products and services. The Company plans to leverage the
professional services resources of these re-seller and co-marketing
organizations to provide certain non-proprietary professional services required
in connection with the implementation of CCM and VALEX. This strategy will allow
the Company to provide and expand its professional services offerings to most
effectively complement its CCM methodology and software applications, and will
help increase the efficient implementation of CCM solutions in anticipation of
increased demands on the Company's services resources.
Increase Direct Sales Globally. The Company currently maintains and is
aggressively expanding its direct sales forces in North America, the U.K. and
Australia. In the future, the Company plans to expand further in Europe and the
Pacific Rim, with particular attention to territories or industries experiencing
trends advantageous to the adoption of the Company's solution, such as industry
deregulation.
PRODUCTS -- VALEX
The Company's customer optimization software product, VALEX, allows end
users to select targeted customer segments, design time- and event-triggered
customized marketing campaigns and continuously execute and measure the
effectiveness of such marketing campaigns. VALEX may be implemented quickly with
a broad range of processes, databases and CIS environments.
VALEX implementations range in size and complexity. A small implementation
may include data for 400,000 customers in a 50-100 gigabyte data warehouse, with
10 business users accessing the system. The price range for VALEX for this size
configuration is $200,000-$250,000. A large implementation may have 20,000,000
customers, a multi-terabyte data warehouse, and more than 100 users. The price
for VALEX in this configuration is typically more than $800,000.
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The principal VALEX components are listed and described in the following
table:
<TABLE>
<CAPTION>
COMPONENT DESCRIPTION
- --------- -----------
<S> <C>
Desktop................................... Allows users to define their core process steps for CCM
and then to organize VALEX components and associated
applications into those process steps.
Segment................................... Allows users to segment the database into groups of
customers for a particular marketing campaign or
analysis.
Profile................................... Allows users to analyze the characteristics of
individual customers within a segment.
Campaign.................................. Allows users to define and execute targeted campaigns
that run continuously and contain event triggers that
respond to customer behavior or inactivity.
Schedule.................................. Allows users to schedule VALEX components and to
automate campaign execution and tracking.
Extract................................... Allows users to select information from the data
warehouse and export this information to CIS and other
applications.
Admin..................................... Allows users to interface VALEX with data warehouses and
provide configuration settings.
Filter.................................... Allows users to capture and analyze lists and
descriptions of customers and their characteristics in
the data warehouse.
</TABLE>
The figure below depicts VALEX and CCM as part of an enterprise-wide
solution.
[A series of diagrams showing the VALEX architecture interfacing with customer
databases and customer touchpoints.]
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<PAGE> 40
A VALEX User Case. The following description and diagram illustrate how
VALEX is used to create, evaluate and refine marketing campaigns for
enterprise-wide customer management.
- Desktop. A user first selects a "work group", which directs a user to
the database to be accessed and the process steps to be performed. A
simplified marketing process may include identifying and planning
opportunities, and then designing, executing and continuously evaluating
and refining campaigns.
- Segment and Profile. During the opportunity identification stage, a user
employs VALEX Segment to define desired groups of customers to be
targeted in a particular campaign. The VALEX Profile component is then
used to further analyze each segment by other attributes in the database
(such as purchasing patterns, demographics, prior campaign history). In
the example pictured below, three segments are defined. The "Targeted
Prospects" segment comprises a group of prospective customers selected
for a direct mail campaign. The "Cross Sell Opportunities" segment
identifies a group of current customers whose purchase behavior indicates
a likelihood of buying certain additional products. The "Likely to Leave"
segment, derived using a statistical model, identifies customers with a
high probability of attrition based on their behavioral and demographic
characteristics.
[A COMPUTER SCREEN DIAGRAM OF VALEX CAMPAIGN DECISION TREE.]
- Campaign. Once the user has decided on segments to be targeted for a
particular campaign, he or she moves to the campaign design stage of the
process. In this stage, a user employs VALEX Campaign to define the
structure of the campaign. The user starts by specifying the campaign
universe, and then defining all customers eligible to participate in the
campaign. In this example, the user then creates three contact segments
that branch off from the campaign universe. Groups are created by linking
a query defined in VALEX Segment to the database of potential contacts
and by specifying rules that determine whether each customer or prospect
meets the campaign selection criteria. Rules are specified through
database queries or data
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<PAGE> 41
mining routines and can establish "triggers" that respond to customer
behavior. Once a group of contacts is identified, it can be subdivided
into smaller random groups that receive different communications.
Subdivisions allow the user to test the relative effectiveness of various
communication strategies, comparing different messages, offers and/or
channels against a control group. In the example above, the user further
divides the "Cross Sell Opportunities" contact group in order to test two
different offers -- "Product Upgrade" and "Discounted
Enrollment" -- against a control group which will not receive any offers.
The behavior of all three "splits" of the "Cross Sell Opportunities"
contact group will be evaluated to improve future campaigns.
- Extract and Schedule. After a campaign has been created, the user links
each element of the campaign to VALEX Extract. The physical destination
of the targeted list of customers and the information content to be
delivered to the customer touchpoint are defined as Extracts. In the
pictured campaign, the "Mail House" extract is formatted for the
generation of personalized direct mail. "Sales Agents", "Call Center" and
"Service Center" extracts directly feed the appropriate system for each
touchpoint. The "Promotional History" extract creates a record for each
customer or prospect included in the campaign with information about that
individual's contact group, offer and channel. This record, stored in a
history table in the data warehouse, is used to measure campaign
effectiveness and drive future communications. Through VALEX Schedule,
campaign execution can be highly automated, reducing or eliminating human
intervention. For instance, VALEX Schedule could automatically generate a
nightly list of the best potential contacts for a cross-sell campaign or
a weekly list of new customers to receive a welcome package through the
mail.
- Metrics Repository. After executing a campaign, VALEX and Metrics
Repository are used to analyze the campaign and refine it for the next
cycle. Metrics Repository enables users to: (i) define campaign history
tables, which update the data warehouse with information about customers
or prospects selected in the campaign and capture information about each
customer at the time they were contacted; (ii) establish test versus
control groups to verify the incremental performance of a new message or
segmentation technique; (iii) track each iteration of a campaign over
time; (iv) define a "response" to a marketing action (e.g., a purchase of
the offered product within two weeks of the start of the campaign); and
(v) link responses to campaign promotions, providing the information
foundation for measuring marketing effectiveness. Because the measurement
needs of businesses vary widely, Metrics Repository is customized to meet
the requirements of each individual business.
VALEX Architecture. VALEX is an open enterprise software solution that can
operate on a variety of platforms in a multi-tiered environment, thereby
providing businesses maximum flexibility in the deployment of the software. For
some smaller installations, both the database and the application server can be
installed on one server with input from a separate client console. Larger
installations may require a three-tiered environment, with separate client,
data-warehouse and application servers. The software has been developed in
Visual C++ and Java and is object oriented. Parallel operation of VALEX enables
it to exploit database and hardware capabilities to operate in large database
environments. VALEX supports many of the common relational databases in use
today, and has been designed to generate structured query languages ("SQL") that
leverage the
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<PAGE> 42
unique capabilities of the relational database systems ("RDBMS") platforms. The
following diagram represents an overview of VALEX and the platforms it supports.
[The graphic depicts a series of diagrams showing the VALEX architecture
interfacing with customer databases and the platforms that VALEX supports.]
Designed to be flexible and scaleable, VALEX uses industry standard
capabilities and interfaces, such as SQL, ODBC, COM, DCOM, MFC and CORBA, to
integrate closely with data warehouse and CIS environments. The Company is also
developing external interfaces to VALEX that will allow consultants, partners or
customers to quickly and easily add their own functional extensions to the
software while maintaining compatibility with future VALEX releases. The Company
believes that VALEX represents the most comprehensive combination of
functionality, scalability and openness in the marketplace today.
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<PAGE> 43
SERVICES
The Company maintains its own integration services consulting group. The
group delivers capabilities to VALEX customers that include data warehouse
design and infrastructure development, business process design capabilities and
all aspects of the CCM implementation. Key service offerings include:
Consulting
Process Design. A central part of the CCM solution is the design and
customization of processes for customer optimization. This includes process
templates in planning, campaign execution, measurement and continuous learning.
The Company's Value Exchange Optimization ("VEO") methodology describes a
process for businesses to allocate marketing investments based on the likely
return of a particular marketing campaign or customer communication. Through
VEO, businesses can make investments based on current and potential customer
profitability and allocate resources to customers with high profit potential
through more frequent and better targeted campaigns and differentiated service
offerings. VEO utilizes the data generated by VALEX to track overall campaign
performance as well as individual customer responses to campaigns. This allows a
business to discern more readily which customers are most likely to respond to
particular campaigns.
VEO identifies gaps between the current and potential profitability of
customers. Companies can then employ VALEX to execute strategies to reduce those
gaps. Through VALEX and VEO, companies gain an understanding of the economics of
customer relationships, measure customer value and provide incentives through
campaigns that influence and optimize customer behavior.
Metrics Repository. The Company's Metrics Repository offering is a custom
application development project that enables a business to measure and visualize
the impact of its investments across customers and campaigns. Measurement is
accomplished through the CCM process steps, which require businesses to
establish a consistent measurement baseline and adopt a process-driven view for
managing and optimizing the value of its customer relationships. The Metrics
Repository is typically implemented through integration of OLAP tools with the
data warehouse and VALEX.
VALEX Rapid Implementation. With VALEX Rapid Implementation, the Company
implements the core VALEX components and integrates them with existing data
warehouse environments within a matter of weeks through a structured,
tightly-managed methodology. Rapid Implementation includes advising on campaign
structures and customer management strategies, training the first series of
users on VALEX and supporting and guiding users through the initial days of
operation.
Customer Support and Service
The Company believes that superior customer support and service are
critical to successful implementation of CCM and VALEX. The Company is committed
to providing high-quality customer support and to maintaining a qualified
customer support and service team. Ongoing customer support and service are
provided on a 24-hour-a-day, 7-day-a-week basis.
Training
The Company offers complete training for its customers and partners. This
training includes end-user interaction with VALEX, administration of VALEX and
best practices in CCM.
Maintenance and Product Upgrades
The Company provides ongoing product support services under its license and
maintenance agreements. Maintenance contracts are typically sold to customers
for one-year terms commencing on the date of the initial VALEX license and may
be renewed for additional periods. The Company also provides product updates to
VALEX free of charge for customers with a maintenance agreement.
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<PAGE> 44
Customers who do not purchase a maintenance agreement but would like to receive
product updates must purchase them from the Company.
PRODUCT DEVELOPMENT
The Company originally introduced VALEX in July 1996 and has subsequently
made a number of product revisions and enhancements. The Company has adopted a
strategy of continuously reevaluating the needs of customers and marketplace
trends to develop new products. The Company's ongoing product development
efforts are focused on:
- Release 2.1-2.2 -- These releases of VALEX will include extensions to its
existing functionality, a new component that links communications to
changes in customer behavior and an improved interface with leading
analytical applications.
- Release 3.0 -- This release will include open interfaces to the VALEX
objects that will allow partners and customers to extend the software
directly, further broadening the base functionality of VALEX.
- Adapting VALEX for Different Languages -- The Company is modifying VALEX
to support multilingual databases and to permit translation into other
languages.
- Delivering a Local Campaign Management Capabilities -- This new module
will enable satellite offices and remote users to design and execute
independent campaigns while coordinating with the central marketing
function.
Each of these capabilities is expected to enter beta testing within the
next 12 months. Subsequent improvements and extensions will include a more
automated customer planning and forecasting capability and improved interfaces
to customer touchpoint applications. There can be no assurance that the Company
will not experience difficulties that could delay or prevent successful
development, introduction and sales of these products or that its new products
and enhancements will adequately meet the requirements of the marketplace and
achieve market acceptance. See "Risk Factors -- Rapid Technological Change and
New Products".
SALES AND MARKETING
The Company markets its software and services through its direct sales
force of 17 quota-carrying sales representatives and indirectly through
re-sellers and co-marketers. As of September 30, 1998, the Company had sales
offices in Boston, Denver, London, England and Sydney, Australia. The Company's
sales force consists of teams made up of sales executives, managers and pre-sale
engineers organized by vertical industry. The Company currently has sales teams
focused on financial services and telecommunications and is currently evaluating
adding sales teams for other vertical industries, which may include
retail/catalog, utilities/energy and insurance.
The Company currently has re-seller relationships with IBM, NCR and others,
which grants these companies the right to re-market VALEX and utilize the
Company's marketing materials. In addition, the Company has co-marketing
arrangements with companies such as Compaq, Ernst & Young, KPMG Peat Marwick,
PricewaterhouseCoopers, SAS Institute and Sun Microsystems to generate leads and
participate in sales efforts. None of the agreements governing the re-seller or
co-marketing relationships with these organizations includes any commitments on
the part of these organizations to effect any minimum number of sales of VALEX,
or to otherwise provide the Company with business. No assurances can be given
that any revenue will be realized by the Company from any of these
relationships.
CUSTOMERS
The Company focuses on selling its CCM solution to leading businesses in
targeted vertical industries. The Company also has made significant sales to
other database-marketing intensive
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<PAGE> 45
businesses that seek to develop customized marketing campaigns. Following are
selected large customers in the financial services and telecommunications
vertical markets, as well as certain customers from other industries.
<TABLE>
<CAPTION>
FINANCIAL SERVICES TELECOMMUNICATIONS OTHER
- ------------------ ------------------ -----
<S> <C> <C>
First USA BC TELECOM Aid Association for Lutherans
Fleet Bank British SKY Broadcasting Dutch Railways
INVESCO Funds Group NEXTEL Federal Express Corporation
KeyCorp Sprint Guidepost
Mellon Bank US WEST New England Business Services
</TABLE>
In 1997, two customers each individually accounted for more than 10% of the
Company's revenues. These customers were Acxiom and Fleet Bank. In the nine
months ended September 30, 1998, only one customer, Acxiom, accounted for more
than 10% of the Company's revenues. Acxiom is a re-seller of the Company's
products and services, and revenues from Acxiom were comprised of sales to
multiple end user businesses.
Customer Case Studies:
The following customer case studies represent the experiences of three of
the Company's customers that have significant operating experience with the
Company's products and that agreed to include information regarding their
experiences in this Prospectus.
Federal Express Corporation, Memphis
Federal Express over the last four years has re-engineered its database
marketing process -- from marketing and campaign planning to customer
segmentation, campaign execution, evaluation and refinement. VALEX has been
instrumental in Federal Express' efforts to automate and accelerate its database
marketing process.
Federal Express reports the following accomplishments:
- A dramatic time reduction in direct-marketing campaign cycles; and
- A major improvement in "prospecting" campaigns.
For its application of VALEX, Federal Express won both the 1997 "Best Data
Warehouse Application" award from the Data Warehouse Institute and the 1997
"Excellence Award" from the National Center for Database Marketing.
KeyCorp, Cleveland
In 1996, KeyCorp implemented a customer-centric data warehouse in an IBM
mainframe environment. KeyCorp began to develop sophisticated plans and concepts
around managing customer relationships over their financial services life cycle,
but found that the basic reporting and OLAP tools that were part of the data
warehouse did not have the capability to translate their strategic plans into
actual campaigns. As a result, KeyCorp's ability to execute campaigns was
constrained by the need for programmers to custom-develop each campaign, an
approach that is expensive, time-consuming and error-prone.
The Company installed VALEX, enabling KeyCorp to access its data warehouse
directly and more quickly and effectively than before. In addition, the Company
provided CCM process optimization services to enable KeyCorp to implement a more
efficient and targeted methodology for planning, executing and measuring
campaigns.
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KeyCorp has reported increased campaign success rates due to automation of
customer segmenting and campaign testing and modeling. Profitability has also
increased due to better cross-selling and increased customer retention.
BC TELECOM, Vancouver
In 1997, BC TELECOM, Canada's second largest telecommunications company,
faced many challenges in marketing its services, including a need to shift its
focus from product marketing to customer-centric marketing, a lack of automation
in managing customer relationships across their lifecycles and limited
capabilities to allocate marketing dollars to customers presenting the greatest
potential value. Although BC TELECOM had made a major investment in a
multi-terabyte data warehouse, it believed that its business processes and
marketing systems were not sufficiently linked to the information available, and
that its large investment was therefore not generating optimal returns.
To solve BC TELECOM's significant integration problems and its need for
quick action, Exchange Applications provided VALEX, Rapid Implementation and CCM
process optimization services in 1997. Within three months of implementation, BC
TELECOM had achieved significant results from highly targeted marketing
campaigns aimed at its 1.7 million residential customers.
COMPETITION
The market for customer optimization software and related services is
highly competitive. There can be no assurance that the Company will maintain its
competitive position against current and potential competitors, especially those
with significantly greater financial, marketing, service, support, technical and
other resources. The Company's products and services are targeted at the
emerging market for customer optimization software solutions. The Company's
competitors are diverse in their orientation and history. The Company's current
and potential competitors fall into the following categories: (i) database
marketing vendors such as Acxiom, Experian (a division of Great Universal
Stores), Harland and Harte-Hanks, which provide a combination of service bureau
capabilities and proprietary software; (ii) small independent software companies
that have created or are attempting to create offerings similar to the VALEX
product; (iii) ERP and CIS vendors such as SAP, Baan, Oracle, Siebel and
Vantive, that may have an interest in broadening their product lines to include
applications with competitive functionality; and (iv) internal information
technology departments that attempt to build their own systems.
The principal competitive factors that favor the Company include: domain
expertise and intellectual property in customer optimization process management;
reputation of the Company and its employees and products; open and flexible
architecture; strong marketing automation and campaign management functionality;
and speed and ease of implementation and use. However, there can be no assurance
that the Company will be able to compete successfully with existing or new
competitors or that competition will not have a material adverse effect on the
Company's business, operating results and financial condition. See "Risk
Factors -- Competition".
PROPRIETARY RIGHTS AND LICENSES
The Company relies primarily on a combination of copyright, trademark and
trade secret laws, confidentiality procedures and contractual provisions to
protect its proprietary rights. In addition, the Company generally licenses
VALEX to end users in object code (machine readable) format, and the Company's
license agreements generally allow the use of VALEX solely by the customer for
internal purposes without the right to sublicense or transfer VALEX. However,
certain customers have required the Company to maintain a source code escrow
account with a third-party software escrow agent, and a failure by the Company
to perform its obligations under the related license and maintenance agreements
or the insolvency of the Company could conceivably cause the release of the
Company's source code to such customers for certain limited purposes. The
Company believes
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<PAGE> 47
that the foregoing measures afford only limited protection. Despite the
Company's efforts to protect its proprietary rights, unauthorized parties may
attempt to copy aspects of the Company's products or to obtain and use
information that the Company regards as proprietary. Policing unauthorized use
of the Company's products is difficult, and while the Company is unable to
determine the extent to which piracy of its software products exists, software
piracy is a viable risk. In addition, the laws of some foreign countries do not
protect the Company's proprietary rights to the same extent as the laws of the
United States. Furthermore, there can be no assurance that the Company's
competitors will not independently develop technology similar to that of the
Company. The Company may increasingly be subject to claims of intellectual
property infringement as the number of products and competitors in the Company's
industry segment grows and the functionality of products in different industry
segments overlaps. Although the Company is not aware that any of its products
infringe upon the proprietary rights of third parties, there can be no assurance
that third parties will not claim infringement by the Company with respect to
current or future products. Any such claims, with or without merit, could be
time-consuming, result in costly litigation, cause product shipment delays or
require the Company to enter into royalty or licensing agreements. Such royalty
or licensing agreements, if required, might not be available on terms acceptable
to the Company or at all, which could have a material adverse effect upon the
Company's business, operating results and financial condition. See "Risk
Factors -- Intellectual Property Rights; Use of Licensed Technology".
The Company has in the past and may in the future resell certain software,
which it licenses from third parties. There can be no assurance that these third
party software licenses will continue to be available to the Company on
commercially reasonable terms. The loss of or inability to maintain or obtain
any of these software licenses could result in delays or reductions in product
shipments until equivalent software could be identified, licensed and
integrated, which could adversely affect the Company's business, operating
results and financial condition.
EMPLOYEES
As of September 30, 1998, the Company had 142 full-time employees,
including 39 primarily engaged in research and development and 42 in sales and
marketing. The Company's future success depends in significant part upon the
continued service of its key technical and senior management personnel and its
continuing ability to attract and retain highly qualified technical and
managerial personnel. Competition for such personnel is intense and there can be
no assurance that the Company can retain its key managerial and technical
employees or that it can attract, assimilate or retain other highly qualified
technical and managerial personnel in the future. None of the Company's
employees is represented by collective bargaining units and the Company, to
date, has not experienced a work stoppage. The Company believes that its
employee relations are good.
FACILITIES
The Company's primary offices are located in approximately 40,000 square
feet in Boston, Massachusetts pursuant to a lease expiring in June 1, 2003. The
Company also leases space for its sales offices in Denver, Colorado, London,
England and Sydney, Australia. In addition, the Company has entered into a
preliminary agreement to lease an additional 7,000 square feet of office space
in Boston, Massachusetts, commencing March 1999.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Set forth below is certain information concerning the directors and
executive officers of Company.
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
- ---- --- -----------
<S> <C> <C>
Andrew J. Frawley...................... 36 Chairman of the Board, President, Chief Executive
Officer and Director
John G. O'Brien........................ 47 Vice President, Chief Financial Officer, Treasurer
and Secretary
David G. McFarlane..................... 35 Executive Vice President, Worldwide Sales and
Services
David L. Fitzgerald.................... 43 Vice President, North American Sales and Alliances
F. Daniel Haley........................ 43 Vice President, Growth and Emerging Markets
Michael D. McGonagle................... 46 Vice President, Product Development
Patrick A. McHugh...................... 35 Vice President, Marketing and Business Development
N. Wayne Townsend...................... 35 Vice President, Integration Services
Stewart I.J. Vassie.................... 38 Vice President, European Operations
Ramanan Raghavendran................... 30 Director
Jeffrey Horing......................... 34 Director
Dean F. Goodermote..................... 45 Director
</TABLE>
Mr. Frawley founded the Company in November 1994 and has served as its
President and Chief Executive Officer since its incorporation in November 1996.
Mr. Frawley was elected Chairman of the Board of Directors of the Company in
January 1998. From July 1993 until founding the Company, Mr. Frawley served as a
principal of Grant & Partners Limited Partnership, a management consulting
company. From May 1989 to July 1993, Mr. Frawley held various positions at
MarketPulse, a subsidiary of Praxis International Inc. and developer and
provider of database marketing products, including serving as Vice President of
North American Operations. Mr. Frawley holds a B.S. in accounting from the
University of Maine and an M.B.A. from Babson College. Mr. Frawley has more than
10 years of experience in the high technology industry.
Mr. O'Brien joined the Company in September 1997 as Vice President, Chief
Financial Officer and Secretary and was elected Treasurer of the Company in July
1998. From November 1996 to April 1997, Mr. O'Brien served as Vice President,
Finance and Chief Financial Officer of Advanced Modular Solutions, a computer
hardware manufacturing company. From August 1993 to November 1996, Mr. O'Brien
served as Corporate Controller of Avid Technology, Inc., a computerized film
editing system manufacturing company. From February 1991 to August 1993, Mr.
O'Brien served as Assistant Corporate Controller at Wang Laboratories, Inc., a
computer hardware and office automation system manufacturing company. Mr.
O'Brien is a C.P.A., holds a B.S. in accounting from Northeastern University,
and an M.B.A. from the Wharton School of the University of Pennsylvania. Mr.
O'Brien has more than 15 years of experience in the high technology industry. As
part of the settlement of Mr. O'Brien's recent divorce proceeding, Mr. O'Brien
voluntarily filed a bankruptcy petition under Chapter 13 of the federal
bankruptcy code. The Company does not believe that the filing of such petition
or the related circumstances reflects on Mr. O'Brien's ability or integrity as
an executive officer of the Company.
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Mr. McFarlane joined the Company in June 1997 as Executive Vice President,
Worldwide Sales and Services. From January 1988 until joining the Company, Mr.
McFarlane held various positions at Project Software & Development, Inc., a
publicly traded software company that develops and markets high value capital
asset software for processing plants and production equipment, most recently
serving as Vice President, International and Alliances. Mr. McFarlane holds a
B.Sc. in electrical engineering and a Masters degree in electrical engineering
from the University of Bath in the U.K. Mr. McFarlane has more than 10 years of
experience in the high technology industry.
Mr. Fitzgerald joined the Company in July 1998 as Vice President, North
American Sales and Alliances. From June 1996 until joining the Company, Mr.
Fitzgerald was the Group Vice President, Eastern Region of The Vantive
Corporation, an application software company. From April 1995 to April 1996, Mr.
Fitzgerald served as Vice President of Sales of Salesoft, Inc., a start-up
company specializing in sales force automation software. From March 1991 to
April 1995, Mr. Fitzgerald served as President of PowerCurve Corporation, a
company which he founded that specializes in systems integration and ERP
implementation services. Mr. Fitzgerald holds a B.S. in engineering from the
University of Massachusetts. Mr. Fitzgerald has more than 15 years of experience
in the high technology industry.
Mr. Haley joined the Company in November 1998 as Vice President, Growth and
Emerging Markets. From October 1997 until joining the Company, Mr. Haley was the
President and Chief Executive Officer of FDH Associates Consulting Group Inc., a
private consulting firm. From February 1995 to October 1997, Mr. Haley was the
President and Chief Executive Officer of Precise Software Ltd., a computer
software company. From May 1989 to February 1995, Mr. Haley was a general
partner of Advent International Corp., a venture capital firm. Mr. Haley holds a
B.S. in Industrial Relations from the University of Massachusetts and an M.B.A.
from the University of Denver. Mr. Haley has more than 20 years of experience in
the high technology industry.
Mr. McGonagle joined the Company upon its founding in November 1994 and has
served as Vice President, Product Development since its incorporation in
November 1996. From November 1993 until joining the Company, he was Vice
President, Research and Development at MarketPulse. From August 1991 to November
1993, he served as Director of Client-Server Development at Praxis International
Inc. Mr. McGonagle holds a B.A. in mathematics from the University of
Massachusetts (Lowell) and a Masters degree in mathematics from Brown
University. Mr. McGonagle has more than 20 years of experience in the high
technology industry.
Mr. McHugh joined the Company in February 1996 and has served as Vice
President, Marketing and Business Development since March 1998. Mr. McHugh
served in various other capacities with the Company between February 1996 and
March 1998, including serving as Vice President, Sales and Vice President,
Marketing. From June 1995 until joining the Company, Mr. McHugh was the Eastern
Region Manager of Stanford Technology Group, a software development company.
From October 1994 to June 1995 he was Northeast Regional Manager of Siemens
Nixdorf, a computer systems manufacturing company, and from October 1993 to
October 1994 he was Northeast Regional Manager of Kendall Square Research, a
computer systems manufacturing company. Mr. McHugh holds a B.S. in marketing and
a B.S. in finance from Northeastern University. Mr. McHugh has more than 10
years of experience in the high technology industry.
Mr. Townsend joined the Company in April 1996 as Vice President,
Integration Services. From April 1994 until joining the Company, Mr. Townsend
was a Project Director at Epsilon, a database marketing services company. From
May 1990 to April 1994, he was a consultant at Andersen Consulting, a management
consulting company. Mr. Townsend holds a B.S. in mechanical engineering from the
Massachusetts Institute of Technology and an M.S. in mechanical engineering from
the University of Dayton. Mr. Townsend has more than 10 years of experience in
the systems integration industry.
Mr. Vassie joined the Company in May 1997 and has served as Vice President,
European Operations since November 1998. Mr. Vassie served in various other
capacities with the Company
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between May 1997 and November 1998, including General Manager, Europe, Middle
East and Africa Operations and Sales Manager, UK Operations. From June 1996 to
December 1996, Mr. Vassie was the UK General Manager of Magna Software Ltd., an
application development software company. From May 1995 to April 1996, Mr.
Vassie was the Sales and Marketing Director of USoft UK Ltd., an application
development software company. From April 1992 to April 1995, Mr. Vassie was the
UK Major Accounts Sales Executive of Compuware, Inc., an application development
software company. Mr. Vassie has more than 20 years of experience in the
software engineering and high technology industry.
Mr. Raghavendran has served as a Director of the Company since March 1997.
Mr. Raghavendran has served as a managing member of Insight Capital Partners, a
private equity investment firm, since January 1997. From 1992 to 1996, Mr.
Raghavendran was employed at General Atlantic Partners, an investment firm. Mr.
Raghavendran also serves on the boards of directors of several privately held
companies.
Mr. Horing has served as a Director of the Company since March 1997. Mr.
Horing has served as a managing member of Insight Capital Partners, a private
equity investment firm, since January 1995. From 1990 to 1994, Mr. Horing was
employed at E.M. Warburg Pincus, an investment firm. Mr. Horing also serves on
the boards of directors of several privately held companies.
Mr. Goodermote has been a Director of the Company since January 1998. Mr.
Goodermote has been the President and Chief Executive Officer of Process
Software Corporation, a software development company, since August 1996. From
August 1986 to August 1996, Mr. Goodermote held various positions at Project
Software and Development, Inc., including President and Chief Operating Officer
and most recently as Chairman of the Board of Directors. Mr. Goodermote also
serves on the boards of directors of several privately held companies. Mr.
Goodermote holds a B.A. in history from the University of Rochester and a M.A.
in Law and Diplomacy from the Fletcher School of Law and Diplomacy of Tufts
University. Mr. Goodermote has more than 15 years of experience in the high
technology industry.
BOARD OF DIRECTORS
The Charter and By-laws provide that the size of the Board of Directors of
the Company (the "Board") shall be determined by resolution of the Board.
The Charter provides for classification of the Board into three classes,
with the members of the respective classes serving for staggered three-year
terms. The first class will consist of Mr. Horing, the second of Mr. Goodermote
and the third of Mr. Frawley and Mr. Raghavendran, with the initial terms of the
directors comprising the classes expiring upon the election and qualification of
the directors at the annual meetings of the stockholders held following the
fiscal years of the Company ending December 31, 1998, 1999 and 2000,
respectively. At each annual meeting of stockholders, directors will be
re-elected or elected for full three-year terms. See "Description of Capital
Stock -- Certain Provisions of the Company's Amended and Restated Certificate of
Incorporation and By-laws".
The Board has established a Compensation Committee and an Audit Committee.
The members of the Compensation Committee are Jeffrey Horing and Dean
Goodermote, and the members of the Audit Committee are Ramanan Raghavendran and
Dean Goodermote.
The current and continuing directors of the Company were nominated and
elected in accordance with the Amended and Restated Stockholders Agreement,
dated as of December 4, 1997, which will terminate upon the closing of this
Offering.
Executive officers of the Company are appointed by the Board and serve
until their successors have been duly elected and qualified. There are no family
relationships among any of the executive officers or directors of the Company.
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<PAGE> 51
Mr. Goodermote, Mr. Horing and Mr. Raghavendran serve on the boards of
directors of certain private companies that engage in software development and
related services. However, the Company does not expect that serving as a
director of these other companies poses any material risk of conflict with their
duties as serving as Directors of the Company. To the extent conflicts develop,
they will be required to abstain from consideration of such items before the
Board of Directors in accordance with the Company's By-laws.
On January 30, 1998, the Company granted to Dean Goodermote an option to
purchase 20,000 shares of Common Stock at an exercise price of $1.35 per share,
vesting over a four-year period. Prior to the Offering, no other directors of
the Company have received compensation for their services in such capacity. The
Directors' Stock Option Plan provides for the grant of stock options to non-
employee directors. The Company anticipates that, following the Offering,
directors who are employees of the Company will not be paid any fees or
additional compensation for service as members of the Board or any committee
thereof and the Company will enter into customary arrangements with respect to
fees and other compensation (including expense reimbursement) for directors who
are not employees of the Company or any of its subsidiaries. The Company
maintains directors' and officers' liability insurance and its By-laws provide
for mandatory indemnification of directors and officers to the fullest extent
permitted by Delaware law. In addition, the Charter limits the liability of
directors of the Company to the Company or its stockholders for breaches of the
directors' fiduciary duties to the fullest extent permitted by Delaware law. See
"Description of Capital Stock -- Certain Anti-Takeover, Limited Liability and
Indemnification Provisions".
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
In March 1997, the Board established a compensation committee responsible
for determining compensation of officers of the Company. Prior to March 1997,
the Company had no compensation committee or other committee of the Board
performing similar functions. Andrew Frawley's salary during such year was
established by the Board and decisions concerning compensation of other
executive officers were made during such year by Mr. Frawley.
EMPLOYMENT CONTRACTS
The officers serve at the discretion of the Board. The Company does not
presently have an employment contract in effect with any of its officers.
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<PAGE> 52
EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth certain information concerning the
compensation earned by the Company's Chief Executive Officer and the other
executive officers of the Company (collectively, "Named Officers") whose total
salary and bonus exceeded $100,000 for services rendered in capacities to the
Company and its subsidiaries during 1997. For disclosure regarding terms of the
stock options, see "Management -- Stock Option Plans".
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
---------------------------------------
ANNUAL (NUMBER OF
COMPENSATION(1) SECURITIES
NAME AND PRINCIPAL ------------------- RESTRICTED STOCK UNDERLYING ALL OTHER
POSITION(S) SALARY BONUS AWARDS(3) OPTIONS GRANTED) COMPENSATION
- ------------------ ------ ----- ---------------- ---------------- ------------
<S> <C> <C> <C> <C> <C>
Andrew J. Frawley....... $200,000 $100,000 $5,092,489 151,200 --
Chairman of the Board,
President and Chief
Executive Officer
David G. McFarlane(2)... 78,757 47,500 -- 300,000 --
Executive Vice
President, Worldwide
Sales and Services
Michael D. McGonagle.... 131,000 30,000 899,900 58,000 --
Vice President,
Product Development
Patrick A. McHugh....... 110,000 175,089 224,975 80,000 --
Vice President,
Marketing
N. Wayne Townsend....... 125,000 85,000 224,975 74,000 --
Vice President,
Integration Services
</TABLE>
- ---------------
(1) Excludes certain perquisites and other benefits the amount of which did not
exceed 10% of the employee's total salary and bonus.
(2) Mr. McFarlane joined the Company in June 1997 and his salary and bonus
reflect compensation earned in the latter half of 1997.
(3) Value is determined by subtracting the purchase price from the fair market
value of the Common Stock as determined by the midpoint of the proposed
offering range ($9.00), multiplied by the number of shares of Common Stock
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<PAGE> 53
Option Grants in Last Fiscal Year
The following table sets forth certain information concerning stock options
granted to each of the Named Officers during 1997. No stock appreciation rights
were granted to these individuals during such year.
<TABLE>
<CAPTION>
NUMBER OF % OF TOTAL
SECURITIES OPTIONS
UNDERLYING GRANTED TO EXERCISE
OPTIONS EMPLOYEES IN PRICE EXPIRATION GRANT DATE
NAME GRANTED 1997 PER SHARE DATE VALUE(1)
- ---- ---------- ------------ --------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Andrew J. Frawley...................... 151,200 10.8% $0.72 7/31/02 $ 60,994
David G. McFarlane..................... 250,000 17.9 0.65 7/31/07 100,851
David G. McFarlane..................... 50,000 3.6 0.65 7/18/06 20,170
Michael D. McGonagle................... 18,000 1.2 0.65 7/31/07 7,262
Michael D. McGonagle................... 40,000 2.9 0.65 7/18/06 16,136
Patrick A. McHugh...................... 30,000 2.1 0.65 7/31/07 12,103
Patrick A. McHugh...................... 50,000 3.6 0.65 7/18/06 20,170
N. Wayne Townsend...................... 18,000 1.3 0.65 7/31/07 7,262
N. Wayne Townsend...................... 56,000 4.0 0.65 7/18/06 22,590
</TABLE>
- ---------------
(1) Represents the estimated fair value of the options as of the date of grant
using the Black-Scholes option pricing model with the following assumptions:
(i) expected volatility of 79%; (ii) expected life of four years; and (iii)
risk-free interest rate of 5.96%. No dividends on common stock were assumed
for purposes of this estimate.
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values
The following table sets forth certain information concerning option
exercises during 1997 and option holdings at December 31, 1997 with respect to
each of the Named Officers.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT DECEMBER 31, 1997(1) AT DECEMBER 31, 1997(2)
ACQUIRED ON VALUE --------------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE(3)(4) UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- -------- ----------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Andrew J. Frawley..... -- -- 151,200 -- $1,251,936 $ --
David G. McFarlane.... -- -- -- 300,000 -- 2,505,000
Michael D. McGonagle.. -- -- 9,000 49,000 75,150 409,150
Patrick A. McHugh..... -- -- 15,000 65,000 125,250 542,750
N. Wayne Townsend..... -- -- 9,000 65,000 75,150 542,750
</TABLE>
- ---------------
(1) "Exercisable" refers to those options which were both exercisable and
vested, while "Unexercisable" refers to those options which were unvested.
(2) Value is determined by subtracting the exercise price from the fair market
value of the Common Stock as determined by the midpoint of the proposed
offering range ($9.00), multiplied by the number of shares underlying the
options.
(3) In March 1998, the Company granted stock options, none of which is currently
exercisable, to the following Named Officers to purchase the corresponding
number of shares of Common Stock at an option exercise price of $3.50 per
share: (i) David G. McFarlane, 30,000 shares of Common Stock; (ii) Michael
D. McGonagle, 9,000 shares of Common Stock; (iii) Patrick A. McHugh, 10,000
shares of Common Stock; and (iv) N. Wayne Townsend, 11,500 shares of Common
Stock. In addition, in March 1998, the Company granted Andrew J. Frawley
options to purchase 105,000 shares of Common Stock at an exercise price of
$3.85 per share.
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<PAGE> 54
(4) On June 12, 1998 (i) David G. McFarlane exercised options to purchase 25,000
shares of Common Stock at an exercise price of $0.65 per share for an
aggregate exercise price of $16,250, (ii) Patrick A. McHugh exercised
options to purchase 15,000 shares of Common Stock at an exercise price of
$0.65 per share for an aggregate purchase price of $9,750, and (iii) N.
Wayne Townsend exercised options to purchase 9,000 shares of Common Stock at
an exercise price of $0.65 per share for an aggregate purchase price of
$5,850.
STOCK OPTION PLANS
1998 Stock Incentive Plan. The Company's 1998 Stock Incentive Plan (the
"1998 Plan") was approved by the Board on July 15, 1998 and was adopted by the
Company's stockholders on November 10, 1998. The aggregate number of shares of
Common Stock available for awards under the 1998 Plan is 2,700,000 shares. The
1998 Plan provides for the grant or award of stock options ("Stock Options") to
purchase shares of Common Stock of the Company. Stock Options granted under the
1998 Plan may be incentive stock options or non-statutory options. The purpose
of the 1998 Plan is to attract and retain outstanding employees through the
incentives of stock ownership. Any employee of the Company (including officers),
and any consultant to and any director of the Company, is eligible to receive
Stock Options under the 1998 Plan. As of November 11, 1998, none of the shares
reserved for issuance under the 1998 Plan was subject to outstanding Stock
Options.
The 1998 Plan is administered by the Board. Subject to the provisions of
the 1998 Plan, the Board has the authority to designate participants and to
determine whether Stock Options granted are incentive stock options or not, the
number of shares to be covered by each Stock Option, the exercise price of the
Stock Option, the period of time over which Stock Options are exercisable or may
be settled, the method of payment and any other terms and conditions of the
awards. All Stock Options are evidenced by Stock Option Agreements between the
Company and the participant.
While the Board determines the prices at which Stock Options may be
exercised under the 1998 Plan, the exercise price of an incentive Stock Option
under the 1998 Plan shall be at least 100% of the fair market value (as
determined under the terms of the 1998 Plan) (or 110% of the fair market value
if the grantee is deemed to own 10% or more of the outstanding voting stock of
the Company) of a share of Common Stock on the date of grant. Stock Options must
be exercised by the tenth anniversary of the date of grant, or if the grantee
owns 10% or more of the outstanding voting stock of the Company, by the fifth
anniversary of the date of the grant.
1996 Stock Incentive Plan. The Company's 1996 Stock Incentive Plan (the
"1996 Plan"), effective November 15, 1996, was approved by the Board of
Directors on November 15, 1996 and adopted by the Company's stockholders in
March 1997. The 1996 Plan provides for the grant or award of Stock Options,
which may be incentive stock options or non-statutory stock options, and for the
direct purchase of shares of Common Stock of the Company ("Restricted Common
Stock"). The purpose of the 1996 Plan is to attract and retain outstanding
employees through the incentives of stock ownership. Any employee of the Company
(including officers), and any consultant to and any director of the Company, is
eligible to receive Stock Options and to purchase Restricted Common Stock under
the 1996 Plan. As of November 11, 1998, the Company had 2,864,208 shares of
Common Stock reserved for issuance remaining under the 1996 Plan, of which
2,421,908 shares were subject to outstanding stock options at a weighted average
exercise price of $3.82 per share.
The 1996 Plan is administered by the Board. Subject to the provisions of
the 1996 Plan, the Board has the authority to designate participants and to
determine whether Stock Options granted are incentive stock options or not, the
number of shares to be covered by each Stock Option, the price of the exercise
of the Stock Option and the purchase price of the Restricted Common Stock, the
time at which Stock Options are exercisable or may be settled, whether
restrictions such as repurchase options are to be imposed on shares subject to
the Stock Options and to the Restricted Common Stock, the method of payment and
any other terms and conditions of the awards. All Stock
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<PAGE> 55
Options and Restricted Common Stock are evidenced by Stock Option Agreements and
Restricted Stock Agreements, respectively, between the Company and the
participant.
While the Board determines the prices at which Stock Options may be
exercised under the 1996 Plan, the exercise price of an incentive Stock Option
under the 1996 Plan shall be at least 100% of the fair market value (as
determined under the terms of the 1996 Plan) (or 110% of the fair market value
if the grantee is deemed to own 10% or more of the outstanding voting stock of
the Company) of a share of Common Stock on the date of grant. Stock Options must
be exercised by the tenth anniversary of the date of grant, or if the grantee
owns 10% or more of the outstanding voting stock of the Company, by the fifth
anniversary of the date of the grant.
In the event that the Company is consolidated with or acquired by another
person or entity in a merger, sale of stock, sale of all or substantially all of
the Company's assets or otherwise (other than a merger or consolidation of the
Company with, or the sale of all or substantially all of the assets of the
Company to, any entity if 50% or more of the aggregate voting power of such
entity is held immediately after such transaction by persons who were
stockholders of the Company immediately prior to such transaction) (an
"Acquisition"), each outstanding Stock Option held by an executive officer of
the Company shall accelerate so as to be fully exercisable for all of the shares
subject to such Stock Option. The foregoing option acceleration provisions may
have the effect of discouraging, delaying or preventing a change in control of
the Company or unsolicited acquisition proposals that a stockholder might
consider favorable, and as a result, such provisions may have an adverse effect
upon the market price for the Common Stock. There are no option acceleration
provisions with respect to Stock Options held by any person other than executive
officers of the Company. The Offering will not trigger the acceleration of
vesting of any Stock Options.
Shares underlying Stock Options generally vest over a four-year period.
However, shares underlying certain Stock Options vest as of the ninth
anniversary of the date of the grant of such options, but vesting of up to 25%
of the original amount of such shares may accelerate and may become exercisable
at the end of each calendar year commencing with 1998 upon satisfaction of
certain performance criteria determined by the Board and the Chief Executive
Officer of the Company.
Restricted Common Stock generally vests over a three-year period. However,
vesting may accelerate in the event of (i) the direct or indirect acquisition by
any person of 50% or more of the aggregate voting power of the Company, or (ii)
the sale of all or substantially all of the assets of the Company (other than a
merger or consolidation of the Company with, or the sale of all or substantially
all of the assets of the Company to, any entity if 50% or more of the aggregate
voting power of such entity is held immediately after such transaction by
persons who were stockholders of the Company immediately prior to such
transaction). The Offering will not trigger the acceleration of vesting of any
Restricted Stock. Upon grant the recipient has full voting and dividend rights
with respect to all shares granted. The shares are subject to a purchase option
of the Company and are subject to restrictions on transfer.
401(k) SAVINGS PLAN
The Company has established a tax-qualified cash or deferred profit sharing
plan (the "401(k) Savings Plan") covering all of the Company's eligible
full-time employees. The Company adopted the 401(k) Savings Plan effective June
1, 1998. Under the plan, participants may elect to contribute, through salary
reductions, up to 15.0% of their annual compensation subject to a statutory
maximum. The Company does not currently provide additional matching
contributions under the 401(k) Savings Plan, but may do so in the future. The
401(k) Savings Plan is designed to qualify under Section 401 of the Internal
Revenue Code of 1986, as amended, so that contributions by employees or by the
Company to the plan, and income earned on plan contributions, are not taxable to
employees until withdrawn from the 401(k) Savings Plan, and so that
contributions by the Company, if any, will be deductible by the Company when
made. The trustee under the plan, at the
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<PAGE> 56
direction of each plan participant, currently invests the assets of the 401(k)
Savings Plan in eight investment options.
OTHER STOCK PLANS
Director Stock Option Plan. The Company's 1998 Director Stock Option Plan
(the "Directors' Plan") was approved by the Board on July 15, 1998. The
Directors' Plan will be administered by the Compensation Committee of the Board.
Under the Directors' Plan, on the business day immediately following each annual
meeting of the stockholders of the Company, commencing with the first annual
meeting of stockholders after December 31, 1998, each person who is then a
non-employee director of the Company will be eligible to receive an option to
purchase such number of shares of Common Stock as determined by the Compensation
Committee at an exercise price equal to the fair market value of the Common
Stock on the date the option is granted. A total of 100,000 shares of Common
Stock have been reserved for issuance under the Directors' Plan. The Directors'
Plan is intended to help the Company attract and retain non-employee directors
on the Company's Board.
Employee Stock Purchase Plan. The Company's 1998 Employee Stock Purchase
Plan (the "Stock Purchase Plan") was approved by the Board on July 15, 1998. The
Stock Purchase Plan will be administered by the Compensation Committee of the
Board. The Stock Purchase Plan is intended to qualify as an "employee stock
purchase plan" under Section 423 of the Internal Revenue Code of 1986, as
amended. The Compensation Committee may grant options to purchase shares of
Common Stock to employees eligible under the Stock Purchase Plan who may acquire
shares of the Company's Common Stock through payroll deductions. The purchase
price for the Company's Common Stock purchased under the Stock Purchase Plan is
85% of the lesser of the fair market value of the shares on the date the option
was granted or the date the option is exercised. A total of 200,000 shares of
Common Stock have been reserved for issuance under the Stock Purchase Plan. The
Stock Purchase Plan is intended to help the Company attract and retain
outstanding employees through the incentives of stock ownership.
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<PAGE> 57
CERTAIN TRANSACTIONS
PREFERRED STOCK ISSUANCE
Pursuant to a Securities Purchase Agreement, dated as of December 4, 1997,
Insight Capital Partners II, L.P. and Wexford Insight LLC each purchased 611,977
shares of Series C Convertible Preferred Stock of the Company for an aggregate
purchase price, in each case, of $2,000,000, or $3.268 per share.
Pursuant to a Stock Purchase and Waiver Agreement (the "Stock Purchase
Agreement"), dated as of December 4, 1997, GAP Coinvestment Partners, L.P.
("GAP") sold an aggregate of 246,006 shares of Series B Convertible Preferred
Stock of the Company to the following purchasers for an aggregate purchase price
of $803,947.58 or $3.268 per share: Andrew J. Frawley, David G. McFarlane,
Daniel Cox, Patrick A. McHugh, Michael D. McGonagle, Stewart I.J. Vassie, Steven
Feldman, Patrick D. Brady, Gregory P. Shlopak, David H. Brault, Ted L. Axelrod,
Terry B. Angstadt, James T. Brady, Dominic F. Mammola, James A. Dooley, Diane K.
Green, and Insight Venture Partners I, L.P.
Pursuant to the Securities Purchase Agreement, dated as of March 18, 1997
(the "Securities Purchase Agreement") (i) Insight Venture Partners II, L.P.
purchased 1,154,775 shares of Series B Preferred Stock from the Company for an
aggregate purchase price of $1,807,222.88, or $1.565 per share; (ii) Wexford
Insight LLC purchased 1,154,775 shares of Series B Preferred Stock from the
Company for an aggregate purchase price of $1,807,222.88, or $1.565 per share;
(iii) GAP purchased 246,006 shares of Series B Preferred Stock from the Company
for an aggregate purchase price of $384,999.39, or $1.565 per share; (iv) GPLP
converted 2,300,000 shares of Series A Convertible Preferred Stock ("Old
Preferred Stock") to 1,725,000 shares of Common at a conversion price of
$3.01333; (v) GPLP purchased 377,408 shares of Series A Preferred Stock from the
Company in consideration of the cancellation of indebtedness in the amount of
$309,751.76 owed by the Company to GPLP representing advances made to the
Company prior to incorporation for operating expenses; (vi) Cyrk purchased
2,522,592 shares of Series A Preferred Stock from the Company in consideration
of the cancellation of indebtedness in the amount of $3,070,372.50 owed by the
Company to Cyrk representing advances made to the Company prior to incorporation
for operating expenses and (vii) the Company paid to Cyrk $1,000,000 to
discharge such indebtedness.
REGISTRATION RIGHTS AGREEMENT
Pursuant to an Amended and Restated Registration Rights Agreement, dated as
of December 4, 1997, the Company granted registration rights to certain
stockholders of the Company, including Insight Venture Partners I, L.P., Insight
Capital Partners II, L.P., Insight Capital Partners (Cayman) II, L.P., Wexford
Management LLC, Cyrk, Inc. ("Cyrk"), Grant & Partners Limited Partnership
("GPLP"), Andrew J. Frawley, Michael J. Feldman, Michael D. McGonagle, David G.
McFarlane, Daniel Cox, Patrick A. McHugh, Stewart I.J. Vassie, Steven Feldman,
Patrick D. Brady, Gregory P. Shlopak, David H. Brault, Ted L. Axelrod, Terry B.
Angstadt, James T. Brady, Dominic F. Mammola, James A. Dooley and Diane K.
Green. See "Shares Eligible for Future Sale -- Registration Rights".
CONTRACT WITH EXCHANGE MARKETING GROUP
Pursuant to several Termination Agreements dated as of March 18, 1997, the
Company and each of Michael J. Feldman, a former director and employee of the
Company, and six other employees of the Company terminated their employment
arrangements with the Company. The Company repurchased an aggregate of 341,125
shares of Common Stock from the departing employees for an aggregate purchase
price of $341.13. Upon termination, Mr. Feldman formed Exchange Marketing Group,
LLC ("EMG"), a marketing consulting company. The Company engaged EMG to provide
consulting services to certain of the Company's customers pursuant to a
Consulting Agreement (the "Consulting Agreement"), dated as of March 18, 1997.
As evidenced by a Promissory Note (the
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<PAGE> 58
"EMG Note"), dated as of March 18, 1997, the Company loaned to EMG $350,000. On
February 5, 1998, the entire principal and interest outstanding under the EMG
Note was repaid. In addition, in connection with the transactions contemplated
by the Consulting Agreement, EMG licensed from the Company certain intellectual
property to be used in its marketing consulting business and the Company and EMG
entered into mutual non-compete agreements dated March 18, 1997 pursuant to
which the Company agreed not to provide database marketing strategy and
marketing program implementation consulting services to third parties for a
period of three years and EMG agreed not to engage in the business of developing
database marketing software or of providing systems integration services for a
period of three years. The Consulting Agreement does not prohibit the Company
from providing services of the type historically provided by the Company.
FOUNDER'S LOANS
As evidenced by a Promissory Note (the "Note"), dated as of December 4,
1997, in the original principal amount of $124,997.73, the Company loaned to Mr.
Frawley the total amount of the purchase price for the 38,249 shares of Series B
Convertible Preferred Stock purchased by Mr. Frawley under the Stock Purchase
Agreement. The Note bears interest at 8% per annum and is secured by 38,249
shares of Series B Convertible Preferred Stock owned by Mr. Frawley. As of
September 30, 1998, the outstanding balance of the indebtedness under the Note
was $130,764.74.
SEPARATION FROM GPLP
Pursuant to an Assignment and Assumption Agreement (the "Assignment and
Assumption Agreement"), dated as of November 15, 1996, the Company purchased
certain assets, including, without limitation, cash, accounts receivable, fixed
assets and certain intangible property, from GPLP, and the Company issued
2,300,000 shares of Series A Convertible Preferred Stock to GPLP and assumed
certain liabilities of GPLP, including, without limitation, indebtedness owed to
Cyrk, indebtedness under leasing arrangements, indebtedness with respect to
employee benefits and accounts payable. In addition, in connection with the
transactions contemplated by the Assignment and Assumption Agreement, each of
Andrew J. Frawley and Michael J. Feldman entered into mutual releases of claims
with Cyrk, GPLP, Alan Grant and GPI, and the Company entered into a fully paid-
up perpetual license with GPLP pursuant to which the Company licensed from GPLP
certain intellectual property.
Prior to March 18, 1997, the Company incurred loans from GPLP and Cyrk in
the amount of $3,380,124.26 for operating expenses. Obligations in respect of
these loans were assumed by the Company pursuant to the Assignment and
Assumption Agreement. On March 18, 1997, the principal and accrued interest
outstanding in respect of the loans was repaid in accordance with the terms of
the Securities Purchase Agreement.
Pursuant to several Restricted Stock Agreements dated as of November 15,
1996, the Company issued (i) 848,800 shares of Common Stock to Andrew J.
Frawley; (ii) 667,000 shares of Common Stock to Michael J. Feldman; (iii)
100,000 shares of Common Stock to Michael D. McGonagle; (iv) 50,000 shares of
Common Stock to Patrick A. McHugh and (v) 50,000 shares of Common Stock to N.
Wayne Townsend, in each case for consideration of $.001 per share.
REPRICING OF STOCK OPTIONS
On November 10, 1998, the terms of Stock Option Agreements between the
Company and certain employees and consultants, as the case may be, of the
Company were amended to reduce the exercise price to $10.00 per share for all
Stock Options granted under Stock Option Agreements with exercise prices greater
than $10.00 per share. The affected employees included David L. Fitzgerald, Vice
President, North American Sales and Alliances, who had been granted 190,000
Stock Options on July 15, 1998 at an exercise price of $14.50 per share.
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<PAGE> 59
CHARTER AMENDMENT
The Company's Certificate of Incorporation in effect prior to the Offering
requires the Company to make certain distributions on the Company's Series A
Preferred Stock in an aggregate amount of up to $3.269 million and on the
Company's Series B Convertible Preferred Stock in an aggregate amount of up to
$4 million upon the closing of the Company's initial public offering if the
offering does not constitute a Qualified Public Offering. A Qualified Public
Offering, as defined in the Certificate of Incorporation, means an initial
public offering in which the product of (i) the price at which the shares of
Common Stock are sold in the offering, multiplied by (ii) the total number of
shares of Common Stock outstanding after giving effect to the offering,
calculated on a fully-diluted basis assuming the exercise or conversion of all
outstanding options and other securities exercisable for or convertible into
Common Stock, exceeds $130 million. On November 12, 1998, the Board of Directors
and stockholders of the Company approved an amendment to the Company's
Certificate of Incorporation that would (x) reduce the redemption price payable
on shares of the Company's Series A Preferred Stock upon the closing of an
initial public offering that is not a Qualified Public Offering from
approximately $3.269 million to approximately $1.635 million, (y) eliminate the
special distribution in the aggregate amount of $4 million payable on the Series
B Convertible Preferred Stock upon the closing of an initial public offering
that is not a Qualified Public Offering and (z) require the Company to issue an
aggregate amount of 100,000 additional shares of Common Stock ratably to the
holders of Series B Convertible Preferred Stock upon conversion of the Series B
Convertible Preferred Stock in connection with an initial public offering that
is not a Qualified Public Offering. The Company desired to effect the amendment
to its Certificate of Incorporation, and the requisite stockholders of the
Company agreed to such amendment, to reduce the distributions required to be
paid by the Company on its capital stock in the event the initial public
offering does not constitute a Qualified Public Offering. The holders of the
Series A Preferred Stock and the Series B Convertible Preferred Stock approved
such amendment to facilitate an initial public offering acceptable to the
Company and its other stockholders. The amendment to the Certificate of
Incorporation will be filed and become effective prior to the effective date of
the registration statement of which this Prospectus forms a part.
LEGAL SERVICES
The Company has, with respect to this Offering and from time to time,
retained the services of the law firm of Bingham Dana LLP. The Company
anticipates that legal fees to be paid to Bingham Dana LLP for 1998 will exceed
$300,000. Neil W. Townsend, a partner at Bingham Dana LLP, is the brother of N.
Wayne Townsend, Vice President, Integration Services of the Company.
FUTURE AFFILIATE TRANSACTIONS
All future transactions, including loans, between the Company and its
officers, directors, principal stockholders and their affiliates, will be
approved by a majority of the Board, including a majority of the independent and
disinterested outside directors on the Board, and will be on terms no less
favorable to the Company than could be obtained from unaffiliated third parties.
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<PAGE> 60
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of September 30, 1998, and as
adjusted to reflect the sale of shares offered hereby, by (i) each person who is
known by the Company to own beneficially more than five percent of the Company's
Common Stock; (ii) each of the Company's directors and Named Officers; (iii) all
current executive officers and directors as a group; and (iv) each of the
Selling Stockholders. Unless otherwise indicated, the address for the following
stockholders is 89 South Street, Boston, Massachusetts 02111.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED BEFORE OWNED AFTER
OFFERING(1) SHARES OFFERING(1)(2)
----------------------- BEING -----------------------
BENEFICIAL OWNER NUMBER PERCENTAGE OFFERED NUMBER PERCENTAGE
- ---------------- ------ ---------- ------- ------ ----------
<S> <C> <C> <C> <C> <C>
Entities affiliated with Insight
Venture Associates, LLC(3)...... 3,557,783 46.0% 3,650,281 37.1%
Cyrk, Inc.(4)..................... 1,150,000 14.9 1,000,000 150,000 1.5
Grant & Partners Limited
Partnership(5).................. 575,000 7.4 -- 575,000 5.9
Michael J. Feldman(6)............. 530,250 6.9 -- 530,250 5.4
Andrew J. Frawley(7).............. 1,038,249 13.2 -- 1,039,746 10.4
David G. McFarlane(8)............. 126,009 1.6 -- 127,027 1.3
John G. O'Brien(9)................ 10,000 * -- 10,000 *
Michael D. McGonagle(10).......... 114,000 1.5 -- 114,196 1.2
Patrick A. McHugh(11)............. 75,000 * -- 75,391 *
N. Wayne Townsend(12)............. 59,000 * -- 59,000 *
Ramanan Raghavendran(13)(14)...... 3,557,783 46.0 -- 3,650,281 37.1
Jeffrey Horing(15)................ 3,557,783 46.0 -- 3,650,281 37.1
Dean F. Goodermote(16)............ -- -- -- -- --
All directors and executive
officers as a group (twelve
persons)........................ 4,994,416 62.5 -- 5,090,519 50.5
</TABLE>
- ---------------
* Indicates less than 1% of the outstanding shares of Common Stock.
(1) Beneficial ownership is calculated in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of Common Stock subject to options held by that person that are
currently exercisable or become exercisable within 60 days following
September 30, 1998 are deemed outstanding. However, such shares are not
deemed outstanding for the purpose of computing the percentage ownership of
any other person. Unless otherwise indicated in the footnotes to this
table, the persons and entities named in the table have sole voting and
sole investment power with respect to all shares beneficially owned,
subject to community property laws where applicable.
(2) Assumes no exercise of the Underwriters' over-allotment option.
(3) Includes 1,209,054 shares held by Insight Venture Partners I, L.P., 520,779
shares held by Insight Capital Partners II, L.P. and 61,198 shares held by
Insight Capital Partners (Cayman) II, L.P., each of which is under common
control with Insight Venture Partners I, L.P. Also includes 1,766,752
shares held by Wexford Insight LLC. Pursuant to a consulting agreement
dated as of June 1, 1996 (the "Insight Consulting Agreement") between
Insight Venture Management Inc. and Wexford Insight LLC, Insight Venture
Partners I, L.P. may vote all of the shares held by Wexford Insight LLC for
certain matters until six months after the completion of this Offering. As
a result, Insight Venture Associates, LLC and its affiliates may be deemed
to be
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<PAGE> 61
the beneficial owners of all of the shares held by Wexford Insight LLC. In
addition, Ramanan Raghavendran and Jeffrey Horing are the managing members
of Insight Venture Associates LLC, and as such they may be deemed to be
beneficial owners of all of the shares held by Insight Venture Partners I,
L.P., Insight Capital Partners II, L.P., Insight Capital Partners (Cayman)
II, L.P. and Wexford Insight LLC. Wexford Insight LLC intends to grant the
Underwriters the right to purchase up to 150,000 shares pursuant to the
Underwriters' over-allotment option. The address of the Insight entities is
122 East 42nd Street, Ste 2300, New York, New York 10168, and the address
of Wexford Insight LLC is 411 West Putnam Avenue, Suite 125, Greenwich,
Connecticut 06830.
(4) Does not include 2,900,000 shares of Series A Preferred Stock which are
eliminated upon consummation of the Offering.
(5) Alan Grant is the President of Grant & Partners, Inc., the general partner
of Grant & Partners Limited Partnership, and as such he may be deemed to be
a beneficial owner of all of the shares held by Grant & Partners Limited
Partnership. Grant & Partners Limited Partnership intends to grant the
Underwriters the right to purchase up to 100,000 shares pursuant to the
Underwriters' over-allotment option. The address of Grant & Partners
Limited Partnership is 150 Federal Street, Boston, Massachusetts 02110.
(6) Includes 30,000 shares held by Smith Barney IRA f/b/o Michael Feldman. Mr.
Feldman intends to grant the Underwriters the right to purchase up to
102,188 shares pursuant to the Underwriters' over-allotment option.
(7) Includes 151,200 shares subject to options that currently are exercisable.
Includes 848,800 shares of Restricted Common Stock, 141,495 shares of which
are unvested and therefore subject to a repurchase option in favor of the
Company. Mr. Frawley intends to grant the Underwriters the right to
purchase up to 57,162 shares pursuant to the Underwriters' over-allotment
option.
(8) Includes 75,000 shares subject to options that currently are exercisable.
Mr. McFarlane intends to grant the Underwriters the right to purchase up to
17,800 shares pursuant to the Underwriters' over-allotment option.
(9) Includes 10,000 shares subject to options that currently are exercisable.
(10) Includes 9,000 shares subject to options that currently are exercisable.
Includes 100,000 shares of Restricted Common Stock which are subject to a
repurchase option in favor of the Company. Mr. McGonagle intends to grant
the Underwriters the right to purchase up to 8,600 shares pursuant to the
Underwriters' over-allotment option.
(11) Includes 50,000 shares of Restricted Common Stock which are subject to a
repurchase option in favor of the Company. Mr. McHugh intends to grant the
Underwriters the right to purchase up to 7,500 shares pursuant to the
Underwriters' over-allotment option.
(12) Includes 50,000 shares of Restricted Common Stock which are subject to a
repurchase option in favor of the Company. Mr. Townsend intends to grant
the Underwriters the right to purchase up to 6,750 shares pursuant to the
Underwriters' over-allotment option.
(13) Includes 1,209,054 shares held by Insight Venture Partners I, L.P., 520,779
shares held by Insight Capital Partners II, L.P., 61,198 shares held by
Insight Capital Partners (Cayman) II, L.P. and 1,766,752 shares held by
Wexford Insight LLC. Mr. Raghavendran is a managing member of Insight
Capital Partners and as such he may be deemed to be a beneficial owner of
all of the shares held by entities affiliated with Insight Capital
Partners. In addition, Insight Venture Partners I, L.P., Insight Capital
Partners II, L.P. and Insight Capital Partners (Cayman) II, L.P. may be
deemed to be beneficial owners of all of the shares held by Wexford Insight
LLC (see Note 3), and as a managing member of Insight Capital Partners, Mr.
Raghavendran may be deemed to be a beneficial owner of all of the shares
held by Wexford Insight LLC.
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<PAGE> 62
(14) The address of Mr. Raghavendran and Mr. Horing is c/o Insight Venture
Associates, LLC, 122 East 42nd Street, Ste 2300, New York, New York 10168.
(15) Includes 1,209,054 shares held by Insight Venture Partners I, L.P., 520,779
shares held by Insight Capital Partners II, L.P., 61,198 shares held by
Insight Capital Partners (Cayman) II, L.P. and 1,766,752 shares held by
Wexford Insight LLC. Mr. Horing is a managing member of Insight Capital
Partners and as such he may be deemed to be a beneficial owner of all of
the shares held by entities affiliated with Insight Capital Partners. In
addition, Insight Venture Partners I, L.P., Insight Capital Partners II,
L.P. and Insight Capital Partners (Cayman) II, L.P. may be deemed to be
beneficial owners of all of the shares held by Wexford Insight LLC (see
Note 3), and as a managing member of Insight Capital Partners, Mr. Horing
may be deemed to be a beneficial owner of all of the shares held by Wexford
Insight LLC.
(16) Does not include 20,000 shares subject to options that are not exercisable
within 60 days of September 30, 1998.
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<PAGE> 63
DESCRIPTION OF CAPITAL STOCK
AUTHORIZED AND OUTSTANDING CAPITAL STOCK
The authorized capital stock of the Company consists of 30,000,000 shares
of Common Stock, par value $.001 per share, and 10,000,000 shares of preferred
stock, par value $.001 per share ("Preferred Stock"). Upon consummation of the
Offering, no shares of Preferred Stock and 9,827,190 shares of Common Stock will
be outstanding. The following summary is qualified in its entirety by reference
to the Company's Charter and By-laws.
COMMON STOCK
As of September 30, 1998, there were 7,827,190 shares of Common Stock
outstanding held of record by 70 stockholders, assuming the conversion of all
shares of Convertible Preferred Stock into an aggregate of 3,879,510 shares of
Common Stock upon closing of this Offering. The holders of Common Stock are
entitled to one vote per share on all matters to be voted upon by the
stockholders. Subject to preferences that may be applicable to any outstanding
Preferred Stock, the holders of Common Stock are entitled to receive ratably
such dividends, if any, as may be declared from time to time by the Board out of
funds legally available therefor. In the event of liquidation, dissolution or
winding up of the Company, the holders of Common Stock are entitled to share
ratably in all assets remaining after payment of liabilities, subject to prior
distribution rights of Preferred Stock, if any, then outstanding. The Common
Stock has no preemptive or conversion rights or other subscription rights. There
are no redemption or sinking fund provisions applicable to the Common Stock. All
outstanding shares of Common Stock are fully paid and nonassessable, and the
shares of Common Stock offered by the Company in the Offering will, when issued,
be fully paid and nonassessable.
PREFERRED STOCK
The Board has the authority to issue the Preferred Stock in one or more
series and to fix the rights, preferences, privileges and restrictions thereof,
including dividend rights, dividend rates, conversion rights, voting rights,
terms of redemption, liquidation preferences and the number of shares
constituting any series or the designation of such series, without further vote
or action by the Company's stockholders. The issuance of Preferred Stock may
have the effect of delaying, deferring or preventing a change in control of the
Company and may adversely affect the voting and other rights of the holders of
Common Stock. At present, the Company has no plans to issue any shares of
Preferred Stock.
CERTAIN ANTI-TAKEOVER, LIMITED LIABILITY AND INDEMNIFICATION PROVISIONS
Delaware Law and Certain Charter and By-Law Provisions
The Charter provides for the division of the Board into three classes as
nearly equal in size as practicable with staggered three-year terms, effective
upon consummation of this Offering. See "Management -- Board of Directors". A
director may be removed only for cause and then only by the vote of a majority
of the shares entitled to vote for the election of directors.
The Charter empowers the Board of Directors, when considering a tender
offer or merger or acquisition proposal, to take into account factors in
addition to potential economic benefits to stockholders. Such factors may
include (i) comparison of the proposed consideration to be received by
stockholders in relation to the then current market price of the Company's
capital stock, the estimated current value of the Company in a freely negotiated
transaction or the estimated future value of the Company as an independent
entity and (ii) the impact of such a transaction on the employees, suppliers and
customers of the Company and its effect on the communities in which the Company
operates.
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<PAGE> 64
The Charter and By-laws provide that, effective upon consummation of the
Offering, any action required or permitted to be taken by the stockholders of
the Company may be taken only at a duly called annual or special meeting of the
stockholders and that special meetings may be called only by the Chairman of the
Board, the President or a majority of the entire Board. These provisions could
have the effect of delaying until the next annual stockholders meeting
stockholder actions which are favored by the holders of a majority of the
outstanding voting securities of the Company, including actions to remove
directors. These provisions may also discourage another person or entity from
making a tender offer for the Company's Common Stock, because such person or
entity, even if it acquired all or a majority of the outstanding voting
securities of the Company, would be able to take action as a stockholder (such
as electing new directors or approving a merger) only at a duly called
stockholders meeting, and not by written consent.
The Delaware General Corporation Law ("DGCL") provides generally that the
affirmative vote of a majority of the shares entitled to vote on any matter is
required to amend a corporation's certificate of incorporation or by-laws,
unless a corporation's certificate of incorporation or by-laws, as the case may
be, requires a greater percentage. The Charter requires the affirmative vote of
a majority of the entire Board and the holders of at least 66 2/3% of the
outstanding voting stock of the Company to amend or repeal any of the foregoing
Charter provisions or to reduce the number of authorized shares of Common Stock
and Preferred Stock. A 66 2/3% vote is also required to amend or repeal the
Company's By-laws. Such stockholder vote would in either case be in addition to
any separate class vote that might in the future be required pursuant to the
terms of any Preferred Stock that might be outstanding at the time any such
amendments are submitted to stockholders. The By-laws may also be amended or
repealed by a majority vote of the Board of Directors.
The By-laws provide that for nominations for the Board or for other
business to be properly brought by a stockholder before an annual meeting of
stockholders, the stockholder must first have given timely notice thereof in
writing to the Secretary of the Company. To be timely, a stockholder's notice
generally must be delivered not later than 120 days in advance of the first
anniversary of the date that the Company's proxy statement to stockholders is
delivered in connection with the prior year's annual meeting of stockholders or
90 days prior to the date of the meeting if no such proxy statement was
delivered to the stockholders. The notice must contain, among other things,
certain information about the stockholder delivering the notice and, as
applicable, background information about each nominee or a description of the
proposed business to be brought before the meeting. Business transacted at a
special meeting is limited to the purposes for which the meeting is called.
The foregoing provisions could have the effect of making it more difficult
for a third party to acquire, or of discouraging a third party from attempting
to acquire, control of the Company. See "Risk Factors -- Effect of Anti-takeover
Provisions".
The Charter contains certain provisions permitted under the DGCL relating
to the liability of directors. These provisions eliminate a director's liability
for monetary damages for a breach of fiduciary duty, except in certain
circumstances involving certain wrongful acts, such as the breach of a
director's duty of loyalty or acts or omissions which involve intentional
misconduct or a knowing violation of law. The Charter and By-laws also contain
provisions indemnifying the directors and officers of the Company to the fullest
extend permitted by the DGCL. The Company expects to obtain, prior to the
consummation of the Offering, a directors and officers liability insurance
policy which provides for indemnification of its directors and officers against
certain liabilities incurred in their capacities as such, which may include
liabilities under the Securities Act of 1933, as amended (the "Securities Act").
The Company believes that these provisions will assist the Company in attracting
and retaining qualified individuals to serve as directors.
The Company is subject to the provisions of Section 203 of the DGCL.
Subject to certain exceptions, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the interested
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<PAGE> 65
stockholder attained such status with the approval of the Board or unless the
business combination is approved in a prescribed manner. A "business
combination" includes certain mergers, assets sales and other transactions
resulting in a financial benefit to the interested stockholder. Subject to
certain exceptions, an "interested stockholder" is a person who, together with
his or her affiliates and associates, owns, or owned within three years prior
15% or more of the corporation's voting stock.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is BankBoston, N.A.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this Offering, the Company will have 9,827,190 shares of
Common Stock outstanding (assuming no exercise of the Underwriters'
over-allotment option and no exercise of outstanding options under the Company's
1996 Plan or other options after September 30, 1998). Of such shares, the
3,000,000 shares sold in this Offering will be freely transferable without
restriction or further registration under the Securities Act, except for any
shares held by an existing "affiliate" of the Company, as that term is defined
by the Securities Act (an "Affiliate"), which shares will be subject to the
resale limitations of Rule 144 adopted under the Securities Act. As of the date
of this Prospectus, 7,727,190 "restricted shares" as defined in Rule 144 will be
outstanding. Of such shares, and without consideration of the contractual
restrictions described below, no shares would be available for immediate sale in
the public market without restriction pursuant to Rule 144(k). Beginning 90 days
after the date of this Prospectus, and without consideration of the contractual
restrictions described below, 1,037,544 shares would be eligible for sale in
reliance upon Rule 144 promulgated under the Securities Act and 1,942,039 shares
would be eligible for sale in reliance upon Rule 701 promulgated under the
Securities Act.
In general, under Rule 144 as currently in effect, beginning 90 days after
the Offering, a person (or persons whose shares are aggregated) who owns shares
that were purchased from the Company (or any Affiliate) at least one year
previously, including a person who may be deemed an Affiliate of the Company, is
entitled to sell within any three-month period a number of shares that does not
exceed the greater of (i) 1% of the then outstanding shares of the Common Stock
(approximately 98,272 shares immediately after the Offering) or (ii) the average
weekly trading volume of the Common Stock on the Nasdaq National Market during
the four calendar weeks preceding the date on which notice of the sale is filed
with the Securities and Exchange Commission (the "Commission"). 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. Any person
(or persons whose shares are aggregated) who is not deemed to have been an
Affiliate of the Company at any time during the 90 days preceding a sale, and
who owns shares within the definition of "restricted securities" under Rule 144
under the Securities Act that were purchased from the Company (or any Affiliate)
at least two years previously, would be entitled to sell such shares under Rule
144(k) without regard to the volume limitations, manner of sale provisions,
public information requirements or notice requirements.
Subject to certain limitations on the aggregate offering price of a
transaction and other conditions, Rule 701 may be relied upon with respect to
the resale of securities originally purchased from the Company by its employees,
directors, officers, consultants or advisers prior to the date the issuer
becomes subject to the reporting requirements of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), pursuant to written compensatory benefit
plans or written contracts relating to compensation of such persons. In
addition, the Commission has indicated that Rule 701 will apply to the typical
stock options granted by an issuer before it becomes subject to the reporting
requirements of the Exchange Act, along with the shares acquired upon exercise
of such options (including exercises after the date of this Prospectus).
Securities issued in reliance on Rule 701 are restricted securities and, subject
to the contractual restrictions described above, beginning 90 days
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<PAGE> 66
after the date of this Prospectus, may be sold (i) by persons other than
Affiliates, subject only to the manner of sale provisions of Rule 144, and (ii)
by Affiliates under Rule 144 without compliance with its one-year holding period
requirement.
All stockholders of the Company, including the officers, directors and
Selling Stockholders, have agreed not to sell any of their shares of Common
Stock for 180 days after the date of this Prospectus without the prior written
consent of the representatives of the Underwriters. As a result of these
contractual restrictions and subject to the provisions of Rules 144(k), 144 and
701, as applicable, 3,011,459 shares subject to restriction will be eligible for
sale upon expiration of the Lock-Up Agreements 180 days after the date of this
Prospectus. See "Underwriting".
The Company has agreed not to offer, sell or otherwise dispose of any
shares of Common Stock or any securities convertible into or exercisable or
exchangeable for Common Stock or any rights to acquire Common Stock for a period
of 180 days after the date of this prospectus, without the prior written consent
of the Representatives of the Underwriters, subject to certain limited
exceptions. See "Underwriting".
After the Offering, the holders of 6,018,565 shares of Common Stock or
their respective transferees, would be entitled to certain rights with respect
to the registration of such shares under the Securities Act. Registration of
such shares under the Securities Act would result in such shares becoming freely
tradable without restriction under the Securities Act (except for shares
purchased by Affiliates) immediately upon the effectiveness of such
registration.
The Company intends to file a registration statement under the Securities
Act covering all shares of Common Stock subject to outstanding stock options as
well as all shares of Common Stock reserved for issuance under the Company's
Stock Plans. Such registration statement is expected to be filed within 90 days
after the date of this Prospectus and will automatically become effective upon
filing. Following such filing, shares registered under such registration
statement will, subject to the Lock-Up Agreements, Rule 144 volume limitation
applicable to Affiliates and the lapsing of the Company's repurchase rights, be
available for sale in the open market upon the exercise of vested options 90
days after the effective date of this Prospectus. At November 11, 1998, options
to purchase 2,421,908 shares were issued and outstanding under the 1996 Plan and
no options were issued and outstanding outside of the 1996 Plan.
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<PAGE> 67
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below (the "Underwriters"), through their Representatives, BT
Alex. Brown Incorporated, Hambrecht & Quist LLC and Adams, Harkness & Hill, Inc.
have severally agreed to purchase from the Company and the Selling Stockholder
the respective numbers of shares of Common Stock set forth opposite its name
below at the initial public offering price less the underwriting discounts and
commissions set forth on the cover page of this Prospectus:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
UNDERWRITER COMMON STOCK
----------- ------------
<S> <C>
BT Alex. Brown Incorporated.................................
Hambrecht & Quist LLC.......................................
Adams, Harkness & Hill, Inc.................................
--------
Total.............................................
========
</TABLE>
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent and that the
Underwriters will purchase all shares of the Common Stock offered hereby if any
such shares are purchased. Under the terms and conditions of the Underwriting
Agreement, the Underwriters are committed to take and pay for all of the shares
offered hereby, if any are taken.
The Company and the Selling Stockholders have been advised by the
Representatives of the Underwriters that the Underwriters propose to offer the
shares of Common Stock in part directly to the public at the initial public
offering price set forth on the cover page of this Prospectus, and in part to
certain securities dealers at such price less a concession of $ per share.
The Underwriters may allow, and such dealers may reallow, a concession not in
excess of $ per share to certain other dealers. After the initial public
offering, the public offering price and other selling terms may be changed by
the Representatives of the Underwriters.
The Selling Stockholders have granted to the Underwriters an option,
exercisable not later than 30 days after the date of this Prospectus, to
purchase up to 450,000 additional shares of Common Stock at the public offering
price less the underwriting discounts and commissions set forth on the cover
page of this Prospectus. To the extent that the Underwriters exercise such
option, each of the Underwriters will have a firm commitment to purchase
approximately the same percentage thereof that the number of shares of Common
Stock to be purchased by it shown in the above table bears to 3,000,000, and
such Selling Stockholders will be obligated, pursuant to the option, to sell
such shares to the Underwriters. The Underwriters may exercise such option only
to cover over-allotments made in connection with the sale of the Common Stock
offered hereby. If purchased, the Underwriters will offer such additional shares
on the same terms as those on which the 3,000,000 shares are being offered.
The Underwriting Agreement contains covenants of indemnity among the
Underwriters, the Company and the Selling Stockholders against certain civil
liabilities, including liabilities under the Securities Act.
The Company, each of its officers and directors, and certain of its
stockholders, including all of the Selling Stockholders, have agreed, subject to
certain exceptions, not to offer, sell or otherwise dispose of any shares of
Common Stock for a period of 180 days after the date of this Prospectus without
the prior written consent of the Representatives of the Underwriters. BT Alex.
Brown Incorporated, on behalf of the Representatives, may, in its sole
discretion and at any time without
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<PAGE> 68
notice, release all or any portion of the securities subject to Lock-up
Agreements. See "Shares Eligible for Future Sale".
The Representatives have advised the Company and the Selling Stockholders
that the Underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
In connection with this offering, the Underwriters and other persons
participating in this offering may engage in transactions that stabilize,
maintain or otherwise affect the price of the Common Stock. Specifically, the
Underwriters may over-allot in connection with this offering, creating a short
position in Common Stock for their own account. To cover over-allotments or to
stabilize the price of the Common Stock, the Underwriters may bid for, and
purchase, shares of Common Stock in the open market. The Underwriters may also
impose a penalty bid whereby they may reclaim selling concessions allowed to an
Underwriter or a dealer for distributing Common Stock in this offering, if the
Underwriters repurchase previously distributed Common Stock in transactions to
cover their short position, in stabilization transactions or otherwise. Finally,
the Underwriters may bid for, and purchase, shares of Common Stock in market
making transactions. These activities may stabilize or maintain the market price
of the Common Stock above market levels that may otherwise prevail. The
Underwriters are not required to engage in these activities and may end any of
these activities at any time.
Prior to this offering, there has been no public market for the Common
Stock of the Company. Consequently, the initial public offering price for the
Common Stock will be determined by negotiations among the Company,
representatives of the Selling Stockholders and the Representatives of the
Underwriters. Among the factors to be considered in such negotiations are the
prevailing market conditions, the results of operations of the Company in recent
periods, the market capitalizations and stages of development of other companies
which the Company, representatives of the Selling Stockholders and the
Representatives of the Underwriters believe to be comparable to the Company,
estimates of the business potential of the Company, the present state of the
Company's development and other factors deemed relevant.
The Underwriters have reserved for sale, at the initial public offering
price, up to five percent of the shares of Common Stock offered hereby for
employees of the Company and certain other individuals who have expressed an
interest in purchasing such shares of Common Stock in this Offering.
Approximately 93 employees of the Company will be purchasing such reserved
shares and certain affiliates of the Company will be purchasing less than 2,000
of such reserved shares in the aggregate. The number of shares available for
sale to the general public will be reduced to the extent such persons purchase
such reserved shares. Any reserved shares not so purchased will be offered by
the Underwriters to the general public on the same basis as other shares offered
hereby.
The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "EXAP", subject to official notice of issuance.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Bingham Dana LLP, Boston, Massachusetts. Certain legal matters in
connection with the Offering will be passed upon for the Underwriters by Ropes &
Gray, Boston, Massachusetts.
EXPERTS
The consolidated financial statements of Exchange Applications, Inc. as of
December 31, 1996 and 1997 and September 30, 1998, and for each of the three
years in the period ended December 31, 1997 and nine months ended September 30,
1998 included in this Prospectus and Registration Statement have been audited by
Arthur Andersen LLP, independent public accountants, as indicated
66
<PAGE> 69
in their report with respect thereto, and included herein in reliance upon the
authority of said firm as experts in giving said reports.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission"), 450 Fifth Street, N.W., Washington, D.C. 20549, a Registration
Statement on Form S-1 (Reg. No. 333-59613) (the "Registration Statement") under
the Securities Act with respect to the Common Stock offered hereby. This
Prospectus does not contain all of the information set forth in the Registration
Statement and the exhibits to the Registration Statement. Statements made in
this Prospectus as to the contents of any contract, agreement or other document
referred to are not necessarily complete but are complete in all material
respects. With respect to each such contract, agreement or other document filed
as an exhibit to the Registration Statement, reference is made to the exhibit
for a more complete description of the matter involved. The Registration
Statement and the exhibits thereto may be inspected and copied at prescribed
rates at the public reference facilities maintained by the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
regional offices of the Commission located at Seven World Trade Center, 13th
Floor, New York, New York 10048 and Citicorp Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661. In addition, the Company is required to
file electronic versions to these documents with the Commission through the
Commission's Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system.
The Commission maintains a World Wide Web site at http://www.sec.gov that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission.
The Company intends to distribute to its stockholders annual reports
containing audited consolidated financial statements. The Company also intends
to make available to its stockholders, within 45 days after the end of each
fiscal quarter, reports for the first three quarters of each fiscal year
containing interim unaudited financial information.
67
<PAGE> 70
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statements of Stockholders' Equity (Deficit)... F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 71
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Exchange Applications, Inc. and subsidiaries:
We have audited the accompanying consolidated balance sheets of Exchange
Applications, Inc., a Delaware corporation, and subsidiaries as of December 31,
1996, and 1997 and September 30, 1998, and the related consolidated statements
of operations, stockholders' equity (deficit) and cash flows for each of the
three years in the period ended December 31, 1997 and the nine-month period
ended September 30, 1998. 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 Exchange Applications, Inc.
and subsidiaries as of December 31, 1996, and 1997 and September 30, 1998, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1997 and the nine-month period ended September
30, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
November 13, 1998
F-2
<PAGE> 72
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
DECEMBER 31, -------------------------
------------------ PRO FORMA
1996 1997 ACTUAL (NOTE 3)
------- -------- ----------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 361 $ 5,273 $ 1,782 $ 1,782
Marketable securities..................................... -- 202 206 206
Accounts receivable, less allowance for doubtful accounts
of $43, $206 and $281 at December 31, 1996 and 1997 and
September 30, 1998, respectively........................ 2,002 3,848 6,773 6,773
Prepaid expenses and other current assets................. -- 729 683 683
------- -------- -------- --------
Total current assets............................... 2,363 10,052 9,444 9,444
Property and equipment, net................................. 606 913 1,989 1,989
Software development costs, net............................. 1,211 -- -- --
Other assets................................................ 9 435 579 579
------- -------- -------- --------
Total assets....................................... $ 4,189 $ 11,400 $ 12,012 $ 12,012
======= ======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 535 $ 422 $ 832 $ 832
Accrued expenses.......................................... 1,313 3,247 4,096 4,096
Current portion of obligations under capital leases....... 22 212 249 249
Current portion of notes payable to related parties....... 1,000 -- -- --
Deferred revenue.......................................... 346 922 1,154 1,154
------- -------- -------- --------
Total current liabilities.......................... 3,216 4,803 6,331 6,331
Obligations under capital leases, net of current portion.... 34 237 177 177
Notes payable to related parties, net of current portion.... 2,234 -- -- --
Commitments (Note 9)
Redeemable Preferred Stock (Notes 10 and 11)................ -- 7,088 7,268 1,635
Stockholders' equity (deficit):
Preferred Stock; $.001 par value --
10,000,000 shares authorized; 2,300,000 shares issued
and outstanding at December 31, 1996.................... 2 -- -- --
Series C Preferred Stock, $.001 par value --
1,223,954 shares designated, issued and outstanding at
December 31, 1997 and September 30, 1998, actual........ -- 1 1 --
Common Stock, $.001 par value --
30,000,000 shares authorized; 2,484,375, 4,234,971,
4,312,685 shares issued at December 31, 1996 and 1997
and September 30, 1998, actual, respectively, and
8,192,195 shares issued on a pro forma basis at
September 30, 1998...................................... 2 4 4 8
Additional paid-in capital................................ 868 4,837 5,428 11,058
Accumulated deficit....................................... (2,167) (5,450) (6,707) (6,707)
Due from officer.......................................... -- (125) (125) (125)
Deferred compensation..................................... -- -- (439) (439)
Cumulative translation adjustment......................... -- 2 68 68
Unrealized gain on marketable securities.................. -- 3 6 6
Treasury stock, at cost; 354,825 shares at December 31,
1997 and 365,005 shares at September 30, 1998, actual
and pro forma........................................... -- -- -- --
------- -------- -------- --------
Total stockholders' equity (deficit)............... (1,295) (728) (1,764) 3,869
------- -------- -------- --------
Total liabilities and stockholders' equity
(deficit)........................................ $ 4,189 $ 11,400 $ 12,012 $ 12,012
======= ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 73
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------------------------- ------------------------
1995 1996 1997 1997 1998
---------- ------------ ---------- ----------- ----------
(NOTE 1) (NOTE 1) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Software license fees............. $ -- $ 1,500 $ 5,765 $ 3,409 $ 9,774
Services and maintenance.......... 1,693 4,534 6,904 4,740 7,392
---------- ---------- ---------- ---------- ----------
Total revenues............. 1,693 6,034 12,669 8,149 17,166
Cost of revenues:
Software license fees............. -- 890 1,707 1,312 186
Services and maintenance.......... 1,012 3,205 5,227 3,553 5,042
---------- ---------- ---------- ---------- ----------
Total cost of revenues..... 1,012 4,095 6,934 4,865 5,228
---------- ---------- ---------- ---------- ----------
Gross profit........................ 681 1,939 5,735 3,284 11,938
Operating expenses:
Sales and marketing............... 128 1,007 3,602 2,139 6,769
Research and development.......... 708 1,325 2,599 1,678 4,154
General and administrative........ 352 1,018 2,158 1,253 2,140
---------- ---------- ---------- ---------- ----------
Total operating expenses... 1,188 3,350 8,359 5,070 13,063
---------- ---------- ---------- ---------- ----------
Loss from operations................ (507) (1,411) (2,624) (1,786) (1,125)
Interest income (expense):
Interest income................... -- 2 89 56 87
Interest expense.................. (47) (197) (64) (20) (39)
---------- ---------- ---------- ---------- ----------
Total interest income
(expense)................ (47) (195) 25 36 48
---------- ---------- ---------- ---------- ----------
Net loss............................ (554) (1,606) (2,599) (1,750) (1,077)
Accretion of discount and dividends
on preferred stock................ -- -- (684) (625) (180)
---------- ---------- ---------- ---------- ----------
Net loss applicable to common
stockholders...................... $ (554) $ (1,606) $ (3,283) $ (2,375) $ (1,257)
========== ========== ========== ========== ==========
Net loss per share (Note 2(c)):
Basic and diluted net loss per
share applicable to common
stockholders.................... $ (10.35) $ (1.12) $ (0.86) $ (0.35)
========== ========== ========== ==========
Basic and diluted weighted average
common shares outstanding....... 155,170 2,919,775 2,758,949 3,640,825
========== ========== ========== ==========
Pro forma net loss per share (Note
2(c)):
Pro forma basic and diluted net
loss per share.................. $ (0.48) $ (0.15)
========== ==========
Pro forma basic and diluted
weighted average common shares
outstanding..................... 5,390,779 7,420,335
========== ==========
Supplemental pro forma basic and
diluted net loss per share........ $ (0.47) $ (0.14)
========== ==========
Supplemental pro forma basic and
diluted weighted average common
shares outstanding................ 5,586,000 7,615,556
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 74
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SERIES C
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
NET PARENT ---------------------- ---------------------- ---------------------
COMPANY NUMBER OF $.001 NUMBER OF $.001 NUMBER OF $.001
INVESTMENT SHARES PAR VALUE SHARES PAR VALUE SHARES PAR VALUE
---------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995................. $ (7) -- $-- -- $-- -- $--
Net loss................................ (554) -- -- -- -- -- --
Comprehensive net loss for the year
ended December 31, 1995............... -- -- -- -- -- -- --
------- ---------- --- ---------- --- --------- --
Balance, December 31, 1995............... (561) -- -- -- -- -- --
Net loss prior to incorporation of the
Company............................... (2,093) -- -- -- -- -- --
Capitalization of the Company........... 2,654 -- -- -- -- -- --
Issuance of Preferred Stock............. -- 2,300,000 2 -- -- -- --
Issuance of common stock................ -- -- -- -- -- 2,484,375 2
Net income after incorporation of the
Company............................... -- -- -- -- -- -- --
Comprehensive net loss for the year
ended December 31, 1996............... -- -- -- -- -- -- --
------- ---------- --- ---------- --- --------- --
Balance, December 31, 1996............... -- 2,300,000 2 -- -- 2,484,375 2
Issuance costs relating to the sale of
Series B Preferred Stock.............. -- -- -- -- -- -- --
Conversion of Preferred Stock to common
stock................................. -- (2,300,000) (2) -- -- 1,725,000 2
Compensation expense relating to stock
options............................... -- -- -- -- -- -- --
Sale of Series C Preferred Stock, net of
issuance costs of $13................. -- -- -- 1,223,954 1 -- --
Accretion of discount and dividends on
Series A Preferred Stock.............. -- -- -- -- -- -- --
Loan to officer......................... -- -- -- -- -- -- --
Issuance of common stock................ -- -- -- -- -- 15,500 --
Exercise of common stock options........ -- -- -- -- -- 10,096 --
Cumulative translation adjustment....... -- -- -- -- -- -- --
Unrealized gain on marketable
securities............................ -- -- -- -- -- -- --
Net loss................................ -- -- -- -- -- -- --
Comprehensive net loss for the year
ended December 31, 1997............... -- -- -- -- -- -- --
------- ---------- --- ---------- --- --------- --
Balance, December 31, 1997............... -- -- -- 1,223,954 1 4,234,971 4
Accretion of dividends on Series A
Preferred Stock....................... -- -- -- -- -- -- --
Exercise of common stock options........ -- -- -- -- -- 77,714
Deferred compensation................... -- -- -- -- -- -- --
Compensation expense associated with
stock options......................... -- -- -- -- -- -- --
Cumulative translation adjustment....... -- -- -- -- -- -- --
Unrealized gain on marketable
securities............................ -- -- -- -- -- -- --
Net loss................................ -- -- -- -- -- -- --
Comprehensive net loss for the nine
months ended September 30, 1998....... -- -- -- -- -- -- --
------- ---------- --- ---------- --- --------- --
Balance, September 30, 1998.............. -- -- -- 1,223,954 1 4,312,685 4
Cancellation of Series A Preferred
Stock................................. -- -- -- -- -- -- --
Conversion of Series B Preferred Stock
to common stock....................... -- -- -- -- -- 2,555,556 3
Conversion of Series C Preferred Stock
to common stock....................... -- -- -- (1,223,954) (1) 1,223,954 1
------- ---------- --- ---------- --- --------- --
Pro Forma Balance, September 30, 1998
(unaudited) (Note 3).................... $ -- -- $-- -- $-- 8,092,195 $8
======= ========== === ========== === ========= ==
<CAPTION>
UNREALIZED
ADDITIONAL CUMULATIVE GAIN ON
PAID-IN ACCUMULATED DUE FROM TRANSLATION DEFERRED MARKETABLE
CAPITAL DEFICIT OFFICER ADJUSTMENT COMPENSATION SECURITIES TOTAL
---------- ----------- -------- ----------- ------------ ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995................. $ -- $ -- $ -- $-- $ -- $ -- $ (7)
Net loss................................ -- -- -- -- -- -- (554)
Comprehensive net loss for the year
ended December 31, 1995............... -- -- -- -- -- -- --
------- ------- ----- -- ----- ------- -------
Balance, December 31, 1995............... -- -- -- -- -- -- (561)
Net loss prior to incorporation of the
Company............................... -- -- -- -- -- -- (2,093)
Capitalization of the Company........... -- (2,654) -- -- -- -- --
Issuance of Preferred Stock............. 868 -- -- -- -- -- 870
Issuance of common stock................ -- -- -- -- -- -- 2
Net income after incorporation of the
Company............................... -- 487 -- -- -- -- 487
Comprehensive net loss for the year
ended December 31, 1996............... -- -- -- -- -- -- --
------- ------- ----- -- ----- ------- -------
Balance, December 31, 1996............... 868 (2,167) -- -- -- -- (1,295)
Issuance costs relating to the sale of
Series B Preferred Stock.............. -- (111) -- -- -- -- (111)
Conversion of Preferred Stock to common
stock................................. -- -- -- -- -- -- --
Compensation expense relating to stock
options............................... 77 -- -- -- -- -- 77
Sale of Series C Preferred Stock, net of
issuance costs of $13................. 3,986 -- -- -- -- -- 3,987
Accretion of discount and dividends on
Series A Preferred Stock.............. -- (684) -- -- -- -- (684)
Loan to officer......................... -- -- (125) -- -- -- (125)
Issuance of common stock................ 10 -- -- -- -- -- 10
Exercise of common stock options........ 7 -- -- -- -- -- 7
Cumulative translation adjustment....... -- -- -- 2 -- -- 2
Unrealized gain on marketable
securities............................ -- -- -- -- -- 3 3
Net loss................................ -- (2,599) -- -- -- -- (2,599)
Comprehensive net loss for the year
ended December 31, 1997............... -- -- -- -- -- -- --
------- ------- ----- -- ----- ------- -------
Balance, December 31, 1997............... 4,837 (5,450) (125) 2 -- 3 (728)
Accretion of dividends on Series A
Preferred Stock....................... (180) -- -- -- -- (180)
Exercise of common stock options........ 51 -- -- -- -- -- 51
Deferred compensation................... 540 -- -- -- (540) -- --
Compensation expense associated with
stock options......................... -- -- -- -- 101 -- 101
Cumulative translation adjustment....... -- -- -- 66 -- -- 66
Unrealized gain on marketable
securities............................ -- -- -- -- -- 3 3
Net loss................................ -- (1,077) -- -- -- -- (1,077)
Comprehensive net loss for the nine
months ended September 30, 1998....... -- -- -- -- -- -- --
------- ------- ----- -- ----- ------- -------
Balance, September 30, 1998.............. 5,428 (6,707) (125) 68 (439) 6 (1,764)
Cancellation of Series A Preferred
Stock................................. 1,634 -- -- -- -- 1,634
Conversion of Series B Preferred Stock
to common stock....................... 3,996 -- -- -- -- -- 3,999
Conversion of Series C Preferred Stock
to common stock....................... -- -- -- -- -- -- --
------- ------- ----- -- ----- ------- -------
Pro Forma Balance, September 30, 1998
(unaudited) (Note 3).................... $11,058 $(6,707) $(125) $68 $(439) $ 6 $ 3,869
======= ======= ===== == ===== ======= =======
<CAPTION>
COMPREHENSIVE
INCOME
(LOSS)
-------------
<S> <C>
Balance, January 1, 1995................. $ --
Net loss................................ (554)
-------
Comprehensive net loss for the year
ended December 31, 1995............... $ (554)
=======
Balance, December 31, 1995...............
Net loss prior to incorporation of the
Company............................... $(2,093)
Capitalization of the Company...........
Issuance of Preferred Stock.............
Issuance of common stock................
Net income after incorporation of the
Company............................... 487
-------
Comprehensive net loss for the year
ended December 31, 1996............... $(1,606)
=======
Balance, December 31, 1996...............
Issuance costs relating to the sale of
Series B Preferred Stock..............
Conversion of Preferred Stock to common
stock.................................
Compensation expense relating to stock
options...............................
Sale of Series C Preferred Stock, net of
issuance costs of $13.................
Accretion of discount and dividends on
Series A Preferred Stock..............
Loan to officer.........................
Issuance of common stock................
Exercise of common stock options........
Cumulative translation adjustment....... $ 2
Unrealized gain on marketable
securities............................ 3
Net loss................................ (2,599)
-------
Comprehensive net loss for the year
ended December 31, 1997............... $(2,594)
=======
Balance, December 31, 1997...............
Accretion of dividends on Series A
Preferred Stock.......................
Exercise of common stock options........
Deferred compensation...................
Compensation expense associated with
stock options.........................
Cumulative translation adjustment....... $ 66
Unrealized gain on marketable
securities............................ 3
Net loss................................ (1,077)
-------
Comprehensive net loss for the nine
months ended September 30, 1998....... $(1,008)
=======
Balance, September 30, 1998..............
Cancellation of Series A Preferred
Stock.................................
Conversion of Series B Preferred Stock
to common stock.......................
Conversion of Series C Preferred Stock
to common stock.......................
Pro Forma Balance, September 30, 1998
(unaudited) (Note 3)....................
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 75
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
----------------------------- ----------------------
1995 1996 1997 1997 1998
------- ------- ------- ----------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss........................................... $ (554) $(1,606) $(2,599) $(1,750) $(1,077)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities --
Amortization of software development costs......... -- 712 1,211 961 --
Depreciation and other amortization................ 49 176 275 128 394
Compensation expense associated with stock
options.......................................... -- -- 77 36 101
Changes in operating assets and liabilities --
Accounts receivable.............................. (452) (1,549) (1,846) (2,121) (2,925)
Prepaid expenses and other current assets........ -- -- (476) (323) 46
Accounts payable................................. 150 385 (113) (171) 411
Accrued expenses................................. 525 872 2,105 806 848
Deferred revenue................................. 418 (72) 576 288 232
------- ------- ------- ------- -------
Net cash provided by (used in) operating
activities................................. 136 (1,082) (790) (2,146) (1,970)
------- ------- ------- ------- -------
Cash flows from investing activities:
Purchase of marketable securities.................. -- -- (200) -- --
Purchases of property and equipment................ (303) (441) (102) (102) (1,291)
Increase in software development costs............. (1,107) (703) -- -- --
Decrease in other assets........................... (6) (3) (679) (615) (144)
------- ------- ------- ------- -------
Net cash used in investing activities........ (1,416) (1,147) (981) (717) (1,435)
------- ------- ------- ------- -------
Cash flows from financing activities:
Proceeds from notes payable to related parties..... 1,800 2,100 -- -- --
Payments of notes payable to related parties....... -- -- (1,000) (1,000) --
Repayments under capital leases.................... (20) (12) (86) (46) (203)
Due from officer................................... -- -- (125) -- --
Exercise of common stock options................... -- -- 7 -- 51
Issuance of common stock........................... -- 2 10 -- --
Issuance of Series B Preferred Stock, net of
offering costs................................... -- -- 3,888 3,888 --
Issuance of Series C Preferred Stock, net of
offering costs................................... -- -- 3,987 -- --
------- ------- ------- ------- -------
Net cash provided by (used in) financing
activities................................. 1,780 2,090 6,681 2,842 (152)
------- ------- ------- ------- -------
Effect of exchange rate changes on cash and cash
equivalents........................................ -- -- 2 10 66
------- ------- ------- ------- -------
Net increase (decrease) in cash and cash
equivalents........................................ 500 (139) 4,912 (11) (3,491)
------- ------- ------- ------- -------
Cash and cash equivalents, beginning of period....... -- 500 361 361 5,273
------- ------- ------- ------- -------
Cash and cash equivalents, end of period............. $ 500 $ 361 $ 5,273 $ 350 $ 1,782
======= ======= ======= ======= =======
Supplemental disclosure of cash flow information --
Cash paid for interest............................. $ 35 $ 155 $ 19 $ 11 $ 41
======= ======= ======= ======= =======
Cash paid for income taxes......................... $ -- $ -- $ 476 $ 273 $ --
======= ======= ======= ======= =======
Supplemental disclosure of noncash financing and
investing activities:
Equipment acquired under capital leases............ $ 81 $ 35 $ 479 $ 456 $ 180
======= ======= ======= ======= =======
Conversion of amounts due to a related party to
Preferred Stock.................................. $ -- $ 870 $ -- $ -- $ --
======= ======= ======= ======= =======
Conversion of Preferred Stock to common stock...... $ -- $ -- $ 2 $ 2 $ --
======= ======= ======= ======= =======
Conversion of notes payable to related parties to
Series A Preferred Stock......................... $ -- $ -- $ 2,405 $ 2,405 $ --
======= ======= ======= ======= =======
Accretion of discount and dividends on Preferred
Stock............................................ $ -- $ -- $ 684 $ 625 $ 180
======= ======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 76
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(1) BACKGROUND AND BASIS OF PRESENTATION
Exchange Applications, Inc. and its subsidiaries (the "Company") is a
provider of open, enterprise customer optimization software and solutions that
enable businesses to maximize the economic value of their customers. The
Company's Continuous Customer Management ("CCM") solution, including its VALEX
software and related consulting and integration services, enables businesses to
retain and expand existing profitable customer relationships and to acquire new
customers by: (i) analyzing enterprise-wide databases of customer information;
(ii) identifying and prioritizing opportunities; (iii) creating customized
streams of targeted, real-time, event-triggered customer communications, such as
special offers, follow-up communications, special discounts, new products or
service offerings and other marketing campaigns; (iv) selecting the most
effective channels through which to communicate with customers, such as direct
mail, call centers, the Internet and sales forces; and (v) continuously
evaluating the impact of individual and collective customer communications on
marketing strategies and customer profitability.
The Company was incorporated in Delaware on November 7, 1996. Prior to
incorporation, the Company operated as a division of two entities, Grant &
Partners, Inc. ("GPI") and Grant & Partners L.P. ("GPLP").
GPI was incorporated in June 1993 and was primarily engaged in providing
management consulting services. In November 1994, the Company began operations
when it acquired the rights to certain intellectual property and hired employees
to commence the development of the VALEX software product.
On March 28, 1995, GPI entered into a limited partnership agreement with
Cyrk, Inc. ("Cyrk") to form GPLP. GPI, as the general partner, contributed all
of its assets and liabilities to GPLP for a 50% limited partnership interest.
Cyrk purchased the remaining 50% limited partnership interest in GPLP. Upon
entering into the partnership agreement, GPI became a holding company, with no
substantial operations.
GPLP was established to provide marketing and customer management services
for companies in a wide range of industries including retailing, transportation,
banking and manufacturing. GPLP operated as two separate divisions, Exchange
Applications ("EA") and Exchange Partners ("EP"). EA's focus was marketing
program design and execution, customer database construction and software
application development. EP's focus was providing a variety of management
consulting services for marketing organizations.
On November 15, 1996, the Company and GPLP entered into an assignment and
assumption agreement whereby GPLP contributed EA to the Company in exchange for
2,300,000 shares of preferred stock ("Preferred Stock") of the Company. In
addition, the Company issued 2,484,375 shares of common stock to certain
employees. The Preferred Stock held by GPLP contained voting rights equal to two
votes for each share of common stock into which the Preferred Stock would
convert. As a result, GPLP held approximately 70% of the voting rights of the
Company, thereby retaining a controlling interest in the Company.
In March 1997, the Company restructured its ownership interests through the
conversion of the 2,300,000 shares of Preferred Stock into 1,725,000 shares of
common stock, the conversion of notes payable to related parties (Cyrk and GPLP)
into 2,900,000 shares of Series A redeemable preferred stock ("Series A
Preferred Stock") (see Note 10), the payment of $1,000,000 to discharge certain
indebtedness to Cyrk, and the sale of 2,555,556 shares of Series B redeemable
convertible preferred stock ("Series B Preferred Stock") to venture capital
investors. As a result of the issuance of Series B Preferred Stock, GPLP and
Cyrk's ownership of the Company decreased to approximately 11% and
F-7
<PAGE> 77
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
38%, respectively, on an as-converted basis. Accordingly, neither GPLP nor Cyrk
retained a controlling interest in the Company.
The accompanying consolidated financial statements prior to the formation
of the Company represent the financial results of the EA division as included in
the consolidated financial statements of GPI from January 1, 1995 to March 27,
1995 and of GPLP from March 28, 1995 to November 14, 1996.
General corporate overhead costs related to corporate headquarters and
shared administrative support were allocated by GPI and GPLP to EA based on a
number of factors, including, for example, personnel and space utilized.
Management believes these allocations were reasonable and the costs of the
services charged to the Company were not materially different from the costs
that would have been incurred if the Company had performed these functions as a
standalone entity.
(2) SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the application
of certain significant accounting policies as described in this note and
elsewhere in the accompanying consolidated financial statements and notes.
(a) Principles of Consolidation
The accompanying consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All significant
intercompany balances have been eliminated in consolidation.
(b) Interim Financial Statements
The accompanying consolidated financial statements as of September 30,
1997 are unaudited but, in the opinion of management, include all
adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of results of operations for the interim period.
Certain financial information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been omitted with respect to the nine-month
period, although the Company believes that the disclosures included are
adequate to make the information presented not misleading. Interim results
are not necessarily indicative of results for a full year.
(c) Net Loss Per Share
In accordance with Statement of Financial Accounting Standards
("SFAS") No. 128, Earnings per Share, basic and diluted net loss per common
share is calculated by dividing the net loss applicable to common
stockholders by the weighted average number of vested common shares
outstanding (See Note 12(b)) for all periods subsequent to November 14,
1996 presented. The basic and diluted net loss per share for the year ended
December 31, 1996 differs significantly from other periods presented as a
result of the weighted average number of common shares outstanding, which
was computed using 1,205,541 vested shares of common stock issued on
November 15, 1996, weighted for the entire year ended December 31, 1996.
Pro forma basic and diluted net loss per share is calculated by dividing
net loss by the weighted average number of vested shares of common stock
and preferred stock, on an as-converted basis, outstanding during the
period.
F-8
<PAGE> 78
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
In accordance with SAB No. 98, the Company has determined that there
were no nominal issuances of the Company's common stock prior to the
Company's planned initial public offering. The dilutive effect of potential
common shares, consisting of outstanding stock options and convertible
preferred stock, is determined using the treasury stock method and the as-
converted method, respectively, in accordance with SFAS No. 128. The
following table reconciles the weighted average common shares outstanding
to the shares used in the computation of basic and diluted and pro forma
basic and diluted weighted average common shares outstanding:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------------- ---------------------
1995 1996 1997 1997 1998
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Weighted average common
shares outstanding......... 319,906 3,575,244 3,475,265 3,905,697
Less: Weighted average
unvested common shares
outstanding................ 164,736 655,469 716,316 264,872
--------- --------- --------- ---------
Basic and diluted weighted
average common shares
outstanding................ 155,170 2,919,775 2,758,949 3,640,825
========= ========= ========= =========
Add: Weighted average common
shares issuable upon
conversion of preferred
stock...................... 2,471,004 3,779,510
--------- ---------
Pro forma basic and diluted
weighted average common
shares outstanding......... 5,390,779 7,420,335
========= =========
Number of shares of Common
Stock to be issued pursuant
to the proposed initial
public offering sufficient
to generate the proceeds
for the redemption of the
Redeemable Preferred Stock
in the amount of $1,635,000
upon the consummation of a
public offering that is not
a Qualified Public Offering
(Note 10).................. 195,221 195,221
--------- ---------
Supplemental pro forma basic
and diluted weighted
average common shares
outstanding................ 5,586,000 7,615,556
========= =========
</TABLE>
Diluted weighted average shares outstanding for all periods presented
exclude the potential common shares from stock options, unvested common
stock and convertible preferred stock, because to include such shares would
have been antidilutive. As of December 31, 1996 and 1997, and September 30,
1998, 3,004,334, 5,598,003 and 6,058,697 potential common shares were
outstanding, respectively.
F-9
<PAGE> 79
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(d) Cash Equivalents and Marketable Securities
The Company accounts for cash equivalents and marketable securities in
accordance with SFAS No. 115, Accounting for Certain Investments in Debt
and Equity Securities. Cash equivalents are short-term, highly liquid
investments with original maturity dates of three months or less. Cash
equivalents are carried at cost, which approximates fair market value. The
Company's marketable securities are classified as available-for-sale and
are recorded at fair value with any unrealized gain or loss recorded as an
element of stockholders' equity (deficit). As of December 31, 1997 and
September 30, 1998, the Company's marketable securities consisted of
investment-grade corporate bonds. As of December 31, 1997 and September 30,
1998, the Company had recorded unrealized gains of approximately $3,000 and
$6,000, respectively.
(e) Long-Lived Assets
In accordance with the provisions of SFAS No. 121, Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed
Of, the Company evaluates the realizability of its long-lived assets at
each reporting period based on projected future cash flows. As of December
31, 1996 and 1997 and September 30, 1998, the Company has determined that
no material adjustment to the carrying value of its long-lived assets was
required.
(f) Software Development Costs
The Company's VALEX software is highly technical and required a
significant engineering and development effort. In accordance with SFAS No.
86, Accounting for the Costs of Computer Software To Be Sold, Leased or
Otherwise Marketed, during 1994, 1995 and 1996, the Company capitalized
certain software development costs relating to VALEX incurred from the date
technological feasibility of the software development project had been
established through June 1996. These costs were amortized over an estimated
useful life of 18 months commencing with the general availability of the
product in June 1996. For the years ended December 31, 1995, 1996 and 1997
and the nine months ended September 30, 1997, the Company charged
approximately $0, $712,000, $1,211,000 and $961,000, respectively, to the
cost of software license fee revenues for the amortization of these costs.
As of December 31, 1997, capitalized software development costs were fully
amortized.
The software development costs incurred subsequent to the commercial
release of VALEX were primarily related to product enhancements and product
maintenance. Consequently, software development costs that would otherwise
be capitalized were not material and, therefore, were expensed as incurred.
(g) Income Taxes
The Company accounts for income taxes in accordance with the
provisions of SFAS No. 109, Accounting for Income Taxes. This statement
requires the Company to recognize a current tax liability or asset for
current taxes payable or refundable and to record a deferred tax asset or
liability for the estimated future tax effects of temporary differences and
carryforwards to the extent they are realizable. A deferred tax provision
or benefit results from the net change in deferred tax assets and
liabilities during the year. A deferred tax valuation allowance is required
if it is "more likely than not" that all or a portion of the recorded
deferred tax assets will not be realized.
F-10
<PAGE> 80
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(h) Financial Instruments
SFAS No. 107, Disclosure About Fair Value of Financial Instruments,
requires disclosures about the fair value of financial instruments.
Financial instruments consist principally of cash equivalents, marketable
securities, accounts receivable, accounts payable, notes payable to related
parties and redeemable preferred stock. The estimated fair value of these
financial instruments approximates their carrying value.
(i) Concentration of Credit Risk
SFAS No. 105, Disclosure of Information About Financial Instruments
with Off-Balance-Sheet Risk and Financial Instruments with Concentrations
of Credit Risk, requires disclosure of any significant off-balance-sheet
and credit risk concentrations. The Company has no significant
off-balance-sheet concentration of credit risk such as foreign exchange
contracts, option contracts or other foreign hedging arrangements.
Financial instruments that potentially subject the Company to
concentrations of credit risk are principally cash equivalents, marketable
securities and accounts receivable. Concentration of credit risk with
respect to accounts receivable is limited to certain customers to whom the
Company makes substantial sales. The Company performs periodic credit
evaluations of its customers and has recorded allowances for estimated
losses.
The following table summarizes the number of customers that
individually comprise greater than 10% of total revenue and/or total
accounts receivable and their aggregate percentage of the Company's total
revenues and accounts receivable.
<TABLE>
<CAPTION>
REVENUE ACCOUNTS RECEIVABLE
----------------------- --------------------------
PERCENT OF PERCENT OF
NUMBER OF TOTAL NUMBER OF TOTAL ACCOUNT
CUSTOMERS REVENUE CUSTOMERS RECEIVABLES
--------- ---------- --------- -------------
<S> <C> <C> <C> <C>
Year Ended --
December 31, 1995.................. 4 78% 3 48%
December 31, 1996.................. 3 41 4 74
December 31, 1997.................. 2 56 2 66
Nine Months Ended --
September 30, 1997................. 2 60 4 70
September 30, 1998................. 1 18 3 34
</TABLE>
(j) Foreign Currency
The functional currencies of the Company's wholly owned subsidiaries
in the United Kingdom and Australia are the local currencies. The financial
statements of the subsidiaries are translated to United States dollars
using period-end exchange rates for assets and liabilities and average
exchange rates during the corresponding period for revenues, cost of
revenues and expenses. Translation gains and losses are deferred and
accumulated as a component of stockholders' equity (deficit). Net gains and
losses resulting from foreign exchange transactions are included in the
consolidated statements of operations and were not significant during the
periods presented.
F-11
<PAGE> 81
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(k) Revenue Recognition
The Company generates revenue from licensing the rights to use its
software to end users and certain re-sellers. The Company also generates
service and maintenance revenues from integrating its software with its
customers' operating environments, the sale of maintenance services and the
sale of certain other consulting and development services.
The Company has recognized revenue in accordance with the provisions
of Statement of Position ("SOP") No. 91-1, Software Revenue Recognition. In
October 1997, the American Institute of Certified Public Accountants
("AICPA") issued SOP 97-2, Software Revenue Recognition, which supercedes
SOP 91-1 and is effective for transactions entered into for fiscal years
beginning after December 15, 1997. The Company adopted the provisions of
SOP 97-2 for the year ended December 31, 1997. The adoption of this
statement did not have a material impact on the Company's results of
operations or financial position.
Revenues from software license fee agreements are recognized upon
execution of a license agreement and delivery of the software, provided
that the fee is fixed or determinable and deemed collectible by management.
If conditions for acceptance are required subsequent to delivery, revenues
are recognized upon customer acceptance. Revenues from software maintenance
agreements are recognized ratably over the term of the maintenance period,
which is typically one year. Revenues from professional service
arrangements are recognized on either a time and materials or
percentage-of-completion basis as the services are performed, provided that
amounts due from customers are fixed or determinable and deemed collectible
by management. Amounts collected or billed prior to satisfying the above
revenue recognition criteria are reflected as deferred revenue or as
customer deposits.
Cost of software license fee revenues consists of costs to distribute
the product, including the cost of the media on which it is delivered and
royalty payments to third party vendors, as well as the amortization of
software development costs. Cost of service and maintenance revenues
consists primarily of consulting and support personnel salaries and related
costs.
The Company provides for estimated warranty costs at the time software
license fee revenue is recognized.
(l) Accounting for Stock-Based Compensation
In 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based
Compensation. As permitted by SFAS No. 123, the Company has continued to
account for employee stock options in accordance with Accounting Principles
Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and
has included the pro forma disclosures required by SFAS No. 123 for all
periods presented.
(m) New Accounting Standards
In April 1998, the AICPA issued SOP 98-5, Reporting on the Costs of
Start-Up Activities, which requires that all nongovernmental entities
expense the costs of start-up activities, including organizational costs,
as those costs are incurred. The Company has historically recorded all such
costs as expenses, in the period incurred.
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 requires
disclosure of all components of comprehensive income on an annual and
interim basis. Comprehensive income is defined as
F-12
<PAGE> 82
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
the change in stockholders' equity (deficit) of a business enterprise
during a period from transactions and other events and circumstances from
nonowner sources. The Company adopted SFAS No. 130, effective January 1,
1998, and has disclosed comprehensive income (loss) for all periods
presented in the accompanying consolidated statements of stockholders'
equity (deficit).
In July 1997, the FASB issued SFAS No. 131, Disclosures About Segments
of an Enterprise and Related Information. SFAS No. 131 requires certain
financial and supplementary information to be disclosed on an annual and
interim basis for each reportable segment of an enterprise. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997. Unless
impracticable, companies would be required to restate prior period
information upon adoption. The Company does not believe the adoption of
this accounting pronouncement will have a significant impact on the
Company's financial statements.
(n) Postretirement Benefits
The Company has no obligations for postretirement benefits.
(o) 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, the
disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those
estimates.
(3) PRO FORMA CONVERSION AND RETIREMENT OF PREFERRED STOCK
On July 15, 1998, the Board of Directors of the Company authorized
management to pursue an initial public offering ("IPO") of the Company's common
stock. Upon closing of the Company's proposed IPO, all of the Company's Series B
and Series C Preferred Stock will automatically convert into 3,779,510 shares of
common stock, or in the event of a public offering that is not a Qualified
Public Offering, 3,879,510 shares of common stock (see Note 10). At the midpoint
of the filing range for the proposed IPO, the Company will not satisfy the
conditions of a qualified offering as defined in Note 10. On November 12, 1998,
the terms of the redemption preference for Series A and Series B Preferred Stock
was amended as described in Note 10. Based on the terms of the amended
redemption preference of the Series A Preferred Stock, Series A Preferred Stock
will be cancelled and the Company will be required to pay 50% of the redemption
preference of $3,269,000. As a result, $1,634,000 will be reclassified to
additional paid-in capital (see Note 10). The pro forma effect of the conversion
and cancellation of the preferred stock on stockholders' equity (deficit) has
been presented separately in the Company's accompanying consolidated balance
sheets and consolidated statements of stockholders' equity (deficit) and Note
11, assuming the conversion and cancellation had occurred as of September 30,
1998.
(4) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated depreciation
and amortization. The Company provides for depreciation and amortization using
the straight-line method to allocate
F-13
<PAGE> 83
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
the cost of property and equipment over their estimated useful lives. Property
and equipment, at cost, and their estimated useful lives are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
ESTIMATED --------------- -------------
USEFUL LIFE 1996 1997 1998
----------- ---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Computers and equipment................. 4 years $ 621 $ 912 $1,589
Furniture and fixtures.................. 10 years 156 307 524
Purchased software...................... 3 years 45 60 527
Leasehold improvements.................. Life of the lease 8 39 93
----- ------ ------
830 1,318 2,733
Less -- Accumulated depreciation and
amortization.......................... 224 405 744
----- ------ ------
$ 606 $ 913 $1,989
===== ====== ======
</TABLE>
Depreciation and amortization expense for the years ended December 31,
1995, 1996 and 1997 and the nine months ended September 30, 1997 and 1998 was
approximately $49,000, $176,000, $275,000, $128,000 and $394,000, respectively.
(5) ACCRUED EXPENSES
Accrued expenses at December 31, 1996 and 1997 and September 30, 1998
consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
---------------- -------------
1996 1997 1998
------ ------ -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Payroll and related costs................. $ 859 $1,508 $2,177
Royalties................................. 153 283 77
Other..................................... 301 1,456 1,842
------ ------ ------
$1,313 $3,247 $4,096
====== ====== ======
</TABLE>
(6) INCOME TAXES
No provision for federal or state income taxes has been recorded, as the
Company incurred net operating losses for all periods presented. The Company had
net operating loss carryforwards of approximately $1,707,000 at September 30,
1998 to reduce future income taxes, if any. These carryforwards expire through
2018 and are subject to review and possible adjustment by the Internal Revenue
Service ("IRS").
The Tax Reform Act of 1986 contains provisions that may limit the amount of
net operating loss and credit carryforwards that the Company may utilize in any
one year in the event of certain cumulative changes in ownership over a
three-year period in excess of 50%, as defined. The Company believes it has
experienced a change in ownership in excess of 50%. The Company does not believe
that this change in ownership will significantly impact the Company's ability to
utilize its net operating loss carryforwards.
F-14
<PAGE> 84
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
The approximate tax effects of temporary differences that give rise to
significant portions of the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
-------------- -------------
1996 1997 1998
---- ---- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Nondeductible expenses and reserves................ $ 365 $ 465 $ 544
Net operating loss carryforwards................... -- 318 683
----- ----- -------
365 783 1,227
----- ----- -------
Valuation allowance................................ (365) (783) (1,227)
----- ----- -------
Net deferred tax asset................... $ -- $ -- $ --
===== ===== =======
</TABLE>
It is the Company's objective to become a profitable enterprise and to
realize the benefits of its deferred tax assets. However, in evaluating the
realizability of these deferred tax assets, management has considered the
Company's short operating history, the volatility of the market in which it
competes and the operating losses incurred to date, and believes that given the
significance of this evidence, a full valuation reserve against its deferred tax
assets is required as of December 31, 1996 and 1997 and September 30, 1998. The
increase in the valuation allowance during these periods relates primarily to
the Company's operating results.
(7) REVOLVING NOTE AGREEMENT
In December 1997, the Company entered into a $2,000,000 revolving note
agreement (the "Note") with a bank. Borrowings and the face amount of
outstanding letters of credit are limited to 75% of qualified receivables. As of
December 31, 1997 and September 30, 1998, letters of credit totaling $945,000
and $971,000, respectively, were outstanding. Borrowings under the Note bear
interest at the bank's prime rate (8.25% at September 30, 1998) plus .75% per
annum, payable monthly in arrears. The Note, which expires May 31, 1999, is
secured by substantially all assets of the Company. As of December 31, 1997 and
September 30, 1998, no borrowings were outstanding under the Note.
Under the Note agreement as amended, the Company must comply with certain
restrictive financial covenants. As of September 30, 1998 the Company was in
compliance with all financial covenants. As of December 31, 1997, the Company
had received waivers from the bank for all events of default.
(8) RELATED PARTY TRANSACTIONS
(a) Notes Payable
As of December 31, 1996, the Company had outstanding demand notes
payable totaling $2,960,000 to Cyrk and $274,000 to GPLP. These notes bore
interest at the prime rate payable monthly in arrears. Interest expense on
the demand notes payable amounted to approximately $41,000, $193,000 and
$43,000 for the years ended December 31, 1995 and 1996 and the nine months
ended September 30, 1997, respectively. On March 18, 1997, $1,000,000 of
principal and accrued interest was repaid and the remaining principal
balance on the Notes was converted into 2,900,000 shares of Series A
Preferred Stock (see Note 11).
F-15
<PAGE> 85
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(b) Transactions with GPLP
As discussed in Note 1, on November 15, 1996, the Company and GPLP
entered into an assignment and assumption agreement whereby the Company
received the EA business from GPLP in exchange for 2,300,000 shares of the
Company's convertible preferred stock. At the date of transfer, the total
liabilities of the EA business exceeded its total assets by approximately
$1,700,000. GPLP contributed $870,000 of its advances to EA to the capital
of the Company.
(c) Exchange Marketing Group
In March 1997, the Company entered into an employment termination
agreement with an officer of the Company. Upon termination, the officer
established Exchange Marketing Group ("EMG"). The Company repurchased
341,125 shares of common stock from the officer and six other employees who
also terminated their employment with the Company.
In March 1997, the Company loaned EMG $350,000, as evidenced by a note
receivable. This note accrued interest at 9% per annum with quarterly
interest payments due commencing June 30, 1997. This note and all accrued
interest were repaid in February 1998.
(9) COMMITMENTS
(a) Lease Obligations
The Company leases certain equipment under agreements that are
accounted for as capital leases and expire at various dates through year
2001. Interest rates on these leases range from 12.0% to 14.5%.
The Company has certain noncancellable operating leases for facilities
and equipment. The operating leases expire at various dates through the
year 2003. The Company has letters of credit outstanding with a bank (see
Note 7) for $971,000 as collateral on its leased facilities and certain
equipment. Total rent expense, net of sublease rent income, under these
agreements was approximately $17,000, $239,000, $399,000, $227,000 and
$637,000 for the years ended December 31, 1995, 1996 and 1997 and the nine
months ended September 30, 1997 and 1998, respectively.
At September 30, 1998, the minimum lease commitments for all leased
facilities and equipment with an initial or remaining term in excess of one
year are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
(IN THOUSANDS)
<S> <C> <C>
1998, (three months).................................... $ 75 $ 361
1999.................................................... 246 1,593
2000.................................................... 125 1,624
2001.................................................... 31 1,510
2002.................................................... -- 1,297
Thereafter.............................................. -- 486
---- ------
Total minimum payments........................ 477 $6,871
======
Less -- Amount representing interest.................... 51
----
Principal obligation.......................... 426
Less -- Current portion................................. 249
----
$177
====
</TABLE>
F-16
<PAGE> 86
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
As of September 30, 1998, the Company had entered into two sublease
agreements that will reduce rent expense by approximately $275,000 for the three
months ended December 31, 1998 and $550,000, $355,000 and $236,000 for the years
ended December 31, 1999, 2000 and 2001, respectively. For the nine-months ended
September 30, 1998, $151,000 sublease rent income was included in the net rent
expense mentioned above.
(b) Royalty
The Company licensed certain intellectual property from a third party,
which has been integrated with VALEX, under a royalty-bearing agreement.
Under the terms of the license agreement, the Company is required to pay
royalties to the licensor totaling approximately $656,000 on the first
$10,000,000 of cumulative VALEX license fees. In the second quarter of
1998, the aggregate sales of VALEX had exceeded the $10,000,000 limit.
Accordingly, the Company has no further royalty obligation under this
agreement. For the years ended December 31, 1995, 1996 and 1997 and the
nine months ended September 30, 1997 and 1998, the Company charged
royalties of approximately $0, $114,000, $456,000, $343,000 and $86,000,
respectively, to the cost of software license fees relating to this
agreement.
(10) PREFERRED STOCK
At incorporation on November 7, 1996, the Company authorized 10,000,000
shares of $.001 par value Preferred Stock for future issuance in one or more
series. On November 15, 1996, the Company issued 2,300,000 shares of Preferred
Stock to GPLP in consideration for a capital contribution of $870,000, as
discussed in Note 1 and Note 8(b).
On March 18, 1997, the Company converted all of its previously outstanding
shares of Preferred Stock into 1,725,000 shares of common stock. The Company
then amended its certificate of incorporation to reduce the number of authorized
shares of its $.001 par value preferred stock to 5,455,556 shares, of which
2,900,000 shares were designated as Series A Preferred Stock and 2,555,556
shares were designated Series B Preferred Stock. The 2,900,000 shares of Series
A Preferred Stock were issued upon the conversion of $2,405,000 of notes payable
to the related parties, as discussed in Note 8(a). The 2,555,556 shares of
Series B Preferred Stock were sold to venture capital investors at a price of
$1.565 per share, with net proceeds to the Company of $3,888,000.
On December 4, 1997, the Company authorized an additional 1,223,954 shares
of $.001 par value Preferred Stock and designated these shares as Series C
Convertible Preferred Stock ("Series C Preferred Stock"). The 1,223,954 shares
of the Series C Preferred Stock were sold to venture capital investors at a
price of $3.268 per share, with net proceeds to the Company of $3,987,000.
The Company loaned $125,000 to an officer for the purchase of approximately
38,000 shares of Series B Preferred Stock from another stockholder. The loan is
evidenced by a note that bears interest at the prime rate and is secured by the
38,000 shares of Series B Preferred Stock the officer purchased. The Company has
accounted for this loan as a stock subscription receivable classified as Due
from Officer in the accompanying consolidated statements of stockholders' equity
(deficit) as of December 31, 1997 and September 30, 1998.
The rights and preferences of the Company's preferred stock are as follows:
Dividends
Each outstanding share of Series A Preferred Stock accrues a
cumulative annual dividend of 8.25%. Holders of Series B Preferred Stock
and Series C Preferred Stock are entitled to a
F-17
<PAGE> 87
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
proportionate share of any cash or noncash common stock dividend as though
they were holders of the number of shares of common stock into which their
shares were convertible as of the date declared. To date, no dividends have
been declared. The Company has provided for Series A Preferred Stock
cumulative dividends by accreting charges against the accumulated deficit
with corresponding increases to the carrying value of the Series A
Preferred Stock. Such increases aggregated approximately $189,000, $130,000
and $180,000 for the year ended December 31, 1997 and the nine months ended
September 30, 1997 and 1998, respectively.
Liquidation Preference
Upon liquidation, the holders of Series C Preferred Stock are entitled
to receive $3.268 per share, plus all accrued or declared but unpaid
dividends, prior to any distribution to any holder of any share of any
other class or series of capital stock. If available assets are sufficient
to permit payment of the full preferential amounts on the Series C
Preferred Stock, then holders of Series B Preferred Stock are entitled to
receive out of any additional assets up to $1.565 per share, plus all
accrued or declared but unpaid dividends, and then holders of Series A
Preferred Stock are entitled to receive out of any additional assets up to
$1.00 per share, plus all accrued or declared but unpaid dividends. If the
assets available for distribution with respect to any such series of
capital stock are insufficient to permit the payment of the full
preferential amount on such series, as described above, then the holders of
such series shall share ratably on the distribution of assets within that
series of stock. If the remaining assets of the Company permit a
distribution to common stockholders, then holders of Series B Preferred
Stock are entitled to share ratably in such distribution with the holders
of common stock as if their shares had been converted to common stock.
Redemption
The Company may at any time redeem all or any portion of the shares of
Series A Preferred Stock then outstanding at $1.00 per share, plus all
accrued or declared but unpaid dividends. The number of shares to be
redeemed by each holder shall be equal to each specific holder's pro rata
share of the total amount outstanding.
If upon any redemption of Series A Preferred Stock the assets
available for redemption are insufficient to pay to the holders of Series A
Preferred Stock the full redemption value, the holders of a majority of
Series A Preferred Stock may elect (i) that no redemption be made (in which
event all rights in respect of the shares to be redeemed shall continue in
full force and effect) or (ii) that the holders shall share ratably in the
redemption according to the respective amounts which would have been
payable to them.
Upon an IPO with gross proceeds of at least $20,000,000 at an offering
price per common share such that the amount obtained by multiplying such
offering price by the number of common stock equivalents, as defined,
outstanding immediately after such offering would be at least $130,000,000
(a "Qualified Offering"), all shares of Series A Preferred Stock would be
automatically canceled and the shares outstanding prior to such closing
would no longer be deemed to be outstanding.
In the event that the Company completes an IPO that is not a Qualified
Offering, holders of Series A Preferred Stock have the option to redeem all
shares held for $0.50 per share plus fifty percent of all accrued or
declared but unpaid dividends. All shares surrendered under such redemption
shall be canceled. Subsequent to redemption, all rights in respect of the
Series A
F-18
<PAGE> 88
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
Preferred Stock, except the right to receive the liquidation preference,
shall cease and terminate, and such shares shall no longer be deemed to be
outstanding.
In connection with the proposed IPO, the Company does not expect to
satisfy the conditions of a Qualified Offering. Accordingly, based upon the
terms of the Series A redemption and upon the closing of the IPO, Series A
Preferred Stock in the amount of $1,634,000 will be reclassified as
additional paid-in capital.
Voting
Holders of Series A Preferred Stock do not have voting rights. Each
share of Series B and Series C Preferred Stock votes ratably with the
common stockholders as if their shares had been converted to common stock.
Conversion
Holders of Series B and Series C Preferred Stock have the option to
convert any such shares into common shares at any time. Upon a conversion
of each share of Series B and Series C Preferred Stock, the number of
common shares to be issued is an amount equal to their respective
liquidation preferences divided by the product of the number of shares
being converted and the conversion price at that time, as defined.
The conversion price shall initially be the respective per share
liquidation preference for each series of preferred stock and is subject to
adjustment in the event that common stock or common stock equivalents are
issued for less per share than the conversion price, subject to certain
exceptions.
Upon closing of any IPO, all outstanding shares of preferred stock
shall be automatically converted into that number of shares of common stock
as would have been the case in the event of an optional conversion. All
rights with respect to the preferred stock shall be deemed automatically
waived upon such conversion.
In the event that the Company completes an IPO that is a Qualified
Offering, all 2,555,556 outstanding shares of Series B Preferred Stock will
be converted into 2,555,556 shares of common stock. In the event that the
Company completes an IPO that is not a Qualified Offering, all 2,555,556
outstanding shares of Series B Preferred Stock will be converted into
2,655,556 shares of common stock. All 1,223,954 outstanding shares of
Series C Preferred Stock will be converted into 1,223,954 shares of common
stock.
F-19
<PAGE> 89
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(11) REDEEMABLE PREFERRED STOCK
The following is a summary of the activity for the Series A and Series B
Preferred Stock:
<TABLE>
<CAPTION>
SERIES A SERIES B
REDEEMABLE CONVERTIBLE REDEEMABLE
PREFERRED STOCK PREFERRED STOCK
----------------------- ----------------------- TOTAL
NUMBER OF REDEMPTION NUMBER OF REDEMPTION REDEMPTION
SHARES VALUE SHARES VALUE VALUE
--------- ---------- --------- ---------- ----------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996...... -- $ -- -- $ -- $ --
Conversion of notes payable to
related parties into Series
A Preferred Stock.......... 2,900,000 2,405 -- -- 2,405
Issuance of Series B Preferred
Stock...................... -- -- 2,555,556 3,999 3,999
Accretion of discount and
dividends on Series A
Preferred Stock............ -- 684 -- -- 684
---------- ------- ---------- ------- -------
Balance, December 31, 1997...... 2,900,000 3,089 2,555,556 3,999 7,088
Accretion of dividends on
Series A Preferred Stock... -- 180 -- -- 180
---------- ------- ---------- ------- -------
Balance, September 30, 1998..... 2,900,000 3,269 2,555,556 3,999 7,268
Pro forma effect of proposed
IPO:
Retirement of Series A
Preferred Stock............ -- (1,634) -- -- (1,634)
Conversion of Series B
Preferred Stock to common
stock...................... -- -- (2,555,556) (3,999) (3,999)
---------- ------- ---------- ------- -------
Pro Forma Balance, September 30,
1998 (unaudited) (Note 3)..... 2,900,000 $ 1,635 -- $ -- $ 1,635
========== ======= ========== ======= =======
</TABLE>
During 1997, the Company issued Series A Preferred Stock at a discount of
$495,000 from its redemption value. The Company accreted this discount to the
Series A Preferred Stock through a charge to accumulated deficit upon issuance.
(12) STOCKHOLDERS' EQUITY (DEFICIT)
(a) Common Stock
At incorporation, the Company authorized 10,000,000 shares of $.001
par value common stock. In March 1997 and December 1997 and July 1998, the
Company amended its certificate of incorporation to increase the number of
authorized shares of $.001 par value common stock to a total of 30,000,000
shares.
The Company has reserved 3,879,510 shares of common stock for the
potential conversion of Series B and Series C Preferred Stock into common
stock. The Company also has reserved 3,724,963 shares of common stock for
the issuance of stock options under the 1996 Stock Incentive Plan. On July
15, 1998, the Company reserved additional shares of common stock in
connection with the adoption of the 1998 Stock Incentive Plan, an Employee
Stock Purchase Plan and a Directors' Stock Option Plan. (See Note 17).
F-20
<PAGE> 90
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(b) Restricted Common Stock
At incorporation, the Company issued 2,484,375 shares of common stock
to the Company's founders and employees at $.001 per share, the fair market
value as determined by the Board of Directors at the time of issuance.
In connection with the issuance of common stock, the Company and two
of its founders signed a Founder Restricted Stock Agreement (the "Founder
Agreement"). These shares vested 50% immediately with the balance vesting
ratably on an annual basis through January 1, 1999.
As provided in the Founder Agreement, if the employment of the
founders is terminated, the Company has the option (the "Company Option")
to purchase their unvested stock. This Company Option shall be exercisable
by the Company at a price equal to the lesser of the issue price or the
fair market value of the stock as determined by the Board of Directors. In
March 1997, one of the founders terminated employment, resulting in the
Company's repurchase of unvested common shares (see Note 8(c)).
In addition, on November 15, 1996, the Company and all of its
employees holding common stock, excluding the two founders, signed
restricted stock agreements (the "Restricted Stock Agreements") providing
for shares issued from the 1996 Stock Incentive Plan to vest retroactively,
25% on the respective employee's date of hire with an additional 25% on
each anniversary thereafter.
According to the Restricted Stock Agreements, if an employee ceases to
provide services to the Company either as a consultant or employee prior to
the third anniversary of the date of hire, the Company has the right to
repurchase the unvested stock from the employee at the price paid by the
employee.
In the event of a change of control, as defined, all remaining
unvested stock held by the founders and employees issued under the Founder
Agreement and Restricted Stock Agreements shall be deemed vested and the
Company's options to repurchase unvested shares of restricted common stock
shall immediately terminate. The completion of the Offering does not
constitute a change of control under the Founder Agreement or any of the
Restricted Stock Agreements.
In March 1997, the Company repurchased 341,125 shares of unvested
common stock at $.001 per share from an officer and six employees who
terminated their employment with the Company. (See Note 8(c)). As of
September 30, 1998 the Company has repurchased an additional 23,880 shares
of unvested common stock at $.001 per share since March 1997 from other
terminated employees.
(13) STOCK OPTIONS
In November 1996, the Company adopted the 1996 Stock Incentive Plan (the
1996 Plan), which provides for the grant of incentive stock options,
nonqualified stock options and restricted common stock to officers, employees
and directors who are also employees of the Company. Nonemployee directors and
outside consultants to the Company are eligible to receive nonqualified options
and restricted common stock only.
The 1996 Plan is administered by the Board of Directors, which determines
the fair market value and the purchase price for such options. Options generally
vest over a four-year period and expire 10 years from the date of grant.
Restricted common stock awards entitle recipients to purchase shares of the
Company's common stock subject to restrictions concerning the sale, transfer and
other disposition of the shares issued until such shares are vested. The shares
subject to options that
F-21
<PAGE> 91
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
expire or are not exercised for other reasons, or any restricted common stock
that is repurchased by the Company will be available for future grant under the
1996 Plan.
In addition, the 1996 Plan provides for the granting of time accelerated
incentive stock options. During 1997 and 1998, approximately 590,000 time
accelerated incentive stock options were granted to certain employees. These
options vest and become exercisable 25% annually upon the achievement of certain
performance criteria (the "Criteria") as approved by the Company on an annual
basis, or after nine years from the date of grant. The Criteria, which are set
each year by the Board of Directors, allows for vesting upon the achievement of
the Criteria as of December 31 for that year.
Stock option activity from the 1996 Plan's inception through September 30,
1998 is as follows:
<TABLE>
<CAPTION>
NUMBER OF RANGE OF WEIGHTED AVERAGE
SHARES EXERCISE PRICES EXERCISE PRICE
--------- --------------- ----------------
<S> <C> <C> <C>
Outstanding, December 31, 1995............. -- $ -- $ --
Granted.................................. 968,575 0.001 0.001
Exercised................................ (968,575) 0.001 0.001
--------- --------------- ------
Outstanding, December 31, 1996............. -- -- --
Granted.................................. 1,449,475 0.65 - 1.35 0.74
Exercised................................ (10,096) 0.65 0.65
Canceled................................. (40,154) 0.65 - 0.85 0.66
--------- --------------- ------
Outstanding, December 31, 1997............. 1,399,225 0.65 - 1.35 0.74
Granted.................................. 827,500 1.35 - 14.50 7.59
Exercised................................ (77,709) 0.65 - 0.85 0.66
Canceled................................. (68,608) 0.65 - 14.50 2.04
--------- --------------- ------
Outstanding, September 30, 1998............ 2,080,408 $ 0.65 - $14.50 $ 3.43
========= =============== ======
Exercisable, September 30, 1998............ 309,591 $ 0.65 - $ 1.35 $ 0.72
========= =============== ======
</TABLE>
In connection with certain stock option grants in March 1998, the Company
recorded $540,000 of deferred compensation expense, which is being amortized and
charged to operations over the four-year vesting period of the related options.
Total option-related compensation expense for the nine months ended September
30, 1998 was $101,000.
On November 10, 1998 the Company amended the terms of all Stock Option
Agreements granted between May 1, 1998 and September 30, 1998 to reflect a
$10.00 per share exercise price. Subsequent to September 30, 1998, the Company
has granted options to purchase 341,500 shares of Common Stock at $10.00 per
share. These options are subject to annual vesting over a four year period.
F-22
<PAGE> 92
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
The Company has computed the pro forma disclosures required under SFAS No.
123 for options granted during 1996, 1997 and 1998 using the Black-Scholes
option pricing model prescribed by SFAS No. 123. The weighted average
assumptions used were as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, NINE MONTHS
---------------------- ENDED
1996 1997 SEPTEMBER 30, 1998
---- ---- ------------------
<S> <C> <C> <C>
Risk-free interest rate................... 6.3% 5.96% 5.40%
Expected dividend yield................... -- -- --
Expected lives............................ 4 years 4 years 4 years
Expected volatility....................... 76% 79% 79%
Weighted average grant date fair value.... $.002 $.46 $1.40
Weighted average remaining contractual
life of options outstanding............. 9.9 years 9.1 years 8.3 years
</TABLE>
Had compensation expense for the Company's stock option plans been
determined consistent with SFAS No. 123, net loss and net loss per share would
have been approximately as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, NINE MONTHS
------------------ ENDED
1996 1997 SEPTEMBER 30, 1998
---- ---- ------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
As reported --
Net loss applicable to common
stockholders.......................... $(1,606) $(3,283) $(1,257)
======= ======= =======
Basic and diluted net loss per share..... $ (1.33) $ (1.12) $ (0.35)
======= ======= =======
Pro forma --
Net loss applicable to common
stockholders.......................... $(1,607) $(3,455) $(2,370)
======= ======= =======
Basic and diluted net loss per share..... $ (1.33) $ (1.18) $ (0.65)
======= ======= =======
</TABLE>
(14) EMPLOYEE BENEFIT PLAN
The Company has a qualified 401(k) savings plan (the "401(k) Plan")
covering all of the Company's eligible full-time employees. Under this plan,
participants may elect to defer a portion of their compensation, subject to
certain IRS limitations. The Company does not currently provide employer
matching contributions under the 401(k) Plan.
F-23
<PAGE> 93
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(15) GEOGRAPHIC INFORMATION
Revenues by geographic destination as a percentage of total revenues are as
follows:
<TABLE>
<CAPTION>
NINE MONTHS
YEARS ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------- --------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
United States.................................. 81% 96% 86% 94% 66%
United Kingdom................................. -- -- 5 1 22%
Canada......................................... 19 4 8 5 10
Other.......................................... -- -- 1 -- 2%
--- --- --- ---- ---
100% 100% 100% 100% 100%
=== === === ==== ===
</TABLE>
The Company established a foreign subsidiary in the United Kingdom in July
1997 and in Australia in January 1998. Operations in various geographic areas,
since the inception of that entity, are summarized as follows:
<TABLE>
<CAPTION>
UNITED UNITED
STATES KINGDOM AUSTRALIA ELIMINATIONS CONSOLIDATED
------ ------- --------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1997
Total revenues...................... $12,092 $ 577 $ -- -- $12,669
======= ====== =======
Net loss............................ $(2,572) $ (27) $ -- -- $(2,599)
======= ====== =======
Identifiable assets................. $11,078 $ 925 $ -- $ (603) $11,400
======= ====== ======= =======
Nine Months Ended September 30, 1998
Total revenues...................... $13,058 $4,098 $ 10 -- $17,166
======= ====== ===== =======
Net income (loss)................... $(2,659) $1,849 $(267) -- $(1,077)
======= ====== ===== =======
Identifiable assets................. $ 9,768 $3,318 $ 126 $(1,200) $12,012
======= ====== ===== ======= =======
</TABLE>
Information with respect to the years ended December 31, 1995, 1996 and the
nine months ended September 30, 1997 are not presented as the Company had no
material foreign operations during those periods.
(16) ALLOWANCE FOR DOUBTFUL ACCOUNTS
A summary of the allowance for doubtful accounts is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
--------------------- -------------
1995 1996 1997 1998
---- ---- ---- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance, beginning of period................ $ -- $ 75 $ 43 $206
Provision for doubtful accounts........... 121 99 180 124
Write-offs................................ (46) (131) (17) (49)
---- ----- ---- ----
Balance, end of period...................... $ 75 $ 43 $206 $281
==== ===== ==== ====
</TABLE>
F-24
<PAGE> 94
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(17) STOCK PLANS AND AMENDMENT TO CERTIFICATE OF INCORPORATION
On July 15, 1998, the Board of Directors and stockholders approved (i) the
adoption of the 1998 Stock Incentive Plan pursuant to which 2,700,000 additional
shares of the Company's common stock have been reserved for future issuance,
(ii) the adoption of an Employee Stock Purchase Plan pursuant to which 200,000
shares of the Company's common stock have been reserved for future issuance,
(iii) the adoption of a Directors' Stock Option Plan pursuant to which 100,000
shares of the Company's common stock have been reserved for future issuance,
(iv) an increase in the number of authorized shares of common stock to
30,000,000 shares and (v) the authorization of 10,000,000 shares of $.001 par
value preferred stock, of which the Board of Directors has full authority to
issue and fix the voting powers, preferences, rights, qualifications,
limitations or restrictions thereof, including dividend rights, conversion
rights, redemption privileges and liquidation preferences and the number of
shares constituting any series or designation of such series.
F-25
<PAGE> 95
BUILDING A CAMPAIGN WITH VALEX
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to run a campaign. Users quickly structure and schedule campaigns with the
time and event triggers by selecting "Campaign Management" to bring up the
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[Back page Graphic]
2. In this example, users drag and drop icons to design a three-branch
campaign. The first branch targets prospects; the middle branch targets
existing customers ripe for cross-selling; the third branch attempts to
retain customers likely to defect. Each branch connects to the most
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Promotion history is captured for all three branches in order to measure
campaign effectiveness.
[Back page Graphic]
3. Users can easily schedule dates and times to run campaigns. In this
example, the user has set the "Likely to Leave" campaign to run every
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[Back page Graphic]
[ART WORK]
[A graphic depicting a recreation of screens from a desktop
PC showing the VALEX Campaign decision tree.]
<PAGE> 96
- ----------------------------------------------------------
- ----------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
----------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................ 3
Risk Factors.............................. 6
Historical Background of the Company...... 14
Use of Proceeds........................... 15
Dividend Policy........................... 15
Capitalization............................ 16
Dilution.................................. 17
Selected Consolidated Financial Data...... 18
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.............................. 20
Business.................................. 32
Management................................ 46
Certain Transactions...................... 55
Principal and Selling Stockholders........ 58
Description of Capital Stock.............. 61
Shares Eligible for Future Sale........... 63
Underwriting.............................. 65
Legal Matters............................. 66
Experts................................... 66
Additional Information.................... 67
Index to Consolidated Financial
Statements.............................. F-1
</TABLE>
----------------------
UNTIL , 1999 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN
ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- ----------------------------------------------------------
- ----------------------------------------------------------
- ----------------------------------------------------------
- ----------------------------------------------------------
3,000,000 SHARES
[EXCHANGE APPLICATIONS LOGO]
COMMON STOCK
------------------------
PROSPECTUS
------------------------
BT ALEX. BROWN
HAMBRECHT & QUIST
ADAMS, HARKNESS & HILL, INC.
, 1998
- ----------------------------------------------------------
- ----------------------------------------------------------
<PAGE> 97
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. Other Expenses of Issuance and Distribution
Expenses of the Registrant in connection with the issuance and distribution
of the securities being registered, other than the underwriting discount, are
estimated as follows:
<TABLE>
<CAPTION>
TOTAL
-----
<S> <C>
SEC Registration Fee........................................ $ 16,000
NASD Fees................................................... $ 6,000
NASDAQ Listing Fees......................................... $ 96,000
Printing and Engraving Expenses............................. $ 150,000
Legal Fees and Expenses..................................... $ 350,000
Accountants' Fees and Expenses.............................. $ 515,000
Expenses of Qualification Under State Securities Laws,
Including Attorneys' Fees................................. $ 10,000
Transfer Agent and Registrar's Fees......................... $ 5,000
Miscellaneous Costs......................................... $ 2,000
----------
Total............................................. $1,150,000
==========
</TABLE>
ITEM 14. Indemnification of Directors, Officers and Employees
Section 145 of the Delaware General Corporation law empowers a Delaware
corporation to indemnify its officers and directors and certain other persons to
the extent and under the circumstances set forth therein.
The Amended and Restated Certificate of Incorporation of the Company and
the Amended and Restated By-laws of the Company, copies of which are filed as
Exhibits 3.1 and 3.2, provide for indemnification of officers and directors of
the Company and certain other persons against liabilities and expenses incurred
by any of them in certain stated proceedings and under certain stated
conditions.
ITEM 15. Recent Sales of Unregistered Securities
On November 15, 1996, in connection with the organization of the
Registrant, the Registrant entered into Restricted Stock Agreements dated as of
such date (Restricted Stock Agreements) with certain key employees of the
Registrant. Pursuant to the Restricted Stock Agreements, the Registrant issued
968,575 shares of restricted Common Stock under the Registrant's 1996 Stock
Incentive Plan to such employees for an aggregate consideration of $968.58 at a
purchase price of $.001 per share.
On November 15, 1996, in addition to the shares of restricted Common Stock
issued pursuant to the Registrant's 1996 Stock Incentive Plan, (i) the
Registrant issued 848,800 shares of restricted Common Stock to Andrew J. Frawley
for an aggregate consideration of $848.80 pursuant to a Restricted Stock
Agreement entered into between the Registrant and Andrew J. Frawley, and (ii)
the Registrant issued 667,000 shares of restricted Common Stock to Michael J.
Feldman for an aggregate consideration of $667.00 pursuant to a Restricted Stock
Agreement entered into between the Registrant and Michael J. Feldman.
The Registrant has, from time to time, repurchased an aggregate of 361,075
shares of Common Stock from its employees for an aggregate consideration of
$361.08.
II-1
<PAGE> 98
On November 15, 1996, in connection with the organization of the
Registrant, the Registrant entered into an Assignment and Assumption Agreement
dated as of such date (Assignment Agreement) with Grant & Partners Limited
Partnership (GPLP) pursuant to which the Registrant issued 2,300,000 shares of
Series A Convertible Preferred Stock to GPLP and assumed certain liabilities of
GPLP in exchange for certain assets of GPLP.
On March 18, 1997, the Registrant entered into a Securities Purchase
Agreement dated as of such date (Securities Purchase Agreement) with certain of
its existing stockholders and certain new investors. Pursuant to the Securities
Purchase Agreement, (i) the Registrant issued 1,154,775 shares of Series B
Preferred Stock to Insight Venture Partners II, L.P. for an aggregate
consideration of $1,807,222.88, (ii) the Registrant issued 1,154,775 shares of
Series B Preferred Stock to Wexford Insight LLC for an aggregate consideration
of $1,807,222.88, (iii) the Registrant issued 246,006 shares of Series B
Convertible Preferred Stock to GAP Coinvestment Partners, L.P. for an aggregate
consideration of $384,999.39, (iv) the Registrant converted 2,300,000 shares of
Series A Convertible Preferred Stock held by GPLP to 1,725,000 shares of Common
Stock, (v) the Registrant issued 377,408 shares of a newly designated Series A
Preferred Stock to GPLP in consideration of the cancellation of certain
indebtedness owed by the Registrant to GPLP, and (vi) the Registrant issued
2,522,592 shares of Series A Preferred Stock to Cyrk, Inc. (Cyrk) in
consideration of the cancellation of certain indebtedness owed by the Registrant
to Cyrk.
On October 3, 1997, the Registrant entered into a Subscription Agreement
dated as of such date with Michael Caccavale pursuant to which the Registrant
issued 15,500 shares of Common Stock to Michael Caccavale for an aggregate
consideration of $13,175.
On December 4, 1997, the Registrant entered into a Securities Purchase
Agreement dated as of such date with Insight Capital Partners II, L.P. and
Wexford Insight LLC pursuant to which (i) the Registrant issued 611,977 shares
of Series C Convertible Preferred Stock to Insight Capital Partners II, L.P. for
an aggregate consideration of $2,000,000, and (ii) the Registrant issued 611,977
shares of Series C Convertible Preferred Stock to Wexford Insight LLC for an
aggregate consideration of $2,000,000.
The Registrant has, from time to time, issued an aggregate of 87,810 shares
of restricted Common Stock to various employees upon the exercise of options
granted pursuant to the Registrant's 1996 Stock Incentive Plan for an aggregate
consideration of $57,708.25 at an average exercise price of $0.66 per share.
No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon an exemption from the registration provisions
of the Securities Act set forth in Section 4(2) thereof relating to sales by an
issuer not involving any public offering or the rules and regulations
thereunder, or, in the case of certain restricted shares, options to purchase
Common Stock and shares issuable upon the exercise of such options, Rule 701 of
the Act. All of the foregoing securities are deemed restricted securities for
purposes of the Act.
II-2
<PAGE> 99
ITEM 16. Exhibits and Financial Statement Schedules
(a) The following is a list of exhibits filed as a part of this
registration statement:
<TABLE>
<CAPTION>
EXHIBITS
- --------
<C> <S>
1.1 Form of Underwriting Agreement.
3.1 Form of Amended and Restated Certificate of Incorporation of
the Registrant. (previously filed)
3.2 Form of Amended and Restated By-laws of the Registrant.
(previously filed)
4.1* Specimen Certificate for Shares of the Registrant's Common
Stock, $0.001 par value.
5.1 Opinion of Bingham Dana LLP with respect to the legality of
the shares being registered.
10.1 Form of 1998 Stock Incentive Plan, with related forms of
stock option agreements. (previously filed)
10.2 1996 Stock Incentive Plan, as amended, with related forms of
stock option agreements and form of restricted stock
agreement. (previously filed)
10.3 Form of 1998 Director Stock Option Plan, with related form
of stock option agreement. (previously filed)
10.4 Form of 1998 Employee Stock Purchase Plan. (previously
filed)
10.5 401(k) Plan. (previously filed)
10.6 Employment Agreement, dated November 15, 1996, between the
Registrant and Andrew J. Frawley. (previously filed)
10.7 Restricted Stock Agreement, dated November 8, 1996, between
the Registrant and Andrew J. Frawley. (previously filed)
10.8 Consulting Agreement, dated March 18, 1997, between the
Registrant and Exchange Marketing Group, LLC. (previously
filed)
10.9 Securities Purchase Agreement, dated March 18, 1997.
(previously filed)
10.10 Securities Purchase Agreement, dated December 4, 1997.
(previously filed)
10.11 Stock Purchase and Waiver Agreement, dated December 4, 1997.
(previously filed)
10.12 Promissory Note, dated December 4, 1997, by Andrew J.
Frawley payable to the Registrant. (previously filed)
10.13 Amended and Restated Stockholders Agreement dated December
4, 1997. (previously filed)
10.14 Amended and Restated Registration Rights Agreement dated
December 4, 1997. (previously filed)
10.15 Letter Agreement, dated December 22, 1997, between the
Registrant and Fleet National Bank, as amended, and the
related Promissory Note. (previously filed)
10.16 Stock Purchase Agreement, dated June 25, 1998, and the
related Waiver Agreement to the Amended and Restated
Stockholders Agreement, dated June 25, 1998. (previously
filed)
10.17 Office lease for 89 South Street, Boston, Massachusetts.
(previously filed)
10.18 Assignment and Assumption Agreement, dated November 15,
1996, between the Registrant and Grant & Partners Limited
Partnership. (previously filed)
10.19 Termination Agreements, each dated March 18, 1997, between
the Registrant and the employee of the Registrant named
therein. (previously filed)
10.20 Consulting Agreement, dated March 18, 1997, between the
Registrant and Exchange Marketing Group, LLC. (previously
filed)
</TABLE>
II-3
<PAGE> 100
<TABLE>
<CAPTION>
EXHIBITS
- --------
<C> <S>
21.1 Subsidiaries of Registrant. (previously filed)
23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Bingham Dana LLP, counsel to Registrant (included
in Exhibit 5.1).
23.3* Consent of GartnerGroup
24.1 Power of Attorney (included in signature page to
Registration Statement as originally filed).
27.1 Financial Data Schedule (9 months ended September 30, 1998)
27.2 Financial Data Schedule (12 months ended December 31, 1997)
(previously filed)
27.3 Financial Data Schedule (12 months ended December 31, 1996)
(previously filed)
</TABLE>
- ---------------
* To be filed by amendment
(b) Financial Statement Schedules
SCHEDULES
All schedules have been omitted because either they are not required, are
not applicable or the information is otherwise set forth in the Consolidated
Financial Statements and notes thereto.
ITEM 17. Undertakings
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions described in Item 14 hereof, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes:
(1) To provide the Underwriter at the closing specified in the
Underwriting Agreement certificates in such denominations and registered in
such names as required by the Underwriter to permit prompt delivery to each
purchaser.
(2) That for purposes of determining any liability under the
Securities Act of 1933, the information omitted from the form of prospectus
filed as part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the Registrant pursuant to Rule
424(b)(1) or (4), or 497(h) under the Securities Act shall be deemed to be
part of this registration statement as of the time it was declared
effective.
(3) That for the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that contains a form
of prospectus shall be deemed to be a new registration statement relating
to the securities offered therein, and the Offering of such securities at
that time shall be deemed to be the initial bona fide offering thereof.
II-4
<PAGE> 101
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant,
Exchange Applications, Inc., has caused this Amendment No. 2 to the Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Boston, Commonwealth of Massachusetts, on this 7th
day of December, 1998.
EXCHANGE APPLICATIONS, INC.
By: /s/ ANDREW J. FRAWLEY
----------------------------------
Andrew J. Frawley
Chairman of the Board, President
and Chief Executive Officer
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to the Registration Statement has been signed below by the following
persons in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ ANDREW J. FRAWLEY Chairman of the Board, December 7, 1998
- --------------------------------------------------- President, Chief Executive
Andrew J. Frawley Officer and Director
(Principal Executive Officer)
/s/ DEAN F. GOODERMOTE* Director December 7, 1998
- ---------------------------------------------------
Dean F. Goodermote
/s/ JEFFREY HORING* Director December 7, 1998
- ---------------------------------------------------
Jeffrey Horing
/s/ RAMANAN RAGHAVENDRAN* Director December 7, 1998
- ---------------------------------------------------
Ramanan Raghavendran
/s/ JOHN G. O'BRIEN* Vice President, Chief December 7, 1998
- --------------------------------------------------- Financial Officer, Treasurer
John G. O'Brien and Secretary (Principal
Financial and Accounting
Officer)
*By: /s/ ANDREW J. FRAWLEY
---------------------------------------------
Andrew J. Frawley
as Attorney-in-Fact
</TABLE>
II-5
<PAGE> 102
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -------- -----------
<C> <S>
1.1 Form of Underwriting Agreement.
3.1 Form of Amended and Restated Certificate of Incorporation of
the Registrant. (previously filed)
3.2 Form of Amended and Restated By-laws of the Registrant.
(previously filed)
4.1* Specimen Certificate for Shares of the Registrant's Common
Stock, $0.001 par value.
5.1 Opinion of Bingham Dana LLP with respect to the legality of
the shares being registered.
10.1 Form of 1998 Stock Incentive Plan, with related forms of
stock option agreements. (previously filed)
10.2 1996 Stock Incentive Plan, as amended, with related forms of
stock option agreements and form of restricted stock
agreement. (previously filed)
10.3 Form of 1998 Director Stock Option Plan, with related form
of stock option agreement. (previously filed)
10.4 Form of 1998 Employee Stock Purchase Plan. (previously
filed)
10.5 401(k) Plan. (previously filed)
10.6 Employment Agreement, dated November 15, 1996, between the
Registrant and Andrew J. Frawley. (previously filed)
10.7 Restricted Stock Agreement, dated November 8, 1996, between
the Registrant and Andrew J. Frawley. (previously filed)
10.8 Consulting Agreement, dated March 18, 1997, between the
Registrant and Exchange Marketing Group, LLC. (previously
filed)
10.9 Securities Purchase Agreement, dated March 18, 1997.
(previously filed)
10.10 Securities Purchase Agreement, dated December 4, 1997.
(previously filed)
10.11 Stock Purchase and Waiver Agreement, dated December 4, 1997.
(previously filed)
10.12 Promissory Note, dated December 4, 1997, by Andrew J.
Frawley payable to the Registrant. (previously filed)
10.13 Amended and Restated Stockholders Agreement dated December
4, 1997. (previously filed)
10.14 Amended and Restated Registration Rights Agreement dated
December 4, 1997. (previously filed)
10.15 Letter Agreement, dated December 22, 1997, between the
Registrant and Fleet National Bank, as amended, and the
related Promissory Note. (previously filed)
10.16 Stock Purchase Agreement, dated June 25, 1998, and the
related Waiver Agreement to the Amended and Restated
Stockholders Agreement, dated June 25, 1998. (previously
filed)
10.17 Office lease for 89 South Street, Boston, Massachusetts.
(previously filed)
10.18 Assignment and Assumption Agreement, dated November 15,
1996, between the Registrant and Grant & Partners Limited
Partnership. (previously filed)
10.19 Termination Agreements, each dated March 18, 1997, between
the Registrant and the employee of the Registrant named
therein. (previously filed)
10.20 Consulting Agreement, dated March 18, 1997, between the
Registrant and Exchange Marketing Group, LLC. (previously
filed)
21.1 Subsidiaries of Registrant. (previously filed)
</TABLE>
<PAGE> 103
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -------- -----------
<C> <S>
23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Bingham Dana LLP, counsel to Registrant (included
in Exhibit 5.1).
23.3* Consent of GartnerGroup
24.1 Power of Attorney (included in signature page to
Registration Statement as originally filed).
27.1 Financial Data Schedule (9 months ended September 30, 1998)
27.2 Financial Data Schedule (12 months ended December 31, 1997)
(previously filed)
27.3 Financial Data Schedule (12 months ended December 31, 1996)
(previously filed)
</TABLE>
- ---------------
* To be filed by amendment
<PAGE> 1
EXCHANGE APPLICATIONS, INC.
Common Stock
(par value $0.001 per share)
---------------------------------------
UNDERWRITING AGREEMENT
_____ __, 1998
BT Alex. Brown Incorporated
Hambrecht & Quist LLC
Adams, Harkness & Hill, Inc.
As representatives of the several Underwriters
named in Schedule I hereto,
c/o BT Alex. Brown Incorporated
One South Street
Baltimore, MD 21202
Ladies and Gentlemen:
Exchange Applications, Inc., a Delaware corporation (the "Company"),
proposes, subject to the terms and conditions stated herein, to issue and sell
to the Underwriters named in Schedule I hereto (the "Underwriters") an aggregate
of 2,000,000 shares of Common Stock (par value $0.001 per share) ("Stock") of
the Company and the stockholders of the Company named in Schedule II hereto (the
"Selling Stockholders") propose, subject to the terms and conditions stated
herein, to sell to the Underwriters an aggregate of 1,000,000 shares and, at the
election of the Underwriters, up to 450,000 additional shares of stock. The
aggregate of 3,000,000 shares to be sold by the Company and the Selling
Stockholders is herein called the "Firm Shares" and the aggregate of 450,000
additional shares to be sold by the Company and the Selling Stockholders is
herein called the "Optional Shares". The Firm Shares and the Optional Shares
that the Underwriters elect to purchase pursuant to Section 2 hereof are herein
collectively called the "Shares".
1. (a) The Company represents and warrants to, and agrees with, each
of the Underwriters that:
<PAGE> 2
(i) A registration statement on Form S-1 (File No. 333-59613) (the
"Initial Registration Statement") in respect of the Shares has
been filed with the Securities and Exchange Commission (the
"Commission"); the Initial Registration Statement (including
any pre-effective amendments thereto) and any post effective
amendment thereto, each in the form heretofore delivered to
you, and, excluding exhibits thereto, to you for each of the
other Underwriters, have been declared effective by the
Commission in such form; other than a registration statement,
if any, increasing the size of the offering (a "Rule 462(b)
Registration Statement"), filed pursuant to Rule 462(b) under
the Securities Act of 1933, as amended (the "Act"), which
became effective upon filing, no other document with respect
to the Initial Registration Statement has heretofore been
filed with the Commission; no stop order suspending the
effectiveness of the Initial Registration Statement, any
post-effective amendment thereto or the Rule 462(b)
Registration Statement, if any, has been issued and no
proceeding for that purpose has been initiated or threatened
by the Commission (any preliminary prospectus included in the
Initial Registration Statement or filed with the Commission
pursuant to Rule 424(a) of the rules and regulations of the
Commission under the Act is hereinafter called a "Preliminary
Prospectus"; the various parts of the Initial Registration
Statement and the Rule 462(b) Registration Statement, if any,
including all exhibits thereto and including the information
contained in the form of final prospectus filed with the
Commission pursuant to Rule 424(b) under the Act in accordance
with Section 5(a) hereof and deemed by virtue of Rule 430A
under the Act to be part of the Initial Registration Statement
at the time it was declared effective, each as amended at the
time such part of the Initial Registration Statement became
effective or such part of the Rule 462(b) Registration
Statement, if any, became or hereafter becomes effective, are
hereinafter collectively called the "Registration Statement";
and such final prospectus, in the form first filed pursuant to
Rule 424(b) under the Act, is hereinafter called the
"Prospectus");
(ii) No order preventing or suspending the use of any Preliminary
Prospectus has been issued by the Commission, and each
Preliminary Prospectus, at the time of filing thereof,
conformed in all material respects to the requirements of the
Act and the rules and regulations of the Commission
thereunder, and did not contain an untrue statement of a
material fact or omit to state a material fact required to be
stated therein or necessary to make the statements therein, in
the light of the circumstances under which they were made, not
misleading; provided, however, that this representation and
warranty shall not apply to any statements or omissions made
in reliance upon and in conformity with information furnished
in writing to the Company by an Underwriter through BT Alex.
Brown Incorporated expressly for use therein or by a Selling
Stockholder expressly for use in the preparation of the
answers therein to Items 7 and 11(l) of Form S-1;
-2-
<PAGE> 3
(iii) The Registration Statement conforms, and the Prospectus and
any further amendments or supplements to the Registration
Statement or the Prospectus will conform, in all material
respects to the requirements of the Act and the rules and
regulations of the Commission thereunder and do not and will
not, as of the applicable effective date as to the
Registration Statement and any amendment thereto, and as of
the applicable filing date as to the Prospectus and any
amendment or supplement thereto, contain an untrue statement
of a material fact or omit to state a material fact required
to be stated therein or necessary to make the statements
therein not misleading; provided, however, that this
representation and warranty shall not apply to any statements
or omissions made in reliance upon and in conformity with
information furnished in writing to the Company by an
Underwriter through BT Alex. Brown Incorporated expressly for
use therein or by a Selling Stockholder expressly for use in
the preparation of the answers therein to Items 7 and 11(l) of
Form S-1;
(iv) Neither the Company nor any of its subsidiaries has sustained
since the date of the latest audited financial statements
included in the Prospectus any material loss or interference
with its business from fire, explosion, flood or other
calamity, whether or not covered by insurance, or from any
labor dispute or court or governmental action, order or
decree, otherwise than as set forth or contemplated in the
Prospectus; and, since the respective dates as of which
information is given in the Registration Statement and the
Prospectus, there has not been any change in the capital stock
or long-term debt of the Company or any of its subsidiaries or
any material adverse change, or any development involving a
prospective material adverse change, in or affecting the
general affairs, management, financial position, stockholders'
equity or results of operations of the Company and its
subsidiaries, otherwise than as set forth or contemplated in
the Prospectus;
(v) The Company and its subsidiaries have good and marketable
title in fee simple to all real property and good and
marketable title to all personal property owned by them, in
each case free and clear of all liens, encumbrances and
defects except such as are described in the Prospectus or such
as do not materially affect the value of such property and do
not interfere with the use made and proposed to be made of
such property by the Company and its subsidiaries; and any
real property and buildings held under lease by the Company
and its subsidiaries are held by them under valid, subsisting
and enforceable leases with such exceptions as are not
material and do not interfere with the use made and proposed
to be made of such property and buildings by the Company and
its subsidiaries;
(vi) The Company has been duly incorporated and is validly existing
as a corporation in good standing under the laws of the State
of Delaware, with power and authority (corporate and other) to
own its properties and conduct its business as described in
-3-
<PAGE> 4
the Prospectus, and has been duly qualified as a foreign
corporation for the transaction of business and is in good
standing under the laws of each other jurisdiction in which it
owns or leases properties or conducts any business so as to
require such qualification, or is subject to no material
liability or disability by reason of the failure to be so
qualified in any such jurisdiction; and each subsidiary of the
Company has been duly incorporated and is validly existing as
a corporation in good standing under the laws of its
jurisdiction of incorporation;
(vii) The Company has an authorized capitalization as set forth in
the Prospectus, and all of the issued shares of capital stock
of the Company have been duly and validly authorized and
issued, are fully paid and non-assessable and conform to the
description of the Stock contained in the Prospectus; and all
of the issued shares of capital stock of each subsidiary of
the Company have been duly and validly authorized and issued,
are fully paid and non-assessable and (except for directors'
qualifying shares) are owned directly or indirectly by the
Company, free and clear of all liens, encumbrances, equities
or claims;
(viii) The unissued Shares to be issued and sold by the Company to
the Underwriters hereunder have been duly and validly
authorized and, when issued and delivered against payment
therefor as provided herein, will be duly and validly issued
and fully paid and non-assessable and will conform to the
description of the Stock contained in the Prospectus;
(ix) The issue and sale of the Shares by the Company and the
compliance by the Company with all of the provisions of this
Agreement and the consummation of the transactions herein
contemplated will not conflict with or result in a breach or
violation of any of the terms or provisions of, or constitute
a default under, any indenture, mortgage, deed of trust, loan
agreement or other agreement or instrument to which the
Company or any of its subsidiaries is a party or by which the
Company or any of its subsidiaries is bound or to which any of
the property or assets of the Company or any of its
subsidiaries is subject, nor will such action result in any
violation of the provisions of the Certificate of
Incorporation or By-laws of the Company or any statute or any
order, rule or regulation of any court or governmental agency
or body having jurisdiction over the Company or any of its
subsidiaries or any of their properties; and no consent,
approval, authorization, order, registration or qualification
of or with any such court or governmental agency or body is
required for the issue and sale of the Shares or the
consummation by the Company of the transactions contemplated
by this Agreement, except the registration under the Act of
the Shares and such consents, approvals, authorizations,
registrations or qualifications as may be required under state
securities or Blue Sky laws in connection with the purchase
and distribution of the Shares by the Underwriters;
-4-
<PAGE> 5
(x) Neither the Company nor any of its subsidiaries is in
violation of its Certificate of Incorporation or By-laws or in
default in the performance or observance of any material
obligation, agreement, covenant or condition contained in any
indenture, mortgage, deed of trust, loan agreement, lease or
other agreement or instrument to which it is a party or by
which it or any of its properties may be bound;
(xi) The statements set forth in the Prospectus under the caption
"Description of Capital Stock", insofar as they purport to
constitute a summary of the terms of the Stock and under the
caption "Underwriting", insofar as they purport to describe
the provisions of the laws and documents referred to therein,
are accurate, complete and fair;
(xii) Other than as set forth in the Prospectus, there are no legal
or governmental proceedings pending to which the Company or
any of its subsidiaries is a party or of which any property of
the Company or any of its subsidiaries is the subject which,
if determined adversely to the Company or any of its
subsidiaries, would individually or in the aggregate have a
material adverse effect on the current or future consolidated
financial position, stockholders' equity or results of
operations of the Company and its subsidiaries; and, to the
best of the Company's knowledge, no such proceedings are
threatened or contemplated by governmental authorities or
threatened by others;
(xiii) The Company owns or has the right to use pursuant to license,
sublicense, agreement, or permission all patents, patent
applications, trademarks, service marks, trade names,
copyrights, trade secrets, confidential information and
proprietary rights and processes ("Intellectual Property")
necessary or desirable for the operation of the business of
the Company as presently conducted and as presently proposed
to be conducted. The Company has taken all necessary and
desirable action to maintain and protect each item of
Intellectual Property that the Company owns or uses. To the
knowledge of the Company, no third party has interfered with,
infringed upon, misappropriated, or otherwise come into
conflict with any Intellectual Property rights of the Company.
The Company has not interfered with, infringed upon,
misappropriated, or otherwise come into conflict with any
Intellectual Property rights of third parties, and there has
never been any charge, complaint, claim, demand, or notice
alleging any such interference, infringement,
misappropriation, or violation (including any claim that the
Company must license or refrain from using any Intellectual
Property rights of any third party). The Company will not
interfere with, infringe upon, misappropriate, or otherwise
come into conflict with, any Intellectual Property rights of
third parties as a result of the continued operation of its
business as presently conducted.
-5-
<PAGE> 6
(xiv) The Company is not and, after giving effect to the offering
and sale of the Shares, will not be an "investment company" or
an entity "controlled" by an "investment company", as such
terms are defined in the Investment Company Act of 1940, as
amended (the "Investment Company Act");
(xv) Neither the Company nor any of its affiliates does business
with the government of Cuba or with any person or affiliate
located in Cuba within the meaning of Section 517.075, Florida
Statutes; and
(xvi) Arthur Andersen LLP, who have certified certain financial
statements of the Company and its subsidiaries, are
independent public accountants as required by the Act and the
rules and regulations of the Commission thereunder.
(b) Each of the Selling Stockholders severally and not jointly
represents and warrants to, and agrees with, each of the Underwriters and the
Company that:
(i) All consents, approvals, authorizations and orders necessary
for the execution and delivery by such Selling Stockholder of
this Agreement and the Power of Attorney and the Custody
Agreement hereinafter referred to, and for the sale and
delivery of the Shares to be sold by such Selling Stockholder
hereunder, have been obtained; and such Selling Stockholder
has full right, power and authority to enter into this
Agreement, the Power-of-Attorney and the Custody Agreement and
to sell, assign, transfer and deliver the Shares to be sold by
such Selling Stockholder hereunder;
(ii) The sale of the Shares to be sold by such Selling Stockholder
hereunder and the compliance by such Selling Stockholder with
all of the provisions of this Agreement, the Power of Attorney
and the Custody Agreement and the consummation of the
transactions herein and therein contemplated will not conflict
with or result in a breach or violation of any of the terms or
provisions of, or constitute a default under, any statute,
indenture, mortgage, deed of trust, loan agreement or other
agreement or instrument to which such Selling Stockholder is a
party or by which such Selling Stockholder is bound or to
which any of the property or assets of such Selling
Stockholder is subject, nor will such action result in any
violation of the provisions of the Certificate of
Incorporation or By-laws of such Selling Stockholder if such
Selling Stockholder is a corporation, the Partnership
Agreement of such Selling Stockholder if such Selling
Stockholder is a partnership or any statute or any order, rule
or regulation of any court or governmental agency or body
having jurisdiction over such Selling Stockholder or the
property of such Selling Stockholder;
(iii) Such Selling Stockholder has, and immediately prior to each
Time of Delivery (as defined in Section 4 hereof) such Selling
Stockholder will have, good and valid title to the Shares to
be sold by such Selling Stockholder hereunder, free and clear
of all
-6-
<PAGE> 7
liens, encumbrances, equities or claims; and, upon delivery of
such Shares and payment therefor pursuant hereto, good and
valid title to such Shares, free and clear of all liens,
encumbrances, equities or claims, will pass to the several
Underwriters;
(iv) Without having undertaken to determine independently the
accuracy or completeness of either the representations and
warranties of the Company contained herein or the information
contained in the Registration Statement, such Selling
Stockholder has no reason to believe that the representations
and warranties of the Company contained in this Section 1 are
not true and correct, is familiar with the Registration
Statement and has no knowledge of any material fact, condition
or information not disclosed in the Registration Statement
which has adversely affected or may adversely affect the
business of the Company; and the sale of the Firm Shares or
the Option Shares by such Selling Stockholder pursuant hereto
is not prompted by any information concerning the Company
which is not set forth in the Registration Statement or the
documents incorporated by reference therein. The information
pertaining to such Selling Stockholder under the caption
"Principal and Selling Stockholders" in the Prospectus is
complete and accurate in all material respects.
(v) During the period beginning from the date hereof and
continuing to and including the date 180 days after the date
of the Prospectus, not to offer, sell contract to sell or
otherwise dispose of, except as provided hereunder, any
securities of the Company that are substantially similar to
the Shares, including but not limited to any securities that
are convertible into or exchangeable for, or that represent
the right to receive, Stock or any such substantially similar
securities (other than pursuant to employee stock option plans
existing on, or upon the conversion or exchange of convertible
or exchangeable securities outstanding as of, the date of this
Agreement), without your prior written consent;
(vi) Such Selling Stockholder has not taken and will not take,
directly or indirectly, any action which is designed to or
which has constituted or which might reasonably be expected to
cause or result in stabilization or manipulation of the price
of any security of the Company to facilitate the sale or
resale of the Shares;
(vii) To the extent that any statements or omissions made in the
Registration Statement, any Preliminary Prospectus, the
Prospectus or any amendment or supplement thereto are made in
reliance upon and in conformity with written information
furnished to the Company by such Selling Stockholder expressly
for use therein, such Preliminary Prospectus and the
Registration Statement did, and the Prospectus and any further
amendments or supplements to the Registration Statement and
the Prospectus, when they become effective or are filed with
the Commission, as the case may be, will conform in all
material respects to the requirements of the Act and the rules
and regulations of the Commission thereunder and will not
contain any untrue statement
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<PAGE> 8
of a material fact or omit to state any material fact required
to be stated therein or necessary to make the statements
therein not misleading;
(viii) In order to document the Underwriters' compliance with the
reporting and withholding provisions of the Tax Equity and
Fiscal Responsibility Act of 1982 with respect to the
transactions herein contemplated, such Selling Stockholder
will deliver to you prior to or at the First Time of Delivery
(as hereinafter defined) a properly completed and executed
United States Treasury Department Form W-9 (or other
applicable form or statement specified by Treasury Department
regulations in lieu thereof);
(ix) Certificates in negotiable form representing all of the Shares
to be sold by such Selling Stockholder hereunder have been
placed in custody under a Custody Agreement, in the form
heretofore furnished to you (the "Custody Agreement"), duly
executed and delivered by such Selling Stockholder to Exchange
Applications, Inc., as custodian (the "Custodian"), and such
Selling Stockholder has duly executed and delivered a Power of
Attorney, in the form heretofore furnished to you (the "Power
of Attorney"), appointing the persons indicated in Schedule II
hereto, and each of them, as such Selling Stockholder's
attorneys-in-fact (the "Attorneys-in-Fact") with authority to
execute and deliver this Agreement on behalf of such Selling
Stockholder, to determine the purchase price to be paid by the
Underwriters to the Selling Stockholders as provided in
Section 2 hereof, to authorize the delivery of the Shares to
be sold by such Selling Stockholder hereunder and otherwise to
act on behalf of such Selling Stockholder in connection with
the transactions contemplated by this Agreement and the
Custody Agreement; and
(x) The Shares represented by the certificates held in custody for
such Selling Stockholder under the Custody Agreement are
subject to the interests of the Underwriters hereunder; the
arrangements made by such Selling Stockholder for such
custody, and the appointment by such Selling Stockholder of
the Attorneys-in-Fact by the Power of Attorney, are to that
extent irrevocable; the obligations of the Selling
Stockholders hereunder shall not be terminated by operation of
law, whether by the death or incapacity of any individual
Selling Stockholder or, in the case of an estate or trust, by
the death or incapacity of any executor or trustee or the
termination of such estate or trust, or in the case of a
partnership or corporation, by the dissolution of such
partnership or corporation, or by the occurrence of any other
event; if any individual Selling Stockholder or any such
executor or trustee should die or become incapacitated, or if
any such estate or trust should be terminated, or if any such
partnership or corporation should be dissolved, or if any
other such event should occur, before the delivery of the
Shares hereunder, certificates representing the Shares shall
be delivered by or on behalf of the Selling Stockholders in
accordance with the terms and conditions of this Agreement and
of the Custody Agreements; and
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<PAGE> 9
actions taken by the Attorneys-in-Fact pursuant to the Powers
of Attorney shall be as valid as if such death, incapacity,
termination, dissolution or other event had not occurred,
regardless of whether or not the Custodian, the
Attorneys-in-Fact, or any of them, shall have received notice
of such death, incapacity, termination, dissolution or other
event.
2. Subject to the terms and conditions herein set forth, (a) the Company
and each of the Selling Stockholders agree, severally and not jointly, to sell
to each of the Underwriters, and each of the Underwriters agrees, severally and
not jointly, to purchase from the Company and each of the Selling Stockholders,
at a purchase price per share of $.............., the number of Firm Shares (to
be adjusted by you so as to eliminate fractional shares) determined by
multiplying the aggregate number of Shares to be sold by the Company and each of
the Selling Stockholders as set forth opposite their respective names in
Schedule II hereto by a fraction, the numerator of which is the aggregate number
of Firm Shares to be purchased by such Underwriter as set forth opposite the
name of such Underwriter in Schedule I hereto and the denominator of which is
the aggregate number of Firm Shares to be purchased by all of the Underwriters
from the Company and all of the Selling Stockholders hereunder and (b) in the
event and to the extent that the Underwriters shall exercise the election to
purchase Optional Shares as provided below, the Company and each of the Selling
Stockholders agree, severally and not jointly, to sell to each of the
Underwriters, and each of the Underwriters agrees, severally and not jointly, to
purchase from the Company and each of the Selling Stockholders, at the purchase
price per share set forth in clause (a) of this Section 2, that portion of the
number of Optional Shares as to which such election shall have been exercised
(to be adjusted by you so as to eliminate fractional shares) determined by
multiplying such number of Optional Shares by a fraction the numerator of which
is the maximum number of Optional Shares which such Underwriter is entitled to
purchase as set forth opposite the name of such Underwriter in Schedule I hereto
and the denominator of which is the maximum number of Optional Shares that all
of the Underwriters are entitled to purchase hereunder.
The Selling Stockholders, as and to the extent indicated in Schedule II
hereto, hereby grant, severally and not jointly, to the Underwriters the right
to purchase at their election up to 450,000 Optional Shares, at the purchase
price per share set forth in the paragraph above, for the sole purpose of
covering overallotments in the sale of the Firm Shares. Any such election to
purchase Optional Shares shall be made in proportion to the maximum number of
Optional Shares to be sold by each Selling Stockholder as set forth in Schedule
II hereto among the Selling Stockholders in proportion to the maximum number of
Optional Shares to be sold by each Selling Stockholder as set forth in Schedule
II hereto. Any such election to purchase Optional Shares may be exercised only
by written notice from you to the Company and the Attorneys-in-Fact, given
within a period of 30 calendar days after the date of this Agreement and setting
forth the aggregate number of Optional Shares to be purchased and the date on
which such Optional Shares are to be delivered, as determined by you but in no
event earlier than the First Time of Delivery (as defined in Section 4 hereof)
or, unless you and the Company and the Attorneys-in-Fact otherwise agree in
writing, earlier than two or later than ten business days after the date of such
notice.
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<PAGE> 10
3. Upon the authorization by you of the release of the Firm Shares, the
several Underwriters propose to offer the Firm Shares for sale upon the terms
and conditions set forth in the Prospectus.
4. (a) The Shares to be purchased by each Underwriter hereunder, in
definitive form, and in such authorized denominations and registered in such
names as BT Alex. Brown Incorporated may request upon at least forty-eight
hours' prior notice to the Company and the Selling Stockholders shall be
delivered by or on behalf of the Company and the Selling Stockholders to BT
Alex. Brown Incorporated, through the facilities of the Depository Trust Company
("DTC"), for the account of such Underwriter, against payment by or on behalf of
such Underwriter of the purchase price therefor by wire transfer to an account
designated by the Company and each of the Selling Stockholders in Federal (same
day) funds. The Company and each Selling Stockholder will cause the certificates
representing the Shares to be made available for checking and packaging at least
twenty-four hours prior to the Time of Delivery (as defined below) with respect
thereto at the office of DTC or its designated custodian (the "Designated
Office"). The time and date of such delivery and payment shall be, with respect
to the Firm Shares, 9:30 a.m., New York City time, on _______ __, 1998 or such
other time and date as BT Alex. Brown Incorporated, the Company and the Selling
Stockholders may agree upon in writing, and, with respect to the Optional
Shares, 9:30 a.m., New York time, on the date specified by BT Alex. Brown
Incorporated in the written notice given by BT Alex. Brown Incorporated of the
Underwriters' election to purchase such Optional Shares, or such other time and
date as BT Alex. Brown Incorporated, the Company and the Selling Stockholders
may agree upon in writing. Such time and date for delivery of the Firm Shares is
herein called the "First Time of Delivery", such time and date for delivery of
the Optional Shares, if not the First Time of Delivery, is herein called the
"Second Time of Delivery", and each such time and date for delivery is herein
called a "Time of Delivery".
(b) The documents to be delivered at each Time of Delivery by or
on behalf of the parties hereto pursuant to Section 7 hereof, including the
cross receipt for the Shares and any additional documents requested by the
Underwriters pursuant to Section 7(m) hereof, will be delivered at the offices
of Ropes & Gray at One International Place, Boston, Massachusetts, 02110 (the
"Closing Location"), and the Shares will be delivered at the Designated Office,
all at such Time of Delivery. A meeting will be held at the Closing Location at
.......p.m., New York City time, on the New York Business Day next preceding
such Time of Delivery, at which meeting the final drafts of the documents to be
delivered pursuant to the preceding sentence will be available for review by the
parties hereto. For the purposes of this Section 4, "New York Business Day"
shall mean each Monday, Tuesday, Wednesday, Thursday and Friday which is not a
day on which banking institutions in New York are generally authorized or
obligated by law or executive order to close.
5. The Company agrees with each of the Underwriters:
(a) To prepare the Prospectus in a form approved by you and to
file such Prospectus pursuant to Rule 424(b) under the Act not later than the
Commission's close of business on the second business day following the
execution and delivery of this Agreement, or, if applicable, such
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<PAGE> 11
earlier time as may be required by Rule 430A(a)(3) under the Act; to make no
further amendment or any supplement to the Registration Statement or Prospectus
which shall be disapproved by you promptly after reasonable notice thereof; to
advise you, promptly after it receives notice thereof, of the time when any
amendment to the Registration Statement has been filed or becomes effective or
any supplement to the Prospectus or any amended Prospectus has been filed and to
furnish you with copies thereof; to advise you, promptly after it receives
notice thereof, of the issuance by the Commission of any stop order or of any
order preventing or suspending the use of any Preliminary Prospectus or
prospectus, of the suspension of the qualification of the Shares for offering or
sale in any jurisdiction, of the initiation or threatening of any proceeding for
any such purpose, or of any request by the Commission for the amending or
supplementing of the Registration Statement or Prospectus or for additional
information; and, in the event of the issuance of any stop order or of any order
preventing or suspending the use of any Preliminary Prospectus or prospectus or
suspending any such qualification, promptly to use its best efforts to obtain
the withdrawal of such order;
(b) Promptly from time to time to take such action as you may
reasonably request to qualify the Shares for offering and sale under the
securities laws of such jurisdictions as you may request and to comply with such
laws so as to permit the continuance of sales and dealings therein in such
jurisdictions for as long as may be necessary to complete the distribution of
the Shares, provided that in connection therewith the Company shall not be
required to qualify as a foreign corporation or to file a general consent to
service of process in any jurisdiction;
(c) Prior to 10:00 a.m., New York City time on the New York
Business Day next succeeding the date of this Agreement and from time to time,
to furnish the Underwriters with copies of the Prospectus in New York City in
such quantities as you may reasonably request, and, if the delivery of a
prospectus is required at any time prior to the expiration of nine months after
the time of issue of the Prospectus in connection with the offering or sale of
the Shares and if at such time any event shall have occurred as a result of
which the Prospectus as then amended or supplemented would include an untrue
statement of a material fact or omit to state any material fact necessary in
order to make the statements therein, in the light of the circumstances under
which they were made when such Prospectus is delivered, not misleading, or, if
for any other reason it shall be necessary during such period to amend or
supplement the Prospectus in order to comply with the Act, to notify you and
upon your request to prepare and furnish without charge to each Underwriter and
to any dealer in securities as many copies as you may from time to time
reasonably request of an amended Prospectus or a supplement to the Prospectus
which will correct such statement or omission or effect such compliance, and in
case any Underwriter is required to deliver a prospectus in connection with
sales of any of the Shares at any time nine months or more after the time of
issue of the Prospectus, upon your request but at the expense of such
Underwriter, to prepare and deliver to such Underwriter as many copies as you
may request of an amended or supplemented Prospectus complying with Section
10(a)(3) of the Act;
(d) To make generally available to its securityholders as soon as
practicable, but in any event not later than eighteen months after the effective
date of the Registration Statement (as defined
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<PAGE> 12
in Rule 158(c) under the Act), an earnings statement of the Company and its
subsidiaries (which need not be audited) complying with Section 11(a) of the Act
and the rules and regulations thereunder (including, at the option of the
Company, Rule 158);
(e) During the period beginning from the date hereof and
continuing to and including the date 180 days after the date of the Prospectus,
not to offer, sell, contract to sell or otherwise dispose of, except as provided
hereunder any securities of the Company that are substantially similar to the
Shares, including but not limited to any securities that are convertible into or
exchangeable for, or that represent the right to receive, Stock or any such
substantially similar securities (other than pursuant to employee or director
stock option, stock purchase or stock incentive plans existing on, or upon the
conversion or exchange of convertible or exchangeable securities outstanding as
of, the date of this Agreement), without your prior written consent;
(f) To furnish to its stockholders as soon as practicable after
the end of each fiscal year an annual report (including a balance sheet and
statements of income, stockholders' equity and cash flows of the Company and its
consolidated subsidiaries certified by independent public accountants) and, as
soon as practicable after the end of each of the first three quarters of each
fiscal year (beginning with the fiscal quarter ending after the effective date
of the Registration Statement), consolidated summary financial information of
the Company and its subsidiaries for such quarter in reasonable detail;
(g) During a period of five years from the effective date of the
Registration Statement, to furnish to you copies of all reports or other
communications (financial or other) furnished to stockholders, and to deliver to
you (i) as soon as they are available, copies of any reports and financial
statements furnished to or filed with the Commission or any national securities
exchange on which any class of securities of the Company is listed; and (ii)
such additional information concerning the business and financial condition of
the Company as you may from time to time reasonably request (such financial
statements to be on a consolidated basis to the extent the accounts of the
Company and its subsidiaries are consolidated in reports furnished to its
stockholders generally or to the Commission);
(h) To use the net proceeds received by it from the sale of the
Shares pursuant to this Agreement in the manner specified in the Prospectus
under the caption "Use of Proceeds";
(i) To use its best efforts to list for quotation the Shares on
the National Association of Securities Dealers Automated Quotations National
Market System ("NASDAQ");
(j) To file with the Commission such information on Form 10-Q as
may be required by Rule 463 under the Act; and
(k) If the Company elects to rely upon Rule 462(b), the Company
shall file a Rule 462(b) Registration Statement with the Commission in
compliance with Rule 462(b) by 10:00 P.M.,
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<PAGE> 13
Washington, D.C. time, on the date of this Agreement, and the Company shall at
the time of filing either pay to the Commission the filing fee for the Rule
462(b) Registration Statement or give irrevocable instructions for the payments
of such fee pursuant to Rule 111(b) under the Act.
6. The Company and each of the Selling Stockholders covenant and agree
with one another and with the several Underwriters that (a) the Company will pay
or cause to be paid the following: (i) the fees, disbursements and expenses of
the Company's counsel and accountants in connection with the registration of the
Shares under the Act and all other expenses in connection with the preparation,
printing and filing of the Registration Statement, any Preliminary Prospectus
and the Prospectus and amendments and supplements thereto and the mailing and
delivering of copies thereof to the Underwriters and dealers; (ii) the cost of
printing or producing any Agreement among Underwriters, this Agreement, the Blue
Sky Memorandum, closing documents (including any compilations thereof) and any
other documents in connection with the offering, purchase, sale and delivery of
the Shares; (iii) all expenses in connection with the qualification of the
Shares for offering and sale under state securities laws as provided in Section
5(b) hereof, including the fees and disbursements of counsel for the
Underwriters in connection with such qualification and in connection with the
Blue Sky survey; (iv) all fees and expenses in connection with listing the
Shares on the NASDAQ; (v) the filing fees incident to, and the fees and
disbursements of counsel for the Underwriters in connection with, securing any
required review by the National Association of Securities Dealers, Inc. of the
terms of the sale of the Shares; (vi) the cost of preparing stock certificates;
(vii) the costs and charges of any transfer agent or registrar; and (viii) all
other costs and expenses incident to the performance of its obligations
hereunder which are not otherwise specifically provided for in this Section; and
(c) such Selling Stockholder will pay or cause to be paid all costs and expenses
incident to the performance of such Selling Stockholder's obligations hereunder
which are not otherwise specifically provided for in this section, including (i)
any fees and expenses of counsel for such Selling Stockholder, and (ii) all
expenses and taxes incident to the sale and delivery of the Shares to be sold by
such Selling Stockholder to the Underwriters hereunder. In connection with
clause (c) of the preceding sentence, BT Alex. Brown Incorporated agrees to pay
New York State stock transfer tax, and the Selling Stockholder agrees to
reimburse BT Alex. Brown Incorporated for associated carrying costs if such tax
payment is not rebated on the day of payment and for any portion of such tax
payment not rebated. It is understood, however, that the Company shall bear, and
the Selling Stockholders shall not be required to pay or reimburse the Company
for, the cost of any other matters not directly relating to the sale and
purchase of the Shares pursuant to this Agreement, and that, except as provided
in this Section, and Sections 8 and 11 hereof, the Underwriters will pay all of
their own costs and expenses, including the fees of their counsel, stock
transfer taxes on resale of any of the Shares by them, and any advertising
expenses connected with any offers they may make.
7. The obligations of the Underwriters hereunder, as to the Shares to be
delivered at each Time of Delivery, shall be subject, in their discretion, to
the condition that all representations and warranties and other statements of
the Company and of the Selling Stockholders herein are, at and as of such Time
of Delivery, true and correct, the condition that the Company and the Selling
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<PAGE> 14
Stockholders shall have performed all of its and their obligations hereunder
theretofore to be performed, and the following additional conditions:
(a) The Prospectus shall have been filed with the Commission
pursuant to Rule 424(b) within the applicable time period prescribed for such
filing by the rules and regulations under the Act and in accordance with Section
5(a) hereof; if the Company has elected to rely upon Rule 462(b), the Rule
462(b) Registration Statement shall have become effective by 10:00 p.m.,
Washington, D.C. time, on the date of this Agreement; no stop order suspending
the effectiveness of the Registration Statement or any part thereof shall have
been issued and no proceeding for that purpose shall have been initiated or
threatened by the Commission; and all requests for additional information on the
part of the Commission shall have been complied with to your reasonable
satisfaction;
(b) Ropes & Gray, counsel for the Underwriters, shall have
furnished to you such opinion or opinions, dated such Time of Delivery, as you
may reasonably request, and such counsel shall have received such papers and
information as they may reasonably request to enable them to pass upon such
matters;
(c) Bingham Dana, LLP, counsel for the Company, shall have
furnished to you their written opinion, dated such Time of Delivery, in form and
substance satisfactory to you as to such matters as you may reasonably request;
(d) Trevor Robinson Solicitors, United Kingdom counsel for the
Company, shall have furnished to you their written opinion, dated the Time of
Delivery, in form and substance satisfactory to you;
(e) The respective counsel for each of the Selling Stockholders,
as indicated in Schedule II hereto, each shall have furnished to you their
written opinion with respect to each of the Selling Stockholders for whom they
are acting as counsel, dated the Time of Delivery, in form and substance
satisfactory to you as to such matters as you may reasonably request;
(f) On the date of the Prospectus at a time prior to the execution
of this Agreement, at 9:30 a.m., New York City time, on the effective date of
any post-effective amendment to the Registration Statement filed subsequent to
the date of this Agreement and also at each Time of Delivery, Arthur Andersen
LLP shall have furnished to you a letter or letters, dated the respective dates
of delivery thereof, in form and substance satisfactory to you, to the effect
set forth in Annex I hereto;
(g) (i) Neither the Company nor any of its subsidiaries shall
have sustained since the date of the latest audited financial statements
included in the Prospectus any loss or interference with its business from fire,
explosion, flood or other calamity, whether or not covered by insurance, or from
any labor dispute or court or governmental action, order or decree, otherwise
than as set forth or contemplated in the Prospectus, and (ii) since the
respective dates as of which information is given
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<PAGE> 15
in the Prospectus there shall not have been any change in the capital stock or
long-term debt of the Company or any of its subsidiaries or any change, or any
development involving a prospective change, in or affecting the general affairs,
management, financial position, stockholders' equity or results of operations of
the Company and its subsidiaries, otherwise than as set forth or contemplated in
the Prospectus, the effect of which, in any such case described in Clause (i) or
(ii), is in the judgment of the Representatives so material and adverse as to
make it impracticable or inadvisable to proceed with the public offering or the
delivery of the Shares being delivered at such Time of Delivery on the terms and
in the manner contemplated in the Prospectus;
(h) On or after the date hereof (i) no downgrading shall have
occurred in the rating accorded the Company's debt securities by any "nationally
recognized statistical rating organization", as that term is defined by the
Commission for purposes of Rule 436(g)(2) under the Act, and (ii) no such
organization shall have publicly announced that it has under surveillance or
review, with possible negative implications, its rating of any of the Company's
debt securities;
(i) On or after the date hereof there shall not have occurred any
of the following: (i) a suspension or material limitation in trading in
securities generally on the New York Stock Exchange or on NASDAQ; (ii) a
suspension or material limitation in trading in the Company's securities on
NASDAQ; (iii) a general moratorium on commercial banking activities declared by
Federal, New York State or Massachusetts State authorities; or (iv) the outbreak
or escalation of hostilities involving the United States or the declaration by
the United States of a national emergency or war, if the effect of any such
event specified in this Clause (iv) in the judgment of the Representatives makes
it impracticable or inadvisable to proceed with the public offering or the
delivery of the Shares being delivered at such Time of Delivery on the terms and
in the manner contemplated in the Prospectus;
(j) The Shares to be sold at such Time of Delivery shall have been
duly listed for quotation on NASDAQ;
(k) The Company has obtained and delivered to the Underwriters
executed copies of an agreement from holders of more than 95% of the outstanding
shares of the Company's Capital Stock, substantially to the effect set forth in
Subsection 5(e) hereof in form and substance satisfactory to you;
(l) The Company shall have complied with the provisions of Section
5(c) hereof with respect to the furnishing of prospectuses on the New York
Business Day next succeeding the date of this Agreement; and
(m) The Company and the Selling Stockholders shall have furnished
or caused to be furnished to you at such Time of Delivery certificates of
officers of the Company and the Selling Stockholders, respectively satisfactory
to you as to the accuracy of the representations and warranties of the Company
and the Selling Stockholders, respectively herein at and as of such Time of
Delivery,
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<PAGE> 16
as to the performance by the Company and the Selling Stockholders of all of
their respective obligations hereunder to be performed at or prior to such Time
of Delivery and as to such other matters as you may reasonably request.
8. (a) The Company agrees:
(i) to indemnify and hold harmless each Underwriter and each
person, if any, who controls any Underwriter within the
meaning of the Act, against any losses, claims, damages or
liabilities to which such Underwriter or any such controlling
person may become subject under the Act or otherwise, insofar
as such losses, claims, damages or liabilities (or actions or
proceedings in respect thereof) arise out of or are based upon
(1) any untrue statement or alleged untrue statement of any
material fact contained in the Registration Statement, any
Preliminary Prospectus, the Prospectus or any amendment or
supplement thereto, (2) the omission or alleged omission to
state therein a material fact required to be stated therein or
necessary to make the statements therein not misleading any
act or failure to act, or (3) any alleged act or failure to
act by any Underwriter in connection with, or relating in any
manner to, the Shares or the offering contemplated hereby, and
which is included as part of or referred to in any loss,
claim, damage, liability or action arising out of or based
upon matters covered by clause (1) or (2) above (provided,
that the Company shall not be liable under this clause (3) to
the extent that it is determined in a final judgment by a
court of competent jurisdiction that such loss, claim, damage,
liability or action resulted directly from any such acts or
failures to act undertaken or omitted to be taken by such
Underwriter through its gross negligence or willful
misconduct)]; provided, however, that the Company will not be
liable in any such case to the extent that any such loss,
claim, damage or liability arises out of or is based upon an
untrue statement or alleged untrue statement, or omission or
alleged omission made in the Registration Statement, any
Preliminary Prospectus, the Prospectus, or such amendment or
supplement, in reliance upon and in conformity with written
information furnished to the Company by or through the
Representatives specifically for use in the preparation
thereof. This indemnity obligation will be in addition to any
liability which the Company may otherwise have.
(ii) to reimburse each Underwriter and each such controlling person
upon demand for any legal or other out-of-pocket expenses
reasonably incurred by such Underwriter or such controlling
person in connection with investigating or defending any such
loss, claim, damage or liability, action or proceeding or in
responding to a subpoena or governmental inquiry related to
the offering of the Shares, whether or not such Underwriter or
controlling person is a party to any action or proceeding. In
the event that it is finally judicially determined that the
Underwriters were not entitled to receive payments for legal
and other expenses pursuant to this subparagraph, the
Underwriters will promptly return all sums that had been
advanced pursuant hereto.
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<PAGE> 17
(b) The Selling Stockholders agree to indemnify the Underwriters
and each person, if any, who controls any Underwriter within the meaning of the
Act, against any losses, claims, damages or liabilities to which such
Underwriter or controlling person may become subject under the Act or otherwise
to the same extent as indemnity is provided by the Company pursuant to Section
8(a) above; provided that with respect to the indemnity of each Selling
Stockholder, other than the Principal Selling Stockholders (the Principal
Selling Stockholders being defined as the Selling Stockholders marked with an
"*" on Schedule II), the indemnity shall, in each case, apply only to the extent
that any such loss, claim, damage or liability arises out of or is based upon an
untrue statement or alleged untrue statement, or omission or alleged omission
made in the Registration Statement, any Preliminary Prospectus or the Prospectus
in reliance upon and in conformity with written information furnished by such
Selling Stockholder specifically for use in the preparation thereof. In no
event, however, shall the liability of any Selling Stockholder for
indemnification under this Section 8(b) exceed the proceeds, net of underwriting
discounts and commissions, received by such Selling Stockholder in the Offering.
This indemnity obligation will be in addition to any liability which the Selling
Stockholders may otherwise have, but in no event will any Selling Stockholder's
total liability under this Agreement exceed the proceeds, net of underwriting
discounts and commissions, received by such Selling Stockholder in the Offering.
(c) Each Underwriter severally and not jointly will indemnify and
hold harmless the Company, each of its directors, each of its officers who have
signed the Registration Statement, the Selling Stockholders, and each person, if
any, who controls the Company or the Selling Stockholders within the meaning of
the Act, against any losses, claims, damages or liabilities to which the Company
or any such director, officer, Selling Stockholder or controlling person may
become subject under the Act or otherwise, insofar as such losses, claims,
damages or liabilities (or actions or proceedings in respect thereof) arise out
of or are based upon (1) any untrue statement or alleged untrue statement of any
material fact contained in the Registration Statement, any Preliminary
Prospectus, the Prospectus or any amendment or supplement thereto, or (2) the
omission or the alleged omission to state therein a material fact required to be
stated therein or necessary to make the statements therein not misleading in the
light of the circumstances under which they were made; and will reimburse any
legal or other expenses reasonably incurred by the Company or any such director,
officer, Selling Stockholder or controlling person in connection with
investigating or defending any such loss, claim, damage, liability, action or
proceeding; provided, however, that each Underwriter will be liable in each case
to the extent, but only to the extent, that such untrue statement or alleged
untrue statement or omission or alleged omission has been made in the
Registration Statement, any Preliminary Prospectus, the Prospectus or such
amendment or supplement, in reliance upon and in conformity with written
information furnished to the Company by or through the Representatives
specifically for use in the preparation thereof. This indemnity agreement will
be in addition to any liability which such Underwriter may otherwise have.
(d) In case any proceeding (including any governmental
investigation) shall be instituted involving any person in respect of which
indemnity may be sought pursuant to this Section 8, such
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<PAGE> 18
person (the "indemnified party") shall promptly notify the person against whom
such indemnity may be sought (the "indemnifying party") in writing. No
indemnification provided for in Section 8(a), (b) or (c) shall be available to
any party who shall fail to give notice as provided in this Section 8(d) if the
party to whom notice was not given was unaware of the proceeding to which such
notice would have related and was materially prejudiced by the failure to give
such notice, but the failure to give such notice shall not relieve the
indemnifying party or parties from any liability which it or they may have to
the indemnified party for contribution or otherwise than on account of the
provisions of Section 8(a), (b) or (c). In case any such proceeding shall be
brought against any indemnified party and it shall notify the indemnifying party
of the commencement thereof, the indemnifying party shall be entitled to
participate therein and, to the extent that it shall wish, jointly with any
other indemnifying party similarly notified, to assume the defense thereof, with
counsel satisfactory to such indemnified party and shall pay as incurred the
fees and disbursements of such counsel related to such proceeding. In any such
proceeding, any indemnified party shall have the right to retain its own counsel
at its own expense. Notwithstanding the foregoing, the indemnifying party shall
pay as incurred (or within 30 days of presentation) the fees and expenses of the
counsel retained by the indemnified party in the event (1) the indemnifying
party and the indemnified party shall have mutually agreed to the retention of
such counsel, (2) the named parties to any such proceeding (including any
impleaded parties) include both the indemnifying party and the indemnified party
and representation of both parties by the same counsel would be inappropriate
due to actual or potential differing interests between them or (3) the
indemnifying party shall have failed to assume the defense and employ counsel
acceptable to the indemnified party within a reasonable period of time after
notice of commencement of the action. It is understood that the indemnifying
party shall not, in connection with any proceeding or related proceedings in the
same jurisdiction, be liable for the reasonable fees and expenses of more than
one separate firm for all such indemnified parties. Such firm shall be
designated in writing by you in the case of parties indemnified pursuant to
Section 8(a) or (b) and by the Company and the Selling Stockholders in the case
of parties indemnified pursuant to Section 8(c). The indemnifying party shall
not be liable for any settlement of any proceeding effected without its written
consent but if settled with such consent or if there be a final judgment for the
plaintiff, the indemnifying party agrees to indemnify the indemnified party from
and against any loss or liability by reason of such settlement or judgment. In
addition, the indemnifying party will not, without the prior written consent of
the indemnified party, settle or compromise or consent to the entry of any
judgment in any pending or threatened claim, action or proceeding of which
indemnification may be sought hereunder (whether or not any indemnified party is
an actual or potential party to such claim, action or proceeding) unless such
settlement, compromise or consent includes an unconditional release of each
indemnified party from all liability arising out of such claim, action or
proceeding.
(e) If the indemnification provided for in this Section 8 is
unavailable to or insufficient to hold harmless an indemnified party under
Section 8(a), (b) or (c) above in respect of any losses, claims, damages or
liabilities (or actions or proceedings in respect thereof) referred to therein,
then each indemnifying party shall contribute to the amount paid or payable by
such indemnified party as a result of such losses, claims, damages or
liabilities (or actions or proceedings in respect thereof)
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<PAGE> 19
in such proportion as is appropriate to reflect the relative benefits received
by the Company and the Selling Stockholders on the one hand and the Underwriters
on the other from the offering of the Shares. If, however, the allocation
provided by the immediately preceding sentence is not permitted by applicable
law then each indemnifying party shall contribute to such amount paid or payable
by such indemnified party in such proportion as is appropriate to reflect not
only such relative benefits but also the relative fault of the Company and the
Selling Stockholders on the one hand and the Underwriters on the other in
connection with the statements or omissions which resulted in such losses,
claims, damages or liabilities, (or actions or proceedings in respect thereof),
as well as any other relevant equitable considerations. The relative benefits
received by the Company and the Selling Stockholders on the one hand and the
Underwriters on the other shall be deemed to be in the same proportion as the
total net proceeds from the offering (before deducting expenses) received by the
Company and the Selling Stockholders bear to the total underwriting discounts
and commissions received by the Underwriters, in each case as set forth in the
table on the cover page of the Prospectus. The relative fault shall be
determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission or alleged omission to state
a material fact relates to information supplied by the Company or the Selling
Stockholders on the one hand or the Underwriters on the other and the parties'
relative intent, knowledge, access to information and opportunity to correct or
prevent such statement or omission.
The Company, the Selling Stockholders and the Underwriters agree that
it would not be just and equitable if contributions pursuant to this Section
8(e) were determined by pro rata allocation (even if the Underwriters were
treated as one entity for such purpose) or by any other method of allocation
which does not take account of the equitable considerations referred to above in
this Section 8(e). The amount paid or payable by an indemnified party as a
result of the losses, claims, damages or liabilities (or actions or proceedings
in respect thereof) referred to above in this Section 8(e) shall be deemed to
include any legal or other expenses reasonably incurred by such indemnified
party in connection with investigating or defending any such action or claim.
Notwithstanding the provisions of this subsection (e), (1) no Underwriter shall
be required to contribute any amount in excess of the underwriting discounts and
commissions applicable to the Shares purchased by such Underwriter, and (2) no
person guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the Act) shall be entitled to contribution from any person who was not
guilty of such fraudulent misrepresentation, and (3) no Selling Stockholder
shall be required to contribute any amount in excess of the net proceeds
received by such Selling Stockholder from the Underwriters in the offering. The
Underwriters' obligations in this Section 8(e) to contribute are several in
proportion to their respective underwriting obligations and not joint.
(f) In any proceeding relating to the Registration Statement, any
Preliminary Prospectus, the Prospectus or any supplement or amendment thereto,
each party against whom contribution may be sought under this Section 8 hereby
consents to the jurisdiction of any court having jurisdiction over any other
contributing party, agrees that process issuing from such court may be served
upon him or it by any other contributing party and consents to the service of
such process and agrees
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<PAGE> 20
that any other contributing party may join him or it as an additional defendant
in any such proceeding in which such other contributing party is a party.
(g) Any losses, claims, damages, liabilities or expenses for which
an indemnified party is entitled to indemnification or contribution under this
Section 8 shall be paid by the indemnifying party to the indemnified party as
such losses, claims, damages, liabilities or expenses are incurred. The
indemnity and contribution agreements contained in this Section 8 and the
representations and warranties of the Company set forth in this Agreement shall
remain operative and in full force and effect, regardless of (1) any
investigation made by or on behalf of any Underwriter or any person controlling
any Underwriter, the Company, its directors or officers or any persons
controlling the Company, (2) acceptance of any Shares and payment therefor
hereunder, and (3) any termination of this Agreement. A successor to any
Underwriter, or to the Company, its directors or officers, or any person
controlling the Company, shall be entitled to the benefits of the indemnity,
contribution and reimbursement agreements contained in this Section 8.
9. (a) This Agreement may be terminated by you by notice to the
Company and the Selling Stockholders at any time prior to the Closing Date if
any of the following has occurred: (i) since the respective dates as of which
information is given in the Registration Statement and the Prospectus, any
material adverse change or any development involving a prospective material
adverse change in or affecting the condition, financial or otherwise, of the
Company and its subsidiaries taken as a whole or the earnings, business,
management, properties, assets, rights, operations, condition (financial or
otherwise) or prospects of the Company and its subsidiaries taken as a whole,
whether or not arising in the ordinary course of business, (ii) any outbreak or
escalation of hostilities or declaration of war or national emergency or other
national or international calamity or crisis or change in economic or political
conditions if the effect of such outbreak, escalation, declaration, emergency,
calamity, crisis or change on the financial markets of the United States would,
in your reasonable judgment, make it impracticable or inadvisable to market the
Shares or to enforce contracts for the sale of the Shares, or (iii) suspension
of trading in securities generally on the New York Stock Exchange or the
American Stock Exchange or limitation on prices (other than limitations on hours
or numbers of days of trading) for securities on either such Exchange, (iv) the
enactment, publication, decree or other promulgation of any statute, regulation,
rule or order of any court or other governmental authority which in your opinion
materially and adversely affects or may materially and adversely affect the
business or operations of the Company, (v) declaration of a banking moratorium
by United States or New York State authorities, (vi) any downgrading, or
placement on any watch list for possible downgrading, in the rating of the
Company's debt securities by any "nationally recognized statistical rating
organization" (as defined for purposes of Rule 436(g) under the Exchange Act);
(vii) the suspension of trading of the Company's common stock by the NASDAQ
Stock Market, the Commission, or any other governmental authority or, (viii) the
taking of any action by any governmental body or agency in respect of its
monetary or fiscal affairs which in your reasonable opinion has a material
adverse effect on the securities markets in the United States; or
-20-
<PAGE> 21
(b) as provided in Sections 7 and 10 of this Agreement.
10. If any Underwriter shall fail to purchase and pay for the portion of
the Shares which such Underwriter has agreed to purchase and pay for at a Time
of Delivery (otherwise than by reason of any default on the part of the Company
or a Selling Stockholder), you, as Representatives of the Underwriters, shall
use your reasonable efforts to procure within 36 hours thereafter one or more of
the other Underwriters, or any others, to purchase from the Company and the
Selling Stockholders such amounts as may be agreed upon and upon the terms set
forth herein, the Shares which the defaulting Underwriter or Underwriters failed
to purchase at such Time of Delivery. If during such 36 hours you, as such
Representatives, shall not have procured such other Underwriters, or any others,
to purchase the Shares agreed to be purchased by the defaulting Underwriter or
Underwriters at such Time of Delivery, then (a) if the aggregate number of
shares with respect to which such default shall occur does not exceed 10% of the
Shares covered hereby, the other Underwriters shall be obligated, severally, in
proportion to the respective numbers of Shares which they are obligated to
purchase hereunder at such Time of Delivery, to purchase the Shares which such
defaulting Underwriter or Underwriters failed to purchase at such Time of
Delivery, or (b) if the aggregate number of Shares with respect to which such
default shall occur exceeds 10% of the Shares covered hereby, the Company and
the Selling Stockholders or you as the Representatives of the Underwriters will
have the right, by written notice given within the next 36-hour period to the
parties to this Agreement, to terminate this Agreement without liability on the
part of the non-defaulting Underwriters or of the Company or of the Selling
Stockholders except to the extent provided in Section 8 hereof. In the event of
a default by any Underwriter or Underwriters, as set forth in this Section 10,
the Time of Delivery may be postponed for such period, not exceeding seven days,
as you, as Representatives, may determine in order that the required changes in
the Registration Statement or in the Prospectus or in any other documents or
arrangements may be effected. The term "Underwriter" includes any person
substituted for a defaulting Underwriter. Any action taken under this Section 10
shall not relieve any defaulting Underwriter from liability in respect of any
default of such Underwriter under this Agreement.
11. The respective indemnities, agreements, representations, warranties and
other statements of the Company, the Selling Stockholders and the several
Underwriters, as set forth in this Agreement or made by or on behalf of them,
respectively, pursuant to this Agreement, shall remain in full force and effect,
regardless of any investigation (or any statement as to the results thereof)
made by or on behalf of any Underwriter or any controlling person of any
Underwriter, or the Company, or any of the Selling Stockholders or any officer
or director or controlling person of the Company, and shall survive delivery of
and payment for the Shares.
12. If this Agreement shall be terminated pursuant to Section 10 hereof,
neither the Company nor the Selling Stockholders shall then be under any
liability to any Underwriter except as provided in Sections 6 and 8 hereof; but,
if for any other reason, any Shares are not delivered by or on behalf of the
Company and the Selling Stockholders as provided herein, the Company and each of
the Selling Stockholders pro rata (based on the number of Shares to be sold by
the Company and such Selling
-21-
<PAGE> 22
Stockholder hereunder) will reimburse the Underwriters through you for all
out-of-pocket expenses approved in writing by you, including fees and
disbursements of counsel, reasonably incurred by the Underwriters in making
preparations for the purchase, sale and delivery of the Shares not so delivered,
but the Company and the Selling Stockholders shall then be under no further
liability to any Underwriter except as provided in Sections 6 and 8 hereof.
13. In all dealings hereunder, you shall act on behalf of each of the
Underwriters, and the parties hereto shall be entitled to act and rely upon any
statement, request, notice or agreement on behalf of any Underwriter made or
given by you jointly or by BT Alex. Brown Incorporated on behalf of you as the
representatives; and in all dealings with any Selling Stockholder hereunder, you
and the Company shall be entitled to act and rely upon any statement, request,
notice or agreement on behalf of such Selling Stockholder made or given by any
or all of the Attorneys-in-Fact for such Selling Stockholder.
All statements, requests, notices and agreements hereunder shall be in
writing, and if to the Underwriters shall be delivered or sent by mail, telex or
facsimile transmission to you as the representatives in care of BT Alex. Brown
Incorporated, 101 Federal Street, 15th Floor, Boston, MA 02110, Attention: Greg
Burkus; copy to BT Alex. Brown Incorporated, One Bankers Trust Plaza, 130
Liberty Street, New York, New York 10006, Attention: General Counsel; and if to
any Selling Stockholder shall be delivered or sent by mail, telex or facsimile
transmission to counsel for such Selling Stockholder at its address set forth in
Schedule II hereto; and if to the Company shall be delivered or sent by mail,
telex or facsimile transmission to the address of the Company set forth in the
Registration Statement, Attention: Secretary; provided, however, that any notice
to an Underwriter pursuant to Section 8(e) hereof shall be delivered or sent by
mail, telex or facsimile transmission to such Underwriter at its address set
forth in its Underwriters' Questionnaire, or telex constituting such
Questionnaire, which address will be supplied to the Company or the Selling
Stockholders by you upon request. Any such statements, requests, notices or
agreements shall take effect upon receipt thereof.
14. This Agreement shall be binding upon, and inure solely to the benefit
of, the Underwriters, the Company and, to the extent provided in Sections 8 and
11 hereof, the officers and directors of the Company and each person who
controls the Company, any Selling Stockholder or any Underwriter, and their
respective heirs, executors, administrators, successors and assigns, and no
other person shall acquire or have any right under or by virtue of this
Agreement. No purchaser of any of the Shares from any Underwriter shall be
deemed a successor or assign by reason merely of such purchase.
15. Time shall be of the essence of this Agreement. As used herein, the
term "business day" shall mean any day when the Commission's office in
Washington, D.C. is open for business.
16. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH
THE LAWS OF THE STATE OF MARYLAND.
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<PAGE> 23
17. This Agreement may be executed by any one or more of the parties hereto
in any number of counterparts, each of which shall be deemed to be an original,
but all such counterparts shall together constitute one and the same instrument.
If the foregoing is in accordance with your understanding, please sign
and return to us eight counterparts hereof, and upon the acceptance hereof by
you, on behalf of each of the Underwriters, this letter and such acceptance
hereof shall constitute a binding agreement among each of the Underwriters, the
Company and each of the Selling Stockholders. It is understood that your
acceptance of this letter on behalf of each of the Underwriters is pursuant to
the authority set forth in a form of Agreement among Underwriters, the form of
which shall be submitted to the Company and the Selling Stockholders for
examination upon request, but without warranty on your part as to the authority
of the signers thereof.
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<PAGE> 24
Any person executing and delivering this Agreement as Attorney-in-Fact
for a Selling Stockholder represents by so doing that he has been duly appointed
as Attorney-in-Fact by such Selling Stockholder pursuant to a validly existing
and binding Power-of-Attorney which authorizes such Attorney-in-Fact to take
such action.
Very truly yours,
Exchange Applications, Inc.
By:________________________________
Name:
Title:
Cyrk, Inc.
Wexford Insight LLC
Grant & Partners Limited Partnership
Michael J. Feldman
Andrew J. Frawley
David G. McFarlane
Michael D. McGonagle
Patrick A. McHugh
N. Wayne Townsend
By:_________________________________
Name:
Title:
As Attorney-in-Fact acting on
behalf of each of the Selling
Stockholders named in Schedule II
to this Agreement
Accepted as of the date hereof:
BT Alex. Brown Incorporated
Hambrecht & Quist LLC
Adams, Harkness & Hill, Inc.
By: BT Alex. Brown Incorporated
By:_____________________
Authorized Officer
On behalf of each of the Underwriters
-24-
<PAGE> 25
SCHEDULE I
NUMBER OF OPTIONAL
SHARES TO BE
TOTAL NUMBER PURCHASED IF
OF MAXIMUM OPTION
FIRM SHARES EXERCISED
TO BE PURCHASED BY UNDERWRITER
--------------- --------------
BT Alex. Brown Incorporated
Hambrecht & Quist LLC
Adams, Harkness & Hill, Inc.
[NAMES OF OTHER UNDERWRITERS]
Total
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<PAGE> 26
SCHEDULE II
<TABLE>
<CAPTION>
NUMBER OF OPTIONAL
SHARES TO BE SOLD IF
TOTAL NUMBER OF FIRM MAXIMUM OPTION
NAME SHARES TO BE SOLD EXERCISED
<S> <C> <C>
The Company 2,000,000 --
The Selling Stockholders:
Cyrk, Inc. (a) 1,000,000 --
Wexford Insight LLC* (b) -- 150,000
Grant & Partners Limited Partnership (c) -- 100,000
Michael J. Feldman (d) -- 102,188
Andrew J. Frawley *(e) -- 57,162
David G. McFarlane*(f) -- 17,800
Michael D. McGonagle*(g) -- 8,600
Patrick A. McHugh*(h) -- 7,500
N. Wayne Townsend*(i) -- 6,750
========= =======
Total 3,000,000 450,000
</TABLE>
- ------------
* Denotes a Principal Selling Stockholder (see Section 8(c)).
(a) This Selling Stockholder is represented by [NAME AND ADDRESS OF COUNSEL] and
has appointed [NAMES OF ATTORNEYS-IN-FACT (NOT LESS THAN TWO)], and each of
them, as the Attorneys-in-Fact for such Selling Stockholder.
(b) This Selling Stockholder is represented by [NAME AND ADDRESS OF COUNSEL] and
has appointed [NAMES OF ATTORNEYS-IN-FACT (NOT LESS THAN TWO)], and each of
them, as the Attorneys-in-Fact for such Selling Stockholder.
(c) This Selling Stockholder is represented by [NAME AND ADDRESS OF COUNSEL] and
has appointed [NAMES OF ATTORNEYS-IN-FACT (NOT LESS THAN TWO)], and each of
them, as the Attorneys-in-Fact for such Selling Stockholder.
(d) This Selling Stockholder is represented by [NAME AND ADDRESS OF COUNSEL] and
has appointed [NAMES OF ATTORNEYS-IN-FACT (NOT LESS THAN TWO)], and each of
them, as the Attorneys-in-Fact for such Selling Stockholder.
(e) This Selling Stockholder is represented by [NAME AND ADDRESS OF COUNSEL] and
has appointed [NAMES OF ATTORNEYS-IN-FACT (NOT LESS THAN TWO)], and each of
them, as the Attorneys-in-Fact for such Selling Stockholder.
(f) This Selling Stockholder is represented by [NAME AND ADDRESS OF COUNSEL] and
has appointed [NAMES OF ATTORNEYS-IN-FACT (NOT LESS THAN TWO)], and each of
them, as the Attorneys-in-Fact for such Selling Stockholder.
(g) This Selling Stockholder is represented by [NAME AND ADDRESS OF COUNSEL] and
has appointed [NAMES OF ATTORNEYS-IN-FACT (NOT LESS THAN TWO)], and each of
them, as the Attorneys-in-Fact for such Selling Stockholder.
(h) This Selling Stockholder is represented by [NAME AND ADDRESS OF COUNSEL] and
has appointed [NAMES OF ATTORNEYS-IN-FACT (NOT LESS THAN TWO)], and each of
them, as the Attorneys-in-Fact for such Selling Stockholder.
(i) This Selling Stockholder is represented by [NAME AND ADDRESS OF COUNSEL] and
has appointed [NAMES OF ATTORNEYS-IN-FACT (NOT LESS THAN TWO)], and each of
them, as the Attorneys-in-Fact for such Selling Stockholder.
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<PAGE> 27
ANNEX I
DESCRIPTION OF COMFORT LETTER
Pursuant to Section 7(d) of the Underwriting Agreement, the accountants
shall furnish letters to the Underwriters to the effect that:
(i) They are independent certified public accountants with respect
to the Company and its subsidiaries within the meaning of the Act and
the applicable published rules and regulations thereunder;
(ii) In their opinion, the financial statements and any
supplementary financial information and schedules (and, if applicable,
financial forecasts and/or pro forma financial information) examined by
them and included in the Prospectus or the Registration Statement
comply as to form in all material respects with the applicable
accounting requirements of the Act and the related published rules and
regulations thereunder; and, if applicable, they have made a review in
accordance with standards established by the American Institute of
Certified Public Accountants of the unaudited consolidated interim
financial statements, selected financial data, pro forma financial
information, financial forecasts and/or condensed financial statements
derived from audited financial statements of the Company for the
periods specified in such letter, as indicated in their reports
thereon, copies of which have been furnished to the representatives of
the Underwriters (the "Representatives") and are attached hereto;
(iii) They have made a review in accordance with standards
established by the American Institute of Certified Public Accountants
of the unaudited condensed consolidated statements of income,
consolidated balance sheets and consolidated statements of cash flows
included in the Prospectus as indicated in their reports thereon copies
of which are attached hereto and on the basis of specified procedures
including inquiries of officials of the Company who have responsibility
for financial and accounting matters regarding whether the unaudited
condensed consolidated financial statements referred to in paragraph
(vi)(A)(i) below comply as to form in all material respects with the
applicable accounting requirements of the Act and the related published
rules and regulations, nothing came to their attention that caused them
to believe that the unaudited condensed consolidated financial
statements do not comply as to form in all material respects with the
applicable accounting requirements of the Act and the related published
rules and regulations;
(iv) The unaudited selected financial information with respect to
the consolidated results of operations and financial position of the
Company for the five most recent fiscal years included in the
Prospectus agrees with the corresponding amounts (after restatements
where applicable) in the audited consolidated financial statements for
such five fiscal years which were included or incorporated by reference
in the Company's Annual Reports on Form 10-K for such fiscal years;
(v) They have compared the information in the Prospectus under
selected captions with the disclosure requirements of Regulation S-K
and on the basis of limited procedures specified in such letter nothing
came to their attention as a result of the foregoing procedures that
caused them to believe that this information does not conform in all
material respects with the disclosure requirements of Items 301, 302,
402 and 503(d), respectively, of Regulation S-K;
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<PAGE> 28
(vi) On the basis of limited procedures, not constituting an
examination in accordance with generally accepted auditing standards,
consisting of a reading of the unaudited financial statements
and other information referred to below, a reading of the latest
available interim financial statements of the Company and its
subsidiaries, inspection of the minute books of the Company and its
subsidiaries since the date of the latest audited financial statements
included in the Prospectus, inquiries of officials of the Company and
its subsidiaries responsible for financial and accounting matters and
such other inquiries and procedures as may be specified in such letter,
nothing came to their attention that caused them to believe that:
(A) (i) the unaudited consolidated statements of income,
consolidated balance sheets and consolidated statements of cash
flows included in the Prospectus do not comply as to form in all
material respects with the applicable accounting requirements of
the Act and the related published rules and regulations, or (ii)
any material modifications should be made to the unaudited
condensed consolidated statements of income, consolidated balance
sheets and consolidated statements of cash flows included in the
Prospectus for them to be in conformity with generally accepted
accounting principles;
(B) any other unaudited income statement data and balance
sheet items included in the Prospectus do not agree with the
corresponding items in the unaudited consolidated financial
statements from which such data and items were derived, and any
such unaudited data and items were not determined on a basis
substantially consistent with the basis for the corresponding
amounts in the audited consolidated financial statements included
in the Prospectus;
(C) the unaudited financial statements which were not
included in the Prospectus but from which were derived any
unaudited condensed financial statements referred to in Clause
(A) and any unaudited income statement data and balance sheet
items included in the Prospectus and referred to in Clause (B)
were not determined on a basis substantially consistent with the
basis for the audited consolidated financial statements included
in the Prospectus;
(D) any unaudited pro forma consolidated condensed financial
statements included in the Prospectus do not comply as to form in
all material respects with the applicable accounting requirements
of the Act and the published rules and regulations thereunder or
the pro forma adjustments have not been properly applied to the
historical amounts in the compilation of those statements;
(E) as of a specified date not more than five days prior to
the date of such letter, there have been any changes in the
consolidated capital stock (other than issuances of capital stock
upon exercise of options and stock appreciation rights, upon
earn-outs of performance shares and upon conversions of
convertible securities, in each case which were outstanding on
the date of the latest financial statements included in the
Prospectus) or any increase in the consolidated long-term debt of
the Company and its subsidiaries, or any decreases in
consolidated net current assets or stockholders' equity or other
items specified by the Representatives, or any increases in any
items specified by the Representatives, in each case as compared
with amounts shown in the latest balance sheet included in the
Prospectus, except in each case for changes, increases or
decreases which the Prospectus discloses have occurred or may
occur or which are described in such letter; and
(F) for the period from the date of the latest financial
statements included in the Prospectus to the specified date
referred to in Clause (E) there were any decreases in
consolidated net revenues or operating profit or the total or per
share amounts of consolidated net income or other items specified
by the Representatives, or any increases in any items
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<PAGE> 29
specified by the Representatives, in each case as compared with
the comparable period of the preceding year and with any other
period of corresponding length specified by the Representatives,
except in each case for decreases or increases which the
Prospectus discloses have occurred or may occur or which are
described in such letter; and
(vii) In addition to the examination referred to in their report(s)
included in the Prospectus and the limited procedures, inspection of
minute books, inquiries and other procedures referred to in paragraphs
(iii) and (vi) above, they have carried out certain specified
procedures, not constituting an examination in accordance with
generally accepted auditing standards, with respect to certain amounts,
percentages and financial information specified by the Representatives,
which are derived from the general accounting records of the Company
and its subsidiaries, which appear in the Prospectus, or in Part II of,
or in exhibits and schedules to, the Registration Statement specified
by the Representatives, and have compared certain of such amounts,
percentages and financial information with the accounting records of
the Company and its subsidiaries and have found them to be in
agreement.
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<PAGE> 30
Annex II(A)
Form of Opinion of Ropes & Gray
-30-
<PAGE> 31
Annex II (B)
Form of Opinion of Bingham Dana, LLP
-31-
<PAGE> 32
Annex II (C)
Form of Opinion of Counsel to Selling Stockholders
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<PAGE> 1
Exhibit 5.1
December 7, 1998
Exchange Applications, Inc.
89 South Street
Boston, Massachusetts 02111
RE: FORM S-1 REGISTRATION STATEMENT
Ladies and Gentlemen:
We have acted as counsel for Exchange Applications, Inc., a Delaware
corporation (the "Company"), in connection with the registration under the
Securities Act of 1933, as amended (the "Act"), of 3,450,000 shares (including
2,000,000 shares to be issued and offered by the Company and 1,000,000
outstanding shares offered by Cyrk, Inc. ("Cyrk"), and also including an
additional 450,000 shares in the aggregate that may be offered by Wexford
Insight LLC, Grant & Partners Limited Partnership, Michael J. Feldman, Andrew J.
Frawley, David G. McFarlane, Michael D. McGonagle, Patrick A. McHugh and N.
Wayne Townsend (collectively referred to herein, together with Cyrk, the
"Selling Stockholders"), in order to cover over-allotments, if any), of Common
Stock, par value $.001 per share, of the Company (the "Shares"), pursuant to a
Registration Statement on Form S-1, File No. 333-59613 (as amended, the
"Registration Statement"), initially filed with the Securities and Exchange
Commission on July 22, 1998. The Shares to be issued and offered by the Company
are referred to below as the "Company Shares" and the Shares to be offered by
the Selling Stockholders are referred to as the "Selling Stockholder Shares."
We have reviewed the corporate proceedings of the Company with respect to
the authorization of the issuance of the Shares. We have also examined and
relied upon originals or copies, certified or otherwise identified or
authenticated to our satisfaction, of such corporate records, instruments,
agreements or other documents of the Company, and certificates of officers of
the Company as to certain factual matters, and have made such investigation of
law and have discussed with officers and representatives of the Company such
questions of fact, as we have deemed necessary or appropriate to enable us to
express the opinions hereinafter expressed. In our examination, we have assumed
the genuineness of all signatures, the conformity to the originals of all
documents reviewed by us as copies, the authenticity and completeness of all
original documents reviewed by us in original or copy form and the legal
competence of each individual executing any document.
<PAGE> 2
Exchange Applications, Inc.
December 7, 1998
Page 2
We have also assumed that (i) an Underwriting Agreement substantially in
the form of Exhibit 1.1 to the Registration Statement, by and among the Company,
the Selling Stockholders and the underwriters named therein (the "Underwriting
Agreement"), will have been duly executed and delivered pursuant to the
authorizing votes of the Board of Directors of the Company and that the Shares
will be sold and issued or transferred only upon the payment therefor as
provided in the Underwriting Agreement; and (ii) the registration requirements
of the Act and all applicable requirements of state laws regulating the sale of
securities will have been duly satisfied.
This opinion is limited solely to the Delaware General Corporation Law as
applied by courts located in Delaware, to the extent applicable to the
transactions that are the subject of this opinion.
Based upon and subject to the foregoing, we are of the opinion that the
Shares have been duly authorized and that the Selling Stockholder Shares are,
and the Company Shares, when delivered and paid for in accordance with the
provisions of the Underwriting Agreement, will be, validly issued, fully paid
and non-assessable.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the reference to this firm under the heading
"Legal Matters" in the Prospectus included in the Registration Statement.
Very truly yours,
/s/ Bingham Dana LLP
--------------------
Bingham Dana LLP
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
reports (and to all references to our Firm) included in or made part of this
registration statement.
Arthur Andersen LLP
Boston, Massachusetts
December 7, 1998
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