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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended MARCH 31, 1999.
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from ____________ to ____________.
Commission file number _________
EXCHANGE APPLICATIONS, INC.
(Exact name of registrant, as specified in its charter)
DELAWARE 04-3338916
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
89 SOUTH STREET, BOSTON, MASSACHUSETTS 02111
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 617-737-2244
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes [X] No [ ]
State the number of shares outstanding of the registrant's common stock, as of
the latest practicable date.
Number of Shares 9,825,090 Outstanding as of May 6, 1999
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Exchange Applications, Inc.
Form 10-Q for the Three Months Ended March 31, 1999
Table of Contents
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page Number
<S> <C>
Item 1. Financial statements (unaudited):
Consolidated Balance Sheets as of March 31, 1999 and December 31, 1998 3
Consolidated Statements of Operations for the three months ended March 31, 1998
and 1999 4
Consolidated Statements of Cash Flows for the three months ended March 31, 1998
and 1999 5
Notes to Interim Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operation 8
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
</TABLE>
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
---------- -------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents.................................... $ 5,207 $ 2,690
Marketable securities........................................ 15,460 15,630
Accounts receivable, net..................................... 7,553 8,665
Prepaid expenses and other current assets.................... 779 1,113
-------- --------
Total current assets.................................. 28,999 28,098
Property and equipment, net.................................... 2,506 3,185
Long term marketable securities................................ 207 204
Other assets................................................... 79 87
-------- --------
Total assets.......................................... $ 31,791 $ 31,574
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................. $ 393 $ 943
Accrued expenses............................................. 5,492 3,740
Current portion of obligations under capital leases.......... 216 187
Deferred revenue............................................. 1,354 1,863
-------- --------
Total current liabilities............................. 7,455 6,733
Obligations under capital leases, net of current portion....... 145 111
Stockholders' equity:
Preferred Stock; $.001 par value --
10,000,000 shares authorized, none issued and outstanding . -- --
Common Stock, $.001 par value --
30,000,000 shares authorized; 10,098,691 and 10,165,508
shares issued at December 31, 1998 and March 31, 1999, 10 10
respectively................................................
Additional paid-in capital................................... 31,688 31,752
Accumulated deficit.......................................... (6,620) (6,210)
Due from officer............................................. (125) (125)
Deferred compensation........................................ (800) (732)
Cumulative translation adjustment............................ 30 30
Unrealized gain on marketable securities..................... 8 5
Treasury stock, at cost; 365,005 shares at December 31, 1998
and March 31, 1999........................................... -- --
-------- --------
Total stockholders' equity............................ 24,191 24,730
-------- --------
Total liabilities and stockholders' equity ........... $ 31,791 $ 31,574
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
3
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EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1998 1999
----------- -----------
<S> <C> <C>
Revenues:
Software license fees..........................................$ 2,711 $ 5,008
Services and maintenance....................................... 2,080 3,312
----------- -----------
Total revenues.......................................... 4,791 8,320
Cost of revenues:
Software license fees.......................................... 84 101
Services and maintenance....................................... 1,635 1,905
----------- -----------
Total cost of revenues.................................. 1,719 2,006
----------- -----------
Gross profit..................................................... 3,072 6,314
Operating expenses:
Sales and marketing............................................ 1,735 3,171
Research and development....................................... 1,207 1,821
General and administrative..................................... 600 899
----------- -----------
Total operating expenses................................ 3,542 5,891
----------- -----------
Income (loss) from operations.................................... (470) 423
Interest income (expense):
Interest income................................................ 41 236
Interest expense............................................... (18) (8)
----------- -----------
Total interest income (expense)......................... 23 228
----------- -----------
Income (loss) before provision for income taxes.................. (447) 651
Provision for income taxes....................................... -- 241
--------- ---------
Net income (loss)................................................ (447) 410
Accretion of discount and dividends on preferred stock........... (60) --
----------- -----------
Net income (loss) applicable to common stockholders..............$ (507) $ 410
=========== ===========
Net income (loss) per share (Note 2(c)):
Basic and diluted net income (loss) per share applicable to
common stockholders............................................$ (0.14) $ 0.04
=========== ===========
Basic weighted average common shares outstanding.............. 3,539,164 9,732,100
=========== ===========
Diluted weighted average common shares outstanding............ 3,539,164 11,604,849
=========== ===========
Pro forma net loss per share for the three months ended March 31, 1998
(Note 2(c)):
Pro forma basic and diluted net loss per share.................$ (0.06)
===========
Pro forma basic and diluted weighted average common shares
outstanding.................................................. 7,318,675
===========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
4
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EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1998 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)................................................ $ (447) $ 410
Adjustments to reconcile net loss to net cash used in operating
activities
Depreciation and other amortization.............................. 87 276
Compensation expense associated with stock options............... 62 68
Changes in operating assets and liabilities --
Accounts receivable............................................. (1,359) (1,112)
Prepaid expenses and other current assets...................... 443 (334)
Accounts payable............................................... 488 550
Accrued expenses............................................... (629) (1,752)
Deferred revenue............................................... 457 509
------- -------
Net cash used in operating activities...................... (898) (1,385)
------- -------
Cash flows from investing activities:
Purchase of marketable securities................................ -- (171)
Purchases of property and equipment.............................. (427) (955)
(Increase) decrease in other assets.............................. -- (8)
------- --------
Net used in investing activities........................... (427) (1,134)
------- -------
Cash flows from financing activities:
Repayments under capital leases.................................. (48) (63)
Exercise of common stock options................................. 2 65
------- ---------
Net cash provided by (used in) financing activities........ (46) 2
-------- -------
Effect of exchange rate changes on cash and cash equivalents....... 46 --
------- -------
Net decrease in cash and cash equivalents.......................... (1,325) (2,517)
------- --------
Cash and cash equivalents, beginning of year....................... 5,273 5,207
------- -------
Cash and cash equivalents, end of year............................. $ 3,948 $ 2,690
======= =======
Supplemental disclosure of cash flow information --
Cash paid for interest........................................... $ 18 $ 8
======= =======
Cash paid for income taxes....................................... $ -- $ --
======= =======
Supplemental disclosure of noncash financing and investing activities:
Accretion of discount and dividends on Preferred Stock........... $ 60 $ --
======= =======
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
5
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EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of Consolidation
The accompanying consolidated financial statements are unaudited and have
been prepared in accordance with generally accepted accounting principles. These
statements include the accounts of Exchange Applications and its wholly owned
subsidiaries.
(b) Interim financial reporting
Certain information and footnote disclosures normally included in the the
Company's annual consolidated financial statements have been condensed or
omitted. The interim consolidated financial statements, in the opinion of
management, reflect all adjustments (consisting only of normal recurring
accruals) necessary for a fair statement of the results for the interim periods
ended March 31, 1998 and 1999, respectively. The results of operations for the
interim periods are not necessarily indicative of the results of operations to
be expected for the entire year. It is suggested that these interim consolidated
financial statements be read in conjunction with the audited consolidated
financial statements for the year ended December 31, 1998, which are contained
in the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission on March 30, 1999.
(c) Net Income (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 for the
three months ended March 31, 1998 is calculated by dividing the net loss
applicable to common stockholders by the weighted average number of vested
common shares outstanding. Pro forma basic and diluted net loss per share for
the three months ended March 31, 1998 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.
For the three months ended March 31, 1999 basic net income per common share
is calculated by dividing the net income applicable to common stockholders by
the weighted average number of vested common shares outstanding for the three
months ended March 31, 1999. Diluted net income per common share for the three
months ended March 31, 1999 is calculated by dividing the net income applicable
to common stockholders by the weighted average number of vested common shares
outstanding and the dilutive effect of potential common shares, consisting of
outstanding stock options, as determined using the treasury stock method in
accordance with SFAS No. 128.
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EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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:
THREE MONTHS ENDED
MARCH 31
1998 1999
--------- ---------
Weighted average common
shares outstanding......... 3,880,165 9,768,176
Less: Weighted average
unvested common shares
outstanding................ 341,001 36,076
--------- --------
Basic and diluted weighted
average common shares
outstanding................ 3,539,164 9,732,100
Add: Dilutive potential common
shares from stock options and
unvested common stock........ __ 1,872,749
Diluted weighted average common
shares outstanding......... 3,539,164 11,604,849
==========
Add: Weighted average common
shares issuable upon
conversion of preferred stock 3,779,511
---------
Pro forma basic and diluted
weighted average common shares
outstanding................ 7,318,675
=========
Diluted weighted average shares outstanding for the three months ended
March 31, 1998 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 March 31, 1998, 5,273,421 potential common
shares were outstanding.
(d) Comprehensive Income
The Company has adopted Statement of Financial Accounting Standards No.
130, Reporting Comprehensive Income ("SFAS No. 130"). SFAS No. 130 requires that
items defined as other comprehensive income, such as foreign currency
translation adjustments, be separately classified in the financial statements
and that the accumulated balance of other comprehensive income be reported
separately from retained earnings and additional paid-in capital in the equity
section of the balance sheet. The components of comprehensive income for the
three months ended March 31, 1998 and 1999 are as follows (in thousands):
THREE MONTHS ENDED MARCH 31,
1998 1999
--------- ---------
Comprehensive income (loss):
Net income (loss) $ (447) $ 410
Other comprehensive income (loss):
Foreign currency adjustment 46 --
Marketable securities adjustment -- (3)
--------- -------
Comprehensive income (loss) $ (401) $ 407
========= =======
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(e) 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.
As of December 31, 1998 and March 31, 1999, the Company's marketable securities
consisted of investment grade corporate bonds. As of March 31, 1999, the
Company's marketable securities had an average remaining maturity date of 62
days. As of December 31, 1998 and March 31, 1999, the Company had recorded
unrealized gains of approximately $8,000 and $5,000, respectively.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This discussion contains forward-looking statements that involve risks and
uncertainties. Exchange Applications' 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 Form 10-Q.
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") 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 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"). 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 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
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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.
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.
RISK FACTORS RELATING TO FORWARD-LOOKING STATEMENTS
Risk Factors Relating to Forward-Looking Statements in this report
concerning the future results of operations, financial condition and business of
the Company are "forward-looking" statements as defined in the Securities Act of
1933 and the Securities Exchange Act of 1934. Investors are cautioned that
information contained in these forward-looking statements is inherently
uncertain, and that actual performance and results may differ materially due to
numerous risk factors, including but not limited to the following: Limited
Operating History; History of Losses, Potential for Significant Fluctuations in
Quarterly Results, Product Concentration; Dependence on Emerging Market for
Customer Optimization Software and Services, Customer Concentration; Dependence
on Certain Industries, Management of Growth, Dependence Upon Key Personnel,
Absence of History as an Independent Company, Rapid Technological Change and New
Products, Competition, Increasing Reliance on Indirect Distribution Channel,
Intellectual Property Rights; Use of Licensed Technology, International
Operation, Control by Existing Stockholders, Product Liability, Year 2000
Compliance, No Prior Market for the Common Stock; Possible Volatility of Share
Price, Anti-Takeover Provisions, Shares Eligible for Future Sale; Registration
Rights. The Company's filings with the Securities and Exchange Commission,
including the Annual Report on Form 10-K for the year ended December 31, 1998,
contain additional information concerning such risk factors.
THREE MONTHS ENDED MARCH 31, 1998 AND 1999
Revenues
The Company's total revenues increased 74% from $4.8 million in the three
months ended March 31, 1998 to $8.3 million for the three months ended March 31,
1999. This increase in total revenues can be attributed to a number of factors,
including:
- an increase in the Company's sales force from 6 direct sales
representatives at March 31, 1998 to 22 at March 31, 1999;
- an increase in international revenues from the Company's subsidiaries
in the United Kingdom and Australia; and
- an increase in services and maintenance revenues from the Company's
growing customer base
Software license fee revenues increased 85% from $2.7 million, or 56.6% of
total revenues, in the three months ended March 31, 1998 to $5.0 million, or
60.2% of total revenues, in the three months ended March 31, 1999. The increase
in software license fee revenues was primarily due to increased market awareness
of the VALEX product, especially in the telecommunications industry, which
resulted in an incremental $1.9 million of software license fee
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revenues from direct sales to customers.
Services and maintenance revenues increased 59% from $2.1 million or 43.4%
of total revenues, in the three months ended March 31, 1998 to $3.3 million, or
39.8% of total revenues, in the three months ended March 31, 1999. The growth of
services and maintenance revenues was directly attibutable to additional service
engagements and maintenance fees from the Company's increased base of customers.
The decrease in services and maintenance revenues as a percentage of total
revenues was primarily attributable to the increased software license fee
revenues resulting from the market acceptance of VALEX and increasing sales of
VALEX by re-sellers and co-marketers that provided certain of the related
services. The Company expects that, over time, the parties with whom it has
undertaken re-seller and co-marketing relationships will perform more of the
professional services associated with software licenses sold through these
channels. Therefore, the Company anticipates that services and maintenance
revenues will remain the same, or decrease slightly, as a percentage of total
revenues. However, if the Company's installed based continues to increase, it is
expected that services and maintenance revenues will increase in absolute
dollars.
For the three months ended March 31, 1999, the Company's top five customers
accounted for 48.9% of total revenues as compared to 79.0% of total revenues for
the three months ended March 31, 1998. None of the top five customers during the
three months ended March 31, 1999 were top five customers during the three
months ended March 31, 1998. The largest customer during the three months ended
March 31, 1999 represented 18.1% of total revenues, while the four largest
customers for the three months ended March 31, 1998 represented 39.2%, 11.0%,
10.4%, and 10.1%, respectively, of the Company's total revenues.
Revenues from customers outside North America were $1.9 million for the
three months ended March 31, 1999, representing approximately 22% of total
revenues. Revenues from customers outside North America were $878,000 for the
three months ended March 31, 1998, representing approximately 18% of total
revenues.
Cost of Revenues
The Company's 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 35.9% in the three
months ended March 31, 1998 to 24.1% in the three months ended March 31, 1999.
Cost of software license fees consists primarily of royalty payments made
to third parties for licensed intellectual property included in the VALEX
product, and costs associated with software packaging and distribution. In
absolute dollars, cost of software license fees increased slightly from $84,000
for the three months ended March 31, 1998 to $101,000 for the three months ended
on March 31, 1999. Cost of software license fees, however, decreased as a
percentage of total revenues from 1.8% to 1.2% for the three months ended March
31, 1998 and 1999, respectively. Cost of software license fees as a percentage
of software license fee revenues decreased from 3.1% to 2.0% for the three
months ended March 31, 1998 and 1999, respectively. The increase in cost of
software license fees for the three months ended March 31, 1999 over March 31,
1998 resulted from increased shipments of VALEX software and, therefore, the
associated royalty expense payable to third parties and costs associated with
software packaging and distribution. This increase was partially offset by the
fact that the Company's primary royalty obligation in 1998, which was payable on
the first $10 million of VALEX sales, was fully satisfied by the end of the
second quarter of 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 both in absolute dollars and as a percentage of revenues.
The Company's cost of services and maintenance consists primarily of
personnel, facility and system costs incurred in providing professional
consulting services, training, and customer support services. As a result of the
increased software license fee revenues, cost of services and maintenance
revenues as a percentage of total revenues decreased from 34.1% for the three
months ended March 31, 1998 to 22.9% for the three months ended March 31, 1999.
Cost of services and maintenance as a percentage of services and maintenance
revenues was 78.6% and 57.5% for the three months ended March 31, 1998 and 1999,
respectively. The decrease was attributable primarily
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to the increased contribution of higher margin maintenance revenues resulting
from the increased installed base of VALEX customers in the three months ended
March 31, 1999 over the same period in 1998.
As the Company sells more of its software products through re-seller and
co-marketing relationships, it is anticipated that the re-sellers will provide
certain of the consulting and maintenance services associated with these sales.
By using the services resources of the re-sellers and co-marketers, the Company
plans to allocate its own professional services resources to:
- direct-sale customers;
- projects that require unique expertise or familiarity with the VALEX
product; and
- newly identified, more profitable opportunities.
Due to this fact, and to the continued increase in contribution from higher
margin maintenance revenues, the Company expects cost of services and
maintenance to decrease slightly as a percentage of both total revenues and
service and maintenance revenues in the foreseeable future.
Overall gross margin increased from 64.1% for the three months ended March
31, 1998 to 75.9% for the three months ended March 31, 1999 due primarily to
increased sales of VALEX.
Operating Expenses
Sales and Marketing. The Company's sales and marketing expenses consist
primarily of salaries for sales and marketing personnel, commissions, travel and
promotional expenses. For the three months ended March 31, 1998 and 1999, sales
and marketing expenses were 36.2% and 38.1% of total revenues, or $1.7 million
and $3.2 million, respectively. The increase is primarily attributable to an
increase in sales and marketing personnel from 24 at March 31, 1998 to 57 at
March 31, 1999, as well as increased spending on certain promotional activities
including trade shows, seminars, and the development of collateral materials
designed to increase awareness of the Company and the VALEX product. The
investment in the sales and marketing personnel and activities has contributed
to increased VALEX revenues and expansion of the customer installation base to
over seventy locations in 21 countries. As the Company expands its business into
new vertical markets and continues the expansion internationally into Europe and
the Asia/Pacific region, the Company expects to continue to invest resources
into the sales and marketing arena. While sales and marketing expenses are
expected to continue to grow in absolute dollars, the Company expects these
expenses to remain the same or decrease slightly as a percentage of total
revenues due to economies of scale and increased contribution from indirect
sales channels.
Research and Development. The Company's 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.
For the three months ended March 31, 1998 and 1999, research and development
expenses were 25.2% and 21.9% of total revenues, or $1.2 million and $1.8
million, respectively. This increase in absolute dollars was primarily a result
of the addition of 25 research and development personnel, including contractors,
in the three months ended March 31, 1999 as compared to the same period in 1998.
Total revenues increased at a faster pace than research and development
expenditures, resulting in a decrease in total research and development expense
as a percentage of total revenues. The Company anticipates that research and
development expenses will continue to increase in absolute dollars but decrease
as a percentage of total revenues as it 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:
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- salaries and related costs;
- outside professional fees;
- provision for bad debts; and
- equipment and software depreciation costs associated with our finance,
legal, human resources, information systems, and administrative
functions.
General and administrative expenses increased from $600,000, or 12.5% of
total revenues, for the three months ended March 31, 1998 to $899,000, or 10.8%
of total revenues, for the three months ended March 31, 1999. Expenses increased
in absolute dollars as the Company added eleven employees to its finance,
information systems, and human resource departments between March 31, 1998 and
March 31, 1999. Expenses declined, however, 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
as a percentage of total revenues as a result of the following factors:
- the implementation of additional management information systems;
- the continuation of the Company's international expansion; and
- the costs that the Company is incurring as a result of being a
publicly-held company.
Interest Income (Expense), Net
Net interest income increased from $23,000 for the three months ended March
31, 1998 to $228,000 for the three months ended March 31, 1999 primarily as a
result of interest earned on proceeds from the Company's initial public offering
completed in December 1998.
Provision for Income Taxes.
No provision for foreign, federal, or state income taxes was recorded for
the three months ended March 31, 1998 because the Company incurred a net loss
during the three month period. For the three months ended March 31, 1999 the
Company recorded a provision for income taxes of $241,000 or 37% of income
before income taxes. It is our belief that 37% represents the effective income
tax rate for 1999 after taking into account certain tax credits and the
utilization of net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
The initial public offering of the Company's common stock completed on
December 14, 1998 resulted in net proceeds of approximately $18.5 million. As of
March 31, 1999 the Company had $18.3 million in cash and short-term investments.
It is the Company's belief that its existing balance of cash, cash equivalents
and short-term investments, combined with its $2.0 million revolving note
agreement with Fleet National Bank 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 our business. There can be no assurance that such capital,
if needed, will be available or will be available on terms the Company finds
acceptable.
Cash and cash equivalents as of March 31, 1999 decreased $2.5 million from
December 31, 1998. Net cash used for operations of approximately $1.4 million
resulted primarily from net income of $754,000 before depreciation
12
<PAGE> 13
expense and non-cash option related compensation expense, offset by an
approximate $2.1 million increase in non-cash working capital. The increase in
non-cash working capital was primarily attributable to an increase in accounts
receivable associated with increased license and services revenue in the 3
months ended March 31, 1999 as compared to the three months ended December 31,
1998 and a reduction of certain accrued expenses from the December 31, 1998
balance as a result of the payment, in the first quarter of 1999, of 1998
year-end performance bonuses as well as some accrued costs related to our
initial public offering. These decreases were partially offset by an increase in
the balance of accounts payable and deferred revenue from December 31, 1998 to
March 31, 1999.
Net cash used in investing activities for the three months ended March 31,
1999 was a result of property and equipment purchases related to the increase in
headcount, the move to new operating facilities in London and expansion of the
current facilities in Boston as well as the acquisition of computer hardware and
software for development and internal operating systems. In addition, the
Company purchased $171,000 of short-term investments with cash that was being
maintained in an overnight cash investment account at December 31, 1998. Net
cash provided by financing activities of $2,000 consisted of $65,000 in proceeds
from the exercise of common stock options offset by $63,000 for the repayment of
capital lease obligations.
The Company had net operating loss carryforwards of approximately $2.2
million at March 31, 1999 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 experienced a change in ownership
in excess of 50%, however the Company does not believe that this change will
significantly impact its ability to utilize the 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 its
operating results. As of March 31, 1999, 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 its international operations expand into less stable economic
environments.
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 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
13
<PAGE> 14
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The following discussion about the Company's market risk disclosures
involves forward looking statements. Actual results could differ materially from
those projected in the forward-looking statements. The Company is exposed to
market risk related to changes in interest rates and foreign currency exchange
rates. The Company does not use derivative financial instruments for speculative
or trading purposes.
Interest Rate Sensitivity. The Company maintains a short-term investment
portfolio consisting mainly of corporate debt securities and U.S. government
agency treasury bills and notes with an average maturity of less then twelve
months. These available-for-sale securities are subject to interest rate risk
and will fall in value if market interest rates increase. If market interest
rates were to increase immediately and uniformly by 10 percent from levels at
March 31, 1999, the fair value of the portfolio would decline by an immaterial
amount.
Foreign Currency Exchange Risk. With sales and services offices in the
United States, United Kingdom and Australia, and a global customer base, the
Company faces exposure to adverse movements in foreign currency exchange rates.
These exposures may change over time as business practices evolve and could have
a material
14
<PAGE> 15
adverse impact on the Company's financial results. Historically the Company's
primary exposure has been nondollar-denominated operating expenses and sales by
its United Kingdom subsidiary. The introduction of the Euro as a common currency
for members of the European Monetary Union, of which the United Kingdom is not a
member, occurred in January 1999. To date, we have not noticed any material
impact from the introduction of the Euro. We have not determined the impact of
the Euro on our foreign currency risk. In addition, as the Company expands its
sales and service presence in the Asia/Pacific region in 1999, its exposure to
foreign currency exchange rate risks from the more volatile economies of this
region will increase. The Company is prepared to hedge against fluctuations in
the British Sterling, Euro, or other foreign currency if the exposure becomes
material. As of March 31, 1999 the Company's material nondollar-denominated
assets and liabilities primarily consisted of cash, accounts receivable, and
accounts payable denominated in British Sterling and Australian dollars.
15
<PAGE> 16
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
27 -- Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter for which this report is
filed
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused the report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EXCHANGE APPLICATIONS, INC.
(Registrant)
Dated: May 13, 1999
By: /s/ John G. O'Brien
--------------------------------
John G. O'Brien
Vice President, Chief Financial Officer,
Treasurer, Secretary
(authorized officer and principal finance
and accounting officer)
17
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