<PAGE> 1
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 JUNE 30, 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 10,973,235 Outstanding as of July 31, 1999
---------- -------------
<PAGE> 2
Exchange Applications, Inc.
Form 10-Q for the Three Months Ended June 30, 1999
Table of Contents
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page Number
-----------
<S> <C>
Item 1. Financial statements (unaudited):
Consolidated Balance Sheets as of June 30, 1999 and 3
December 31, 1998
Consolidated Statements of Operations for the three and
six months ended June 30, 1998 and 1999 4
Consolidated Statements of Cash Flows for the six months
ended June 30, 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 9
Item 3. Quantitative and Qualitative Disclosure about Market Risk 18
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
</TABLE>
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<PAGE> 3
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, JUNE 30,
1998 1999
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ................................... $ 5,207 $ 20,797
Marketable securities ....................................... 15,460 15,147
Accounts receivable, net .................................... 7,553 10,229
Prepaid expenses and other current assets ................... 779 1,250
-------- --------
Total current assets ................................. 28,999 47,423
Property and equipment, net ................................... 2,506 3,718
Long-term marketable securities ............................... 207 2,985
Other assets .................................................. 79 87
-------- --------
Total assets ......................................... $ 31,791 $ 54,213
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................ $ 393 $ 642
Accrued expenses ............................................ 5,492 5,464
Current portion of obligations under capital leases ......... 216 --
Deferred revenue ............................................ 1,354 2,447
-------- --------
Total current liabilities ............................ 7,455 8,553
Obligations under capital leases, net of current portion ...... 145 --
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 11,270,618
shares issued at December 31, 1998 and June 30, 1999,
respectively............................................... 10 11
Additional paid-in capital .................................. 31,688 51,869
Accumulated deficit ......................................... (6,620) (5,406)
Due from officer ............................................ (125) (125)
Deferred compensation ....................................... (800) (667)
Cumulative translation adjustment ........................... 30 (5)
Unrealized gain on marketable securities .................... 8 (17)
Treasury stock, at cost; 365,005 shares at December 31, 1998
and June 30, 1999 ......................................... -- --
-------- --------
Total stockholders' equity ........................... 24,191 45,660
-------- --------
Total liabilities and stockholders' equity ........... $ 31,791 $ 54,213
======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
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<PAGE> 4
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
1998 1999 1998 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Software license fees ............................................. $ 3,105 $ 6,051 $ 5,816 $ 11,059
Services and maintenance .......................................... 2,522 3,994 4,602 7,305
------------ ------------ ------------ ------------
Total revenues ............................................. 5,627 10,045 10,418 18,364
Cost of revenues:
Software license fees ............................................. 45 63 129 164
Services and maintenance .......................................... 1,667 2,402 3,302 4,307
------------ ------------ ------------ ------------
Total cost of revenues ..................................... 1,712 2,465 3,431 4,471
------------ ------------ ------------ ------------
Gross profit ........................................................ 3,915 7,580 6,987 13,893
Operating expenses:
Sales and marketing ............................................... 2,428 3,480 4,163 6,650
Research and development .......................................... 1,509 2,009 2,716 3,830
General and administrative ........................................ 742 1,055 1,342 1,954
------------ ------------ ------------ ------------
Total operating expenses ................................... 4,679 6,544 8,221 12,434
------------ ------------ ------------ ------------
Income (loss) from operations ....................................... (764) 1,036 (1,234) 1,459
Interest income (expense):
Interest income ................................................... 14 240 56 475
Interest expense .................................................. (8) -- (27) (8)
------------ ------------ ------------ ------------
Total interest income, net ................................. 6 240 29 467
------------ ------------ ------------ ------------
Income (loss) before provision for income taxes ..................... (758) 1,276 (1,205) 1,926
Provision for income taxes .......................................... -- 472 -- 713
------------ ------------ ------------ ------------
Net income (loss) ................................................... (758) 804 (1,205) 1,213
Accretion of discount and dividends on preferred stock .............. (60) -- (120) --
------------ ------------ ------------ ------------
Net income (loss) applicable to common stockholders ................. $ (818) $ 804 $ (1,325) $ 1,213
============ ============ ============ ============
Net income (loss) per share (Note 2(c)):
Basic net income (loss) per share applicable to common stockholders . $ (0.22) $ 0.08 $ (0.37) $ 0.12
============ ============ ============ ============
Diluted net income (loss) per share applicable to common stockholders $ (0.22) $ 0.07 $ (0.37) $ 0.10
============ ============ ============ ============
Basic weighted average common shares outstanding ................. 3,656,258 10,125,292 3,597,711 9,946,734
============ ============ ============ ============
Diluted weighted average common shares outstanding ............... 3,656,258 12,208,362 3,597,711 11,906,605
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
1998 1999
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)................................................ $(1,205) $ 1,213
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and other amortization.............................. 228 637
Compensation expense associated with stock options............... 126 133
Changes in operating assets and liabilities --
Accounts receivable............................................. (1,392) (2,676)
Prepaid expenses and other current assets....................... 2 (471)
Accounts payable................................................ 812 251
Accrued expenses................................................ 198 (28)
Deferred revenue................................................ 802 1,093
------- -------
Net cash provided by (used in) operating activities........ (429) 152
------- -------
Cash flows from investing activities:
Purchase of marketable securities................................ -- (2,490)
Purchases of property and equipment.............................. (923) (1,849)
(Increase) decrease in other assets.............................. 77 (8)
------- --------
Net cash used in investing activities...................... (846) (4,347)
------- -------
Cash flows from financing activities:
Repayments under capital leases.................................. (110) (361)
Issuance of common stock in second public offering, net of offering costs --
20,010
Exercise of common stock options................................. 41 172
------- ---------
Net cash provided by (used in) financing activities........ (69) 19,821
-------- -------
Effect of exchange rate changes on cash and cash equivalents....... 48 (36)
------- --------
Net increase (decrease) in cash and cash equivalents............... (1,296) 15,590
------- -------
Cash and cash equivalents, beginning of year....................... 5,273 5,207
------- -------
Cash and cash equivalents, end of period........................... $ 3,977 $20,797
======= =======
Supplemental disclosure of cash flow information --
Cash paid for interest........................................... $ 13 $ 8
======= =======
Cash paid for income taxes....................................... $ -- $ 26
======= =======
Supplemental disclosure of noncash financing and investing activities:
Equipment acquired under capital leases.......................... $ 20 $ --
======= ======
Accretion of discount and dividends on Preferred Stock........... $ 120 $ --
======= ======
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
5
<PAGE> 6
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 June 30, 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 and six months ended June 30, 1998 is calculated by dividing the net loss
applicable to common stockholders by the weighted average number of vested
common shares outstanding.
For the three and six months ended June 30, 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 and six month period then ended. Diluted net income per common
share for the three and six months ended June 30, 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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<PAGE> 7
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 weighted
average common shares outstanding:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
1998 1999 1998 1999
--------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Weighted average common
shares outstanding 3,899,054 10,143,857 3,889,609 9,956,017
Less: Weighted average
unvested common shares
outstanding 242,796 18,565 291,898 27,405
--------- ---------- --------- ----------
Basic and diluted weighted
average common shares
outstanding 3,656,258 10,125,292 3,597,711 9,928,612
Add: Dilutive potential common
shares from stock options and
unvested common stock -- 2,083,070 -- 1,977,993
--------- ---------- --------- ----------
Diluted weighted average
common shares outstanding 3,656,258 12,208,362 3,597,711 11,906,605
========= ========== ========= ==========
</TABLE>
Diluted weighted average shares outstanding for the six months ended June
30, 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 June 30, 1998, 5,886,927 potential common shares were
outstanding.
(d) Comprehensive Income (Loss)
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 (loss), such as foreign currency
translation adjustments, be separately classified in the financial statements
and that the accumulated balance of other comprehensive income (loss) be
reported separately from retained earnings and additional paid-in capital in the
equity section of the balance sheet. The components of comprehensive income
(loss) for the three and six months ended June 30, 1998 and 1999 are as follows
(in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1999 1998 1999
----- ----- ------- -------
<S> <C> <C> <C> <C>
Comprehensive income (loss):
Net income (loss) $(758) $ 804 $(1,205) $ 1,213
Other comprehensive income (loss):
Foreign currency adjustment 3 (35) 48 (35)
Marketable securities adjustment 1 (22) 2 (25)
----- ----- ------- -------
Comprehensive income (loss) $(754) $ 747 $(1,155) $ 1,153
===== ===== ======= =======
</TABLE>
(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 amortized cost,
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<PAGE> 8
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 June 30, 1999, the Company's marketable securities
consisted of investment grade corporate bonds. As of December 31, 1998 and June
30, 1999, the Company had recorded unrealized gains and (losses) of
approximately $8,000 and ($17,000), respectively.
(e) Public Stock Offering
On June 8, 1999 the Company completed a second stock offering, whereby it sold
1,000,000 shares of its common stock at a price of $22.00 per share.
The net proceeds to the Company, after offering cost, were $20,010,000.
8
<PAGE> 9
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 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
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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 continue to 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.
SIX MONTHS ENDED JUNE 30, 1998 AND 1999
Revenues
The Company's total revenues increased 76% from $10.4 million in the six
months ended June 30, 1998 to $18.4 million for the six months ended June 30,
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 June 30, 1998 to 21 at June 30, 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 90% from $5.8 million, or 55.8% of
total revenues, in the six months ended June 30, 1998 to $11.0 million, or 60.2%
of total revenues, in the six months ended June 30, 1999. The increase in
software license fee revenues was primarily due to increased market awareness of
the VALEX product, especially in the telecommunications industry and new
emerging vertical markets such as utilities and retail, which resulted in an
incremental $3.4 million of software license fee revenues from sales to
customers in those vertical markets.
Services and maintenance revenues increased 58% from $4.6 million or 44.3%
of total revenues for the six months ended June 30, 1998 to $7.3 million, or
39.8% of total revenues for the six months ended June 30, 1999. The growth of
services and maintenance revenues was directly attributable 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. As the Company continues
to expand its services offering to include newly identified, more profitable
opportunities, as well as projects that require unique expertise or familiarity
with the VALEX product, it is expected that services and maintenance revenues
will remain constant or increase slightly as a percentage of total revenues.
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For the six months ended June 30, 1999, the Company's top five customers
accounted for 34.2% of total revenues as compared to 53.6% of total revenues for
the six months ended June 30, 1998. Only one of the top five customers during
the six months ended June 30, 1999 was a top five customer during the six months
ended June 30, 1998. The largest customer during the six months ended June 30,
1999 represented 9.6% of total revenues, while the two largest customers for the
six months ended June 30, 1998 represented 24.1% and 9.9%, respectively, of the
Company's total revenues.
Revenues from customers outside North America were $6.3 million for the
six months ended June 30, 1999, representing approximately 34% of total revenues
as compared to $1.6 million or 15% of total revenues for the comparable period
in the prior year.
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 32.9% in the six months
ended June 30, 1998 to 24.4% in the six months ended June 30, 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 $129,000
for the six months ended June 30, 1998 to $164,000 for the six months ended June
30, 1999. Cost of software license fees, however, decreased as a percentage of
total revenues from 1.2% to 0.9% for the six months ended June 30, 1998 and
1999, respectively. Cost of software license fees as a percentage of software
license fee revenues decreased from 2.2% to 1.5% for the six months ended June
30, 1998 and 1999, respectively. The increase in cost of software license fees
for the six months ended June 30, 1999 over June 30, 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 31.7% for the six
months ended June 30, 1998 to 23.5% for the six months ended June 30, 1999. Cost
of services and maintenance as a percentage of services and maintenance revenues
was 71.8% and 59.0% for the six months ended June 30, 1998 and 1999,
respectively. The decrease was attributable primarily to the increased
contribution of higher margin maintenance revenues resulting from the increased
installed base of VALEX customers in the six months ended June 30, 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.
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<PAGE> 12
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 remain the same or decrease slightly as a percentage of both
total revenues and service and maintenance revenues in the foreseeable future.
Overall gross margin increased from 67.1% for the six months ended June
30, 1998 to 75.7% for the six months ended June 30, 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 six months ended June 30, 1998 and 1999, sales and
marketing expenses were 40.0% and 36.2% of total revenues, or $4.2 million and
$6.7 million, respectively. The increase is primarily attributable to an
increase in sales and marketing personnel from 24 at June 30, 1998 to 53 at June
30, 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 eighty locations in 23 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 six months ended June 30, 1998 and 1999, research and development
expenses were 26.1% and 20.9% of total revenues, or $2.7 million and $3.8
million, respectively. This increase in absolute dollars was primarily a result
of the addition of 28 research and development personnel, including contractors,
in the six months ended June 30, 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:
- salaries and related costs;
- outside professional fees; and
- equipment and software depreciation costs associated with our
finance, legal, human resources, information systems, and
administrative functions.
General and administrative expenses increased from $1.3 million, or 12.9%
of total revenues, for the six months ended June 30, 1998 to $2.0 million, or
10.6% of total revenues, for the six months ended June 30, 1999. Expenses
increased in absolute dollars as the Company added seven employees to its
finance, information systems, and human resource departments between June 30,
1998 and June 30, 1999 and incurred approximately $150,000 in additional expense
as a result of being a publicly held company. Expenses declined, however, as a
percentage of total revenues, due primarily to economies of scale. The Company
expects general and administrative expenses to
12
<PAGE> 13
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 $29,000 for the six months ended June
30, 1998 to $467,000 for the six months ended June 30, 1999 primarily as a
result of interest earned on proceeds from the Company's initial public offering
completed in December 1998, and to a lesser extent its second public offering
completed in June 1999.
Provision for Income Taxes.
No provision for foreign, federal, or state income taxes was recorded for
the six months ended June 30, 1998 because the Company incurred a net loss
during the six month period. For the six months ended June 30, 1999 the Company
recorded a provision for income taxes of $713,000 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.
THREE MONTHS ENDED JUNE 30, 1998 AND 1999
Revenues
The Company's total revenues increased 79% from $5.6 million in the three
months ended June 30, 1998 to $10.0 million for the three months ended June 30,
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 June 30, 1998 to 21 at June 30, 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 95% from $3.1 million, or 55.2% of
total revenues, in the three months ended June 30, 1998 to $6.1 million, or
60.2% of total revenues, in the three months ended June 30, 1999. The increase
in software license fee revenues was primarily due to increased market awareness
of the VALEX product, especially in the telecommunications industry and new
emerging vertical markets such as utilities and retail, which resulted in an
incremental $2.3 million of software license fee revenues from sales to
customers in those vertical markets.
Services and maintenance revenues increased 58% from $2.5 million or 44.8%
of total revenues, in the three months ended June 30, 1998 to $4.0 million, or
39.8% of total revenues, in the three months ended June 30, 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.
13
<PAGE> 14
For the three months ended June 30, 1999, the Company's top five customers
accounted for 44.0% of total revenues as compared to 57.9% of total revenues for
the three months ended June 30, 1998. Only one of the top five customers during
the three months ended June 30, 1999 was a top-five customer during the three
months ended June 30, 1998. The two largest customers during the three months
ended June 30, 1999 represented 11.1% and 10.1% of total revenues, respectively,
while the three largest customers for the three months ended June 30, 1998
represented 17.7%, 11.6%, and 10.4%, respectively, of the Company's total
revenues.
Revenues from customers outside North America were $4.4 million for the
three months ended June 30, 1999, representing approximately 44% of total
revenues as compared to $723,000 or approximately 13% of total revenues for the
comparable period in the prior year.
Cost of Revenues
Total cost of revenues as a percentage of total revenues declined from
30.4% in the three months ended June 30, 1998 to 24.5% in the three months ended
June 30, 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 $45,000
for the three months ended June 30, 1998 to $63,000 for the three months ended
on June 30, 1999. Cost of software license fees, however, decreased as a
percentage of total revenues from 0.8% to 0.6% for the three months ended June
30, 1998 and 1999, respectively. Cost of software license fees as a percentage
of software license fee revenues decreased from 1.4% to 1.0% for the three
months ended June 30, 1998 and 1999, respectively. The increase in cost of
software license fees for the three months ended June 30, 1999 over June 30,
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.
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 29.6% for the three
months ended June 30, 1998 to 23.9% for the three months ended June 30, 1999.
Cost of services and maintenance as a percentage of services and maintenance
revenues was 66.1% and 60.1% for the three months ended June 30, 1998 and 1999,
respectively. The decrease was attributable primarily to the increased
contribution of higher margin maintenance revenues resulting from the increased
installed base of VALEX customers in the three months ended June 30, 1999 over
the same period in 1998.
Overall gross margin increased from 69.6% for the three months ended June
30, 1998 to 75.5% for the three months ended June 30, 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 June 30, 1998 and 1999, sales
and marketing expenses were 43.1% and 34.6% of total revenues, or $2.4 million
and $3.5 million, respectively. The increase is primarily attributable to an
increase in sales and marketing personnel from 24 at June 30, 1998 to 53 at June
30, 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.
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 June 30, 1998 and 1999, research and development
expenses were 26.8% and 20.0% of total revenues, or $1.5
14
<PAGE> 15
million and $2.0 million, respectively. This increase in absolute dollars was
primarily a result of the addition of 28 research and development personnel,
including contractors, in the three months ended June 30, 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.
General and Administrative. General and administrative expenses increased from
$742,000, or 13.2% of total revenues, for the three months ended June 30, 1998
to $1.1 million, or 10.5% of total revenues, for the three months ended June 30,
1999. Expenses increased in absolute dollars as the Company added seven
employees to its finance, information systems, and human resource departments
between June 30, 1998 and June 30, 1999 and incurred additional costs related to
being a public company. Expenses declined, however, as a percentage of total
revenues, due primarily to economies of scale.
Interest Income (Expense), Net
Net interest income increased from $6,000 for the three months ended June
30, 1998 to $240,000 for the three months ended June 30, 1999 primarily as a
result of interest earned on proceeds from the Company's initial public offering
completed in December 1998, and to a lesser extent its second public offering
completed in June 1999.
Provision for Income Taxes.
No provision for foreign, federal, or state income taxes was recorded for
the three months ended June 30, 1998 because the Company incurred a net loss
during the three month period. For the three months ended June 30, 1999 the
Company recorded a provision for income taxes of $472,000 or 37% of income
before income taxes.
LIQUIDITY AND CAPITAL RESOURCES
The second public offering of the Company's common stock completed on June
8, 1999 resulted in net proceeds of approximately $20.0 million. As of June 30,
1999 the Company had $35.9 million in cash and short-term investments and an
additional $3.0 million of long-term investments. In June 1999, the Company
modified the terms of its revolving note agreement with Fleet National Bank
increasing the credit limit from $2.0 million to $5.0 million. It is the
Company's belief that its existing balance of cash, cash equivalents and
short-term investments, combined with its $5.0 million revolving note agreement
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 June 30, 1999 increased $15.6 million from
December 31, 1998. Net cash provided by operations of approximately $152,000
resulted primarily from net income of $2.0 million before depreciation expense
and non-cash option related compensation expense, offset by an approximate $1.8
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 three months ended
June 30, 1999 as compared to the three months ended December 31, 1998 which was
partially offset by an increase in the balance of deferred revenue from December
31, 1998 to June 30, 1999.
Net cash used in investing activities for the six months ended June 30,
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 $2.5 million of investments with a portion of the proceeds
from the Company's second public stock offering in June 1999. Net cash provided
by financing activities of $19.8 million consisted of net cash proceeds from the
second public stock offering of $20 million, $172,000 in proceeds from the
exercise of common stock options during the 6 months ended June 30, 1999, and an
offsetting use of cash of $361,000 resulting from the Company's buyout of its
capital lease obligations in
15
<PAGE> 16
April 1999.
The Company had net operating loss carryforwards of approximately $2.2
million at June 30, 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 June 30, 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.
Within the last year the Company has 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
16
<PAGE> 17
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
June 30, 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 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 June 30 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.
17
<PAGE> 18
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Stockholders of the Company was held on May 26,
1999.
(b) The Annual Meeting was held to consider and vote upon electing one
director of the Company to hold office for a three-year term and until his
successor has been duly elected and qualified.
(c) The results of the votes cast with respect to the nominee are summarized
below:
<TABLE>
<CAPTION>
Director name For Withheld
- ------------- --- --------
<S> <C> <C>
Jeffrey Horing 7,030,283 5,601
</TABLE>
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
18
<PAGE> 19
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: August 5, 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)
19
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-1-1999
<PERIOD-END> JUN-30-1999
<CASH> 20,797
<SECURITIES> 18,132
<RECEIVABLES> 10,556
<ALLOWANCES> 327
<INVENTORY> 0
<CURRENT-ASSETS> 47,423
<PP&E> 5,326
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<TOTAL-ASSETS> 54,213
<CURRENT-LIABILITIES> 8,553
<BONDS> 0
0
0
<COMMON> 11
<OTHER-SE> 45,649
<TOTAL-LIABILITY-AND-EQUITY> 54,213
<SALES> 18,364
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<CGS> 4,471
<TOTAL-COSTS> 6,650
<OTHER-EXPENSES> 5,784
<LOSS-PROVISION> 0
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<INCOME-PRETAX> 1,926
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