EXCHANGE APPLICATIONS INC, 10-Q, 2000-11-14

EXCHANGE APPLICATIONS INC
10-Q, 2000-11-14
COMPUTER INTEGRATED SYSTEMS DESIGN

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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 SEPTEMBER 30, 2000.

[ ] 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 32,240,742 Outstanding as of October 31, 2000
---------- ----------------

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<PAGE>

Exchange Applications, Inc.

Form 10-Q for the Three Months Ended September 30, 2000

Table of Contents

PART I. FINANCIAL INFORMATION

Page
Number
------
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of September 30, 2000 and
December 31, 1999 3
Consolidated Statements of Operations for the three and
nine months ended September 30, 1999 and 2000 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and 2000 5
Notes to Interim Consolidated Financial Statements 6

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10

Item 3. Quantitative and Qualitative Disclosure about Market Risk 18

PART II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20

2
<PAGE>

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

<TABLE><CAPTION>
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31, SEPTEMBER 30,

1999 2000
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ................................... $ 14,678 $ 5,934
Marketable securities ....................................... 14,429 1,992
Accounts receivable, net .................................... 11,329 18,606
Prepaid expenses and other current assets ................... 2,538 2,793
--------- ---------
Total current assets ................................. 42,974 29,325
Property and equipment, net ................................... 4,570 10,236
Long-term marketable securities ............................... 5,030 1,001
Non current assets from Microstrategy Incorporated transaction. 62,030 47,313
Other assets .................................................. 461 9,369
Goodwill ...................................................... -- 126,684
Other intangible assets ....................................... -- 27,282
--------- ---------
Total assets ......................................... $ 115,065 $ 251,210
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................ $ 701 $ 4,562
Accrued expenses ............................................ 5,167 11,231
Current portion of obligations under capital leases ......... -- 1,571
Current portion of Microstrategy Incorporated obligation .... 15,377 22,219
Current portions of notes payable to certain former
shareholders of Customer Analytics, Inc. .................. -- 2,125
Deferred revenue ............................................ 6,455 4,349
--------- ---------
Total current liabilities ............................ 27,700 46,807
Obligations under capital leases, net of current portion ...... -- 1,358
Note payable to certain former shareholders of Customer
Analytics, Inc. ............................................ -- 2,125
Microstrategy Incorporated obligation, net of current portion. 16,653 --

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; 24,053,471 and 32,471,046
shares issued at December 31, 1999 and September 30, 2000,
respectively .............................................. 24 32
Additional paid-in capital .................................. 56,869 245,023
Accumulated deficit ......................................... (5,513) (43,541)
Due from officer ............................................ (125) (125)
Deferred compensation ....................................... (517) (332)
Cumulative translation adjustment ........................... 39 (124)
Unrealized gain (loss) on marketable securities ............. (65) (13)
Stock subscription .......................................... 20,000 --
Treasury stock, at cost; 366,565 shares at December 31, 1999
and September 30, 2000, respectively ....................... -- --
--------- ---------
Total stockholders' equity ........................... 70,712 200,920
--------- ---------
Total liabilities and stockholders' equity ........... $ 115,065 $ 251,210
========= =========

The accompanying notes are an integral part of these consolidated financial statements.

3
</TABLE>
<PAGE>
<TABLE><CAPTION>
EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 2000 1999 2000
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Software license fees ...................................... $ 6,793 $ 5,940 $ 17,852 $ 29,553
Services and maintenance ................................... 4,402 6,549 12,066 17,736
------------ ------------ ------------ ------------
Total revenues ...................................... 11,195 12,489 29,918 47,289
Cost of revenues:
Software license fees ...................................... 68 164 232 526
Services and maintenance ................................... 2,721 5,896 7,172 13,386
------------ ------------ ------------ ------------
Total cost of revenues .............................. 2,789 6,060 7,404 13,912
------------ ------------ ------------ ------------
Gross profit ................................................. 8,406 6,429 22,514 33,377
Operating expenses:
Sales and marketing ........................................ 3,712 7,424 10,451 18,453
Research and development ................................... 2,648 5,885 6,818 13,673
General and administrative ................................. 1,262 6,356 3,407 10,510
Cost of acquisition ........................................ 1,388 -- 1,388 --
Amortization of goodwill and other intangibles ............. -- 9,288 -- 12,814
Amortization of Microstrategy investment ................... -- 4,906 -- 14,916
------------ ------------ ------------ ------------
Total operating expenses ............................ 9,010 33,839 22,064 70,366
------------ ------------ ------------ ------------
Income (loss) from operations ................................ (604) (27,410) 450 (36,989)
Interest income (expense):
Interest income ............................................ 452 169 917 1,017
Interest expense from capital leases and notes payable .... -- (160) -- (160)
Interest expense from discount on Microstrategy
Incorporated obligation .................................. -- (554) -- (1,875)
------------ ------------ ------------ ------------
Total interest income (expense), net ................ 452 (545) 917 (1,018)
------------ ------------ ------------ ------------
Income (loss) before provision for income taxes .............. (152) (27,975) 1,367
Provision for income taxes ................................... (56) -- 657 (21)
------------ ------------ ------------ ------------
Net income (loss) ............................................ (96) (27,975) 710 (38,028)
Accretion of discount and dividends on preferred stock ....... -- -- -- --
------------ ------------ ------------ ------------
Net income (loss) applicable to common stockholders .......... $ (96) $ (27,975) $ 710 $ (38,028)
============ ============ ============ ============
Net income (loss) per share (Note 2(c)):

Basic net income (loss) per share applicable to common
stockholders ............................................... $ (0.00) $ (0.89) $ 0.03 $ (1.38)
============ ============ ============ ============
Diluted net income (loss) per share applicable to common
stockholders ............................................... $ (0.00) $ (0.89) $ 0.03 $ (1.38)
============ ============ ============ ============
Basic weighted average common shares outstanding ........... 23,109,692 31,578,464 21,674,848 27,530,431
============ ============ ============ ============
Diluted weighted average common shares outstanding ........ 23,109,692 31,578,464 25,877,054 27,530,431
============ ============ ============ ============

The accompanying notes are an integral part of these consolidated financial statements.

4
</TABLE>
<PAGE>
<TABLE><CAPTION>

EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

NINE MONTHS ENDED
SEPTEMBER 30,

1999 2000
-------- --------
<S> <C> <C>
Cash flows from operating activities:

Net income (loss) ..................................................................... $ 710 $(38,028)

Adjustments to reconcile net loss to net cash used in
operating activities:
Amortization of Microstrategy Incorporated asset ...................................... -- 14,916
Non cash interest related to Microstrategy Incorporated obligation .................... -- 1,874
Depreciation and other amortization ................................................... 1,102 2,280
Increase in allowance for doubtful account and write off of
uncollectible receivables ........................................................... -- 1,277
Amortization of goodwill and other intangibles ........................................ -- 12,794
Compensation expense associated with stock options .................................... 949 171
Changes in operating assets and liabilities--
Accounts receivable .................................................................. (3,839) (2,678)
Prepaid expenses and other current assets ........................................... (997) (89)
Accounts payable .................................................................... 654 866
Accrued expenses .................................................................... (137) 1,430
Deferred revenue .................................................................... 1,999 (9,363)
-------- --------
Net cash provided by (used in) operating activities ............................. 441 (14,550)
-------- --------

Cash flows from investing activities:

Payment of acquisition liabilities, acquired .......................................... -- (4,384)
Purchase of marketable securities ..................................................... (7,847) 16,523
Purchases of property and equipment ................................................... (2,806) (5,931)
Increase in other assets .............................................................. (8) (8,595)
-------- --------
Net cash used in investing activities ........................................... (10,661) (2,387)
-------- --------

Cash flows from financing activities:

Proceeds from capital leases .......................................................... -- 3,000

Repayments under capital leases ....................................................... (380) (436)
Issuance of common stock in second public offering,
net of offering costs .............................................................. 20,010 --
Issuance of common stock by eXstatic Software prior
to acquisition ..................................................................... 850 --
Issuance of common stock under ESPP ................................................... -- 272
Exercise of common stock options ...................................................... 463 5,520
-------- --------
Net cash provided by (used in) financing activities ............................. 20,943 8,356
-------- --------
Effect of exchange rate changes on cash and cash equivalents ............................ 55 (163)
-------- --------
Net increase (decrease) in cash and cash equivalents .................................... 10,778 (8,744)
-------- --------
Cash and cash equivalents, beginning of period .......................................... 5,247 14,678
-------- --------
Cash and cash equivalents, end of period ................................................ $ 16,025 $ 5,934
======== ========

Supplemental disclosure of cash flow information--
Cash paid for interest ................................................................ $ 11 $ 12
======== ========
Cash paid for income taxes ............................................................ $ 30 $ 157
======== ========

Supplemental disclosure of noncash financing and investing activities:

Equipment acquired under capital leases ............................................... $ -- $ 3,000
======== ========

The accompanying notes are an integral part of these consolidated financial statements.

5
</TABLE>
<PAGE>

EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) BACKGROUND AND BASIS OF PRESENTATION

Exchange Applications, Inc. and its subsidiaries (the "Company"), doing
business as Xchange Inc., provides eCustomer Relationship Management (eCRM)
solutions that help companies earn a greater share of their customers' business
through relevant, personalized customer communications. Xchange provides an
open-platform eCRM software and services solution that enables clients to
customize offers based on profile information, synchronize offers across all
customer channels in real-time and track the responses. This solution provides
companies with the opportunity to improve their acquisition and retention of
customers and increase customer relationship profitability.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements are unaudited, except
for the December 31, 1999 consolidated balance sheet, 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
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 presentation of the operating results for the
interim periods ended September 30, 1999 and 2000, 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, 1999,
which are contained in the Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission on March 30, 2000.

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 nine months ended September 30, 2000 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 nine months ended September 30, 1999 and 2000 basic net
income per common share is calculated by dividing the net income (loss)
applicable to common stockholders by the weighted average number of vested
common shares outstanding for the nine month periods then ended. Diluted net
income per common share for the nine months ended September 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 and
unvested common shares, as determined using the treasury stock method in
accordance with SFAS No. 128.

6
<PAGE>

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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 2000 1999 2000
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Weighted average common
shares outstanding ......... 23,126,144 31,578,464 21,713,440 27,530,431
Less: Weighted average
unvested common shares
outstanding ................ 16,452 -- 38,592 --
---------- ---------- ---------- ----------
Basic and diluted weighted
average common shares
outstanding ................ 23,109,692 31,578,464 21,674,848 27,530,431

Add: Dilutive potential common
shares from stock options and
unvested common stock ........ -- -- 4,240,798 --
Diluted weighted average
common shares outstanding .... 23,109,692 31,578,464 25,915,646 27,530,431
========== ========== ========== ==========
</TABLE>

Diluted weighted average shares outstanding for the three and nine months
ended September 30, 2000 exclude the potential common shares from stock options
because to include such shares would have been antidilutive. For the three month
period ended September 30, 1999 and 2000, the Company had 4,485,242 and
3,609,297 potential common shares outstanding, respectively. For the nine month
period ended September 30, 2000, the Company had 4,523,538 potential common
shares outstanding.

(d) REVENUE RECOGNITION

The Company recognizes revenue based on the provisions of Statement of
Position, or SOP, No. 97-2, Software Revenue Recognition, as amended by SOP No.
98-4 and SOP No. 98-9, and the provisions of SOP No. 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts.

Software license fee revenues are generated from licensing the rights to
the use of the Company's packaged software products. Services and maintenance
revenues are generated from sales of maintenance, consulting, training and
hosting services performed for customers that license the Company's products.
The Company has concluded that effective with the new generation of Xchange
Dialogue products released in the third quarter of 2000, certain of the
implementation services related to the Dialogue product suite are essential to
the customer's use of the packaged software products in arrangements where the
Company is responsible for implementation services. Similarly, the
implementation services for the Company's Xchange Real Time and Xchange EnAct
products are essential to the customer's use of those packaged software
products. As such, the Company recognizes revenue for these arrangements
following the percentage-of-completion method over the implementation period.
Percentage of completion is measured by the percentage of implementation hours
incurred to date compared to estimated total implementation hours. This method
is used because management has determined that past experience has shown
expended hours to be the best measure of progress on these engagements. In
situations where the Company is not responsible for implementation services, or
where the product configuration being delivered does not require the
implementation services deemed to be essential to the customer's use of the
software.

The Company recognizes revenue on delivery of the packaged software if
there is persuasive evidence of an arrangement, collection is probable, the fee
is fixed or determinable and vendor-specific objective evidence exists to
allocate the total fees to all undelivered elements of the arrangement.

7
<PAGE>

Vendor-specific objective evidence is based on the price charged when an
element is sold separately or, in the case of an element not yet sold
separately, the price established by authorized management, if it is probable
that the price, once established, will not change before market introduction.
Elements included in multiple-element arrangements could consist of software
products, maintenance, consulting and training services.

Revenue from maintenance services is recognized ratably over the term of
the contract, typically one year. Consulting revenue is primarily related to
implementation services performed on a time-and-materials basis under separate
service arrangements. Revenue from consulting and training services is
recognized as services are performed. In addition, the Company recognizes
consulting revenue for its application hosting service. The revenue is
recognized over the service delivery period based on either a pre-determined
monthly service fee or a usage based pricing model.

In certain situations, the Company may enter into transactions with third
parties to acquire technology from those entities at the same time that the
Company sells its technology to those same third parties. In those instances,
the Company applies Accounting Principles Board Opinion No. 29 "Accounting for
Nonmonetary Transactions: and Emerging Issues Task Force Issue No. 86-29
"Nonmonetary Transactions: Magnitude of the Boot and the Exceptions to the Use
of Fair Value" to such transactions.

(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 nine months ended September 30, 1999 and 2000 are as
follows (in thousands):

<TABLE><CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 2000 1999 2000
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Comprehensive income (loss):
Net income (loss) ...................... $ (152) $(27,975) $ 710 $(38,028)
Other comprehensive income (loss):
Cummulative translation adjustment . 90 (211) 55 163
Unrealized gain (loss) on marketable (10) 9 (35) 52
-------- -------- -------- --------
Comprehensive income (loss) ............ $ (72) $(28,177) $ 730 $(38,139)
======== ======== ======== ========
</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, 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, 1999 and September 30, 2000, the
Company's marketable securities consisted of investment grade corporate bonds.
As of December 31, 1999 and September 30, 2000, the Company had recorded
unrealized losses of approximately $65,000 and $13,000, respectively. At
September 30, 2000, the weighted average number of days until maturity of the
Company's marketable securities and longterm investments were 262 and 516 days,
respectively.

8
<PAGE>

(f) ACQUISITION OF CUSTOMER ANALYTICS, INC.

On June 13, 2000, the Company acquired Customer Analytics, Inc. (CA), a
Company that specializes in the development and licensing of marketing campaign
management solutions targeted at the local branch level. The Company exchanged
4,461,684 shares of its common stock for all the outstanding shares of common
stock of CA; 761,602 of these shares issued were placed into escrow as security
for indemnification obligations of CA pursuant to the merger agreement. In
addition, the Company assumed all of the outstanding employee stock options of
CA which converted into options to aquire 758,712 shares of Exchange
Applications common stock. As of the date of the consummation of the
acquisition, the common stock issued by the Company and the issued stock options
had a market value of $110,942,000 based on a per share value of $22.20.

The purchase price was allocated based upon the fair value of the
identified assets acquired. These allocations represent the fair values
determined by an independent appraisal. The allocation has resulted in acquired
goodwill of $94,895,000 which is being amortized on a straight line basis over a
five year period. The Company is in the process of finalzing the purchase
accounting related to the CA acquisition and expects any adjustments to be
finalized by the end of the fouth quarter of 2000. The Company has also
allocated $3,700,000 to the assembled work force, $8,000,000 to the customer
base, and $17,750,000 to purchased technology and technological know-how aquired
from CA as determined by the independent appraisal, which are being amortized on
a straight line basis over a three year period.

(g) LONG-LIVED ASSETS

In accordance with the provisions of SFAS No. 121, "Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of",
the Company evaluates the realizability of its long-lived assets periodically
based on projected future cash flows. As of September 30, 2000 the Company's
long-lived assets consisted of technology and the related distribution rights
acquired from third parties, goodwill and other intangible assets from
acquisitions, and fixed assets. The Company has determined that no material
adjustment to the carrying value of its long lived assets was required as of
September 30, 2000.

(h) RECLASSIFICATION

Certain reclassifications have been made to prior year's financial
statements to conform to the current year's presentation.

9
<PAGE>

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

BUSINESS OVERVIEW

Exchange Applications, Inc. and its subsidiaries (the "Company"), doing
business as Xchange Inc., provides eCustomer Relationship Management (eCRM)
solutions that help companies earn a greater share of their customers' business
through relevant, personalized customer communications. Xchange provides an
open-platform eCRM software and services solution that is designed to help
clients customize offers based on profile information, synchronize offers across
multiple customer channels in real-time and track the responses. This solution
is designed to provide companies with opportunities to improve their acquisition
and retention of customers and to increase customer relationship profitability.
Xchange's eCRM solutions are licensed for use at approximately 250 client sites
in 33 countries, as well as five of the six leading U.S. marketing service
bureaus.

CORPORATE OVERVIEW

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 customer communications 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
the first module of the Xchange Dialogue product family, the Company's marketing
automation software product. Since this initial introduction of Xchange
Dialogue, the Company has continued to focus significant resources on the
development of additional functionality and features of the Xchange Dialogue
suite as well as the development and acquisition of additional solutions within
the Company's eCRM solution set including Xchange Real Time, Xchange EnAct, and
the email marketing and analytic modules of the Xchange Dialogue suite. The
Company also has continued to expand its marketing activities, build the Xchange
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.

In August 1999, the Company acquired eXstatic (formerly Gino Borland, Inc.)
in a transaction accounted for as a pooling of interest. eXstatic develops and
markets software products that enable businesses to plan, create and execute
highly personalized, permission-based email communications based on customer
profiles. In accordance with pooling of interests accounting, the results of
operations have been restated to reflect the historical results of eXstatic on
an as combined basis. In March 2000, the Company aquired Knowledge Stream
Partners (KSP) in a transaction accounted for under the purchase method. KSP
specializes in consulting and software development for advanced data mining and
online/offline analytics. Most recently, in June 2000, the Company acquired
Customer Analytics, Inc. in a transaction accounted for under the purchase
method. Customer Analytics develops and markets campaign management solutions
focused on creating, executing, analyzing and measuring customer communications
at the local or branch level.

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

10
<PAGE>

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. Furthermore, if
services provided in connection with a software arrangement are essential to the
functionality of the software, software license fee revenues are recognized on
the percentage-of-completion method as the services are performed.

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 prior to satisfying the above revenue recognition criteria are
reflected as deferred revenue.

Through June 30, 2000 the Company had experienced significant quarterly
revenue growth. However, due to a number of factors, including poor sales
execution and the impact of contract accounting on certain of the transactions
signed late in the third quarter, the Company realized a decline in quarterly
revenue of 36% from the second quarter of 2000 to the third quarter of 2000.
There can be no assurance that we will be able to achieve or sustain growth in
the future, and our past performance should not be relied upon. Many of the
Company's latest generation of products, released in the second and third
quarter 2000, have a high dependancy on services for delivery of the solution.
The Company has concluded that the implementation services are essential to the
customer's use of the packaged software products in certain arrangements where
the Company is responsible for implementation services and therefore will be
accounting for those contracts under the contract accounting method as the
services are performed. Variability in the delivery cycle of product
implementation services, combined with the Company's lengthy and variable sales
cycle may make predictability of license revenue more difficult. 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 be able to achieve or sustain increasing revenues.

RISK FACTORS

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 MAKES EVALUATING OUR
BUSINESS DIFFICULT; RECENT TRANSACTIONS, INCLUDING ACQUISITIONS OF KNOWLEDGE
STREAM PARTNERS AND CUSTOMER ANALYTICS AS WELL AS TRANSACTIONS WITH
MICROSTRATEGY INCORPORATED WILL RESULT IN SHORT TERM LOSSES; WE MAY RUN OUT OF
MONEY IF WE INCUR CONTINUING LOSSES AND WE ARE NOT ABLE TO RAISE ADDITIONAL
CAPITAL; QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY AND INVESTORS
SHOULD NOT RELY ON THEM TO PREDICT OUR FUTURE PERFORMANCE; OUR BUSINESS MAY
SUFFER IF OUR SOLUTIONS ARE NOT ACCEPTED BY NEW CUSTOMERS; IF WE DO NOT
SUCCESFULLY INTEGRATE ACQUIRED TECHNOLOGY INTO OUR PRODUCT OFFERING, OUR
BUSINESS MAY SUFFER; THE LOSS OF ONE OF OUR LARGEST CUSTOMERS COULD CAUSE OUR
REVENUES TO DROP QUICKLY AND UNEXPECTEDLY; WE NEED TO MANAGE OUR GROWTH
EFFECTIVELY OR WE MAY NOT SUCCEED; IF WE LOSE OUR KEY PERSONNEL, OR FAIL TO
ATTRACT AND RETAIN ADDITIONAL PERSONNEL, OUR BUSINESS AND GROWTH MAY SUFFER; OUR
BUSINESS WILL NOT GROW IF WE DO NOT KEEP PACE WITH RAPIDLY CHANGING
TECHNOLOGIES; OUR STOCK PRICE OR OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE
ARE NOT ABLE TO EFFICIENTLY INTEGRATE ACQUISITIONS; OUR OPERATING LOSSES MAY
HARM OUR STOCK PRICE; COMPETITION COULD REDUCE OUR MARKET SHARE AND HARM OUR
BUSINESS; IF WE DO NOT SUCCESSFULLY MAINTAIN OUR RELATIONSHIPS WITH INDIRECT
DISTRIBUTION

11
<PAGE>

CHANNELS, OUR SALES COULD DECLINE OR COULD GROW MORE SLOWLY THAN EXPECTED; WE
HAVE A LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS AND OTHERS
COULD INFRINGE ON OR MISAPPROPRIATE OUR PROPRIETARY RIGHTS; IF WE DO NOT
SUCCESSFULLY GROW AND MANAGE OUR INTERNATIONAL OPERATIONS, OUR BUSINESS WILL
SUFFER; CURRENCY FLUCTUATIONS AND GENERAL ECONOMIC CONDITIONS IN OUR FOREIGN
MARKETS MAY IMPACT OUR CUSTOMERS' SPENDING AND THE VALUE OF MONEY OWED TO US;
OUR FOUNDERS, OFFICERS AND PRINCIPAL STOCKHOLDERS HAVE SUBSTANTIAL CONTROL OVER
OUR VOTING STOCK AND HAVE THE ABILITY TO MAKE DECISIONS THAT COULD ADVERSELY
AFFECT OUR STOCK PRICE; WE MAY BE SUBJECT TO FUTURE PRODUCT LIABILITY CLAIMS;
OUR COMMON STOCK PRICE IS LIKELY TO BE VOLATILE AND COULD DROP UNEXPECTEDLY; WE
HAVE ADOPTED ANTI-TAKEOVER PROVISIONS THAT COULD AFFECT THE MARKET PRICE OF OUR
COMMON STOCK OR OUR ABILITY TO SELL OUR BUSINESS. The Company's filings with the
Securities and Exchange Commission, including its Annual Report on Form 10-K for
the year ended December 31, 1999 as well as its Form S-3/A filed with the SEC on
November 2, 2000, contain additional information concerning such risk factors.

RECENT ACCOUNTING PRONOUNCEMENTS

In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 "Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25." This interpretation
clarifies the application of Opinion No. 25, among others issued, (a) the
definition of employees for the purpose of applying Opinion No. 25, (b) the
criteria for determining whether a plan qualifies as a noncompensatory plan, (c)
the accounting consequences of various modifications to the terms of a
previously issued stock option or award, and (d) the accounting for an exchange
of stock compensation awards in a business combination. The interpretation was
effective as of July 1, 2000 and the effects of applying the Interpretation are
recognized on a prospective basis. The adoption of the Interpretation did not
have a material impact on the Company's financial condition or results of
operations.

NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 2000

Revenues

The Company's total revenues increased 58% from $29.9 million in the nine
months ended September 30, 1999 to $47.3 million for the nine months ended
September 30, 2000. This increase in total revenues can be attributed to a
number of factors, including:

o an increase in the Company's sales force from 25 direct sales
representatives at September 30, 1999 to 39 at September 30, 2000;
o an increase in international revenues from the Company's subsidiaries
in the United Kingdom and Australia; and
o an increase in services and maintenance revenues from the Company's
growing customer base
o an expansion in both the number of indirect sales channels, as well as
an increase in revenues generated through those channels
o incremental revenues as a result of products and service offerings
obtained through acquisition; and
o incremental revenues from the delivery of product and services acquired
through transactions accounted for under the purchase accounting method
and therefore not included in the comparable period last year.

Software license fee revenues increased 65.5% from $17.9 million, or 59.7%
of total revenues, in the nine months ended September 30, 1999 to $29.6 million,
or 62.5% of total revenues, in the nine months ended September 30, 2000. The
increase in software license fee revenues was primarily due to increased market
awareness of the Xchange Dialogue product family, including both the Company's
original Xchange Dialogue product as well as the email messaging module added in
the second half of 1999. In addition the Company realized incremental revenues
in 2000 from the release of two new products, Xchange Real Time and the
analytical reporting module of the Xchange Dialogue suite, as well as revenues
associated with the Xchange EnAct product acquired in June 2000.

Services and maintenance revenues increased 47.0% from $12.1 million, or
40.3% of total revenues, for the nine months ended September 30, 1999 to $17.7
million, or 37.5% of total revenues, for the nine months ended

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<PAGE>

September 30, 2000. 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
the Company's suite of products.

With the introduction of the second generation of Xchange Dialogue products
in the three month period ended September 30, 2000, as well as the Xchange EnAct
and Xchange Real Time products in the second quarter of 2000, the Company
anticipates that a significant number of its software license transactions will
be accounted for under the contract accounting method going forward. The
adoption of contract accounting, combined with an increased dependancy on
services in the delivery of the Company's software solutions will result in a
shift in the mix of software and services going forward.

For the nine months ended September 30, 2000, the Company's top five
customers accounted for 29.7% of total revenues as compared to 34.8% of total
revenues for the nine months ended September 30, 1999. Only one of the top five
customers during the nine months ended September 30, 2000 was a top five
customer during the nine months ended September 30, 1999. The largest customer
during the nine months ended September 30, 2000 represented 12.5% of total
revenues, while the largest customer for the nine months ended September 30,
1999 represented 12.0% of the Company's total revenues.

Revenues from customers outside North America were $15.0 million for the
nine months ended September 30, 2000, representing approximately 32% of total
revenues, as compared to $9.5 million, or 32% 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 increased from 24.7% in the nine
months ended September 30, 1999 to 29.4% in the nine months ended September 30,
2000 largely as a result of the decrease in the higher margin software license
fee revenue in the three months ended September 30, 2000.

Cost of software license fees consists primarily of royalty payments made
to third parties for licensed intellectual property included in the Xchange
Dialogue and Xchange Real Time products, and costs associated with software
packaging and distribution. Cost of software license fees increased from
$232,000, or 0.8% of total revenues for the nine months ended September 30, 1999
to $526,000, or 1.1% of total revenues for the nine months ended September 30,
2000. Cost of software license fees as a percentage of software license fee
revenues increased from 1.3% to 1.8% for the nine months ended September 30,
1999 and 2000, respectively. The increase in cost of software license fees for
the nine months ended September 30, 2000 over September 30, 1999 primarily
resulted from increased shipments of Xchange Dialogue software and, therefore,
the associated royalty expense payable to third parties and costs associated
with software packaging and distribution. In addition, the Company incurred
incremental royalty obligations associated with the shipment of Xchange Real
Time in the second quarter of 2000 as well as third party royalties associated
with the second generation of the analytical module of the Dialogue product,
shipped in the third quarter of 2000. The Company has added additional
components to its software products offering through strategic partnerships with
third party suppliers. As the Company realizes software revenue from these
additional components we expect cost of revenues to increase both in absolute
dollars and as a percentage of total 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
decrease in software license fee revenues recognized in the third quarter 2000,
cost of services and maintenance revenues as a percentage of total revenues
increased from 24.0% for the nine months ended September 30, 1999 to 28.3% for
the nine months ended September 30, 2000. Cost of services and maintenance as a
percentage of services and maintenance revenues was 59.4% and 75.5% for the nine
months ended September 30, 1999 and 2000, respectively. The increase was
attributable primarily to the decrease in revenues from services engagements
resulting

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<PAGE>

from the poor software sales execution. The Company anticipates its software
sales execution to improve in the fourth quarter and into 2001, however there
can be no guarantee of that occuring. In addition, as a result of the increased
dependancy on implementation services in the delivery of the Company's software
solutions, the Company currently anticipates the relationship of software and
services revenue to move towards a higher services component in new business
transactions entered in the future. Due to these facts, as well as the increased
contribution from higher margin maintenance revenues, the Company anticipates
cost of services and maintenance to decrease as a percentage of both total
revenues and services and maintenance revenue.

Overall gross margin decreased from 75.3% for the Nine months ended
September 30, 1999 to 70.6% for the nine months ended September 30, 2000 due
primarily to the decrease in software contribution to the revenue mix in the
third quarter 2000.

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 nine months ended September 30, 1999 and 2000,
sales and marketing expenses were 34.9% and 39.0% of total revenues, or $10.5
million and $18.5 million, respectively. The increase in absolute dollars is
primarily attributable to an increase in sales and marketing personnel from 54
at September 30, 1999 to 117 at September 30, 2000, 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 it products. The investment in the sales and marketing personnel and
activities has contributed to the expansion of the customer installation base to
over 250 locations in 33 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. The Company realized a decrease in total revenue
from the second to third quarter 2000. In order to achieve the revenue growth
targets in the future we will not be decreasing the absolute dollars spent in
the sales and marketing arena, but instead anticipate an increase in total
spending for the foreseeable future. This fact, combined with the anticipated
lower revenue as compared to prior periods, will result in sales and marketing
expenses to be higher as a percentage of total revenue as compared to levels
prior to June 30, 2000

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 nine months ended September 30, 1999 and 2000, research and development
expenses were 22.8% and 28.9% of total revenues, or $6.8 million and $13.7
million, respectively. This increase in absolute dollars was primarily a result
of the increase in research and development personnel, including contractors,
from 102 at September 30, 1999 to 142 at September 30, 2000. The Company
anticipates that research and development expenses will continue to increase in
absolute dollars. In addition, as a result of the anticipated lower revenue as
compared to prior years, the Company expects research and development to
increase 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:

o salaries and related costs;

o outside professional fees; and

o equipment and software depreciation costs associated with our finance,
legal, human resources, information systems, and administrative
functions.

General and administrative expenses increased from $3.4 million, or 11.4%
of total revenues, for the nine months ended September 30, 1999 to $10.5
million, or 22.2% of total revenues, for the nine months ended September

14
<PAGE>

30, 2000. Expenses increased in absolute dollars as a result of an increase in
the number of employees in its finance, information systems, and human resource
departments from 33 at September 30, 1999 to 70 at September 30, 2000. In
addition, the Company incurred approximately $2.8M of one time charges
associated with the write-off of specific bad debts, the increase in the bad
debt and sales return allowance, and compensation expense associated with tax
exposures on international stock option exercises. Going forward, the Company
expects general and administrative expenses to continue to grow in absolute
dollars as a result of the following factors:

o the implementation of additional management information systems;

o the continuation of the Company's domestic and international expansion;
and

o the costs to support the expected increase in operating headcount
across the organization.

In addition, as a result of the anticipated lower revenue as compared to
prior years, the Company expects general and administrative costs to increase as
a percentage of total revenue.

INTEREST INCOME (EXPENSE), NET

Net interest income increased from $917,000 for the nine months ended
September 30, 1999 to $1,017,000 for the nine months ended September 30, 2000
primarily as a result of interest earned on proceeds from the Company's second
public offering completed in June 1999. The Company realized $160,000 of
interest expense in the nine months ended September 30, 2000 as compared to zero
in the same period last year. The interest expense was primarily related to
notes payable to certain former shareholders of Customer Analytics. The Company
anticipates that interest income, net of interest expense, will be lower in the
future as a result of the decline in revenues an operating profit excluding
amortization of goodwill and the Microstrategy investment.

PROVISION FOR INCOME TAXES.

No provision for foreign, federal, or state income taxes was recorded for
the nine months ended September 30, 2000 because the Company incurred a net loss
during the Nine month period. For the nine months ended September 30, 1999 the
Company recorded a provision for income taxes of $657,000 or 48.0% of income
before income taxes. The Company had been using an effective tax rate of 37% of
income before income taxes prior to the GBI acquisition in August 1999, which
was accounted for as a pooling. Prior to its acquisition, GBI was structured as
a sub-chapter S corporation and, as such, the tax benefit of losses incurred
through August 20, 1999 reverted to that company's principals. Therefore, the
historical effective tax rate after incorporating the GBI statement of
operations is significantly higher than the 37% provided for by the Company
through the period.

THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 2000

REVENUES

The Company's total revenues increased 11.6% from $11.2 million in the
three months ended September 30, 1999 to $12.5 million for the three months
ended September 30, 2000. This increase in total revenues can be attributed to
revenues associated with product and services offerings obtained through
acquisition, an increase in services revenues generated from email hosting
services and maintenance fees offset by a decrease in software license fees as a
result of poor software sales execution and the impact of contract accounting on
revenue recognized from transactions signed late in the third quarter of 2000.

Software license fee revenues decreased 12.6% from $6.8 million, or 60.7%
of total revenues, in the three months ended September 30, 1999 to $5.9 million,
or 47.6% of total revenues, in the three months ended September 30, 2000. The
decrease in software license fee revenues was due to a combination of poor sales
execution as well as the impact of contract accounting on revenue recognized
from transactions signed late in the third quarter of 2000.

15
<PAGE>

Services and maintenance revenues increased 48.8% from $4.4 million or
39.3% of total revenues, in the three months ended September 30, 1999 to $6.5
million, or 52.4% of total revenues, in the three months ended September 30,
2000. The growth of services and maintenance revenues was directly attributable
to additional email hosting revenues and maintenance fees from the Company's
increased base of customers. The increase in services and maintenance revenues
as a percentage of total revenues was primarily attributable to the decrease in
software license fee revenues as a percentage of total revenue in the quarter.

For the three months ended September 30, 2000, the Company's top five
customers accounted for 37.9% of total revenues as compared to 44.2% of total
revenues for the three months ended September 30, 1999. None of the top five
customers during the three months ended September 30, 2000 was a top five
customers during the three months ended September 30, 1999. The largest customer
during the three months ended September 30, 2000 represented 13.0% of total
revenues, while the largest customer for the three months ended September 30,
1999 represented 20.9% of the Company's total revenues. No other customer
represented 10% or more of revenue in either period.

Revenues from customers outside North America were $7.0 million for the
three months ended September 30, 2000, representing approximately 56% of total
revenues as compared to $3.2 million or approximately 28% of total revenues for
the comparable period in the prior year.

COST OF REVENUES

Total cost of revenues as a percentage of total revenues increased from
24.9% in the three months ended September 30, 1999 to 48.5% in the three months
ended September 30, 2000.

The Company's cost of services and maintenance consists primarily of
personnel, facility and system costs incurred in providing professional
consulting services, training, hosted software services for the Xchange Dialogue
product suite, and customer support services. As a result of the decreased
software license fee revenues, cost of services and maintenance revenues as a
percentage of total revenues increased from 24.3% for the three months ended
September 30, 1999 to 47.2% for the three months ended September 30, 2000. Cost
of services and maintenance as a percentage of services and maintenance revenues
was 61.8% and 90.0% for the three months ended September 30, 1999 and 2000,
respectively. The increase was attributable primarily to decrease in services
engagements, and the related revenues, resulting from the poor software sales
execution. The Company anticipates that improved sales execution will result in
an increase in services engagements and therefore an increase in services
revenues and a decrease in the cost of services and maintenance as a percentage
of services and maintenance revenue.

Overall gross margin decreased from 75.1% for the three months ended
September 30, 1999 to 51.5% for the three months ended September 30, 2000 due
primarily to decreased software license fee revenues.

OPERATING EXPENSES

16
<PAGE>

respectively. The increase in absolute dollars is primarily attributable to an
increase in sales and marketing personnel from 54 at September 30, 1999 to 117
at September 30, 2000, 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 its eCRM solution
set. The increase in sales and marketing as a percentage of revenue is primarily
a result of the decrease in software license fee revenue over the same period
last year.

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 September 30, 1999 and 2000, research and development
expenses were 23.7% and 47.1% of total revenues, or $2.6 million and $5.9
million, respectively. This increase in absolute dollars was primarily a result
of an increase in the number of research and development personnel, including
contractors, from 102 at September 30, 1999 to 142 at September 30, 2000. The
increase in research and development as a percentage of revenue is primarily a
result of the decrease in software license fee revenue over the same period last
year.

GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
from $1.3 million, or 11.3% of total revenues, for the three months ended
September 30, 1999 to $6.4million, or 50.9% of total revenues, for the three
months ended September 30, 2000. The increase in absolute dollars was the result
of an increase in the number of general and administrative personnel in the
finance, information systems, and human resource departments from 33 at
September 30, 1999 to 70 at September 30, 2000. In addition, the Company
incurred approximately $2.8M of one time charges associated with the write-off
of specific bad debts and compensation expense associated with tax exposures on
international stock option exercises. The increase in general and adminstrative
expenses as a percentage of revenue is primarily a result of the decrease in
software license fee revenue over the same period last year.

INTEREST INCOME (EXPENSE), NET

Net interest income decreased from $452,000 for the three months ended
September 30, 1999 to $169,000 for the three months ended September 30, 2000
primarily as a result of the use of cash and investments to fund the operations
of the Company as well as the use of cash related to the acquisitions of
Knowledge Stream Partners and Customer Analytics. Interest expense of $554,000
and $160,000 for the three months ended September 30, 2000 related to the
MicroStrategy obligation and the Company's notes payable and capital lease
obligations, respectively.

PROVISION FOR INCOME TAXES.

No provision for foreign, federal, or state income taxes was recorded for
the three months ended September 30, 1999 and 2000, respectively because the
Company incurred a net loss during the three month period. The Company had been
using an effective tax rate of 37% of income before income taxes prior to the
GBI acquisition in August 1999, which was accounted for as a pooling. Prior to
its acquisition, GBI was structured as a sub-chapter S corporation and, as such,
the tax benefit of losses incurred through August 20, 1999 reverted to that
company's principals. Therefore, the historical effective tax rate after
incorporating the GBI statement of operations is significantly higher than the
37% provided for by the Company through the period.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2000 the Company had $7.9 million in cash and
short-term investments and an additional $1.0 million of long-term investments.
The Company assumed $5.0 million in notes payable to certain former shareholders
of Customer Analytics as part of the merger completed in the second quarter of
2000. The notes bear interest at a rate of 5% per annum, and have payments of
$2,875,000 plus accrued interest due December 31, 2000 and $2,125,000 plus
accrued interest due June 1,2002. The Company is currently in the process of
seeking an expansion of its credit facility as well as additional equity
financing to meet these obligations as well as its general corporate operating
cash requirements. There can be no assurance that the Company will be succesful
in either of

17
<PAGE>

these financing alternatives. If we are not succesful in obtaining additional
financing, the Company may be at risk of running out of money as early as March
31, 2001.

Cash and cash equivalents as of September 30, 2000 decreased $8.7 million
from December 31, 1999. Net cash used in operations of approximately $14.6
million resulted primarily from a loss of $4.7 million excluding amortization
expense and other non-cash charges and the decrease in deferred revenue.

Net cash used in investing activities of $2.4 million for the nine months
ended September 30, 2000 was a result of property and equipment purchases
related to the increase in headcount, expansion and integration of the Company's
operating sites, and the acquisition of computer hardware and software for
development and internal operating systems. In addition, the Company used $4.4
million of cash to fund acquisition liabilities arising from the KSP and
Customer Analytics acquisitions and $8.6 million of cash to fund the purchase of
technology and the related distribution rights from third parties for use in the
Company's Dialogue solution set. These uses of cash were offset by the proceeds
from the maturity of short term and long term investments. Net cash provided by
financing activities of $8.4 million consisted of $5.5 million in proceeds from
the exercise of common stock options during the nine months ended September 30,
2000, $272,000 in proceeds from the issuance of common stock under the Company's
Employee Stock Purchase Plan and $3.0 million in proceeds from capital leases
entered into during the nine months ended September 30, 2000.

The Company currently has sales offices in the United Kingdom, Japan, 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 September 30, 2000, 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.

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
September 30, 2000, 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. In addition, as the Company
expands its sales and service presence in the Asia/Pacific region in 2000, 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 September 30, 2000 the Company's material
nondollar-denominated assets and liabilities primarily

18
<PAGE>

consisted of cash, accounts receivable, and accounts payable denominated in
British Sterling and Australian dollars.

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

As a result of the acquisition of Customer Analytics Holdings, Inc. on
June 30, 2000, the Company filed a report on Form 8-K on September 1,
2000.

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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: November 11, 2000

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)