UNITED STATES 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, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the transition period from ______________ to______________.
Commission file number 000-27449
---------
RESOURCEPHOENIX.COM
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 52-2190830
- -------------------------------- ----------------------------------
State of Jurisdiction I.R.S. Employer Identification No.
2401 Kerner Boulevard, San Rafael, California 94901-5527
- --------------------------------------------------------------------------------
Address of Principal Executive Offices Zip Code
Registrant's telephone number, including area code: (415) 485-4500
--------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
preceding requirements for the past 90 days.
Yes No X
----- -----
The number of shares outstanding of the Registrant's Common Stock as of November
19, 1999 was 11,200,000.
<PAGE>
RESOURCEPHOENIX.COM AND SUBSIDIARY
FORM 10-Q - For the Quarterly Period Ended September 30, 1999
INDEX
Part I. Financial Information Page
Item 1. Unaudited Condensed Financial Statements
a) Condensed Balance Sheets - September 30, 1999 and
December 31, 1998...........................................3
b) Condensed Statements of Operations - Three and Nine Months
Ended September 30, 1999 and 1998...........................4
c) Condensed Statement of Changes in Stockholders'
Equity - Year Ended December 31, 1998
and Nine Months Ended September 30, 1999....................5
d) Condensed Statements of Cash Flows - Nine Months
Ended September 30, 1999 and 1998...........................6
e) Notes to Condensed Financial Statements.....................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..........12
Part II. Other Information
Item 1. Legal Proceedings......................................27
Item 2. Change in Securities...................................27
Item 3. Defaults Upon Senior Securities........................28
Item 4. Submission of Matters to a Vote of Securities Holders..28
Item 5. Other Information......................................28
Item 6. Exhibits and Reports on Form 8-K.......................28
Signature .......................................................29
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
------------------------
RESOURCEPHOENIX.COM AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
September 30,
December 31, 1999
1998 (Unaudited)
------------ -------------
ASSETS
Current Assets:
Cash and cash equivalents $ 503 $ 37
Accounts receivable, net of allowance of $56 at
September 30, 1999 and $8 at December 31, 1998 419 846
Receivable from affiliates 182 241
Prepaid expenses and other current assets 20 245
-------- --------
Total current assets 1,124 1,369
Property and equipment, at cost, net of
accumulated depreciation 694 2,637
Other assets 4 465
-------- --------
Total assets $ 1,822 $ 4,471
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued liabilities $ 1,195 $ 1,738
Deferred revenue 627 693
Payable to Shareholder -- 5,232
-------- --------
Total current liabilities 1,822 7,663
Commitment and Contingencies
Stockholder's Equity:
Preferred stock -- --
Class A common stock -- 43
Class B common stock 6,397 10,913
Accumulated deficit (6,397) (14,148)
-------- --------
Total stockholder's equity -- (3,192)
-------- --------
Total liabilities and stockholder's equity $ 1,822 $ 4,471
======== ========
The accompanying notes are an integral part of these statements.
3
<PAGE>
RESOURCEPHOENIX.COM AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------------- -------------------------
1998 1999 1998 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenue:
Contract service revenue $ 577 $ 984 $ 1,822 $ 2,739
Contract service revenue -
affiliate 589 800 1,623 1,713
Software revenue -- 521 39 2,019
----------- ----------- ----------- -----------
Total revenue 1,166 2,305 3,484 6,471
Operating expenses:
Cost of providing services 1,040 1,423 3,388 3,829
Cost of providing software
revenue 210 231 238 633
General and administrative 489 1,470 1,156 2,469
Research and development 588 1,022 1,255 2,373
Client acquisition 262 1,384 615 2,473
Stock-related compensation -- (3,335) -- 1,956
Depreciation and amortization 80 251 221 479
----------- ----------- ----------- -----------
Total operating expenses 2,669 2,446 6,873 14,212
----------- ----------- ----------- -----------
Loss from operations (1,503) (141) (3,389) (7,741)
Other income (expense) 51 (23) 6 (10)
----------- ----------- ----------- -----------
Net loss $ (1,452) $ (164) $ (3,383) $ (7,751)
=========== =========== =========== ===========
Basic and diluted net loss per share $ (0.20) $ (0.02) $ (0.47) $ (1.08)
Shares used in computing basic and
diluted net loss per share 7,200,000 7,200,000 7,200,000 7,200,000
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE>
RESOURCEPHOENIX.COM AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF
CHANGES IN STOCKHOLDER'S EQUITY
(In thousands, except share and per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Class A Class B Total
Common Common Accum- Stock-
Stock Stock ulated holders'
Shares Amount Shares Amount Deficit Equity
------ ------ ------ ------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1998 $ -- 1,000 $ 6,397 $ (6,397) $ 0
Net loss -- -- (7,751) (7,751)
Capital contribution from
stockholder -- 3,603 -- 3,603
Cancellation of stock (1,000) -- -- --
Issuance of Class B common
stock 7,200,000 -- -- --
Dividend -- (1,000) -- (1,000)
Compensation payable in stock -- 1,956 -- 1,956
Transfer of Class B Stock and
Issuance of Class A
common stock 28,000 43 (28,000) (43) -- --
---------- ---------- ---------- ---------- ---------- ----------
Balance at September 30, 1999
(Unaudited) 28,000 $ 43 7,172,000 $ 10,913 $ (14,148) $ (3,192)
========== ========== ========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE>
RESOURCEPHOENIX.COM AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
------------------
1998 1999
------- -------
Operating Activities
Net loss $(3,383) $(7,751)
Adjustments to reconcile net loss to net cash
used in
operating activities:
Depreciation and amortization 221 479
Stock-related compensation -- 1,956
Change in operating assets and liabilities:
Accounts receivable 190 (427)
Receivable from affiliates 254 (59)
Prepaid expenses and other assets 36 (686)
Accounts payable and accrued liabilities (116) 543
Deferred revenue 123 66
------- -------
Net cash used in operating activities (2,675) (5,879)
Investing activities
Purchase of property and equipment (175) (948)
------- -------
Net cash used in investing activities (175) (948)
Financing activities
Proceeds from capital contribution 2,580 2,129
Proceeds from note payable to Shareholder 256 4,232
------- -------
Net cash provided by financing
activities 2,836 6,361
Net increase (decrease) in cash and cash equivalents (14) (466)
Cash and cash equivalents, beginning of period 106 503
------- -------
Cash and cash equivalents, end of period $ 92 $ 37
======= =======
Supplemental disclosure of non cash financing
activities
Contribution of property and equipment from
affiliate $ -- $ 1,474
Dividend in the form of a note to shareholder $ -- $ 1,000
The accompanying notes are an integral part of these statements.
6
<PAGE>
RESOURCEPHOENIX.COM AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Unaudited)
Note 1. Accounting Policies:
Basis of Presentation
The financial information of ReSourcePhoenix.com and Subsidiary ("the
Company") as of and for the three and nine months ended September 30, 1999 and
1998 is unaudited, but includes all adjustments (consisting only of normal
recurring adjustments) that the Company considers necessary for a fair
presentation of the consolidated financial position at such dates and the
operations and cash flows for the periods then ended. Certain prior period
amounts have been reclassified to conform to the current period presentation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
The accompanying interim financial statements should be read in
conjunction with the audited consolidated financial statements and related notes
included in the Company's Registration Statement (Form S-1) for the period ended
December 31, 1998. Certain information and footnote disclosures normally
included in annual financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to the
Securities and Exchange Commission rules and regulations. Interim results of
operations for the three and nine month periods ended September 30, 1999 are not
necessarily indicative of operating results or performance levels that can be
expected for the full fiscal year.
Concentration of Credit Risk
The Company does not require collateral or other security to support
credit sales, but does perform ongoing credit evaluations of its customers'
financial condition. The Company provides allowances for bad debts based on
historical experience and specific identification, which, to date, have been
insignificant.
For the year ended December 31, 1998, two customers, Phoenix Leasing
Incorporated (an affiliate) and GE Capital Aviation Services/PIMC, accounted for
41% and 20% of the Company's net revenues. For the nine months ended September
30, 1999, two customers, PLI and John Hancock accounted for 21% and 22% of the
Company's net revenues.
Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards, or SFAS, No. 133, Accounting for Derivative
Instruments and Hedging Activities and in June 1999, issued SFAS No. 137,
"Accounting for Derivative and Hedging Activities-Deferral of the Effective Date
of FASB Statement No. 133". SFAS No. 133 establishes methods for derivative
financial instruments and hedging activities related to those instruments, as
well as other hedging activities. SFAS No. 137 deferred for one year the
effective date of SFAS No. 133. SFAS No. 133, as amended, must be adopted for
March 31, 2001. Earlier adoption is permitted. Because the Company does not
currently hold any derivative instruments and does not currently engage in
hedging activities, it expects that the adoption of SFAS No. 133 and No. 137
will not have a material impact on their financial position or results of
operations.
7
<PAGE>
Note 2. Property and Equipment:
Major classes of property and equipment are as follows (in thousands):
September 30,
December 31, 1999
1998 (Unaudited)
------------ -------------
Furniture, fixtures and equipment $ 812 $ 3,062
Software 322 494
------- -------
1,134 3,556
Less accumulated depreciation and
amortization (440) (919)
------- -------
Net property and equipment $ 694 $ 2,637
======= =======
On June 1, 1999, property and equipment in the amount of $1,592,000,
less accumulated depreciation of $118,000 was transferred at historical cost
from an affiliate to the Company. The Company is continuing to depreciate these
assets based on their original useful lives.
Note 3. Stockholders' Equity
Stock Split
On September 13, 1999 the Board of Directors approved a 1 to .72
reverse stock split of its $.001 par value Class B common stock. As a result of
the stock split, authorized and outstanding common shares decreased by 28%. The
rights of the security holders of these securities were not otherwise modified.
All references in the financial statements to number of shares and per share
amounts of the Company's Class B common stock reflect the effect of the reverse
stock split.
On September 30, 1999, the majority shareholder transferred 28,000
shares of stock to unaffiliated individuals. Per the Company's Amended and
Restated Certificate of Incorporation, upon the request for transfer, the 28,000
Class B common stock shares convert to Class A common stock shares.
Preferred Stock
On August 4, 1999, 5,000,000 shares of undesignated preferred stock
were authorized for issuance. The Company's Board of Directors has the authority
to issue preferred stock in one or more series and to establish the rights and
restrictions granted to or imposed on any unissued shares of preferred stock and
to fix the number of shares constituting any series without any further vote or
action by the stockholders. The Company's Board has the authority, without
approval of the stockholders, to issue preferred stock that has voting and
conversion rights superior to the common stock, which could have the effect of
delaying or preventing a change in control.
Note 4. Stock Based Incentive Plans:
On January 1, 1999, the Company adopted an Incentive Plan ("the Phantom
Plan") for its key employees, whereby share appreciation and dividend income
rights were granted to such employees by reference to the Company's common
shares. Upon exercise of such rights, the employees are required to provide to
the Company an amount equal to $2.08 per share. The rights granted under the
Phantom Plan vest ratably over four years.
8
<PAGE>
Additionally, the Phantom Plan contains terms and conditions that
provide for its modification. In the event of a sale of the Company, each
participant in the Phantom Plan shall receive a pro rata portion of the sale
price, less the initial share value, as defined. Participants may also elect,
after the end of the first year after the date of the award of such shares, to
cash out of the Phantom Plan and receive from the Company an amount equal to two
times the pro rata portion of the change in the Company's pre-tax earnings
multiplied by the vesting percentage. In the event of an initial public
offering, the Company shall issue to each participant a number of shares of the
Company's common stock in settlement of the rights then outstanding.
Compensation expense of $1,956,000 related to the Phantom Plan has been
recognized to reflect the cumulative rights vested as of September 30, 1999.
This charge increases common stock, as the Company issued shares in its October
14, 1999 initial public offering. For purposes of calculating compensation
expense under the Phantom Plan, the Company revised it's estimate of the fair
value of the Company's common stock based on the initial public offering price.
The revision in estimate resulted in a $3.3 million decrease in stock related
compensation expense. This decrease was recorded at September 30, 1999.
On August 4, 1999, the Company terminated the Phantom Plan, subject to
the closing of the Company's initial public offering. All outstanding awards
under the Phantom Plan have been terminated and replaced by option grants under
the Stock Option Plan (defined below), in each case subject to the closing of
the Company's initial public offering.
On August 4, 1999, the Board of Directors adopted its 1999 Stock Plan
("the Stock Option Plan") pursuant to which a total of 1,260,000 shares of Class
A common stock have been reserved for issuance to provide additional incentive
to its employees, officers, directors and consultants. Pursuant to the Stock
Option Plan, the Company may grant stock options and stock purchase rights to
employees, officers, directors and consultants. The Board of Directors granted
options to purchase an aggregate of 846,291 shares of Class A common stock at an
exercise price of $2.08 per share, subject to the closing of the Company's
initial public offering. These grants will vest fully upon the closing of the
Company's initial public offering.
Upon the completion of the initial public offering, the Company will
recognize compensation expense in an amount equal to the excess of the fair
value of common stock over the exercise price of such options to the extent that
such expense exceeds the amounts previously recognized under the Phantom Plan at
September 30, 1999. The excess fair market value to be recognized on October 14,
1999 is $3.1 million.
Note 5. Net Loss Per Share
Basic net loss per common share is calculated by dividing net loss by
the weighted average number of common shares outstanding. Diluted net loss per
share reflects the potential dilution of securities by adding other common stock
equivalents, including stock options and warrants, in the weighted average
number of common shares outstanding for a period, if dilutive. Potentially
dilutive securities have been excluded from the computation as their effect is
antidilutive.
The Company issued 7,200,000 of its Class B common stock on August 4,
1999 in exchange for all issued and outstanding shares of the Subsidiary (as
adjusted to give effect to the Company's 1 to 0.72 reverse stock split on
September 14, 1999).
9
<PAGE>
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------------- ---------------------------
1998 1999 1998 1999
----------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
Net (loss) $ (1,452) $ (164) $ (3,383) $ (7,751)
Basic and diluted net loss per
common share $ (0.20) $ (0.02) $ (0.47) $ (1.08)
Weighted average number of common
Shares used for basic and diluted per
Share amounts 7,200,000 7,200,000 7,200,000 7,200,000
</TABLE>
Note 6. Commitments and Contingencies:
The Company is not currently involved in any material legal
proceedings. The Company is not aware of any legal proceedings pending against
it.
Note 7. Related Party Transactions
The Company provides accounting, investor administration and
information technology services to certain affiliates, wholly owned by the
Company's majority stockholder. For the nine months ended September 30, 1999 and
1998 the Company recorded revenue of $1,713,000 and $1,623,000, respectively,
for the provision of these services. These services were charged at the fully
allocated cost to provide such services.
On April 1, 1997 the Company also received from the same affiliated
company certain employees who performed corporate functions including legal,
human relations, facilities, word processing and communications. These employees
were transferred back to the affiliate as of January 1, 1998. Effective August
1, 1999, these functions were transferred back to the Company. For the nine
months ended September 30, 1999 and 1998 the Company paid the affiliate $657,000
and $336,000 , respectively, for these services, which is included in the
Condensed Consolidated Statements of Operations.
The Company has amounts due from affiliates for services of $241,000
and $182,000 as of September 30, 1999 and December 31, 1998 respectively.
On August 26, 1999, the Company issued two secured notes payable to its
majority shareholder for $1,245,000 and $1,005,000 (which includes $79,000
payable to shareholder at June 30, 1999). On September 12, 1999, the Company
declared a dividend of $1,000,000, which was paid in the form of a secured note
payable to its majority stockholder. On September 30, 1999 the Company issued a
secured note payable to its majority shareholder for $1,927,000. All four notes
bear interest at a rate of 9% per annum and accrued interest at September 30,
1999 of $24,000 is included in the notes payable balance. Also on September 30,
1999, the Company issued a secured note payable to its majority shareholder for
$549,000. $518,000 of the note was used by the majority shareholder to partially
offset amounts owed to the Company for fees by affiliates which are wholly owned
by the majority shareholder. The net proceeds of the notes were used to fund the
operations of the Company.
Note 8. Profit Sharing:
The Company has a profit sharing plan covering substantially all
employees who meet certain age and service requirements. Contributions to the
plan by the Company are made at the discretion of the Board of Directors. The
profit sharing expense was $141,000 and $84,000 for the nine months ended
September 30, 1999 and 1998, respectively.
10
<PAGE>
Note 9. Subsequent Event:
On October 14, 1999, the Company commenced an initial public offering
of its Class A common stock. The offering consisted of 4,000,000 shares of Class
A common stock issued to the public at $8.00 per share. On October 19, 1999 the
Company closed its initial public offering, which resulted in net proceeds to
the Company, before expenses, of $29,760,000.
On October 6 and October 13, 1999 the Company issued two secured notes
payable to its majority shareholder for $700,000 each. Both notes bear interest
at a rate of 9% per annum. The proceeds were used to fund the operations of the
Company. On October 20, 1999 the Company paid notes payable totaling $6,631,000
to its majority shareholder, including accrued interest of $54,200, using
proceeds from the initial public offering.
11
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our
financial statements and the notes appearing elsewhere in this Form 10-Q. The
following discussion contains forward-looking statements. Our actual results may
differ materially from those projected in the forward-looking statements.
Factors that might cause future results to differ materially from those
projected in the forward-looking statements include those discussed in "Factors
that May Affect Future Results" included in this Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Overview
ReSourcePhoenix.com provides outsourced financial and management
reporting, accounting management, transaction processing and record keeping
services. We allow our clients to focus on their core businesses by outsourcing
the infrastructure and operations of these critical back-office functions.
Our operating subsidiary, ReSource/Phoenix, Inc., commenced operations
on January 1, 1997. Before this time, we operated as part of Phoenix Leasing
Incorporated, a sponsor and syndicator of publicly-traded limited partnerships,
for more than 25 years. In August 1999, we reorganized into a holding company
structure. As a result, we currently conduct all of our operations through our
wholly-owned subsidiary ReSource/Phoenix, Inc.
We introduced our S.T.A.R. and our original ReFOCOS services in 1993.
Using our S.T.A.R. service, we perform a variety of investor relations functions
for sponsors of limited partnerships and real estate investment trusts. Using
our original ReFOCOS service, we perform a wide variety of accounting, finance,
transaction processing and other related services for our clients. Our S.T.A.R.
and original ReFOCOS services are based on point-to-point client-server
technology.
In March 1999, we began licensing our M.A.R.S. software, which is a
sales force automation application aimed at the mutual fund and variable annuity
industries. All of our software clients have entered into annual software
maintenance and support contracts. The first of these contracts comes up for
renewal in the second quarter of 2000.
We introduced our Web-enabled ReFOCOS service and our hosted M.A.R.S.
service in November 1998 and August 1999, respectively. Our Web-enabled ReFOCOS
service is similar to our original ReFOCOS service, except that clients can now
access the service over the Internet. We have recently completed the
implementation of our first hosted M.A.R.S. client. Our M.A.R.S. service
offerings include a hosted software service in which we install and maintain the
M.A.R.S. software in our data operations center for our clients.
As of September 30, 1999, all but one of our ReFOCOS clients, who
collectively generated approximately 43% of our revenues for the nine months
ended September 30, 1999, could access our service using the Internet. The
remainder of our service clients, who collectively generated 26% of revenues for
the nine months ended September 30, 1999, access our service using non-Internet
communications. During the same period, we derived approximately 31% of our
revenues from software, including license fees and related services. Moving
forward, however, we expect that software revenues will decline as a percentage
of revenues as we add clients for our hosted M.A.R.S. service and as we devote
greater resources to our other outsourced business services.
We will record aggregate negative compensation expense of approximately
$3,052,000 in the fourth quarter of 1999 in connection with the grant of stock
options to some of our officers and employees. The entire amount will be
recognized as the effective time of our initial public offering.
Contract service revenue. We derive contract service revenue from fees
to provide monthly information technology, accounting, finance and transaction
processing for both ReFOCOS and S.T.A.R. clients and from one-time installation
12
<PAGE>
fees. We recognize monthly fees as these services are performed and installation
fees once installation is complete.
Contract service revenue - affiliate. We derive contract service
revenue - affiliate by providing our S.T.A.R. and ReFOCOS services to our
affiliates. Prior to August 1, 1999 we charged our affiliates the fully
allocated cost to provide such services. Effective August 1, 1999, we increased
our fees to affiliates to reflect a market rate. We recognize affiliate revenue
in the same manner as our contract service revenues. See "Relationship with
Phoenix Companies and Certain Transactions - Intercompany Agreements."
Software revenue. We derive software revenue from software license
fees, consulting services, training and maintenance for our M.A.R.S. software.
Software license fee revenue consists principally of up-front license fees
earned from the licensing of the M.A.R.S. software. Revenue from up-front
software license agreements is recognized in accordance with the American
Institute of Certified Public Accountants Statement of Position 97-2. This
revenue is recognized when delivery has occurred, collection is deemed probable,
the fee is fixed or determinable, and vendor-specific objective evidence exists
to allocate the total fee to all delivered and undelivered elements of the
arrangement. To date, we have licensed our M.A.R.S. product primarily on a
perpetual basis. Consulting services and training revenues are recognized as
services are performed and accepted by the customers. Maintenance revenue is
recognized ratably over the term of the agreement. In instances where software
license agreements include a combination of consulting services, training and
maintenance, these separate elements are unbundled from the agreement based on
the element's fair value.
Components of costs and expenses. Cost of providing services includes
salaries and benefits for personnel in our S.T.A.R. and ReFOCOS operations
groups, fees paid to outside service providers other than implementation service
providers and other miscellaneous operating costs. Cost of providing software
revenue includes salaries and benefits for personnel in our M.A.R.S. technical
support and installation groups and costs related to consulting, training and
maintenance, and updates. Prior to the quarter ended June 30, 1998, these costs
were expensed as research and development. General and administrative expenses
includes salaries and benefits for management personnel, fees paid to outside
service providers for corporate-related services and other corporate overhead.
Research and development expenses include salaries and benefits for personnel
engaged in M.A.R.S. development, consulting fees paid to outside service
providers engaged in M.A.R.S. development and other miscellaneous costs
associated with M.A.R.S. development. Client acquisition expense includes
salaries, benefits and commissions paid to our sales and marketing and
implementation personnel, travel expenses of our sales and marketing and
implementation personnel, advertising expenses and fees paid to outside
implementation consultants.
Consolidated Results of Operations
The following table sets forth, for the periods indicated, certain
items reflected in our condensed consolidated statements of operations expressed
as a percentage of revenue.
13
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Three months Nine months
ended ended
September 30, September 30,
--------------- --------------
1998 1999 1998 1999
------ ------ ------ ------
Consolidated Statements of Operations data:
Revenue:
Contract service revenue 49.5% 42.7% 52.3% 42.3%
Contract service revenue - affiliate 50.5 34.7 46.6 26.5
Software revenue -- 22.6 1.1 31.2
----- ----- ----- -----
Total revenue 100.0 100.0 100.0 100.0
Operating expenses:
Cost of providing services 89.2 61.7 97.2 59.2
Cost of providing software revenue 18.0 10.0 6.8 9.8
General and administrative 41.9 63.8 33.2 38.2
Research and development 50.4 44.3 36.0 36.7
Client acquisition 22.5 60.0 17.7 38.2
Stock-related compensation -- (144.7) -- 30.2
Depreciation and amortization 6.9 10.9 6.3 7.4
----- ----- ----- -----
Total operating expenses 228.9 106.0 197.2 219.7
----- ----- ----- -----
Loss from operations (128.9) (6.0) (97.2) (119.7)
Other income (expense) 4.4 (1.0) 0.2 (0.2)
----- ----- ----- -----
Net loss (124.5)% (7.0)% (97.0)% (119.9)%
===== ===== ===== =====
Revenue. Total revenue increased 97.7% in the third quarter and 85.7%
in the first nine months of 1999, when compared with the same periods of 1998.
Contract service revenue. We derive contract service revenue from fees to
provide monthly information technology, accounting, finance and transaction
processing for both ReFOCOS and S.T.A.R. clients, from one-time installation
fees and from maintenance and hosting fees for our MARS software. We recognize
monthly fees as these services are performed.
Contract service revenue increased 70.5% and 50.3% for the three and
nine month periods ended September 30, 1999 compared to the same periods last
year, respectively. The increase was primarily due to a higher number of
S.T.A.R. and ReFOCOS clients. The number of our S.T.A.R. clients increased to 14
at September 30, 1999 from 13 at September 30, 1998. The number of our ReFOCOS
clients increased to 15 at September 30, 1999 from 9 at September 30, 1998.
Contract Service Revenue - Affiliate. We derive contract service
revenue - affiliate by providing our S.T.A.R. and ReFOCOS services to our
affiliates. We recognize affiliate revenue in the same manner as our contract
service revenues.
Contract service revenue from affiliates increased 35.8% and 5.5% for
the three and nine month periods ended September 30, 1999 compared to the same
periods last year, respectively. The increase was largely due to re-negotiated
Administrative Service Agreements with the Phoenix Companies which increased the
scope of services provided by the Company and reflects the market rate for
providing these services to the affiliates.
Software Revenue. We derive software revenue from software license
fees, installation services and training for our M.A.R.S. software. Software
license fee revenue consists principally of up-front license fees earned from
the licensing of the M.A.R.S. software.
Software revenue for the nine months ended September 30, 1999 increased
to $2,019,000 from $39,000 in the same period last year. $521,000 of software
revenue was recognized in the quarter, of which $454,000 resulted from new
billings during the period. We recognized an additional $66,000 of software
revenue that had been deferred at June 30, 1999. Prior to the quarter ended June
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30, 1999, the MARS product was in beta testing at client sites. Customer
acceptance was contingent upon installation of a final working copy of the
software which occurred during the quarter ended June 30, 1999. As a result of
customer acceptance we were able to begin recognizing revenue. Prior to quarter
ended June 30, 1999, software license revenue was deferred as customer
acceptance had not been received as required by SOP 97-2.
Expenses
Cost of providing services includes salaries and benefits for personnel
in our S.T.A.R. and ReFOCOS operations groups, fees paid to outside service
providers other than implementation service providers and other miscellaneous
operating costs. Cost of providing software revenue includes salaries and
benefits for personnel in our M.A.R.S. technical support and installation
groups. Prior to the quarter ended June 30, 1998, these costs were expensed as
research and development. General and administrative expenses includes salaries
and benefits for management personnel, fees paid to outside service providers
for corporate-related services and other corporate overhead. Research and
development expenses include salaries and benefits for personnel engaged in
M.A.R.S. development, consulting fees paid to outside service providers engaged
in M.A.R.S. development and other miscellaneous costs associated with M.A.R.S.
development. Client acquisition expense includes salaries, benefits and
commissions paid to our sales, marketing and implementation personnel, travel
expenses of our sales, marketing and implementation personnel, and advertising
expenses and fees paid to outside implementation consultants.
Cost of providing service. Cost of providing services increased 36.8%
and 13.0% for the three and nine month periods ended September 30, 1999 compared
to the same periods last year, respectively. The increases are primarily due to
growth in the number of clients serviced which required the addition of
personnel and consultants in our operations group and resulted in an increase in
compensation and overhead expenses.
Cost of providing software revenue. Cost of providing software revenue
increased 10.0% and 166.0% for the three and nine month periods ended September
30, 1999 compared to the same periods last year, respectively. The increases are
due to the increase in the number of M.A.R.S. installations which required
additional personnel and resulted in increased compensation and travel expenses.
General and administrative expenses. General and administrative
expenses increased 200.6% and 113.6% for the three and nine month periods ended
September 30, 1999 compared to the same periods last year, respectively. The
increases are primarily due to the hiring of additional management and
administrative personnel to support our operations and the transfer to the
Company of affiliate personnel on August 1, 1999.
Overhead expenses increased to support the additional headcount.
Research and development expenses. Research and development expenses
increased 73.8% and 89.1% for the three and nine month periods ended September
30, 1999 compared to the same periods last year, respectively. The increases are
largely attributable to hiring additional full-time and contract personnel to
develop enhancements and new features to our M.A.R.S software product.
Client acquisition expense. Client acquisition expenses increased
428.2% and 302.1% for the three and nine month periods ended September 30, 1999
compared to the same periods last year, respectively. The increases are
primarily due to hiring additional sales, marketing and implementation personnel
to support our ReFOCOS services and additional sales and marketing personnel
related to our M.A.R.S product.
Stock related compensation expense. Stock compensation expense is
related to our incentive plan which went into effect on January 1, 1999 (the
"Phantom Plan") and was terminated on August 4, 1999, subject to the closing of
our initial public offering. Compensation expense has been recognized to reflect
the cumulative rights vested as of September 30, 1999. The expense increased to
$1,956,000 in the nine months ended September 30, 1999 from zero for the same
period last year to reflect these rights. A reduction, totaling $3.3 million, in
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the cumulative expense was recorded in the third quarter to reflect the revised
estimated valuation of the common stock based on the anticipated initial public
offering price. Additional expense of $3.1 million will be recorded in the
fourth quarter to reflect the immediate vesting of stock in the Employee Stock
Option Plan that replaced the Phantom Plan as a result of the initial public
offering.
Liquidity and Capital Resources
From inception until October 14, 1999, the effective date of our
initial public offering, we financed our operations primarily through equity
contributions and loans from our majority shareholder, the Gus and Mary Jane
Constantin 1978 Living Trust. On October 14, 1999 the Company raised
approximately $28.7 million, net of underwriting discounts, commissions and
other expenses from the initial pubic offering.
At September 30, 1999, we had approximately $37,000 of cash and cash
equivalents. Net cash used in operating activities for the nine months ended
September 30, 1999 and 1998, was $5,879,000 and $2,675,000 , respectively. Prior
to October 14, 1999 our working capital needs were funded by our majority
shareholder on an as-needed basis. The increase in cash used in operating
activities in 1999 compared to 1998 was primarily the result of net losses.
Net cash used in investing activities was $948,000 and $175,000 for the
nine months ended September 30, 1999 and 1998, respectively. The increase in net
cash used in investing activities resulted from capital expenditures for data
processing equipment, and furniture and fixtures. We expect to continue to make
additional capital expenditures for new office space, furniture, equipment and
fixtures to support the continued growth of our operations.
Net cash provided by financing activities was $6,361,000 and $2,836,000
for the nine months ended September 30, 1999 and 1998, respectively. Net cash
provided by financing activities in 1999 and 1998 was primarily a result of
equity investments and loans made to us by our majority stockholder. All loans
made by our majority stockholder were repaid with the net proceeds of our
initial public offering.
We believe that the net proceeds from our October 14, 1999 initial
public offering, together with existing cash balances will be sufficient to meet
our working capital and capital expenditure requirements for at least the next
12 months. We may also utilize cash to acquire or invest in complementary
businesses or to obtain the right to use complementary technologies, although we
do not have any pending plans to do so. We may sell additional equity or debt
securities or enter into new credit facilities.
Year 2000
Many currently installed computer systems and software products are
unable to distinguish between twentieth century dates and twenty-first century
dates because such systems were developed using two digits rather than four to
determine the applicable year. For example, computer programs that have date-
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This error could result in system failures 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. As a result, many companies' software and computer systems
may need to be upgraded or replaced to comply with such "year 2000"
requirements.
State of readiness. Our business is dependent on the operation of
numerous systems that could potentially be affected by year 2000-related
problems. Those systems include, among others:
o the M.A.R.S. software product that we license to customers;
o hardware and software systems that we use in our operations,
including our proprietary software systems as well as software
supplied by third parties;
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o communications networks such as our client/server network, the
Internet and our private intranet;
o the hardware and software systems of our customers and suppliers;
and
o non-information technology systems and services, such as
utilities, telephone systems and building systems.
We are currently reviewing the year 2000 readiness of our hardware,
software and systems we depend on to run our operations. The phases of our year
2000 program are as follows:
o assignment of responsibility for issues, such as systems,
facilities, equipment, software and legal audit, which was
completed in the summer of 1998;
o inventory of all aspects of our operations and relationships
subject to the year 2000 problem, which was completed in the
summer of 1998 for existing systems and is ongoing for new
components as these new components are added to our system;
o communication as necessary with significant suppliers to determine
the readiness of their products and systems, which was completed
in August 1999 for critical suppliers and is ongoing for
non-critical suppliers;
o comprehensive analysis, including impact analysis and cost
analysis, of our year 2000 readiness, which was completed in April
1999 for critical components of our system and is ongoing for
non-critical components of our system; and
o testing and remediation, which was completed for our S.T.A.R.
service in June 1999, completed for our M.A.R.S. software product
and service in August 1999 and was completed for our ReFOCOS
service in September 1999.
To date, we have not encountered any material year 2000 problems with
the hardware and software systems we use in our operations that have not been
corrected. In addition, our vendors have certified to us that the hardware and
software they provide to us are year 2000-compliant. In the event that any such
vendors' products, services or systems do not meet the year 2000 requirements on
a timely basis, our business could be seriously harmed.
Risks. Year 2000-related errors or defects that affect the operation of
our software could result in:
o delay or loss of revenue;
o cancellation of customer contracts;
o diversion of development resources;
o damage to our reputation;
o increased customer support and warranty costs; and
o litigation costs.
Success of our year 2000 compliance efforts may also depend on the
success of our customers in dealing with their year 2000 issues. Our M.A.R.S.
product is generally integrated into enterprise systems involving sophisticated
hardware and complex software products which may not be year 2000-compliant and
this may have an adverse impact on or demand for our M.A.R.S. product.
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Although we have not been a party to any litigation or arbitration
proceeding to date involving our products or services and related to year 2000
compliance issues, we cannot assure you that we will not in the future be
required to defend our products or services in such proceedings, or to negotiate
resolutions of claims based on year 2000 issues. The costs of defending and
resolving year 2000-related disputes, regardless of the merits of such disputes,
and any liability for year 2000-related damages, including consequential
damages, would seriously harm our business, financial condition and operating
results.
In addition, we believe that purchasing patterns of customers and
potential customers may be affected by year 2000 issues as companies expend
significant resources to correct or upgrade their current software systems for
year 2000 compliance or defer additional software purchases until after 2000. As
a result, some customers and potential customers may have more limited budgets
available to purchase software products such as those offered by us, and others
may choose to refrain from changes in their information technology environment
until after 2000. Still other companies are accelerating purchases of software
products prior to 2000, causing an increase in short-term demand which may, in
turn, cause a corresponding decrease in long-term demand for software products.
To the extent year 2000 issues cause significant change in, delay in, or
cancellation of, decisions to purchase our products or services, our business
could be materially adversely affected.
Contingency plan. We could experience material adverse effects on our
business if we fail to identify all year 2000 dependencies in our systems and in
the systems of our suppliers, customers and financial institutions. Therefore,
we have contingency plans for handling year 2000 problems that are not detected
and are correcting any identified problems prior to their occurrence. If
previously undetected year 2000 issues occur, we plan to consult with Oracle and
our other vendors to determine if the problem relates to products supplied by
these vendors and is wide-spread among users of these products. If the problems
are widespread, we will apply resolutions provided by these vendors. If the
problem is not widespread, we will investigate whether all of the latest year
2000 patches and configuration recommendations from the vendors have been
applied, and apply as necessary. If the problem persists we will investigate the
particular problem. If the problem seems to be hardware, operating system or
network related, we will apply the appropriate vendor fix or transfer operations
to our business resumption site at SunGard, whichever is a lower risk.
Costs. To date, we have not incurred any material costs directly
associated with our year 2000 compliance efforts, except for compensation
expense associated with our salaried employees who have devoted some of their
time to our year 2000 assessment and remediation efforts. We do not expect the
total cost of year 2000 problems to be material to our business, financial
condition and operating results. However, we have not completed our year 2000
investigation and we will continue to evaluate our products, software provided
by third parties and infrastructure systems that we rely on. Despite our
efforts, we may not identify and remediate all significant year 2000 problems on
a timely basis, remediation efforts may involve significant time and expense,
and unremediated problems may have a material adverse effect on our business.
See "Additional Factors that may Affect Future Results -- If our computer
systems and software products are not year 2000 compliant, our services could be
disrupted."
Additional Factors that May Affect Future Results
We operate in a dynamic and rapidly changing environment that involves
numerous risks and uncertainties. The following section lists some, but not all,
of these risks and uncertainties that may have a material adverse effect on our
business, financial condition or results of operations. This section should be
read in conjunction with the unaudited Condensed Consolidated Financial
Statements and Notes thereto included in Part I - Item 1 of this Quarterly
Report (Form 10-Q) and the audited Consolidated Financial Statements and Notes
thereto, and Management's Discussion and Analysis of Financial Condition and
Results of Operations for the year ended December 31, 1998 contained in our
Registration Statement (Form S-1).
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This Form 10-Q contains forward looking statements that involve risks
and uncertainties. These statements relate to our future plans, objectives,
expectations and intentions, and the assumptions underlying or relating to any
of these statements. These statements may be identified by the use of words such
as "expect," "anticipate," "intend" and "plan." Our actual results may differ
materially from those discussed in these statements. Factors that could
contribute to such differences include, but are not limited to, those discussed
below and elsewhere in this Form 10-Q.
Our success depends on the acceptance and increased use of Internet-based
software applications and business process outsourcing solutions. We cannot be
sure that these solutions will gain market acceptance.
Our business model depends on the adoption of Internet-based software
applications and business process outsourcing solutions by commercial users. Our
business would suffer dramatically if these solutions are not accepted or not
perceived to be effective. The market for Internet services, virtual private
networks and widely distributed Internet-enabled packaged application software
has only recently begun to develop. The growth of Internet-based business
process outsourcing solutions could also be limited by:
o concerns over transaction security and user privacy;
o inadequate network infrastructure for the entire Internet; and
o inconsistent performance of the Internet.
In addition, growth in demand for and acceptance of Internet-based
software applications and business process outsourcing solutions, including our
ReFOCOS service, by early stage and middle market companies is highly uncertain.
It is possible that our outsourced business information solutions may never
achieve market acceptance. If the market for our services does not grow or grows
less than we currently anticipate, our business, financial condition and
operating results would be seriously harmed.
Our ReFOCOS service is targeted at early stage and middle market companies,
which may be more likely to be acquired or to cease operations than other
companies. As a result, our client base may be more volatile than the client
bases of companies that have greater emphasis on more established companies.
Our ReFOCOS service is targeted at early stage and middle market
companies, which may be more likely to be acquired or to cease operations than
other companies. As a result, our client base may be more volatile than the
client bases of companies that have greater emphasis on more established
companies. We have lost three unaffiliated clients to date, one because the
client was acquired and two because the clients ceased operations. If we
experience greater than expected client turnover, either because our clients are
acquired, cease operations or for any other reason, our business, financial
condition and operating results could be seriously harmed.
Our growth will be limited if we are unable to attract and retain qualified
personnel.
We must continue to attract and retain qualified information
technology, accounting, finance and transaction processing professionals in
order to perform services to our existing and future clients. The personnel
capable of filling these positions are in great demand and recruiting and
training them requires substantial resources. We may not be able to hire the
necessary personnel to implement our business strategy, or we may need to pay
higher compensation for employees than we currently expect. We cannot assure you
that we will succeed in attracting and retaining the personnel we need to grow.
Our current and historical financial information may not be comparable to our
future financial results.
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Our historical revenues were derived primarily from services that we do
not expect to be the focus of our business in the future. We introduced our
S.T.A.R. services and our original ReFOCOS service in 1993. Our Web-enabled
ReFOCOS service and our hosted M.A.R.S. service, were introduced in November
1998 and August 1999, respectively. Because our historical revenues were derived
from a different type of service than the services that we plan to emphasize in
the future, our historical financial results may not be comparable to our future
financial results. In addition, our M.A.R.S. and S.T.A.R. services are marketed
to specialized financial services clients. Our ReFOCOS services are marketed to
a broader, less specialized market than either of our M.A.R.S. or S.T.A.R.
services. We do not have much experience selling to the market that we have
targeted for our ReFOCOS service. We may be unsuccessful in our efforts to
market to this target market.
We recently began to market M.A.R.S. as a hosted application in which
our clients can outsource to us several functions, including database
management, call center services, telemarketing services and sales transaction
processing. Our strategy is to emphasize hosting M.A.R.S. in our data centers
while continuing to offer M.A.R.S. as a licensed software product to our clients
that prefer a software-only solution. As a result, we expect that software
license fees will decline as a percentage of revenues as we add clients to our
outsourced M.A.R.S. services and devote greater resources to our other
outsourced financial and management reporting services.
We expect to continue to incur operating losses and negative cash flow.
We expect to have significant operating losses and to record
significant net cash outflow on a quarterly and annual basis. Our business has
not generated sufficient cash flow to fund our operations without requiring
external sources of capital. Starting our company and building our network
required substantial capital and other expenditures. Further developing our
business and expanding our network will require significant additional capital
and other expenditures. We may not be able to obtain additional capital on terms
favorable to us or at all.
Our stock price could fluctuate dramatically because of fluctuations in our
quarterly operating results. This could result in substantial losses to
investors.
Period-to-period comparisons of our operating results may not be a good
indication of our future performance. Moreover, our operating results in some
quarters may not meet the expectations of stock market analysts or investors. In
that event, our stock price would likely fall significantly. As a result of the
evolving nature of the markets in which we compete, we may have difficulty
accurately forecasting our revenue in any given period. In addition to the
factors discussed elsewhere in this section, a number of factors may cause our
revenue to fall short of our expectations or cause our operating results to
fluctuate including:
o the announcement or introduction of new or enhanced products or
services by our competitors;
o pricing changes by us or our competitors;
o the timing and frequency of new client engagements or
cancellations; and
o sales cycle fluctuations.
We must implement our services for new clients in a timely and
cost-effective manner. To the extent that we are unable to staff client
implementations using internal staff, we will need to delay our client
implementations or hire outside software and systems integration consultants,
whose services generally are much more costly. If we delay implementation for
any client, we may not meet the expectations of that client, which could damage
our relationship with that client. A delay in implementation would also postpone
our recognition of revenues from that client, perhaps into a subsequent
financial reporting period, which could cause us not to meet analyst or investor
expectations for that period. If we hire outside software and systems
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integration consultants, our operating expenses will increase and our operating
results will be harmed.
Stock markets often experience significant price and volume
fluctuations. These fluctuations, as well as general economic and political
conditions unrelated to our performance, may adversely affect the price of our
Class A common stock. In particular, following initial public offerings, the
market prices for stocks of Internet and technology-related companies often
reach levels that bear no relationship to the operating performance of these
companies. These market prices are generally not sustainable and could vary
widely. The market prices of the securities of Internet-related and
technology-related companies have been especially volatile. If our Class A
common stock trades to high levels following our initial public offering, it
could eventually experience a significant decline. In addition, if our operating
results in some quarters do not meet the expectations of stock market analysts
or investors the price of our Class A common stock will likely fall
significantly.
Our operating results depend on our relationships with a limited number of
clients. As a result, the loss of a single client may seriously harm our
operating results.
Our results of operations and our business depend on our relationships
with a limited number of large clients. As a result, the loss of a single client
may seriously harm our operating results. Set forth below is the percentage of
revenues for the nine months ended September 30, 1999 and the twelve months
ended December 31, 1998 for each of our clients that accounted for more than 10%
of our revenues and for our ten largest clients combined:
December 31, September 30,
1998 1999
------------ -------------
Phoenix Leasing (an affiliate) 41% 21%
GE Capital Aviation Services/PIMC 20% --
John Hancock Advisors -- 22%
Total of ten largest clients combined: 86% 80%
We cannot assure you that we will be able to maintain our historical
rate of growth or our current level of revenues derived from any of our clients
in the future. The termination of our business relationships with any of our
significant clients or a material reduction in the use of our services by any of
our significant clients, could seriously harm our business and operating
results.
We rely on third parties to supply us with the software, hardware and services
necessary to provide our services. The loss of any of this third party software,
hardware or services may be difficult to replace and may harm our operating
results.
A substantial portion of the software that is integrated into our
services is licensed from third parties, including Oracle Corporation and Necho
Systems Corp. If we were to lose the right to use the software that we have
licensed from Oracle, Necho or other third parties, our operations would be
seriously harmed. Our agreements with our software vendors are non-exclusive.
Our vendors may choose to compete with us directly. Oracle, for example,
recently announced a Web-enabled version of its enterprise resource planning
software that it plans to market directly to middle market businesses. Our
vendors may also enter into strategic relationships with our competitors. These
relationships may take the form of strategic investments, or marketing or other
contractual arrangements. Our competitors may also license and utilize the same
technology in competition with us. We cannot assure you that the vendors of
technology used in our products will continue to support this technology in its
current form. We also cannot assure you that we will be able to adapt our own
offerings to changes in this technology. In addition, we cannot assure you that
the financial or other difficulties of our vendors will not adversely affect the
technologies incorporated into our services, or that if these technologies
become unavailable we will be able to find suitable alternatives.
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In addition, we depend on third parties, such as Cisco Systems, Inc.
and Sun Microsystems, Inc., to supply servers, routers, firewalls, encryption
technology and other key components of our telecommunications and network
infrastructure. If any of our vendors fail to provide needed products or
services in a timely fashion or at an acceptable cost, our business, financial
condition and operating results could be seriously harmed. A disruption in
telecommunications capacity could prevent us from maintaining our standard of
service. Some of the key components of our system and network are available only
from sole or limited sources in the quantities and quality we demand.
We also depend on the services of software and systems integration
firms to help us establish service with new clients. If the services of these
firms became unavailable for any reason, our services to new clients could be
delayed. In addition, we could be forced to pay higher rates for the services of
these or substitute firms. If either of these events were to occur, our
business, financial condition and operating results could be seriously harmed.
Our business and reputation may be harmed if we make mistakes in performing our
services.
Our business is subject to various risks resulting from errors and
omissions in performing services for our clients. We perform accounting,
finance, transaction processing, tax reporting, transfer agency and other
services for our clients. We process data received from our clients that is
critical to our clients' businesses and operations. We may make mistakes in
performing our services, which may result in claims being made against us. If we
do make mistakes, we cannot assure you that our financial reserves or insurance
will be adequate to cover any claims made against us. In addition, our business
reputation will be seriously harmed if we make any mistakes, which could
adversely affect our relationships with our existing clients and our ability to
attract new clients.
Our software products and the software that we have integrated into our services
may have unknown defects that could harm our reputation or decrease market
acceptance of our services.
We derived approximately 31.2 % of our revenues from licensing our
M.A.R.S. software product in the nine months ended September 30, 1999. Our
clients rely on this software to perform critical business functions such as
sales and expense tracking and fulfillment/inventory tracking. Because our
clients depend on our M.A.R.S. software for their critical systems and business
functions, any interruptions caused by unknown defects in our software could
damage our reputation, cause our clients to initiate product liability suits
against us, divert our research and development resources, cause us to lose
revenue or delay market acceptance of the outsourced business service that is
based on this software. Any of these things could harm our business. Our
software may contain errors or defects, particularly when new versions or
enhancements are released. We may not discover software defects that affect our
current software or enhancements until after they are sold. Although we have not
experienced any material software defects to date, any defects could cause our
clients to experience severe system failures.
The software applications that we license from Oracle, Necho and other
third parties and integrate into our service offerings may contain defects when
introduced or when new versions or enhancements are released. We cannot assure
you that software defects will not be discovered in the future. If our services
incorporate software that has defects and these defects adversely affect our
service offerings, our business, reputation and operating results may be harmed.
The markets we serve are highly competitive and many of our competitors have
much greater resources.
Our current and potential competitors include applications service
providers, systems integrators, and software and hardware vendors. Our
competitors, who may operate in one or more of these areas, include companies
such as Andersen Consulting, DIGEX, Inc., Exodus Communications, Inc.,
International Business Machines Corporation, PricewaterhouseCoopers LLP, and
USInternetworking, Inc. Some of our competitors may make strategic acquisitions
or establish cooperative relationships among themselves or with third parties to
increase their ability to rapidly gain market share by addressing the needs of
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our prospective clients. These relationships may take the form of strategic
investments or marketing or other contractual arrangements.
Many of our competitors have substantially greater financial, technical
and marketing resources, larger customer bases, longer operating histories,
greater name recognition and more established relationships in the industry than
we do. We cannot be sure that we will have the resources or expertise to compete
successfully in the future. Our competitors may be able to:
o more quickly develop and expand their network infrastructures and
service offerings;
o better adapt to new or emerging technologies and changing customer
needs;
o negotiate more favorable licensing agreements with software
application vendors;
o more successfully recruit qualified information technology,
accounting, finance and transaction processing professionals;
o negotiate more favorable services agreements with software and
systems integrators;
o devote greater resources to the marketing and sale of their
services; and
o adopt more aggressive pricing policies.
Some of our competitors may also be able to provide customers with
additional benefits at lower overall costs. We cannot be sure that we will be
able to match cost reductions by our competitors. In addition, we believe that
there is likely to be consolidation in our markets, which could increase price
and other competition in ways that could seriously harm our business, financial
condition and operating results. Finally, there are few substantial barriers to
entry, and we have no patented technology that would bar competitors from our
market.
We rely on rapidly changing technology and must anticipate new technologies.
The technologies in which we have invested are rapidly evolving. As a
result, we must anticipate and rapidly adapt to changes in technology to keep
pace with the latest technological advances that are likely to affect our
business and competitive position. For example, we recently adapted our ReFOCOS
service, which formerly used a client-server communications architecture, to use
an Internet communications architecture. Our future success will depend on our
ability to deploy advanced technologies and respond to technological advances in
a timely and cost effective manner. Even if we are able to deploy new
technologies in a timely manner, we may incur substantial cost in doing so. If
we are unable to develop or successfully introduce new technology on an as
needed basis or if we are unable to do so in a cost effective manner, our
business, financial condition and operating results would be seriously harmed.
We plan to expand very rapidly and managing our growth may be difficult.
We have recently begun to aggressively expand our operations. To the
extent that our business continues to grow both geographically and in terms of
the number of products and services we offer, we must:
o expand, train and manage our employee base effectively;
o enlarge our network and infrastructure to accommodate new clients;
o expand our infrastructure and systems to accommodate the growth of
our existing clients; and
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o improve our management, financial and information systems and
controls.
We must recruit qualified information technology personnel, for which
there is high demand and short supply. In addition, we must also recruit
qualified accounting, finance and transaction processing personnel, which are
also in high demand. We recently opened our first office outside of northern
California and plan to open additional sales offices and data centers outside of
California. We don't have much experience operating a multi-office business.
There will be additional demands on our operations group and sales,
marketing and administrative resources as we increase our service offerings and
expand our target markets. The strains imposed by these demands are magnified by
the early stage nature of our operations. If we cannot manage our growth
effectively, our business, financial condition or operating results could be
seriously harmed.
We depend on a limited number of key executives who would be difficult to
replace.
Our success depends in significant part on the continued services of
our senior management personnel. Gus Constantin, our chairman and chief
executive officer, founded us and our predecessor business more than 27 years
ago. Bryant Tong, our president and chief operating officer, has worked for us
and our predecessor business for more than 16 years. David Brunton, our vice
president and chief financial officer, has worked for us and our predecessor
business for more than 12 years. Losing one or more of our key executives could
seriously harm our business, financial condition and operating results. We
cannot assure you that we will be able to retain our key executives or that we
would be able to replace any of our key executives if we were to lose their
services for any reason. If we had to replace any of our key executives, we
would not be able to replace the significant amount of knowledge that many of
our key executives have about us.
We could be harmed if our products, services or technologies are not compatible
with other products, services or technologies.
We believe that our ability to compete successfully also depends on the
continued compatibility of our services with products, services and network
architectures offered by various vendors. If we fail to conform to a prevailing
or emerging standard, our business, results of operations and financial
condition could be seriously harmed. We cannot be sure that their products will
be compatible with ours or that they will adequately address changing customer
needs. We also cannot be sure what new industry standards will develop. We also
cannot be sure that we will be able to conform to these new standards quickly
enough to stay competitive. In addition, we cannot be sure that products,
services or technologies developed by others will not make our products,
services or technologies noncompetitive or obsolete.
If we do not effectively address our market, we may never realize a return on
the investments we have made to execute our strategy.
We have made substantial investments to pursue our strategy. These
investments include:
o developing relationships with particular software providers,
including Oracle and Necho;
o investing to develop unique product features, including invoice
reporting and imaging functions; and
o developing implementation resources around specific applications.
These investments may not be successful. More cost-effective strategies
may be available to compete in this market. We may have chosen to focus on the
wrong application areas or to work with the wrong partners. Potential customers
may not value the specific product features in which we have invested. We cannot
assure you that our strategy will prove successful.
24
<PAGE>
Intellectual property infringement claims against us, even without merit, could
cost a significant amount of money to defend and divert management's attention
away from our business.
As the number of software products in our target market increases and
the functionality of these products further overlaps, software industry
participants may become increasingly subject to infringement claims. Someone may
even claim that our technology infringes their proprietary rights. Any
infringement claims, even if without merit, can be time consuming and expensive
to defend. For example, we recently incurred significant expenses to
successfully defend a meritless copyright infringement lawsuit that was filed
against us. These suits may divert management's attention and resources and
could cause service implementation delays. They also could require us to enter
into costly royalty or licensing agreements. If successful, a claim of product
infringement against us and our inability to license the infringed or similar
technology could adversely affect our business.
We may be liable if we lose client data from natural disasters or for any other
reason.
We currently conduct all of our data processing and network operations
at our facility in San Rafael, California. In the event of a catastrophic
disaster at our San Rafael data operations center, SunGard Recovery Services
Inc. will provide business resumption of our critical systems at their data
center in Philadelphia.
We have comprehensive disaster recovery procedures in place, including
uninterruptible power supply systems with seven day capacity, back-up power
generators, nightly backup of our critical data, systems with off-site data
vaults, and 24 and 72 hour service level agreements for recovering systems and
data from the last available backup. However, we cannot assure you that our
disaster recovery procedures are sufficient, or that our client's data would be
recoverable in the event of a disaster.
Our operations are dependent on SunGard being able to successfully
provide back-up processing capability if we are unable to protect our computer
and network systems against damage from a major catastrophe such as an
earthquake or other natural disaster, fire, power loss, security breach,
telecommunications failure or similar event. We cannot assure you that the
precautions that we have taken to protect ourselves against these types of
events will prove to be adequate. If we suffer damage to our data or operations
center, experience a telecommunications failure or experience a security breach,
our operations could be seriously interrupted. We cannot assure you that any
such interruption or other loss will be covered by our insurance. Any such
interruption or loss could seriously harm our business and results of
operations.
If our computer systems and software products are not year 2000-compliant, our
services could be disrupted.
We confront the Year 2000 problem in three contexts.
Our clients. Many of our clients and prospective clients maintain their
operations on computer systems that may not be Year 2000-compliant. The failure
of any clients to ensure that their systems are Year 2000-compliant could
seriously harm their businesses, which in turn could seriously harm our
business, financial condition and operating results. In addition, clients or
prospective clients may delay purchasing software and related services,
including our ReFOCOS, S.T.A.R. and M.A.R.S. services and M.A.R.S. software, due
to concerns related to the Year 2000 problem.
Our services. We sell computer-related services, so our risk of
lawsuits relating to Year 2000 issues may be greater than that of companies in
other industries. Because our computer products and services may incorporate
components from different providers, it may be difficult to determine which
component may cause a Year 2000 problem. As a result, we may become subject to
Year 2000-related lawsuits whether or not our products and services are Year
2000-compliant.
25
<PAGE>
Our suppliers. Our business could be adversely affected if we cannot
obtain products, services or systems that are Year 2000-compliant when we need
them. In addition, if our vendors and service providers cannot deliver their
products because of Year 2000 compliance problems, our business, financial
condition and operating results could be seriously harmed.
Gus Constantin can exert substantial control over our company.
Gus Constantin, our founder, chairman and chief executive officer, owns
all of the shares of our Class B common stock, each share of which entitles its
holder to five votes on most stockholder actions. As a result, Mr. Constantin
will have 89.9% of the combined voting power of both classes of our common stock
upon closing of the Company's initial public offering . Holders of Class A
common stock will be entitled to one vote per share and in the aggregate will
have 10.1% of the combined voting power of both classes of our common stock
after this offering. As a result of his stock ownership after this offering, Mr.
Constantin will be in a position, without the approval of our public
stockholders, to take corporate actions that could conflict with the interests
of our public stockholders, such as:
o amending our charter documents;
o approving or defeating mergers or takeover attempts;
o determining the amount and timing of dividends paid to himself and
to holders of Class A common stock;
o changing the size and composition of our board of directors and
committees of our board of directors; and
o otherwise controlling management and operations and the outcome of
most matters submitted for a stockholder vote.
Approximately 8.0 million, or 66.7%, of our total outstanding shares are
restricted from immediate resale but may be sold into the market in the near
future. This could cause the market price of our Class A common stock to drop
significantly, even if our business is doing well.
Upon closing of the Company's initial public offering, we will have
4,028,000 shares of Class A common stock outstanding. This includes the
4,000,000 shares that we are selling in this offering, which may be resold in
the public market immediately as long as these shares are not purchased by our
affiliates. The remaining 66.7%, or 8,018,291 shares, of our total outstanding
shares, including 846,291 shares subject to options that will become exercisable
upon closing of our initial public offering, and 7,172,000 of Class B common
stock will become available for resale in the public market as shown in the
chart below.
As restrictions on resale end, the market price of our Class A common
stock could drop significantly if the holders of restricted shares sell them or
are perceived by the market as intending to sell them.
Number Percent of
of Total
Shares Outstanding Date of Availability for Sale into Public Market
------ ----------- ------------------------------------------------
8,018,291 66.7% 181 days after the closing of the initial public
offering, subject in some cases to volume limitations
Our charter documents could deter a takeover effort, which could inhibit your
ability to receive an acquisition premium for your shares.
26
<PAGE>
Provisions of our certificate of incorporation, bylaws and Delaware law
could make it more difficult for a third party to acquire us, even if doing so
would be beneficial to our stockholders. In addition, we are subject to the
provisions of Section 203 of the Delaware General Corporation Law. This statute
could prohibit or delay the accomplishment of mergers or other takeover or
change in control in attempts with respect to us and, accordingly, may
discourage attempts to acquire us.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use of Proceeds
On August 4, 1999, we issued 7,200,000 shares of Class B common stock
to Gus Constantin in exchange for the outstanding capital stock of
ReSource/Phoenix, Inc., a California corporation. The foregoing issuance was
made in reliance on Section 4(2) of the Securities Act as a transaction not
involving any public offering. All of the securities were acquired by the
recipient for investment and not with a view toward the resale or distribution
thereof. The recipient was a director and officer of ours and a sophisticated
investor, the offer and sales were made without any public solicitation and the
stock certificates bear restrictive legends. No underwriter was involved in the
transactions and no commissions were paid. The recipient had adequate access,
through his relationships with the Company, to information about the Company.
On August 4, 1999, we granted options to purchase an aggregate of
846,291 shares of our Class A common stock to some of our employees under our
1999 stock option plan. The options were granted at an exercise price of $2.08
per share, subject to the closing of our initial public offering. The option
grants were exempt from registration under the Securities Act of 1933, as
amended (the "Securities Act"), in reliance on Rule 701 of the Securities Act.
On September 30, 1999, the majority shareholder transferred 28,000
shares of stock to unaffiliated individuals. Per the Company's Amended and
Restated Certificate of Incorporation, upon the request for transfer, the 28,000
Class B common stock shares convert to Class A common stock shares.
On October 14, 1999 we commenced our initial public offering (the
"Offering"), which consisted of 4,000,000 shares of our Class A common stock at
$8.00 per share pursuant to a registration statement (No. 333-84589) declared
effective by the Securities and Exchange Commission on October 14, 1999. The
Offering has been terminated and all shares have been sold. The managing
underwriters for the Offering were BancBoston Robertson Stephens, Inc. and
Thomas Weisel Partners LLC. Aggregate proceeds from the Offering were $32
million.
We incurred approximately $3.34 million in total expenses in connection with the
Offering, comprised of approximately $2.24 million in underwriters' discounts
and commissions and $1.1 million in other expenses.
After deducting expenses of the Offering, the net offering proceeds to
us were $28.7 million. Because the effective date of the Offering occurred
subsequent to the end of the reporting period, none of the proceeds had been
used at September 30, 1999. The approximate amount of net offering proceeds used
through November 1, 1999 was $6.6 million to repay outstanding promissory notes
to our majority stockholder, the Gus and Mary Jane Constantin 1978 Living Trust.
The remaining net proceeds have been invested in short-term cash instruments
pending final deployment. We currently estimate that the net proceeds of the
offering will be used as follows:
o 15% to 25% for capital expenditures; and
27
<PAGE>
o 55% to 65% for general corporate purposes, including working
capital.
As of the date of this Form 10-Q, we can only estimate the particular
uses for the net proceeds received from the Offering. As a result, the foregoing
estimates and our use of proceeds are subject to change at our management's
discretion. The amounts actually expended for each of the purposes listed above
may vary significantly depending upon a number of factors, including the
progress of our marketing programs and capital spending requirements.
From time to time, in the ordinary course of business, we may pursue
the acquisition of new or complementary businesses, products or technologies in
an effort to enter into new business areas, diversify our sources of revenue and
expand our product and service offerings. A portion of the net proceeds may be
used to fund acquisitions or investments. We currently have no arrangements,
agreements or understandings, and are not engaged in active negotiations for any
material acquisitions or investments.
Other than the repayment of promissory notes to our majority
shareholder noted above, no payments from the net proceeds of the Offering
constituted direct or indirect payments to directors, officers or general
partners of the Company or their associates, to persons owning 10% or more of
any class of equity securities of the Company or to any affiliates of the
Company.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended September
30, 1999.
28
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
RESOURCEPHOENIX.COM
-------------------
(Registrant)
Date Title Signature
---- ----- ---------
November 19, 1999 Chief Operating Officer /S/ BRYANT J. TONG
- ----------------- ------------------
(Bryant J. Tong)
November 19, 1999 Chief Financial Officer /S/ DAVE BRUNTON
- ----------------- ----------------
(Dave Brunton)
29
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