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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999.
Or
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______, 19__.
Commission file number : 000-24695
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TOWNE SERVICES, INC.
(Exact name of registrant as specified in its charter)
Georgia 62-1618121
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3295 River Exchange Drive, Suite 350, Norcross, Georgia 30092
(Address of principal executive offices and zip code)
(770) 734-2680
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
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 requirements for the past 90 days (1)Yes X No ;(2)Yes X No .
--- --- --- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date. 19,803,611 shares
outstanding at May 4, 1999.
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TOWNE SERVICES, INC.
INDEX TO FORM 10-Q/A
PAGE
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PART I CONDENSED CONSOLIDATED FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of
December 31, 1998 and March 31, 1999 3
Condensed Consolidated Statements of Operations for the Three
Months Ended March 31, 1998 and 1999 4
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 1998 and 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
PART II OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 2. Changes in Securities and Use of Proceeds 18
Item 3. Defaults upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
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PART I.
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TOWNE SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND MARCH 31, 1999
DECEMBER 31, MARCH 31,
1998 1999
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(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 13,081,284 $ 5,024,542
Accounts receivable, net of allowance
for uncollectible accounts of $347,065 and $337,565
in 1998 and 1999, respectively 3,552,478 5,170,946
Notes receivable from employees 167,305 170,625
Other 229,732 392,079
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Total current assets 17,030,799 10,758,192
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PROPERTY AND EQUIPMENT, net 2,116,987 3,155,617
NOTES RECEIVABLE FROM EMPLOYEES 81,565 83,265
GOODWILL, net 14,955,414 14,792,089
OTHER INTANGIBLES, net 1,134,614 1,077,883
OTHER ASSETS, net 100,249 81,396
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$ 35,419,628 $ 29,948,442
==============================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 125,763 $ 800,014
Accrued liabilities 1,273,148 1,092,117
Accrued compensation 250,391 558,915
Accrued termination costs 497,910 437,076
Current portion of long-term debt 5,000,000 -
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Total current liabilities 7,147,212 2,888,122
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SHAREHOLDERS' EQUITY:
Preferred stock, no par value; 20,000,000 shares authorized, 0 issued
and outstanding December 31, 1998 and March 31, 1999, respectively - -
Common stock, no par value; 50,000,000 shares authorized, 19,651,390 and
19,803,611 issued and outstanding December 31, 1998 and March 31,
1999, respectively 52,363,084 52,418,798
Warrants outstanding 41,000 41,000
Accumulated deficit (24,131,668) (25,399,478)
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Total shareholders' equity 28,272,416 27,060,320
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$ 35,419,628 $ 29,948,442
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The accompanying notes are an integral part of these balance sheets.
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TOWNE SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1999
FOR THE THREE
MONTHS ENDED
MARCH 31,
1998 1999
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(UNAUDITED)
REVENUES $ 547,954 $ 4,604,460
COSTS AND EXPENSES:
Costs of processing, servicing and support 374,128 953,990
Research and development 74,024 71,840
Sales and marketing 485,562 3,239,832
Stock compensation expense 5,971,590 36,339
General and administrative 1,347,282 1,648,336
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Total costs and expenses 8,252,586 5,950,337
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OPERATING LOSS (7,704,632) (1,345,877)
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OTHER EXPENSES:
Interest (income) expense, net 64,289 (78,067)
Financing costs for stock issued to nonemployees 323,000 -
---------------------------------
Total other expenses 387,289 (78,067)
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NET LOSS $ (8,091,921) $ (1,267,810)
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PREFERRED STOCK DIVIDENDS (5,108,000) -
ACCRETION OF WARRANTS WITH REDEMPTION FEATURE (211,000) -
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NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS $(13,410,921) $ (1,267,810)
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NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
PER COMMON SHARE:
Basic $ (1.11) $ (0.06)
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Diluted $ (1.11) $ (0.06)
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Weighted Average Common Shares Outstanding 12,077,352 19,765,493
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The accompanying notes are an integral part of these statements.
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TOWNE SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1999
1998 1999
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(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $ (8,091,921) $ (1,267,810)
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Adjustments to reconcile net loss to net cash
used in operating activities:
Compensation expense recognized for stock option grants 5,971,590 36,339
Financing costs for stock issued to nonemployees 323,000 -
Depreciation 39,980 155,243
Amortization of intangibles and goodwill - 426,118
Amortization of deferred financing fees 20,896 -
Amortization of debt discount 10,103 -
Changes in operating assets and liabilities, net of assets acquired:
Accounts receivable (237,441) (1,618,468)
Prepaid & other assets (146,339) (143,494)
Accounts payable (172,432) 674,251
Accrued liabilities 81,360 (294,862)
Accrued compensation 685,997 308,524
Accrued termination costs - -
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Total adjustments 6,576,714 (456,349)
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Net cash used in operating activities (1,515,207) (1,724,159)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in notes receivable from employees - (5,020)
Purchase of Banking Solutions, Inc. - (153,065)
Purchase of property and equipment, net (223,094) (1,193,873)
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Net cash used in investing activities (223,094) (1,351,958)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options - 19,375
Repayment of debt (15,397) (5,000,000)
Proceeds from issuance of preferred stock 1,500,000 -
Proceeds from issuance of common stock 1,217,269 -
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Net cash provided by (used in) financing activities 2,701,872 (4,980,625)
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NET INCREASE IN CASH 963,571 (8,056,742)
CASH AND CASH EQUIVALENTS, beginning of period 2,536,439 13,081,284
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CASH AND CASH EQUIVALENTS, end of period $ 3,500,010 $ 5,024,542
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SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for income taxes $ - $ -
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Cash paid for interest $ 42,083 $ 5,890
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Stock subscription receivable $ 427,500 $ -
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The accompanying notes are an integral part of these statements.
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TOWNE SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BACKGROUND
Towne Services, Inc. ("Towne Services" or the "Company") provides
transaction based on-line services and products to small businesses and
community banks in the United States. Towne uses internet and telecommunication
connections to link Towne's customers, banks and other providers of business
management tools to Towne via an electronic gateway. Towne's electronic
processing systems convert the in-house credit transactions of small businesses
into automated accounts which are processed electronically in much the same way
as credit card transactions are processed. Usually, in-house credit transactions
are completed without a credit card or cash, are recorded and processed manually
and then billed to the customer at a later date. The TOWNE CREDIT(R) system
electronically processes in-house consumer credit transactions of small and
medium size retail merchants. The TOWNE FINANCE(R) system, a commercial version
of TOWNE CREDIT, is an automated asset management and financing system that
processes business-to-business credit transactions for small commercial
businesses. The CASHFLOW(SM) MANAGER system is an accounts receivable financing
program similar to the TOWNE FINANCE product. Through the use of the Company's
products and services, small businesses can automate certain manual processes,
accelerate cash flow, provide better customer service, reduce paperwork and
shift many other administrative burdens to Towne Services. In addition, the
Company provides complementing products and services to banks that enable them
to generate interest-bearing revolving credit accounts by financing the accounts
receivable of these small businesses. Through the use of the Company's products,
banks can monitor customers' accounts receivable and generate detailed status
reports, and may attract new business customers who, in turn, may become
customers of Towne Services.
2. BASIS OF PRESENTATION
UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying consolidated financial statements for the three months
ended March 31, 1998 and 1999 are unaudited. In the opinion of the management of
the Company, these financial statements reflect all adjustments, consisting only
of normal recurring adjustments necessary for a fair presentation of the
financial statements. Certain information and footnote disclosures usually found
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. The results of operations
for the three months ended March 31, 1999 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1999 or for any
other future periods.
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3. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for
reporting and presentation of comprehensive income and its components in a full
set of general purpose financial statements. This statement is effective for
periods beginning after December 15, 1997. The Company adopted SFAS No. 130
effective January 1, 1998. The adoption of SFAS No. 130 did not have a material
impact on the Company's financial statements, as comprehensive income did not
differ from the reported net loss.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," which establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. The Company's
operating business segments provide electronic transaction processing for small
business in-house accounts. The product lines offered by the Company use the
Company's central administrative offices for customer support, centralized
processing and sales support. In addition, the Company's sales force markets all
products within their assigned markets. Consequently, the Company considers all
of its products as one reportable segment under the definitions in SFAS No. 131.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at its fair value. SFAS No. 133
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special accounting
for qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. A company may also implement SFAS No. 133 as of
the beginning of any fiscal quarter after issuance (that is, fiscal quarters
beginning June 16, 1999 and thereafter). SFAS No. 133 cannot be applied
retroactively; it must be applied to (a) derivative instruments and (b) certain
derivative instruments embedded in hybrid contracts that were issued, acquired,
or substantively modified after December 31, 1997. The adoption of SFAS No. 133
is not expected to have a material impact on the Company's financial statements.
4. INITIAL PUBLIC OFFERING
In August 1998 the Company completed an initial public offering ("IPO")
of its common stock. The total proceeds of the IPO, net of underwriting
discounts and offering expenses, were approximately $27.0 million. The Company
issued 3,850,000 shares at an offering price at $8.00 per share. In connection
with the IPO, the Company converted all outstanding shares of Series A
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Preferred Stock into 1,217,903 shares of common stock and warrants for 308,982
shares of common stock were exercised.
5. ACQUISITIONS
In June 1998, the Company acquired certain assets and liabilities of
Credit Collection Solutions, Inc. ("CCS") for approximately $510,000 cash and
the issuance of up to 100,000 shares of the Company's common stock if certain
financial results are achieved. CCS is a developer of computer software for
processing payments and tracking collections. In connection with the purchase of
CCS, the Company has recorded goodwill in the amount of $440,000, which is being
amortized over a period of 5 years.
In December 1998, the Company acquired the outstanding stock of Banking
Solutions, Inc. ("BSI") for approximately $14.9 million in cash and stock. In
connection with the acquisition of BSI, the Company issued 744,431 shares of
Towne's common stock at $6.73 per share. The remainder of the purchase price was
paid in cash. Towne also agreed to pay former officers of BSI amounts of money
which are contingent upon future performance criteria. BSI is a developer and
provider of a transaction processing system, CASHFLOW MANAGER, an accounts
receivable financing program similar to the TOWNE FINANCE product. The Company
recorded this transaction using the purchase method of accounting. The Company
has allocated goodwill in the amount of $14.6 million, which is being amortized
over a period of 12 years. The Company has recorded $1.1 million to an
intangible asset for BSI's customer list, which is being amortized over a period
of 5 years. The Company recognized a one-time charge in the amount of $2.3
million in December 1998 related to employee terminations which were not
identified at the date of purchase.
5. LONG TERM DEBT OBLIGATIONS
In August 1998, the Company repaid all of its then current and long-term
debt obligations then outstanding using proceeds of the initial public offering.
This resulted in an extraordinary one-time charge to net income of $476,000,
which is comprised of $218,000 unamortized discount on a note payable to Sirrom
Investments, Inc. and $258,000 deferred debt issuance costs.
In January 1999, the Company paid in full the First Union National Bank note
of $5,000,000.
6. SUBSEQUENT EVENTS
On March 25, 1999 Towne entered into a merger agreement to acquire
Forseon Corporation, a company based in Riverside, California. Forseon provides
products and services that process inventory, accounts receivable and point of
sale transaction information and generate merchandise forecasts and management
reports for retail businesses in the United States and Canada. These products
and services often improve small retail businesses' ability to compete
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with larger chain retailers by providing automated processing and business
management capabilities similar to those used by these larger competitors.
Forseon's management reports assist these small business owners in developing
and implementing their merchandising strategies as well as receivables
management and marketing plans.
The merger agreement provides for the combination of Towne's and
Forseon's businesses through the merger of Forseon with a subsidiary of Towne.
Towne will issue a total of 2,075,345 shares of its common stock in exchange for
all outstanding stock and options to acquire stock in Forseon. Ten percent of
the Towne common stock will be held back in escrow to satisfy the
indemnification obligations of Forseon stockholders under the merger agreement.
The merger will be accounted for as a pooling of interests. There are many risks
involved with this merger and it may not actually occur for a variety of
reasons, including if the merger agreement and related matters must be approved
by the holders of 90% of the outstanding Forseon common stock and we cannot
guarantee this approval will be obtained. See the "Risk Factors" section of
Towne's registration statements on Form S-4 (No. 333-76493) filed with the
Securities and Exchange Commission ("SEC") on April 23, 1999 and Form S-1
(No. 333-76859) filed with the SEC on April 22, 1999, as amended.
On April 22, 1999, Towne filed a registration statement on Form S-1 to
register up to 8,050,000 shares of its common stock for sale to the public.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
This Interim Report contains several "forward-looking statements" concerning
Towne Services' operations, performance, prospects, strategies and financial
condition, including its future economic performance, intent, plans and
objectives and the likelihood of success in developing and expanding its
business. These statements are based upon a number of assumptions and estimates
which are subject to significant uncertainties, many of which are beyond the
control of Towne Services. Words such as "may," "would," could," "will,"
"expect," "anticipate," "believe," "intend," "plan," and "estimate" are meant to
identify such forward-looking statements. Actual results may differ materially
from those expressed or implied by such forward-looking statements. Factors that
could cause actual results to differ materially include, but are not limited to:
- - Towne's limited operating history and whether it will be able to
achieve or maintain profitability;
- - whether Towne can attract and retain sales and marketing personnel or
enter new marketing alliances to grow its business;
- - whether Towne can obtain, continue and manage growth or execute
agreements with new customers;
- - whether the market will accept new products and enhancements from
Towne;
- - whether Towne can successfully integrate the operations of companies it
acquires;
- - increased competition;
- - the unknown effects of possible system failures and rapid changes in
technology; and
- - other factors discussed in this report and in Towne's registration
statements on Form S-1 (No. 333-76859) as filed with the Securities and
Exchange Commission on April 22, 1999 and Form S-4 (No. 333-76493)
filed with the Securities and Exchange Commission on April 23, 1999, as
amended, including the "Risk Factors" section contained therein.
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OVERVIEW
Towne establishes an electronic gateway that links business and bank
customers with Towne and other providers of products and services. Towne
currently generates revenues through the deployment and use of three primary
products and ancillary services: TOWNE CREDIT, TOWNE FINANCE, and CASHFLOW
MANAGER. With each of these products, we generate initial set-up fees, discount
fees and monthly transaction processing fees. Management believes the prices
charged for both the initial set-up fees and the recurring transaction fees are
based upon the relative fair value of the related services provided.
Accordingly, we recognize these fees as the related services are provided.
Set-up fees include charges for installation, implementation and
training of our bank and business customers. We recognize revenues related to
our set-up fees upon execution of the related contract or, if appropriate, upon
settlement of any contract contingencies. Set-up fees charged to each bank vary
depending on the asset size of the bank and the number of communities served. We
also charge set-up fees to our business customers based either upon a flat rate
or upon the expected transaction volume. Revenues are deferred for contracts
that contain certain cancellation clauses or return guarantees until the
cancellation or guarantee period has expired.
With each of our transaction processing products, our business customer
pays a discount fee to its bank equal to a percentage of the value of each
transaction processed. In addition, the business' customer pays to the bank
interest and fees for amounts owed on account. We generate recurring revenue by
collecting a portion of the discount fee and, if applicable, interest paid on
these accounts, as well as by charging monthly transaction processing fees.
Monthly transaction processing fees include charges for electronic processing,
statement rendering and mailing, settling payments, recording account changes
and new accounts, leasing and selling point of sale terminals and collecting
debts.
Costs of processing, servicing and support include installation costs
for our products and costs related to customer service, information systems
personnel and installation services.
Research and development expenses consist of salary and related
personnel costs, including costs for employee benefits, computer equipment and
support services, used in product and technology development. We believe that
our research and development expenditures, which aid in the design of new
products and product enhancements to respond to changes in customer demand, are
essential for obtaining and retaining a leadership position in our marketplace.
Most research and development expenditures are expensed as incurred; however, we
have capitalized certain development costs under Statement of Financial
Accounting Standards ("SFAS") No. 86 when the products reached technological
feasibility.
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Sales and marketing expenses consist primarily of salaries and
commissions, travel expenses, advertising costs, trade show expenses and costs
of marketing materials. These expenses also include the costs incurred to
develop our indirect marketing channels.
On July 30, 1998 our initial public offering was declared effective by
the SEC. We sold 3,850,000 shares of common stock at $8.00 per share and
received proceeds of $27.0 million, after deducting underwriting discounts and
other expenses related to the offering.
In December 1998, Towne acquired the outstanding capital stock of
Banking Solutions, Inc., for approximately $14.9 million in cash and stock. In
connection with the acquisition of Banking Solutions, Towne issued 744,431
shares of Towne common stock at $6.73 per share. The remainder of the purchase
price was paid in cash. Towne also agreed to pay former officers of Banking
Solutions amounts of money which are contingent upon future performance
criteria. Banking Solutions is a developer and provider of a transaction
processing system, CASHFLOW MANAGER, an accounts receivable financing program
similar to the TOWNE FINANCE product. Towne recorded this transaction using the
purchase method of accounting. Towne has recorded goodwill in the amount of
$14.6 million, which is being amortized over a period of 12 years. Towne has
recorded a $1.1 million intangible asset for the purchase of BSI's customer
list, which is being amortized over a period of 5 years. Towne also recognized a
one time charge in the amount of $2.3 million in December 1998, related to
employee terminations which were not identified at the date of purchase.
On March 25, 1999 we entered into a merger agreement to acquire Forseon
Corporation, a company based in Riverside, California. Forseon provides products
and services that process inventory, accounts receivable and point of sale
transaction information and generate merchandise forecasts and management
reports for retail businesses in the United States and Canada. The merger
agreement provides for the combination of Towne's and Forseon's businesses
through the merger of Forseon with a subsidiary of Towne. Towne will issue a
total of 2,075,345 shares of its common stock in exchange for all outstanding
stock and options to acquire stock in Forseon. Ten percent of the Towne common
stock will be held back in escrow to satisfy the indemnification obligations of
Forseon stockholders under the merger agreement. The merger will be accounted
for as a pooling of interests. There are many risks involved with this merger
and it may not actually occur for a variety of reasons, including if the merger
agreement and related matters are not approved by the holders of 90% of the
outstanding Forseon common stock. See the "Risk Factors" section of Towne's
registration statements on Form S-4 (No. 333-76493) filed with the SEC on
April 16, 1999 and Form S-1 (No. 333-76859) filed with the SEC on
April 23, 1999, as amended, for a discussion of these risks.
Towne Services had net losses of approximately $8.1 million and $1.3
million for the three months ended March 31, 1998 and 1999, respectively. For
the year ended December 31, 1998, Towne had an accumulated deficit of $24.1
million. Approximately $12.9 resulted from one-time non-cash charges, and $2.3
million of this accumulated deficit resulted from a one-time
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charge relating to employee termination agreements subsequent to the purchase of
Banking Solutions, Inc. in December 1998. For the three months ended March 31,
1999 Towne had an accumulated deficit of approximately $25.4 million.
Towne reported total revenues of $548,000 and $4.6 million for the
three months ended March 31, 1998 and 1999, respectively. Towne has experienced
net losses of $8.1 million and $1.3 million in each of these periods,
respectively and expects to continue to incur losses for the foreseeable future.
The number of Towne Services employees at December 31, 1998 was 169, compared to
177 employees at March 31, 1999. Towne currently intends to expand its sales and
marketing operations, to invest more in product research and development, to
pursue strategic acquisitions and to improve its internal operating and
financial infrastructure, all of which will increase its operating expenses.
Because of our limited operating history, management believes that period to
period comparisons of our operating results are not meaningful. Although we have
experienced significant revenue growth recently, there can be no assurance that
such growth rates are sustainable, and they should not be relied upon as
indicators of future performance. Our prospects must be considered in light of
the risks, expenses and difficulties frequently encountered by companies in the
early stage of development and relatively new and changing markets. There can be
no assurance that we will be successful in addressing such risks and
difficulties or that we will achieve profitability in the future.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1998 AND 1999
Revenues. Towne's revenues increased from $548,000 for the three months
ended March 31, 1998 to $4.6 million for the three months ended March 31, 1999.
During these two periods, set-up fees accounted for approximately 68% and 31% of
total revenues, respectively. Recurring revenues accounted for approximately 35%
and 64% of total revenues, respectively. The increase in revenues during these
periods resulted primarily from an increase in the number of customers and
higher set-up fees and transaction processing fees charged to new customers. The
increase in recurring revenues as a percentage of total revenues resulted
primarily from an increase in the number of transaction processing fees that
generate recurring revenues.
Costs of Processing, Servicing and Support. Costs of processing,
servicing and support increased from $374,000 for the three months ended March
31, 1998 to $954,000 for the three months ended March 31, 1999. These costs were
approximately 68% and 21% of revenues, respectively, for these two periods. The
dollar amount of costs of processing, servicing and support increased as a
result of the addition of new customers and additional services and support
functions necessary to support Towne's growth, including the result of our
acquisitions. Towne anticipates that these costs will continue to increase as
new customers are added. Costs of processing, servicing and support decreased as
a percentage of revenue as a result of substantially increased revenues and
improved operating efficiencies.
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Research and Development. Research and development expenses decreased
from $74,000 for the three months ended March 31, 1998 to $72,000 for the three
months ended March 31, 1999. Research and development expenses represented
approximately 14% and 2% of revenues, respectively, during these two periods. We
do not expect to incur significant costs to make our products year 2000
compliant because we believe our products are currently designed to properly
function through and beyond the year 2000. See "--Effects of the Year 2000."
Sales and Marketing. Sales and marketing expenses increased from
$486,000 for the three months ended March 31, 1998 to $3.2 million for the three
months ended March 31, 1999. Sales and marketing expenses were approximately 89%
and 70% of revenues, respectively, during these two periods. The increase in
these expenses is primarily the result of significant increases in the number of
sales personnel in remote locations, related travel expenses and costs for
marketing materials used to recruit potential bank and business customers. Towne
anticipates that sales and marketing expenses will continue to increase as we
continue to expand our direct sales and marketing force and hire additional
personnel to promote our indirect sales channels.
Stock Compensation Expense. Stock compensation expense was $6.0 million
for the three months ended March 31, 1998 and $36,000 for the three months ended
March 31, 1999. In the first quarter of 1998, Towne sold shares of common stock
and issued options to acquire common stock at what management believed to be the
fair market value of the common stock at that time. Based upon outside sales to
third parties, a valuation and the initial public offering price at the time,
Towne recorded a one time non-cash charge for the additional value. Towne will
record approximately $727,000 ($145,000 per year) of compensation expense over
the five year vesting period of the options.
General and Administrative. General and administrative expenses
increased from $1.3 million for the three months ended March 31, 1998 to $1.6
million for the three months ended March 31, 1999. These costs represented
approximately 246% and 36% of revenues, respectively, for these two periods. The
increase in the dollar amount of these expenses was primarily the result of
increases in the number of executive and administrative employees and the costs
associated with executive and administrative expenses related to our growth. In
addition, Towne incurred costs related to being a public company, including
annual and other public reporting costs, directors' and officers' liability
insurance, investor relations programs and professional services fees. We
anticipate that general and administrative expenses will continue to increase in
the near future as Towne upgrades internal and financial reporting systems to
enhance management's ability to obtain and analyze information about our
operations.
Interest (Income) Expense, Net. Towne reported net interest expense of
$64,000 for the three months ended March 31, 1998 and net interest income of
$78,000 for the three months ended March 31, 1999. Net interest expense
decreased as a result of the repayment of debt obligations and net interest
income increased as a result of earnings on investments of cash proceeds
received from the initial public offering.
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Income Taxes. As of December 31, 1998, Towne Services had net operating
losses ("NOLs") of approximately $17.6 million for federal tax purposes, which
will expire if not utilized beginning in 2011. Towne has not recognized any
benefit from the future use of such NOLs because management's assumptions of
future profitable operations contain risks that do not provide sufficient
assurance to recognize such tax benefits currently.
During our short history, our operating results have varied
significantly and are likely to fluctuate significantly in the future as a
result of a combination of factors. These factors include:
- whether or not the market accepts current and future products and
services;
- whether new competitors emerge or existing competitors gain market
share faster than we do;
- whether new technologies are developed which make our systems outdated
or obsolete;
- whether costs of doing business increase as a result of higher wages,
sales commissions, taxes and other operating costs;
- whether seasonal trends in consumer purchasing impact the volume of
transactions processed; and
- general economic factors and the impact of potential acquisitions to
our operations.
In addition, the amount of revenues associated with particular set-up
fees can vary significantly based upon the number of products used by customers
for any particular period. We establish our expenditure levels for product
development, sales and marketing and other operating expenses based, in large
part, on our anticipated revenues. As a result, if revenues fall below
expectations, operating results and net income are likely to be adversely and
disproportionately affected because only a portion of our expenses vary with
revenues.
Liquidity and Capital Resources
Since its inception, Towne has financed its operations primarily
through sales of its equity securities in private placements, its initial public
offering and through credit facilities. Through December 1997, Towne received
aggregate net proceeds of $4.3 million from the sale of its common stock. In
March 1998, Towne received net proceeds of $1.5 million from the sale of its
Series A Preferred Stock in a private placement. In July 1998, Towne received
net proceeds of $27.0 million from the initial public offering of its common
stock.
In August 1998, Towne paid off all then existing current and long term
debt obligations, which consisted of a $1.5 million term note and several lines
of credit, with proceeds received from its initial public offering. The early
extinguishment of some of these debt obligations resulted in an extraordinary
loss of $476,000, which is comprised of $218,000 unamortized discount on the
$1.5 million term note and $258,000 in deferred debt issuance costs.
In December 1998, Towne borrowed $5.0 million on a short-term line of
credit from First Union National Bank. The line of credit has a term of one year
with an interest rate of LIBOR
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plus 2.0% (7.1% at December 31, 1998). It is secured by a deposit account Towne
maintains with the lender. The line of credit was paid in full in January 1999.
Towne will continue to negotiate with certain other financial institutions to
establish a credit facility for future working capital and acquisition
financing, but there can be no assurance that such negotiations will be
successful.
Net cash used in operating activities was approximately $1.5 million
for the three months ended March 31, 1998 and $1.7 million for the three months
ended March 31,1999. Net cash used in operating activities for the three months
ended March 31, 1998 represents a $8.1 million net loss partially offset by a
$6.0 million non-cash charge related to stock compensation expense, a $595,000
increase in accounts payable and accrued expenses, a $237,000 increase in
accounts receivable and a $146,000 increase in prepaid expenses and other
assets. Net cash used in operating activities for the three months ended March
31, 1999 represents a $1.3 million net loss partially offset by a $688,000
increase in accounts payable and accrued expenses, a $1.6 million increase in
accounts receivable and a $143,000 increase in prepaid expenses and other
assets.
Net cash used in investing activities was approximately $233,000 for
the three months ended March 31, 1998 and $1.4 million for the three months
ended March 31,1999. Net cash used in investing activities for the three months
ended March 31,1998 represents purchases of computer equipment used in
conducting Towne's business. Net cash used in investing activities for the three
months ended March 31, 1999 represents an increase of $153,000 of expenses
related to the purchase of Banking Solutions, Inc., $1.2 million for the
purchase of computer equipment and other capital equipment used in conducting
Towne's business and $5,000 in notes receivable due from employees.
Net cash provided by financing activities for the three months ended
March 31, 1998 consisted primarily of $2.7 million from the issuance of
securities. Net cash used in financing activities for the three months ended
March 31, 1999 consisted primarily of $5.0 million for the repayment of
outstanding short term debt obligations.
EFFECTS OF THE YEAR 2000
Our business and customer relationships rely on computer software
programs, internal operating systems and telephone and other network
communications connections. If any of these programs, systems or network
connections are not programmed to recognize and properly process dates after
December 31, 1999 (the "Year 2000" issue), significant system failures or errors
may result which could have a material adverse effect on the business, financial
condition, or results of operations of both our company and the affected
customers. We have conducted tests on our proprietary point of sale terminals,
network connections and transaction processing software and believe that our
TOWNE CREDIT, TOWNE FINANCE, CASHFLOW MANAGER and COLLECTION WORKS products and
network connections we maintain are able to process dates after December 31,
1999. For our internal accounting and operating systems and network
communications, we use software and other products provided by third parties and
we have received warranties or other assurances that these products are
programmed to address
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the Year 2000 issue. Our personnel will continue to test our network connections
to help ensure that these programs and systems continue to address the Year 2000
issue. We intend to modify or replace any products or systems that are unable to
properly function as a result of the Year 2000 issue and currently believe we
will be able to do so without incurring costs or delays which would have a
material adverse effect on our financial condition.
We supply point of sale terminals and other products needed to run our
processing systems to our customers and have not tested any other products or
systems used in our customers' businesses. If our customers do not successfully
address Year 2000 issues in their operations and, as a result, experience
temporary or permanent interruptions in their businesses, we may lose revenues
from these customers, which could have a material adverse effect on its
business, financial condition and results of operations. We believe that many
financial institutions and small businesses, including our customers, are still
in the preliminary stages of analyzing their systems for Year 2000 issues. It is
impossible to estimate the potential expenses involved or delays which may
result from the failure of these institutions and third parties to resolve their
Year 2000 issues in a timely manner and there can be no assurance that such
expenses, failures or delays will not have a material adverse effect on our
business, financial condition or results of operations.
EFFECTS OF ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and presentation of
comprehensive income and its components in a full set of general purpose
financial statements. This statement is effective for periods beginning after
December 15, 1997. Towne adopted SFAS No. 130 on January 1, 1998. The adoption
of SFAS 130 did not have a material impact on Towne's financial statements as
comprehensive income did not differ from the reported net loss for all periods
presented.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," which establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. This
statement is effective for financial statements for periods beginning after
December 15, 1997. The adoption of SFAS No. 131 did not have an impact on our
financial statements, as we operate in one business segment, electronic
transaction processing. Our operating business segments provide electronic
transaction processing for small business in-house accounts. The segments use
our central administrative offices for customer support, centralized processing
and sales support. In addition, our sales force markets all products within
their assigned markets. We consequently consider all of our products as one
reportable segment under the definitions in SFAS No. 131.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards requiring that
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every derivative instrument, including certain derivative instruments embedded
in other contracts, be recorded in the balance sheet as either an asset or
liability measured at its fair value. SFAS No. 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. SFAS No. 133 is effective for fiscal years beginning after
June 15, 1999. A company may also implement SFAS No. 133 as of the beginning of
any fiscal quarter after issuance, that is, fiscal quarters beginning June 16,
1988 and thereafter. SFAS No. 133 cannot be applied retroactively; it must be
applied to (1) derivative instruments and (2) certain derivative instruments
embedded in hybrid contracts that were issued, acquired, or substantively
modified after December 31, 1997. The adoption of SFAS No. 133 will not have a
material impact on our financial statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We do not use derivative financial instruments in our operations or
investments and do not have significant operations subject to fluctuations in
foreign currency exchange rates. Our $5.0 million credit facility has an
interest rate which is based, at our election, upon the lender's prime rate. As
of March 31, 1999, no amounts were outstanding under this credit facility and,
therefore, we do not believe it has a significant risk due to potential
fluctuations in interest rates at this time. Changes in interest rates which
dramatically increase the interest rate on the credit facility would make it
more costly to borrow proceeds under that facility and may impede our
acquisition and growth strategies if management determines that the costs
associated with borrowing funds are too high to implement these strategies.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On July 30, 1998 the Company's initial public offering was
declared effective by the Securities and Exchange Commission. In the
initial public offering, the Company sold 3,850,000 shares of common
stock at $8.00 per share. The Company received proceeds of $27.0
million (net), after deducting underwriting discounts of $2.2 million
and expenses related to the initial public offering. Upon completion of
the initial public offering, all outstanding shares of Series A
Preferred Stock were converted to 1,217,903 shares of common stock and
warrants for 308,982 shares of common stock were exercised.
Use of net proceeds from the initial public offering have been
as follows:
1. $2.2 million for the repayment of indebtedness
outstanding under the Company's loan facility with
Sirrom Investments, Inc., and the Company's loan from
Citizens Bank.
2. $13.0 million related to the acquisition of Banking
Solutions consisting of $10.7 million related to the
purchase of goodwill and $2.3 million related to
employee termination agreements.
3. The balance (approximately $11.8 million) for working
capital and general corporate purposes, including to
offset operating losses.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
In December 1998, Towne Services, Inc. (the "Company")
acquired the outstanding common stock of Banking Solutions, Inc. for
approximately $14.9 million in cash and stock. The Company accounted
for this transaction using the purchase method of accounting and
allocated approximately $14.6 million to goodwill. The Company
originally amortized the goodwill over 25 years; however, after further
evaluation of the acquired entity, the Company changed the amortization
life to 12 years. The interim financial statements have been restated
to show increased amortization expense of $210,688 for the period.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A) EXHIBITS
2.1 Agreement and Plan of Merger by and among Towne Services, Inc., TSI
Acquisition One, Inc., Forseon Corporation and certain of the
stockholders of Forseon Corporation dated as of March 25, 1999.**
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2.2 Form of Escrow Agreement to be entered into by and among Towne
Services, Inc., Dan Paul and Allen Merrill, each in their capacity as
a Stockholder Representative, and First Union National Bank.**
3.1 Amended and Restated Articles of Incorporation, as filed with the
Secretary of the State of Georgia on July 29, 1998.*
3.2 Amended and Restated Bylaws, effective May 19,1998.*
4.1 See Exhibits 3.1 and 3.2 for provisions of the Amended and Restated
Articles of Incorporation and Amended and Restated Bylaws defining
the rights of the holders of Common Stock of the Company.
10.1+ Sublease agreement by and among Technology Park/Atlanta, Inc. and
Towne Services dated March 9, 1999.
27.1 Financial Data Schedule (for SEC use only).
- -----------------
* Incorporated by reference to the exhibits to the Company's Registration
Statement on Form S-1 (No. 333-53341) as declared effective by the
Securities and Exchange Commission on July 30, 1998.
** Incorporated by reference to the exhibits to the Company's Registration
Statement on Form S-4 (No. 333-76493) filed on April 16, 1999.
+ Previously filed.
B) REPORTS ON FORM 8-K
Form 8-K/A (No. 000-24695) filed with SEC on February 16, 1999 to
declare the stock purchase agreement dated November 30, 1998 by and
between Towne Services Inc., and BSI Acquisition Corporation and
Banking Solutions, Inc., and certain shareholders of BSI.
Form 8-K (No. 000-24695) filed with SEC on April 6, 1999 to report the
public announcement of the Agreement and Plan of Merger, dated as of
March 25, 1999 by and among Forseon Corporation and Towne Services,
Inc.
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SIGNATURES
Pursuant to the requirements 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.
TOWNE SERVICES, INC.
June 9, 1999 /s/ Drew W. Edwards
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Date Drew W. Edwards
Chairman of the Board and Chief Executive Officer
(principal executive officer)
June 9, 1999 /s/ Bruce F. Lowthers, Jr.
- ------------------ --------------------------------------------------
Date Bruce F. Lowthers, Jr.
Chief Financial Officer
(principal financial and accounting officer)
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