UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
[ ] 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 000-24931
SECURITY FIRST TECHNOLOGIES CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 58-2395199
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3390 PEACHTREE ROAD, NE, SUITE 1700, ATLANTA, GA 30326
(Address of principal executive offices)
(Zip Code)
404/812-6300
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed 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.
Yes No X
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Shares outstanding as of November 2, 1998: Common 11,474,315
SECURITY FIRST TECHNOLOGIES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
ASSETS
Current assets:
Cash $ 17,779 $ 3,137
Investment securities available for sale (amortized cost of $16,759
at December 31, 1997) -- 16,814
Accounts receivable, net of allowance for doubtful accounts
of $250 at September 30, 1998 and $257 at December 31, 1997 4,531 4,297
Other current assets 867 1,141
-------- --------
Total current assets 23,177 25,389
Premises and equipment, net 8,851 5,797
Goodwill and purchased technology, net of accumulated amortization of
$5,649 at September 30, 1998 and $1,368 at December 31, 1997 341 4,622
Other assets 2,510 384
-------- --------
Total assets $ 34,879 $ 36,192
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,508 $ 486
Accrued expenses 2,681 1,550
Accrued stock option compensation expense 2,475 1,602
Deferred revenues 12,214 9,016
-------- --------
Total current liabilities 18,878 12,654
-------- --------
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized
5,000,000 shares
Series A, convertible. Issued and outstanding 1,174,110 shares at
September 30, 1998 and 1,251,084 at December 31, 1997 2,583 2,679
Series B, convertible. Issued and outstanding 749,064 shares at
at September 30, 1998 10,000 --
Common stock, $0.01 par value. Authorized, 60,000,000
shares. Issued and outstanding 11,303,344 and 10,487,245
shares at September 30, 1998 and December 31, 1997, respectively 113 105
Additional paid in capital 79,067 72,885
Accumulated deficit (75,410) (52,035)
Accumulated other comprehensive income:
Net unrealized gains on investment securities available for sale -- 55
Cumulative foreign currency translation adjustment (352) (151)
-------- --------
Total stockholders' equity 16,001 23,538
-------- --------
Total liabilities and stockholders' equity $ 34,879 $ 36,192
======== ========
1
SECURITY FIRST TECHNOLOGIES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- -------------------------------
1998 1997 1998 1997
--------------------------------- -------------------------------
Revenues:
Software licenses $ 1,069 $ 1,094 $ 2,508 $ 2,954
Professional services 4,549 1,661 10,183 4,239
Data center 927 122 1,831 236
------------------------------- -------------------------------
Total revenues 6,545 2,877 14,522 7,429
------------------------------- -------------------------------
Direct costs:
Software licenses 20 391 60 1,365
Professional services 2,806 1,157 6,606 3,827
Data center 1,937 1,854 5,585 5,078
------------------------------- -------------------------------
Total direct costs 4,763 3,402 12,251 10,270
------------------------------- -------------------------------
Gross margin 1,782 (525) 2,271 (2,841)
------------------------------- -------------------------------
Operating expenses:
Selling and marketing 955 992 3,163 3,163
Product development 3,717 2,696 10,707 7,595
General and adminstrative 1,370 991 3,810 3,458
Depreciation and amortization 761 401 2,050 1,081
Amortization of goodwill and acquisition charges 110 346 4,281 1,033
------------------------------- -------------------------------
Total operating expenses 6,913 5,426 24,011 16,330
------------------------------- -------------------------------
Operating loss (5,131) (5,951) (21,740) (19,171)
Interest income 52 346 442 1,116
------------------------------- -------------------------------
Loss from continuing operations (5,079) (5,605) (21,298) (18,055)
Discontinued operations:
Loss from operations (1,562) (236) (2,889) (187)
Gain on disposal 812 -- 812 --
------------------------------- -------------------------------
Loss from discontinued operations (750) (236) (2,077) (187)
------------------------------- -------------------------------
Net loss $ (5,829) $ (5,841) $ (23,375) $ (18,242)
=============================== ===============================
Basic and diluted net loss per common share
from continuing operations $ (0.45) $ (0.62) $ (1.97) $ (2.10)
Basic and diluted net loss per common
share from discontinued operations (0.07) (0.02) (0.19) (0.02)
------------------------------- -------------------------------
Basic and diluted net loss per common share $ (0.52) $ (0.64) $ (2.16) $ (2.12)
=============================== ===============================
Weighted average number of shares of
common stock outstanding 11,175,737 9,060,726 10,823,323 8,596,580
------------------------------- -------------------------------
2
SECURITIY FIRST TECHNOLOGIES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
COMPREHENSIVE
SHARES AMOUNT INCOME
--------------- ------------- -----------------
SERIES A PREFERRED STOCK
Balance December 31, 1997 1,251,084 $ 2,679
Conversion of preferred stock to common stock (76,974) (96)
--------------- -------------
Balance September 30, 1998 1,174,110 $ 2,583
--------------- -------------
SERIES B PREFERRED STOCK
Balance December 31, 1997 -- --
Sale of preferred stock 749,064 10,000
--------------- -------------
Balance September 30, 1998 749,064 $10,000
--------------- -------------
COMMON STOCK
Balance December 31, 1997 10,487,245 $ 105
Conversion of preferred stock to common stock 76,974 1
Sale of common stock, net of expenses 92,593 1
Common stock issued upon the exercise of options 464,922 4
Issuance of common stock in exchange for software license 181,610 2
--------------- -------------
Balance September 30, 1998 11,303,344 $ 113
--------------- -------------
ADDITIONAL PAID-IN CAPITAL
Balance December 31, 1997 $72,885
Conversion of preferred stock to common stock 95
Sale of common stock, net of expenses 969
Common stock issued upon the exercise of options 1,820
Issuance of options to acquire common and preferred stock 1,300
Issuance of common stock in exchange for software license 1,998
-------------
Balance September 30, 1998 $79,067
-------------
ACCUMULATED DEFICIT
Balance December 31, 1997 $ (52,035)
Net loss (23,375) $ (23,375)
-------------
Balance September 30, 1998 $ (75,410)
-------------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance December 31, 1997 $ (96)
Changes in net unrealized gains on investment securities available for sale (55) (55)
Change in cumulative foreign currency translation adjustment (201) (201)
------------- --------------
Comprehensive income $ (23,631)
------------- ==============
Balance September 30, 1998 $ (352)
-------------
TOTAL STOCKHOLDERS' EQUITY $16,001
=============
3
SECURITY FIRST TECHNOLOGIES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1998 1997
--------- ----------
Cash flows from operating activities:
Net loss $(23,375) $(18,242)
Adjustments to reconcile net loss to net cash used in
operating activities:
Loss from discontinued operations 2,889 187
Depreciation and amortization including acquisition charges 6,446 2,989
Gain on disposal of discontinued operations (812) --
Compensation expense for stock options 1,489 396
Provision for doubtful accounts receivable 280 --
Increase in accounts receivable (633) (2,912)
Decrease (increase) in other assets 46 (748)
Increase (decrease) in accounts payable 1,022 (765)
Increase (decrease) in accrued expenses 1,093 (175)
Increase in deferred revenue 3,198 7,811
-------- --------
Net cash used in continuing operating activities (8,357) (11,459)
Net cash provided by (used in) discontinued operations 3,480 (187)
-------- --------
(4,877) (11,646)
-------- --------
Cash flows from investing activities:
Sales of investment securities available for sale 1,983 5,981
Sales of banking operations 1,500 --
Purchases of investment securities (6,235)
Maturities of investment securities available for sale 8,000 12,004
Purchases of premises and equipment (3,534) (2,399)
-------- --------
Net cash provided by investing activities 7,949 9,351
-------- --------
Cash flows from financing activities:
Sale of common stock, net of expenses 970 4,676
Sale of preferred stock 10,000 1,315
Proceeds from exercise of stock options 800 109
-------- --------
Net cash provided by financing activities 11,770 6,100
-------- --------
Effect of exchange rate changes on cash (200) --
-------- --------
Net increase in cash 14,642 3,805
Cash at beginning of period 3,137 4,122
-------- --------
Cash at end of period $ 17,779 $ 7,927
======== ========
4
SECURITY FIRST TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Security
First Technologies Corporation and its wholly-owned subsidiary, Security First
Technologies, Inc. ("S1), (collectively, the "Company"). Security First
Technologies Corporation is the successor company to Security First Network Bank
("SFNB") as a result of the reorganization completed on September 30, 1998.
Accordinly, all historical financial information for periods prior to September
30, 1998 is that of SFNB. Significant intercompany accounts and transactions
have been eliminated in consolidation. The consolidated financial statements for
the three and nine month periods ended September 30, 1998 and 1997 are unaudited
and do not include information or footnotes necessary for a complete
presentation of financial condition, results of operations and cash flows. The
interim financial statements include all adjustments, consisting only of normal
recurring adjustments, which in the opinion of management are necessary to
present fairly the Company's consolidated financial statements. The results of
operations for the three and nine months ended September 30, 1998 are not
necessarily indicative of the expected results for the year ending December 31,
1998. The following should be read in conjunction with the SFNB's historical
financial statements included in the Company's registration statement filed on
August 25, 1998.
As more fully discussed in note 2, the Company has sold its banking
operations, which have been presented as discontinued operations in the
accompanying consolidated financial statements.
2. DISCONTINUED OPERATIONS AND SALE OF BANKING OPERATIONS, TECHNOLOGY
LICENSING AGREEMENTS, AND SALE OF COMMON STOCK
On September 30, 1998, the Company completed the sale of its banking
operations to the Royal Bank of Canada, through one of its U.S. based
subsidiaries ("Royal Bank"). Royal bank paid $3 million in excess of the net
assets sold (including $1.5 million holdback for indemnification which will be
received eighteen months from the closing date). The banking operations included
substantially all of the loans and investment securities as well as its deposit
relationships and were legally separated from the technology operations through
the formation of a holding company and the contribution of $10 million in
capital. The Company recorded a gain of $812 thousand on the sale of the banking
operations. The gain on sale includes a $1.3 million charge related to the
estimated fair value of options to purchase the Company's capital stock issued
to Royal Bank in connection with the sale of the banking operations. The options
give Royal Bank the right to purchase 733,818 shares of common and preferred
stock for an aggregate of $10 million at prices ranging from $11.88 to $15.81
per share at specified periods through June 2000.
The banking assets held for sale had been presented net of the related
liabilities in the accompanying 1997 consolidated balance sheet and the losses
from the banking operations are reflected in the accompanying consolidated
statements of operations as discontinued operations. Net interest income for the
nine month period ended September 30, 1998 was $1.3 million and the net loss
excluding the gain on disposal was $2.9 million. The increase in the loss from
discontinued operations
5
for the three months ended September 30, 1998 is the result of one time charges
related to the sale of the banking operations.
In addition to the sale of the banking operations, Royal Bank has entered
into technology licensing and consulting arrangements with the Company for $6
million, which were effective upon closing of the sale of the banking
operations. Also, Royal Bank purchased 92,593 shares of the Company's common
stock for $1 million in cash on March 9, 1998.
3. STOCK PURCHASE AGREEMENTS
On June 29, 1998, the Company entered into a Stock Purchase Agreement and
other technology and license agreements with State Farm Mutual Automobile
Insurance Company ("State Farm"). Pursuant to the Stock Purchase Agreement,
effective September 30, 1998 State Farm purchased 749,064 shares of non-voting,
zero coupon preferred stock of the Company for $10.0 million. The preferred
stock is redeemable at the option of the Company within the first two years of
issuance. The preferred stock is convertible after two years into 535,045 shares
of common stock based on a conversion price of $18.69.
On June 30, 1998, the Company entered into a relationship with BroadVision,
Inc. under a Stock Purchase Agreement and other technology and licensing
agreements. Under the Stock Purchase Agreement, BroadVision purchased on July
15, 1998, 181,610 shares of the Company's common stock by granting to the
Company a license agreement which gives the Company the right to resell
BroadVision's marketing suite of software products by integrating the product
with S1's software products. In addition, on October 1, 1998, the companies
exchanged common stock, amounting to 129,702 shares of the Company for 123,001
shares of BroadVision, based upon the average of the closing price of the
respective stock for the ten business days preceding July 31, 1998.
4. COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"). This statement establishes standards for reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. SFAS 130 requires all items that are required to
be recognized under accounting standards as components of comprehensive income
be reported in an annual financial statement that is displayed in equal
prominence with the other annual financial statements. For interim period
financial statements, enterprises are required to disclose a total for
comprehensive income in those financial statements. Comprehensive income for the
nine months ended September 30, 1998 and 1997 was ($23.6) million and ($18.3),
respectively. The term "comprehensive income" is used in SFAS 130 to describe
the total of all components of comprehensive income including net income. "Other
comprehensive income" refers to revenues, expenses, gains, and losses that are
included in comprehensive income but excluded from earnings under current
accounting standards. Currently, "other comprehensive income" for the Company
consists solely of items previously recorded as a component of stockholders'
equity under SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities" and SFAS 52, "Foreign Currency Translation". The Company has adopted
the interim-period disclosure requirements of SFAS 130 and will
6
adopt the annual financial statement reporting and disclosure requirements of
SFAS 130 effective December 31, 1998.
5. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
an Enterprise and Related Information." SFAS No. 131 supercedes SFAS 14,
"Financial Reporting in Segments of a Business Enterprise", and establishes
standards for the way public business enterprises are to report information
about operating segments in annual financial statements and requires those
enterprises to report selected financial 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 adoption of this new standard did not require significant changes
to the Company's current segment information that is presented in the 1997
annual financial statements and did not impact interim financial statements for
the quarter ended September 30, 1998 as the interim disclosures are not required
in the first year of adoption.
In October 1997, the Accounting Standards Executive Committee issued
Statement of Position ("SOP") No. 97-2, "Software Revenue Recognition." SOP No.
97-2, which revises the rules for accounting for software transactions by
superceding SOP 91-1, "Software Revenue Recognition," is effective for financial
statements for years beginning after December 15, 1997. The adoption of SOP 97-2
did not have a material effect on the interim financial statements for the three
and nine months ended September 30, 1998.
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis should be read in conjunction with
the consolidated financial statements and notes thereto included elsewhere
herein and SFNB's historical financial statements included in the Company's
registration statement filed on August 25, 1998.
General. Security First Technologies Corporation is the successor company to
Security First Network Bank as a result of the reorganization completed on
September 30, 1998. S1 develops, markets, installs and services integrated,
brandable Internet applications that enable financial services entities to offer
products, services and transactions over the Internet in a secure environment.
S1 generates revenues from licensing the Virtual Financial Manager ("VFM") suite
of software products, providing professional services relating to the
installation and integration of the software, and providing data center
processing services and technical support to financial services entities.
S1's primary product is VFM, a suite of software products designed to
provide consumers remote access to all aspects of their balance sheet via the
Internet. This virtual net worth solution allows consumers to have access to all
of their financial information on a current market valuation basis even though
the information is maintained on separate computer systems operated by banks,
brokerage firms, insurance companies, credit card processors, etc. S1's initial
product in the suite, "Virtual Bank Manager," ("VBM") allows end-users to view,
categorize, update and generate reports on account detail, view balance
information and execute banking transactions over the Internet such as transfers
and bill payments. The second product in the suite, "Virtual Credit Card
Manager," provides customers access to an on-line credit card account statement
and allows end users to view, categorize and generate reports on account detail.
Virtual Investment Manager, which was released this year, allows customers the
ability to open brokerage accounts, enter and execute stock and mutual fund
transactions and view portfolio positions.
S1 continues to enhance the existing VFM suite by developing new
applications and migrating existing products to a more efficient software
architecture. Implementations and upgrades to VBM version 4.0 began in the third
quarter of 1998. This release will consolidate all existing users of VBM onto
the same version of VBM, which is expected to occur by the third quarter 1999.
In addition, this version will improve the operational efficiencies and
stability of the existing product. Along with this VBM release, S1 also released
Virtual Loan Manager ("VLM"), which will allow end users to view loan balances
and make loan payments.
On June 30, 1998, the Company entered into a relationship with BroadVision,
Inc. under a Stock Purchase Agreement and other technology and licensing
agreements. Under the Stock Purchase Agreement, BroadVision purchased on July
15, 1998, 181,610 shares of the Company's common stock by granting to S1 a
license agreement which gives S1 the right to resell BroadVision's "One-to-One"
marketing suite of software products. S1 is currently integrating the
BroadVision "One-to-One" marketing product with the VFM suite. The addition of
the "One-to-One" product will allow financial services entities to better market
their services to their customers using the VFM products through intelligent
cross-selling, relationship management and content management capabilities.
Management anticipates that it will earn
8
revenues from this arrangement by direct sales of the "One-to-One" licenses,
fees for implementing the product and ongoing fees for running the product in
the S1 Data Center.
S1 is also currently working on the development of the next generation of
the VFM suite of products which will incorporate technology supporting
marketing, client services and a more scalable transaction processing operating
environment. This version of VFM is expected to be released in 1999. In
addition, development of Virtual Insurance Manager began in the third quarter of
1998. Future products in the suite anticipated to be developed include Virtual
Corporate Cash Manager and Virtual Bill Presentment.
S1 derives revenues from financial services entities primarily through one
of the following three distribution channels:
o By processing Internet transactions through the S1 data center.
Financial services entities pay a monthly fee for processing and
technical support based on the number of their customers using the
VFM product.
o By licensing VFM to third party data processors. Third party data
processors install VFM at their own data processing centers and offer
the product to their financial services clients. S1 earns fees from
third party data processing centers through a monthly fee based on the
number of customers of the financial services entity who are using the
product.
o By licensing VFM directly to financial services entities which operate
their own data centers "in-house". S1 receives a license fee up-front
plus receives an annual recurring charge for ongoing product upgrades
and support and maintenance which is based on the greater of the
number of customers or a percentage of the initial license fee.
Additionally, S1 provides professional services related to the installation and
integration of the VFM product, including installing the product at third party
data processing centers and financial services entities and integrating the
financial services entity's data processing systems with the S1 data center.
Customers are charged for these services primarily on a time and materials
basis.
9
QUARTERLY FINANCIAL AND OPERATING DATA FOR THE FIVE QUARTERS
ENDED SEPTEMBER 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE, PER CUSTOMER AND PER FULL TIME
EQUIVALENT (FTE) DATA)
- -------------------------------------------------------------------------------------------------------------------
SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30,
1997 1997 1998 1998 1998
- -------------------------------------------------------------------------------------------------------------------
REVENUES:
Software licenses $ 1,094 $ 1,188 $ 669 $ 770 $ 1,069
Professional services 1,661 2,038 2,449 3,185 4,549
Data center 122 175 310 594 927
-------- -------- -------- -------- --------
Total revenues 2,877 3,401 3,428 4,549 6,545
-------- -------- -------- -------- --------
DIRECT COSTS:
Software licenses 391 240 20 20 20
Professional services 1,157 1,519 1,570 2,230 2,806
Data center 1,854 1,869 1,823 1,825 1,937
-------- -------- -------- -------- --------
Total direct costs 3,402 3,628 3,413 4,075 4,763
-------- -------- -------- -------- --------
OPERATING EXPENSES:
Selling and marketing 992 1,142 1,071 1,137 955
Product development 2,696 2,912 3,383 3,607 3,717
General and adminstrative 991 1,179 1,204 1,236 1,370
Depreciation and amortization 401 660 637 652 761
Goodwill amortization and acquisition charges 346 3,492 2,088 2,083 110
-------- -------- -------- -------- --------
Total operating expenses 5,426 9,385 8,383 8,715 6,913
-------- -------- -------- -------- --------
Operating loss (5,951) (9,612) (8,368) (8,241) (5,131)
Interest income 346 365 255 135 52
-------- -------- -------- -------- --------
LOSS FROM CONTINUING OPERATIONS $ (5,605) $ (9,247) $ (8,113) $ (8,106) $ (5,079)
======== ======== ======== ======== ========
NET LOSS PER COMMON SHARE FROM
CONTINUING OPERATIONS BEFORE LOSS FROM
NON-RECURRING CHARGES, GOODWILL
AMORTIZATION AND ACQUISITION CHARGES $ (0.58) $ (0.59) $ (0.57) $ (0.56) $ (0.44)
NET LOSS PER COMMON SHARE
FROM CONTINUING OPERATIONS $ (0.62) $ (0.93) $ (0.77) $ (0.75) $ (0.45)
WEIGHTED AVERAGE SHARES OUTSTANDING 9,061 9,892 10,524 10,763 11,176
CASH PROVIDED BY (USED IN)
CONTINUING OPERATIONS $ 4,007 $ (7,110) $ (4,972) $ (3,980) $ 595
CASH AND INVESTMENT SECURITIES $ 28,181 $ 19,951 $ 15,352 $ 8,971 $ 17,779
SUMMARY INCOME STATEMENT ANALYSIS (AS A PERCENTAGE OF TOTAL REVENUES)
REVENUES:
Software licenses 38% 35% 20% 17% 16%
Professional services 58% 60% 71% 70% 70%
Data center 4% 5% 9% 13% 14%
-------- -------- -------- -------- --------
Total revenues 100% 100% 100% 100% 100%
-------- -------- -------- -------- --------
DIRECT COSTS:
Software licenses 14% 7% 1% 0% 0%
Professional services 40% 45% 46% 49% 43%
Data center 64% 55% 53% 40% 30%
-------- -------- -------- -------- --------
Total direct costs 118% 107% 100% 90% 73%
-------- -------- -------- -------- --------
OPERATING EXPENSES:
Selling and marketing 34% 34% 31% 25% 15%
Product development 94% 86% 99% 79% 57%
General and adminstrative 34% 35% 35% 27% 21%
-------- -------- -------- -------- --------
LOSS FROM CONTINUING OPERATIONS (195%) (272%) (237%) (178%) (78%)
======== ======== ======== ======== ========
GROSS MARGINS:
Software licenses 64% 80% 97% 97% 98%
Professional services 30% 25% 36% 30% 38%
Data center (1,420%) (968%) (488%) (207%) (109%)
-------- -------- -------- -------- --------
Total gross margin (18%) (7%) 0% 10% 27%
======== ======== ======== ======== ========
DATA CENTER REVENUE PER QUARTERLY AVERAGE CUSTOMERS $ 9.90 $ 9.55 $ 9.64 $ 13.34 $ 14.75
PROFESSIONAL SERVICES REVENUE
PER AVERAGE PROFESSIONAL SERVICES FTE* $ 45,000 $ 46,000 $ 52,000 $ 47,000 $ 56,000
- ----------
* Excludes revenue from pass through costs.
10
The table below reflects quarterly information on the number of financial
services entities that have either executed a letter of intent or signed
contract to use the S1 software applications and technology segregated by
distribution channel for the five quarterly periods ended September 30, 1998.
The table also shows quarterly information on the number of financial services
entities using VFM by distribution channel. All amounts represent totals as of
the end of each respective period.
SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30,
1997 1997 1998 1998 1998
--------- -------- --------- -------- ---------
NUMBER OF FINANCIAL INSTITUTIONS:**
S1 Data Center 18 17 17 17 16
Third party data processors* 32 43 56 58 62
Direct license in-house 6 6 7 6 6
------- ------- ------- ------- -------
Total 56 66 80 81 84
======= ======= ======= ======= =======
INSTITUTIONS USING VFM THROUGH:
S1 Data Center 6 8 12 12 10
Third party data processors* 3 11 16 17 35
Direct license in-house -- 4 4 4 4
------- ------- ------- ------- -------
Total 9 23 32 33 49
======= ======= ======= ======= =======
NUMBER OF VFM CUSTOMERS:
S1 Data Center 28,000 32,700 44,000 58,100 77,000
Third party data processors* -- 400 2,000 4,000 7,500
Direct license in-house* -- 1,400 5,800 40,000 67,000
------- ------- ------- ------- -------
Total customers using VFM 28,000 34,500 51,800 102,100 151,500
======= ======= ======= ======= =======
NUMBER OF VFM ACCOUNTS:
S1 Data Center 37,000 49,500 69,400 94,600 128,000
Third party data processors* -- 700 4,400 8,400 15,000
Direct license in-house* -- 2,000 26,200 160,000 244,000
------- ------- ------- ------- -------
Total accounts processed on VFM 37,000 52,200 100,000 263,000 387,000
======= ======= ======= ======= =======
- ----------
* Information based on discussions with officials of third party data
processors and direct licensees.
** Including subsidiaries of bank holding companies, the number of entities
who have agreed to use VFM is in excess of 100 at September 30, 1998.
RESULTS OF OPERATIONS - COMPARISON OF THREE AND NINE MONTHS ENDED SEPTEMBER 30,
1998 AND 1997
Revenues and Operating Margins
S1's total revenue was $6.5 million for the quarter ended September 30,
1998, a 127% increase from $2.9 million for the comparable period in 1997. The
primary components of third quarter 1998 revenue were $1.1 million in software
license fees, $4.5 million in professional service fees and $0.9 million in data
center fees. Direct costs associated with S1's revenues were $4.8 million in
third quarter 1998, up from $3.4 million in the comparable period in 1997.
For the nine months ended September 30, 1998, total revenue increased to
$14.5 million from $7.4 million, a 95% increase. Direct costs increased 19% from
$10.3 million for the nine months ended September 30, 1997 to $12.3 million for
the nine months ended September 30, 1998. As a result of the size of the
companies S1 does business with and the magnitude of the implementations for
companies of this size along with the limited amount of capacity to perform
implementations, in any given period a significant portion of the revenues of S1
may be attributed to one or two customers. For the nine months ended September
30, 1998, two
11
customers represented 42% and 10% of total revenues. For the nine months ended
September 30, 1997, two customers represented 13% and 10% of total revenues.
Software Licensing. Software license fees, which accounted for
approximately 16% of third quarter 1998's total revenues, were $1.1 million,
which is consistent with third quarter 1997. For the nine months ended September
30, 1998, software license fees were $2.5 million compared to $3.0 million in
the corresponding period in 1997. Software license fees decreased between 1997
and 1998 as there were four implementations of direct licenses occurring in 1997
for which the license fee was recognized on a percentage of completion basis
over the implementation period. These implementations were completed in the
fourth quarter of 1997. During 1998 there have not been any new in-house direct
license implementations occurring as new implementations of VFM are occurring
either in the S1 Data Center or through third party data processors. In
September 1998, S1 received $5.0 million in license fees from Royal Bank related
to technology and licensing agreements. These license fees have been recorded as
deferred revenue and are recognized as revenue using the subscription method
over a period of three years. Software license fees increased in the third
quarter of 1998 as compared to the second quarter of 1998 as a result of the
recognition of revenue from these agreements. In addition, software license
revenue increased between second and third quarter 1998 as a result of license
fees from third party data processors.
Direct costs associated with software licenses were $20 thousand for the
three months and $60 thousand for the nine months ended September 30, 1998
compared to $391 thousand for the three months and $1.4 million for the nine
months ended September 30, 1997. In 1997, the direct costs associated with
software license fees mainly consisted of the amortization of purchased
technology. Purchased technology included technology acquired in previous
acquisitions and software development costs paid to an independent contractor in
1995 and 1996. These costs have been amortized using the straight line method
over a period of 3 years, which is the amount representing the greater of the
amortization using the straight-line method or the ratio of current revenues to
total anticipated revenues. During the fourth quarter of 1997, SFNB wrote off
the remaining unamortized balance of goodwill and purchased technology
associated with acquisitions in 1996 after determining that there were minimal
future cash flows expected to be derived from these intangible assets.
Accordingly, direct costs for software license fees decreased in the third
quarter and year to date periods of 1998 as compared to the same periods for
1997.
Professional Services. Professional services revenues increased to $4.5
million in third quarter of 1998 from $1.7 million in third quarter 1997. For
the nine months ended September 30, 1998, professional services revenues
increased $6.0 million from $4.2 million to $10.2 million. The direct costs
associated with professional services, which are primarily personnel costs, were
$2.8 million in third quarter 1998, resulting in a gross margin $1.7 million or
38%, versus a gross margin in the third quarter 1997 of $504 thousand or 30%.
For the nine months ended September 30, 1998, direct costs for professional
services were $6.6 million, resulting in a gross margin of $3.6 million compared
to direct costs of $3.8 million and a gross margin of $412 thousand for the same
period in 1997. The increase in professional services revenues and
12
the improvement in the gross margin in 1998 as compared to 1997 can be
attributed to the elimination of fixed pricing established for S1's initial
implementation contracts for professional services. Under these arrangements, S1
was limited in the amount it could bill for professional services to a fixed
price contained in the contract. In addition, S1 experienced increased costs to
implement these financial services entities as a result of delays experienced in
the early implementations in integrating VBM with the customers' legacy
mainframe systems resulting in the accrual of losses related to these contracts
in early 1997. As S1 has gained more experience in implementing VFM, and because
S1 now prices its contracts based on time and materials, management anticipates
that the professional services' margin will remain comparable to that realized
in the third quarter of 1998. In addition, the increase in revenue for the three
and nine month periods ended September 30, 1998 is also attributed to pass
through costs related to implementations. As further discussed the section "Year
2000", S1 is in the process of converting all financial services entities to VBM
version 4.0. These conversions will require a significant portion of S1's
implementation resources. Management is currently evaluating the potential
impact on professional services margins due to the deployment of such resources
and the potential discounting of services related to these implementations.
Data Center. Data center revenues, which includes revenues for technical
support provided to financial services entities using VFM, increased to $927
thousand in third quarter 1998 from $122 thousand in third quarter 1997. Data
center revenues increased to $1.8 million for the nine months ended 1998
compared to $236 thousand for the nine months ended 1997. The average quarterly
revenue per billable customer increased to $14.75 in the third quarter 1998 from
$9.90 in the third quarter 1997. The increase in revenues is attributed to
minimums now set for data processing services and increased maintenance fees.
Management anticipates that the average quarterly revenue per billable customer
will decrease as financial services entities increase the number of their
customers using the product.
Direct costs of approximately $1.9 million were associated with data center
operations in third quarter 1998 resulting in a negative gross margin of $1.0
million. This compares to direct costs of $1.9 million and a negative gross
margin of $1.7 million in the third quarter 1997. For the nine months ended
September 30, 1998, direct costs associated with the data center were $5.6
million compared to $5.1 million for the nine months ended September 30, 1997.
The direct costs of the data center are attributable to establishing the basic
infrastructure (composed of personnel and equipment) needed to process accounts
for the growing financial services entity customer base. The established
capacity at September 30, 1998 should be adequate to meet the anticipated growth
in the number of entities using the data center for several quarters.
In an effort to reduce data center costs, the Company, which had previously
outsourced the operations of the data center, ended its data center facilities
management agreement. The Company anticipates it will experience cost savings of
approximately $200 thousand on a quarterly basis from both the elimination of
the cost plus arrangement and the ability to more efficiently utilize the
existing infrastructure. As a result of the termination of this agreement, two
financial institutions, which had a limited number of customers using the data
center,
13
elected not to reenter into data center contracts with S1. Since these
institutions were relatively inactive, management does not anticipate this to
have a significant impact on revenues.
During the month of September 1998, the data center processed, including
SFNB, in excess of 128,000 Internet banking accounts, representing approximately
77,000 customers. This represents an increase of 246% in the number of accounts
from approximately 37,000 and an increase of 175% in the number of customers
from approximately 28,000 for the month of September 1997. Based on current
costs, management anticipates that the data center will reach a break-even gross
margin when approximately 225,000 customers are processed on a monthly basis.
Revenues associated with the data center are directly influenced by the numbers
of financial services entities that are using VFM products through the S1 data
center and the product marketing efforts of these financial services entities.
Operating Expenses
Operating expenses increased to $6.9 million in third quarter 1998 from
$5.4 million in the third quarter 1997. The increase in operating expenses
occurred in product development costs which increased $1.0 million and general
and administrative expenses which increased $0.4 million.
Approximately $3.7 million of the third quarter 1998 operating expenses
related to product development costs as compared to $2.7 million in third
quarter 1997. The increase in product development costs is related primarily to
an increase in personnel expenses for additional product development
initiatives, including integration of Broadvision's One-to-One marketing suite
of software products and development of the next generation of the VFM suite of
products. The increase in product development costs represents management's
commitment to enhancing the current VFM products by migrating the existing
products to more efficient software architecture and to developing new VFM
applications, including the Virtual Investment Manager and Virtual Loan Manager
which were released in 1998.
General and administrative expenses increased from $1.0 million in the
third quarter of 1997 to $1.4 million in the third quarter of 1998. A portion of
the increase is attributable to charges related to the termination of the
facilities management agreement for the data center discussed above. The
remaining increase relates to the expanded personnel infrastructure to manage
the growth of the Company.
Selling and marketing expenses for the three and nine months ended
September 30, 1998 were consistent with the amounts for the three and nine
months ended September 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES
Total stockholders' equity decreased to $16.0 million as of September 30,
1998 from $23.5 million at December 31, 1997. The decrease in stockholders'
equity is primarily attributable to the $23.4 million net loss incurred during
1998. This decrease was partially offset by the issuance of 92,593 shares of
common stock to Royal Bank for $1 million
14
in March 1998, the issuance of 749,064 shares of preferred stock to State Farm
for $10.0 million on September 30, 1998, and the issuance of 181,610 shares of
common stock to Broadvision in exchange for a license to Broadvision's product.
As part of the Royal Bank transaction, the Company has issued to Royal Bank
four separate options to purchase up to an aggregate $10.0 million in capital
stock of the Company. The first option has a per share exercise price of $11.88
and expires at the end of December 1998. The second option has a per share
exercise price of $13.07 and expires at the end of June 1999. The third option
has a per share exercise price of $14.38 and expires at the end of December
1999. The fourth option has a per share exercise price of $15.81 and expires at
the end of June 2000. If exercised, the Company will issue 733,818 shares of
common and preferred stock over the 21 month option period
At September 30, 1998, the Company had $17.8 million in cash and $4.5
million in accounts receivable to fund future operations. For the nine months
ended September 30, 1998, the Company used $8.4 million in continuing operations
compared to $11.5 million in comparable period in 1997. During the quarter ended
September 30, 1998, the cash provided by continuing operations was $0.6 million
which included $6.0 million received from the sale of licenses to Royal Bank as
compared to cash used in operations of $4.0 million in the second quarter 1998.
The Company anticipates that cash used in operations will approximate $5.0
million in the fourth quarter 1998. Management believes that the Company has
adequate cash resources available to fund operations through 1999 at which time
the Company anticipates it will become cash flow positive from operations. If
additional capital is needed, the Company intends to continue to pursue capital
raising opportunities similar to the Strategic Tactical Advisory Relationship
partnership program through which it has raised capital in the past. S1 did not
have any material capital commitments at September 30, 1998, however S1 does
expect to make approximately $0.6 million in capital expenditures during the
remainder of 1998.
15
YEAR 2000
The Year 2000 issue relates to the use by many existing computer programs
of only two digits to identify a year in the date field. If not corrected, many
computer applications could fail or create erroneous results by or at the Year
2000. The Company recognizes the need to ensure that the potential Year 2000
software failures will not adversely impact its operations. A Company wide task
force, with representation from all major business units, was established in
1997 to evaluate and manage the risks, solutions and cost associated with
addressing this issue which affects both the internal computer systems as well
as the software applications that the Company licenses to customers. The task
force has identified all business systems, products and services, including
third party software used by S1 and in conjunction with VFM, and determining
whether they are Year 2000 compliant. In addition, the Company has developed and
is implementing plans of action for the systems and products which are not Year
2000 compliant. The Company believes that based on the assessments completed to
date, that critical Year 2000 issues can be corrected. The failure of the
Company or third party software which is used by S1 or in conjunction with VBM
to be Year 2000 compliant could have a material adverse impact on the Company's
financial position and results of operations.
Management has determined that its newest version of the VBM software,
which was released in 1998, is Year 2000 compliant. Complete "end to end"
testing is anticipated to occur as part of the VBM implementation process.
Accordingly, management anticipates that all financial services entity customers
will be converted to the new version by third quarter 1999. These conversions
will require a significant portion of S1's implementation resources. Management
is currently evaluating the potential impact on professional services margins
due to the deployment of resources and potential discounting of services related
to these implementations.
The costs incurred in addressing the Year 2000 problem are being expensed
as incurred in compliance with generally accepted accounting principles. None of
these costs are expected to materially impact the results of operations in any
one period. A significant portion of the costs to be incurred are not expected
to be incremental but rather are related to current development efforts.
FORWARD-LOOKING STATEMENTS
Statements in Management's Discussion and Analysis in the sections captioned
Results of Operations - Comparison of Three and Nine Months Ended September 30,
1998 and 1997, Liquidity and Capital Resources, and Year 2000 are
forward-looking statements within the meaning of the Securities Exchange Act of
1934, as amended. Actual results, performance or developments may differ
materially from those expressed or implied by such forward-looking statements as
a result of market uncertainties and other factors related to Internet-based
businesses. The market for Internet-based financial services has only recently
begun to develop and market acceptance of the Company's products and services is
uncertain. The market for the Company's products and services is characterized
by rapidly changing technology, evolving industry standards, emerging
competition and frequent new products and service introductions. Such
developments, as well as unforeseen developments in the Internet commerce
industry, could limit the marketability of the Company's products and services
and, thus, have an adverse impact on the Company's financial position and
results of operations.
16
PART II -- OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not applicable.
(b) Not applicable.
(c) On September 30, 1998, State Farm Mutual Automobile Insurance
Company purchased in a private placement 749,064 shares of the Company's Series
B Redeemable Convertible Preferred Stock for an aggregate purchase price of $10
million pursuant to the Stock Purchase Agreement, dated as of June 29, 1998, by
and among SFNB, the Company and State Farm. The offer and sale of the stock
satisfied the requirements of Section 4(2) of the Securities Act of 1933, as
amended (the "Securities Act") (transactions by an issuer not involving any
public offering).
(d) Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) At a meeting held on September 25, 1998, the Board of Directors of
SFNB, as sole shareholder of the Company, approved the Amended and Restated
Certificate of Incorporation of the Company.
(b) Not applicable.
(c) See (a) above.
(d) Not applicable.
17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit No. Description
27 Financial Data Schedule
(b) Not applicable.
18
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.
SECURITY FIRST TECHNOLOGIES CORPORATION
(Registrant)
Date: November 4, 1998 /s/ Robert F. Stockwell
------------------------------------
Robert F. Stockwell
Chief Financial Officer,
Treasurer and Secretary
(Principal Financial Officer and
Principal Accounting Officer)
19
EXHIBIT INDEX
Exhibit No. Description
27 Financial Data Schedule
20