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Form 10QSB for LION INC WA

17-May-2004

Quarterly Report

OVERVIEW

In December 2003, we completed a strategic acquisition that hasaccelerated our ability to deliver advanced business solutions to an expandeduniverse of larger, more diverse customers, and remain consistent with our focuson enhancing the Company's ability to attain its strategic objectives. Theseobjectives include solidifying a reputation as a preferred business partner inthe mortgage industry while generating sustainable growth in revenue andprofitability. LION's acquisition of substantially all of the assets of IgnitionMortgage Technology Solutions, Inc. ("Ignition") represented an opportunity toacquire compatible products that extend our customer base, add incrementaltechnology and intellectual property that would have required years ofdevelopment and tens of millions of dollars of investment for LION to generateorganically, and to assimilate a cadre of highly talented industryprofessionals.

The first quarter 2004 results were impacted significantly by thisacquisition and are summarized as follows:

CONDENSED RESULTS

                                      Three months ended                                           March 31,                                  --------------------------                                      2004           2003                                  -----------    -----------

Revenues                          $ 3,877,393    $ 1,786,720Operating expenses                  3,860,701      1,627,080                                  -----------    -----------    Operating income                   16,692        159,640Other expense - net                                       (3,260)        (3,937)                                  -----------    -----------                                       13,432        155,703Income tax expense                        509             --                                  -----------    -----------    Net income                    $    12,923    $   155,703                                  ===========    ===========

        Basic                     $        --    $        --                                  ===========    ===========        Diluted                   $        --    $        --                                  ===========    ===========

LION has been predominately a broker centric company. Due to theacquisition of Ignition assets, we have seen a shift to a more diversifiedcustomer base. The percent of revenue from lender customers has now increased to56% in the first quarter of 2004 compared to 15% in the same quarter in theprior year.

This increase is due primarily to the LockPoint Xtra(R) and Pipeline Toolsproduct lines. This revenue mix in the first quarter from lender and brokercustomers should be consistent throughout 2004.

LION's shift from a subscription based business model to a blend ofsubscription based and transaction based models continues to move forward. Thesubscription based model has performed well for LION in competitive markets withrising interest rates. The transaction based model allows LION to take advantageof higher loan origination volumes when interest rates are low. During the firstquarter of 2004, revenues from LION's transaction based model comprised 54% oftotal revenues compared to only 4% in the same quarter in the prior year. Wecurrently have no plan to achieve a certain percentage of our business astransaction based. Our intent is to have a blend of both models that will havescalability for the future.

During the first quarter, product releases and feature set upgrades werelaunched for all of our product lines; LION Pro Mortgage 101, Retail Websites,Lockpoint Xtra(R), and Pipeline Tools. There were also terminations ornon-renewals of two Pipeline Tools and one LockPoint Xtra(R) contracts that wereoffset by a strengthening of sales in all product lines during the latter halfof the quarter. This included a sale of each product for LockPoint Xtra(R) andPipeline Tools. The LockPoint Xtra(R) sale is intriguing as it will be LION'sfirst sale that combines the functionality of LockPoint Xtra(R) and RetailWebsite technologies and tools. This will begin our process of combining thestrength of the Ignition and LION product lines.

With the loss of two Pipeline Tools and one LockPoint Xtra(R) contractsin the first quarter, it is possible that revenue for the second quarter couldbe slightly less than first quarter. However, with strong sales in all productlines in the latter half of first quarter which have extended into the secondquarter, the new launches of product releases and feature set upgrades on allproducts, and the ongoing integration of the Ignition and LION products,management still anticipates a doubling of revenue for 2004 compared to 2003.

BACKGROUND ON PRODUCTS AND SERVICES

During 2004, LION will be assessing and integrating the product lines ofLION and Ignition so that it can better serve broader segments of the mortgageindustry. As various phases of the product integration are completed, we willbegin talking about our products and services differently. Currently, standalone products include LION Pro, Mortgage 101, Retail Web Sites, LockPointXtra(R), and Pipeline Tools. Any statistics or metrics noted below are as ofMarch 31, 2004.

LION PRO, used by over 7,500 mortgage brokers nationwide, consists ofLION Loan Search, LoanLink (subprime loan exchange platform), News Now(high-value market data) and Ratesheets on Demand (aggregated ratesheets). It ispackaged and often private labeled for both large companies and originationteams along with individual or small mortgage brokers. Through this passwordprotected product, originators can access one of the nation's largest databasesof wholesale mortgage rate, fee, and program information to instantly price anymortgage loan. This database is updated daily in 77 regions in the country.There are 128 participating lenders and nearly 133,000 regionalized loanprograms in the loan search database. Revenues from the LION Pro product lineare generated from mortgage brokers and originators subscribing to the service,origination teams private-labeling this service for their own companies, andfrom participating lenders.

MORTGAGE 101 is an interactive service provided through LION'swww.mortgage101.com consumer portal which connects potential mortgage applicantswith a network of mortgage lenders who offer mortgage programs, rates, andservices. Mortgage 101 also provides education to home buyers and

owners through informative articles, interactive calculators and real-time ratecomparison technology. This product is one of the leading sources of leads forreal estate financing by mortgage originators and is a preferred platform forthem to market to their customers. Through the Mortgage 101 brand, LION hasgrown its co-branded real estate sites to over 39,000 which consist of realtors,real estate offices, relocation sites, associations, and city portals. Trafficfrom these branded and co-branded sites along with search engine activityaverages over 400,000 unique visitors each month to this consumer portal.Revenues are generated from mortgage brokers or originators who participate inthe pay-per-lead program or advertise through the Mortgage 101 site.

RETAIL WEB SITES are offered to mortgage companies and individualoriginators to help educate consumers about mortgages, market their services toborrowers, generate more business, efficiently connect with service providers,and better serve their borrowers. This product is intended to create and fosterrelationships between consumers and mortgage originators while enabling mortgagecompanies and originators to more efficiently manage their online productionchannel and maximize the business value received from their online operations.Both template and custom design solutions deliver a combination of standard andcustom content to over 2,700 web sites and over 4,700 user accounts. Revenuesare generated from web site set up and monthly hosting fees along with fees forrelated functionality tools.

LOCKPOINT XTRA(R) ("LPX") is a Point-of-Sale and back office suite ofproducts that provide rate distribution, float registration, real-timerisk-based pricing and rate locking capabilities in a customer's website, loancenter or call center environment. The LockPoint Xtra(R) service is provided tolenders, investors and conduits that are LION licensees and gives them theability to maintain their product and pricing rules and expressions, and topublish risk-based lockable loan prices to their customer base via LPX clientapplications. Revenues are generated from initial implementation fees, recurringmonthly billings based on loan amount volumes with monthly minimums which mayvary from customer to customer, and custom development services.

PIPELINE TOOLS ("PT") is a complete risk management and pipeline trackingsystem. PT gives customers the tools necessary to manage interest rate risk aswell as fallout risk. PT tracks and examines current loan inventory, whichallows lenders to extrapolate and manipulate data to make more informed tradingdecisions. Typical users of PT include secondary marketing executives, traders,risk managers, price desks, and shipping managers. Revenues are generated frominitial implementation fees, recurring monthly billings based on loan amountvolumes with monthly minimums which may vary from customer to customer, andcustom development services.

DETAILED RESULTS OF OPERATIONS

REVENUES

                                         Three Months Ended March 31,                                         ----------------------------                                             2004            2003                                         ------------      ----------         REVENUES BY PRODUCT:         Lion Pro                        $    776,391      $  775,309         Mortgage 101                         547,766         512,505         Retail web sites                     598,744         498,906         LockPoint Xtra                       764,177              --         Pipeline Tools                     1,190,315              --                                         ------------      ----------

         Total revenues                  $  3,877,393      $1,786,720                                         ============      ==========

MORTGAGE 101 revenues, which are comprised of LION's subscription andpay-per-lead based lead programs along with broker ad banner programs, increasedapproximately $35,261 or 7% over the same quarter in the prior year. Thisincrease is lower than the trends LION saw during 2003 due to decreased loanvolumes that resulted from lower refinance volumes in late 2003 and early 2004.LION's shift to a pay-per-lead model in 2003 is the main reason this productline has been able to continue its growth trend. During the first quarter of2004, 53% of Mortgage 101 revenue was due to the transactional or pay-per-leadconcept whereas only 5% was transactional based in the same quarter in the prioryear. The Company will continue to be challenged to duplicate or exceed theMortgage 101 revenues in 2004 as industry loan origination volumes will probablydecline throughout 2004 as interest rates begin to climb. The refinement ofLION's pay-per-lead model will play an important role in meeting this challenge.

RETAIL WEB SITE revenues increased approximately $100,000 or 20% in thefirst quarter of 2004 compared to the same quarter in the prior year. TheCompany continues to successfully compete with this product line due to a suiteof professional web site products designed to provide comprehensive internetbased business solutions to mortgage companies of all sizes which feature bothtemplate based and customized design solutions.

LOCKPOINT XTRA(R) and PIPELINE TOOLS revenues are generated from initialimplementation fees with new customers, recurring monthly billings based on loanamount volumes with monthly minimums which may vary from customer to customer,and custom development services. Revenues are primarily transactional based andare contributing successfully to LION's move to a more diversified mix oftransactional based and subscription based revenues. The two productscontributed approximately $1,954,000 to the Company's revenue during the firstquarter of 2004.

OPERATING EXPENSES

                                          Three Months Ended March 31,                                          ---------------------------                                              2004            2003                                          -----------     -----------

       Direct costs                       $ 1,464,350     $   315,556       Selling and marketing                  496,579         573,468       General and administrative           1,165,150         539,653       Research and development               600,250          87,401       Depreciation and amortization          134,372         111,002                                          -----------     -----------

       Total operating expenses           $ 3,860,701     $ 1,627,080                                          ===========     ===========

Direct costs are comprised primarily of web site fulfillment, technologyinfrastructure support, product and contract support, productdeployment/onboarding, quality control, and salaries related to the dailyupdates to rates, fees, and other loan program information. Direct costsincreased to $1,464,350 from $315,556 for the three months ended March 31, 2004and 2003, respectively. This represents an increase of $1,148,794 or 364%.Direct costs as a percentage of revenues increased to 38% from 18% for the threemonths ended March 31, 2004 and 2003, respectively. Approximately 85% of theincrease is attributable to the added infrastructure related to the Ignitionasset purchase. LION now has two major data centers, one a primary and the othera redundant backup. In addition, the LockPoint Xtra(R) and Pipeline Toolsproducts require allocated resources to deliver and maintain the underlyingservice to customers. Compared to LION's other products, the LockPoint Xtra(R)and Pipeline Tools products require more time and resources to deploy before aservice is up and running. Once the infrastructure of LION and Ignition areintegrated by the end of the second quarter or early in the third quarter of2004, the Company should be able to reduce direct costs over the last half of2004.

SELLING AND MARKETING

Selling and marketing expenses are comprised of advertising and marketingcosts, sales salaries and related support costs. Selling and marketing expensesdecreased to $496,579 from $573,468 for the three months ended March 31, 2004and 2003, respectively. This represents a decrease of $76,889 or 13%. Theseexpenses as a percentage of revenues were 13% and 32% for the three months endedMarch 31, 2004 and 2003, respectively. The decrease is primarily due to theelimination of approximately $141,000 of sales, support and marketing effortsrelated to the two alliances that the Company was involved with during the firstpart of 2003 that were discontinued later in that year. This reduction wasoffset by an increase of approximately $64,000 of selling and marketing expensesdue to the positive efforts of LION's commissioned broker sales force and theaddition of seasoned sales personnel related to the Ignition asset acquisition.

GENERAL AND ADMINISTRATIVE

General and administrative expenses are comprised of management andadministrative salaries and related costs, legal and audit fees, outsideconsulting services, telecommunications expenses, occupancy costs, and otheradministrative related expenses. General and administrative expenses increasedto $1,165,150 from $539,653 for the three months ended March 31, 2004 and 2003,respectively. This represents an increase of $625,497 or 116%. General andadministrative expenses as a percentage of revenues were 30% for both of thefirst quarters of 2004 and 2003. Approximately 84% of this increase in expensewas directly related to the impact of the Ignition asset purchase. The increasewas due primarily to the addition of a new CEO and Co-President of operations inDecember 2003, one-time incentive bonuses to various management personnel due tothe successful completion of the Ignition asset purchase, various infrastructureintegration efforts, and legal and audit fees incurred during the first quarter.

RESEARCH AND DEVELOPMENT

Research and development expenses are comprised primarily of engineeringsalaries and related costs. Research and development expenses increased to$600,250 from $87,401 for the three months ended March 31, 2004 and 2003,respectively. This represents an increase of $512,849 or 587%. Research anddevelopment expenses as a percentage of revenues were 15% and 5% for the threemonths ended March 31, 2004 and 2003, respectively. Approximately 79% of thisincrease was attributable to research and development efforts on the LockPointXtra(R) and Pipeline Tools product lines. The remainder of the increase was dueto efforts in the LION Pro, Mortgage 101 and Retail Website product lines. TheCompany will continue to focus on various key initiatives including but notlimited to enhancing the conversion of consumer traffic into higher-value leadgeneration and developing new functionality to the retail web site and LION Prosuite of products. The LockPoint Xtra(R) and Pipeline Tools product lines havedefined and established research and development functions in the Company's GigHarbor, Washington and Sausalito, California locations. While the Companyanticipates a higher commitment to research and development in 2004 compared to2003 in order to support its product initiatives, it is also apparent that theunderlying resources need to be evaluated so that they are used in the mostefficient way for the individual product lines and also the integration ofvarious components of these product lines. Extensive concept, design andimplementation efforts will be necessary as the product lines of LION andIgnition are integrated in order to provide a seamless mortgage businesssolution to consumers, realtors, mortgage originators and lenders on a singleintegrated technology platform.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization expense increased to $134,372 from $111,002for the three months ended March 31, 2004 and 2003, respectively. Thisrepresents an increase of $23,370 or 21%. The increase is due to additionaldepreciation related to the purchase of equipment, computers and software alongwith the addition of internally developed software for internal use.

LIQUIDITY AND CAPITAL RESOURCES

The Company has financed its liquidity needs over the last several yearsthrough revenue generated from operations and equipment lease financing. Duringthe first quarter of 2004, the Company also received proceeds through theexercise of warrants and stock options. With the recent increase in theCompany's stock price, it is possible that additional proceeds could begenerated during the remainder of 2004 through the exercise of in-the-moneystock options.

At March 31, 2004, we had approximately $3,473,000 in cash and cashequivalents and working capital of approximately $3,106,000. The Company'sliquidity position has never been better. The change in cash and cashequivalents is as follows:

                                           Three Months Ended March 31,                                          -----------------------------                                              2003              2002                                          -----------       -----------       NET CASH PROVIDED BY (USED IN)       Operating activities               $   604,546       $   315,310       Investing activities                  (136,181)         (122,906)       Financing activities                   120,950           (10,716)                                          -----------       -----------

       Net increase                       $   589,315       $   181,688                                          ===========       ===========

During the three months ended March 31, 2004, operating activitiesprovided net cash of $604,546. The net cash provided by operating activities wasprimarily attributable to revenue growth, primarily from the Retail Websites,LockPoint Xtra(R) and Pipeline Tools product lines and payments on accountsreceivable, primarily from large accounts receivable balances acquired in theIgnition asset purchase, which were offset by a pay down of accrued liabilitiesrelated to legal, accounting and other fees associated with the acquisition ofIgnition assets.

INVESTING ACTIVITIES

During the three months ended March 31, 2004, investing activities usedcash of $136,181 and was primarily due to the capitalized portion of softwaredevelopment costs related to the enhancement of underlying infrastructuredelivering the LION Pro Corporate product line and upgrades to computer hardwareand software.

FINANCING ACTIVITIES

During the three months ended March 31, 2004, net proceeds from financingactivities were $120,950. Warrants and stock options were exercised during thequarter totaling approximately $141,000. This was offset by payments totalingapproximately $20,000 on notes payable and capitalized lease obligations relatedto the acquisition of application and database software, computers, servers,furniture and telecommunications systems upgrades over the previous two years.Due to the Company's present stock price and existence of many stock optionsthat are in-the-money, the exercise of stock options could continue to be sourceof funds throughout 2004.

COMMITMENTS AND CAPITAL EXPENDITURES

The Company has no material commitments for capital expenditures for2004. The acquisition of Ignition assets included two major datacenters inSunnyvale, California and Seattle, Washington, but equipment and software usedto operate the datacenters is up to date. During 2004, a replacement program ofthis equipment will be developed and during 2005 and 2006 will be implemented.

OVERALL LIQUIDITY AND CAPITAL RESOURCES

It is management's assessment that its liquidity and capital resourceneeds for its growth plans for 2004 and extending into 2005 will be adequatelymet through its working capital and cash flows from operations.

FACTORS THAT MAY AFFECT FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-QSB contains statements that areforward-looking. These statements are based on current expectations andassumptions that are subject to risks and uncertainties. All statements thatexpress expectations and projections with respect to future matters may beaffected by changes in the Company's strategic direction, as well asdevelopments beyond the Company's control. We cannot assure you that ourexpectations will necessarily come to pass. Actual results could differmaterially because of issues and uncertainties such as those listed below andelsewhere in this Report, and in the other documents we file with the SEC. Thesefactors, among others, may adversely impact and impair our business and shouldbe considered in evaluating our financial outlook.

WE HAVE A LIMITED HISTORY OF PROFITS AND OUR FUTURE PROFITABILITY REMAINS

UNCERTAIN. IN ADDITION, FINANCIAL RESULTS FOR ANY PARTICULAR PERIOD WILL NOT

PREDICT RESULTS FOR FUTURE PERIODS.

We are working toward a goal of revenue growth and sustainedprofitability. Annual revenues increased to $8.1 million from $6.4 million for2003 and 2002, respectively. Revenue increased to $3,877,393 for the firstquarter of 2004 compared to $2,646,692 for the prior quarter and $1,786,720 forthe first quarter of 2003. The Company anticipates strong growth in revenue in2004 compared to 2003. While we sustained a loss in 2002 totaling approximately$109,000, we have had seven consecutive quarters of profitability beginning thethird quarter of 2002 through the first quarter of 2004. Due to the acquisitionof most of the assets of Ignition in December 2003, the Company will be facedwith additional costs during the first six months of 2004 and perhaps longerwhile it integrates and streamlines its facility, telecommunications, datacenterand other infrastructure. Until this integration is complete, profitability willbe constrained.

Although we currently anticipate that 2004 will be a profitable year, ourprospects must be considered in light of the risks, expenses and difficultiesfrequently encountered by companies in new and rapidly evolving markets,including uncertainty of revenues, markets, profitability and the need to raisecapital to fund our ongoing operations. We cannot assure you that we will besuccessful in addressing these risks or that we can be operated profitably,which depends on many factors, including the success of our marketing program,control of expenses levels and the success of our business activities. Ourfuture operating results will depend on a variety of factors, including thosediscussed in the other factors set forth below.

WE ARE LARGELY DEPENDENT ON KEY PERSONNEL WHO MAY NOT CONTINUE TO WORK FOR US.

We are substantially dependent on the continued services of our keypersonnel, including our officers, engineers and other significant employees.These individuals have acquired specialized knowledge and skills with respect toLION. We are continuing to create the redundancies that will reduce the relianceon these individuals, but have not completed this task and will not for at leastthe remainder of 2004 if not longer. Furthermore, we have not entered intoemployment agreements with these significant employees except for our CEO,Co-President of Sales and Marketing, Co-President of Operations, CFO and theproduct manager for our Mortgage 101 product group. If any of these individualswere to leave LION unexpectedly, we could face substantial difficulty in hiringqualified successors and could experience a loss in productivity while any suchsuccessor obtains the necessary training and experience. We provide stockoptions, which currently serve to retain and motivate key employees as theybecome vested in their initial stock option grants. While management personnelare typically granted additional stock options, which will usually vest over aperiod of four years subsequent to their hire date to provide additionalincentive to remain at LION, the initial option grant is typically the largestand an employee may be more likely to leave

our employ upon completion of the vesting period for the initial option grant.We expect that we will need to attract, train, retain and motivate additionaltechnical, managerial, marketing and customer support personnel. Competition forthese personnel may be intense, particularly for individuals with suitableexperience. We face the risk that if we are unable to attract and integrate newpersonnel, or retain and motivate existing personnel, our business will beadversely affected.

WE ARE SUBSTANTIALLY DEPENDENT ON A LIMITED NUMBER OF SIGNIFICANT CUSTOMERS.

Our success depends on our ability to expand, retain and enhance ouradvanced business solution customers. Our expanded product line as a result ofthe acquisition of Ignition assets carries with it the risk that our revenuesmay be dependent on a limited number of significant customers, rather than abroad-based broker and customer network. As part of the acquisition, LION becamethe assignee of certain customer contracts, most of which have initial contractperiods or renewals expiring throughout 2004 and 2005 and typically haverenewable successive one-year terms and in a few cases successive two-yearterms. Revenues from these contracts are expected to comprise over 40% of theCompany's anticipated revenues in 2004. While we did have one LockPoint Xtracustomer and two Pipeline Tools customers discontinue their contracts with usduring the first quarter of 2004, we also had two new sales during the quarterfor one LockPoint Xtra and one Pipeline Tools. Revenue recognition from thesetwo new sales probably will not be reported until sometime during the thirdquarter. While we have no reason to believe the other large contracts will notbe renewed, there can be no assurance that these former Ignition customers willrenew their contracts with LION, or that we will be able to attract newcustomers at rates sufficient to maintain a stable or growing revenue base. Ifwe are unsuccessful in enrolling new customers to equalize the attrition rate,if any, of existing Ignition customers, our overall share of the advancedbusiness solution market could be reduced, and consequently our businessoperating results and financial condition may be materially adversely affected.

OUR OPERATIONS MAY BE VULNERABLE TO DISRUPTION PROBLEMS.

We do not have multiple site capacity for our LION Pro, Mortgage 101 orRetail Web Site services, however, we do have this in place for our LockPointXtra(R) and Pipeline Tools services. We are in the process of developingmultiple site capacity for all of our services, but this will not be completeduntil some time late in 2004. We have in place comprehensive data tape backupprocedures for our operational and administrative databases. Our replicationsoftware provides a high level of hardware backup for the database byduplicating our database across several powerful servers. However, despiteprotective measures, our operations could be vulnerable to damage from floods,fire, earthquakes, power loss, telecommunications failures, break-ins,terrorism, and similar events. The prospect of such unscheduled interruptions ispossible in the foreseeable future, and we are unable to predict theiroccurrence, duration or cessation.

Despite the implementation of security measures which are constantlyupdated, our systems may be vulnerable to unauthorized access, computer virusesand other disruptive problems. We could experience interruptions in service as aresult of the accidental or intentional actions of Internet users, current andformer employees or others. Unauthorized access might lead to interruptions,delays or cessation in service to subscribers or deter potential subscribers.Although we intend to constantly update industry-standard security measures,these measures have been circumvented in the past, and there can be no assurancethat measures we adopt will not be circumvented in the future. We do not carrysufficient business interruption insurance to compensate us for losses that mayoccur as a result of any of these events. Eliminating computer viruses andalleviating other security problems may require interruptions, delays orcessation of service to our subscribers, which could have a materially adverseaffect on our business, operating results and financial condition.

VOLUME OF SHARES ELIGIBLE FOR SALE COULD IMPAIR OUR STOCK PRICE AND HINDER

FUTURE FINANCING EFFORTS.

As of March 31, 2004, virtually all of the 33,735,228 outstanding sharesof common stock held by existing shareholders were currently eligible for resalein the open market, subject in certain cases to the volume and other conditionsof Rule 144. There are no contractual restrictions on the resale of theoutstanding common stock. The sale in the public market of these shares ofcommon stock, or the perception that these sales may occur, may depressprevailing market prices of the common stock or hinder potential futurefinancing efforts.

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