UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 1997
[ ] 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 0-28152
Affinity Technology Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
57-0991269
(I.R.S. Employer Identification No.)
1201 Main Street, Suite 2080
Columbia, SC 29201-3201
(Address of principal executive offices)
(Zip code)
(803) 758-2511
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.0001 per share
(Title of class)
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 [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant was approximately $16,136,102 as of March 17,
1998. For purposes of such calculation, shares of Common Stock held by persons
who hold more than 10% of the outstanding shares of Common Stock and shares held
by directors and officers of the Registrant and their immediate family members
have been included because such persons may be deemed to be affiliates. This
determination is not necessarily conclusive.
There were 30,155,673 shares of Registrant's Common Stock outstanding
as of March 17, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Registrant's proxy statement with respect to the 1998
Annual Meeting of Stockholders of the Registrant have been incorporated by
reference herein.
<PAGE>
Item 1 of this Form 10-K entitled "Business" and Item 7 of this Form
10-K entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Forward-looking statements are inherently uncertain and
actual results could differ materially from those expressed or implied by the
forward-looking statements. These forward-looking statements should be
considered in the context of the business risks set forth below in Item 1 of
this report under the caption "Business Risks."
Part I
Item 1 Business
General
The Company was formed to develop and market technologies that enable
financial institutions and other businesses to provide consumer financial
services electronically with reduced or no human intervention. For the period
from inception (January 12, 1994) through December 31, 1994, the Company was a
development stage company, and its activities principally related to developing
its Decision Support System/Real Time ("DeciSys/RT" Service Mark) (formerly
known as the DSS system) and the Affinity Automated Loan Machine ("ALM"
Registered Trademark), raising capital and recruiting personnel.
Prior to early 1997 the Company's primary products and services
consisted of the ALM system and a call center decisioning system which provided
financial institutions the ability to originate unsecured consumer loans with
little or no human intervention. During this period the Company's customers
primarily utilized the ALM delivery channel which captured origination
information for unsecured consumer loan applications and then routed this
information to DeciSys/RT for an automated decision.
Even though the Company believes the market for its products and
services are vast, in 1997 the Company continued to experience disappointing
revenue growth and an extremely lengthy sales cycle for its products. Average
consumer use of ALMs in service and average rates for loan approvals have been
lower than most customer expectations. While certain customers have deployed
their ALMs in a manner that has resulted in acceptable loan approval rates, the
Company believes that the economic viability of the ALM as an acceptable
alternative to traditional and new lending methods has not yet been established,
which has resulted in the termination of the Company's relationships with one
significant ALM customer, another potentially significant ALM customer and
certain other ALM customers. The terminations have not significantly affected
the Company's operating results.
During 1997 the Company continued its channel and product development
to enable the automated decisioning, processing and fulfillment of financial
product transactions by DeciSys/RT originating through not only ALMs, but also
other non-ALM channels, including call centers, branches, and automobile
dealerships. The Company's system includes inherent architecture that enables
integration of origination, processing and fulfillment across a wide range of
interface channels with the consumer. A significant new channel system developed
in 1997 is e-xpertLender ("e-xpertLender" Service Mark). e-xpertLender is the
Company's system that establishes connectivity among all of a financial
institution's delivery channels, its automated decisioning system, and its risk
management group. e-xpertLender also, upon approval, gives the consumer a choice
of closing methods that include branches, ALMs, mail, and third party closing
agents. The system enables call center agents and branch personnel to inquire as
to the status of applications anytime and electronically notifies loan officers
with respect to exceptions and the reason for referral. e-xpertLender replaced
the Company's call center decisioning system (Assets3) previously developed
under a joint venture agreement with Union Planters Corporation. The Company no
longer markets the Assets3 system. Additionally, the joint venture agreement was
terminated in 1997 (see Note 2 of "Notes to Consolidated Financial Statements -
Summary of Significant Accounting Policies - Minority Interest").
The Company's expanded product capabilities for the ALM or
e-xpertLender include auto loan vouchers, the ability to open checking accounts,
overdraft protection, the ability to apply for lines of credit and credit cards,
unsecured personal loans, direct and indirect auto loans, mortgages, and
insurance, as well as counter offers to applicants who qualify for a loan amount
higher or lower than the loan amount originally requested. Financial product
origination capabilities currently under development include home equity loans
and the ability to apply for home equity lines of credit.
Substantially all the Company's revenues to date have been derived from
fees charged for the installation of the Company's products and services, sales
and rental of ALMs and performance of professional services in conjunction with
the installation of the Company's technology. To a lesser extent, the Company
has derived recurring revenues from transactions processed through DeciSys/RT.
The Company's strategy is to generate a recurring revenue stream from
transaction fees while recovering its cost of assembling, installing and
maintaining products and services through revenue generated by set-up, ALM sales
and rental and other fees.
In May 1997 the Company acquired the assets of Buy American, Inc. and
Project Freedom, Inc. ("Buy American") for $300,000 in cash and 259,460 shares
of common stock, plus additional consideration of up to $6,000,000 (no less than
80% of which would be payable in stock) depending on the performance of the
business acquired during the five year period following the acquisition. The
principal assets purchased in conjunction with the acquisition consisted of
technology designed to originate automobile insurance policies through a kiosk
("the automobile insurance system") and a patent on the process utilized by the
automobile insurance system. Buy American was in an early stage of development
at the time of the acquisition, and the Company has continued development of the
automobile insurance system. The automobile insurance system is very similar to
the ALM System in its appearance, functions and interaction with consumers (see
Note 7 of "Notes to Consolidated Financial Statements - Acquisition").
Except for the loans originated through Surety Mortgage, Inc.
("Surety"), a wholly-owned subsidiary of the Company formed in January 1998, the
Company does not make or guarantee loans, does not receive any interest income
or other fees directly from borrowers and does not offer, endorse or guarantee
any other products or services offered by its financial institution customers
(see "Products and Services - Mortgage Brokerage Business"). Under the terms of
the contractual relationships with its customers, the Company is entitled to
payment without regard to whether consumer loans made through an ALM or
e-xpertLender are repaid.
Products and Services
The Company's DeciSys/RT system automates the processing and
consummation of financial products and services. Based on the Company's
proprietary object-oriented software, DeciSys/RT uses a multi-tiered
client/server architecture to provide a stable, scalable platform capable of
processing large numbers of transactions in a reliable, efficient and timely
fashion. DeciSys/RT can simultaneously interact with consumers to capture
personal information (such as through touch-screen terminals) and with third
parties (such as credit bureaus) that supply additional information necessary to
consummate the transaction efficiently. A central server located at the
Company's Network Operations Center ("NOC") coordinates the flow and analysis of
information and evaluates, based on each customer's underwriting model, whether
and on what terms the transaction can be consummated.
The Company has focused its product development efforts on exploiting
its DeciSys/RT technology to enhance transaction origination, processing and
fulfillment systems. The Company believes its DeciSys/RT technology is useful to
businesses, such as consumer lending institutions, engaged in transactions that
require collecting information from consumers and third parties, analyzing such
information and providing transaction fulfillment. For such transactions, the
channel integration in conjunction with the speed and efficiency of
DeciSys/RT-based systems have the potential to offer significant advantages when
compared to more labor intensive and less technically advanced origination,
processing and fulfillment systems.
The Affinity ALM
General. The ALM and DeciSys/RT (together, the "ALM System") fully
automate the consumer lending process, enabling consumers to apply for and, if
approved, receive a personal loan (including loan documentation and proceeds) in
as little as 10 minutes without involving loan officers, customer service
representatives or other lending personnel. Similar in appearance to an
automated teller machine ("ATM"), the ALM is a fully automated system that
utilizes the Company's proprietary DeciSys/RT technology to process certain
financial service transactions, generate the underlying documentation and
distribute proceeds from loan transactions. The Company believes the deployment
of ALMs in retail centers, the workplace, leisure and travel destinations and
other non-traditional banking locations will enable the Company's customers to
reduce their costs of processing certain consumer financial service transactions
and maintain or increase their revenues and assets. The Company also believes
its customers can use the ALM as a substitute for traditional branch-based
consumer transactions, which involves significant personnel costs and typically
takes substantially more time to complete.
Design and Features. The ALM looks and interacts with consumers much
like an ATM and can be operated as a free standing kiosk. The Company's existing
customers have located ALMs in traditional branch offices, malls, retail stores
and other retail environments.
The ALM System contains a magnetic strip card reader used to identify
loan applicants by credit card, charge card, or debit card, a personal
identification number ("PIN") pad which can be used in conjunction with the
magnetic strip card reader to capture PIN codes used by debit and ATM cards as
an alternative or additional method to identify loan applicants, a touch-screen
monitor used to elicit information from applications, a magnetic pen and
signature capture unit used to electronically execute loan documents, a magnetic
ink character reference ("MICR") reader used to verify savings and checking
account information, a digital camera system used to photograph applicants as
they sign loan documents, video cameras used to take pictures at intervals
during all hours of ALM operations, a laser printer used to print loan documents
and checks on site and a modem connecting the ALM to the Company's NOC. The
software supporting each ALM System is modified by the Company to meet the
marketing and underwriting requirements of each financial institution customer.
The ALM Systems in service during 1995, 1996 and early 1997 primarily
permitted consumers to apply for and receive unsecured consumer loans in
amounts, and on terms and conditions, specified by the particular ALM sponsor.
Also during this period the Company continued to develop additional financial
products which could be originated at an ALM and processed through DeciSys/RT.
The products and services currently available through an ALM System include auto
loan vouchers, the ability to open checking accounts, overdraft protection, the
ability to apply for lines of credit and credit cards, unsecured personal loans,
direct and indirect auto loans, mortgages, and insurance. The ALM system can
also make counter offers to applicants who qualify for a loan amount higher or
lower than the loan amount originally requested. The ALM System also has the
ability to cross-sell other products and services offered by the institution
during the time the applicant is waiting for a decision on a loan application.
Financial product origination capabilities currently under development include
home equity loans and the ability to apply for home equity lines of credit. In
addition, financial product fulfillment capabilities using the ALM as a
fulfillment device are available for all of the Company's products offered using
DeciSys/RT. The Company's developmental activities are subject to the risks
inherent in the development of new products and applications, including the
development of unforeseen design or engineering problems. See "Business Risks -
Early Stage Products and Services."
Fraud Detection. The ALM System employs a number of methods intended to
detect and prevent fraudulent loan applications, some of which are standard for
all ALMs and some of which are customized to fit each customer's underwriting
model and specifications. Certain information, such as credit card data, is
verified by contacting third-party verification services. In addition, the
DeciSys/RT system contains fraud analysis software that evaluates
consumer-supplied data, such as social security numbers and addresses, against a
number of format and consistency tests. Moreover, additional fraud analysis is
performed through the use of on-line fraud detection service providers. As a
further deterrent, each ALM imprints a digital photograph of the loan applicant
on all checks and other loan documents generated in a transaction. The Company
periodically refines its fraud detection programs to include other forms of data
verification to aid in the identification of fraud. Although the Company is
unaware of any significant instances of fraud in connection with loans
consummated through the use of ALMs, the rate of fraudulent activity could
increase. See "Business Risks - Risk of Fraud in Consumer Lending."
Deployment. The Company currently is able to design, assemble and
install an ALM System for a new customer in 45 to 90 days from the time an order
is accepted. The Company generally is able to assemble and install additional
ALMs for a customer's existing ALM System in approximately 45 days.
The Company subcontracts with unaffiliated third parties to construct
the ALM enclosure, assemble certain ALM components and provide periodic
maintenance for ALMs placed in service. Otherwise, all aspects of assembly and
installation, including purchasing of components, ALM final testing and
transportation, currently are performed by employees of the Company. Once the
systems have been designed and assembled, the Company tests the operational
readiness of each ALM. During this stage, customers are required to review the
appearance of the ALM and to run test transactions in order to check adherence
to the customer's underwriting model. Prior to installation, each customer must
certify in writing that its ALM System meets its lending and other standards.
After an initial order is received, the Company consults with the
customer to prepare any necessary specialized software applications and loan
documentation and to design the exterior graphics of the ALM and the computer
screens. The Company works closely with its customers to develop the program
design and consumer interface and assists its customers in complying with
regulatory requirements by providing, among other things, forms prepared by a
third-party provider of standardized documents for financial services. The
Company, through its demographic and underwriting consulting staff, periodically
consults with its customers regarding ALM performance.
The Company has established relationships with vendors of the hardware
components of the ALM. The Company purchases ALM components as needed to meet
firm and expected orders. The Company believes that all ALM components are
available from a wide variety of sources.
The Company generally is not obligated to retrofit ALMs in service with
new hardware, software or other product enhancements. However, the Company
believes that it is often advantageous to do so in order to reduce costs
associated with maintaining multiple production versions in service.
Accordingly, the Company's ALM agreements generally require ALM customers to
accept enhancements and generally require those who do not desire to accept
operational upgrades to ALMs in service to pay a special maintenance fee. Due to
cost savings often associated with upgrades and the Company's goal of expanding
consumer acceptance and usage of ALMs, the Company historically has upgraded
ALMs in service. The net costs of such upgrades have not been significant to
date and are not expected to be material in the future. With respect to product
enhancements allowing ALMs to offer new products, the Company may charge
additional fees to incorporate such products into ALMs in service.
e-xpertLender
During 1997, the Company developed its e-xpertLender System
("e-xpertLender"), which enables automated decisioning and processing of certain
financial products by DeciSys/RT through ALMs and other non-ALM channels,
including call centers, branches, and automobile dealerships. e-xpertLender
establishes connectivity among all of a financial institution's delivery
channels, its automated decisioning system, and its risk management group. The
system enables call center agents and branch personnel to inquire as to the
status of any transaction anytime and for loan transactions electronically
notifies loan officers with respect to any exceptions and the reason for
referral. e-xpertLender supports the ability to open, process and track through
closing checking accounts, overdraft protection, the ability to apply for lines
of credit and credit cards, unsecured personal loans, direct and indirect auto
loans and home equity loans and lines of credit. Using the e-xpertLender inquiry
capabilities, a lender can review online the status of a transaction and, when
appropriate, make counter offers to applicants who qualify for a loan amount
higher or lower than the loan amount originally requested. e-xpertLender also,
upon approval, gives the consumer a choice of closing methods that includes
branches, ALMs, mail and third party closing agents. The Company is currently
enhancing e-xpertLender so the products and services currently available through
the ALM and DeciSys/RT will also be available through other channels including
call centers, branches, the Internet, and automobile dealerships. The Company
currently has one customer utilizing its e-xpertLender system.
In addition to the origination capabilities enabled by e-xpertLender,
the Company has developed interfaces with other existing third-party origination
channels used by potential and current clients. Inherent in the Company's
channel architecture is the ability of the technology to integrate channels
through the exchange of message sets or an Application Program Interface
("API"). The ability of the Company's technology to exchange information,
whether it is between the Company's channels or other third-party channels,
allows integration of transaction origination, processing and fulfillment
activities across a wide range of channels with the consumer.
Deployment. Upon an order of e-xpertLender, the Company enters into a
contract with the customer pursuant to which the customer is granted a
non-exclusive license to use certain software supporting the system. The Company
is responsible for the installation of the e-xpertLender software and
integration of the system with DeciSys/RT. The Company currently has only one
customer utilizing e-xpertLender system and such system has been deployed in
phases as the functionality of the system has been developed and completed
components accepted by the customer. The Company believes e-xpertLender system
for a new customer can be installed in 60 to 90 days from the time an order is
accepted. However, due to the limited history of e-xpertLender installations and
the nature of the initial installation process, no assurance can be given that
the Company will be able to meet installation estimates contemplated by the
Company.
Revenues - ALMs and e-xpertLender
Revenue Sources. The Company derives both recurring and one-time
revenues from the ALM and e-xpertLender systems as described below.
Transaction, Software and Hardware Maintenance Fees. Upon order of an
ALM and/or e-xpertLender the Company enters into an agreement with the customer
pursuant to which the customer agrees to pay a transaction fee for each
application and each loan transaction consummated based on a percentage of the
principal amount of the loan on a completed unit basis. The amount of such
transaction fees will depend on a variety of factors, including the type of loan
and the number of ALMs and e-xpertLender workstations operated by the particular
customer. During 1997, the Company revised the ALS Agreement, so that the
customer agrees to pay monthly ALM hardware maintenance fees and software
maintenance fees associated with the software supporting the system.
Set-Up Fees. The Company's agreements provide for the payment of set-up
fees to cover the installation of the ALM hardware and system software and/or
the e-xpertLender system as well as the non-exclusive right to use the software,
both of which are generally determined based on the number of ALMs and
e-xpertLender workstations operated by the customer. Generally, such fees are
paid by customers when the systems are ordered. Set-up fees are initially
recorded as deferred revenue. Upon acceptance of an ALM and/or e-xpertLender
system, the Company generally recognizes as revenue (i) the portion of such
set-up fee associated with the installation in an amount approximately equal to
the cost of set-up and installation, and (ii) an additional component of the
set-up fees related to non-refundable license fees. The remainder of such set-up
fees is recognized as deferred revenue and amortized ratably over the term of
the agreement. Certain of the Company's ALS Agreements entered into during 1995
and 1996 provide that the customer may apply a portion of the initial set-up fee
to future transaction and other fees. The Company capitalizes the unearned
portion of such set-up fee as deferred revenue, which is amortized ratably as
revenue over the term of the related agreement.
ALM Sales and Rental Fees. The Company enters into a lease agreement
with its customers under which the customer agrees to pay a monthly rental fee
for the hardware components of the ALM. The amount of the rental fee typically
is based on the number of ALMs operated by the customer, and the rental term
generally is 48 months. The Company recognizes revenue associated with ALM
leases pursuant to Statement of Financial Accounting Standards No. 13 ("SFAS
13"), "Accounting for Leases." Under SFAS 13, the Company's ALMs are either
sales-type or operating leases. If the ALMs meet the criteria for sales-type
leases under SFAS 13, the present value of the future minimum lease payments is
recognized as sales revenue in the period in which the sale occurs. Rental
revenue associated with operating leases is recognized as rental revenue over
the term of the ALM lease.
Professional Services Fees. In conjunction with the installation of the
Company's technology, additional customer-specific technology development is
performed from time to time by the Company. The Company generally enters into a
contract with the customer for the performance of these services. Upon
completion of its contractual obligations and acceptance of professional
services by the customer, the Company generally recognizes the corresponding
revenue associated with such services.
Integrated Performance Management Services. In conjunction with the
installation of an ALM and e-xpertLender system, the Company may agree to
perform services designed to refine the system to aid in targeting customer
market initiatives. These services include ALM site selection and evaluation,
integration and evaluation of current processing capabilities, focus group
results and marketing research studies, education, incentive training and
marketing and promotional services. The Company generally enters into a contract
with the customer for the performance of these services, and upon completion of
its contractual obligations, the Company generally recognizes the corresponding
revenue associated with these services.
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Mortgage Brokerage Business
In January 1998 the Company formed Surety to engage in activities
incidental to the mortgage brokerage business, including marketing, originating,
closing and selling mortgage loans to permanent investors. Surety offers first
mortgage loans directly to consumers and immediately sells such loans to
wholesale mortgage bankers ("wholesalers") that sponsor the loan programs
offered by Surety. Surety only offers consumers loans that will be acquired by
wholesalers under such programs. Moreover, upon making loan commitments to
consumers, Surety immediately receives a commitment from a wholesaler to acquire
the loan upon closing, thereby reducing the risk of loss. Prior to the time a
loan is closed, the loan is submitted to a wholesaler for underwriting.
Accordingly, when the loans are closed they are immediately transferred to a
wholesaler, thereby minimizing any credit risk associated with lending
activities.
The Company formed Surety for the primary purpose of directly deploying
technology developed by the Company (primarily ALMs) in a manner in which the
Company believes will facilitate future deployment of its mortgage loan
products. Surety's mission is to find the best deployment locations and develop
deployment and business strategies which provide actual market data that can be
used to market the Company's mortgage loan products to the Company's prospective
customers. The Company believes that the formation of Surety will provide a cost
effective means to gather and test market data which may shorten the lengthy
sales cycle often encountered by the Company. See "Business Risks - Lengthy
Sales Cycle."
Surety will earn revenues from fees charged to consumers for the
origination services it performs and from premiums on loan sales paid by the
wholesaler. Revenues from interest associated with such loans is not expected to
be significant since Surety does not contemplate holding any loans for any
significant period of time prior to the sale of the loan.
Second Look Program
The Company has developed a program (the "Second Look" program) to
provide a means through which loan applications that are rejected by the primary
ALM sponsor can be reviewed and funded at the ALM by one or more secondary
lenders during a single application process. The Second Look program is designed
to enable the ALM System to serve two traditionally distinct consumer finance
markets: the "prime" market, consisting of consumers with more attractive credit
profiles who are often served by banks, and the "sub-prime" market, consisting
of consumers with less attractive credit profiles who are more likely to be
served by consumer finance companies. Under the Second Look program, a consumer
applying for a loan through an ALM would first be considered by the institution
that operates the ALM. If the consumer does not meet the primary institution's
lending requirements, he or she may be considered by one or more secondary
lenders serving the sub-prime market. If the consumer qualifies for a loan from
a secondary lender, the loan could be consummated at the ALM. In such event, the
primary ALM sponsor would receive a fee, the secondary lender would book the
loan and the consumer would obtain the loan from the secondary lender. The
Company believes that the Second Look function can be performed without adding
significant time to the application process. Under the Second Look program, if
such program is successfully implemented, the Company would enter agreements
with second look lenders whereby the Company would earn transaction fees for
loans processed. The Company would receive a transaction fee equal to a
percentage of the aggregate principal amount of all loans funded through the
Second Look program.
Certain regulatory issues, including in particular, state and federal
regulation of consumer finance companies as well as the underperformance of ALMs
in relation to current and prospective customer expectations, have prevented the
Company from implementing the Second Look program. No assurance can be given
that the Company will ever earn any revenues from its Second Look program. See
"Business Risks - Governmental Regulation" and "Uncertainties of Future
Regulation-Unproven Market, Unproven Acceptance of the Company's Products and
Services."
Sales and Marketing
The Company has concentrated its sales and marketing resources on
participation in well-recognized and widely attended industry trade shows and
regional presentations at which attendees are offered the opportunity to
participate in a live and interactive demonstration of the ALM, e-xpertLender,
DeciSys/RT and corresponding processing capabilities of the Company's financial
products and services. The Company also utilizes direct mailing of literature
and videos, advertisements in trade magazines and other targeted materials. The
Company has an internal marketing group that coordinates the marketing of the
Company's technology and its products and services nationwide through customer
meetings, trade shows and the use of public relations firms and advertising
agencies. Additionally, this group has designed marketing support materials for
use by the Company's customers to educate their personnel and assist in
educating consumers and creating product awareness. The Company has also
developed and administers incentive-based transaction improvement programs.
The Company's marketing group has established an in-house demographic
and underwriting consulting staff to consult with existing and prospective
customers to identify suitable locations for ALMs and refine underwriting models
to achieve desired rates of return and risk tolerance, through market and
process research. The Company also provides after-sale support to its customers
with respect to improving the performance of ALM operations.
The Company's direct sales force is functionally segregated to target
five distinct industry groups: large regional commercial banks, savings banks,
credit unions, mortgage banks and other financial service providers. To leverage
the Company's direct marketing group and sales force, the Company has entered
into strategic alliances with certain vendors that presently service the
technology needs of financial institutions and other potential customers of the
Company. Such vendors sell products or services that are complementary to the
ALM, e-xpertLender and/or the DeciSys/RT system and have established sales
organizations which have formed existing relationships with potential customers
of the Company. Under such agreements, such vendors will receive a commission
for their sales efforts. The Company also has entered into an agreement with a
certain hardware vendor, under which such vendor will market and sell kiosks
that contain and access the software applications developed by the Company in a
manner comparable to the Company's ALM. Under such agreements, such vendor is
able to manufacture and sell their own kiosks, directly interact with customers
with respect to ALM and e-xpertLender design, certification and implementation
and receive a portion of the transaction fees generated by system usage.
Competition
The market for products and services that enable electronic commerce is
highly competitive and is subject to rapid innovation and technological change,
shifting consumer preferences, frequent new product introductions and
competition from traditional products and services having all or some of the
same features as products and services enabling electronic commerce. Competitors
in this market have frequently taken different strategic approaches and have
launched substantially different products or services in order to exploit the
same perceived market opportunity. Until the market actually validates a
strategy through widespread acceptance of a product or service, it is difficult
to identify all current or potential market participants or gauge their relative
competitive position. There can be no assurance that the ALM, e-xpertLender, or
DeciSys/RT will be competitive technologically or otherwise, or that any other
products and services currently available or developed by the Company will be
competitive technologically or otherwise. The ability of the Company to compete
in the market will depend upon, among other things, broad acceptance of the
Company's products and services and on the Company's ability to continually
improve and expand the ALM, e-xpertLender, DeciSys/RT and other products and
services the Company may develop to meet changing customer requirements.
Electronic commerce technologies in general, including the ALM and
e-xpertLender, compete with traditional consumer lending methods, including
in-person loan applications at branch offices of financial institutions and cash
advances on credit cards, home equity lines of credit and other revolving credit
facilities, some or all of which are employed by the Company's existing and
potential customers. The ability of the ALM, e-xpertLender and DeciSys/RT and of
any other electronic commerce products and services the Company currently offers
or may develop to compete with traditional lending methods will be dependent in
part on consumer acceptance of electronic commerce in general and industry
acceptance of the Company's products and services in particular.
The Company also faces competition from companies engaged in the
business of producing automated lending systems and other alternatives to
conventional consumer lending, including software and data processing companies
and technology and service companies. In particular, the Company is aware of
several companies, including Dyad Corporation ("Dyad"), that have developed
video and other kiosk technology for the delivery of financial services. In
addition, the Company is aware of certain companies that have designed and are
marketing software that enables loan applications to be taken over the
telephone. The Company also is aware that many banks have begun using on-line
services, such as America-On-Line, Inc. ("America-On-Line"), CompuServe, Inc.
("CompuServe") and Prodigy Services Co. ("Prodigy"), to provide certain
financial services electronically, and is aware of several companies that have
already made substantial investments in software products that enable various
other home banking services, including International Business Machines
Corporation ("IBM"), Microsoft Corp. ("Microsoft"), Intuit Inc. ("Intuit") and
Meca Software, Inc. ("Meca"). Further, the Company understands that ULTRADATA
Corporation ("ULTRADATA") has developed certain on-line processing systems for
the credit union market that may be in direct competition with the Company's
products and services. The Company will also compete with Credit Management
Solutions, Inc. ("CMSI") in connection with its e-xpertLender based automobile
loan system. See "Business Risks Competition, Future Price Erosion."
The Company expects competition to increase in the future from existing
and new competitors that produce automated loan systems and other alternatives
to traditional consumer lending methods. Such competitors may include actual or
potential customers of the Company that may develop competitive technology
internally. Most of the Company's current and potential competitors in the
market for its products have substantially greater financial, marketing and
technical resources than the Company. Accordingly, the Company may not be able
to compete successfully against new or existing competitors. Furthermore,
competition may reduce the prices the Company is able to charge for its products
and services, thereby potentially lowering revenues and margins, which would
have a material adverse effect on the Company's business, operating results and
financial condition. See "Business Risks - Rapid Technological Changes" and " -
Competition; Future Price Erosion."
Technology
The DeciSys/RT system employs a multi-tiered client/server architecture
that integrates the consumer interface, application analysis function and
multiple data sources together in a seamless operating environment. The
DeciSys/RT architecture enables true multi-tasking, which permits an expedient
loan decision. The DeciSys/RT uses standard C++ code and object-oriented
programming which permits the decoupling of functional development from system
deployment, greatly reducing the time and cost of maintenance. The Company
anticipates easy platform portability by using standards such as the TCP/IP
communications protocol and C++ programming language, while maintaining
compatibility with widely accepted third-party database programs and operating
systems.
The Company's NOC, located in Columbia, South Carolina, connects to the
various ALMs and e-xpertLender workstations in service through a private
network. The NOC is connected to the network via dedicated 56.6 Kbps lines
(upgradable to T-1) while the ALMs use dial-up connections and e-xpertLender
systems utilize T-1 or dial-up connectivity. The Company also maintains leased
line connections to TRW Inc., Trans Union Corporation, Equifax Inc. and other
providers of information for validation of a consumer's identity and loan
underwriting. The combination of data-encryption techniques and the closed loop
nature of the system provide for a secure environment.
The Company's operations are dependent on its ability to protect its
central computer system against damage from fire, earthquake, power loss,
telecommunications failure or similar events. All of the Company's computer
equipment constituting its central computer system, including its processing
operations, is located at the Company's NOC in Columbia, South Carolina. The
Company has adopted a formal disaster recovery plan and has contracted with a
major disaster recovery company for back-up, off-site processing systems capable
of supporting its DeciSys/RT operations in the event of system and other
failure.
Intellectual Property
The Company has applied with the United States Patent and Trademark
Office ("PTO") for patents to protect the closed loop lending system utilized
by, and the other essential features of, the ALM System. Such applications and
all amendments thereto to date have been rejected by the PTO. The Company
nevertheless intends to continue prosecution of its applications and, if
necessary, appeal the PTO's rejection of such patent applications. "Affinity,"
"DeciSys/RT," and "e-xpertLender" are registered service marks and "ALM" and
"More Assets, Less Infrastructure" are registered trademarks of the Company.
During 1997, the Company acquired the assets of Buy American, which
includes a patent covering the processing of insurance products automatically
through a kiosk.
The Company's success and ability to compete is heavily dependent upon
its proprietary technology. The Company also relies on trade secret and
copyright law and employee, customer and business partner confidentiality
agreements to protect its technology. However, the Company believes that factors
such as technological and creative skills of its personnel, new product
developments, frequent product enhancements, name recognition and reliable
product maintenance are essential to establishing and maintaining a
state-of-the-art technological system. There can be no assurance that the
Company will be able to protect its technology from disclosure or that others
will not develop technologies that are similar or superior to the Company's
technology. See "Business Risks - Limited Protection of Technology."
Research and Development
The Company's software and financial product origination development
activities include home equity loans and the ability to apply for home equity
lines of credit and the enhancement of the technological capabilities associated
with the current products and services available through the ALM, e-xpertLender,
and DeciSys/RT.
The Company's ability to attract and retain highly skilled research and
development personnel is important to the Company's success. During 1997 and
1996, the Company spent approximately $3,526,257 and $2,905,232, respectively,
on research and development activities or approximately 85.0% and 57.2% of 1997
and 1996 revenues, respectively. The Company anticipates that it will continue
to commit substantial resources to research and development activities for the
future.
Government Regulation
The financial services industry is subject to extensive and complex
federal and state regulation. The Company's current and prospective customers,
which consist of state and federally chartered banks, savings and loans, credit
unions, consumer finance companies and other consumer lenders, as well as
customers in the insurance industry that the Company may target in the future,
operate in markets that are subject to extensive and complex federal and state
banking and insurance regulation. The Company's products and services must be
designed to work within the regulatory environment in which its customers
operate.
Federal and state laws and regulations also regulate the lending
practices of financial institutions. These laws include federal and state
truth-in-lending disclosure rules, state usury laws, the Equal Credit
Opportunity Act, which prohibits discrimination in lending practices, the
Electronic Funds Transfer Act, which regulates electronic funds transfers, the
Fair Credit Reports Act, which regulates access to and use of credit records
maintained by credit bureaus, and the Community Reinvestment Act, which requires
financial institutions to serve the credit needs of the entire community in
which they operate, including low and middle income neighborhoods. While these
regulations must be taken into account in the design of the Company's products
and services, the Company itself is not directly subject to these regulations
and the Company's standard ALS Agreement with its customers provides that the
customer will be responsible for compliance with these laws.
Some consumer groups have expressed concern regarding the privacy and
security of ALMs and whether electronic lending is a desirable technological
development in light of the current level of consumer debt. While the Company
believes these concerns are unfounded, it is possible that consumer groups or
others could take actions to cause one or more states eventually to promulgate
specific regulations applicable to the deployment and operation of ALMs. The
Company cannot predict, however, when such regulations might be implemented, if
ever, or the effects of any such regulation on the Company's business, operating
results or financial condition. See "Business Risks - Government Regulation and
Uncertainties of Future Regulation."
<PAGE>
Employees
At December 31, 1997, the Company employed approximately 152 full-time
employees and 1 part-time employee. The Company has no collective bargaining
agreements.
Backlog
At March 31, 1998, the Company had contracts for professional services,
technology set-up and delivery of other product software, under which the
Company is obligated to perform services that will result in approximately $1.9
million of revenues. At March 31, 1997, the Company had contracts for the
delivery of products and services with revenues of approximately $1.3 million.
Business Risks
In addition to the other information in this report, readers should
carefully consider the following important factors, among others, that in some
cases have affected, and in the future could affect, the Company's actual
results and could cause the Company's actual consolidated results of operations
to differ materially from those expressed in any forward looking statements made
by, or on behalf of, the Company.
Limited Operating History; Significant Losses; Accumulated Deficit;
Future Losses
The Company was incorporated in January of 1994 and placed its first
ALM in service in January 1995. Accordingly, the Company has a limited operating
history upon which an evaluation of the Company and its prospects can be based.
To date, the Company has generated minimal operating revenues, has incurred
significant losses and has experienced substantial negative cash flow from
operations. The Company had an accumulated deficit as of December 31, 1997 of
$28,105,547, with operating losses of $705,971 for the period from inception
(January 12, 1994) through December 31, 1994, and $2,308,029, $9,692,195 and
$15,399,352 for the years ended December 31, 1995, 1996 and 1997, respectively.
The Company expects to incur substantial additional costs to complete its
products and services in development, to enhance and market the ALM,
e-xpertLender and DeciSys/RT and to complete any new products and services that
may be developed by the Company. There can be no assurance that the Company will
ever achieve profitability or, if achieved, sustain such profitability.
The Company's prospects must be considered in light of the risks,
expenses, and difficulties frequently encountered by companies in their early
stage of development, particularly technology based companies operating in
unproven markets with unproven products. To address these risks, the Company
must, among other things, respond to competitive developments, attract and
motivate qualified personnel, establish effective distribution channels,
effectively manage any growth that may occur and continue to upgrade its
technologies and successfully commercialize products and services incorporating
such technologies.
Potential for Fluctuation in Quarterly Results
Because the Company has a limited operating history, management has
very little data upon which to base estimated operating revenues and expenses.
In addition, the Company has rapidly expanded its technology, installation,
sales and marketing and other resources in order to support its growth
objectives. The levels of these expenditures, which are to a large extent fixed,
are based in part on the Company's goals as to its future revenues. The
Company's revenues are affected by many factors, including demand for the
Company's technology and demand for any additional products or services
developed by the Company, introduction and enhancement of products and services
by the Company and its competitors, market acceptance of such technology in
existence or developed in the future, mix of distribution channels through which
products are sold and general economic conditions (particularly those conditions
affecting financial products and services supply and demand). Further, the
Company's current customer base is highly concentrated and such concentration
may have a significant effect on revenues due to the uncertainty of new and
additional sales of the Company's technology. See "- Lack of Product
Diversification; Dependence on Consumer Retail Lending Industry; Cyclical Nature
of Consumer Lending." Shortfalls in demand for the Company's technology in
relation to the Company's expectations, and the occurrence of other factors
which have caused revenues to fall short of the Company's expectations, have had
and may continue to have an adverse effect on the Company's business, operating
results and financial condition.
The uncertainty regarding the extent and timing of any revenue growth
coupled with the Company's substantial operating expenses (many of which the
Company is unable to adjust in a timely manner) means that the Company will
likely continue to experience substantial quarterly fluctuations in its
operating results. In addition, the Company will continue to commit significant
resources to further fund research and development, develop new distribution
channels and broaden its customer support capabilities. To the extent these
expenses are not preceded or followed by substantially increased revenues, the
Company's business, operating results and financial condition will be materially
adversely affected.
In accordance with Statement of Financial Accounting Standards No. 13
"Accounting for Leases," the Company treats certain of its leases for which the
present value of future minimum lease payments exceeds 90% of the cost of the
related ALM as sales-type leases and all other leases are treated as operating
leases. For sales-type leases, the Company recognizes as revenue, generally upon
ALM installation and acceptance, the present value of the aggregate future
minimum lease payments to be received during the term of the related rental
agreement using the Company's incremental borrowing rate for lease-secured
transactions as the discount rate. For operating leases, the Company recognizes
lease payments as revenue ratably over the term of the applicable agreement. A
default by any significant customer of its obligation to make lease payments or
a termination of an ALM agreement could have an adverse effect on the Company's
quarterly operating results, particularly with regard to ALMs that are leased
under agreements treated as sales-type leases.
As a result of all the foregoing factors and other factors discussed
under "Business Risks," the Company believes that period-to-period comparisons
of its results of operations are not necessarily meaningful and should not be
relied upon as an indication of future performance. Moreover, it is likely that
in some future quarter the Company's operating results will be below the
expectation of public market analysts and investors. In such event, the price of
the Company's common stock could be materially adversely affected.
Unproven Market; Unproven Acceptance of the Company's Products and
Services
The market for products and services that enable electronic commerce is
new, developing and uncertain. As is typical in the case of a new and rapidly
evolving industry, demand and market acceptance for recently introduced products
and services are subject to a high level of uncertainty. The Company's future
growth and financial performance will depend upon consumer acceptance of
electronic commerce as an attractive means of conducting certain consumer
financial transactions and also upon institutional acceptance of the Company's
products as a preferred means for serving consumers. Such institutional
acceptance will in part depend on continued and growing use of relatively new
quantitative credit scoring methodologies that are amenable to automation. If
the electronic commerce market fails to grow or grows more slowly than
anticipated, or if lenders reduce their use of quantitative credit scoring
tools, the Company's business, operating results and financial condition would
be materially adversely affected. Furthermore, even if this market does
experience substantial growth, there can be no assurance that the Company's
products and services will be commercially successful or benefit from such
growth. Failure of either the providers of consumer financial services or the
consumers of such services to quickly accept electronic commerce distribution
channels in general, and the Company's electronic commerce enabling technologies
in particular, or the inability of the Company's products and services to
satisfy its customers' or consumers' expectations, have had and may continue to
have an adverse effect on the Company's business, operating results and
financial condition.
Because the market for the Company's products and services is new,
evolving and uncertain, it is difficult to determine the size and predict the
future growth rate, if any, of this market. The market for the Company's
products, including the ALM and e-xpertLender, and its planned products and
services may never be developed, or may develop at a slower pace than expected,
or such products and services may not be adopted by participants in this market
or may be adopted by only a limited number of participants. If the market fails
to develop or develops more slowly than expected, or if the Company's products
and services do not achieve significant market acceptance, the Company's
business, operating results and financial condition would be materially
adversely affected.
None of the Company's ALM customers has, to the Company's knowledge,
made any determination with respect to making ALMs a significant component of
its long-term retail delivery strategy. Accordingly, there can be no assurance
when or if any additional orders will be forthcoming. Further, even if the
Company does succeed in generating substantial additional orders from existing
customers, uncertainty as to the timing and implementation of any such orders
adds to the unpredictability of the Company's quarterly operating results.
As of March 31, 1998, there were 121 ALMs deployed or accepted and
awaiting deployment. Agreements with one customer covering 50 ALMs, entered into
in 1996, provided that if, after two years in service, the ALMs covered by such
agreements did not meet certain performance criteria, the customer could
terminate the agreements with respect to the ALMs subject to payment of a fee
based on the number of months remaining under the contract. In February 1998,
the Company and such customer agreed to terminate their relationship, which
includes the return of all 50 ALMs. Further, agreements with one customer
covering eight ALMs in service provided that if such ALMs did not achieve loan
volumes averaging one loan per day over a one month period in the second quarter
of 1997, the customer could terminate the agreement with respect to such ALMs.
The ALMs did not achieve loan volumes averaging one loan per day during the
applicable period and the agreement was terminated. In addition, agreements with
one customer covering 30 ALMs deployed or awaiting deployment provide for the
waiver of the monthly rental fee for any month during which such ALMs do not
process a certain volume of loans, which volume of loans is substantially
greater than the volume of loans processed by ALMs currently deployed by such
customer.
Lengthy Sales Cycle
The Company has to date experienced a lengthy sales cycle for the ALM
and e-xpertLender. In most cases, the time between initial customer order
contact and the execution of a final contract has exceeded six months. While the
Company believes that the length of the sales cycle may compress over time if
the Company's technology gains acceptance in the marketplace, there can be no
assurance such compression will take place in the future.
Early Stage Products and Services
The Company's ALM, e-xpertLender, DeciSys/RT, and planned products and
services are in the early stages of development and are subject to the risks
inherent in the development and marketing of new products including the
development of unforeseen design or engineering problems with the Company's
products and applications. There can be no assurance that these or other risks
associated with new product development will not occur. The occurrence of one or
more of these risks could have a material adverse effect on the Company's
business, operating results and financial condition.
Rapid Technological Changes
The market for products and services that enable electronic commerce is
highly competitive and subject to rapid innovation and technological change,
shifting consumer preferences, frequent new product introductions and
competition from traditional products and services having all or some of the
same features as products and services enabling electronic commerce. Competitors
in this market have frequently taken different strategic approaches and have
launched substantially different products or services in order to exploit the
same perceived market opportunity. Until the market validates a strategy through
widespread acceptance of a product or service, it is difficult to identify all
current or potential market participants or gauge their relative competitive
position. There can be no assurance that the ALM, e-xpertLender or the
DeciSys/RT system will be competitive technologically or otherwise or that any
other products and services available or developed by the Company will be
competitive technologically or otherwise. The ability of the Company to compete
in this market will depend upon, among other things, broad acceptance of the
Company's products and services and on the Company's ability continually to
improve the ALM, e-xpertLender and the DeciSys/RT system and other products and
services the Company has available or may develop to meet changing customer
requirements. There can be no assurance that the Company will successfully
identify new product and service opportunities and develop and bring to the
market new and enhanced services and products in a timely manner; that such
products, services and technologies will be commercially successful; that the
Company will benefit from such development; or that products, services and
technologies developed by others will not render the Company's products,
services and technologies noncompetitive or obsolete. If the Company is unable
to penetrate new markets in a timely manner in response to changing market
conditions or customer requirements or if new or enhanced products do not
achieve a significant degree of market acceptance, the Company's business,
operating results and financial condition would be materially and adversely
affected.
<PAGE>
Competition, Future Price Erosion
Electronic commerce technologies in general, including the ALM and
e-xpertLender, compete with traditional consumer lending methods, including
in-person loan applications at branch offices of financial institutions and cash
advances on credit cards and other revolving credit facilities, some or all of
which are employed by the Company's existing and potential customers. The
ability of the ALM and e-xpertLender and of any other electronic commerce
products and services the Company may develop to compete with traditional
lending methods will be dependent in part on consumer acceptance of electronic
commerce in general and industry acceptance of the Company's products and
services in particular.
The Company also faces competition from companies engaged in the
business of producing automated lending systems and other alternatives to
conventional consumer lending, including software and data processing companies
and technology and service companies. In particular, the Company is aware of
several companies, including Dyad, that have developed video and other kiosk
technology for the delivery of financial services. In addition, the Company is
aware of certain companies that have designed and are marketing software that
enables loan applications to be taken over the telephone. The Company also is
aware that many banks have begun using on-line services, such as
America-On-Line, CompuServe and Prodigy, to provide certain financial services
electronically, and is aware of several companies that have already made
substantial investments in software products that enable various other home
banking services, including IBM, Microsoft, Intuit, and Meca. Moreover, IBM and
The Chase Manhattan Bank have announced a system for processing automobile loans
over the Internet. Further, the Company understands that ULTRADATA has developed
certain on-line processing systems for the credit union market that may be in
direct competition with the Company's products and services. The Company will
also compete with CMSI in connection with its e-xpertLender automobile loan
system, which is in development. See "Business - Products and Services."
The Company expects competition to increase in the future from existing
and new competitors that produce automated loan systems and other alternatives
to traditional consumer lending methods. Such competitors may include actual or
potential customers of the Company that may develop competitive technology
internally. Most of the Company's current and potential competitors in the
market for its products and services have substantially greater financial,
marketing and technical resources than the Company. Accordingly, the Company may
not be able to compete successfully against new or existing competitors.
Furthermore, competition may reduce the prices that the Company is able to
charge for its products and services thereby potentially lowering revenues and
margins, which would have a material adverse effect on the Company's business,
operating results and financial condition. See "Business Competition."
Lack of Product Diversification; Dependence on Consumer Retail Lending
Industry; Cyclical Nature of Consumer Lending
For the year ended December 31, 1997, the Company derived a substantial
portion of its recurring revenues from its ALM operations. Further, a
substantial portion of the Company's revenues in the future are expected to be
derived from fees associated with the ALM, e-xpertLender and DeciSys/RT
technologies. Accordingly, the Company will be heavily dependent on market
acceptance of these technologies and, in particular, its acceptance as a vehicle
for executing transactions historically executed through traditional
distribution channels. The failure of the Company to generate demand for the ALM
and e-xpertLender or the occurrence of any significant technological problems
with the ALM, e-xpertLender and DeciSys/RT would have a material adverse effect
on the Company's business, operating results and financial condition.
The Company's business is currently concentrated on the consumer
lending industry and is expected to be so concentrated for the foreseeable
future, thereby making the Company susceptible to a downturn in that industry.
For example, a decrease in consumer lending could result in smaller overall
market for the Company's products and services. Furthermore, U.S. banks are
continuing to consolidate, decreasing the overall potential number of buyers for
the Company's products and services. Moreover, three customers accounted for
approximately 68% of the Company's revenue in 1997. The Company expects that its
operating revenues will continue to be attributable to a relatively small number
of customers. See "--Unproven Market; Unproven Acceptance of the Company's
Products and Services." These factors as well as others affecting the consumer
lending industry could have a material adverse effect on the Company's business,
operating results and financial condition.
The Company's business currently depends upon the volume of consumer
loans made through ALMs and e-xpertLender. Historically, demand for consumer
loans has been cyclical, in large part based on general economic conditions and
cycles in overall consumer indebtedness levels. Changes in general economic
conditions that adversely affect the demand for consumer loans or the
willingness of financial institutions to provide funds for such loans, such as
changes in interest rates and the overall consumer indebtedness level, could
have a material adverse effect on the Company's business, operating results and
financial condition.
Limited Protection of Technology
The Company is heavily dependent upon its technology, but holds no patents with
respect to such technology except the patent related to issuance of insurance
products at a kiosk which was acquired in accordance with the acquisition of Buy
American. The Company has applied with the PTO for patents to protect the closed
loop lending system utilized by, and the other essential features of, the ALM
System. Such applications and all amendments thereto to date have been rejected
by the PTO. The Company nevertheless intends to continue prosecution of its
applications and, if necessary, appeal the PTO's rejection of such patent
applications.
The Company regards certain of its technology as critical to its
business and attempts to protect such technology under copyright and trade
secret laws and through the use of employee, customer and business partner
confidentiality agreements. Such measures, however, afford only limited
protection, and the Company may not be able to maintain the confidentiality of
its technology.
As result of the foregoing factors, existing and potential competitors may
be able to develop products and services that are competitive with or superior
to the Company's products and services, and such competition could have a
material adverse effect on the Company's business, operating results and
financial condition. See "Business- Intellectual Property."
New Management; Management of Growth
The Company's rapid growth has placed and may continue to place a
significant strain on the Company's managerial, operational and financial
resources. As of December 31, 1997, the Company had grown to approximately 153
employees from 135 and 55 employees at December 31, 1996 and 1995, respectively,
and six employees at December 31, 1994. The inability of management and recently
hired employees of the Company to adjust quickly to, and perform as expected in,
their respective roles within the Company could have a material adverse effect
on the Company's business, operating results and financial condition.
To manage growth, the Company must continue to implement and improve
its operational and financial systems and to expand, train and manage its
employee base. The Company also will be required to manage multiple
relationships with various customers, business partners and other third parties.
Moreover, the Company has incurred significant expenses associated with its
rapid growth and may incur additional unexpected costs relating to its
anticipated expansion. The Company's systems, procedures or controls may not be
adequate to support the Company's operations and Company management may not be
able to achieve the rapid expansion necessary to exploit potential market
opportunities for the Company's products and services. The Company's future
operating results may also depend on its ability to expand its sales and
marketing and research and development organizations, implement and manage new
distribution channels to penetrate markets and expand its support organization.
If the Company is unable to manage growth effectively, the Company's business,
operating results and financial condition will be materially adversely affected.
Risk of Fraud in Consumer Lending
Consumer credit transactions, such as those processed by the ALM,
involve the risk of consumer fraud. The customer operating the ALM is
responsible for the selection and use of the loan origination and underwriting
parameters incorporated in the software supporting the ALM. In addition,
pursuant to the Company's standard ALS agreement, the Company disclaims (i) the
responsibility for the collection of any payments due from loan applicants and
(ii) liability or responsibility to customers or others with respect to
liability caused or alleged to be caused directly or indirectly by an ALM. The
Company is unaware of any significant instances of fraud in connection with the
funding of loans through the use of its ALM. However, the rate of fraudulent
activity could increase, especially if the number of transactions processed by
ALMs increase. Moreover, in light of the limited operating experience of the
Company, there can be no assurance that the Company's experience with respect to
fraud to date is indicative of future performance for the ALM or any other
product or service that the Company may develop. While the Company shifts the
risk of collection in any given transaction to its customers under the terms of
the ALS agreement, the Company may nevertheless be held responsible for losses
associated with fraudulent transactions if such transactions are attributable to
the Company's malfeasance. The Company has not attempted to procure insurance to
cover losses it may incur in connection with such fraud and does not know
whether such insurance is available. Furthermore, even if the Company is not
directly liable or contractually liable for fraudulent transactions processed by
its ALMs, an increase in fraud to levels greater than those experienced in
traditional and other emerging consumer credit processing systems would likely
have a material and adverse impact on the ability of the Company to attract and
retain financial institution customers and thus on the Company's business,
operating results and financial condition. In addition, the Company may not be
able to control adequately the occurrence of fraud in the future or may only be
able to do so at considerable cost, either of which would materially and
adversely affect the Company's business, operating results and financial
condition.
Risk of Third-Party Network Failure
The ALM relies on third parties for certain fraud detection systems and
for obtaining credit information about loan applicants. Additionally, the
Company uses an Affinity-dedicated private data network provided by a third
party to gain access to the networks maintained by such third parties. Prolonged
or repeated failure of (i) a network that provides access to information
necessary to complete a loan transaction through the Company's ALMs or (ii) the
Company's network access provider to provide access to such networks or to ALMs
in service would materially and adversely affect the Company's business,
operating results and financial condition.
Dependence on Third Parties
The expected rapid growth of the market for products that enable
electronic commerce, together with the number and resources of competitors
seeking to serve that market and the limited resources of the Company, make the
success of the Company and its business dependent on, among other things, its
ability to identify and reach agreements and work successfully with third
parties. In particular, the Company relies or expects to rely on third parties
in connection with its customer relationships, strategic alliance arrangements
(see "- Undeveloped Distribution Channels"), assembly of products and other
areas. There can be no assurance that the Company will be successful in
identifying such third parties, that it will be able to reach suitable
agreements with such third parties or that it will be able to successfully
implement any such agreements that are or have been reached. Failure by the
Company to accomplish any of the above could have a material adverse effect on
the Company's business, operating results and financial condition.
The Company's success depends particularly on the ability of customers
and third parties to market successfully the Company's products and services.
For example, the ability of the Company to realize recurring revenues from
transactions is dependent on the success of its customers in generating consumer
demand for transactions using the Company's products and services. Failure of
ALM customers to generate and sustain consumer demand for the ALM and other
products and services that may be developed by the Company has had and may
continue to have an adverse effect on the Company's business, operating results
and financial condition. Although the Company views its strategic and other
alliances with third parties as an important factor in the development and
commercialization of its products and services, there can be no assurance that
such third parties view their alliances with the Company as significant for
their own businesses or that they will not reassess their commitment to the
Company at a time in the future. Currently, the Company's agreements with ALM
customers generally do not require them to meet minimum performance
requirements. Instead, the Company relies on the voluntary efforts of such
customers to promote consumer acceptance and use of ALMs. The Company's ability
to maintain relationships with its customers and third parties will depend, in
part, on its ability to successfully enhance products and services and develop
new products and services. The Company's inability to meet such requirements
could result in its customers and third parties seeking alternative providers of
the Company's products and services, which would have an adverse effect on the
Company's business, operating results and financial condition.
<PAGE>
Undeveloped Distribution Channels
The Company currently sells its products and services directly through
its own sales force, marketing agreements with strategic partners and
distribution agreements with other entities. For the Company to achieve broad
distribution of the ALM or any other products or services it may develop, it
must implement effective marketing and distribution arrangements with third
parties. The inability of the Company to enter into favorable arrangements with
strategic partners and other entities could have a material adverse effect on
the Company's business, operating results and financial condition. Furthermore,
the Company could incur significant costs and expend substantial time to train
and educate strategic partners about the Company's products and services. If the
Company is unable to successfully and efficiently train and educate strategic
partners or other third parties, the Company may not achieve, or achieve in a
timely fashion, broad distribution of its products and services. To the extent
broad distribution of the Company's products and services is not achieved, there
would be a material adverse effect on the Company's business, operating results
and financial condition.
Dependence on Key Employees
The Company is highly dependent on certain key executive officers and
technical employees. The Company is also dependent on its ability to recruit,
retain and motivate high quality personnel. Competition for such personnel is
intense, and the inability to attract and retain qualified employees or the loss
of current key employees could materially and adversely affect the Company's
business, operating results and financial condition. Additionally, the Company
does not maintain "key man" insurance policies on any of its employees other
than Jeff A. Norris, its President and Chief Executive Officer (which policy
provides coverage of only $1.5 million), nor does the Company intend to secure
such insurance. The loss of the services of any of the Company's executive
officers could have a material adverse effect upon the Company's business,
operating results and financial condition.
Shares Eligible for Future Sale; Possible Adverse Effect on Market Price
Sales of substantial amounts of Common Stock in the public market or
the prospect of such sales could adversely affect the market price for the
Company's Common Stock and the ability of the Company to raise equity capital in
the future. As of March 17, 1998, the Company had outstanding an aggregate of
30,155,673 shares of Common Stock. Of such shares, an aggregate of approximately
12,430,240 shares of Common Stock are freely tradeable without restriction or
further registration under the Securities Act of 1933 (the "Securities Act"),
except for any of such shares acquired by "affiliates" of the Company, as that
term is defined in Rule 144 under the Securities Act ("Affiliates"). The Company
believes that the holders of the remaining 17,725,433 shares are "Affiliates" of
the Company and, accordingly, that such shares may be sold without registration
only in compliance with the Securities Act (including Rule 144). At December 31,
1997, approximately 44,600 and 315,110 options were exercisable under the 1996
and 1995 Option Plans, respectively. Weighted average exercise price was $6.09
and $0.44 and the weighted average remaining contractual life was 9.3 and 7.8
years under the 1996 and 1995 Option Plans, respectively, at December 31, 1997.
There were warrants exercisable into an aggregate of 3,471,340 shares of common
stock at a weighted average exercise price of approximately $0.0001 per share.
The issuance of shares of capital stock to address liquidity needs of the
Company or for other business purposes could also adversely affect the market
price of the Company's Common Stock.
Volatility of Stock Price and Risk of Litigation
The Company's Common Stock price has been extremely volatile and has
experienced substantial and sudden fluctuations. In addition, the stock market
has experienced significant price and volume fluctuations that have especially
affected the market prices of equity securities of many high technology
companies, and that often have been unrelated to the operating performance of
such companies. These broad market fluctuations have adversely affected and may
continue to adversely affect the market price of the Company's Common Stock. In
the past, following periods of volatility in the market price of a company's
securities, securities class action litigation has often been instituted against
such a company. Such litigation could result in substantial costs and a
diversion of management's attention and resources, which would have a material
adverse effect on the Company's business, operating results and financial
condition.
<PAGE>
Control by Principal Stockholders
The directors and executive officers of the Company collectively
beneficially own approximately 45.5% of the Common Stock and Jeff A. Norris, the
Company's President and Chief Executive Officer, individually beneficially owns
35.3% of the Common Stock of the Company. As a result, these persons will be
able to exercise control over matters requiring stockholder approval, including
the election of directors and approval of significant corporate transactions.
Such concentration of ownership may have the effect of delaying or preventing a
change in control of the Company and could have an adverse effect on the market
price of the Common Stock.
Government Regulation and Uncertainties of Future Regulation
The financial services industry is subject to extensive and complex
federal and state regulation. The Company's current and prospective customers,
which consist of state and federally chartered banks, savings and loans, credit
unions, consumer finance companies and other consumer lenders, as well as
customers in the insurance industry that the Company may target in the future,
operate in markets that are subject to extensive and complex federal and state
banking and insurance regulation. The Company's products and services must be
designed to work within the extensive and evolving regulatory constraints in
which its customers operate. These constraints include federal and state
truth-in-lending disclosure rules, state usury laws, the Equal Credit
Opportunity Act, the Electronic Funds Transfer Act, the Fair Credit Reporting
Act, the Community Reinvestment Act, and restrictions on the establishment,
number and location of branch offices and remote electronic banking facilities
such as automated teller machines. Because many of these regulations were
promulgated before the development of products that enable electronic commerce
(such as the ALM), the application of such regulations to any products and
services developed by the Company must be determined on a case-by-case basis.
Affinity has not attempted to review the laws of each state that might be
applicable to the deployment of ALMs or e-xpertLender. It is possible that other
states may have or will in the future adopt specific regulations applicable to
the deployment and operation of ALMs. Furthermore, some consumer groups have
expressed concern regarding the privacy and security of ALMs, the use of
automated credit scoring tools in underwriting and whether electronic lending is
a desirable technological development in light of the current level of consumer
debt. It is possible that consumer groups or others could take actions to cause
one or more states eventually to promulgate specific regulations applicable to
the deployment and operation of ALMs and/or e-xpertLender. Regulations currently
existing or promulgated in the future that significantly restrict the ability of
a financial institution to install ALMs at multiple locations outside branch
offices or otherwise adversely affect the use of ALMs or any other products or
services the Company has or may develop could have a material adverse effect on
the Company's business, operating results and financial condition.
Anti-Takeover Provisions
Certain provisions of Delaware law and the Company's Certificate of
Incorporation and by-laws could have the effect of making it more difficult for
a third party to acquire, or of discouraging a third party from attempting to
acquire, control of the Company. Such provisions could limit the price that
certain investors might be willing to pay in the future for shares of the
Company's Common Stock. These provisions of Delaware law and the Company's
Certificate of Incorporation and by-laws may also have the effect of
discouraging or preventing certain types of transactions involving an actual or
threatened change of control of the Company (including unsolicited takeover
attempts), even though such a transaction may offer the Company's stockholders
the opportunity to sell their stock at a price above the prevailing market
price. Certain of these provisions allow the Company to issue Preferred Stock
with rights senior to those of the Common Stock and other rights that could
adversely affect the interest of holders of Common Stock without any further
vote or action by the stockholders. The issuance of Preferred Stock, for
example, could decrease the amount of earnings or assets available for
distribution to the holders of Common Stock or could adversely affect the rights
and powers, including voting rights, of the holders of the Common Stock. In
certain circumstances, such issuance could have the effect of decreasing the
market price of the Common Stock, as well as having the anti-takeover effects
discussed above.
<PAGE>
Item 2. Properties
The Company's principal executive offices are located at 1201 Main
Street in Columbia, South Carolina. Such office space encompasses approximately
33,000 square feet and is currently under lease which expires in 2001. The
Company also leases approximately 2,800 square feet of office space at 1500
Hampton Street, Suite 130 in Columbia, South Carolina, under a lease which is
due to expire in 2001. The Company's primary assembly and quality assurance
facilities are located at 2500 Leaphart Road in West Columbia, South Carolina,
which encompasses approximately 19,000 square feet and is currently under lease
which expires in 2001. The Company also sub-leases approximately 1,000 square
feet of sales office space in New York, New York from Columbia Financial
Partners, L.P., an affiliate of Alan H. Fishman, who is Chairman of the Board
and a director of the Company.
Item 3. Legal Proceedings
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Executive Officers of the Registrant
Name Age Position with the Company
Jeff A. Norris 37 President and Chief Executive
Officer and Director
Joseph A. Boyle 44 Senior Vice President, Chief
Financial Officer, Secretary
and Treasurer
Clement D. Lamarre 65 Senior Vice President - Operations and
Sales
Terrence J. Sabol, Sr. 52 Senior Vice President - Technology
John D. Rogers 54 Senior Vice President
Jeff A. Norris, founder of the Company, has served as the Company's Chief
Executive Officer and as a director since March 1994 and served as Chairman of
the Board from March 1994 to April 1996 and as Treasurer from March 1994 to
February 1996. Mr. Norris held the position of President from March 1994 to May
1994 and reassumed that position in October 1995. Prior to founding the Company,
Mr. Norris was employed as a salesman by Digital Equipment Corporation for nine
years.
Joseph A. Boyle became Senior Vice President and Chief Financial Officer of the
Company in September 1996 and Secretary and treasurer in May 1997. Prior to
joining the Company, Mr. Boyle served as Price Waterhouse LLP engagement partner
for all of its Kansas City, Missouri financial services clients and as a member
of the firm's Mortgage Banking Group. Mr. Boyle was employed by Price Waterhouse
LLP from September 1982 to August 1996.
Clement D. Lamarre, Senior Vice President of Sales and Operations, became an
employee of the Company in May 1997. From June 1996 until May 1997, Mr. Lamarre
provided consulting services to the Company. Prior to joining the Company, from
1991 to 1997, Mr. Lamarre owned and operated his own consulting business and
prior to 1991, Mr. Lamarre was employed as Director of Wholesale and Retail
Distribution by Digital Equipment Corporation.
Terrence J. Sabol, Sr., Senior Vice President of Technology, joined the Company
in October 1995. From July 1990 to October 1995, he served as Products Manager
for Policy Management Systems Corporation, a Columbia, South Carolina company
that provides and supports computer systems for insurance companies.
John D. Rogers became Senior Vice President of the Company in January 1997. Mr.
Rogers served as President of Affinity Processing Corporation, a majority owned
subsidiary of the Company, from May 1996 until May 1997. Prior to joining the
Company, Mr. Rogers served as Executive Vice President of the Information
Services Group of BISYS Group, Inc., from 1989-1996.
<PAGE>
Part II
Item 5. Market for Registrants' Common Equity and Related Stockholder Matters
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
(d) The Company's registration statement on Form S-1 (File No.
333-1170) with regard to an initial public offering of 5,060,000
shares of common stock, par value $.0001 per share, of the Company
was declared effective by the Securities and Exchange Commission
on April 24, 1996. As set forth in the Company's Form SR, Report
of Sales of Securities and Use of Proceeds Therefrom, Montgomery
Securities and Donaldson, Lufkin & Jenrette Securities Corporation
acted as the managing underwriters for the offering, which
commenced April 25, 1996. As of December 31, 1997, the Company has
used net proceeds of $60,078,000 from the offering as follows:
<TABLE>
<CAPTION>
Direct or indirect
payments to directors,
officers, general
partners of the issuer
or their associates; to
persons owning ten
percent or more of any
class of equity
securities
of the issuer; and to Direct or indirect
affiliates of the issuer. payments to others
-------------------------------- ------------------------
<S> <C> <C>
Construction of plant, building and facilities $ -
Purchase and installation of machinery and equipment 4,691,000
Purchase of real estate -
Acquisition of other business(es) 300,000
Repayment of indebtness $ 771,000 1 1,000,000
Working capital 17,717,000
Temporary investments:
US Treasury obligations 20,545,000
Commercial paper 1,521,000
Money market / cash 1,540,000
Other purposes:
Marketing 3,747,000
Research & development 6,016,000
Purchase of software 2,230,000
<FN>
1 Reflects the repayment of debt owed to Carolina First Corporation, as
described under the caption "Use of Proceeds" in the Company's Prospectus, dated
April 25, 1996.
</FN>
</TABLE>
<PAGE>
The Company's common stock is traded on The Nasdaq National Market
under the symbol "AFFI." The following table presents the high and low sales
prices of the Company's common stock for the periods indicated during 1996 and
1997, as reported by The Nasdaq National Market. The Company completed its
initial public offering in the second quarter of 1996 at a price of $13.00 per
share. As of March 17, 1997, there were 199 stockholders of record of the common
stock.
Sales Price Per Share
High Low
1996:
April 25, 1996 to June 30, 1996 $24.25 $7.63
Third Quarter 1996 14.25 6.00
Fourth Quarter 1996 10.75 6.25
1997:
First Quarter 1997 8.13 4.75
Second Quarter 1997 5.13 3.50
Third Quarter 1997 4.13 2.81
Fourth Quarter 1997 3.75 2.25
The Company has never paid dividends on its capital stock. The Company
intends to retain earnings, if any, for use in its business and does not
anticipate paying any cash dividends in the foreseeable future.
<PAGE>
Item 6. Selected Financial Data
The following table presents selected financial data of the Company for
the periods indicated. The following financial data should be read in
conjunction with the information set forth under "Management's Discussion and
Analysis of Financial Condition and Results of Operations," the Company's
Consolidated Financial Statements and Notes thereto and other information
included elsewhere in this report.
<TABLE>
<CAPTION>
Period from
Inception
(January 12,
Year ended 1994) to
December 31, December 31,
1997 1996 1995 1994
------------------ ------------------ ------------------- -------------------
<S> <C> <C> <C> <C>
Statements of Operations Data:
Revenues $ 4,146,899 $ 5,081,818 $ 1,524,911 $ -
Costs and expenses:
Cost of revenues 2,125,646 3,088,321 1,101,330 -
Research and development 3,526,257 2,905,232 368,452 264,600
Selling, general and administrative expenses 15,892,560 10,819,381 2,305,653 428,896
------------------ ------------------ ------------------- -------------------
Total costs and expenses 21,455,463 16,812,934 3,775,435 693,496
------------------ ------------------ ------------------- -------------------
Operating loss (17,397,564) (11,731,116) (2,250,524) (693,496)
Interest income 2,033,571 2,099,004 48,476 -
Interest expense (35,359) (60,083) (105,981) (12,475)
------------------ ------------------ ------------------- -------------------
Net loss $ (15,399,352) $ (9,692,195) $ (2,308,029) $ (705,971)
================== ================== =================== ===================
================== ================== =================== ===================
Net loss per share - basic and diluted $ (0.54) $ (0.40) $ (0.15) $ (0.08)
================== ================== =================== ===================
================== ================== =================== ===================
Shares used in computing net loss per share 28,477,880 24,136,480 15,044,286 9,185,078
================== ================== =================== ===================
</TABLE>
<TABLE>
<CAPTION>
December 31,
1997 1996 1995 1994
------------------ ------------------ ------------------- -------------------
<S> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents $ 4,470,185 $ 31,563,950 $ 1,235,983 $ 29,985
Short-term investments 19,135,415 10,583,997 - -
Working capital (deficit) 28,599,560 43,672,679 (1,134,465) (431,547)
Net investment in sales-type leases,
less current portion 1,328,741 2,386,010 860,295 -
Total assets 42,209,570 56,098,857 4,591,168 338,172
Notes payable, less current portion - - 222,399 200,000
Capital lease obligations to related party,
less current portion - 66,245 148,119 199,508
Capital stock of subsidiary held by
Minority investor - 200,000 137,500 -
Stockholders' equity 39,230,570 52,134,639 617,412 (679,463)
</TABLE>
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The Company was formed to develop and market technologies that enable
financial institutions and other businesses to provide consumer financial
services electronically with reduced or no human intervention. From the period
of inception (January 12, 1994) through December 31, 1994, the Company was a
development stage company, and its activities principally related to developing
its DeciSys/RT technology (formerly known as the "DSS System") and the Affinity
Automated Loan Machine ("ALM"), raising capital and recruiting personnel.
During 1995, 1996 and early 1997 the Company's primary products and
services consisted of the ALM and a call center decisioning system that provided
financial institutions the ability to originate unsecured consumer loans with
little or no human intervention. During this period, the Company's customers
primarily utilized the ALM delivery channel which captures origination
information for unsecured consumer loan applications and then routes this
information to the Company's proprietary DeciSys/RT for an automated decision.
Also during this period the Company continued to develop additional financial
products which could be originated at an ALM and processed through DeciSys/RT.
These products included loans secured by cash collateral, and the functions
necessary to open checking accounts, renew existing loans, cross sell other
products and make counter offers to applicants who qualify for a loan amount
higher or lower than the loan originally requested.
During 1997 the Company continued its channel and product development
to enable the automated decisioning, processing and fulfillment of financial
product transactions by DeciSys/RT originating through not only ALMs, but also
other non-ALM channels, including call centers, branches, and automobile
dealerships. The Company's system includes inherent architecture that enables
integration of origination, processing and fulfillment across a wide range of
interface channels with the consumer. A significant new channel system developed
in 1997 is e-xpertLender. e-xpertLender is the Company's system that establishes
connectivity among all of a financial institution's delivery channels, its
automated decisioning system, and its risk management group. e-xpertLender also,
upon approval, gives the consumer a choice of closing methods that include
branches, ALMs, mail, and third party closing agents. The system enables call
center agents and branch personnel to inquire as to the status of applications
at anytime and electronically notifies loan officers with respect to exceptions
and the reason for referral. e-xpertLender replaced the Company's call center
decisioning system (Assets3) previously developed under a joint venture
agreement with Union Planters Corporation. The Company no longer markets the
Assets3 system. Additionally, the joint venture agreement was terminated in 1997
(see Note 2 of "Notes to Consolidated Financial Statements - Summary of
Significant Accounting Policies - Minority Interest").
To date, the Company has generated minimal operating revenues, has
incurred significant losses and has experienced substantial negative cash flow
from operations. The Company's prospects must be considered in light of the
risks, expenses and difficulties frequently encountered by companies in their
early stage of development, particularly technology-based companies operating in
unproven markets with unproven products. The Company had an accumulated deficit
as of December 31, 1997 of $28,105,547, with operating losses of $15,399,352,
$9,692,195, and $2,308,029 for the years ended December 31, 1997, 1996 and 1995,
respectively. The Company expects to incur substantial additional costs to
develop its financial product origination capabilities, to enhance and market
the ALM, e-xpertLender and Decisys/RT and to complete any new products and
services that may be developed. Accordingly, there can be no assurance that the
Company will ever be able to achieve profitability or, if achieved, sustain such
profitability.
The market for the Company's products and services is new, evolving and
uncertain, and it is difficult to determine the size and predict the future
growth rate, if any, of this market. In addition, the market for products and
services that enable electronic commerce is highly competitive and is subject to
rapid innovation and competition from traditional products and services having
all or some of the same features as products and services enabling electronic
commerce. Competitors in this market have frequently taken different strategic
approaches and have launched substantially different products or services in
order to exploit the same perceived market opportunity. Until the market has
validated a strategy through widespread acceptance of a product or service, it
is difficult to identify all current or potential market participants or gauge
their relative competitive position.
<PAGE>
Revenue and Expense Recognition
The Company's ALM pricing structure is designed to recapture a portion
of the Company's costs through set-up and lease fees and to generate over the
long term a greater portion of revenues through recurring transaction fees. The
Company's ALM lease pricing generally is tiered based on the number of ALMs
ordered and operated by each customer. However, the terms of each contract
reflect negotiations between the Company and the customer. Depending on whether
certain criteria are met, ALM leases may be reported as sales-type leases or
operating leases.
Pursuant to the Company's standard ALM Automated Loan System Agreement
(the "ALS Agreement"), (i) the Company (a) grants to the customer a
non-exclusive right to use the software supported by the Company's Decisys/RT
system and (b) agrees to provide technical assistance to the customer during the
term of such agreement and (ii) the customer agrees to pay the initial set-up
fee, a non-refundable fee for the non-exclusive right to use the software as
well as fees for each application and each loan transaction consummated based on
a percentage of the principal amount of the loan. At the time an order is placed
by a customer, the Company typically collects a non-refundable set-up fee as
well as a non-refundable fee for the non-exclusive right to use the software,
all of which are initially recorded as deferred revenue. Generally, upon
installation of an ALM, the Company recognizes as revenue the non-refundable fee
for the non-exclusive right to use the software and a portion of the set-up fee
in an amount approximately equal to the cost of set-up and installation of such
ALM, with the remainder of such set-up fee amortized ratably over the term of
the ALS Agreement. Additionally, under the ALS Agreement, the Company collects
other miscellaneous processing fees that are designed to help the Company
recapture a portion of its processing costs. The Company recognizes these fees
as revenue when earned under the terms of the ALS Agreement.
The Company generally leases ALM hardware to its customers under a
standard rental agreement that typically is non-cancelable and has a term of 48
months, although certain of the Company's agreements allow customers to
terminate such agreements prior to the end of their term in certain
circumstances. In accordance with Statement of Financial Accounting Standards
No. 13 ("SFAS 13"), "Accounting for Leases," the Company treats certain leases
as sales-type leases, and other leases are treated as operating leases. For its
sales-type leases, under SFAS 13, the Company recognizes as revenue, generally
upon ALM installation, the present value of the aggregate future minimum lease
payments to be received during the term of the related rental agreement using
the Company's estimated incremental borrowing rate for lease-secured
transactions as the discount rate. The difference between the aggregate future
minimum lease payments and the present value of such lease payments is
capitalized as unearned interest income and amortized into revenue over the term
of the rental agreement. For operating leases, the Company recognizes lease
payments as revenue ratably over the term of the applicable agreement.
Significant fluctuations in quarterly revenue and operating results may result
depending on whether leases consummated during a period are sales-type or
operating leases.
Prior to May 31, 1995, the Company generally used an agreement that
provided for (i) an initial fee, substantially all of which is credited against
future licensing fees at a predetermined rate over the term of the agreement,
and (ii) monthly or quarterly licensing fees equal to the greater of a minimum
amount and a fee calculated based upon the principal amount of loans funded.
Such agreements have terms of 12, 24 or 48 months. The Company has recorded the
prepaid portion of the initial fee as deferred revenue, which is amortized over
the term of the particular agreement. The Company treats such agreements as
operating leases. Accordingly, monthly and quarterly fees under such agreements
are recognized as revenue over the term of the applicable agreements. The
Company depreciates the cost of ALMs leased under such agreements over five
years using the straight-line method. At December 31, 1997, there were 48 ALMs
in service under such agreements.
In conjunction with the installation of the Company's technology, the
Company may agree to perform additional customer specific technology development
for the customer. The Company generally enters into a contract with the customer
for the performance of these services which typically defines deliverables,
specific delivery and acceptance dates and specified fees for such services.
Upon completion and acceptance of the deliverables by the customer, the Company
recognizes the corresponding revenue as professional services.
The Company accounts for research and development costs as operating
costs and expenses such costs in the period incurred. In accordance with
Statement of Financial Accounting Standards No. 86 ("SFAS 86"), "Computer
Software to be Sold, Leased or Otherwise Marketed," the Company capitalizes
software costs incurred in the development of a software application after the
technological feasibility of the application has been established. Technological
feasibility is established when an application design and a working model of the
application have been completed and the completeness of the working model and
its consistency with the application design have been confirmed by testing. From
the time technological feasibility is established until the time the relevant
application is available for general release to customers, software development
costs incurred are capitalized at the lower of cost or net realizable value.
Thereafter, costs related to the application are again expensed as incurred.
Capitalized software development costs are amortized using the greater of the
revenue curve or straight-line method over the estimated economic life of the
application. Software costs capitalized include direct labor, other costs
directly associated with the development of the related application and an
allocation of indirect costs, primarily facility costs and other costs
associated with the Company's software development staff. The Company bases such
allocation on the percentage of the Company's total labor costs represented by
the software development labor costs.
Results of Operations
Revenues
The Company's revenues were $4,146,899, $5,081,818 and $1,524,911
for the years ended December 31, 1997, 1996 and 1995, respectively.
Sales and rental fees of $1,590,620, initial set-up fees of $638,687,
professional services of $792,734 and transaction fees and other income of
$1,124,858 represented approximately 38.4%, 15.4%, 19.1% and 27.1%,
respectively, of the Company's revenues for 1997. During 1996 the Company's
revenues consisted of sales and rental fees of $2,552,158, non-recurring license
revenue of $1,800,000, initial set-up fees of $426,848 and transaction and other
fees of $302,812 which accounted for approximately 50.2%, 35.4%, 8.4% and 6.0%,
respectively, of the Company's revenues for 1996. Sales and rental fees of
$1,275,101, initial set-up fees of $128,715 and transaction and other fees of
$121,095 accounted for approximately 83.6%, 8.4% and 7.9%, respectively, of the
Company's revenues for 1995.
The decrease in sales and rental fees for the year ended December 31,
1997 as compared to 1996 is due to an overall decrease in the number of ALMs
deployed under sales-type leases during 1997. The increase in sales and rental
fees for the year ended December 31, 1996 as compared to 1995 is primarily
attributable to an overall increase in the number of ALMs deployed under
sales-type and operating leases during 1996. During 1997, the Company
consummated sales-type leases for 28 ALMs compared to 74 and 30 ALM sales-type
leases in 1996 and 1995, respectively.
The increase in initial set-up fees for the year ended December 31,
1997 as compared to 1996 is attributable to a general increase in the amount of
set-up fees charged as well as set-up fees which were recognized in association
with the deployment of ALMs in conjunction with a short-term pilot program. The
increase in initial set-up fees for the year ended December 31, 1996 as compared
to 1995 is essentially attributable to an increase in the number of ALMs
deployed during 1996 under both sales-type and operating leases. At December 31,
1997, 1996 and 1995, there were a total of 171, 164 and 51 ALMs, respectively,
under both sales-type and operating leases. Subsequent to December 31, 1997, the
Company and a significant ALM customer terminated their relationship with
respect to 50 ALMs under sales-type and operating leases. The Company does not
believe that such action had or will have a material effect on the Company's
financial condition or operating results.
The increase in transaction fees and other income for the year ended
December 31, 1997 as compared to 1996 is primarily attributable to transaction
revenue earned from financial service applications processed using DeciSys/RT
and from processing credit card and other debit card transactions. In addition,
during 1997 the Company experienced an increase in revenue associated with the
accretion of deferred fees due to an increase in the overall number of ALMs
under both sales-type and operating leases throughout 1997 as compared to 1996.
The increase in transaction fees and other income for the year ended December
31, 1996 as compared to 1995 is primarily due to an increase in transaction fees
and revenue associated with the accretion of deferred fees, both of which are
associated with an increase in the overall number of ALMs under both sales-type
and operating leases throughout 1996 as compared to 1995.
Non-recurring license fees of $1.8 million during 1996 reflect one-time
license fees paid by Union Planters Corporation to Affinity Processing
Corporation ("APC"), a subsidiary of the Company, for a perpetual, royalty-free
license to use the Company's call center decisioning system (formerly known as
"Assets(3)") in North America. Pursuant to an arrangement among the Company, APC
and Union Planters, all amounts paid by Union Planters to APC as license fees
were paid by APC to the Company as license fees.
During 1997 the Company recognized revenue associated with contracts to
perform professional services, primarily for one customer. Generally such
services involve customizing the Company's products to operate in accordance
with a customer's specifications. Prior to 1997 the Company had not entered into
any significant agreements of this type.
Total ALM sales and professional services for 1997 were to 5 customers.
All ALM sales represented new customer relationships, while professional
services were performed for 4 of the 5 new customers. One customer accounted for
60.2% and 91.3% of ALM sales and rental and professional services revenue, while
two customers accounted for 48% and 13%, respectively, of total revenue during
1997. For information relating to customer revenue concentrations for 1996, see
Note 10 of "Notes to Consolidated Financial Statements - Segment Information."
The loss of any one of these customers may have a material adverse effect on the
Company's financial condition or results of operations due to the developing
nature of the Company's customer base and revenue streams. The Company expects
that a substantial portion of the Company's operating revenues in the future may
continue to be attributable to relatively few customers. Such customer
concentration may cause significant fluctuations in the Company's quarterly and
annual revenues due to the uncertainty of the timing of new and additional
orders for ALMs.
In 1997, the Company continued to experience disappointing revenue
growth and an extremely lengthy sales cycle for its products. Average consumer
use of ALMs in service and average rates for loan approvals have been lower than
most customers' expectations. While certain customers have deployed their ALMs
in a manner that has resulted in acceptable loan approval rates, the Company
believes that the economic viability of the ALM as an acceptable alternative to
traditional and new lending methods has not yet been established, which has
resulted in the terminations of the Company's relationship with one significant
ALM customer, another potentially significant ALM customer and certain other ALM
customers. Such activities did not significantly affect the Company's historical
operating results.
Costs and Expenses
Cost of Revenues. Cost of revenues for the years ended December 31,
1997, 1996 and 1995 were $2,125,646, $3,088,321 and $1,101,330, respectively.
Cost of revenues primarily reflects (i) set-up costs including the cost of
preparing ALMs for installation, (ii) the cost of ALM components and (iii)
salaries and overhead allocated to cost of revenues. Approximately $493,143 or
23% of the Company's cost of revenues for 1997 was attributable to the cost of
materials used in the assembly of ALMs, compared to $1,353,334 or 43.8% and
$698,604 or 63.4% during 1996 and 1995, respectively. The cost of ALM hardware
sold under capital leases, depreciation expense for hardware leased to customers
under operating leases and other direct and indirect costs associated with sales
and rental revenues totaled $1,041,455, $2,426,476 and $891,040 for the years
ended December 31, 1997, 1996 and 1995, respectively. Labor and other direct and
indirect costs associated with initial set-up fees totaled $232,077, $426,848
and $122,404 for the years ended December 31, 1997, 1996 and 1995, respectively.
Labor and other direct and indirect costs associated with transactions and other
revenue totaled $328,067, $91,063 and $87,886 for the years ended December 31,
1997, 1996 and 1995, respectively. Labor and other direct and indirect costs
associated with professional services revenue during 1997 totaled $524,047.
Direct and indirect costs associated with license revenue in 1996 consisted
primarily of allocated salaries and overhead and totaled $143,934.
The decrease in the cost of revenues for the year ended December 31,
1997 as compared to 1996, excluding the costs associated with professional
services in 1997 and license revenue in 1996, is primarily attributable to an
overall decrease in the number of ALMs deployed during the period under both
sales-type and operating leases offset by an increase in depreciation expense
associated with an increase in the number of ALMs in service under operating
lease arrangements during 1997. The increase in the cost of revenues for the
year ended December 31, 1996 as compared to the same period in 1995, excluding
the costs associated with license revenue in 1996, is attributable to an overall
increase in the number of ALMs deployed during the period under both sales-type
and operating leases offset by cost efficiencies in 1996 associated with the
redesign and standardization of the installation process, as discussed below.
The cost of designing, assembling and installing individual ALMs
fluctuated significantly during 1995. Prior to September 1995, the Company
incurred significant costs in customizing ALM designs for customers. Since that
time, the Company has standardized the base operating system and redesigned the
cabinet structure, graphics and component installation to reduce the cost,
assembly time and ALM size. Further, during 1997 and 1996 the Company outsourced
certain aspects of ALM cabinet construction, hardware assembly and delivery to
reduce costs.
Research and Development. Research and development expenses for the
year ended December 31, 1997 were $3,526,257, compared to $2,905,232 and
$368,452 for the years ended December 31, 1996 and 1995, respectively. The
increase in research and development expenses is primarily attributable to the
Company's enhancement of its DeciSys/RT technology and the development of
additional financial product origination capabilities during 1997 and 1996.
During 1997 and 1996, the Company capitalized $451,304 and $214,820,
respectively, of software development costs related primarily to the development
of certain loan applications. During 1995, the Company capitalized $216,587 of
software development costs related to the ALM. Capitalized software development
costs are being amortized over 48 months. The Company anticipates that it will
continue to commit substantial resources to research and development activities
for the foreseeable future.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses for the year ended December 31, 1997 were
$15,892,560, compared to $10,819,381 and $2,305,653 for the years ended December
31, 1996 and 1995, respectively. SG&A expenses during 1997 consisted primarily
of personnel costs of $9,672,691; professional fees of $1,891,751, consisting
primarily of legal, accounting, recruiting and relocation fees; advertising and
marketing costs of $1,488,147; deferred compensation expense amortization of
$480,534; and travel costs of $935,270. SG&A expenses during 1996 consisted
primarily of personnel costs of $5,375,856; professional fees of $2,290,017
consisting primarily of legal, accounting, recruiting and relocation fees;
advertising and marketing costs of $1,661,508; deferred compensation expense
amortization of $1,028,489; and travel costs of $791,693. SG&A expenses during
1995 consisted primarily of personnel costs of $585,421; professional fees of
$372,076 consisting principally of legal fees associated with capital
financings, the Company's patent applications and general corporate matters;
deferred compensation expense amortization of $524,248; and travel costs of
$114,823.
The increase in personnel costs for the year ended December 31, 1997 as
compared to 1996, and the year ended December 31, 1996 as compared to 1995, is
attributable to an increase in the number of employees and timing of such
increases during 1997 and 1996 associated with expansion of the Company's
operating activities. The decrease in deferred compensation expense for the year
ended December 31, 1997 as compared to 1996, is due to the forfeiture of stock
options granted under the Company's 1995 Stock Option Plan. The increase in
deferred compensation expense for the year ended December 31, 1996 as compared
to 1995, is due to an increase in the amortization of deferred compensation
associated with the issuance of additional stock options in 1996 under the
Company's 1995 Stock Option Plan.
Interest Income
Interest income of $2,033,571 and $2,099,004 during 1997 and 1996,
respectively, primarily reflects interest income attributable to the short-term
investment of the proceeds from the Company's initial public offering in May
1996. Interest income also reflects the amortization of deferred interest income
attributable to ALM sales-type leases. The amount of interest income
attributable to short-term investments and the amortization of deferred interest
was substantially unchanged in 1997 as compared to 1996. Interest income of
$48,476 for the year ended December 31, 1995 reflects the amortization of
deferred interest income attributable to ALM sales-type leases.
Interest Expense
Interest expense for the year ended December 31, 1997 was $35,359,
compared to $60,083 and $105,981 for the years ended December 31, 1996 and 1995,
respectively. The decrease for the year ended December 31, 1997 as compared to
1996, is due primarily to payments made under the terms of capital lease
obligations and other charges. The decrease for the year ended December 31, 1996
as compared to the same period in 1995, is due primarily to the repayment of
outstanding debt with the proceeds from the Company's initial public offering.
Income Taxes
The Company has recorded a valuation allowance for the full amount of
its deferred income tax assets as of December 31, 1997, 1996 and 1995, based on
management's evaluation of the recognition criteria as set forth in Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes."
Liquidity and Capital Resources
The Company has generated operating losses of $28,105,547 since its
inception and has financed its operations primarily through net proceeds from
its initial public offering in May 1996. Prior to the Company's initial public
offering, the Company's operations were financed through the private sale of
debt and equity securities, capital lease obligations, bank financing, factoring
of ALM rental contracts, and loans from affiliates. Net proceeds from the
Company's initial public offering were $60,088,516.
Net cash used in 1997 to fund operations was $15,394,559. During 1997,
net proceeds from the offering and other sources of cash were used to fund
operations and capital expenditures of $1,683,755. At December 31, 1997, cash,
cash equivalents and short-term investments were $23,605,600 and working capital
was $28,599,560. At December 31, 1996, cash, cash equivalents and short-term
investments were $42,147,947 and working capital was $43,672,679.
The Company continues to use a substantial amount of existing cash
resources to fund its operations. If the Company continues to use cash resources
at the rate used in 1997, the Company will deplete its existing cash resources
in the latter part of 1999. The Company believes existing cash, cash
equivalents, internally generated funds and available borrowings will be
sufficient to meet the Company's currently anticipated operating expenditure
requirements during 1998. During 1998, the Company expects to continue to use a
significant amount of existing cash, cash equivalents and internally generated
funds to fund research and development, marketing efforts designed to promote
consumer awareness and use of its products and services and capital
expenditures. In order to fund more rapid expansion, to develop new or enhanced
products or to address liquidity needs caused by shortfalls in revenues, the
Company may need to raise additional capital in the future. If additional funds
are raised through the issuance of equity securities, the percentage ownership
of the stockholders of the Company will be reduced, stockholders may experience
additional dilution, or such equity securities may have rights, preferences or
privileges senior to common stock. There can be no assurance that additional
financing will be available when needed on terms acceptable to the Company or at
all. If adequate funds are not available or not available on acceptable terms,
the Company may be unable to develop, enhance and market products, retain
qualified personnel, take advantage of future opportunities, or respond to
competitive pressures, any of which could have a material adverse effect on the
Company's business, operating results and financial condition.
In July 1997, the Company adopted a share repurchase plan under which
the Company was authorized to use up to $2 million of general corporate funds to
acquire from time to time in the open market shares of the outstanding common
stock of the Company. As of December 31, 1997, the Company had repurchased a
total of 336,000 shares at an average price of $2.58 per share for an aggregate
cost of $867,438 under the share repurchase plan. In addition, during 1997 the
Company has repurchased an aggregate of 643,066 shares of its common stock from
former employees of the Company at an aggregate cost of $484 pursuant to stock
purchase agreements with such former employees.
Implications of Year 2000 Issues
The Company has evaluated its existing applications and systems against
anticipated Year 2000 issues and has modified its software to address identified
issues. All current and future technology initiatives are being developed with
Year 2000 issues in mind and will also be tested and modified accordingly, if
necessary, to eliminate known issues. The Company has determined that no
significant modifications or replacement of portions of its software are
necessary to assure that its computer systems will function properly with
respect to dates in the year 2000 and beyond.
The Company has initiated discussions with significant suppliers,
customers and financial institutions to ensure those parties have appropriate
plans to remediate Year 2000 issues where their systems interface with the
Company's systems or otherwise impact operations. The Company is assessing the
extent its operations are vulnerable should those organizations fail to
remediate properly their computer systems.
Item 7.(a) Quantitative and Qualitative Disclosures about Market Risk
Not Applicable.
<PAGE>
Item 8. Financial Statements and Supplemental Data
The report of independent auditors and consolidated financial statements are set
forth below (see item 14(a)(1) for list of financial statements and financial
statement schedules):
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Affinity Technology Group, Inc.
We have audited the accompanying consolidated balance sheets of Affinity
Technology Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Affinity
Technology Group, Inc. and subsidiaries at December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
Greenville, South Carolina
March 11, 1998
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31,
1997 1996
---------------------- --------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 4,470,185 $ 31,563,950
Investments 19,135,415 10,583,997
Accounts receivable, less allowance for doubtful
accounts of $400,120 and $198,987 at December 31, 1997
and 1996,respectively 1,944,947 327,895
Net investment in sales-type leases - current:
Third parties 1,537,902 620,270
Related party 195,026 245,110
Inventories 2,960,038 2,804,978
Other current assets 799,628 820,987
---------------------- --------------------
Total current assets 31,043,141 46,967,187
Net investment in sales-type leases - non-current:
Third parties 1,317,753 2,159,832
Related party 10,988 226,178
Property and equipment, net 6,028,980 6,073,303
Software development costs, less accumulated
amortization of $117,807 and $67,686 at December
31, 1997 and 1996, respectively 750,323 363,721
Other assets 3,058,385 308,636
====================== ====================
Total assets $ 42,209,570 $ 56,098,857
====================== ====================
</TABLE>
See accompanying notes.
<PAGE>
<TABLE>
<CAPTION>
December 31,
1997 1996
---------------------- ----------------------
<S> <C> <C>
Liabilities and stockholders' equity Current liabilities:
Current portion of capital lease obligations to related $ 64,222 $ 69,987
party
Accounts payable 666,824 1,442,662
Accrued expenses 390,584 802,534
Accrued compensation and related benefits 561,391 455,405
Current portion of deferred revenue - related party 40,463 81,259
Current portion of deferred revenue - third parties 720,097 442,661
---------------------- ----------------------
Total current liabilities 2,443,581 3,294,508
Capital lease obligations to related party, less current
portion - 66,245
Deferred revenue - related party - 39,805
Deferred revenue - third parties 535,419 363,660
Capital stock of subsidiary held by minority investor - 200,000
Commitments and contingent liabilities
Stockholders' equity:
Common stock, par value $0.0001; authorized
60,000,000 shares, issued 31,550,199 in 1997
and 27,879,680 shares in 1996 3,155 2,788
Additional paid-in capital 69,858,571 68,777,090
Deferred compensation (1,558,574) (3,939,044)
Treasury stock, at cost (992,207 shares at
December 31, 1997) (967,035) -
Accumulated deficit (28,105,547) (12,706,195)
---------------------- ----------------------
Total stockholders' equity 39,230,570 52,134,639
====================== ======================
Total liabilities and stockholders' equity $ 42,209,570 $ 56,098,857
====================== ======================
</TABLE>
See accompanying notes.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Years ended December 31,
1997 1996 1995
---------------------- ---------------------- ----------------------
<S> <C> <C> <C>
Revenues:
Transactions and other $ 1,124,858 $ 302,812 $ 121,095
Initial set-up 638,687 426,848 128,715
Sales and rental (including $286,413 and $400,591
from related party for 1996 and 1995, 1,590,620 2,552,158 1,275,101
respectively)
Professional services 792,734 - -
License revenue - 1,800,000 -
---------------------- ---------------------- ----------------------
4,146,899 5,081,818 1,524,911
Costs and expenses:
Cost of revenues 2,125,646 3,088,321 1,101,330
Research and development 3,526,257 2,905,232 368,452
Selling, general and administrative expenses 15,892,560 10,819,381 2,305,653
---------------------- ---------------------- ----------------------
Total costs and expenses 21,544,463 16,812,934 3,775,435
---------------------- ---------------------- ----------------------
Operating loss (17,397,564) (11,731,116) (2,250,524)
Interest income 2,033,571 2,099,004 48,476
Interest expense - third parties - - (23,325)
Interest expense - related parties (35,359) (60,083) (82,656)
---------------------- ---------------------- ----------------------
Net loss $ (15,399,352) $ (9,692,195) $ (2,308,029)
====================== ====================== ======================
Net loss per share - basic and diluted $ (0.54) $ (0.40) $ (0.15)
====================== ====================== ======================
Shares used in computing net loss per share 28,477,880 24,136,480 15,044,286
====================== ====================== ======================
</TABLE>
See accompanying notes.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Preferred Preferred Additional Total
Stock, Stock, Common Paid-in Deferred Treasury Accumulated Stockholders'
Series A Series B Stock Capital Compensation Stock Deficit Equity
---------- ----------- -------- ------------ --------------- ------------- --------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $ - $ - $ 1,508 $ 25,000 $ - $ - $ (705,971) $ (679,463)
Issuance of preferred
stock,Series A 250,000 - - - - - - 250,000
Issuance of preferred
stock, Series B - 2,732,356 - - - - - 2,732,356
Issuance of common stock - - 162 98,138 - - - 98,300
Deferred compensation
related to grant of stock
options - - - 4,114,822 (4,114,822) - - -
Amortization of deferred
compensation - - - - 524,248 - - 524,248
Net loss - - - - - - (2,308,029) (2,308,029)
---------- ----------- --------- ----------- ------------- ----------- --------------- ----------------
Balance at December 31, 1995 250,000 2,732,356 1,670 4,237,960 (3,590,574) - (3,014,000) 617,412
Exercise of warrants - 45,417 - - - - - 45,417
Conversion of preferred
stock (250,000) (2,777,773) 602 3,027,171 - - - -
Initial public offering - - 506 60,088,010 - - - 60,088,516
proceeds
Exercise of stock options - - 10 46,990 - - - 47,000
Deferred compensation
related to grant of stock
options - - - 1,376,959 (1,376,959) - - -
Amortization of deferred
compensation - - - - 1,028,489 - - 1,028,489
Net loss - - - - - - (9,692,195) (9,692,195)
---------- ----------- -------- ------------ ------------- ----------- --------------- ----------------
Balance at December 31, 1996 - - 2,788 68,777,090 (3,939,044) - (12,706,195) 52,134,639
Exercise of warrants - - 4 37,473 - - - 37,477
Exercise of warrants by
related party - - 240 - - - - 240
Exercise of stock options - - 30 144,034 - - - 144,064
Amortization of deferred
compensation - - - - 480,534 - - 480,534
Forfeiture of stock
options - - - (1,899,936) 1,899,936 - - -
Purchase of treasury stock - - - (967,035) - (967,035)
Issuance of common stock
in exchange for capital
stock of subsidiary held by
minority investor - - 67 1,599,933 - - - 1,600,000
Issuance of common stock
for acquisition - - 26 1,199,977 - - - 1,200,003
Net loss - - - - - - (15,399,352) (15,399,352)
========== =========== ======== =========== ============= ============= ============= ==============
Balance at December 31, 1997 $ - $ - $ 3,155 $69,858,571 $(1,558,574) $(967,035) $(28,105,547) $39,230,570
========== =========== ======== ============ ============= =========== =============== ================
</TABLE>
See accompanying notes.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years ended December 31,
1997 1996 1995
---------------------- ---------------------- ---------------------
<S> <C> <C> <C>
Operating activities
Net loss $ (15,399,352) $ (9,692,195) $ (2,308,029)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 2,066,270 902,846 145,248
Amortization of deferred compensation 480,534 1,028,489 524,248
Provision for doubtful accounts 456,841 170,000 3,667
Inventory valuation allowance 230,000 20,000 46,000
Deferred revenue 368,594 (1,098,072) 754,227
Deferred license revenue - - 1,237,500
Other 195,505 59,243 22,931
Changes in current assets and liabilities:
Accounts receivable (2,073,893) (261,531) (146,962)
Net investment in sales-type leases 189,721 (2,093,519) (1,157,871)
Inventories (755,248) (2,420,946) (257,317)
Other assets (6,633) (784,976) (28,232)
Accounts payable (775,838) 702,449 486,309
Accrued expenses (477,046) 508,361 281,313
Accrued compensation and related benefits 105,986 233,331 187,478
---------------------- ---------------------- ---------------------
Net cash used in operating activities (15,394,559) (12,726,520) (209,490)
Investing activities
Purchases of property and equipment (1,683,755) (5,558,806) (1,350,702)
Proceeds from sale of property and equipment 144,535 - -
Software development costs (451,304) (214,820) (216,587)
Purchases of short-term investments (34,345,695) (10,583,997) -
Sales of short-term investments 25,794,277 - -
Other (300,000) (349,618) (5,954)
---------------------- ---------------------- ---------------------
Net cash used in investing activities (10,841,942) (16,707,241) (1,573,243)
Financing activities
Proceeds from notes payable to related parties - 450,000 769,269
Proceeds from notes payable to third parties - 1,000,000 250,000
Principal payments on capital leases (72,010) (156,289) (53,075)
Payments on notes payable to related parties - (775,416) (170,427)
Payments on notes payable to third parties - (1,000,000) (300,536)
Proceeds from sale of capital stock of subsidiary to
minority interest - 62,500 137,500
Purchase of treasury stock (871,775) - -
Exercise of warrants 37,717 45,417 -
Exercise of options 48,804 47,000 -
Proceeds from issuance of common stock - 60,088,516 1,000
Proceeds from issuance of preferred stock - - 2,355,000
---------------------- ---------------------- ---------------------
Net cash (used in) provided by financing activities (857,264) 59,761,728 2,988,731
---------------------- ---------------------- ---------------------
Net (decrease) increase in cash (27,093,765) 30,327,967 1,205,998
Cash and cash equivalents at beginning of year 31,563,950 1,235,983 29,985
====================== ====================== =====================
Cash and cash equivalents at end of year $ 4,470,185 $ 31,563,950 $ 1,235,983
====================== ====================== =====================
Cash paid during the year for:
Interest $ - $ 85,287 $ 67,377
</TABLE>
See accompanying notes.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 1997
1. The Company
Affinity Technology Group, Inc. (the "Company") was incorporated on January 12,
1994. On May 1, 1996, the Company completed a public offering of 5,060,000
shares of $0.0001 par value Common Stock (the "Initial Public Offering"). The
Initial Public Offering price was $13 per Common Share resulting in gross
offering proceeds of $65,780,000. Proceeds to the Company, net of underwriters'
discount and total offering expenses, were $60,088,516.
Simultaneously with the offering the preferred stock of the Company, consisting
of 23,810 shares of Series A Preferred Stock and 32,967 shares of Series B
Preferred Stock (including 3,702 shares of Series B Preferred Stock issued upon
the exercise of outstanding warrants), was automatically converted into an
aggregate of 6,018,362 shares of Common Stock.
Since its formation the Company has concentrated its product development efforts
primarily on a "closed loop" electronic commerce system that enables financial
institutions to automate the processing and consummation of consumer loans and
other financial services at the point of sale. This technology is designed to
enable financial institutions to open new distribution channels for their
products and services, thereby increasing assets and revenues and broadening
customer relationships while reducing their operating and infrastructure costs.
The primary platform currently offered by the Company is the Automated Loan
Machine ("ALM"), which permits a consumer to apply for and, if determined to be
a suitable credit risk, receive a loan without human intervention in as little
as 10 minutes. Similar in appearance to an automated teller machine ("ATM"), the
Affinity ALM is a fully automated system that utilizes the Company's proprietary
DeciSys/RT technology to process consumer loans, generate the underlying loan
documentation and distribute loan proceeds. In addition, the ALM can be
programmed to process other financial services transactions such as the
establishment of savings and checking accounts, the consummation of joint loans,
certain secured loans and credit consolidation loans and the issuance of credit
cards.
Similar to the ALM platform, the Company has developed the e-xpertLender
platform. This platform permits a financial institution to input consumer
applicant information resembling information captured by the ALM, and using
DeciSys/RT to process all of the financial services available via the ALM in
considerably less time than the ALM. In addition to the financial services
processing capabilities e-xpertLender integrates with the subscriber financial
institution's legacy system providing inquiry, routing and tracking
functionality.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Affinity
Technology Group, Inc. and its subsidiaries, Affinity Bank Technology
Corporation, Affinity Clearinghouse Corporation, Affinity Credit Corporation,
Affinity Processing Corporation ("APC"), Affinity Mortgage Technology, Inc.
and Multi Financial Services, Inc. and its wholly owned subsidiary Surety
Mortgage, Inc. All significant intercompany balances and transactions have been
eliminated in consolidation.
Segment Information
In June of 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS 131"), effective for years
beginning after December 15, 1997. SFAS 131 establishes standards for the
disclosure of financial and descriptive information pertaining to an
enterprise's reportable operating segments in annual and interim financial
statements. The Company does not expect the adoption of SFAS 131 will have a
material impact on the presentation of the Company's financial results or
financial position.
Software Revenue Recognition
In October of 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-2 "Software Revenue Recognition" ("SOP 97-2"),
effective for transactions entered into in fiscal years beginning after December
15, 1997. SOP 97-2 provides guidance on software revenue recognition associated
with the licensing and selling of computer software. The Company continues to
assess the effects that the adoption of SOP 97-2 will have on the presentation
of the Company's financial statements.
Minority Investor
An unrelated third party exchanged 240,570 shares of APC common stock for
666,667 shares of ATG common stock on May 21,1997. The exchange was accounted
for as a purchase of minority interest in a majority owned subsidiary. The fair
market value of the ATG common stock at the time of the exchange was
approximately $1,600,000. The unrelated third party had previously acquired the
shares of APC common stock for aggregate consideration of $125,000, and 90,988
shares of APC convertible preferred stock, which was acquired for aggregate
consideration of $75,000 ("capital stock of subsidiary held by minority
investor" as captioned in the Company's 1996 financial statements). These
holdings represented a 24.9% minority interest in APC at December 31, 1996.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Concentrations of Credit Risk
The Company markets its products to financial institutions throughout the United
States. The Company performs ongoing credit evaluations of customers and retains
a security interest in leased equipment.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Investments
The Company has adopted Statement of Financial Accounting Standards No. 115
("SFAS 115"), "Accounting for Certain Investments in Debt and Equity
Securities." In accordance with SFAS 115, the Company classifies its investments
as held to maturity or available for sale. Prior to 1997, all of the Company's
investments were being held to maturity and were classified accordingly. During
1997, the Company acquired certain investments which have been classified as
available for sale. At December 31, 1997 approximately $12,700,000 and
$6,400,000 were classified as available for sale and held to maturity,
respectively. Investments consist of investments in certificates of deposit,
corporate bonds and U.S. Government securities with maturities greater than
three months. Such investments are reported at amortized cost at December 31,
1997, which approximates fair value. The Company did not recognize any
unrealized holding gains or losses associated with investments classified as
available for sale during the year ended December 31, 1997.
Inventories
Inventories at December 31, 1997 and 1996 are stated at the lower of cost or
market. Cost is determined using the first-in, first-out ("FIFO") cost flow
assumption.
Property and Equipment
Property and equipment are recorded at cost. Depreciation and amortization are
computed using the straight-line method over the estimated useful lives of the
assets. Estimated useful lives range from five to ten years for office furniture
and fixtures and three to five years for all other depreciable assets.
Depreciation expense (including amortization of equipment leased under capital
leases) was $1,799,259, $848,699 and $109,918 during 1997, 1996 and 1995,
respectively.
Software Development Costs
Costs incurred in the development of software, which is incorporated as part of
the Company's products or sold separately, are capitalized after a product's
technological feasibility has been established. Capitalization of such costs is
discontinued when a product is available for general release to customers.
Software development costs are capitalized at the lower of cost or net
realizable value and amortized using the greater of the revenue curve method or
the straight-line method over the estimated economic life of the related
product. Amortization begins when a product is ready for general release to
customers.
Amortization of capitalized software development was $64,702, $54,147 and
$13,539 during 1997, 1996 and 1995, respectively.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Intangible Assets
Intangible assets arising from the excess of cost over acquired assets is being
amortized by the straight line method over their estimated useful life of ten
years. Intangible assets, primarily goodwill, consisted of $1,470,000 which was
recorded in conjunction with the acquisition of Buy American, Inc. and Project
Freedom, Inc. (see Note 7), and approximately $1,400,000 which was recorded in
conjunction with the exchange of APC common stock for ATG common stock. See
"Minority Investor" above. Accumulated amortization associated with these
intangible assets approximated $86,000 at December 31, 1997.
The carrying value of intangible assets are assessed if information and
circumstances suggest impairment. If the assessment identifies that carrying
values are not recoverable, the Company would reduce carrying values by
estimated deficiencies based upon discounted cash flows over the remaining
amortization period.
Revenue Recognition
Initial set-up - The Company leases ALMs to customers utilizing both sales-type
and operating lease arrangements and concurrently enters into a service and
processing agreement (the "ALS Agreement") with the customer. Pursuant to the
ALS Agreement, the customer pays an initial set-up fee which is initially
recognized as deferred revenue. Generally upon installation of an ALM, the
Company recognizes as revenue the portion of the initial set-up fee attributable
to the related costs of set-up and installation. The remainder of the initial
fee is deferred and amortized ratably over the term of the ALS Agreement.
Transaction fees - Transaction fee revenue is recognized as the related
transactions are processed. Transaction processing fees and other revenues
represented approximately 26%, 4% and 4% of total revenue during 1997, 1996 and
1995, respectively.
Professional services - In conjunction with the installation of the Company's
technology, periodically additional customer specific technology development is
performed by the Company in the form of professional services. The Company
generally enters into a contract with the customer for the performance of these
services. Upon completion and acceptance of professional services by the
customer, the Company recognizes the corresponding revenue.
Sales and rental - Revenue and costs related to leases of ALM equipment are
recognized in accordance with Statement of Financial Accounting Standards No.
13, "Accounting for Leases" (see Note 3). Revenue from sales-type leases is
generally recognized when the equipment is installed and accepted by the
customer. Operating lease revenue is recognized ratably over the lease term.
Software licensing - The Company recognizes revenue from sales of software
licenses upon delivery of the software product to a customer, unless the Company
has significant related obligations remaining. When significant obligations
remain after the software product has been delivered, revenue is not recognized
until such obligations have been completed or are no longer significant. The
costs of any remaining insignificant obligations are accrued when the related
revenue is recognized.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Deferred revenues - Deferred revenues relate to unearned revenue on ALM leases.
Deferred license revenue at December 31, 1995 related to a non-exclusive,
perpetual, royalty-free license, to be granted to a financial institution, to
use one of the Company's software products, Assets(3). The financial institution
is the unaffiliated third party who held the minority interest in APC - see
"Minority Investor" above. At December 31, 1995, the financial institution had
paid the Company $1,237,500 as a license fee for use of an initial version of
Assets(3) in the United States, which was deferred pending delivery of the
product. The Company delivered the product to the financial institution in 1996,
and accordingly recognized the deferred revenue in income. In addition, the
financial institution exercised an option to purchase for $562,500 a perpetual
royalty-free license to use Assets(3) in North America, which option became
exercisable upon the Company's enhancement of such system. The Company delivered
such enhancement during 1996 and recorded the additional license fee as revenue
upon delivery and acceptance by the financial institution.
Cost of Revenues
Cost of revenues consists of costs associated with initial set-up, transaction
fees, sales and rental revenues and professional services. Costs associated with
initial set-up fees include labor, other direct costs and an allocation of
related indirect costs. Labor and other direct costs associated with initial
set-up fees totaled $232,077, $426,848 and $122,404 for the years ended December
31, 1997, 1996 and 1995, respectively. Costs associated with sales and rental
revenues include the cost of the leased ALM hardware, other direct costs and an
allocation of related indirect costs. Costs of ALM hardware sold under
sales-type leases, depreciation expense for hardware leased to customers under
operating leases and other direct costs associated with sales and rental
revenues totaled $1,041,455, $2,426,476 and $746,820 for the years ended
December 31, 1997, 1996 and 1995, respectively. Costs associated with
professional services include labor, other direct costs and an allocation of
related indirect costs. Labor and other direct and allocation of indirect costs
associated with professional services totaled $524,047 for the year ended
December 31, 1997.
Net Loss Per Share of Common Stock
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128")
effective for fiscal years ending after December 15, 1997, which supersedes
Accounting Principles Board Opinion No. 15 "Earnings Per Share" ("APB 15"). SFAS
128 changes the method used to compute earnings per share and requires companies
to restate all prior periods where applicable. Under the new requirements for
calculating basic earnings per share, the dilutive effect of stock options and
warrants are to be excluded. The Company has adopted SFAS 128 and all net loss
per share of Common Stock amounts presented have been computed based on the
weighted average number of shares of Common Stock outstanding in accordance with
SFAS 128.
Income Taxes
Deferred income taxes are calculated using the liability method prescribed by
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("SFAS 109").
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Stock Based Compensation
The Company accounts for stock options in accordance with APB Opinion No.25,
"Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, no
compensation expense is recognized for stock or stock options issued at fair
value. For stock options granted at exercise prices below the estimated fair
value, the Company records deferred compensation expense for the difference
between the exercise price of the shares and the estimated fair value. The
deferred compensation expense is amortized ratably over the vesting period of
the individual options. For performance based stock options, the Company records
compensation expense related to these options over the performance period.
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" ("SFAS 123"), provides an alternative to APB 25 in accounting for
stock based compensation issued to employees. SFAS 123 provides for a fair value
based method of accounting for employee stock options and similar equity
instruments. However, for companies that continue to account for stock based
compensation arrangements under APB 25, SFAS 123 requires disclosure of the pro
forma effect on net income and earnings per share as if the fair value based
method prescribed by SFAS 123 had been applied. The Company intends to continue
to account for stock based compensation arrangements under APB No. 25 and has
adopted the pro forma disclosure requirements of SFAS 123.
Advertising Expense
The cost of advertising is expensed as incurred. Advertising and marketing
expense was approximately $1,488,147, $1,662,000 and $154,000 during 1997, 1996
and 1995, respectively.
Reclassification
Certain amounts in 1996 and 1995 have been reclassified to conform to 1997
presentations for comparability. These reclassifications have no effect on
previously reported stockholders' equity or net loss.
3. Sales-Type and Operating Leases
The components of the net investment in sales-type leases are as follows:
<TABLE>
<CAPTION>
December 31,
1997 1996
-------------------- --------------------
<S> <C> <C>
Total minimum lease payments receivable $ 3,124,181 $ 3,271,650
Residual values 360,000 360,000
-------------------- --------------------
3,484,181 3,631,650
Less unearned interest income (422,512) (380,260)
==================== ====================
Net investment in sales-type leases 3,061,669 3,251,390
==================== ====================
Net investment is classified as:
Current 1,732,928 865,380
Non-current 1,328,741 2,386,010
==================== ====================
$ 3,061,669 $ 3,251,390
==================== ====================
</TABLE>
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Future minimum lease payments to be received on sales-type and operating leases
at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
Sales-Type Operating
-------------------- --------------------
<S> <C> <C>
1998 $ 1,644,639 $ 108,000
1999 801,998 108,000
2000 429,261 -
2001 248,283 -
-------------------- --------------------
$ 3,124,181 $ 216,000
==================== ====================
</TABLE>
4. Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
December 31,
1997 1996
-------------------- -------------------
<S> <C> <C>
Electronic parts and other components $ 1,396,826 $ 1,166,277
Work in process 829,269 213,646
Finished goods 906,950 1,445,055
-------------------- -------------------
3,133,045 2,824,978
Reserve for obsolescence (173,007) (20,000)
==================== ===================
$ 2,960,038 $ 2,804,978
==================== ===================
</TABLE>
5. Property and Equipment
Property and equipment consists of the following:
<TABLE>
<CAPTION>
December 31,
1997 1996
-------------------- -------------------
<S> <C> <C>
ALM equipment leased to others under operating leases $ 935,521 $ 1,473,569
Data processing equipment 2,326,651 2,219,525
Demonstration equipment 582,857 433,727
Office furniture and fixtures 2,338,381 1,347,182
Automobiles 72,003 72,003
Purchased software 2,229,955 1,469,605
-------------------- -------------------
8,485,368 7,015,611
Less accumulated depreciation and amortization (2,456,388) (942,308)
--------------------
===================
$ 6,028,980 $ 6,073,303
==================== ===================
</TABLE>
Accumulated depreciation of ALM equipment leased to others was $424,141 and
$328,433 at December 31, 1997 and 1996, respectively.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Stockholders' Equity
Convertible Preferred Stock
Pursuant to the Company's Certificate of Incorporation, the Board of Directors
has the authority, without further action by the stockholders, to issue up to
5,000,000 shares of preferred stock in one or more series and to fix the
designations, powers, preferences, privileges, and relative participating,
optional or special rights and the qualifications, limitations or restrictions
thereof, including dividend rights, conversions rights, voting rights, terms of
redemption and liquidation preferences, any or all of which may be greater than
the rights of the Common Stock. At December 31, 1997 there are no shares of
preferred stock issued or outstanding.
Stock Split
During April 1996, the Company's Board of Directors approved a 106-for-1 common
stock split and an increase in the common stock par value to $.0001 effective
immediately upon completion of the Initial Public Offering. All common share,
option and warrant data have been restated to reflect the split.
Stock Option Plans
During 1995, the Company adopted the 1995 Option Plan under which incentive
stock options and nonqualified stock options may be granted to employees,
directors, consultants or independent contractors. At December 31, 1997, the
weighted average exercise price was $0.44 and the weighted average remaining
contractual life was 7.8 years. This plan closed during April 1996.
In April 1996, the Company adopted the 1996 Stock Option and Incentive Plan.
Under the terms of both plans, incentive options may be issued at an exercise
price not less than the estimated fair market value on the date of grant.
Generally, options granted vest ratably over a 60 month term. However, options
granted in 1995 to certain officers vest over a shorter period. At December 31,
1997, approximately 44,600 and 315,110 options are exercisable under the 1996
and 1995 Option Plans, respectively. At December 31, 1997, weighted average
exercise price was $6.09 and the weighted average remaining contractual life was
9.3 years.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Stockholder's Equity (continued)
A summary of activity under the 1996 and 1995 Option Plans is as follows:
<TABLE>
<CAPTION>
Shares Options Outstanding
----------------------------------------
Available Number Price
for Grant Of Shares Per Share
------------------- -------------------- -------------------
<S> <C> <C> <C>
1995 Stock Option Plan
Shares reserved 2,173,000 - -
Options granted (1,645,120) 1,645,120 $0.44
Options canceled/forfeited 5,300 (5,300) -
------------------- -------------------- -------------------
Balance at December 31, 1995 533,180 1,639,820 $0.44
Options granted (178,080) 178,080 $0.44
Options canceled/forfeited 78,758 (78,758) $0.44
Options exercised - (106,000) $0.44
Plan closed (433,858) - -
------------------- -------------------- -------------------
Balance at December 31, 1996 - 1,633,142 $0.44
Options canceled/forfeited - (426,544) $0.44
Options exercised - (319,202) $0.44
=================== ==================== ===================
Balance at December 31, 1997 - 887,396 $0.44
=================== ==================== ===================
1996 Stock Option Plan
Shares reserved 1,900,000 - -
Options granted (97,500) 97,500 $11.88
------------------- -------------------- -------------------
Balance at December 31, 1996 1,802,500 97,500 $11.88
Options granted (744,225) 744,225 $2.63 - $7.38
Options canceled/forfeited 125,525 (125,525) $4.25 - $11.88
------------------- -------------------- -------------------
Balance at December 31, 1997 1,183,800 716,200 $2.63 - $11.88
=================== ==================== ===================
</TABLE>
The Company has recorded in 1996 and 1995 deferred compensation expense totaling
$5,491,781 for the difference between the grant price and the deemed fair value
of certain of the Company's common stock options granted under the 1995 Plan.
During 1997 the Company adjusted the deferred compensation expense to reflect
actual compensation expense earned by terminated employees. The Company
continues to amortize the deferred compensation of the remaining individuals
still employed by the Company over the vesting period of the individual options.
The vesting periods for options granted to one of the Company's officers are:
(a) 90 days from employment date for a portion of the options and (b) a 48 month
period following such 90 day period for the remainder of the options. The
vesting period for other options is generally 60 months. Amortization of
deferred compensation in 1997, 1996 and 1995 totaled $480,534, $1,028,489 and
$524,248, respectively.
During 1994 and 1995, in connection with the execution of employment agreements
with two executive officers and a consulting agreement with one of the Company's
directors, the Company sold 4,155,200 shares of restricted common stock to the
officers and directors for nominal consideration. Under the terms of the
agreements, up to 764,048 of the shares were subject to repurchase by the
Company based on cost at a sliding scale over a 60 month term (resulting in a
reduced number of shares subject to repurchase) if the related employment
arrangements terminate. During 1997 the two officers terminated their employment
and the Company repurchased 643,066 shares pursuant to the provisions of the
employment agreements.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Stockholder's Equity (continued)
During 1996, 40,000 performance based stock options were awarded in connection
with an employment agreement of a key employee. Under the terms of this
agreement, these options lapsed based upon the Company not meeting certain 1997
operating results. In addition, of the total options granted during 1997 131,100
were performance based stock options awarded in connection with employment
agreements with key employees. Under the terms of these agreements, these
options may lapse if certain performance measures are not met. Under the terms
of these agreements, 84,000 of these options lapsed based upon the required
performance measures not being met. If the remaining required performance
measures are met these options generally vest over a 60 month period.
The pro forma disclosures required by SFAS 123 regarding net loss and loss per
share are stated as if the Company has accounted for stock options granted
subsequent to December 31, 1994 using fair values. Using the Black-Scholes
option pricing model the fair value at the date of grant for these options was
estimated using the following assumptions: risk-free interest rates ranging from
5.4% to 6.7% for 1997, 5.8% to 6.8% for 1996 and 5.3% to 6.8% for 1995,
volatility factor of the expected market price of the Company's common stock of
0.75 for 1997 and 0.69 for 1996 and 1995, and an expected option life ranging
from 1 to 5 years.
The Black-Scholes and other option pricing models were developed for use in
estimating fair value of traded options which have no vesting restrictions and
are fully transferable. In addition, option pricing models require the input of
highly subjective assumptions. The Company's employee stock options have
characteristics significantly different than those of traded options, and
changes in the subjective assumptions can materially affect the fair value
estimate. Accordingly, in management's opinion, these existing models may not
necessarily provide a reliable single measure of the fair value of employee
stock options.
For purposes of pro forma disclosures, the estimated fair values of the options
are amortized to expense over the expected life of the options. The Company's
pro forma information follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------------- ----------------- -------------------
<S> <C> <C> <C>
Pro forma net loss $(16,258,811) $(10,662,080) $(2,279,981)
Pro forma net loss per share - basic and diluted $(0.57) $(0.44) $(0.15)
</TABLE>
Stock Warrants
In 1995, the Company formalized an agreement with a related party, resulting
from certain financing arrangements preceding the Initial Public Offering, for
the issuance of a stock warrant under which the party had the right to purchase
up to an aggregate of 6,666,340 shares of common stock at a purchase price of
approximately $.0001 per share. The agreement also specified that the warrant
could be exercised in whole or in part at any time prior to December 31, 2015
only if, absent prior written regulatory approval, after giving effect of such
exercise, the party beneficially own less than five percent of the outstanding
shares of the Company's common stock. During 1997 the party obtained written
regulatory approval to exercise the warrant in its entirety. The warrant is not
transferable without regulatory approval. On December 31, 1997 and December 28,
1995, the party exercised portions of the warrant and acquired 2,400,000 and
795,000 shares of Common Stock, respectively.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Stockholder's Equity (continued)
Pursuant to an agreement reached in 1994, the Company issued warrants to
purchase certain equity securities as might be determined by a subsequent
financing for an aggregate purchase price of $7,500. Pursuant to the terms of
the agreements, and in conjunction with the Company's issuance of Series B
Preferred Stock in 1995, the holders of these warrants became entitled to
purchase an aggregate of 79 shares of Series B Preferred Stock at the price of
$93.366 per share. These warrants were exercised concurrently with the
completion of the Initial Public Offering and were automatically converted into
8,374 shares of Common Stock. The warrants had negligible value at the time of
issuance.
In 1995, the Company issued warrants to purchase shares of Common Stock for an
aggregate purchase price of $37,500. Pursuant to the terms of the agreements,
and in conjunction with the Company's issuance of Series B Preferred Stock in
October 1995, the per share exercise price was established at approximately
$0.88, and accordingly, the warrants represented rights to purchase 42,571
shares of Common Stock. During 1997 all of these warrants were exercised
pursuant to the terms of the agreements. The warrants had negligible value at
the time of issuance.
The Company agreed, in connection with the issuance of a convertible note in
1995, to issue a warrant to a director of the Company. In 1995, the Company
issued the warrant to the director for the right to purchase 3,623 shares of
Series B Preferred Stock at an exercise price of $10.50 per share. The warrant
was exercised concurrently with the completion of the Initial Public Offering in
1996 and automatically converted into 384,038 shares of common stock. The
warrant had negligible value at the time of issuance.
Convertible Notes
During 1995, the Company issued 707,868 shares of Common Stock upon conversion
of $75,000 notes payable to individuals plus accrued interest of $5,944.
Accordingly, the Company transferred $80,944 to stockholders' equity to record
the conversion.
During 1995, the Company issued convertible notes payable for proceeds totaling
$640,000. Subsequently in 1995, these notes and the accrued interest thereon
were converted by the holders into 136,210 shares of Common Stock and 27,854
shares of Preferred Stock. Accordingly, the Company transferred $649,656 to
stockholders' equity to record the conversion.
7. Acquisition
On May 7, 1997 the Company acquired the assets of Buy American, Inc. and Project
Freedom, Inc., two related companies, for aggregate consideration consisting of
$300,000 in cash and issuance of 259,460 shares of restricted common stock. The
acquisition was accounted for as a purchase. The results of operations of Buy
American, Inc. and Project Freedom, Inc. are included in the consolidated
financial statements from the date of acquisition. The consolidated results of
operations for the period ended December 31, 1997 would not be materially
different had the acquisition taken place at the beginning of the year.
The restricted common stock issued in association with the acquisition is
subject to a call option by the Company and put option by the sellers. The
Company has a single option to repurchase any or all shares of restricted common
stock at a price of $5.78 per share. The sellers of Buy American, Inc. and
Project Freedom, Inc. have a single option to sell any or all the shares of
restricted common stock to the Company at a price of $3.47 per share. These
options are exerciseable for a 30 day period ending May 31, 1999.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. Acquisition (continued)
Additionally, performance consideration in the form of future issuances of
common stock and cash payments are contingent upon specified performance
objectives and continued employment of a principal officer of Buy American, Inc.
and Project Freedom, Inc. by the Company. The contingent performance
consideration encompasses the five year period following the date of acquisition
of the assets of Buy American, Inc. and Project Freedom, Inc. Future issuance
of common stock and disbursement of cash will result in an additional element
of the purchase price.
8. Leases
Future minimum lease payments under capital leases in effect at December 31,
1997 are as follows:
1998 $ 69,558
-------------------
Total 69,558
Less amounts representing interest (5,336)
===================
Capital lease obligation to related party $ 64,222
===================
The Company has noncancellable operating leases for the rental of its office and
ALM assembly operations. Future minimum lease payments under these leases at
December 31, 1997 are as follows:
1998 578,341
1999 632,501
2000 638,001
2001 351,834
-------------------
Total $ 2,200,677
===================
In 1997, 1996 and 1995 the Company incurred rent expense, including rent
associated with cancelable rental agreements, of $798,930, $445,954 and $74,773,
respectively.
9. Income Taxes
As of December 31, 1997, the Company had federal and state net operating loss
carryforwards of approximately $27,356,100. The net operating loss carryforwards
will begin to expire in 2009 if not utilized.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. Income Taxes (continued)
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities consisted of the following at:
<TABLE>
<CAPTION>
December 31,
1997 1996
--------------------- ---------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 10,384,400 $ 4,351,700
Other 306,700 110,500
--------------------- ---------------------
Total deferred tax assets 10,691,100 4,462,200
--------------------- ---------------------
Deferred tax liabilities:
Capitalized software costs (284,800) (121,200)
Capital leases (158,100) (92,500)
Depreciation (318,800) (266,000)
Other - (1,700)
--------------------- ---------------------
Total deferred tax liabilities (761,700) (481,400)
--------------------- ---------------------
Less:
Valuation allowance (9,929,400) (3,980,800)
===================== =====================
Total net deferred taxes $ - $ -
===================== =====================
</TABLE>
The Company has recorded a valuation allowance for the full amount of its
deferred income tax assets as of December 31, 1997 and 1996, based on
management's evaluation of the evidential recognition requirements under the
criteria of SFAS 109. The main component of the evidential recognition
requirements was the Company's cumulative pretax losses since inception.
10. Segment Information
The Company conducts its business within one industry segment. To date, all
revenues generated have been from transactions with North American customers.
Three customers accounted for 68% of revenues in 1997 which individually
represented 48%, 13% and 7% of revenues. Two customers accounted for 58% of
revenues in 1996 which individually represented 37% and 21% of revenues, of
which $1.8 million or 34% of total revenues, related to the non-exclusive,
perpetual, royalty-free license for the call center decisioning system; see Note
2 "Summary of Significant Accounting Policies - Deferred Revenue." Four
customers accounted for 83% of revenues in 1995 which individually represented
26%, 26%, 17% and 14% of revenues.
11. Other Related Party Transactions
The Company leases ALMs to a bank which holds a warrant to acquire shares of
common stock of the Company. See Note 6. The Company has installed and otherwise
delivered a number of ALMs on behalf of the bank during 1996 and 1995. The
Company had a net investment of approximately $216,000 in sales-type leases and
trade accounts receivable of approximately $264,000 with the bank as of December
31, 1997. The bank also provided financing for the Company in the form of an
unsecured loan preceding the Initial Public Offering and provided lease
financing for a small portion of ALM hardware.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
12. Commitments and Contingencies
The Company is subject to legal actions from time to time which have arisen in
the ordinary course of business. Certain claims have also been filed by
plaintiffs who claim certain rights, damages or interests incidental to the
Company's formation and development. The Company intends to vigorously contest
all such actions and, in the opinion of management, the Company has meritorious
defenses and the resolution of such actions will not materially affect the
financial position of the Company.
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
Part III
Item 10. Directors and Executive Officers of the Registrant
Information required by this Item will be contained in the Registrant's
definitive proxy statement relating to its Annual Meeting of Stockholders to be
held on May 28, 1998 under the captions "Board of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compiance" which are incorporated by reference
herein.
Item 11. Executive Compensation
Information required by this Item will be contained in the Registrant's
definitive proxy statement relating to its Annual Meeting of Stockholders to be
held on May 28, 1998 under the caption "Executive Compensation", which is
incorporated by reference herein.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this Item will be contained in the Registrant's
definitive proxy statement relating to its Annual Meeting of Stockholders to be
held on May 28, 1998 under the caption "Security Ownership of Management and
Certain Beneficial Owners," which is incorporated by reference herein.
Item 13. Certain Relationships and Related Transactions
Information required by this Item will be contained in the Registrant's
definitive proxy statement relating to its Annual Meeting of Stockholders to be
held on May 28, 1998 under the caption "Certain Transactions" which is
incorporated by reference herein.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) The following consolidated financial statements of Affinity
Technology Group, Inc. and subsidiaries included in this
Annual Report on Form 10-K are included in Item 8.
i. Consolidated Balance Sheets as of December 31, 1997 and 1996.
ii. Consolidated Statement of Operations for the years ended
December 31, 1997, 1996 and 1995.
iii. Consolidated Statements of Stockholders' Equity for the yearS
ended December 31, 1997, 1996 and 1995.
iv. Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995.
v. Notes to the Consolidated Financial Statements for the years
ended December 31, 1997, 1996, and 1995.
(2) Schedule II - see additional section of this Report.
No other financial statement schedules are to be filed with
this Annual Report on Form 10-K due to the absence of the conditions
under which they are required or because the required information is
included within the consolidated financial statements or the notes
thereto included herein.
(3) Exhibits:
Exhibit Number Description
- -------------------- ----------------------------------------------------------
3.1 Certificate of Incorporation of Affinity Technology Group,
Inc. which is hereby incorporated by reference to Exhibit
3.1 to the Registration Statement on Form S-1 of Affinity
Technology Group, Inc. (File No. 333-1170).
3.2 By-laws of Affinity Technology Group, Inc. which is hereby
incorporated by reference to Exhibit 3.2 to the
Registration Statement on Form S-1 of Affinity Technology
Group, Inc. (File No. 333-1170).
4.1 Specimen Certificate of Common Stock which is hereby
incorporated by reference to Exhibit 4.1 to the
Registration Statement on Form S-1 of Affinity Technology
Group, Inc. (File No. 333-1170).
4.2 Warrant to Purchase Common Stock of Affinity Technology
Group, Inc. date November 8, 1995, for the purchase,
subject to certain conditions, up to 6,666,340 shares of
Common Stock which is hereby incorporated by reference to
Exhibit 4.7 to the Registration Statement on Form S-1 of
Affinity Technology Group, Inc. (File No. 333-1170).
4.3 Sections 4, 7 and 8 of the Certificate of Incorporation
of Affinity Technology Group, Inc., as amended, and
Article II, Sections 3, 9, and 10 of the By-laws of
Affinity Technology Group, Inc., as amended which are
incorporated by reference to Exhibits 3.1 and 3.2,
respectively.
10.1* Employment Agreement, dated October 1, 1995, between
Affinity Technology Group, Inc. and Carl M. Donnelly
which is hereby incorporated by reference to Exhibit 10.3
to the Registration Statement on Form S-1 of Affinity
Technology Group, Inc. (File No. 333-1170).
10.2 Letter Agreement, dated March 13, 1995, between Affinity
Technology Group, Inc. and Alan H. Fishman which is
hereby incorporated by reference to Exhibit 10.6 to
the Registration Statement on Form S-1 of Affinity
Technology Group, Inc. (File No. 333-1170).
10.3* Form of Stock Option Agreement (1995 Stock Option
Plan) which is hereby incorporated by reference to
Exhibit 10.7 to the Registration Statement on Form S-1
of Affinity Technology Group, Inc. (File No. 333-1170).
10.4* Form of Stock Option Agreement (1996 Stock Option Plan)
which is hereby incorporated by reference to Exhibit 10.8
to the Registration Statement on Form S-1 of Affinity
Technology Group, Inc. (File No. 333-1170).
10.5* Form of Stock Option Agreement (Directors'Stock Option
Plan) which is hereby incorporated by reference to
Exhibit 10.9 to the Registration Statement on Form S-1
of Affinity Technology Group, Inc. (File No. 333-1170).
10.6* 1995 Stock Option Plan of Affinity Technology Group, Inc.
which is hereby incorporated by reference to Exhibit
10.10 to the Registration Statement on Form S-1 of
Affinity Technology Group, Inc. (File No. 333-1170).
10.7* 1996 Stock Option Plan of Affinity Technology Group, Inc.
which is hereby incorporated by reference to Exhibit
10.11 to the Registration Statement on Form S-1 of
Affinity Technology Group, Inc. (File No. 333-1170).
10.8* Non-Employee Directors' Stock Option Plan of Affinity
Technology Group, Inc. which is hereby incorporated by
reference to Exhibit 10.12 to the Registration Statement
on Form S-1 of Affinity Technology Group, Inc.
(File No. 333-1170).
10.9 Stock Rights Agreement, dated October 20, 1995, between
Affinity Technology Group, Inc. and certain investors
which is hereby incorporated by reference to Exhibit
10.15 to the Registration Statement on Form S-1 of
Affinity Technology Group, Inc. (File No. 333-1170).
21 Subsidiaries of Affinity Technology Group, Inc. which is
hereby incorporated by reference to Exhibit 21 to the
Registration Statement on Form S-1 of Affinity Technology
Group, Inc. (File No. 333-1170).
23.1 Consent of Independent Auditors.
27 Financial Data Schedule.
* Denotes a management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K filed in the 4th quarter of 1996:
The Registrant did not file any Current Reports on Form 8-K during the last
fiscal quarter of the period covered by this report.
(c) Exhibits
The exhibits required by Item 601 of Regulation S-K are filed herewith and
incorporated by reference herein. The response to this portion of Item 14 is
submitted under Item 14(a) (3).
(d) Financial Statement Schedules.
The response to this portion of Item 14 is submitted under Item 14(a)(2).
<PAGE>
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registration has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Affinity Technology Group, Inc.
Date: March 31, 1998 By: /s/ Jeff A. Norris
Jeff A. Norris
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signatures Title Date
- --------------------------------------- --------------------------------------------------- -------------------------
<S> <C> <C>
/s/ Jeff A. Norris March 31, 1998
- ---------------------------------------
Jeff A. Norris President, Chief Executive Officer and Director
(principal executive officer)
/s/ Alan H. Fishman March 31, 1998
- ---------------------------------------
Alan H. Fishman Chairman and Director
/s/ Robert M. Price, Jr. March 31, 1998
- ---------------------------------------
Robert M. Price, Jr. Director
/s/ Edward J. Sebastian March 31, 1998
- ---------------------------------------
Edward J. Sebastian Director
/s/ Peter R. Wilson March 31, 1998
- ---------------------------------------
Peter R. Wilson, Ph.D. Director
/s/ Joseph A. Boyle March 31, 1998
- ---------------------------------------
Joseph A. Boyle Senior Vice President and Chief Financial Officer
(principal financial officer)
/s/ Richard R. Butcher March 31, 1998
- ---------------------------------------
Richard R. Butcher Controller
(principal accounting officer)
</TABLE>
<PAGE>
Schedule II - Valuation and Qualifying Accounts
Affinity Technology Group, Inc.
<TABLE>
<CAPTION>
COL.A COL. B. COL. C COL. D COL. E
Additions
--------------------------------------
Charged to Other
Balance at Charged to Costs Accounts -
Beginning of and Expenses Describe Deductions-Describe Balance at End
Description Period of Period
- --------------------------------------- ------------------ ------------------- ------------------ ------------------- --------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31,
1997
Reserves and allowances deducted from asset accounts:
Allowance for doubtful $ 198,987 $ 456,841 $ 255,708 (1) $ 400,120
accounts
Reserve for inventory 20,000 230,000 76,993 (2) 173,007
obsolescence
YEAR ENDED DECEMBER 31,
1996
Reserves and allowances deducted from asset accounts:
Allowance for doubtful $ 3,667 $ 170,000 $ 25,320 (3) $ - $ 198,987
accounts
Reserve for inventory 46,000 20,000 - 46,000 (2) 20,000
obsolescence
YEAR ENDED DECEMBER 31,
1995
Reserves and allowances deducted from asset accounts:
Allowance for doubtful $ - $ 3,667 $ - $ 3,667
accounts
Reserve for inventory - 46,000 - 46,000
obsolescence
<FN>
(1) Uncollectible accounts written off, net of recoveries.
(2) Obsolete parts written off.
(3) Immaterial other charges.
</FN>
</TABLE>
<PAGE>
Exhibit Index
Exhibit Number Description
- --------------------------------------- ----------------------------------
23.1 Consent of Ernst & Young LLP
27 Financial Data Schedule
<PAGE>
Exhibit 23.1 - Consent of Independent Auditors
We consent to the use of our report dated March 11, 1998 included in this Annual
Report (Form 10-K) of Affinity Technology Group, Inc.
Our audits also included the financial statement schedule of Affinity Technology
Group. Inc. listed in Item 14(a). This schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on the
financial statement schedule based on our audits. In our opinion, the financial
statement schedule referred to above, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
We also consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-10435) pertaining to the Affinity Technology Group, Inc. 1995
Stock Option Plan, 1996 Stock Option and the Non-Employee Directors' Stock
Option Plan, of our report dated March 11, 1998, with respect to the
consolidated financial statements of Affinity Technology Group, Inc., and our
report included in the preceding paragraph with respect to the financial
statement schedule included in this Annual Report (Form 10-K) for the year ended
December 31, 1997.
/s/ ERNST & YOUNG LLP
Greenville, South Carolina
March 31, 1998
<PAGE>
Exhibit 27 - Financial Data Schedule
This schedule contains summary financial information extracted from the
consolidated financial statements for the year ended December 31, 1997 and is
qualified in its entirety by reference to such statements.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 4,470,185
<SECURITIES> 19,135,415
<RECEIVABLES> 2,345,067
<ALLOWANCES> 400,120
<INVENTORY> 2,960,038
<CURRENT-ASSETS> 31,043,141
<PP&E> 8,485,368
<DEPRECIATION> 2,456,388
<TOTAL-ASSETS> 42,209,570
<CURRENT-LIABILITIES> 2,443,581
<BONDS> 0
0
0
<COMMON> 3,155
<OTHER-SE> 39,227,415
<TOTAL-LIABILITY-AND-EQUITY> 42,209,570
<SALES> 0
<TOTAL-REVENUES> 4,146,899
<CGS> 2,125,646
<TOTAL-COSTS> 21,544,463
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 686,841
<INTEREST-EXPENSE> (1,998,212)
<INCOME-PRETAX> (15,399,352)
<INCOME-TAX> 0
<INCOME-CONTINUING> (15,399,352)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (15,399,352)
<EPS-PRIMARY> (0.54)
<EPS-DILUTED> (0.54)
</TABLE>
