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, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from ____________ to _____________.
Commission file number 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 [ ]
<PAGE>
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 $16,653,000 as of March 19,
1999. 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 29,499,673 shares of the Registrant's Common Stock
outstanding as of March 19, 1999.
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 in 1994 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.
To date the Company has generated substantial operating losses and
experienced an extremely lengthy sales cycle for its products. Average consumer
use of ALMs in service and average rates of loan approvals have been lower than
most customer expectations. The Company believes that the economic viability of
the ALM as an alternative to traditional and new lending methods has not yet
been established, and several of the Company's ALM customers have terminated
their relationship with the Company. At December 31, 1998, there were 82 ALMs in
operation. Although the Company has developed and is developing other products
and services to exploit its DeciSys/RT technology, to date such products and
services have not generated substantial revenues, and the Company has been
required to use a substantial amount of existing cash resources to fund its
operations. Although the Company believes that existing cash, cash equivalents
and internally generated funds will be sufficient to fund operations through
1999, such resources, together with projected revenues that may be received
under existing contracts, will be insufficient to fund the Company's operations
in 2000 and beyond. To remain viable after 1999, the Company must substantially
increase revenues, raise additional capital and/or substantially reduce its
operations. No assurances can be given that the Company will be able to increase
its revenues, raise additional capital or reduce its operations in a manner that
would allow it to continue operations in 2000 and beyond.
During 1995, 1996 and early 1997 the Company's primary products and
services consisted of the ALM, 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, and a call center
decisioning system that provided financial institutions with the ability to
originate unsecured consumer loans with reduced or no human intervention. During
this period, the Company's customers primarily utilized the ALM delivery
channel. 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
ability 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 amount 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 enables integration of origination, processing
and fulfillment through a wide range of channels with the consumer. A
significant new channel system developed in 1997 is e-xpertLender, which
establishes connectivity between the Company's automated decisioning system and
a financial institution's delivery channels and its risk management group.
e-xpertLender also, upon approval, gives the consumer a choice of closing or
fulfillment 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 any time and electronically notifies loan
officers with respect to exceptions and the reason for referral. e-xpertLender
replaced the Company's previously developed call center decisioning system.
During 1998 the Company's principal activities were directed toward
enhancing its e-xpertLender product delivery capabilities and designing and
developing a system to process automobile loans pursuant to a development
contract with Citibank. The Company currently is developing a generic automobile
loan processing system to be sold, under the brand name of iDEAL, to other
financial institutions.
During 1998, the Company committed significant development and other
internal resources to fulfilling its obligations under the Citibank contract and
developing the iDEAL system. As a result, the Company was unable to, and did
not, devote significant resources to the development, sales or marketing of any
of its other products and services. The Company deployed only one ALM during
1998.
In the latter part of 1998 the Company renewed its efforts to design
additional products available through its ALM. Such products include software to
capture consumer application information to originate a mortgage loan ("Mortgage
ALM") and an automobile insurance policy ("automobile insurance kiosk"). The
Company believes that significant development efforts will be necessary during
1999 to complete the Mortgage ALM and automobile insurance kiosk for sale to
potential customers. The Company has formed a wholly owned subsidiary, Surety
Mortgage, Inc. ("Surety"), to deploy Mortgage ALMs for the purpose of
originating mortgage loans and to gain an understanding of the market and
consumer response to the Mortgage ALM, prior to marketing Mortgage ALMs to the
financial services industry. The Company does not anticipate any significant
sales of Mortgage ALMs or automobile insurance kiosks will occur before the
latter part of 1999.
In February 1999, the U.S. Patent and Trademark Office issued to the
Company a patent that covers certain automated lending processes and methods.
The Company believes the patent provides it with proprietary rights covering
fully automated loan processing which is initiated by a consumer through a
remote computer interface, which the Company believes includes the Internet,
wide area networks, local area networks, and any other communications network.
Kiosk lending systems, including ALMs, are also included within the scope of the
patent.
During February 1999, the Company formed a wholly owned subsidiary,
decisioning.com, Inc., which will hold certain rights to the Company's patent
and will develop and implement strategies to commercialize and license the
Company's rights under the patent. Through decisioning.com the Company intends
to deliver a real time decisioning service ("rtDS") to financial institutions.
rtDS, which is based on the Company's previously developed technology, will be
an outsourced service enabling lenders to deliver credit decisions to loan
applicants using the Internet. decisioning.com and rtDS are in an early stage of
development, and the Company does not expect any significant licensing or sales
opportunities before the latter part of 1999.
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 accept and capture consumer personal information through
remote input devices (such as through touch-screen terminals or terminals
operated by loan officers) and through automated interaction with third parties
(such as credit bureaus) that supply additional information necessary to process
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 to reach a credit decision 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.
<PAGE>
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.
Design and Features. The ALM looks and interacts with consumers much like
an ATM and can be operated as a free standing kiosk. The ALM 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 applicants, 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 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 and
unsecured personal loans. 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.
New ALM Products. The Company is also developing the Mortgage ALM.
Similar to the ALM, the Mortgage ALM is a kiosk designed to allow consumers to
pre-qualify for a mortgage loan, determine the payments for specified loan
amounts and apply for a mortgage loan.
The Company is also developing an automobile insurance kiosk that will
allow a consumer to consummate an insurance transaction without human
intervention. The insurance kiosk provides consumers with the ability to compare
rates and coverages available from several insurance carriers and select the
carrier and coverage appropriate for the consumer's situation. Once the consumer
selects a carrier and the desired coverage, the kiosk will allow the consumer to
bind the insurance coverage at the kiosk, in real-time and without human
intervention.
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 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 has the ability to imprint 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 Electronic Commerce
Transactions."
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
System. During this stage, customers are required to review the appearance of
the ALM and to run test transactions in order to verify 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 System 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, 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 between the
Company's automated decisioning system and a financial institution's delivery
channels and its risk management group. The system enables call center agents
and branch personnel to inquire as to the status of any transaction at any time
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, applications for lines of credit and credit cards, unsecured
personal loans and direct and indirect auto loans. 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 include
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 only one customer utilizing the e-xpertLender
system. Such system has been deployed in phases as the functionality of the
system has been developed and completed. The Company believes an 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 such installation estimates.
iDEAL
The Company is developing an Indirect Electronic Automobile Lending system
("iDEAL"), which will enable automated decisioning and processing of automobile
loan applications originating at an automobile dealer. iDEAL is an expansion of
the core technology of e-xpertLender, enhanced specifically for supporting
lending activities associated with obtaining automobile loan applications
through an automobile dealer. Upon receipt of the loan application, the
loan-processing personnel input the loan applicant's information into the iDEAL
system through a standard set of input screens. The applicant's information is
immediately transmitted to the Company's proprietary DeciSys/RT system and an
automated lending decision is transmitted to the loan-processing center. The
iDEAL system enables financial institution personnel to inquire as to the status
of any transaction at any time and notifies the financial institution with
respect to exceptions. In situations where an exception exists or an automated
decision cannot be rendered due to credit attributes of the loan applicant or
collateral values, iDEAL enables the financial institution to electronically
refer the loan application to a credit analyst so additional evaluations can be
made. The iDEAL system allows the credit analyst to input additional information
received from the loan applicant or the dealer and render a new decision. In
addition, iDEAL provides support for auditing and dealer funding of approved
loans when the loan package is completed.
Mortgage Brokerage Business
In January 1998, the Company formed Surety to engage in the mortgage
brokerage business, including marketing, originating, closing and selling
mortgage loans to permanent investors. The Company formed Surety for the primary
purpose of directly deploying Mortgage ALMs in a manner in which the Company
believes will facilitate future marketing and deployment of its mortgage loan
processing products. Surety's mission is to locate viable deployment locations
and develop deployment and business strategies which provide actual market data
that can be used to market the Company's mortgage loan processing products to
prospective customers. During January 1999, Surety deployed its first Mortgage
ALM in a pilot program with a real estate agency.
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 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
due to changes in interest rates. Prior to the time a loan is closed, the loan
is usually 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.
Sales and Marketing
The Company currently maintains a sales force consisting of two sales
people. Currently, the primary focus of the sales people is to sell the
Company's iDEAL product. The Company does not have a dedicated sales force for
its ALMs, insurance or mortgage products and services.
The Company has an internal marketing group that coordinates marketing
efforts nationwide through customer meetings, trade shows and the use of public
relations firms. The Company participates in well-recognized and widely attended
industry trade shows and regional presentations at which attendees are offered
the opportunity to participate in demonstrations 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 consults with existing and prospective customers to
identify instances where the Company's technologies are a suitable solution to
core business issues confronting such customers. Using market and process
research, the Company also consults with existing and potential customers to
identify suitable locations for ALMs and other Company technologies and refines
underwriting models to achieve desired rates of return and risk tolerance. The
Company also provides after-sale support to its customers with respect to
improving the performance of the ALM operations.
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 Company's products and
services 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 such products and services the Company may
develop to meet changing customer requirements.
Electronic commerce technologies in general, including the ALM,
e-xpertLender and iDEAL, compete with traditional consumer lending methods,
including in-person 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 Company's products and services 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 and processing systems and other alternatives to
conventional consumer transactions, including software and data processing
companies and technology and service companies. In particular, several
companies, including Dyad Corporation ("Dyad"), Alltell Corporation ("Alltell"),
FiData, Inc. ("FiData") and AnyTime Access, Inc. ("Anytime Access"), have
developed video and other kiosk technology for the delivery of financial
services. In addition, certain companies 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 and
Internet service providers 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. Several
companies, including ARC Systems ("ARC") and Island Mortgage Network ("Island
Mortgage"), have developed certain on-line processing systems to automate the
mortgage application and underwriting processes. Further, the Company
understands that ULTRADATA Corporation ("ULTRADATA"), Anytime Access, and FiData
have 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"),
Corporate Solutions International, Inc. ("CSI"), APPRO Systems, Inc. ("APPRO")
and American Management Systems ("AMS") in connection with the Company's
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 if not all of the Company's current and potential competitors
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".
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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 expedited
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 through a
private network to the various ALMs and e-xpertLender workstations in service.
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 the e-xpertLender system
utilizes T-1 or dial-up connections. 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
NOC 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 and off-site processing systems capable of supporting its DeciSys/RT
operations in the event of system and other failure.
Intellectual Property
On February 9, 1999, the Company was issued a patent for its system and
method for real-time loan approval over a computer network without human
intervention ("System and Method for Real Time Loan Approval", U. S. Patent No.
5,870,721). The Company also holds a patent covering the processing of insurance
products automatically through a kiosk ("Method and Apparatus for Issuing
Insurance from Kiosk", U.S. Patent No. 5,537,315). Further, "Affinity",
"DeciSys/RT" and "e-xpertLender" are registered service marks, and "ALM" and
"More Assets, Less Infrastructure" are registered trademarks of the Company.
The Company has applied with the United States Patent and Trademark
Office ("PTO") for additional patents to protect certain features of the
Company's technology, including additional aspects of its closed loop lending
system, its automated insurance product, and its Internet related products and
services. Certain of such applications and amendments thereto have been rejected
by the PTO and others are at a preliminary stage. There can be no assurance that
any of the Company's patent applications will be allowed by the PTO.
The Company's success and ability to compete is heavily dependent upon its
proprietary technology. The Company also relies on patent, 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 ability to attract and retain highly skilled research and
development personnel is important to the Company's success. During 1998, 1997
and 1996, the Company spent approximately $2,560,000, $3,526,000 and $2,905,000,
respectively, on research and development activities which represented
approximately 96.4%, 85.0% and 57.2% of 1998, 1997 and 1996 revenues,
respectively. During 1998, the Company capitalized approximately $1,041,000 of
software development costs.
During 1998 the Company substantially reduced the number of employees
on its research and development staff. While the Company believes that its
current research and development staff is sufficient to support ongoing
developmental projects, the Company does not currently have the capacity to
initiate any significant new projects. Further, additional reductions to the
Company's research and development staff may be necessary to conserve existing
cash resources during 1999. Such reductions may prevent or delay current product
development efforts.
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 real estate development, real estate sales and insurance industries
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 Reporting 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 (with the exception of its mortgage subsidiary) is not
directly subject to these regulations, and the Company's standard 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 electronic commerce 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."
Employees
At December 31, 1998, the Company employed approximately 87 full-time
employees and 1 part-time employee, compared to 152 full-time and 1 part-time
employee at December 31, 1997. During the second half of 1998 the Company
reduced its work force significantly. The Company has no collective bargaining
agreements.
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 Capital Resources; Operating Losses
The Company has generated operating losses of $42,978,548 since its
inception and has financed its operations primarily through net proceeds from
its initial public offering in May 1996. Net proceeds from the Company's initial
public offering were $60,088,516. At December 31, 1998, cash and liquid
investments were $10,095,242. Net cash used during the year ended December 31,
1998 to fund operations was approximately $9,498,000. Proceeds from the offering
and other sources of cash were used to fund current period operations, research
and development of approximately $2,560,000, software development of
approximately $1,041,000, capital expenditures of approximately $696,000 and the
repurchase of outstanding shares of the Company's common stock of approximately
$2,404,000.
The Company continues to use a substantial amount of existing cash
resources to fund its operations. If the Company continued to use cash resources
at the rate used in 1997 and 1998, the Company would deplete its existing cash
resources in the latter part of 1999; however, the Company has taken certain
measures to reduce its cash depletion rate, including decreasing its employee
base. Currently, the Company's employee base is approximately 42% less than it
was at December 31, 1997. The Company believes existing cash, cash equivalents
and internally generated funds will be sufficient to meet the Company's
currently anticipated cash requirements through 1999. However no assurances can
be given that the Company's existing cash resources will be sufficient to fund
the Company's cash requirements for 1999. Moreover, existing cash resources and
projected revenues that may be received under existing contracts will be
insufficient to fund the Company's operations in 2000 and beyond. Accordingly,
to remain viable after 1999, the Company must substantially increase revenues,
raise additional capital and/or substantially reduce its operations. No
assurance can be given that the Company will be able to increase its revenues,
raise additional capital or reduce its operations in a manner that would allow
it to continue operations through 2000. In order to fund operations, the Company
may need to raise additional funds through the issuance of equity securities, in
which case 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.
Further, there can be no assurance that additional financing will be available
when needed on terms favorable to the Company or at all. If adequate funds are
not available or not available on acceptable terms, the Company may be unable to
continue operations, 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.
Significant Losses; Accumulated Deficit; Future Losses
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, 1998
of $42,978,548 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,
$15,399,352 and $14,873,001 for the years ended December 31, 1995, 1996, 1997
and 1998, 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, iDEAL 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, motivate
and retain 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
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, types 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 "Dependence on
Consumer Retail Lending Industry; Cyclical Nature of Consumer Lending."
Shortfalls in revenues in relation to 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 revenues 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 may 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 ALM leases for which
the present value of future minimum lease payments exceeds 90% of the cost of
the related ALM as sales-type leases. 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.
<PAGE>
Lengthy Sales Cycle
The Company has to date experienced a lengthy sales cycle for its
products. In most cases, the time between initial customer 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 technologies gain 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 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 Company's products and services
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 to continually
improve its products and services 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.
Competition; Future Price Erosion
Electronic commerce technologies in general, including the Company's
products and services, compete with traditional consumer lending methods,
including in-person applications at branch offices of financial institutions or
at automobile dealerships 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 Company's products and services 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, several companies, including
Dyad, Alltell, FiData, and AnyTime Access, have developed video and other kiosk
technology for the delivery of financial services. In addition, certain
companies 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 online services and Internet service providers 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. Several companies, including ARC and Island
Mortgage, have developed certain on-line processing systems to automate the
mortgage application and underwriting processes. Further, the Company
understands that ULTRADATA, Anytime Access, and FiData have 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, CSI, APPRO and AMS in connection with the Company's
automobile loan system.
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 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.
Dependence on Consumer Retail Lending Industry; Cyclical Nature of
Consumer Lending
The Company's business is currently concentrated in 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 a 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, one customer accounted for
approximately 49% of the Company's revenue in 1998. 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 its products and services. 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 regards certain of its technology as critical to its
business and attempts to protect such technology under patent, 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 a result, 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".
Risk of Fraud in Electronic Consumer Transactions
Electronic consumer transactions involve the risk of consumer fraud. The
customers using the Company's products are responsible for the selection and use
of the origination and underwriting parameters incorporated in the software
supporting the Company's products and services. The Company is unaware of any
significant instances of fraud in connection with the funding of loans through
the use of the Company's products and services. However, the rate of fraudulent
activity could increase, especially if the number of transactions processed by
the Company's products and services 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 Company's products and services. While the Company shifts
the risk of collection in any given transaction to its customers under the terms
of its 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
the Company's products and services, 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 Company relies on third parties for certain fraud detection systems
and for obtaining credit information about loan applicants. Additionally, the
Company uses a 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 system or (ii) the Company's
network access provider to provide access to such networks or products 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 may rely on third parties in
connection with its customer relationships, strategic alliance arrangements,
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
customers to generate and sustain consumer demand for the Company's products and
services 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 in the future. Currently, the Company's agreements
with 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 the Company's products and
services. 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.
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. To date, such strategic
partnerships and distribution agreements have not resulted in substantial sales
of the Company's products and services. For the Company to ever achieve broad
distribution of the products or services it may develop, it will have to
implement effective marketing and distribution programs. The inability of the
Company to develop and implement effective marketing programs could have a
material adverse effect on the Company's business, operating results and
financial condition. 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 key employees 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 19, 1999, the Company had outstanding an aggregate of
29,499,673 shares of Common Stock. Of such shares, an aggregate of approximately
12,683,000 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 approximately 16,817,000 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). In
this regard, Jeff A. Norris, the Company's founder and a director, has filed
notice to sell up to 2,040,800 shares over a three month period under Rule 144,
and Mr. Norris may decide to sell additional shares in the future. At December
31, 1998, approximately 39,000 and 623,000 options are exercisable under the
1996 and 1995 Option Plans, respectively, and at weighted average exercise
prices of $1.55 and $0.44, respectively, with a weighted average remaining
contractual life of 9.38 years and 7.83 years, respectively. There also are
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; Possible
Delisting of Securities from NASDAQ Stock Market
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 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.
During September, 1998, the Company was notified by the Nasdaq Stock
Market, Inc. ("Nasdaq") that the Company was not in compliance with Nasdaq
listing standards that require the Company's stock to maintain a minimum bid
price of $1.00 or more. As a result, the Company was provided until December 2,
1998 to regain compliance with such standards (which would require the common
stock to have a closing bid price of $1.00 or more for at least ten consecutive
business days). The Company's common stock did not regain compliance by December
2, 1998, and the Company requested a review by Nasdaq, which stayed delisting
into 1999. During the period in which the delisting was stayed, the Company's
common stock closed at or above $1.00 for the necessary 10 consecutive trading
days, and Nasdaq thereafter notified the Company that it had evidenced
compliance with all requirements for continued listing on the Nasdaq National
Market. The Company's common stock continues to trade at or above the Nasdaq's
minimum price of $1.00 per share; however, there can be no assurances the
Company will be able to maintain compliance with Nasdaq listing standards in the
future.
Control by Principal Stockholders
The directors and executive officers of the Company collectively
beneficially own approximately 48.4% of the Common Stock and Jeff A. Norris, a
director of the Company, individually beneficially owns 35.6% of the Common
Stock of the Company. As a result, these persons will be able to exercise
substantial influence 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 real estate development, real estate sales and insurance
industries 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, the application of such regulations to any
products and services developed by the Company must be determined on a
case-by-case basis. The Company has not attempted to review the laws of each
state that might be applicable to the deployment of its products and services.
It is possible that other states may have or will in the future adopt specific
regulations applicable to the deployment and operation of the Company's products
and services. Furthermore, some consumer groups have expressed concern regarding
the privacy and security of the ALM, 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 the Company's products and services. 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.
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 that 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
R. Murray Smith 54 President and Chief Executive
Officer and Director
Joseph A. Boyle 45 Senior Vice President, Chief
Financial Officer and Treasurer
Paul E. Adams 47 Senior Vice President - Sales
Terrence J. Sabol, Sr. 53 Senior Vice President - Technology
John D. Rogers 55 Senior Vice President
R. Murray Smith, became President and Chief Executive Officer of the
Company in May 1998 and a director of the Company in July 1998. Before joining
the Company, Mr. Smith was President and Chief Executive Officer of Adaptive
Decision Systems, a firm he established in 1987 that develops custom systems for
credit scoring, behavior scoring, target marketing, and fraud detection. Before
founding Adaptive Decision Systems, Mr. Smith was Senior Vice President of Avco
Financial Services in Irvine, California. He was previously an executive with
The St. Paul Companies in St. Paul, Minnesota.
Joseph A. Boyle became Senior Vice President and Chief Financial Officer of the
Company in September 1996 and Treasurer in May 1997. From May 1997 to July 1998,
Mr. Boyle also served as Secretary of the Company. Prior to joining the Company,
Mr. Boyle served as Price Waterhouse LLP engagement partner for most 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 June
1982 to August 1996.
Paul E. Adams became Senior Vice President of Sales in July 1998. Prior to
joining the Company, Mr. Adams served as Vice President, Strategic Alliances in
the Finance Industry Group of American Management Systems from November 1987 to
December 1997. Prior to joining American Management Systems in 1987, Mr. Adams
was an Account Executive at The Fair, Isaac Companies from 1978 to 1987.
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 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 to 1996.
<PAGE>
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
(a) 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 1997 and 1998, as reported by The Nasdaq National
Market. As of March 19, 1999, there were 266 stockholders of
record of the common stock.
Sales Price Per Share
High Low
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
1998
First Quarter 1998 3.03 2.25
Second Quarter 1998 2.25 0.69
Third Quarter 1998 1.09 0.50
Fourth Quarter 1998 0.97 0.22
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>
(b) 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, 1998, 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 5,482,000
Purchase of real estate -
Acquisition of other business(es) 300,000
Repayment of indebtness $ 771,000 1 1,000,000
Working capital 27,169,000
Temporary investments:
US Treasury obligations 7,691,000
Commercial paper 1,521,000
Money market / cash 883,000
Other purposes:
Marketing 4,454,000
Research & development 8,575,000
Purchase of software 2,232,000
<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>
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,
1998 1997 1996 1995 1994
----------------- ---------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
Statements of Operations Data:
Revenues $ 2,656,259 $ 4,146,899 $ 5,081,818 $ 1,524,911 $ -
Costs and expenses:
Cost of revenues 1,165,293 2,125,646 3,088,321 1,101,330 -
Research and development 2,559,600 3,526,257 2,905,232 368,452 264,600
Selling, general and
Administrative expenses 14,837,695 15,892,560 10,819,381 2,305,653 428,896
----------------- ---------------- --------------- ---------------- ---------------
Total costs and expenses 18,562,588 21,544,463 16,812,934 3,775,435 693,496
----------------- ---------------- --------------- ---------------- ---------------
Operating loss (15,906,329) (17,397,564) (11,731,116) (2,250,524) (693,496)
Interest income 1,044,251 2,033,571 2,099,004 48,476 -
Interest expense (10,923) (35,359) (60,083) (105,981) (12,475)
----------------- ---------------- --------------- ---------------- ---------------
Net loss $ (14,873,001) $ (15,399,352) $ (9,692,195) $ (2,308,029) $ (705,971)
================ =============== ================ ===============
================= ================ =============== ================ ===============
Net loss per share -
basic and diluted $ (0.50) $ (0.54) $ (0.40) $ (0.15) $ (0.08)
================= ================ =============== ================ ===============
================ =============== ================ ===============
Shares used in computing
net loss per share 29,755,034 28,477,880 24,136,480 15,044,286 9,185,078
================= ================ =============== ================ ===============
</TABLE>
<TABLE>
<CAPTION>
December 31,
1998 1997 1996 1995 1994
---------------- ---------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents $ 2,026,932 $ 4,470,185 $ 31,563,950 $ 1,235,983 $ 29,985
Short-term investments 8,068,310 19,135,415 10,583,997 - -
Working capital (deficit) 13,543,782 28,599,560 43,672,679 (1,134,465) (431,547)
Net investment in sales-type
Leases, less current portion 574,347 1,328,741 2,386,010 860,295 -
Total assets 24,196,875 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 - - 66,245 148,119 199,508
party, less current portion
Capital stock of subsidiary held
by minority investor - - 200,000 137,500 -
Stockholders' equity 22,556,201 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 in 1994 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
ALM, raising capital and recruiting personnel.
Until early 1997 the Company's primary products and services consisted of
the ALM, 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, and a call center decisioning system that
provided financial institutions with the ability to originate unsecured consumer
loans with reduced or no human intervention. During 1997, the Company developed
e-xpertLender, which connects the Company's automated decisioning system with a
financial institution's delivery channels, and its risk management group and
gives the consumer a choice of closing methods that include branches, ALMs,
mail, and third party closing agents. During 1998, the Company began developing
a system to process automobile loans pursuant to a development contract with
Citibank. The Company is currently developing a generic automobile loan
processing system to be sold, under the brand name of iDEAL, to other financial
institutions.
During 1998, the Company committed significant development and other
internal resources to enhancing its e-xpertLender product and fulfilling its
obligations under its Citibank contract. As a result, the Company was unable to,
and did not, devote significant resources to the development, sales and
marketing of any of its other products and services. The Company deployed only
one ALM during 1998, and ALMs deployed before 1998 have generally not met the
expectations of the Company's customers.
To date, the Company has generated substantial operating losses and
experienced an extremely lengthy sales cycle for its products. Average consumer
use of ALMs in service and average rates of loan approvals have been lower than
most customer expectations. The Company believes that the economic viability of
the ALM as an alternative to traditional and new lending methods has not yet
been established, and several of the Company's ALM customers have terminated
their relationship with the Company. At December 31, 1998, there were 82 ALMs in
operation. Although the Company has developed and is developing other products
and services to exploit its DeciSys/RT technology, to date such products and
services have not generated substantial revenues, and the Company has been
required to use a substantial amount of existing cash resources to fund its
operations. Although the Company believes that existing cash, cash equivalents
and internally generated funds will be sufficient to fund operations through
1999, such resources, together with projected revenues that may be received
under existing contracts, will be insufficient to fund the Company's operations
in 2000 and beyond. To remain viable after 1999, the Company must substantially
increase revenues, raise additional capital and/or substantially reduce its
operations. No assurances can be given that the Company will be able to increase
its revenues, raise additional capital or reduce its operations in a manner that
allows it to continue operations in 2000 and beyond.
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, 1998 of $42,978,548, with operating losses of $14,873,001,
$15,399,352 and $9,692,195 for the years ended December 31, 1998, 1997 and 1996,
respectively. The Company expects to incur substantial additional costs to
develop its financial product origination capabilities, to enhance and market
iDEAL, e-xpertLender, the ALM 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.
<PAGE>
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.
Results of Operations
Revenues. The Company's revenues were $2,656,259, $4,146,899 and
$5,081,818 for the years ended December 31, 1998, 1997 and 1996, respectively.
The types of revenue recognized by the Company in the years ended December 31,
1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
Years ended December 31,
---------------------------------------------------------------------------------
1998 1997 1996
------------------------ --- ------------------------ -- ------------------------
% of % of % of
Amount Total Amount Total Amount Total
---------------- ------- --------------- -------- ---------------- --------
<S> <C> <C> <C> <C> <C> <C>
Transaction fees $ 750,936 28.3 $ 545,551 13.2 $ 172,569 3.4
Mortgage processing fees 453,657 17.1 - - - -
Initial set-up fees 91,000 3.4 638,687 15.4 426,848 8.4
Sales and rental fees 66,369 2.5 1,590,620 38.4 2,552,158 50.2
Professional services fees 797,301 30.0 792,734 19.1 - -
Other income 496,996 18.7 579,307 13.9 130,243 2.6
License revenue - - - - 1,800,000 35.4
================ ======= =============== ======== ================ ========
$ 2,656,259 100.0 $ 4,146,899 100.0 $ 5,081,818 100.0
================ ======= =============== ======== ================ ========
</TABLE>
The nature and types of revenues earned by the Company has changed
significantly in the three-year period ended December 31, 1998. During 1996, the
primary source of revenue was from the deployment of ALMs under sales-type
leases. Additionally, in 1996 the Company recognized $1.8 million of license
revenue associated with the development, deployment and licensing of a specific
call center decisioning system. In 1997 the Company entered into a contract to
provide professional services to a specific customer to customize its core
technology to accommodate an enterprise-wide loan processing system, which
became the basis of the Company's e-xpertLender system. The delivery of
professional services under the contract continued into 1998. In addition, the
Company began processing mortgage loans through a wholly owned subsidiary,
Surety Mortgage, Inc. ("Surety") in 1998. For 1998, a substantial percentage of
the Company's revenues were attributable to professional services fees,
transaction revenues and mortgage processing fees.
In 1998, the Company experienced an overall decline in revenue and
continues to face an extremely lengthy sales cycle for its products. The Company
generated substantially less revenue in 1998 from ALMs than in prior periods.
Average consumer use of ALMs in service and average rates for loan approvals
continue to be lower than most customers' expectations. The Company continues to
believe that the economic viability of the ALM as an acceptable alternative to
traditional and new lending methods has not been established.
The Company's revenue plan for 1999 is primarily to sell and deploy its
products and services into environments which are able to generate significant
transaction volume and transaction fees over extended periods of time.
Accordingly, the Company may elect to forego significant upfront revenue in the
form of set-up and licensing fees if it believes that the potential exists to
recover upfront costs in the form of transaction fees in a reasonable period of
time.
Transaction fees. The increase in transaction fees in 1998 compared to
1997 is attributable primarily to the deployment in mid-1997 of the Company's
first e-xpertLender system. Transaction fees processed through such system were
generated for the entire year of 1998 compared to a shorter period in 1997.
Transaction fees associated with processing credit and debit card transactions
through the Company's Transaction Processing Division ("TPS") decreased slightly
from approximately $245,000 in 1997 to approximately $218,000 in 1998. The
increase in transaction fees in 1997 compared to 1996 is also attributable
primarily to the deployment in mid-1997 of the Company's first e-xpertLender
system and to a full year of TPS operations in 1997 compared to only two months
of operations in 1996. In December 1998, the Company sold TPS to a third party.
Mortgage Processing fees. Surety engages in mortgage brokerage activities
which includes originating, processing and selling mortgage loan products to
outside investors. Surety originates and processes mortgage loans directly with
consumers or on behalf of correspondents, and immediately sells such loans to
institutions that sponsor the loan programs offered by Surety. Surety only
offers loans that will be acquired by such institutions under such programs.
Upon making the loan commitment to the borrower, Surety immediately receives a
commitment from an institution to acquire the loan upon closing. Mortgage
processing fees include gains on sales of mortgage loans to institutions and
loan fees received for originating and processing the loan. Loan origination
fees and all other direct costs associated with originating loans are recognized
at the time the loans are sold. The Company did not generate revenues from
mortgage processing services prior to 1998.
Initial Set-up fees. Set-up fees recognized in 1998, 1997, and 1996
were associated with the deployment of 1 ALM, 53 ALMs, and 79 ALMs,
respectively. Set-up fees in 1998 also reflected fees deferred in conjunction
with services rendered to one customer in 1997 which were recognized in 1998
upon the decision of the customer not to deploy the Company's ALMs. The increase
in set-up fees recognized in 1997 compared to 1996 is attributable to an
increase in the amount of set-up fees charged and the short-term deployment of
25 ALMs in early 1997 in a pilot program. The pilot program was terminated after
a short period and, accordingly, the set-up fees paid by the customer were then
recognized.
Sales and Rental fees. The decrease in sales and rental revenue in 1998
compared to 1997 is attributable to a substantial decrease in ALM deployments in
1998. Amounts recognized in 1998 also consisted of rental payments received on
ALMs deployed under operating leases in prior years. In 1997 the Company
recognized sales revenue associated with the deployment of 28 ALMs under
sales-type leases as well as rental revenue associated with ALMs deployed under
operating leases. The decrease in sales and rental revenues in 1997 as compared
to 1996 is attributable to a decrease in the deployment of ALMs under sales-type
leases in 1997 compared to 1996. In 1997 the Company deployed 28 ALMs under
sales-type leases compared to 74 in 1996.
Professional services fees. When the Company agrees to provide
professional services to customize its core technology to conform to a specific
customer request, 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 specific deliverables by the customer, the
Company recognizes the corresponding revenue as professional services revenue.
The level of professional services revenue remained consistent in 1998 compared
to 1997. In both years, professional services revenue related primarily to the
customization of the Company's e-xpertLender system to meet a specific
customer's requirements. Such customer represented 97.1% and 91.3% of
professional services revenue in 1998 and 1997, respectively. Prior to 1997 the
Company did not generate professional services revenues.
License Revenue. 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
between 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. The
Company has not engaged in similar licensing arrangements subsequent to 1996.
One customer accounted for 97.1% of professional services revenue for
1998 and 60.2% and 91.3% of ALM sales and rental and professional services
revenue, respectively, during 1997. This same customer accounted for 48.8% and
48.0% of total revenue for 1998 and 1997, respectively. One other customer
accounted for 13% of total revenue during 1997. For information relating to
customer revenue concentrations for 1996, see Note 11 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 the Company's
products and services.
Costs and Expenses
Costs of Revenues. Costs of revenues for the years ended December 31,
1998, 1997 and 1996 were $1,165,293, $2,125,646 and $3,088,321, respectively.
Cost of revenues includes the direct costs associated with the generation of
specific types of revenue and the allocation of certain indirect costs when such
costs are specifically identifiable and allocable to revenue producing
activities. During the two years ended December 31, 1998, the nature and amounts
of costs, as well as gross profit margins, associated with certain revenue
producing activities varied significantly due to changes in the nature of the
services offered by the Company and due to different pricing structures offered
to certain customers.
Costs of revenues and the percentage of the costs of revenues to total
costs of revenues for the years ended December 31, 1998, 1997 and 1996 are as
follows:
<TABLE>
<CAPTION>
Years ended December 31,
---------------------------------------------------------------------------------
1998 1997 1996
------------------------ --- ------------------------ -- ------------------------
% of % of % of
Amount Total Amount Total Amount Total
---------------- ------- --------------- -------- ---------------- --------
<S> <C> <C> <C> <C> <C> <C>
Transaction fees $ 388,734 33.4 $ 328,067 15.4 $ 91,063 2.9
Mortgage processing fees 192,726 16.5 - - - -
Initial set-up fees - - 232,077 10.9 426,848 13.8
Sales and rental fees 379,775 32.6 1,041,455 49.0 2,426,476 78.6
Professional services fees 204,058 17.5 524,047 24.7 - -
License revenue - - - - 143,934 4.7
================ ======= =============== ======== ================ ========
$ 1,165,293 100.0 $ 2,125,646 100.0 $ 3,088,321 100.0
================ ======= =============== ======== ================ ========
</TABLE>
Costs of transaction fees. The costs of transaction fees consist primarily
of the direct costs incurred by the Company to process loan applications and
debit and credit card transactions through its systems. Such direct costs are
associated with services provided by third parties and include the costs of
credit reports, fraud reports and communications networks used by the Company.
The costs of transaction fees increased in 1998 compared to 1997 and in
1997 compared to 1996 due to an increase in volume of transactions the Company
processed through its systems.
Costs of mortgage processing fees. The costs of mortgage processing
fees consist of the direct cost incurred by Surety associated with the
underwriting, processing and closing of mortgage loans. Such costs include
credit reports, appraisal reports, flood certifications and administration fees
charged by the purchasers of loans originated by Surety.
Costs of initial set-up fees. The costs of initial set-up fees are
related to the initial costs incurred to deploy and install ALMs. Such costs
include the allocation of direct and indirect labor and certain other indirect
costs associated with the initial preparation and deployment of ALMs for the
Company's customers. Additionally, the costs include direct costs incurred by
the Company, including shipping costs and amounts paid to third parties.
The Company's deployment of ALMs was insignificant in 1998, and no
costs were incurred in 1998 in association with initial set-up revenue
recognized. The decrease in the costs of set-up fee revenue in 1997 as compared
to 1996 is due primarily to the deployment of fewer ALMs in 1997. In 1997 the
Company deployed 53 ALMs compared to 79 in 1996 under both sales-type and
operating leases. Additionally, the Company improved its deployment processes in
1997 which resulted in greater cost efficiencies being realized compared to
1996.
Costs of sales and rental fees. Costs of sales and rental fees are
primarily related to the costs of ALM hardware components associated with ALMs
deployed under sales-type leases, maintenance of installed ALMs and depreciation
associated with ALMs deployed under operating leases. In 1998 the costs of sales
and rental revenue of $379,775 consisted primarily of depreciation related to
ALMs deployed under operating leases and the costs associated with maintaining
the Company's installed base of ALMs. Costs of sales and rental revenues was
significantly lower in 1998 compared to 1997 primarily as a result of the
deployment in 1997 of 28 ALMs under sales-type leases compared to only 1 ALM
deployed under a sales-type lease in 1998. The decrease in the costs of sales
and rental revenues in 1997 as compared to 1996 was primarily the result of
fewer ALM deployments in 1997 compared to 1996 when the Company deployed 71 ALMs
under sales-type leases.
Under the terms of an agreement with one customer covering 30 ALMs, the
customer's payment obligation to the Company is based on ALM performance, which
has resulted in revenues insufficient to cover the depreciation expense
recognized by the Company. Accordingly, the costs of sales and rental revenues
exceeded the sales and rental revenues recognized by the Company for such
contract.
Costs of professional services fees. The costs of professional services
fees consist of the costs of the direct labor and the allocation of certain
indirect costs associated with performing software and system customization
services for customers. The decrease in 1998 compared to 1997 was due to a
decrease in the amount of work necessary to complete specific projects in 1998
compared to 1997.
Costs of license revenue. The costs of license revenue recognized in
1996 consist primarily of allocated salaries and overhead associated with the
licensing of the Assets3 system to Union Planters Bank.
Research and Development. 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.
Research and development expenses for the year ended December 31, 1998
were $2,559,600, compared to $3,526,257 and $2,905,232 for 1997 and 1996,
respectively. The decrease in research and development expense is due to an
overall decrease in the number of employees involved in development activities
and the progression of certain development activities to a point where the costs
of such activities are capitalized pursuant to applicable accounting guidelines
during 1998. The increase in research and development expense for the year ended
December 31, 1997 as compared to 1996, is primarily attributable to an increase
in the average number of employees involved in development activities in 1997
and to the Company's continued enhancement of its DeciSys/RT technology and the
development of additional financial product origination capabilities in 1997.
During 1998, 1997 and 1996, the Company capitalized approximately
$1,041,000, $451,000 and $215,000, respectively, of software development costs
related primarily to the development of certain financial service applications
processed using DeciSys/RT. When a product is available for general release to
customers, capitalization of such costs is discontinued and amounts capitalized
are generally amortized over a 48 month period. 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, 1998 were
$14,837,695, compared to $15,892,560 and $10,819,381 for the years ended
December 31, 1997 and 1996, respectively.
SG&A expenses during 1998 consisted primarily of personnel costs of
approximately $6,283,000; professional fees of approximately $1,722,000,
consisting primarily of legal, accounting, recruiting and relocation fees;
advertising and marketing costs of approximately $193,000; deferred compensation
expense amortization of approximately $599,000; and, travel costs of
approximately $437,000. SG&A expenses during 1997 consisted primarily of
personnel costs of approximately $7,207,000; professional fees of approximately
$1,892,000, consisting primarily of legal, accounting, recruiting and relocation
fees; advertising and marketing costs of approximately $1,488,000; deferred
compensation expense amortization of approximately $481,000; and, travel costs
of approximately $935,000. SG&A expenses during 1996 consisted primarily of
personnel costs of approximately $3,842,000; professional fees of approximately
$2,290,000, consisting primarily of legal, accounting, recruiting and relocation
fees; advertising and marketing costs of approximately $1,662,000; deferred
compensation expense amortization of approximately $1,028,000; and, travel costs
of approximately $792,000.
The decrease in SG&A expense for the year ended December 31, 1998, as
compared to 1997 is primarily attributable to a decrease in: (i.) employment
costs, primarily wage and recruiting costs associated with an overall reduction
in the Company's employee base; (ii.) advertising and marketing costs; (iii.)
professional fees consisting primarily of legal, accounting, recruiting and
relocation fees; and, (iv.) travel costs. The decrease in SG&A expenses was
partially offset by an increase in: (i.) depreciation and amortization expense
associated with an overall increase in the Company's depreciable assets; (ii.)
an increase in inventory valuation allowances associated with potentially
obsolete ALM shells due to planned design improvements; and, (iii.) costs
associated with benefits including severance benefits for certain employees
terminated during 1998.
The increase in SG&A expense for the year ended December 31, 1997, as
compared to 1996, is primarily attributable to an increase in the average number
of employees and timing of such increases during 1997 associated with expansion
of the Company's operating activities and an increase in depreciation and
amortization expense associated with an increase in the Company's depreciable
assets. The increase in SG&A expenses was offset by a decrease in deferred
compensation expense for the year ended December 31, 1997 as compared to 1996,
due to the forfeiture of stock options granted under the Company's 1995 Stock
Option Plan.
Interest Income
Interest income of $1,044,251, $2,033,571 and $2,099,004 during 1998,
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 decrease in interest
income for the year ended December 31, 1998 as compared to 1997, is due to a
decrease in cash and cash equivalents and investments balances as compared to
the same period of 1997 and to a lesser extent a decrease in the amount of
amortization of deferred interest income associated with ALMs under sales-type
lease agreements. 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 Expense
Interest expense for the year ended December 31, 1998 was $10,923,
compared to $35,359 and $60,083 for 1997 and 1996, respectively. The decrease
for the year ended December 31, 1998 as compared to 1997, and for the year ended
December 31, 1997 as compared to 1996, is due primarily to payments made under
the terms of capital lease obligations. In addition, the Company incurred debt
in 1996 to fund its operations prior to its initial public offering.
<PAGE>
Income Taxes
The Company has recorded a valuation allowance for the full amount of
its net deferred income tax assets as of December 31, 1998, 1997, and 1996,
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 $42,978,548 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.
The Company continues to use a substantial amount of existing cash
resources to fund its operations. If the Company continued to use cash resources
at the rate used in 1997 and 1998, the Company would deplete its existing cash
resources in the latter part of 1999; however, the Company has taken certain
measures to reduce its cash depletion rate, including decreasing its employee
base. Currently, the Company's employee base is approximately 42% less than it
was at December 31, 1997. The Company believes existing cash, cash equivalents
and internally generated funds will be sufficient to meet the Company's
currently anticipated cash requirements through 1999. However no assurances can
be given that the Company's existing cash resources will be sufficient to fund
the Company's cash requirements for 1999. Moreover, existing cash resources and
projected revenues that may be received under existing contracts will be
insufficient to fund the Company's operations for 2000 and thereafter.
Accordingly, to remain viable after 1999, the Company must substantially
increase revenues, raise additional capital and/or substantially reduce its
operations. No assurances can be given that the Company will be able to increase
its revenues, raise additional capital or reduce its operations in a manner that
would allow it to continue operations in 2000 and beyond. In order to fund
operations, the Company may need to raise additional funds through the issuance
of equity securities, in which case 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 favorable to the Company or at all. If adequate
funds are not available or not available on acceptable terms, the Company may be
unable to continue operations; 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.
Net cash used during the year ended December 31, 1998, to fund operations
was approximately $9,498,000 compared to approximately $15,395,000 and
$12,727,000 for the same periods in 1997 and 1996, respectively. Proceeds from
the offering and other sources of cash were used to fund current period
operations, research and development of approximately $2,560,000, software
development of approximately $1,041,000, capital expenditures of approximately
$696,000 and the repurchase of outstanding shares of the Company's common stock
of approximately $2,404,000. During 1997, net proceeds from the offering and
other sources of cash were used to fund operations, research and development of
approximately $3,526,000, capital expenditures of approximately $1,566,000,
repurchase of outstanding shares of the Company's common stock of approximately
$967,000 and software development of approximately $569,000. During 1996, net
proceeds from the offering and other sources of cash were used to fund
operations, capital expenditures of approximately $5,559,000, research and
development of approximately $2,905,000 and software development of
approximately $215,000. At December 31, 1998, 1997 and 1996, cash and liquid
investments were $10,095,242, $23,605,600 and $42,147,947, and working capital
was $13,543,782, $28,599,560 and $43,672,679, respectively.
During 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. During the first quarter of 1998, the Company expanded its
share repurchase plan by authorizing the use of an additional $2 million of
general corporate funds under the plan. As of December 31, 1998, the Company had
repurchased a total of 1,417,000 shares at an average price of $2.31 per share
for an aggregate cost of $3,271,700 under the share repurchase plan. In
addition, during 1997 the Company 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 repurchase agreements with such former employees.
During June 1998, Surety entered into an agreement with a lender to
establish a credit facility with a maximum borrowing amount of $2,000,000.
Pursuant to the terms of the agreement, Surety may obtain advances from the
lender for funding of mortgage loans made by Surety during the interim period
between the funding and sale of the loans to permanent investors. All advances
made pursuant to the agreement are secured by a security interest in the rights
and benefits due Surety in conjunction with the making of the underlying loan.
The credit facility bears interest at the lender's prime rate plus 50 basis
points and expires on June 1, 1999. Surety had $141,480 in outstanding
borrowings under the Loan Warehousing Agreement bearing an interest rate of
8.25% as of December 31, 1998.
During 1997 in connection with its acquisition of Buy American, Inc.
and Project Freedom, Inc., the Company issued restricted common stock subject to
a put option by the sellers. Under such agreement, the sellers have an option to
sell any or all the shares of restricted common stock held by them to the
Company at a price of $3.47 per share. These options are exercisable for a 30
day period ending May 31, 1999. The Company expects that the former owners of
Buy American, Inc. and Project Freedom, Inc. will elect to exercise their option
to sell their stock to the Company for an aggregate amount of approximately
$900,000.
Implications of Year 2000 Issues
Year 2000 issues generally involve the potential impact on a company if
computer systems fail to accurately interpret data after December 31, 1999.
Since many computer programs have historically been designed to read and
interpret years in a two-digit format, a computer program or system that is not
redesigned or otherwise updated may be incapable of distinguishing between the
year 2000 and the year 1900, which may result in systems failure or the
generation of inaccurate data. The risks associated with Year 2000 issues are
significant due to the reliance of most companies on interaction with automated
information or services provided by third parties that may be subject to Year
2000 issues. Moreover, it is frequently difficult to assess a third party's
ability, diligence, and success in addressing Year 2000 issues. In many cases,
reliance must be placed on representations received from third parties regarding
the existence of Year 2000 issues that may affect the continuity or quality of
critical services they provide.
The Company's business primarily involves the automated processing of
financial service transactions through both internally developed and externally
purchased computer software and hardware systems. Additionally, the Company is
dependent on third parties to deliver certain automated services essential to
support the Company's internal operations and its ability to process financial
services transactions for its customers. The computer systems used by the
Company to process financial services transactions are generally interfaced with
its customers' systems and, accordingly, the Company's ability to deliver
uninterrupted service may be adversely affected if its customers have not
adequately addressed Year 2000 issues.
The Company has undertaken various initiatives to date to address Year
2000 issues. Such initiatives have included an evaluation of its information
technology ("IT"), which consists of computer hardware and software, and
non-information technology ("Non-IT"), which generally includes systems that
rely on imbedded chip technology. The Company anticipates that its Year 2000
assessment, remediation, testing and implementation efforts will be completed by
September 30, 1999. The Company does not anticipate that any material
modification or refinement of its IT or Non-IT systems will be necessary to
adequately address and resolve Year 2000 issues; however, failure to identify,
assess, remediate, test and implement solutions to Year 2000 issues could result
in a system failure or the use of inaccurate data, which could disrupt the
Company's operations and adversely affect its ability to provide uninterrupted
services to its customers.
The Company divided its activities into two categories for purposes of
evaluating and tracking issues related to the Year 2000. "Services Systems" are
those computer software and hardware systems, including third party services,
used to provide processing services for the Company's customers. "Operations
Systems" are those computer software and hardware systems, including third party
services, utilized by the Company for internal operating and administrative
purposes.
Services Systems
The Company's processing services are delivered through ALMs or web
server-based systems, both of which are connected to the Company's Network
Operating Center ("NOC"). The NOC uses multiple servers to process financial
services transactions and is connected to various third party systems that
provide essential information required for the processing of financial services
transactions. Such third party services include, but are not limited to, credit
bureaus, credit scoring agencies, consumer identification sources and other
fraud detection service providers. Moreover, the Company's ALMs and web
server-based systems are connected to the NOC through communications networks
and links provided by third parties. The Company's ALMs, web server-based
systems and the NOC consist of both IT and Non-IT systems.
ALM Systems. ALMs are freestanding kiosks that consist of hardware,
software and communications systems. The Company's customers have deployed ALMs
to serve as a point of entry for consumer information as well as a delivery
vehicle to fulfill financial services transactions. ALM systems, including
software applications, hardware and component devices and communications
connection to the NOC have been tested using certain date testing parameters as
follows: December 31, 1999; January 3, 2000; February 28, 2000; February 29,
2000; and, March 1, 2000. The Company has requested that third party providers
of IT and Non-IT components and systems used in or in conjunction with the ALM
systems provide evidence of their system's compliance with Year 2000 issues. To
date, the Company has received no communication that any third party service
providers are non-compliant with Year 2000 issues. Evidence supporting
compliance has been received from most third parties that provide critical
systems or service used in the ALM system. During the course of its evaluation
of Year 2000 issues pertaining to the ALM system, the Company identified one
operating software system that will require an upgrade to remediate Year 2000
issues. The Company expects that the required upgrades will be completed by
September 1, 1999.
Certain of the Company's services are accessed and utilized by external
systems of its customers. The Company has published an interface standard for
access to its services by these external systems, and the data elements of this
interface are Year 2000 compliant. This includes the interface to customer
created and maintained web pages for providing the Company's services using the
Internet.
Web Server-based Systems. The Company also provides service to its
customers using web server-based systems. These systems provide access to the
Company's services through customer maintained computer networks such as call
centers and indirect lending operations systems. The web server-based systems
access the Company's NOC through browser based applications which are
independent of the operating systems and hardware environments utilized by the
Company's customers. As a result, customers must ensure that these operating
system and hardware environments are Year 2000 compliant. Testing of these
systems is in process and is expected to be completed along with all necessary
remediation by September 1, 1999. Completion of the Company's Year 2000
initiatives with respect to its web server-based systems is dependent upon
completion of Year 2000 initiatives surrounding testing and implementation of
certain third party systems and services. Additionally, web server-based systems
are connected to the Company's NOC through dedicated third party communications
systems, and the Company has received statements from the provider of these
communications systems that such systems will operate in the Year 2000 and
beyond.
NOC Systems. The Company's NOC uses multiple servers to enable services
provided by its ALM and web server-based systems. These servers are
interconnected using standard Ethernet network facilities using TCP/IP
protocols. The Company is conducting tests on these servers and their operating
systems. All testing is expected to be completed along with all necessary
remediation by September 1, 1999. In addition, the Company is in the process of
soliciting and receiving statements from the various third party providers of
the IT and Non-IT components of these server systems regarding compliance with
Year 2000 issues.
The Company is dependent on services and systems provided by third
parties to maintain continuous and uninterrupted service to its customers.
Moreover, the Company's ability to fully certify its systems is dependent upon
successful implementation of Year 2000 compliant systems by third party service
providers. The Company anticipates that it will complete its assessment of Year
2000 issues related to third parties by September 1, 1999. The Company believes
that if certain third parties that provide essential services to the Company are
unable to demonstrate compliance with Year 2000 issues, the Company can switch
to alternative third party service providers and obtain substantially comparable
services at substantially the same cost.
Operations Systems
Operations Systems are those computer hardware and software systems
utilized by the Company for internal operating and administrative purposes.
Certain systems utilized by the Company for operating purposes are also
dependent on third party service providers, however, to a much lesser extent
than the systems utilized by the Company to provide services to its customers.
Operations systems include, but are not limited to, those systems used for
accounting, billing, human resources, payroll, internal communications and
management of software resources. Additionally, Operations Systems include other
devices used for ongoing operations such as telephone and PBX systems, personal
and network computers and fax machines. Third party services used in the
Company's internal operations include Internet and telephone services and other
communications services.
The Company is completing its remediation, testing and implementation
activities with respect to its Operations Systems. During the course of its
assessment the Company identified one Operations System that was not year 2000
compliant. The Company anticipates that remediation will be completed by
September 1, 1999.
Operations Non-IT systems may contain imbedded chip technology, which
complicates the Company's Year 2000 identification, assessment, remediation and
testing efforts. Based upon its identification and assessment efforts to date,
the Company believes that no replacement of critical computer equipment or
software will be necessary. In addition, in the ordinary course of replacing
computer equipment and software, the Company attempts to obtain replacements
that are Year 2000 compliant.
The Company is completing its assessment regarding certain non-critical
Operations Systems and services provided by third parties. The assessment of
critical Operations Systems and services by third parties has been completed
which generally included obtaining representations that such systems were Year
2000 compliant. The Company is in the process of soliciting and obtaining
representations regarding all other systems and services provided by third
parties with respect to Year 2000 issues. The Company currently does not have
sufficient information to ascertain whether all third party system and service
providers will be Year 2000 compliant by September 1, 1999.
Costs of Addressing Year 2000 Issues
The automated systems developed by the Company and upon which it is
primarily dependent to deliver services to its customers were designed and
developed in consideration of Year 2000 issues. Accordingly, the incremental
cost associated with addressing Year 2000 issues in the initial design and
development of the Company's systems has been insignificant. Similarly, the
Company's internally developed operating systems have been developed since 1994,
and the incremental costs associated with Year 2000 issues have been
insignificant. The costs associated with Year 2000 issue assessment,
identification, remediation and testing have not been significant, and the
Company does not believe that significant future costs will be incurred to
complete its assessment and remediation of Year 2000 issues.
Risks Associated with Year 2000 Issues
The Company is still evaluating Year 2000 issues and there can be no
assurance that the Company will be completely successful in its efforts to
assess, identify, remediate and test all Year 2000 issues including the Year
2000 issues which may affect critical services supplied by third parties. If the
Company is unable to complete its assessment or otherwise improperly assesses or
fails to adequately remediate Year 2000 issues, the Company may be unable to
provide continuous and uninterrupted services to its customers. Accordingly, the
Company could suffer the loss of revenue, customers and future sales as well as
expose itself to litigation. Similarly, the Company may be exposed to the
disruption of its business activities and diversion of resources that could
materially and adversely affect the operations and activities of the Company.
Any amount of potential lost revenue or liability related to year 2000 issues
cannot be reasonably estimated at this time.
To address the uncertainty and risks associated with Year 2000 issues,
the Company is developing contingency and recovery plans. Such plans are being
developed based on an assessment of possible scenarios that may result from Year
2000 issues and include the possible failure of the Company's systems and third
party systems and services. The Company anticipates that its planning efforts
and development of contingency plans will be complete by September 30, 1999.
Item 7(a). Quantitative and Qualitative Disclosures about Market Risk
The Company's market risk exposure is the potential loss arising from
changes in interest rates and its impact on investments and the Company's
mortgage brokerage business. The Company does not believe such risk is material.
The Company's cash and cash equivalents consist of highly liquid investments
with maturities of three months or less. At December 31, 1998, short term
investments consist of approximately $1,500,000 in a certificate of deposit with
a maturity of less than three months and approximately $6,500,000 in U.S.
Government securities with maturities greater than three months when purchased,
which are currently held as available for sale. Further, when the Company
receives a commitment to originate a mortgage loan from a consumer or
correspondent, the Company immediately receives a commitment from an investor to
buy such mortgage loan. The Company does not believe that its mortgage brokerage
business exposes it to significant market risk for changes in interest rates.
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, 1998 and 1997, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. 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, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
Greenville, South Carolina
March 12, 1999
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31,
1998 1997
---------------------- ---------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 2,026,932 $ 4,470,185
Investments 8,068,310 19,135,415
Accounts receivable, less allowance for
doubtful accounts of $45,513 and
$400,120 at December 31, 1998 and 1997,
respectively 727,999 1,944,947
Net investment in sales-type leases - current:
Third parties 534,302 1,537,902
Related party - 195,026
Inventories 2,054,542 2,960,038
Other current assets 1,349,995 799,628
---------------------- ---------------------
Total current assets 14,762,080 31,043,141
Net investment in sales-type leases - non-current:
Third parties 574,437 1,317,753
Related party - 10,988
Property and equipment, net 4,511,924 5,911,540
Software development costs, less accumulated amortization of
$111,211 and $117,807 at December 31, 1998 and 1997,
respectively 1,773,057 867,763
Other assets 2,575,377 3,058,385
====================== =====================
Total assets $ 24,196,875 $ 42,209,570
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
December 31,
1998 1997
---------------------- ---------------------
<S> <C> <C>
Liabilities and stockholders' equity Current liabilities:
Current portion of capital lease obligations to related $ - $ 64,222
party
Accounts payable 184,619 666,824
Accrued expenses 388,466 390,584
Accrued compensation and related benefits 359,670 561,391
Notes payable 141,480 -
Current portion of deferred revenue - related party - 40,463
Current portion of deferred revenue - third parties 144,063 720,097
---------------------- ---------------------
Total current liabilities 1,218,298 2,443,581
Deferred revenue 422,376 535,419
Commitments and contingent liabilities
Stockholders' equity:
Common stock, par value $0.0001; authorized
60,000,000 shares, issued
31,572,880 shares in 1998 and 31,550,199
shares in 1997 3,157 3,155
Additional paid-in capital 69,392,545 69,858,571
Deferred compensation (489,656) (1,558,574)
Treasury stock, at cost (2,073,207 and 992,207 shares at
December 31, 1998 and 1997, respectively) (3,371,297) (967,035)
Accumulated deficit (42,978,548) (28,105,547)
---------------------- ---------------------
Total stockholders' equity 22,556,201 39,230,570
====================== =====================
Total liabilities and stockholders' equity $ 24,196,875 $ 42,209,570
====================== =====================
</TABLE>
See accompanying notes.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Years ended December 31,
1998 1997 1996
---------------------- ---------------------- ----------------------
<S> <C> <C> <C>
Revenues:
Transactions $ 750,936 $ 545,551 $ 172,569
Mortgage processing services 453,657 - -
Initial set-up 91,000 638,687 426,848
Sales and rental (including $286,413 from related
party during 1996) 66,369 1,590,620 2,552,158
Professional services 797,301 792,734 -
Other income 496,996 579,307 130,243
License revenue - - 1,800,000
---------------------- ---------------------- ----------------------
2,656,259 4,146,899 5,081,818
Costs and expenses:
Cost of revenues 1,165,293 2,125,646 3,088,321
Research and development 2,559,600 3,526,257 2,905,232
Selling, general and administrative expenses 14,837,695 15,892,560 10,819,381
---------------------- ---------------------- ----------------------
Total costs and expenses 18,562,588 21,544,463 16,812,934
---------------------- ---------------------- ----------------------
Operating loss (15,906,329) (17,397,564) (11,731,116)
Interest income 1,044,251 2,033,571 2,099,004
Interest expense (10,923) (35,359) (60,083)
---------------------- ---------------------- ----------------------
Net loss $ (14,873,001) $ (15,399,352) $ (9,692,195)
====================== ====================== ======================
Net loss per share - basic and diluted $ (0.50) $ (0.54) $ (0.40)
====================== ====================== ======================
Shares used in computing net loss per share 29,755,034 28,477,880 24,136,480
====================== ====================== ======================
</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, $250,000 $2,732,356 $ 1,670 $4,237,960 $(3,590,574) $ - $(3,014,000) $ 617,412
1995
Exercise of warrants - 45,417 - - - - - 45,417
Conversion of (250,000) (2,777,773) 602 3,027,171 - - - -
preferred stock
Initial public
offering proceeds - - 506 60,088,010 - - - 60,088,516
Exercise of stock - - 10 46,990 - - - 47,000
options
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, - - 2,788 68,777,090 (3,939,044) - (12,706,195) 52,134,639
1996
Exercise of warrants - - 4 37,473 - - - 37,477
Exercise of warrants
by related party - - 240 - - - - 240
Exercise of stock - - 30 144,034 - - - 144,064
options
Amortization of
deferred compensation - - - - 480,534 - - 480,534
Forfeiture of stock - - - (1,899,936) 1,899,936 - - -
options
Purchase of treasury - - - (967,035) - (967,035)
stock
Issuance of common
stock in exchange
for capital stock of
subsidiary held by - - 67 1,599,933 - - - 1,600,000
minority investor
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, - - 3,155 69,858,571 (967,035) (28,105,547) 39,230,570
1997 (1,558,574)
Exercise of stock - - 2 4,228 - - - 4,230
options
Amortization of
deferred compensation - - - - 598,664 - - 598,664
Forfeiture of stock - - - (470,254) 470,254 - - -
options
Purchase of treasury - - - - - (2,404,262) - (2,404,262)
stock
Net loss - - - - - - (14,873,001) (14,873,001)
---------- ----------- ---------- ------------- -------------- ------------- ------------- -------------
Balance at December 31, $ - $ - $ 3,157 $69,392,545 $ (489,656) $(3,371,297) $(42,978,548) $22,556,201
1998
========== =========== ========== ============= ============== ============= ============= =============
</TABLE>
See accompanying notes.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years ended December 31,
1998 1997 1996
---------------------- ---------------------- ----------------------
<S> <C> <C> <C>
Operating activities
Net loss $ (14,873,001) $ (15,399,352) $ (9,692,195)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 2,369,220 2,066,270 902,846
Amortization of deferred compensation 598,664 480,534 1,028,489
Provision for doubtful accounts 370,000 456,841 170,000
Inventory valuation allowance 1,060,000 230,000 20,000
Deferred revenue 187,175 368,594 (1,098,072)
Other 94,808 195,505 59,243
Changes in current assets and liabilities:
Accounts receivable 543,906 (2,073,893) (261,531)
Net investment in sales-type leases 937,388 189,721 (2,093,519)
Inventories 450,258 (755,248) (2,420,946)
Other assets (550,367) (6,633) (784,976)
Accounts payable (482,205) (775,838) 702,449
Accrued expenses (2,118) (477,046) 508,361
Accrued compensation and related benefits (201,721) 105,986 233,331
---------------------- ---------------------- ----------------------
Net cash used in operating activities (9,497,993) (15,394,559) (12,726,520)
Investing activities
Purchases of property and equipment (696,122) (1,566,315) (5,558,806)
Proceeds from sale of property and equipment 47,622 144,535 -
Software development costs (1,041,091) (568,744) (214,820)
Purchases of short-term investments (9,436,211) (34,345,695) (10,583,997)
Sales of short-term investments 20,503,316 25,794,277 -
Other - (300,000) (349,618)
---------------------- ---------------------- ----------------------
Net cash provided by (used in) investing activities 9,377,514 (10,841,942) (16,707,241)
Financing activities
Proceeds from notes payable to related parties - - 450,000
Proceeds from notes payable to third parties 141,480 - 1,000,000
Principal payments on capital leases (64,222) (72,010) (156,289)
Payments on notes payable to related parties - - (775,416)
Payments on notes payable to third parties - - (1,000,000)
Proceeds from sale of capital stock of subsidiary to
minority interest - - 62,500
Purchase of treasury stock (2,404,262) (871,775) -
Exercise of warrants - 37,717 45,417
Exercise of options 4,230 48,804 47,000
Proceeds from issuance of common stock - - 60,088,516
Proceeds from issuance of preferred stock - - -
---------------------- ---------------------- ----------------------
Net cash (used in) provided by financing activities (2,322,774) (857,264) 59,761,728
---------------------- ---------------------- ----------------------
Net (decrease) increase in cash (2,443,253) (27,093,765) 30,327,967
Cash and cash equivalents at beginning of year 4,470,185 31,563,950 1,235,983
----------------------
====================== ======================
Cash and cash equivalents at end of year $ 2,026,932 $ 4,470,185 $ 31,563,950
====================== ====================== ======================
Cash paid during the year for:
Interest $ - $ - $ 85,287
</TABLE>
See accompanying notes.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 1998
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 approximately $60,089,000.
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.
One of the platforms 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 deposit 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.
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
Corporation and Multi Financial Services, Inc. and its wholly owned subsidiary
Surety Mortgage, Inc., ("Surety"). All significant inter-company balances and
transactions have been eliminated in consolidation.
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.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies
Investments
The Company classifies its investments as held to maturity or available for
sale. At December 31, 1998 approximately $6,500,000 and $1,500,000 was
classified as available for sale and held to maturity, respectively. Investments
consist of investments in certificates of deposit and U.S. Government securities
with maturities greater than three months when purchased. Such investments are
reported at amortized cost, which approximates fair value. The Company had no
unrealized holding gains or losses associated with investments classified as
available for sale during the years ended December 31, 1998, 1997 and 1996.
Fair Value of Financial Instruments
The carrying amounts reported in the balance sheet for cash and cash
equivalents, investments, accounts receivable, net investment in sales-type
leases, accounts payable and notes payable approximate their fair values. Fair
values of investments are based on quoted market prices.
Inventories
Inventories at December 31, 1998 and 1997 are stated at the lower of cost or
market. Cost is determined using the first-in, first-out ("FIFO") cost flow
assumption.
Other Current Assets
Other current assets at December 31, 1998 consisted of deferred contract costs
of $810,457, prepaid expenses of $418,781 and interest receivable of $120,757.
At December 31, 1997, other current assets consisted of deferred contract costs
of $170,945, prepaid expenses of $255,870 and interest receivable of $372,813.
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 approximately $1,893,000, $1,799,000 and $849,000 during 1998, 1997
and 1996, 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 approximately $82,000,
$65,000 and $54,000 during 1998, 1997 and 1996, respectively.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Valuation of Long-Lived Assets
In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" ("SFAS 121"), the Company periodically evaluates the carrying
value of long-lived assets to be held and used, including property and equipment
and goodwill, when events and circumstances warrant such a review. The carrying
value of a long-lived asset is considered impaired when the anticipated
undiscounted cash flow from such asset is separately identifiable and is less
than its carrying value. In the event of such, a loss is recognized based on the
amount by which the carrying value exceeds the fair market value of the
long-lived asset. Fair market value is determined primarily using the
anticipated cash flows discounted at a rate commensurate with the risk involved.
Based on the anticipated cash flows from the Company's business plan, management
believes that no impairment writedown is required for long-lived assets for the
year ended December 31, 1998.
Intangible Assets
Intangible assets arising from the excess of cost over acquired assets are
amortized by the straight line method over their estimated useful life of ten
years. Intangible assets, primarily goodwill, consisted of approximately
$1,470,000 which was recorded in conjunction with the acquisition of Buy
American, Inc. and Project Freedom, Inc. (see Note 8), 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 $373,000 and
$86,000 at December 31, 1998 and 1997, respectively.
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. These holdings represented a 24.9% minority interest
in APC at December 31, 1996.
Software Revenue Recognition
The Company has adopted the American Institute of Certified Public Accountants
("AICPA") 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 did
not recognize any revenue during 1998 associated with contracts subject to SOP
97-2 guidance.
During 1998, the AICPA issued Statement of Position 98-4, "Deferral of the
Effective Date of a Provision of SOP 97-2, Software Revenue Recognition" ("SOP
98-4"), effective as of March 31, 1998. SOP 98-4 postponed the adoption of a
provision of SOP 97-2 for one year.
Also during 1998, the AICPA issued Statement of Position 98-9, "Modification of
SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions"
("SOP 98-9"). Effective December 15, 1998, SOP 98-9 amends SOP 98-4 to further
postpone the adoption of certain provisions of SOP 97-2 as provided by SOP 98-4,
for fiscal years beginning on or before March 15, 1999. All other provisions of
SOP 98-9, which amend certain passages of SOP 97-2, are effective for
transactions entered into in fiscal years beginning after March 15, 1999.
The Company continues to assess the effects that the adoption of SOP 97-2, as
amended by SOP 98-4 and SOP 98-9, will have on the presentation of the Company's
financial statements.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
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
standard 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 revenue represented
approximately 28%, 13% and 3% of total revenue during 1998, 1997 and 1996,
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.
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.
Mortgage processing services - Surety engages in mortgage brokerage activities
which generally involve originating, processing, and selling mortgage loan
products to outside investors. Surety originates and/or process mortgage loans
directly with consumers or on behalf of correspondents and immediately sells
such loans to investors that sponsor the loan programs offered by Surety. Surety
only offers loans that will be acquired by the investors under such programs.
Upon making the loan commitment to the borrower, Surety immediately receives a
commitment from an investor to acquire the loan upon closing. Loan origination
fees include gains on sales of mortgage loans to investors and loan origination
fees received for originating and processing the loan. Loan origination fees and
all direct costs associated with originating loans are recognized at the time
the loans are sold.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Cost of Revenues
Cost of revenues consists of costs associated with initial set-up, transaction
fees, sales and rental revenues, professional services and mortgage processing
services. Costs associated with initial set-up fees include labor, other direct
costs and an allocation of related indirect costs. The Company's deployment of
ALMs was insignificant in 1998 and no costs were incurred in 1998 in association
with initial set-up revenue recognized. Labor and other direct costs associated
with initial set-up fees totaled approximately $232,000 and $427,000 for the
years ended December 31, 1997 and 1996, 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 approximately $380,000, $1,041,000 and $2,426,000
for the years ended December 31, 1998, 1997 and 1996, 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 approximately
$204,000 and $524,000 for the years ended December 31, 1998 and 1997,
respectively. Costs associated with mortgage processing services include direct
costs associated with originating and processing mortgage loans and totaled
approximately $193,000 for the year ended December 31, 1998. Prior to 1998 the
Company did not perform services of this nature.
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 $193,000, $1,488,000 and $1,662,000 during 1998, 1997
and 1996, respectively.
Net Loss Per Share of Common Stock
In 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 superseded Accounting
Principles Board Opinion No. 15, "Earnings Per Share" ("APB 15"). SFAS 128
changed 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 adopted SFAS 128 in 1997 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. Stock warrants and stock options were not included in the calculation
of dilutive loss per common share because the Company has experienced operating
losses in all periods presented and, therefore, the effect would be
antidilutive.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
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").
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 related to sales-type leases.
Segment Information
The Company has adopted the reporting requirements of Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information"("SFAS 131"), in its financial statements for the year ended
December 31, 1998. SFAS No. 131 establishes standards for the way that companies
report information about operating segments in annual financial statements. It
also establishes standards for related disclosures about products and services,
geographic areas, and major customers as well as the reporting of selected
information about operating segments in interim financial reports to
stockholders. In accordance with management's oversight of the Company's
operations, the Company conducts its business within one industry segment -
financial services technology.
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.
Reclassification
Certain amounts in 1997 and 1996 have been reclassified to conform to 1998
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,
1998 1997
-------------------- --------------------
<S> <C> <C>
Total minimum lease payments receivable $ 1,244,355 $ 3,124,181
Residual values - 360,000
-------------------- --------------------
1,244,355 3,484,181
Less unearned interest income (135,616) (422,512)
==================== ====================
Net investment in sales-type leases $ 1,108,739 $ 3,061,669
==================== ====================
Net investment in sales-type leases is classified as:
Current $ 534,302 $ 1,732,928
Non-current 574,437 1,328,741
==================== ====================
$ 1,108,739 $ 3,061,669
==================== ====================
</TABLE>
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. Sales-Type and Operating Leases (continued)
Future minimum lease payments to be received on sales-type leases at December
31, 1998 are as follows:
<TABLE>
<CAPTION>
Sales-Type
--------------------
<S> <C>
1999 $ 616,278
2000 363,662
2001 264,415
--------------------
$ 1,244,355
====================
</TABLE>
4. Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
December 31,
1998 1997
-------------------- -------------------
<S> <C> <C>
Electronic parts and other components $ 1,062,180 $ 1,396,826
Work in process 1,207,915 829,269
Finished goods 880,145 906,950
-------------------- -------------------
3,150,240 3,133,045
Reserve for obsolescence (1,095,698) (173,007)
==================== ===================
$ 2,054,542 $ 2,960,038
==================== ===================
</TABLE>
5. Property and Equipment
Property and equipment consists of the following:
<TABLE>
<CAPTION>
December 31,
1998 1997
-------------------- -------------------
<S> <C> <C>
ALM equipment leased to others under operating leases $ 676,326 $ 935,521
Data processing equipment 2,622,410 2,326,651
Demonstration equipment 687,632 582,857
Office furniture and fixtures 2,359,147 2,338,381
Automobiles 72,003 72,003
Purchased software 2,164,463 2,112,515
-------------------- -------------------
8,581,981 8,367,928
Less accumulated depreciation and amortization (4,070,057) (2,456,388)
-------------------- ------------------
$ 4,511,924 $ 5,911,540
==================== ===================
</TABLE>
Accumulated depreciation of ALM equipment leased to others was approximately
$455,000 and $424,000 at December 31, 1998 and 1997, respectively.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Notes Payable
During June 1998, Surety entered into an agreement with a lender to establish a
credit facility with a maximum borrowing amount of $2,000,000. Pursuant to the
terms of the agreement, Surety may obtain advances from the lender for funding
of mortgage loans made by Surety during the interim period between the funding
and sale of the loans to permanent investors. All advances made pursuant to the
agreement are secured by a security interest in the rights and benefits due
Surety in conjunction with the making of the underlying loan. The credit
facility bears interest at the lender's prime rate plus 50 basis points and
expires on June 1, 1999. Outstanding borrowings under the Loan Warehousing
Agreement as of December 31, 1998 were $141,480 bearing an interest rate of
8.25%.
7. 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, conversion 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, 1998 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, 1998,
approximately 623,000 options are exercisable. At December 31, 1998, the
weighted average exercise price was $0.44 and the weighted average remaining
contractual life was 7.83 years. This plan closed during April 1996.
In April 1996, the Company adopted the 1996 Incentive Stock Option 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.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. Stockholders' Equity (continued)
A summary of activity under the 1996 and 1995 Option Plans is as follows:
<TABLE>
<CAPTION>
Options Outstanding
--------------------------------------
Weighted
Shares Average
Available Number Price
for Grant Of Shares Per Share
------------------ ------------------ ---------------
<S> <C> <C> <C>
1995 Stock Option Plan
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
Options canceled/forfeited - (175,642) $0.44
Options exercised - (9,540) $0.44
================== ================== ===============
Balance at December 31, 1998 - 702,214 $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 $ 6.07
Options canceled/forfeited 125,525 (125,525) $ 7.17
------------------ ------------------ ---------------
Balance at December 31, 1997 1,183,800 716,200 $ 6.66
Options granted (1,544,255) 1,544,255 $ 1.03
Options canceled/forfeited 636,805 (636,805) $ 5.63
================== ================== ===============
Balance at December 31, 1998 276,350 1,623,650 $ 1.55
================== ================== ===============
</TABLE>
A summary of stock options exercisable and stock options outstanding under the
1996 Option Plan is as follows:
<TABLE>
<CAPTION>
1996 Stock Option Plan
- - -------------------------------------------------------------------------------------------------------------------
Options Exercisable Options Outstanding
at December 31, 1998 At December 31, 1998
------------------------------- -------------------------------------------------------
Weighted
Weighted Weighted Average
Range of Average Average Remaining
Exercise Number Price Number Price Contractual
Prices Exercisable Per Share Outstanding Per Share Life (years)
- - -------------------- --------------- ------------ --------------- ---------------- ----------------
<C> <C> <C> <C> <C> <C>
$ 0.50 - $ 0.94 - $ 1,345,875 $ 0.90 9.6
-
$ 2.19 - $ 3.75 15,590 $ 3.75 167,810 $ 3.01 8.9
$ 6.75 - $ 7.38 23,105 $ 7.30 109,965 $ 7.32 8.0
=============== ===============
$ 0.50 - $ 7.38 38,695 $ 5.87 1,623,650 $ 1.55 9.4
=============== ===============
</TABLE>
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. Stockholders' Equity (continued)
The Company has recorded in 1996 and 1995 deferred compensation expense totaling
approximately $5,492,000 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. Generally, options granted vest ratably over a 60 month
term. Amortization of deferred compensation in 1998, 1997 and 1996 totaled
approximately $599,000, $481,000 and $1,028,000, respectively.
During July 1998, in connection with the employment of the President and Chief
Executive Officer of the Company, the Company issued an option to purchase
250,000 shares of common stock of the Company at an exercise price of $0.94 per
share. The exercise price equaled the estimated fair market value on the date of
grant. This option vests ratably over a 60 month term. The issuance of this
option is independent of the 1995 and 1996 Incentive Stock Option Plans.
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 on 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.
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 because the Company did not meet 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 lapsed during 1997 and 47,100 lapsed during
1998 because the required performance measures were not met.
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
4.2% to 5.6% for 1998, 5.4% to 6.7% for 1997 and 5.8% to 6.8% for 1996;
volatility factor of the expected market price of the Company's common stock of
0.67, 0.75 and 0.69 for options issued during 1998, 1997 and 1996, respectively;
and an expected option life ranging from 1 to 5 years. The weighted average fair
value for options granted under the 1996 Plan during 1998, 1997 and 1996 was
$0.69, $2.97 and $5.82, respectively. The fair value of options granted during
1998 in connection with the employment of the President and Chief Executive
Officer of the Company, was $0.44.
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.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. Stockholders' Equity (continued)
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>
1998 1997 1996
----------------- ----------------- -------------------
<S> <C> <C> <C>
Pro forma net loss $ (14,811,559) $ (16,258,811) $ (10,662,080)
Pro forma net loss per share - basic and diluted $ (0.50) $ (0.57) $ (0.44)
</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 owns 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.
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 agreement, 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 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.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. 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 exercisable for a 30 day period ending May 31, 1999.
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.
9. Leases
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, 1998 are as follows:
<TABLE>
<CAPTION>
<S> <C>
1999 $ 632,501
2000 638,001
2001 351,834
-------------------
Total $ 1,622,336
===================
</TABLE>
In 1998, 1997 and 1996 the Company incurred rent expense, including rent
associated with cancelable rental agreements, of approximately $915,000,
$799,000 and $446,000, respectively.
10. Income Taxes
As of December 31, 1998, the Company had federal and state net operating loss
carryforwards of approximately $40,465,000. The net operating loss carryforwards
will begin to expire between 2009 and 2013 if not utilized.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. 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:
<TABLE>
<CAPTION>
December 31,
1998 1997
--------------------- ---------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 15,860,400 $ 10,384,400
Inventory valuation reserve 415,900 65,700
Capital leases 343,800 -
Other 156,600 241,000
--------------------- ---------------------
Total deferred tax assets 16,276,700 10,691,100
--------------------- ---------------------
Deferred tax liabilities:
Capitalized software costs (673,000) (284,800)
Capital leases (158,100) -
Depreciation (301,600) (318,800)
--------------------- ---------------------
Total deferred tax liabilities (974,600) (761,700)
--------------------- ---------------------
Less:
Valuation allowance (15,302,100) (9,929,400)
===================== =====================
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, 1998 and 1997, based on
management's evaluation of the evidential recognition requirements under the
criteria of SFAS 109. During 1998 and 1997, the total valuation allowance
increased approximately $5,372,700 and $5,948,600, repectively. The main
component of the evidential recognition requirements was the Company's
cumulative pretax losses since inception.
11. Segment Information
The Company conducts its business within one industry segment - financial
services technology. To date, all revenues generated have been from transactions
with North American customers. One customer, the Dime Savings Bank of New York,
accounted for 49% and 48% of revenues in 1998 and 1997, respectively. Two other
customers accounted for 20% of revenues in 1997, which individually represented
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." All other segment
disclosures required by SFAS 131 are included in the consolidated financial
statements or in the notes to the consolidated financial statements.
<PAGE>
Affinity Technology Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
12. Other Related Party Transactions
The Company had leased ALMs to a bank which holds a warrant to acquire shares of
common stock of the Company. See Note 7. The Company has installed and otherwise
delivered a number of ALMs on behalf of the bank during 1996 and 1995. Pursuant
to a contract termination agreement executed between the bank and the Company,
amounts due the Company totaling approximately $505,000 were settled in
consideration of a $50,000 payment and the return of the ALMs to the Company.
The amount due the Company was charged to the allowance for doubtful accounts as
of December 31, 1998. 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.
During February 1998, Surety entered into an agreement with Resource Bancshares
Mortgage Group, Inc. ("RBMG"), pursuant to which the Company will underwrite and
process mortgage loans in accordance with guidelines specified by RBMG. The
Company receives a fee from RBMG for the underwriting and processing services
performed. During 1998, the Company processed and sold to RBMG approximately
$18,300,000 in mortgage loans resulting in approximately $330,000 in revenue for
the Company. The Chairman of the Board and Chief Executive Officer of RBMG is a
member of the Company's Board of Directors.
13. Commitments and Contingent Liabilities
As of December 31, 1998, Surety had $2,475,900 in commitments outstanding to
originate and sell mortgage loans. Commitments to originate mortgage loans
represent mortgage loan applications where the borrower has locked in the
interest rate. Commitments to sell mortgage loans to investors represent
optional commitments to sell mortgage loans at a future date and at a specified
price.
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 claimed certain rights, damages or interests incidental to the
Company's formation and development. During 1998, certain of these claims were
resolved in a manner that did not have a material impact on the Company's
financial condition or results of operations. Additionally, a former employee
has filed suit against the Company alleging breach of contract and non-payment
of wages. 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, 1999 under the captions "Board of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compliance," 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, 1999 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, 1999 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, 1999 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, 1998 and 1997.
ii. Consolidated Statement of Operations for the years ended
December 31, 1998, 1997 and 1996.
iii. Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1998, 1997 and 1996.
iv. Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.
v. Notes to the Consolidated Financial Statements for the years
ended December 31, 1998, 1997, and 1996.
(2) Schedule II - See additional sections 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.
<PAGE>
(3) Exhibits:
<TABLE>
<CAPTION>
Exhibit Number Description
- - -------------------- ------------------------------------------------------------------------------------------------
<S> <C>
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. dated November 8, 1995,
for the purchase, subject to certain conditions, of 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 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).
10.2* 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).
10.3* 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).
10.4* 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).
10.5* 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).
10.6* 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).
10.7* 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).
10.8 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).
10.9* Declaration of First Amendment to 1995 Stock Option Plan of Affinity Technology Group, Inc.
10.11* Declaration of First Amendment to 1996 Stock Option Plan of Affinity Technology Group, Inc.
10.10* Nonqualified Stock Option Agreement, dated as of July 29, 1998, between Affinity Technology
Group, Inc and R. Murray Smith, which is hereby
incorporated by reference to Exhibit 10 of the Quarterly
Report on Form 10-Q of Affinity Technology Group, Inc.
for the quarter ended September 30, 1998.
21 Subsidiaries of Affinity Technology Group, Inc.
23.1 Consent of Independent Auditors.
27 Financial Data Schedule.
</TABLE>
* Denotes a management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K filed in the 4th quarter of 1998:
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, 1999 By: /s/ R. Murray Smith
--------------------
R. Murray Smith
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/ R. Murray Smith March 31, 1999
- - ---------------------------------------
R. Murray Smith President, Chief Executive Officer and Director
(principal executive officer)
/s/ Alan H. Fishman March 31, 1999
- - ---------------------------------------
Alan H. Fishman Director
/s/ Robert M. Price, Jr. March 31, 1999
- - ---------------------------------------
Robert M. Price, Jr. Director
/s/ Edward J. Sebastian March 31, 1999
- - ---------------------------------------
Edward J. Sebastian Director
/s/ Peter R. Wilson, Ph.D. March 31, 1999
- - ---------------------------------------
Peter R. Wilson, Ph.D. Director
- - ---------------------------------------
Jeff A. Norris Director March 31, 1999
/s/ Joseph A. Boyle March 31, 1999
- - ---------------------------------------
Joseph A. Boyle Senior Vice President, Chief Financial Officer
and Treasurer (principal financial officer)
/s/ Richard R. Butcher March 31, 1999
- - ---------------------------------------
Richard R. Butcher Vice President and Controller
(principal accounting officer)
</TABLE>
Schedule II - Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
- - -------------------------------------- ---------------- ---------------------------------- ----------------- -----------------
COL.A COL. B. COL. C COL. D COL. E
-----------------
- - -------------------------------------- ---------------- ---------------------------------- ----------------- -----------------
Additions
----------------------------------
----------------- ----------------
Charged to
Balance at Charged to Other Accounts
Beginning of Costs and - Describe Deductions-DescribeBalance at End
Description Period Expenses of Period
- - -------------------------------------- ---------------- ----------------- ---------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1998
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $ 400,120 $ 370,000 $ - $ 724,607 (1) $ 45,513
Reserve for inventory obsolescence
173,007 1,060,000 - $ 137,309 (2) 1,095,698
Year ended December 31, 1997
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $ 198,987 $ 456,841 $ - $ 255,708 (1) $ 400,120
Reserve for inventory obsolescence
20,000 230,000 - 76,993 (2) 173,007
Year ended December 31, 1996
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $ 3,667 $ 170,000 $ 25,320 (3) $ - $ 198,987
Reserve for inventory obsolescence
46,000 20,000 - 46,000 (2) 20,000
<FN>
(1) Uncollectible accounts written off, net of recoveries.
(2) Obsolete parts written off.
(3) Immaterial other changes.
</FN>
</TABLE>
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
Exhibit Number Description
- - ---------------------- ------------------------------------------------------------------------------------------------
<S> <C>
10.10 Declaration of First Amendment to 1996 Stock Option Plan of Affinity Technology Group, Inc.
10.11 Declaration of First Amendment to 1995 Stock Option Plan of Affinity Technology Group, Inc.
21 Subsidiaries of Affinity Technology Group, Inc.
23.1 Consent of Ernst & Young LLP
27 Financial Data Schedule
</TABLE>
<PAGE>
Exhibit 10.10 - Declaration of First Amendment to 1996 Stock Option Plan of
Affinity Technology Group, Inc.
DECLARATION OF FIRST AMENDMENT
TO
1996 STOCK OPTION PLAN OF
AFFINITY TECHNOLOGY GROUP, INC.
THIS DECLARATION OF FIRST AMENDMENT, made as of the 12th day of
October, 1998, by AFFINITY TECHNOLOGY GROUP, INC., a Delaware corporation (the
"Company"), to the 1996 Stock Option Plan of Affinity Technology Group, Inc. (as
amended and restated effective October 31, 1996) (the "Plan");
R E C I T A L S:
WHEREAS, it is deemed advisable to amend the Plan to provide that
options granted under the Plan shall vest and become exercisable upon a change
in control of the Company.
NOW, THEREFORE, BE IT RESOLVED, that effective as of October 12, 1998,
the Plan shall be amended by adding Section 7(f) to the Plan to read as follows:
(f) Notwithstanding any provisions of the plan to the
contrary, in the event of a Change in Control of the Company
(as hereinafter defined), all options outstanding as of the
date of such Change of Control shall become fully exercisable,
whether or not then otherwise exercisable. For purposes of
this Section 7(f), a Change in Control shall be deemed to
occur as of: (i) the date on which any "person" or "group" (as
such terms are used in Sections 13(d) and 14(d) of the 1934
Act) becomes the beneficial owner (as defined in Rules 13d-3
and 13d-5 under the 1934 Act) of shares representing more than
50% of the combined voting power of the then-outstanding
securities entitled to vote generally in elections of
directors of the Corporation ("Voting Stock"); (ii) the date
on which the stockholders of the Corporation approve a
definitive agreement under which the Corporation will
consolidate with or merge into any other corporation, or
convey, transfer or lease all or substantially all of its
assets to any person, or any other corporation will merge into
the Corporation, and, in the case of any such transaction, the
outstanding common stock of the Corporation will be converted
into cash, securities or other property, unless the
stockholders of the Corporation immediately before such
transaction own, directly or indirectly immediately following
such transaction, at least 51% of the combined voting power of
the outstanding securities of the corporation resulting from
such transaction in substantially the same proportion as their
ownership of the Voting Stock immediately before such
transaction; or (iii) the date on which there shall have been
a change in a majority of the Board of Directors of the
Corporation within a 12-month period unless the nomination for
election of each new director was approved by the vote of
two-thirds of the directors then still in office who were in
office at the beginning of the 12-month period.
IN WITNESS WHEREOF, this Declaration of First Amendment is executed on
behalf of Affinity Technology Group, Inc. as of the day and year first above
written.
AFFINITY TECHNOLOGY GROUP, INC.
By: /s/ R. Murray Smith
R. Murray Smith, President and
Chief Executive Officer
<PAGE>
Exhibit 10.10 - Declaration of First Amendment to 1995 Stock Option Plan of
Affinity Technology Group, Inc.
DECLARATION OF FIRST AMENDMENT
TO
1995 STOCK OPTION PLAN OF
AFFINITY TECHNOLOGY GROUP, INC.
THIS DECLARATION OF FIRST AMENDMENT, made as of the 12th day of
October, 1998, by AFFINITY TECHNOLOGY GROUP, INC., a Delaware corporation (the
"Company"), to the 1995 Stock Option Plan of Affinity Technology Group, Inc. (as
amended and restated effective October 31, 1996) (the "Plan");
R E C I T A L S:
WHEREAS, it is deemed advisable to amend the Plan to provide that
options granted under the Plan shall vest and become exercisable upon a change
in control of the Company.
NOW, THEREFORE, BE IT RESOLVED, that effective as of October 12, 1998,
the Plan shall be amended by adding Section 7(f) to the Plan to read as follows:
(f) Notwithstanding any provisions of the plan to the
contrary, in the event of a Change in Control of the Company
(as hereinafter defined), all options outstanding as of the
date of such Change of Control shall become fully exercisable,
whether or not then otherwise exercisable. For purposes of
this Section 7(f), a Change in Control shall be deemed to
occur as of: (i) the date on which any "person" or "group" (as
such terms are used in Sections 13(d) and 14(d) of the 1934
Act) becomes the beneficial owner (as defined in Rules 13d-3
and 13d-5 under the 1934 Act) of shares representing more than
50% of the combined voting power of the then-outstanding
securities entitled to vote generally in elections of
directors of the Corporation ("Voting Stock"); (ii) the date
on which the stockholders of the Corporation approve a
definitive agreement under which the Corporation will
consolidate with or merge into any other corporation, or
convey, transfer or lease all or substantially all of its
assets to any person, or any other corporation will merge into
the Corporation, and, in the case of any such transaction, the
outstanding common stock of the Corporation will be converted
into cash, securities or other property, unless the
stockholders of the Corporation immediately before such
transaction own, directly or indirectly immediately following
such transaction, at least 51% of the combined voting power of
the outstanding securities of the corporation resulting from
such transaction in substantially the same proportion as their
ownership of the Voting Stock immediately before such
transaction; or (iii) the date on which there shall have been
a change in a majority of the Board of Directors of the
Corporation within a 12-month period unless the nomination for
election of each new director was approved by the vote of
two-thirds of the directors then still in office who were in
office at the beginning of the 12-month period.
IN WITNESS WHEREOF, this Declaration of First Amendment is executed on
behalf of Affinity Technology Group, Inc. as of the day and year first above
written.
AFFINITY TECHNOLOGY GROUP, INC.
By: /s/ R. Murray Smith
R. Murray Smith, President and
Chief Executive Officer
<PAGE>
Exhibit 21 - Subsidiaries of Affinity Technology Group, Inc.
<TABLE>
<CAPTION>
Name Jurisdiction of Incorporation Percent Owned
- - ------------------------------------------- ----------------------------------- ------------------------------
<S> <C> <C>
Affinity Bank Technology Corporation Delaware, USA 100%
Affinity Clearinghouse Corporation Delaware, USA 100%
Affinity Credit Corporation Delaware, USA 100%
Affinity Processing Corporation Delaware, USA 100%
Affinity Mortgage Technology Corporation Delaware, USA 100%
Multi Financial Services, Inc. Delaware, USA 100%
Surety Mortgage, Inc. Delaware, USA 100%
decisioning.com, inc. Delaware, USA 100%
</TABLE>
Exhibit 23.1 - Consent of Independent Auditors
We consent to the use of our report dated March 12, 1999 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 12, 1999, 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, 1998.
/s/ ERNST & YOUNG LLP
Greenville, South Carolina
March 31, 1999
<PAGE>
Exhibit 27 - Financial Data Schedule
This schedule contains summary financial information extracted from the
consolidated financial statements for the year ended December 31, 1998 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-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,026,932
<SECURITIES> 8,068,310
<RECEIVABLES> 773,512
<ALLOWANCES> 45,513
<INVENTORY> 2,054,542
<CURRENT-ASSETS> 14,762,080
<PP&E> 8,581,981
<DEPRECIATION> 4,070,057
<TOTAL-ASSETS> 24,196,875
<CURRENT-LIABILITIES> 1,218,298
<BONDS> 0
0
0
<COMMON> 3,157
<OTHER-SE> 22,553,044
<TOTAL-LIABILITY-AND-EQUITY> 24,196,875
<SALES> 0
<TOTAL-REVENUES> 2,656,259
<CGS> 1,165,293
<TOTAL-COSTS> 18,562,588
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,430,000
<INTEREST-EXPENSE> (1,033,328)
<INCOME-PRETAX> (14,873,001)
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