<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO ________
COMMISSION FILE NUMBER 000-21735
CREDIT MANAGEMENT SOLUTIONS, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 52-1549401
- --------------------------------------------------------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
5950 SYMPHONY WOODS ROAD, COLUMBIA, MARYLAND 21044
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (410) 740-1000
----------------------------
FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE
LAST REPORT.
Indicate by check _ whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 7,643,034 shares of the
Company's Common Stock, $.01 par value, were outstanding as of November 9, 1998.
1
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CREDIT MANAGEMENT SOLUTIONS, INC.
INDEX
<TABLE>
<CAPTION>
Page
----
Part I -- Financial Information
<S> <C> <C>
Item 1. Financial Statements (unaudited)................................................................................ 3
Consolidated Balance Sheets -- September 30, 1998 and December 31, 1997.......................................... 3
Consolidated Statements of Operations -- Three Months Ended September 30, 1998
and 1997 and Nine Months Ended September 30, 1998 and 1997....................................................... 4
Consolidated Statements of Cash Flows --Nine Months Ended September 30,
1998 and 1997.................................................................................................. 5
Notes to Consolidated Financial Statements....................................................................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.................................................................. 7
Item 3. Certain Factors That May Affect Future Results,
Financial Condition and the Market Price of Securities........................................................ 12
Part II -- Other Information
Item 1. Legal Proceedings............................................................................................... 19
Item 2. Changes in Securities........................................................................................... 19
Item 3. Defaults upon Senior Securities................................................................................. 19
Item 4. Submission of Matters to a Vote of Security Holders............................................................. 19
Item 5. Other Information............................................................................................... 19
Item 6. Exhibits and Reports on Form 8-K................................................................................ 19
Signatures...................................................................................................... 21
</TABLE>
2
<PAGE> 3
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CREDIT MANAGEMENT SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
----------------- ----------------
(unaudited)
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 630,938 $20,569,300
Investments available-for-sale 10,257,570 -
Accounts receivable, net of allowance of $380,861 and $194,856
in 1998 and 1997, respectively 4,606,862 3,550,927
Costs and estimated earnings in excess of billings on uncompleted
contracts 860,534 503,875
Prepaid expenses and other current assets 395,901 463,849
Deferred income taxes 58,513 58,513
----------- -----------
Total current assets 16,810,318 25,146,464
PROPERTY AND EQUIPMENT:
Computer equipment and software 6,073,455 3,442,792
Office furniture and equipment 1,042,995 941,733
Leasehold improvements 673,805 499,404
----------- -----------
7,790,255 4,883,929
Accumulated depreciation and amortization (2,493,513) (1,677,138)
----------- -----------
5,296,742 3,206,791
Software development costs, net of accumulated amortization of
$268,374 and $178,583 in 1998 and 1997, respectively 89,791 179,582
Other assets 245,246 423,886
----------- -----------
Total assets $22,442,097 $28,956,723
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,403,191 $ 2,225,745
Accrued payroll and related expenses 1,004,898 1,059,177
Billings in excess of costs and estimated earnings on uncompleted
contracts 431,477 588,522
Deferred revenue 1,835,572 1,632,339
Current portion of capital lease obligations 83,753 138,165
----------- -----------
Total current liabilities 4,758,891 5,643,948
LONG-TERM DEBT:
Capital lease obligations, less current portion 40,868 101,390
Commitments and contingent liabilities - -
----------- -----------
Total liabilities 4,799,759 5,745,338
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 1,000,000 shares authorized; no
Shares issued or outstanding - -
Common stock, $.01 par value; 40,000,000 shares authorized;
7,643,034 and 7,615,510 shares issued and outstanding at
September 30, 1998 and December 31, 1997, respectively 76,430 76,155
Additional paid-in capital 26,820,583 26,645,247
Retained earnings (deficit) (9,254,675) (3,510,017)
----------- -----------
Total stockholders' equity 17,642,338 23,211,385
----------- -----------
Total liabilities and stockholders' equity $22,442,097 $28,956,723
=========== ===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS
3
<PAGE> 4
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
---------------------------------------------------
1998 1997
------------------------ ------------------------
(unaudited) (unaudited)
<S> <C> <C>
REVENUES:
License and software development fees $ 2,820,611 $ 3,131,084
Maintenance fees 998,165 974,698
Computer hardware sales 39,988 98,466
Service bureau revenues 369,857 179,023
----------- -----------
Total revenues 4,228,621 4,383,271
COSTS OF REVENUES:
Cost of license and software development fees 1,653,880 1,743,541
Cost of maintenance fees 216,427 330,535
Cost of computer hardware sales 103,078 137,306
Cost of service bureau revenues 880,332 672,986
----------- -----------
2,853,717 2,884,368
----------- -----------
Gross Profit 1,374,904 1,498,903
OTHER OPERATING EXPENSES:
Selling, general and administrative expenses 2,786,886 1,877,161
Research and development costs 587,199 682,004
----------- -----------
3,374,085 2,559,165
----------- -----------
Loss from operations (1,999,181) (1,060,262)
OTHER INCOME (EXPENSE):
Interest expense (6,497) (10,743)
Interest income 178,691 301,265
Amortization of excess of assigned value of
Identifiable assets over cost of an acquired
Interest - -
172,194 290,522
----------- -----------
Net loss $(1,826,987) $ (769,740)
----------- -----------
Basic and diluted loss per common share $ (0.24) $ (0.10)
=========== ===========
Shares used in computation 7,641,278 7,610,484
=========== ===========
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------------------------
1998 1997
------------------------ ------------------------
(unaudited) (unaudited)
<S> <C> <C>
REVENUES:
License and software development fees $ 6,996,071 $ 8,049,264
Maintenance fees 3,002,076 2,258,198
Computer hardware sales 431,059 948,155
Service bureau revenues 1,177,995 414,310
----------- -----------
Total revenues 11,607,201 11,669,927
COSTS OF REVENUES:
Cost of license and software development fees 5,146,747 4,999,355
Cost of maintenance fees 765,204 586,435
Cost of computer hardware sales 603,822 863,463
Cost of service bureau 2,434,346 1,341,706
----------- -----------
8,950,119 7,790,959
----------- -----------
Gross Profit 2,657,082 3,878,968
OTHER OPERATING EXPENSES:
Selling, general and administrative expenses 7,386,103 5,871,800
Research and development costs 1,642,535 1,327,054
----------- -----------
9,028,638 7,198,854
----------- -----------
Loss from operations (6,371,556) (3,319,886)
OTHER INCOME (EXPENSE):
Interest expense (23,773) (45,372)
Interest income 653,462 949,727
Amortization of excess of assigned value of
Identifiable assets over cost of an acquired
Interest - 50,792
629,689 955,147
----------- -----------
Net loss $(5,741,867) $(2,364,739)
----------- -----------
Basic and diluted loss per common share $ (0.75) $ (0.31)
=========== ===========
Shares used in computation 7,631,999 7,591,299
=========== ===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS
4
<PAGE> 5
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------------------------
1998 1997
----------------------------------------------------
(unaudited) (unaudited)
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss ($5,741,867) ($2,364,739)
ADJUSTMENTS:
Depreciation 823,929 413,309
Amortization of excess of assigned value of
Identifiable assets over cost of an acquired interest - (50,792)
Amortization of software development costs 89,791 89,791
Amortization of discount on debt securities included
in interest income (63,349) -
Gain on disposal of property and equipment (13,906) (6,431)
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Accounts receivable, net (1,055,935) (969,227)
Prepaid expenses and other current assets 67,948 270,182
Accounts payable (822,554) (1,694,524)
Accrued payroll and related expenses (54,279) (185,364)
Net billings in excess of costs and estimated
gross profit on uncompleted contracts (513,704) (278,893)
Deferred revenue 203,233 439,625
Accrued interest on stockholders loans - 6,025
------------ -----------
NET CASH USED IN OPERATING ACTIVITIES (7,080,693) (4,331,038)
INVESTING ACTIVITIES:
Purchase of investments available-for-sale (10,197,012) -
Proceeds from sale of property and equipment 50,201 7,995
Purchase of property and equipment (2,771,535) (1,652,058)
------------ -----------
NET CASH USED IN INVESTING ACTIVITIES (12,918,346) (1,644,063)
FINANCING ACTIVITIES:
Repayments of stockholder loans - (235,538)
Payments under capital lease obligations (114,934) (178,796)
Repayments of long-term debt - (11,692)
Proceeds from exercise of stock options 62,640 -
Proceeds from issuance of common stock 112,971 4,258,318
Other - 50,413
------------ -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 60,677 3,882,705
------------ -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS (19,938,362) (2,092,396)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 20,569,300 23,501,633
------------ -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 630,938 $21,409,237
============ ===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
5
<PAGE> 6
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete consolidated financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Consolidated results of operations for the three and nine month
periods ended September 30, 1998 are not necessarily indicative of the results
that may be expected for the fiscal year ending December 31, 1998. For further
information, refer to the financial statements and footnotes thereto included in
the Company's annual report on Form 10-K for the year ended December 31, 1997.
NOTE 2. INVESTMENTS AVAILABLE-FOR-SALE
The Company invested approximately $10 million in securities classified as
available-for-sale. The securities consist of commercial paper with an A-1/P-1
rating and maturities of up to 60 days whose cost approximates fair value.
Available-for-sale securities are carried at fair value, with the unrealized
gains and losses, net of tax, reported as a separate component of stockholders'
equity. The amortized cost of debt securities in this category is adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization is included in interest income. Realized gains and losses and
declines in value judged to be other-than-temporary on available-for-sale
securities are included in interest income. The cost of securities sold is based
on the specific identification method. Interest and dividends on securities
classified as available-for-sale are included in interest income.
NOTE 3. LOSS PER SHARE
The following table summarizes the computations of loss per share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------------- -------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
Numerator for basic and diluted loss per common share: 1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net loss $ (1,826,987) $ (769,740) $ (5,741,867) $ (2,364,739)
------------ ----------- ------------- ------------
Denominator:
Denominator for basic and diluted loss per common
Share - weighted-average shares 7,641,278 7,610,484 7,631,999 7,591,299
------------ ----------- ------------- ------------
Basic and diluted loss per common share $ (0.24) $ (0.10) $ (0.75) $ (0.31)
------------ ----------- ------------- ------------
</TABLE>
Dilutive loss per common share is equal to basic loss per common share because
if potentially dilutive securities were included in the computations, the
results would be anti-dilutive.
6
<PAGE> 7
NOTE 4. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
Uncompleted contracts consist of the following components:
<TABLE>
<CAPTION>
BALANCE SHEET CAPTION
----------------------------------------------------------
COSTS AND ESTIMATED BILLINGS IN EXCESS
EARNINGS IN EXCESS OF COSTS AND
OF BILLINGS ESTIMATED EARNINGS TOTAL
----------------------------------------------------------------------------
<S> <C> <C> <C>
December 31, 1997:
Cost and estimated earnings $3,899,095 $ 272,953 $4,172,048
Billings 3,395,220 861,475 4,256,695
---------- ---------- ----------
$ 503,875 $ (588,522) $ (84,647)
========== ========== ==========
September 30, 1998:
Costs and estimated earnings $2,877,686 $ 628,509 $3,506,195
Billings 2,017,152 1,059,986 3,077,138
---------- ---------- ----------
$ 860,534 $ (431,477) $ 429,057
========== ========== ==========
</TABLE>
All receivables on contracts-in-progress are expected to be collected within
twelve months.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's interim
results of operations and financial condition. This discussion should be read in
conjunction with the Management's Discussion and Analysis of Financial Condition
and Results of Operations included in the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997. This report contains certain
statements of a forward-looking nature relating to future events or the future
financial performance of the Company. Investors are cautioned that such
statements are only predictions and that actual events or results may differ
materially. In evaluating such statements, investors should carefully consider
the various factors identified in this Report which could cause actual results
to differ materially from those indicated by such forward-looking statements,
including the matters set forth in "--Certain Factors That May Affect Future
Results, Financial Condition and the Market Price of Securities."
OVERVIEW
The Company was incorporated in 1987 to commercialize an automated credit
processing system developed by James R. DeFrancesco, the Company's Chairman and
Chief Executive Officer, and Scott L. Freiman, the Company's Executive Vice
President, while they were employed by American Financial Corporation ("AFC"),
an automobile finance servicing company owned by Mr. DeFrancesco. AFC was
acquired in October 1987 by Perpetual Savings Bank, FSB. Mr. DeFrancesco and Mr.
Freiman retained ownership of AFC's credit processing software which formed the
basis for CreditRevue. CreditRevue was initially released in 1988. Since its
initial release, the Company has continually enhanced CreditRevue in response to
the needs of its customers. CreditConnection became commercially available in
July 1996. The OneScore(TM) service, developed in conjunction with Dun &
Bradstreet, was the Company's initial Service Bureau offering and was introduced
in October 1997. The Company is introducing additional service bureau product
offerings including Batch OneScore (referred to as Dun & Bradstreet OneScore),
Portfolio Moritoring and a service bureau version of its CreditRevue software
License fees for CreditRevue are recognized based on a percentage-of-completion
method, measured generally on a cost-incurred basis. The Company typically
charges a nonrefundable fee of 25% of the preliminary estimate of the total
license fee to develop an analysis of the customer's credit operations and a
plan for the configuration and implementation of CreditRevue according to the
customer's requirements. Costs consist primarily of direct labor and temporary
contract labor. Contracts in progress are reviewed periodically, and revenues
and earnings are adjusted based on revisions in contract value and estimated
time to completion. The Company has introduced and is continuing to refine a new
version of its CreditRevue software, referred to as CreditRevue 2000. This new
version of CreditRevue has been redesigned to be more easily configured and
deployed. CreditRevue 2000 will be licensed and delivered to service bureau
clients. The Company recognizes revenue for maintenance fees pro rata over the
term of the related agreement, which is generally one year. Maintenance fees
received in advance of revenue recognition are included in deferred revenue. In
addition, as a convenience to its customers, the Company offers third-party
computer hardware through various reseller arrangements.
7
<PAGE> 8
However, neither third-party hardware nor third-party software sales are a focus
of the Company's overall marketing strategy. For the nine months ended September
30, 1997 and September 30, 1998, revenues from third-party hardware and software
sales accounted for 11.0% and 4.0% of total revenues, respectively. Revenues
from resales of third-party computer hardware and software are recognized at the
time of shipment and installation.
Certain of the Company's products and services, including CreditConnection and
CreditRevue Service Bureau, are charged on a per transaction basis. As a result,
the Company anticipates that transaction-based revenue will represent an
increasing proportion of the Company's revenue. The Company's sales and
marketing efforts will no longer be exclusively targeted at generating
license-based revenue but will be increasingly focused on generating
transaction-based revenue from prospective customers. The Company's anticipated
future growth is based, in large part, on the success of these products and
services and the transition to a transaction-based revenue stream. Accordingly,
the failure by the Company to generate demand for CreditConnection or
CreditRevue Service Bureau, the occurrence of any significant technological
problems, such as a system failure incurred prior to the implementation of a
back-up computer system, any inadequacy of the Company's business interruption
insurance to cover costs associated with system failure or business
interruptions, or the failure of the Company to successfully manage the
transition to a transaction-based revenue stream would have a material adverse
effect on the Company's business, results of operations and financial condition.
Since 1987, the Company has continually invested in the development and
introduction of new products, services and enhancements to its software.
Research and development expenditures are expensed as incurred. Certain software
development costs are capitalized subsequent to the establishment of
technological feasibility in accordance with Statement of Financial Accounting
Standards No. 86, Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed. Based on the Company's current research and
development process, technological feasibility is established upon completion of
a working model. The Company intends to continue to expend substantial resources
on developing new products and services and enhancements to its software to
incorporate technological developments and satisfy evolving customer needs.
As of September 30, 1998, the Company had 16 employees in its sales and
marketing organization. The Company intends to hire a significant number of
additional sales and marketing personnel in the future to help the Company
expand its market presence. Competition for such personnel is intense, and there
can be no assurance that the Company can retain its existing sales personnel or
that it can attract, assimilate or retain additional highly qualified sales
persons in the future. If the Company is unable to hire such personnel on a
timely basis, the Company's business, results of operations and financial
condition could be materially and adversely affected.
RESULTS OF OPERATIONS
Total Revenues. Total revenues decreased 3.5% from $4.4 million in the three
months ended September 30, 1997 to $4.2 million in the three months ended
September 30, 1998. The Company's revenues are derived from four sources:
license and software development fees, maintenance fees, computer hardware sales
and service bureau related sources including Credit Connection service fees,
CreditRevue service bureau operations and Dun & Bradstreet related revenues.
Total revenues decreased 0.5% from $11.7 million in the nine months ended
September 30, 1997 to $11.6 million in the nine months ended September 30, 1998.
License and Software Development Fees. CreditRevue has accounted for
substantially all of the Company's license and software development fee revenue
through September 30, 1998. License and software development fees decreased 9.9%
from $3.1 million in the three months ended September 30, 1997 to $2.8 million
in the three months ended September 30, 1998. The decrease during this most
recent period resulted primarily from delays in obtaining new CreditRevue
clients.
License and software development fees decreased 13.1% from $8.0 million in the
nine months ended September 30, 1997 to $7.0 million in the nine months ended
September 30, 1998. This decrease is also related to the timing of new contract
signings on a year-to-year basis. License and software development fees declined
during the nine month period ended September 30, 1998, as a result of fewer new
contracts during the early part of 1998.
8
<PAGE> 9
Maintenance Fees. Maintenance fees include fees from software maintenance
agreements. Maintenance fees increased 2.4% from $1.0 million in the three
months ended September 30, 1997 to $1.0 million in the three months ended
September 30, 1998. Maintenance fees increased 32.9% from $2.3 million in the
nine months ended September 30, 1997 to $3.0 million in the nine months ended
September 30, 1998. The growth in these revenues during these periods was the
result of increased maintenance fees associated with the increased number of
licenses of CreditRevue outstanding during such periods.
Computer Hardware Sales. Computer hardware sales revenue decreased 59.4% from
$98,000 in the three months ended September 30, 1997 to $40,000 in the three
months ended September 30, 1998. Computer hardware sales revenue decreased 54.5%
from $0.9 million in the nine months ended September 30, 1997 to $0.4 million in
the nine months ended September 30, 1998. Computer hardware sales revenue
consists of revenues received from resales of third-party hardware in connection
with the license and installation of the Company's software or sales of
additional third-party hardware to existing customers. The fluctuation of such
revenues during these periods is the result of customer purchase preferences for
computer hardware systems. In certain instances, CreditRevue customers have
volume discount arrangements with hardware resellers making them eligible for
discounts greater than those offered by the Company.
Service Bureau Fees. Service Bureau revenues originate from several sources
including: CreditConnection transaction and interface fees, Dun & Bradstreet
OneScore, Portfolio Management transaction and implementation fees and
CreditRevue Service Bureau. Total Service Bureau revenues increased 106.6% from
$179,000 in the three months ended September 30, 1997 to $370,000 in the three
months ended September 30, 1998. The CreditConnection service was commercially
released in 1996 and generated $293,000 of revenue for the three months ended
September 30, 1998 compared to $179,000 for the three months ended September 30,
1997, an increase of 63.9%. Dun & Bradstreet OneScore was commercially released
in the fourth quarter of 1997, Portfolio Monitoring and CreditRevue Service
Bureau were commercially released in the first quarter of 1998. These Service
Bureau products account for aggregate revenue of $76,000 in the quarter ended
September 30, 1998 and $273,000 for the nine months ended September 30, 1998.
Total Service Bureau revenues increased 184.3% from $0.4 million in the nine
months ended September 30, 1997 to $1.2 million in the nine months ended
September 30, 1998, principally from increases in CreditConnection revenues.
Cost of License and Software Development Fees. Cost of license and software
development fees consist primarily of salaries and benefits and allocations of
office space expense for in-house programmers and the cost of temporary
contract labor. Cost of license and software development fees decreased 5.1%
from $1.7 million in the three months ended September 30, 1997 to $1.7 million
in the three months ended September 30, 1998. As a percentage of license fee
and software development fee revenue, cost of license and software development
fees were 55.7% and 58.6% in the three months ended September 30, 1997 and
1998, respectively. Although cost of license and software development fee
revenue declined on a quarter to quarter basis, these costs increased as a
percent of corresponding revenues. The increase in cost of license and software
fees as a percentage of license and software development fees over these
periods is related to: (1) the fluctuation in the Company's quarterly revenues;
and (2) hourly labor costs associated with temporary contractors during periods
in which the Company experienced increased demand for its products. The
Company's cost to deploy software licenses and related services is relatively
fixed, which may result in periods where costs exceed revenues in periods which
experience revenue fluctuation. With respect to temporary contractors, the
Company's costs on a full-time equivalent basis for these contractors is
generally twice the amount incurred by the Company for its in-house technical
personnel.
Cost of license and software development fees increased 2.9% from $5.0 million
in the nine months ended September 30, 1997 to $5.1 million in the nine months
ended September 30, 1998. As a percentage of license fee and software
development fee revenue, cost of license and software development fees were
62.1% and 73.6% in the nine months ended September 30, 1997 and 1998,
respectively. This percentage increase was caused by fixed costs associated with
declining revenues.
Costs of Maintenance Fees. Cost of maintenance fees consists primarily of
personnel and related costs for customer maintenance and support. Cost of
maintenance fees decreased 34.5% from $0.3 million in the three months ended
September 30, 1997 to $0.2 million in the three months ended September 30, 1998.
As a percentage of maintenance fee revenue, cost of maintenance fees was 33.9%
and 21.7% in the three months ended September 30, 1997 and 1998, respectively.
The fluctuation in the percentage of cost of maintenance fees to maintenance
fee revenues in 1997 and 1998 results from incremental increases in revenues
relative to staffing for maintenance personnel. Staffing utilization
efficiencies will vary based on the timing and training of additions to
9
<PAGE> 10
maintenance staff personnel and the timing of additional maintenance contract
sales. Additionally, the cost of maintenance for third-party software that is
resold is included in cost of maintenance fees for the period ended September
30, 1998.
Cost of maintenance fees increased 30.5% from $0.6 million in the nine months
ended September 30, 1997 to $0.8 million in the nine months ended September 30,
1998. As a percentage of maintenance fee revenue, cost of maintenance fees was
26.0% and 25.5% in the nine months ended September 30, 1997 and 1998,
respectively.
Cost of Computer Hardware Sales. Cost of computer hardware sales consists of (i)
the Company's cost of computer hardware resold to the Company's customers that
are licensing CreditRevue and (ii) salaries and benefits for systems integration
employees. Cost of computer hardware sales decreased 24.9% from $137,000 in the
three months ended September 30, 1997 to $103,000 in the three months ended
September 30, 1998. As a percentage of computer hardware sales revenue, cost of
computer hardware sales was 139.4% and 257.8% in the three months ended
September 30, 1997 and 1998, respectively. The increase in the cost of computer
hardware sales as a percent of revenue is the result of lower hardware
revenues, while fixed expenses, primarily personnel-related in nature, remained
constant during the same period.
As a result of lower hardware sales during the period, cost of computer hardware
sales decreased 30.1% from $0.9 million in the nine months ended September 30,
1997 to $0.6 million in the nine months ended September 30, 1998. As a
percentage of computer hardware sales revenue, cost of computer hardware sales
was 91.1% and 140.1% in the nine months ended September 30, 1997 and the nine
months ended September 30, 1998, respectively. The fixed costs associated with
personnel on staff to facilitate hardware sales will cause costs to exceed
revenues with periods of lower revenues. The Company's margin on computer
hardware sales fluctuates based on changes in product sales mix, volume
discounts to significant customers, and negotiated mark-ups with customers.
Cost of Service Bureau Revenues. Of the three primary sources of service bureau
revenues; CreditConnection, Dun & Bradstreet OneScore and CreditRevue service
bureau, only CreditConnection was operational in both 1997 and 1998. Cost of
service bureau revenues consist primarily of personnel costs associated with the
operation and support of the service bureau. Other costs of service bureau
revenues include equipment rental expenses, communications network costs from
third-parties and hardware and software pass through expenses. Service bureau
costs for the three months ended September 30, 1997 and 1998 were $0.9 million
and $0.7 million, respectively. Cost of service bureau revenues during the
three months ended September 30, 1997 and 1998 exceeded service bureau revenues
because of start-up costs associated with establishing these new service bureau
offerings. Dun & Bradstreet OneScore was commercially introduced in the fourth
quarter of 1997. As these new services continue to gain market acceptance,
corresponding costs of service bureau fees are expected to decrease as a
percent of service bureau revenues.
Cost of service bureau revenue increased 81.4% from $1.3 million in the nine
months ended September 30, 1997 to $2.4 million in the nine months ended
September 30, 1998. As a percentage of service bureau revenue, cost of service
bureau was 323.4% and 206.7% in the nine months ended September 30, 1997 and
1998, respectively.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 48.5% from $1.9 million in the three months
ended September 30, 1997 to $2.8 million in the three months ended September 30,
1998. Of this $0.9 million increase, approximately one-half relates to increases
in administrative expenses associated with filling several senior
management positions. The balance of approximately $0.4 million relates to
non-salary administrative expenses, including depreciation and sales and
marketing expenses. Selling, general and administrative expenses includes (i)
salaries, commissions and bonuses paid to sales and marketing personnel, as well
as travel and promotional expenses, (ii) salaries of administrative,
executive and financial personnel, and (iii) outside professional fees.
Selling, general and administrative expenses increased 25.8% from $5.9 million
in the nine months ended September 30, 1997 to $7.4 million in the nine months
ended September 30, 1998. Of this $1.5 million increase, approximately $0.9
million was related to non-salary based administrative expenses, including
depreciation, travel, internal networking, advertising, and an increase in bad
debt expense related to increased billings. The remainder of the increase of
approximately $0.5 million is associated with filling several senior management
positions. Certain of these expenses increased due to an increase in expenses
associated with the growth of the Company on a year to year basis.
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Research and Development Costs. Research and development costs consist primarily
of salaries and benefits of in-house programmers. These costs decreased $0.1
million during the three months ended September 30, 1998 as compared to the
three months ended September 30, 1997 due primarily to the limited use of
higher cost outside contractors. All development activities during the 1997
and 1998 periods were expensed.
Research and development costs increased $0.3 million during the nine months
ended September 30, 1998 as compared to the nine months ended September 30,
1997 due primarily to staffing additions. The increased staffing was required
to address a number of strategic development efforts including
CreditConnection, CreditRevue 2000, and Dun & Bradstreet OneScore Portfolio
Monitoring Services. There were no research and development expenses capitalized
during 1997 or 1998.
Interest Income. Interest income decreased $0.1 million in the three months
ended September 30, 1998 as compared to the three months ended September 30,
1997. The decrease in interest income over such periods relates primarily to
lower cash and investment balances resulting from operating losses and capital
expenditures.
Interest income decreased $0.3 million in the nine months ended September 30,
1998 as compared to the nine month period ended September 30, 1997.
Year 2000 Compliance
YEAR 2000 ISSUE. The Year 2000 issue is a result of computer programs or systems
which store or process date-related information using only two digits to
represent the year. These programs or systems may not be able to properly
distinguish between a year in the 1900's and a year in the 2000's. Failure of
these programs or systems to distinguish between the two centuries could cause
the programs and or systems to yield erroneous results or even to fail.
STATE OF READINESS. The Company recognizes the significance of the year 2000
issue and has implemented a formal year 2000 program to minimize the impact of
the year 2000 on the Company and its customers ("Year 2000 Program"). The Year
2000 Program addresses both information technology ("IT") and non-IT systems,
for systems used by the Company as well as those provided by the Company to its
customers. The Year 2000 Program is being implemented by a Year 2000 Team which
includes members from all levels of management and all functional areas of the
Company. Individual members of the Year 2000 Team communicate daily with respect
to year 2000 issues. The Year 2000 Team meets as a group on a regular basis, and
subgroups of the Team meet as needed to address specific issues.
The Company is using employees of the Company to identify and address year 2000
issues. The Year 2000 Program involves six basic stages: (1) inventory of all
potentially affected software products and software-related services, (2)
analysis of such products and services to identify any areas that require change
or replacement, (3) change or replacement of the identified areas, (4) testing,
(5) implementation of the changes or replacements, and (6) contingency plans.
Because the Company is not only a user of software products and software-related
services, but also provides software products and software-related services to
its customers, the Company's Year 2000 Program addresses both software products
and software-related services used by the Company and those provided by the
Company to its customers.
While different areas of the Company's Year 2000 Program are currently at
different stages, the Company has given priority to software products and
software-related services that it provides to its customers. Analysis,
remediation, testing and implementation for approximately 40% of the products
and services provided to the Company's customers had been completed as of
September 30, 1998. The Company plans to substantially complete implementation
of any necessary changes and replacements to software products and
software-related services used and provided by the Company by the end of the
first quarter of 1999. Many of the Company's customers are financial
institutions regulated by the FDIC, the Federal Reserve, the OCC and other
federal financial institution regulators. With respect to software products and
software-related services provided to these customers, the Company intends to
complete its implementation of any necessary changes and replacements so that
these customers will be able meet the guidelines imposed by such federal
regulators. The Company is also implementing procedures to ensure that any
future software products and software-related services, as well as enhancements
to existing software products and software-related
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services, are developed in accordance with the Company's year 2000 coding
standards.
In the course of its business, the Company uses certain software products
provided by third-parties, and certain of the Company's products and services
interface to third-party systems. In cases where a third-party has provided
year 2000 interface specifications, the Company is in the process of developing,
testing and implementing new interface code to comply with those specifications.
The Company has received information from various other third-party providers
regarding the year 2000 readiness of their products and is in the process of
reviewing such information. The Company is also sending requests to other
third-parties for information regarding the year 2000 readiness of their
products and systems. As the Company does not have any control over these
third-parties, the Company cannot guarantee that such third-party products and
systems will not suffer any adverse effects due to the year 2000.
COSTS. As of September 30, 1998, the Company has not incurred material expenses
in connection with its Year 2000 Program. All expenses to date have been
associated with the opportunity cost of time spent by employees of the Company
on the Year 2000 Program, particularly on the analysis, development, testing and
implementation relating to software products and software-related services
provided to customers. The Company estimates that the aggragate opportunity cost
incurred as of September 30, 1998 is approximately $100,000. To complete the
Year 2000 Program, in addition to the opportunity costs of employees' time, the
Company may also need to purchase replacement products. The Company has not yet
determined its projected costs of the entire Year 2000 Program.
RISKS. If a product or service provided by the Company is found to cause damage
or injury to a customer of the Company due to a failure of such product or
service to operate without any adverse effect due to date related processing
associated with the year 2000, the Company could be liable to such customer for
a breach of warranty, depending on the specific contractual arrangement between
the Company and such customer. Although the Company's contractual arrangement
with each of its customers generally limits the Company's liability to such
customer, the Company cannot accurately predict whether or to what extent any
legal claims will be brought against the Company, or whether the Company will
otherwise be adversely affected by such claims.
In addition, a failure by the Company to make its products year 2000 compliant
could result in a decrease in sales of the Company's products and services,
delays in the development of other of the Company's products and services, an
increase in the costs associated with year 2000 remediation, and an increase in
litigation costs. The year 2000 issue may also have an indirect effect on the
Company's business and operations to the extent that potential customers of the
Company may be using significant resources to address year 2000 issues, and
therefore may have fewer resources to evaluate and purchase other products and
services such as the products and services offered by the Company, which could
have a material adverse effect on the Company's business, general condition and
results of operation. If a material third-party product or system which the
Company uses or interfaces to fails to operate properly due to the year 2000,
such failure could have a material adverse effect on the Company's business,
financial condition and results of operations.
CONTINGENCY PLANS. The Company will have a dedicated year 2000 support staff
which will be prepared to address year 2000 issues. The Company is currently in
the process of developing additional contingency plans which will be implemented
if necessary. The Company expects to complete development of the contingency
plans by the end of the first quarter of 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its working capital needs, operating losses and
investments in property and equipment from the net proceeds from the Company's
initial public offering completed in December 1996. During the nine months ended
September 30, 1998, the Company consumed $7.1 million of cash in operations. Of
the $7.1 million of cash used in operations, $5.7 million was consumed by net
operating losses. Additionally, during the nine month period accounts receivable
grew by approximately $1.1 million, and accounts payable declined by
approximately $0.8 million. The increase in receivables tends to be cyclical
relative to contract signings and relates to the increased billing activity in
the third quarter.
The Company's cash used in investing activities, other than for short-term
investments, consists principally of investments in property and equipment.
During the nine months ended September 30, 1997 and 1998, the Company invested a
total of $1.7 and $2.8 million in property and equipment, respectively. These
investments were directly attributable to the Company's growth in operations.
The Company is in the process of constructing a new data center in conjunction
with a move to new leased offices in the fourth quarter of 1998. It is
anticipated that current cash resources and financing alternatives are adequate
to meet the financing needs associated with this move.
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In conjunction with the fourth quarter office relocation, the Company will be
attempting to sublease, for a three year term, approximately 25,000 square feet
of office space which it currently occupies. While the Company is confident it
can sublease this space in favorable terms, and is actively engaged in this
process, there can be no assurance that the Company will succeed with its
efforts in a timely fashion. The maximum financial exposure, should the Company
fail to sublease any space during the three year period is approximately $2
million.
The Company has historically relied principally on its bank line of credit and
proceeds from its initial public offering completed in December 1996 for its
financing needs. The Company received $22.6 million of net proceeds from its
initial public offering. The Company maintains a secured bank line of credit in
the amount of $1.5 million, of which there was no balance outstanding at
September 30, 1998. The line of credit bears interest at the bank's prime rate
per annum (8.5% at September 30, 1998). Further, the bank's line of credit
requires the bank's written consent prior to, among other things, (i) the
payment of cash dividends, (ii) the Company's engagement in a substantially
different business activity, or (iii) the purchase by the Company of any
interest in another enterprise or entity
The Company currently anticipates that its available cash resources, expected
cash flows from operations, and its bank line of credit will be sufficient to
meet its presently anticipated working capital, capital expenditure and debt
repayment requirements through 1999.
ITEM 3. CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS, FINANCIAL CONDITION AND
THE MARKET PRICE OF SECURITIES.
Uncertainty of Future Results of Operations; Fluctuations in Quarterly Results
of Operations. Prior growth rates in the Company's revenue and net income should
not be considered indicative of future results of operations. Future results of
operations will depend upon many factors, including market acceptance of new
services, including the Company's CreditConnection and CreditRevue Service
Bureau Service, the demand for the Company's products and services, the
successful distribution and implementation of the Company's products and
services, the successful transition from predominantly license fee-based revenue
to predominantly transaction fee-based revenue, the timing of new product and
service development and introductions and software enhancements by the Company
or its competitors, the level of product, service and price competition, the
length of the Company's sales cycle, the size and timing of individual
transactions, the delay or deferral of customer implementations, the Company's
success in expanding its customer support organization, direct sales force and
indirect distribution channels, the nature and timing of significant marketing
programs, the mix of products and services sold, the timing of new hires, the
ability of the Company to timely develop and successfully market new products
and services and control costs, competitive conditions in the industry and
general economic conditions. In addition, the decision to implement the
Company's products or services typically involves a significant commitment of
customer resources and is subject to the budget cycles of the Company's
customers. Licenses of CreditRevue generally reflect a relatively high amount of
revenue per order. The loss or delay of individual orders, therefore, would have
a significant impact on the Company's revenue and quarterly results of
operations. The timing of revenue is difficult to predict because of the length
and variability of the Company's sales cycle, which has ranged to date from two
to 18 months from initial customer contact to the execution of a license
agreement. In addition, since a substantial portion of the Company's revenue is
recognized on a percentage-of-completion basis, the timing of revenue
recognition for its licenses may be materially and adversely affected by delays
or deferrals of customer implementations. Such delays or deferrals may also
increase expenses associated with such implementations which would materially
and adversely affect related operating margins. The Company's operating expenses
are based in part on planned product and service introductions and anticipated
revenue trends and, because a high percentage of these expenses are relatively
fixed, a delay in the recognition of revenue from a limited number of
transactions could cause significant variations in operating results from
quarter-to-quarter and could result in operating losses. To the extent such
expenses precede, or are not subsequently followed by, increased revenues, the
Company's results of operations would be materially and adversely affected. As a
result of these and other factors, revenues for any quarter are subject to
significant variation, and the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. There can be no
assurance that the Company will be profitable in any future quarter or that such
fluctuations in results of operations will not result in volatility in the price
of the Company's Common Stock. Due to all of the foregoing factors, it is likely
that in some future quarter the Company's results of operations will be below
the expectations of public market analysts and investors. In such event, the
market price of the Company's Common Stock will be materially and adversely
affected.
Dependence on CreditRevue Product Line. License fees, maintenance fees and
third-party computer hardware sales
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associated with licenses and installations of CreditRevue accounted for the
majority of the Company's revenues through September 30, 1998. Although the
Company has introduced its CreditConnection service, the Company expects that
revenues generated from licenses and installations of CreditRevue will continue
to account for a significant portion of the Company's revenues for the
foreseeable future. The Company has introduced and is continuing to refine a new
version of its CreditRevue software, referred to as CreditRevue 2000. This new
version of CreditRevue is initially targeted towards the service bureau market.
There can be no assurance that CreditRevue 2000 will achieve market acceptance
or that the Company will successfully develop, refine or market CreditRevue 2000
in a timely fashion, if at all. The failure of the Company to successfully
develop, refine or market CreditRevue 2000 would have a material adverse effect
on the Company's business, results of operations and financial condition. The
life cycles of the Company's products and services are difficult to predict due
to the effect of new product and service introductions or software enhancements
by the Company or its competitors, market acceptance of new and enhanced
versions of the Company's products and services, and competition in the
Company's marketplace. A decline in the demand for CreditRevue, whether as a
result of competition, technological change, price reductions or otherwise,
would have a material adverse effect on the Company's business, results of
operations and financial condition.
Lengthy Sales and Implementation Cycle. The licensing of the Company's software
products and sales of its services is often an enterprise-wide decision by
prospective customers and generally requires the Company to provide a
significant level of education to prospective customers regarding the use and
benefits of the Company's products and services. In addition, the implementation
of the Company's software products involves a significant commitment of
resources by prospective customers and is commonly accompanied by substantial
reengineering efforts and a review of the customer's credit analysis,
decisioning and funding processes. The cost to the customer of the Company's
products and services is typically only a portion of the related hardware,
software, development, training and integration costs associated with
implementing a large-scale automated credit origination information system. For
these and other reasons, the period between initial customer contact and the
implementation of the Company's products is often lengthy (ranging from between
two and 18 months) and is subject to a number of significant delays over which
the Company has little or no control. The Company's implementation cycle could
be lengthened by increases in the size and complexity of its license
transactions and by delays or deferrals in its customers' implementation of
appropriate interfaces and networking capabilities. Delays in the sale or
implementation of a limited number of license transactions could have a material
adverse effect on the Company's business, results of operations and financial
condition and cause the Company's results of operations to vary significantly
from quarter to quarter.
Market Acceptance of CreditConnection; Transition to Transaction-Based Revenue.
The Company's CreditConnection service was commercially introduced in 1996 and
the Company's CreditRevue Service Bureau service was commercially introduced
through strategic alliance partner, AnyTime Access, in January, 1998. The
CreditConnection service and the CreditRevue Service Bureau service (as provided
by AnyTime Access and other third parties to which the Company licenses the
CreditRevue Service Bureau) are projected to account for a significant portion
of the Company's revenues in the future. As demand and market acceptance for
these services are subject to a high level of uncertainty, the Company will be
heavily dependent on their market acceptance. There can be no assurance that
these services will be commercially successful. Since inception in 1996,
CreditConnection has generated approximately $1.6 million in revenues. The
failure of the Company to generate demand for CreditConnection or CreditRevue
Service Bureau or the occurrence of any significant technological problems with
such services would have a material adverse effect on the Company's business,
results of operations and financial condition. Further, the market acceptance of
the CreditConnection service has taken longer than originally anticipated.
Although the Company is exploring additional distribution options, including
staffing a direct sales force, to further enhance the CreditConnection service,
there can be no assurance that any such channels will be available to the
Company on commercially reasonable terms, or at all. The failure of the Company
to successfully commercialize the CreditConnection service would have a material
adverse effect on the Company's business, financial condition and results of
operations. Historically, virtually all of the Company's revenues have been
derived from license fees, maintenance fees and hardware sales associated with
licenses and installations of CreditRevue. Under the terms of its license
agreements, a majority of the Company's revenues are realized during the
configuration and installation of CreditRevue. However, the Company anticipates
that a significant portion of the Company's future revenues will be derived from
per-usage transaction-based fees charged to credit originators and financial
institutions for transactions originated from the CreditConnection and
CreditRevue Service Bureau services. There can be no assurance that the Company
will successfully manage the transition of a significant portion of its revenues
from license-based revenue to transaction-based revenue. The failure of the
Company to successfully manage the transition to a transaction-based revenue
stream would have a material adverse effect on the Company's business, results
of operations and financial condition.
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Reliance on Certain Relationships. The Company has established relationships
with a number of companies that it believes are important to its sales,
marketing and support activities, as well as to its product, service and
software development efforts. The Company has relationships with automated
scorecard companies, hardware vendors and credit bureaus. There can be no
assurance that these companies, most of which have significantly greater
financial and marketing resources than the Company, will not develop or market
products and services which will compete with the Company's products and
services in the future. Furthermore, since many of these relationships are
informal in nature, they are terminable by either party at will. Other
relationships are terminable by either party after a relatively short notice
period. There can be no assurance that these companies will not otherwise
discontinue their relationships with or support of the Company. The failure by
the Company to maintain its existing relationships or to establish new
relationships in the future, because of a divergence of interests, acquisition
of one or more of these third parties or other reasons, could have a material
adverse effect on the Company's business, results of operations and financial
condition.
In addition, the Company has formed strategic alliances with Automatic Data
Processing (ADP) and Universal Computer Systems (UCS) for remarketing
CreditConnection and with Dun & Bradstreet for the marketing of OneScore. There
can be no assurance that these relationships will be successful. Moreover, there
can be no assurance that these companies will actively remarket CreditConnection
or OneScore. The failure by the Company to leverage and maintain its existing
relationships ADP, UCS and Dun & Bradstreet, or to establish new relationships
in the future, because of a divergence of interests, acquisition of one or more
of these third parties or other reasons, could have a material adverse effect on
the Company's business, results of operations and financial condition.
Dependence on Large License Fee Contracts and Customer Concentration. A
relatively small number of customers have accounted for a significant percentage
of the Company's revenues. License fees for CreditRevue are based on a
percentage-of-completion method on a cost-incurred basis with the final
installment being paid in full upon acceptance of the Company's software. The
Company receives continuing revenues on CreditRevue from annual maintenance
agreements which commence upon acceptance of the software by the customer.
Maintenance agreements are renewable annually by the customer, and the license
agreements are generally co-terminus with the maintenance agreements. Although
the Company has experienced a high degree of customer loyalty, the Company
cannot predict how many maintenance agreements will be renewed or the number of
years of renewal. Revenues generated by the Company's 10 largest customers
accounted for 48.8% and 65.1% of total revenues in 1997 and 1996, respectively.
None of the Company's customers accounted for 10% or more of total revenues in
1997 or 1996. The Company expects that a limited number of customers will
continue to account for a significant percentage of revenue for the foreseeable
future. The loss of any major customer or any reduction or delay in orders by
any such customer, delay or deferral in configurations or enhancements by such
customers or the failure of the Company to successfully market its products or
services to new customers, could have a material adverse effect on the Company's
business, results of operations 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 the consumer
lending industry. For example, a decrease in consumer lending could result in a
smaller overall market for the Company's products and services. Furthermore,
banks in the United States are continuing to consolidate, decreasing the overall
potential number of customers for the Company's products and services. In
addition, demand for consumer loans has been historically 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, the willingness of financial institutions
to provide funds for such loans, changes in interest rates and the overall
consumer indebtedness level, as well as other factors affecting the consumer
lending industry, could have a material adverse effect on the Company's
business, results of operations and financial condition.
Management of Changing Business. The Company has experienced significant changes
in its business, such as an expansion in the Company's staff and customer base
and the development of new products, services and enhancements to its software,
including the recent commercial release of CreditConnection. Such changes have
placed and may continue to place a significant strain upon the Company's
management, systems and resources. The Company's ability to compete effectively
and to manage future changes will require the Company to continue to improve its
financial and management controls, reporting systems and procedures and
budgeting and forecasting capabilities on a timely basis and expand its sales
and marketing work force, and train and manage its employee work force. There
can be no
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assurance that the Company will be able to manage such changes successfully. The
Company's failure to do so could have a material adverse effect upon the
Company's business, results of operations and financial condition.
Dependence on Key Personnel. The Company's future performance depends in
significant part upon the continued service of its key technical, sales and
senior management personnel, particularly James R. DeFrancesco, Chairman and
Chief Executive Officer, Peter M. Leger, President and Chief Operating Officer,
and Scott L. Freiman, Executive Vice President. The Company has obtained
key-person life insurance on the lives of each of Messrs. DeFrancesco and
Freiman. The loss of the services of one or more of the Company's executive
officers could have a material adverse effect on the Company's business, results
of operations and financial condition. The Company retains its key employees
through the use of equity incentive programs, including stock option plans,
employee stock purchase plans, and competitive compensation packages. The
Company has no employment agreements and does not intend to enter into any such
agreements in the foreseeable future. The Company's future success also depends
on its continuing ability to attract and retain highly qualified technical,
customer support, sales and managerial personnel. In particular, the Company has
encountered difficulties in hiring sufficient numbers of programmers and
technical personnel. Competition for qualified personnel is intense, and there
can be no assurance that the Company will be able to retain its key technical,
sales and managerial employees or that it can attract, assimilate or retain
other highly qualified technical, sales and managerial personnel in the future.
Rapid Technological Change; Risk Associated with New Products, Services or
Enhancements. The credit processing software products and services industry in
which the Company competes is characterized by rapid technological change,
frequent introductions of new products and services, changes in customer demands
and evolving industry standards. The introduction or announcement of new
products, services or enhancements by the Company or one or more of its
competitors embodying new technologies or changes in industry standards or
customer requirements could render the Company's existing products or services
obsolete or unmarketable. Accordingly, the life cycles of the Company's products
are difficult to estimate. The Company's future results of operations will
depend, in part, upon its ability to enhance its products and services and to
develop and introduce new products and services on a timely and cost-effective
basis that will keep pace with technological developments and evolving industry
standards, as well as address the increasingly sophisticated needs of the
Company's customers. There can be no assurance that these new products and
services will gain market acceptance or that the Company will be successful in
developing and marketing new products or services that respond to technological
change, evolving industry standards and changing customer requirements, that the
Company will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these products or
services, or that its new products or services will adequately meet the
requirements of the marketplace and achieve any significant degree of market
acceptance. In addition, a majority of the Company's current products operate in
the UNIX operating system. Although the Company's software is designed to work
with other operating environments, a requirement to port to a different
operating system could be costly and time consuming and could have a material
adverse effect on the Company's business, results of operations and financial
condition. Failure of the Company to develop and introduce, for technological or
other reasons, new products and services in a timely and cost-effective manner
could have a material adverse effect on the Company's business, results of
operations and financial condition. Furthermore, the introduction or
announcement of new product or service offerings or enhancements by the Company
or the Company's competitors may cause customers to defer or forgo purchases of
the Company's products or services, which could have a material adverse effect
on the Company's business, results of operations and financial condition.
Year 2000 Compliance
YEAR 2000 ISSUE. The Year 2000 issue is a result of computer programs or systems
which store or process date-related information using only two digits to
represent the year. These programs or systems may not be able to properly
distinguish between a year in the 1900's and a year in the 2000's. Failure of
these programs or systems to distinguish between the two centuries could cause
the programs and or systems to yield erroneous results or even to fail.
STATE OF READINESS. The Company recognizes the significance of the year 2000
issue and has implemented a formal year 2000 program to minimize the impact of
the year 2000 on the Company and its customers ("Year 2000 Program"). The Year
2000 Program addresses both information technology ("IT") and non-IT systems,
for systems used by the Company as well as those provided by the Company to its
customers. The Year 2000 Program is being implemented by a Year 2000 Team which
includes members from all levels of management and all functional areas of the
Company. Individual members of the Year 2000 Team communicate daily with respect
to year 2000 issues. The Year 2000 Team meets as a group on a regular basis, and
subgroups of the Team meet as needed to address specific issues.
The Company is using employees of the Company to identify and address year 2000
issues. The Year 2000 Program involves six basic stages: (1) inventory of all
potentially affected software products and software-related services, (2)
analysis of such products and services to identify any areas that require change
or replacement, (3) change or replacement of the identified areas, (4) testing,
(5) implementation of the changes or replacements, and (6) contingency plans.
Because the Company is not only a user of software products and software-related
services, but also provides software products and software-related services to
its customers, the Company's Year 2000 Program addresses both software products
and software-related services used by the Company and those provided by the
Company to its customers.
While different areas of the Company's Year 2000 Program are currently at
different stages, the Company has given priority to software products and
software-related services that it provides to its customers. Analysis,
remediation, testing and implementation for approximately 40% of the products
and services provided to the Company's customers had been completed as of
September 30, 1998. The Company plans to substantially complete implementation
of any necessary changes and replacements to software products and
software-related services used and provided by the Company by the end of the
first quarter of 1999. Many of the Company's customers are financial
institutions regulated by the FDIC, the Federal Reserve, the OCC and other
federal financial institution regulators. With respect to software products and
software-related services provided to these customers, the Company intends to
complete its implementation of any necessary changes and replacements so that
these customers will be able meet the guidelines imposed by such federal
regulators. The Company is also implementing procedures to ensure that any
future software products and software-related services, as well as enhancements
to existing software products and software-related services, are developed in
accordance with the Company's year 2000 coding standards.
In the course of its business, the Company uses certain software products
provided by third parties, and certain of the Company's products and services
interface to third party systems. In cases where a third party has provided year
2000 interface specifications, the Company is in the process of developing,
testing and implementing new interface code to comply with those specifications.
The Company has received information from various other third party providers
regarding the year 2000 readiness of their products and is in the process of
reviewing such information. The Company is also sending requests to other third
parties for information regarding the year 2000 readiness of their products and
systems. As the Company does not have any control over these third parties, the
Company cannot guarantee that such third party products and systems will not
suffer any adverse effects due to the year 2000.
COSTS. As of September 30, 1998, the Company has not incurred material expenses
in connection with its Year 2000 Program. All expenses to date have been
associated with the opportunity cost of time spent by employees of the Company
on the Year 2000 Program, particularly on the analysis, development, testing and
implementation relating to software products and software-related services
provided to customers. The Company estimates that the aggragate opportunity cost
incurred as of September 30, 1998 is approximately $100,000. To complete the
Year 2000 Program, in addition to the opportunity costs of employees' time, the
Company may also need to purchase replacement products. The Company has not yet
determined its projected costs of the entire Year 2000 Program.
RISKS. If a product or service provided by the Company is found to cause damage
or injury to a customer of the Company due to a failure of such product or
service to operate without any adverse effect due to date related processing
associated with the year 2000, the Company could be liable to such customer for
a breach of warranty, depending on the specific contractual arrangement between
the Company and such customer. Although the Company's contractual arrangement
with each of its customers generally limits the Company's liability to such
customer, the Company cannot accurately predict whether or to what extent any
legal claims will be brought against the Company, or whether the Company will
otherwise be adversely affected by such claims.
In addition, a failure by the Company to make its products year 2000 compliant
could result in a decrease in sales of the Company's products and services,
delays in the development of other of the Company's products and services, an
increase in the costs associated with year 2000 remediation, and an increase in
litigation costs. The year 2000 issue may also have an indirect effect on the
Company's business and operations to the extent that potential customers of the
Company may be using significant resources to address year 2000 issues, and
therefore may have fewer resources to evaluate and purchase other products and
services such as the products and services offered by the Company, which could
have a material adverse effect on the Company's business, general condition and
results of operation. If a material third party product or system which the
Company uses or interfaces to fails to operate properly due to the year 2000,
such failure could have a material adverse effect on the Company's business,
financial condition and results of operations.
CONTINGENCY PLANS. The Company will have a dedicated year 2000 support staff
which will be prepared to address year 2000 issues. The Company is currently in
the process of developing additional contingency plans which will be implemented
if necessary. The Company expects to complete development of the contingency
plans by the end of the first quarter of 1999.
System Interruption and Security Risks; Potential Liability; Possible Lack of
Adequate Insurance; and System
16
<PAGE> 17
Inadequacy. The Company's operations are dependent, in part, on its ability to
protect its system from interruption by damage from fire, earthquake, power
loss, telecommunication failure, unauthorized entry or other events beyond the
Company's control. The Company's computer equipment constituting its central
computer system, including its processing operations, is located at a single
site. The Company is currently in the planning stages of acquiring and
implementing a back-up, off-site processing system capable of fully supporting
its operations in the event of system failure. The Company, during 1997,
implemented a limited redundant data center and will be upgrading its main data
center in the fourth quarter of 1998. Prior to such implementation, the
Company's operations are subject to substantial risks, including temporary
interruptions resulting from damage caused by any one or more of the foregoing
factors or due to other causes including computer viruses, hackers or similar
disruptive problems. While the Company maintains $1.6 million of property
insurance coverage, business interruption insurance coverage, $2.0 million of
errors and omissions insurance coverage and $10.0 million of umbrella insurance
coverage, such insurance may not be adequate to compensate the Company for all
losses that may occur or to provide for costs associated with system failure or
business interruption. Any damage or failure that causes interruptions in the
Company's operations could have a material adverse effect on the Company's
business, results of operations and financial condition. Persistent problems
continue to affect public and private data networks. For example, in a number of
networks, hackers have bypassed firewalls and have appropriated confidential
information. Such computer break-ins and other disruptions may jeopardize the
security of information stored in and transmitted through the computer systems
of the parties utilizing the Company's services, which may result in significant
liability to the Company and also may deter potential customers from using the
Company's services. In addition, while the Company attempts to be careful with
respect to the employees it hires and maintain controls through software design
and security systems to prevent unauthorized employee access, it is possible
that, despite such safeguards, an employee of the Company could obtain access,
which would also expose the Company to a risk of loss or litigation and possible
liability to users. The Company attempts to limit its liability to customers,
including liability arising from the failure of the security features contained
in the Company's system and services, through contractual provisions. However,
there can be no assurance that such limitations will be enforceable. There can
be no guarantee that the growth of the Company's customer base will not strain
or exceed the capacity of its computer and telecommunications systems and lead
to degradations in performance or system failure. Any damage, failure or delay
that causes interruptions in the Company's operations could have a material
adverse effect on the Company's business, results of operations and financial
condition.
Risk of Defects, Development Delays and Lack of Market Acceptance. Software
products and services as sophisticated as those offered by the Company often
encounter development delays and may contain defects or failures when introduced
or when new versions are released. The Company has in the past and may in the
future experience delays in the development of software and has discovered, and
may in the future discover, software defects in certain of its products. Such
delays and defects may result in lost revenues during the time corrective
measures are being taken. Although the Company has not experienced material
adverse effects resulting from any such defects or delays to date, there can be
no assurance that, despite testing by the Company, errors will not be found in
its existing software in future releases or enhancements, or that the Company
will not experience development delays, resulting in delays in the commercial
release of new products and services, the loss of market share or the failure to
achieve market acceptance. Any such occurrence could have a material adverse
effect upon the Company's business, results of operations and financial
condition.
Future Capital Needs; Uncertainty of Additional Financing. The Company currently
anticipates that its available cash resources combined with anticipated funds
from operations will be sufficient to meet its presently anticipated working
capital and capital expenditure requirements through 1999. Thereafter, the
Company may need to raise additional funds.
The Company may need to raise additional funds sooner in order to fund more
rapid expansion, to develop new or enhanced products and services, to respond to
competitive pressures or to acquire complementary businesses or technologies. If
additional funds are raised through the issuance of equity securities, the
percentage ownership of the stockholders of the Company will be reduced,
stockholders may experience additional dilution, or such equity securities may
have rights, preferences or privileges senior to those of the holders of the
Company's 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 are not available on acceptable terms, the
Company may be unable to develop or enhance its products and services, take
advantage of future opportunities or respond to competitive pressures, which
could have a material adverse effect on the Company's business, results of
operations and financial condition.
17
<PAGE> 18
Government Regulation and Uncertainties of Future Regulation. The Company's
current and prospective customers, which consist of state and federally
chartered banks, saving and loan associations, credit unions, consumer finance
companies and other consumer lenders, as well as customers in the industries
that the Company may target in the future, operate in markets that are subject
to extensive and complex federal and state regulations. While the Company is not
itself directly subject to such regulations, 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 Fair Credit Reporting Act and the Community Reinvestment
Act. Furthermore, some consumer groups have expressed concern regarding the
privacy and security of automated credit processing, the use of automated credit
scoring tools in credit underwriting and whether electronic lending is a
desirable technological development in light of the current level of consumer
debt. The failure by the Company's products and services to support customers'
compliance with current regulations and to address changes in customers'
regulatory environment, or to adapt to such changes in an efficient and
cost-effective manner, could have a material adverse effect on the Company's
business, results of operations and financial condition.
Control by Existing Stockholders. Assuming no exercise of outstanding options,
James R. DeFrancesco, the Company's Chairman and Chief Executive Officer, and
Scott L. Freiman, the Company's Executive Vice President, collectively
beneficially own approximately 64% of the outstanding shares of Common Stock. As
a result, these stockholders will be able to exercise control over matters
requiring stockholder approval, including the election of directors, and the
approval of mergers, consolidations and sales of all or substantially all of the
assets of the Company. This may prevent or discourage tender offers for the
Company's Common Stock unless such stockholders approve the terms.
Possible Volatility of Stock Price. The trading price of the Company's Common
Stock could be subject to significant fluctuations in response to variations in
quarterly operating results, the gain or loss of significant orders, changes in
earning estimates by analysts, announcements of technological innovations or new
products by the Company or its competitors, general conditions in the consumer
lending and software industries, credit processing software and services and
other events or factors. In addition, the stock market in general has
experienced extreme price and volume fluctuations which have affected the market
price for many companies in industries similar or related to that of the Company
and which have been unrelated to the operating performance of these companies.
These market fluctuations may adversely affect the market price of the Company's
Common Stock.
Effect of Certain Charter Provisions; Anti-takeover Effects of Certificate of
Incorporation, Bylaws and Delaware Law. The Company's Board of Directors has the
authority to issue up to 1,000,000 shares of Preferred Stock and to determine
the price, rights, preferences, privileges and restrictions, including voting
rights of those shares without any further vote or action by the stockholders.
The Preferred Stock could be issued with voting, liquidation, dividend and other
rights superior to those of the Common Stock. The rights of the holders of
Common Stock will be subject to, and may be adversely affected by the rights of
the holders of any Preferred Stock that may be issued in the future. The
issuance of Preferred Stock could have the effect of making it more difficult
for a third party to acquire a majority of the outstanding voting stock of the
Company. Further, certain provisions of the Company's Certificate of
Incorporation, including provisions that create a classified Board of Directors,
and certain provisions of the Company's Bylaws and of Delaware law could delay
or make more difficult a merger, tender offer or proxy contest involving the
Company.
18
<PAGE> 19
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
3.1 Certificate of Incorporation*
3.2 Bylaws of the Company*
4.1 Specimen certificate for Common Stock of the Company*
4.2 See Exhibits 3.1 and 3.2 for provisions of the
Certificate of Incorporation and Bylaws of the Company
defining rights of holders of Common Stock of the Company
10.1 Form of Project Commencement Agreement*
10.2 Form of Software License Agreement*
10.3 Form of Software Maintenance Agreement*
10.4 Form of Professional Services Agreement*
10.5 Form of Credit Connection Lender Agreement (for
CreditRevue Licensees)*
10.6 Form of Credit Connection Lender Agreement (for
non-CreditRevue Licensees)*
10.7 Form of Credit Connection Dealer Subscription Agreement*
10.8.1 Office Building Lease between Symphony Woods Limited
Partnership and the Company dated October 29, 1993*
10.8.2 Office Building Lease between Symphony Woods Limited
Partnership and the Company dated February 10, 1995*
19
<PAGE> 20
10.8.3 First Amendment to Lease dated March 29, 1995*
10.8.4 Second Amendment to Lease dated August 12, 1996*
10.9 Promissory Note dated December 31, 1995 given by the
Company to James R. DeFrancesco*
10.10 Business Loan Agreement between The Columbia Bank and the
Company dated June 10, 1994*
10.11 1996 Credit Management Solutions, Inc. Non-Qualified Stock
Option Plan*
10.12 1996 Credit Management Solutions, Inc. Employee Stock
Purchase Plan*
10.13 1996 Credit Management Solutions, Inc. Long-Term incentive
Plan*
10.14 Form of Tax Indemnification Agreement*
10.15 1996 Credit Management Solutions, Inc. Non-Qualified
Stock Option Plan*
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the quarter
for which this report is filed.
20
--------------
*Incorporated by reference to the Exhibits filed with the Company's
Registration Statement on Form S-1, File NO.333-14007.
20
<PAGE> 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CREDIT MANAGEMENT SOLUTIONS, INC.
---------------------------------
(Registrant)
Date: November 13, 1998 /s/ James R. DeFrancesco
-------------------------
James R. DeFrancesco
Chief Executive Officer and
Chairman of the Board of
Directors (Principal Executive
Officer)
Date: November 13, 1998 /s/ Robert P. Vollono
-----------------------
Robert P. Vollono
Senior Vice President, Treasurer,
Chief Financial Officer and
Director (Principal Financial
and Accounting Officer)
21
<PAGE> 22
CREDIT MANAGEMENT SOLUTIONS, INC.
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description Page
- ----------- ----------- ----
<S> <C> <C>
3.1 Certificate of Incorporation*
3.2 Bylaws of the Company*
4.1 Specimen certificate for Common Stock of the Company*
4.2 See Exhibits 3.1 and 3.2 for provisions of the Certificate
of Incorporation and Bylaws of the Company defining rights
of holders of Common Stock of the Company
10.1 Form of Project Commencement Agreement*
10.2 Form of Software License Agreement*
10.3 Form of Software Maintenance Agreement*
10.4 Form of Professional Services Agreement*
10.5 Form of Credit Connection Lender Agreement (for CreditRevue
Licensees)*
10.6 Form of Credit Connection Lender Agreement (for non-CreditRevue
Licensees)*
10.7 Form of Credit Connection Dealer Subscription Agreement*
10.8.1 Office Building Lease between Symphony Woods Limited Partnership
and the Company dated October 29, 1993*
10.8.2 Office Building Lease between Symphony Woods Limited Partnership
and the Company dated February 10, 1995*
10.8.3 First Amendment to Lease dated March 29, 1995*
10.8.4 Second Amendment to Lease dated August 12, 1996*
10.9 Promissory Note dated December 31, 1995 given by the Company
to James R. DeFrancesco*
10.10 Business Loan Agreement between The Columbia Bank and the Company dated June 10, 1994*
10.11 1996 Credit Management Solutions, Inc. Non-Qualified Stock Option
Plan*
10.12 1996 Credit Management Solutions, Inc. Employee Stock Purchase Plan*
10.13 1996 Credit Management Solutions, Inc. Long-Term Incentive Plan*
</TABLE>
22
<PAGE> 23
<TABLE>
<S> <C>
10.14 Form of Tax Indemnification Agreement*
10.15 1996 Credit Management Solutions, Inc. Non-Qualified Stock Option
Plan*
27 Financial Data Schedule
</TABLE>
- ------------
*Incorporated by reference to the Exhibits filed with the Company's
Registration Statement on Form S-1, File No. 333-14007.
23
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001024339
<NAME> CREDIT MANAGEMENT SOLUTIONS, INC.
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 630,938
<SECURITIES> 10,257,570
<RECEIVABLES> 4,987,723
<ALLOWANCES> 380,861
<INVENTORY> 0
<CURRENT-ASSETS> 16,810,318
<PP&E> 7,790,255
<DEPRECIATION> 2,493,513
<TOTAL-ASSETS> 22,442,097
<CURRENT-LIABILITIES> 4,758,891
<BONDS> 0
0
0
<COMMON> 76,430
<OTHER-SE> 17,642,338
<TOTAL-LIABILITY-AND-EQUITY> 22,442,097
<SALES> 431,059
<TOTAL-REVENUES> 11,607,201
<CGS> 603,822
<TOTAL-COSTS> 8,950,119
<OTHER-EXPENSES> 9,028,638
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 629,689
<INCOME-PRETAX> (5,741,867)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,741,867)
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<NET-INCOME> (5,741,867)
<EPS-PRIMARY> (.75)
<EPS-DILUTED> (.75)
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