<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 JUNE 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)
<TABLE>
<S> <C>
DELAWARE 52-1549401
- -------------------------------------------------------------------------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
5950 SYMPHONY WOODS ROAD, COLUMBIA, MARYLAND 21044
- -------------------------------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
</TABLE>
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: 7,641,414 shares of
the Company's Common Stock, $.01 par value, were outstanding as of August 12,
1998.
1
<PAGE> 2
CREDIT MANAGEMENT SOLUTIONS, INC.
INDEX
<TABLE>
<CAPTION>
Page
----
Part I -- Financial Information
<S> <C> <C>
Item 1. Financial Statements (unaudited)....................................................................3
Consolidated Balance Sheets -- June 30, 1998 and December 31, 1997...................................3
Consolidated Statements of Operations -- Three Months Ended
June 30, 1998 and 1997 and Six Months Ended June 30, 1998 and 1997................................4
Consolidated Statements of Cash Flows --Six Months Ended June 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. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
------------ ------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,579,242 $ 20,569,300
Investments available-for-sale 10,139,834 -
Accounts receivable, net of allowance of $389,677 and $194,856
in 1998 and 1997, respectively 3,741,313 3,550,927
Costs and estimated earnings in excess of billings on uncompleted contracts 951,245 503,875
Prepaid expenses and other current assets 477,494 463,849
Deferred income taxes 58,513 58,513
------------ ------------
Total current assets 19,947,641 25,146,464
PROPERTY AND EQUIPMENT:
Computer equipment and software 4,327,835 3,442,792
Office furniture and equipment 1,042,995 941,733
Leasehold improvements 654,830 499,404
------------ ------------
6,025,660 4,883,929
Accumulated depreciation and amortization (2,190,563) (1,677,138)
------------ ------------
3,835,097 3,206,791
Software development costs, net of accumulated amortization of
$238,443 and $178,583 in 1998 and 1997, respectively 119,722 179,582
Other assets 1,059,333 423,886
------------ ------------
Total assets $ 24,961,793 $ 28,956,723
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,645,103 $ 2,225,745
Accrued payroll and related expenses 1,094,893 1,059,177
Billings in excess of costs and estimated earnings on uncompleted contracts 375,276 588,522
Deferred revenue 2,269,883 1,632,339
Current portion of capital lease obligations 91,397 138,165
------------ ------------
Total current liabilities 5,476,552 5,643,948
LONG-TERM DEBT:
Capital lease obligations, less current portion 58,657 101,390
Commitments and contingent liabilities - -
------------ ------------
Total liabilities 5,535,209 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;
7,634,856 and 7,615,510 shares issued and outstanding at
June 30, 1998 and December 31, 1997, respectively 76,349 76,155
Additional paid-in capital 26,778,847 26,645,247
Retained earnings (deficit) (7,428,612) (3,510,017)
------------ ------------
Total stockholders' equity 19,426,584 23,211,385
------------ ------------
Total liabilities and stockholders' equity $ 24,961,793 $ 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ ------------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C>
REVENUES:
License and software development fees $ 1,402,005 $ 2,470,551 $ 4,175,460 $ 4,918,180
Maintenance fees 1,021,219 718,812 2,003,911 1,283,500
Computer hardware sales 216,929 26,217 391,071 849,689
Service bureau revenues 495,411 118,331 808,137 235,287
----------- ----------- ----------- -----------
Total revenues 3,135,564 3,333,911 7,378,579 7,286,656
COSTS OF REVENUES:
Cost of license and software development fees 1,661,143 1,800,776 3,492,867 3,255,814
Cost of maintenance fees 287,143 157,054 548,776 255,900
Cost of computer hardware sales 253,738 61,102 500,744 726,157
Cost of service bureau 854,707 386,858 1,554,014 668,720
----------- ----------- ----------- -----------
3,056,731 2,405,790 6,096,401 4,906,591
----------- ----------- ----------- -----------
Gross Profit 78,833 928,121 1,282,178 2,380,065
OTHER OPERATING EXPENSES:
Selling, general and administrative expenses 2,276,915 2,095,373 4,599,216 3,994,639
Research and development costs 570,460 360,646 1,055,336 645,050
----------- ----------- ----------- -----------
2,847,375 2,456,019 5,654,552 4,639,689
----------- ----------- ----------- -----------
Loss from operations (2,768,542) (1,527,898) (4,372,374) (2,259,624)
OTHER INCOME (EXPENSE):
Interest expense (9,816) (14,801) (17,276) (34,630)
Interest income 221,215 317,801 474,771 648,463
Amortization of excess of assigned value of
identifiable assets over cost of an acquired
interest - - - 50,792
----------- ----------- ----------- -----------
211,399 303,000 457,495 664,625
----------- ----------- ----------- -----------
Loss before income taxes (2,557,143) (1,224,898) (3,914,879) (1,594,999)
Income tax expense - 148,040 - -
----------- ----------- ----------- -----------
Net loss $(2,557,143) $(1,372,938) $(3,914,879) $(1,594,999)
=========== =========== =========== ===========
Basic loss per common share $ (0.33) $ (0.18) $ (0.51) $ (0.21)
=========== =========== =========== ===========
Diluted loss per common share $ (0.33) $ (0.18) $ (0.51) $ (0.21)
=========== =========== =========== ===========
</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>
SIX MONTHS ENDED
JUNE 30,
--------------------------------
1998 1997
------------ ------------
(unaudited) (unaudited)
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (3,914,879) $ (1,594,999)
ADJUSTMENTS:
Depreciation 513,425 249,549
Amortization of excess of assigned value of
Identifiable assets over cost of an acquired interest - (50,792)
Amortization of software development costs 59,861 59,861
Amortization of discount on debt securities included in interest income (86,196) -
Loss (gain) on disposal of property and equipment - (6,431)
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Accounts receivable, net (190,386) (919,023)
Prepaid expenses and other current assets (13,645) 4,269
Accounts payable (580,641) (1,847,463)
Accrued payroll and related expenses 35,716 23,327
Net billings in excess of costs and estimated
gross profit on uncompleted contracts (660,616) 170,017
Deferred revenue 637,544 253,990
Accrued interest on stockholders loans - 6,025
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (4,199,817) (3,651,670)
INVESTING ACTIVITIES:
Purchase of investments available-for-sale (10,057,354) -
Proceeds from sale of property and equipment - 7,995
Purchase of property and equipment (1,141,731) (972,725)
Increase in other assets (635,447) -
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (11,834,532) (964,730)
FINANCING ACTIVITIES:
Repayments of stockholder loans - (235,538)
Payments under capital lease obligations (89,502) (117,915)
Repayments of long-term debt - (8,713)
Proceeds from exercise of stock options 43,740 -
Proceeds from issuance of common stock 90,053 4,224,442
Other - 50,413
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 44,291 3,912,689
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (15,990,058) (703,711)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 20,569,300 23,501,633
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,579,242 $ 22,797,922
============ ============
</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 six month periods
ended June 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 SIX MONTHS ENDED
----------------------------- ------------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Numerator for basic and diluted loss per common share:
Net loss $(2,557,143) $(1,372,938) $(3,914,879) $(1,594,999)
----------- ----------- ----------- -----------
Denominator:
Denominator for basic and diluted loss per common
Share - weighted-average shares 7,634,778 7,606,219 7,627,240 7,581,653
----------- ----------- ----------- -----------
Basic and diluted loss per common share $ (0.33) $ (0.18) $ (0.51) $ (0.21)
----------- ----------- ----------- -----------
</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)
======================= ====================== ======================
June 30, 1998:
Costs and estimated earnings $ 2,121,758 $ 513,770 $ 2,635,528
Billings 1,170,513 889,046 2,059,559
----------------------- ---------------------- ----------------------
$ 951,245 $ (375,276) $ 575,969
======================= ====================== ======================
</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 President 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, Portfolio Monitoring 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 as a core functional
system with customer specific enhancements delivered after initial system
implementation. Post implementation customer-unique enhancements are billed on a
time and material
7
<PAGE> 8
basis. The initial deployment of CreditRevue 2000 will be directed toward
offering CreditRevue in a service bureau environment. 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. However, neither third-party hardware nor third-party
software sales are a focus of the Company's overall marketing strategy. For the
six months ended June 30, 1997 and June 30, 1998, revenues from third-party
hardware and software sales accounted for 13.5% and 5.3% 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 June 30, 1998, the Company had 14 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 6.0% from $3.3 million in the three
months ended June 30, 1997 to $3.1 million in the three months ended June 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 increased 1.3% from $7.3 million in the six months ended June 30,
1997 to $7.4 million in the six months ended June 30, 1998.
License and Software Development Fees. CreditRevue has accounted for
substantially all of the Company's license and software development fee revenue
through June 30, 1998. License and software development fees decreased 43.3%
from $2.5 million in the three months ended June 30, 1997 to $1.4 million in the
three months ended June 30, 1998. The decrease during this most recent period
resulted primarily from delays in signing new CreditRevue clients.
License and software development fees decreased 15.1% from $4.9 million in the
six months ended June 30, 1997 to $4.2 million in the six months ended June 30,
1998.
Maintenance Fees. Maintenance fees include fees
8
<PAGE> 9
from software maintenance agreements. Maintenance fees increased 42.1% from $.7
million in the three months ended June 30, 1997 to $1.0 million in the three
months ended June 30, 1998. Maintenance fees increased 56.1% from $1.3
million in the six months ended June 30, 1997 to $2.0 million in the six
months ended June 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 increased
727.4% from $26,000 in the three months ended June 30, 1997 to $.2 million in
the three months ended June 30, 1998. Computer hardware sales revenue decreased
54.0% from $0.8 million in the six months ended June 30, 1997 to $0.4 million
in the six months ended June 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 318.7%
from $118,000 in the three months ended June 30, 1997 to $495,000 in the
three months ended June 30, 1998. The CreditConnection service was
commercially released in 1996 and generated $393,000 of revenue for the three
months ended June 30, 1998 compared to $118,000 for the three months ended June
30, 1997, an increase of 231.8%. 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 an aggregate revenue of $102,000 in the
quarter ended June 30, 1998.
Total Service Bureau revenues increased 243.5% from $0.2 million in the six
months ended June 30, 1997 to $0.8 million in the six months ended June 30,
1998.
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 7.8% from $1.8
million in the three months ended June 30, 1997 to $1.7 million in the three
months ended June 30, 1998. As a percentage of license fee and software
development revenue, cost of license and software development fees were 72.9%
and 118.5% in the three months ended June 30, 1997 and the three months ended
June 30, 1998, respectively. Although cost of license and software development
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 (2)
hourly labor costs associated with temporary contractors during periods in which
the Company experienced increased demand for its products; and (3) the increased
labor costs associated with the transition to the CreditRevue 2000 product. 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. With respect to the transition to
CreditRevue 2000, it is necessary to train certain of the Company's in-house
technical personnel on this new architecture, while at the same time continuing
to support those existing customer projects for CreditRevue Classic(TM), the
Company's traditional CreditRevue product offering. This transition requirement
has resulted in increased staffing levels during the period that contracts are
completed and are replaced by new contracts based on the CreditRevue 2000
product. Total labor costs as a percentage of revenue are also expected to
decrease as the Company and its customers move to a greater level of product
standardization available with the CreditRevue 2000 offering.
Cost of license and software development fees increased 7.3% from $3.3 million
in the six months ended June 30, 1997 to $3.5 million in the six months ended
June 30, 1998. As a percentage of license fee and software development revenue,
cost of license and software development fees were 66.2% and 83.7% in the six
months ended June 30, 1997 and the six months ended June 30, 1998, respectively.
9
<PAGE> 10
Costs of Maintenance Fees. Cost of maintenance fees consists primarily of
personnel and related costs for customer maintenance and support. Cost of
maintenance fees increased 82.8% from $.2 million in the three months ended June
30, 1997 to $0.3 million in the three months ended June 30, 1998. As a
percentage of maintenance fee revenue, cost of maintenance fees was 21.8% and
28.8% in the three months ended June 30, 1997 and the three months ended June
30, 1998, respectively. The dollar increase in the cost of maintenance fees
reflects the growth in license fees for CreditRevue during the periods presented
and the resultant increase in the number of installations. The fluctuation in
the percentage of cost of maintenance fees to maintenance fee revenues in 1997
and 1998 results from incremental increases in staffing for maintenance
personnel as maintenance revenues have increased. Staffing utilization
efficiencies will vary based on the timing and training of additions to
maintenance staff personnel. Additionally, the cost of maintenance for third
party software that is resold is included in cost of maintenance fees for the
period ended June 30, 1998.
Cost of maintenance fees increased 114.5% from $.3 million in the six months
ended June 30, 1997 to $0.5 million in the six months ended June 30, 1998. As a
percentage of maintenance fee revenue, cost of maintenance fees was 19.9% and
27.4% in the six months ended June 30, 1997 and the six months ended June 30,
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 increased 315.3% from $61,000 in the
three months ended June 30, 1997 to $.3 million in the three months ended June
30, 1998. As a percentage of computer hardware sales revenue, cost of computer
hardware sales was 233.1% and 117.0% in the three months ended June 30, 1997 and
the three months ended June 30, 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. Additionally, hardware sales were higher for
the three month period ended June 30, 1998 as compared to the same period in
1997, resulting in a higher cost of sales.
As a result of lower sales during the period, cost of computer hardware sales
decreased 31.0% from $0.7 million in the six months ended June 30, 1997 to $0.5
million in the six months ended June 30, 1998. As a percentage of computer
hardware sales revenue, cost of computer hardware sales was 85.5% and 128.0% in
the six months ended June 30, 1997 and the six months ended June 30, 1998,
respectively. 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 fees 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 the three months ended June 30, 1997, and June 30, 1998 were $0.4 million
and $0.9 million, respectively. Cost of service bureau revenues during the three
months ended June 30, 1997 and June 30, 1998 exceeded service bureau revenues
because of start up costs associated with establishing the service bureau. 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 increased 132.4% from $0.7 million in the six months
ended June 30, 1997 to $1.6 million in the six months ended June 30, 1998. As a
percentage of Service Bureau revenue, Cost of Service Bureau was 284.2% and
192.3% in the six months ended June 30, 1997 and the six months ended June 30,
1998, respectively.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 8.7% from $2.1 million in the three months
ended June 30, 1997 to $2.3 million in the three months ended June 30, 1998.
This $0.2 million increase resulted from increases in non-salary based
administrative expenses, consisting primarily of 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
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promotional expenses, and (ii) salaries of administrative, executive and
financial personnel, and (iii) outside professional fees.
Selling, general and administrative expenses increased 15.1% from $4.0 million
in the six months ended June 30, 1997 to $4.6 million in the six months ended
June 30, 1998. Of this $0.6 million increase, approximately $0.6 million of the
increase related to non-salary based administrative expenses, including
depreciation, travel, internal networking, advertising, and an increase in bad
debt expense related to increased billings. Certain of these expenses increased
due to an increase in expenses associated with the growth of the Company on a
year-to-year basis.
Research and Development Costs. Research and development costs consist primarily
of salaries and benefits of in-house programmers. These costs increased $0.2
million during the three months ended June 30, 1998 as compared to the three
months ended June 30, 1997 due primarily to the addition of six employees since
June 1997. The increase staffing was required to address a number of strategic
development efforts underway during 1997 including on going efforts for
CreditConnection, CreditRevue 2000, Dun & Bradstreet OneScore and CreditRevue
service bureau projects. All development activities during the 1997 and 1998
periods were expensed. During the period from September 1994, the direct payroll
costs of certain programmers were capitalized as software development costs. See
Note 1 to Notes to Consolidated Financial Statements in the Company's 10-K or
Annual Report for the year ended December 31, 1997.
Research and development costs increased $0.4 million during the six months
ended June 30, 1998 as compared to the six months ended June 30, 1997 due
primarily to staffing additions. There were no research and development expenses
capitalized during 1997 or 1998.
Interest Income. Interest income decreased to $0.1 million in the three months
ended June 30, 1998 as compared to the three months ended June 30, 1997. The
decrease in interest income over such periods relates primarily to interest
earned on the proceeds from the Company's initial public offering.
Interest income decreased to $0.2 million in the six months ended June 30, 1998
as compared to the six month period ended June 30, 1997. The increase in
interest income over such periods relates primarily to interest earned on the
proceeds from the Company's initial public offering in December 1996.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept or recognize only two digit entries in the date code field. These systems
and software products will need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, in less than two
years, computer systems and/or software used by many companies and governmental
agencies may need to be upgraded to comply with such Year 2000 requirements.
The Company has made an assessment of its solutions and believes that its
solutions are Year 2000 compliant. However, the software and hardware products
used by the Company's customers and certain public utilities, including
telecommunications companies and electric companies, may not be Year 2000
compliant, thereby disrupting the ability of customers to utilize the Company's
product. The Company is currently in the process of evaluating the Year 2000
compliance of (i) the third-party products used in its internal systems, and
(ii) the Company's major vendors. The Company anticipates that any such
evaluation will be completed by [THE FIRST QUARTER OF 1999]. The Company does
not believe that the costs of the evaluation of Year 2000 compliance or to
address any of its Year 2000 compliance issues will be material. However, the
impact of the Year 2000 issues cannot be determined at this time. The failure
by certain third parties, particularly the Company's customers, to address
their Year 2000 issues on a timely basis could have a material adverse effect
on the Company's business, results of operations or financial condition.
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 six months ended
June 30, 1997, the Company consumed net cash in operating activities of $3.7
million. During the six months ended June 30, 1998, the Company consumed $4.2
million of cash in operations. The primary use of cash in operations was the
reduction in accounts payable of approximately $1.8 million and an increase in
accounts receivable of 0.9 million for the period ended June 30, 1997 and from
the net growth of cost in excess of billings of $.7 million and the reduction of
accounts payable and accrued expenses of $.6 million during the six months ended
June 30, 1998.
The Company's cash used in investing activities consists principally of
investments in property and equipment. During the six months ended June 30, 1997
and 1998, the Company invested a total of $1.0 and $1.1 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.
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 June
30, 1998. The line of credit bears interest at the bank's prime rate per annum
(9.25% at June 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.
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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, 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.
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Dependence on CreditRevue Product Line. License fees, maintenance fees and
third-party computer hardware sales associated with licenses and installations
of CreditRevue accounted for virtually all of the Company's revenues through
June 30, 1998. Although the Company has recently 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. 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 or 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 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 a result, demand and market
acceptance for these services are subject to a high level of uncertainty, and
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 $1.3 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
CreditConnection service has taken longer to commercialize than originally
anticipated. Although the Company is exploring additional distribution options
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
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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.
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
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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
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, President and
Chief Executive Officer, and Scott L. Freiman, Executive Vice President. The
Company has obtained for 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.
Impact of Year 2000. The Company has completed an assessment of the potential
impact of Year 2000 related issues and has assigned resources to continually
update its Year 2000 assessment. Based on the initial assessment, it has been
determined that the Company will not experience any material adverse impact to
its business, operations or financial condition as a result of Year 2000 issues.
The Company's internal technology environment is based on state-of-the-art
hardware and software components which are already either entirely or
substantially Year 2000 compliant. The products the Company licenses to others
are already either entirely or substantially Year 2000 compliant. Modifications
to the interfaces between the Company's installed products and other systems
within client environments may be required. The Company has initiated formal
communications with all of its significant suppliers and large customers to
determine the extent to which the Company's interface systems are vulnerable to
those third parties failure to remediate their own Year 2000 issues. There is no
guarantee that the systems of other companies on which the Company's systems
rely will be timely converted and would not have an adverse effect on the
Company's systems.
System Interruption and Security Risks; Potential Liability; Possible Lack of
Adequate Insurance; and System 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
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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 late 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 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.
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,
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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 President 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.
17
<PAGE> 18
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
(a) The Company's Annual Meeting of Stockholders was held on
May 22, 1998.
(b) Not applicable
(c) Motions before stockholders
(1) Election of Three Directors
<TABLE>
<CAPTION>
NAME VOTES FOR VOTES AGAINST NON VOTES ABSTENTIONS
---- --------- ------------- --------- -----------
<S> <C> <C> <C> <C>
Scott L. Freiman 7,000,630 264,042 0 0
Miles H. Grody 7,001,630 262,042 0 0
Stephen X. Graham 7,002,512 262,160 0 0
</TABLE>
(2) Ratification of Ernst & Young, LLP as Auditors
<TABLE>
<CAPTION>
VOTES FOR VOTES AGAINST NON VOTES ABSTENTIONS
--------- ------------- --------- -----------
<S> <C> <C> <C> <C>
7,260,437 3,800 0 435
</TABLE>
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*
18
<PAGE> 19
<TABLE>
<S> <C>
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*
10.14 Form of Tax Indemnification Agreement*
10.15 1996 Credit Management Solutions, Inc. Non-Qualified Stock Option Plan*
27 Financial Data Schedule
</TABLE>
(b) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the quarter
for which this report is filed.
- -------------------
*Incorporated by reference to the Exhibits filed with the Company's Registration
Statement on Form S-1, File NO. 333-14007.
19
<PAGE> 20
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: August __, 1998 /s/ James R. DeFrancesco
-----------------------------------------------
James R. DeFrancesco
President, Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
Date: August __, 1998 /s/ Robert P. Vollono
-----------------------------------------------
Robert P. Vollono
Senior Vice President, Treasurer, Chief
Financial Officer and Director (Principal
Financial and Accounting Officer)
20
<PAGE> 21
CREDIT MANAGEMENT SOLUTIONS, INC.
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description Page
- ----------- ----------- ----
<S> <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>
21
<PAGE> 22
<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>
22
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001024339
<NAME> CREDIT MANAGEMENT SOLUTIONS, INC.
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 4,579,242
<SECURITIES> 10,139,834
<RECEIVABLES> 4,130,990
<ALLOWANCES> 389,677
<INVENTORY> 0
<CURRENT-ASSETS> 19,947,641
<PP&E> 6,025,660
<DEPRECIATION> 2,190,563
<TOTAL-ASSETS> 24,961,793
<CURRENT-LIABILITIES> 5,476,552
<BONDS> 0
0
0
<COMMON> 76,349
<OTHER-SE> 19,350,235
<TOTAL-LIABILITY-AND-EQUITY> 24,961,793
<SALES> 391,071
<TOTAL-REVENUES> 7,378,579
<CGS> 500,744
<TOTAL-COSTS> 6,096,401
<OTHER-EXPENSES> 5,654,552
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 457,495
<INCOME-PRETAX> (3,914,879)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,914,879)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,914,879)
<EPS-PRIMARY> (.51)
<EPS-DILUTED> (.51)
</TABLE>
