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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED [NO FEE
REQUIRED]
FOR THE TRANSITION PERIOD FROM
TO
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COMMISSION FILE NUMBER 000-21735
CREDIT MANAGEMENT SOLUTIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 52-1549401
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
5950 SYMPHONY WOODS ROAD, COLUMBIA, MD 21044
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (410) 740-1000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Common Stock, $0.01 par value Nasdaq National Market
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
At March 25, 1998, Credit Management Solutions, Inc. had 7,619,467 shares
of Common Stock, par value $0.01, outstanding.
While it is difficult to determine the number of shares owned by
non-affiliates, the registrant estimates that the aggregate market value of
outstanding Common Stock on March 25, 1998 (based upon the average bid and asked
prices of such Common Stock on the Nasdaq National Market on March 25, 1998)
held by non-affiliates was approximately $23.1 million. For this computation,
the registrant has excluded the market value of all shares of its Common Stock
reported as beneficially owned by officers, directors and certain significant
stockholders of the registrant. Such exclusion shall not be deemed to constitute
an admission that any such stockholder is an affiliate of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10, 11, 12 and 13 of Part III of this Form 10-K are incorporated by
reference from the registrant's definitive Proxy Statement to be furnished to
stockholders in connection with the 1998 Annual Meeting of Stockholders. This
Proxy Statement will be filed with the Securities and Exchange Commission
pursuant to Regulation 14A promulgated under the Securities Exchange Act of
1934, as amended, not later than April 30, 1998.
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PART I
ITEM 1. BUSINESS.
This report contains certain statements of a forward-looking nature
relating to future events or the future financial performance of Credit
Management Solutions, Inc. ("CMSI" or the "Company"). Investors are cautioned
that such statements are only predictors and that actual events or results may
differ materially. In evaluating such statements, investors should specifically
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 "-- Risk Factors."
The Company was incorporated under the laws of the State of Maryland in
1987 and reincorporated under the laws of the State of Delaware in December
1996. CMSI is a developer and provider of software solutions and services for
automating the consumer and small business credit analysis, decisioning and
funding process. The Company's products and services allow its customers to
automate the entire credit application process by enabling the rapid
transmission of credit applications to multiple funding sources, expediting
credit application analysis and decisioning and facilitating compliance with
federal and state regulatory requirements. The Company's core product,
CreditRevue(R), analyzes credit applications by automatically accessing
third-party credit bureau reports, consulting the lending institution's internal
loan guidelines and incorporating the loan "scorecards" used by lending
institutions. To further support the needs of the lending industry, the Company
developed CreditConnection(R), which became commercially available in July 1996.
CreditConnection, a software-based service, links sources of credit origination
through an online network that allows applications to be transmitted to multiple
funding sources and credit decisions to be delivered back to the point of origin
in a matter of minutes. To date, CreditConnection has generated approximately
$666,500 in revenues.
PRODUCTS AND SERVICES
CreditRevue(R)
CreditRevue is a UNIX-based software solution designed to automate the
entire credit application process from the entry of the credit application to
the credit decision and through the transfer of the funding information to the
lender's servicing system. Using CreditRevue, a lender can automate the analysis
of a wide range of consumer lending products, including vehicle loans and
leases, home equity loans and credit cards. Before CreditRevue is installed, the
Company completes a review of the customer's credit application processing
environment. CreditRevue is then configured to address the lender's
specifications, including the lender's underwriting, approval and funding
processes. The Company designs interfaces to the lender's other related systems,
such as their branch automation software, customer information repository, and
loan servicing software.
The Company markets the following supplemental CreditRevue products:
- CreditRevue(R) 2000(TM). The Company has completed the new version of
CreditRevue, which is designed to allow the software to be configured
without extensive coding. This new version of CreditRevue is currently
being deployed to new customers. The Company believes this new design
will reduce the current implementation time for a CreditRevue system
from eight to 10 months to four to six months. With the introduction
of CreditRevue 2000, the Company's traditional CreditRevue product
offering is referred to as CreditRevue Classic.
- CreditRevue Student Lending(TM) is a specialized version of
CreditRevue which in addition to providing the full functionality of
CreditRevue is configured to support the requirements of the student
lending marketplace.
- CreditRevue Maestro(TM) is a product designed to work in conjunction
with a client's existing order entry system providing complete
background credit analysis and decisioning capabilities based on
client defined criteria.
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- CreditRevue Service Bureau(TM), which is designed to allow lenders to
connect multiple terminals or personal computers to a service bureau
system to access CreditRevue. CreditRevue Service Bureau is designed
to be used by small and medium sized financial institutions seeking to
minimize the up-front hardware and software costs of an in-house
system. The Company will initially pursue strategic marketing
alliances with established service bureau providers whereby such
providers will be licensed to re-market CreditRevue Service Bureau to
their existing clients on a transaction fee basis.
- Dun & Bradstreet OneScore(TM) is a credit scoring product to assess
small businesses. Using advanced statistical techniques, Dun &
Bradstreet (D&B) has developed a blended scoring model that permits
D&B's comprehensive commercial information to be intelligently
combined with information on principals of the business concerned. The
consumer information is provided by independent consumer bureaus to
help customers better assess credit risks in dealings with smaller
businesses. The Company uses its proprietary credit processing system
to implement the D&B model on behalf of D&B's customers. This is a
transaction fee oriented service for which the Company receives a fee
for each OneScore generated by a D&B client.
CreditConnection(R)
CreditConnection offers connectivity between points of credit origination,
such as automobile dealers, and multiple funding sources. CreditConnection
allows a dealer to enter a credit application for a consumer loan or lease. The
dealer can request one or more credit bureaus which can then be reviewed in
several different formats. The dealer can select one or more lending
institutions to which the credit application should be sent and can specify
criteria which determines how the application is to be sequenced and
automatically forwarded to secondary sources (e.g., if the first lending
institution does not respond within 10 minutes). The dealer can then view the
lenders' credit decisions online. When the lending institution supports
automated funding, the dealer can have the funds for the loan transferred to the
dealer's bank account without having to wait for the actual contract to arrive
at the funding source. CreditConnection provides several other features to
dealerships, including online vehicle valuation guides and broadcast news from
participating funding sources. For the funding source, CreditConnection provides
a single interface to communicate with any number and type of credit
originators.
The Company's agreements with each lending institution that subscribes to
the CreditConnection service include a provision that the Company and the
lending institution develop and implement a marketing plan describing how the
lending institution will utilize its sales force to increase dealership
subscriptions to the CreditConnection service. The Company also has been
pursuing remarketing arrangements for the CreditConnection service with vendors
that provide automated systems for dealership management and operations. The
Company has signed agreements to form strategic alliances with the Dealer
Service Group of ADP and Universal Computer Systems (UCS) to remarket
CreditConnection. The agreements with ADP and UCS provide that such parties
offer the CreditConnection service as their standard approach to establish
electronic interfaces between dealerships and financial institutions. Under
certain limited circumstances, ADP and UCS may provide an interface which is
different from the Company's. ADP and UCS do not currently remarket any third
party products or services which compete with the CreditConnection service. See
"-- Sales and Marketing."
The Company's agreements with lending institutions that are licensees of
CreditRevue typically require that the CreditConnection service be utilized as
the exclusive interface between CreditRevue software and applications
transmitted electronically from third parties. The ability of CreditConnection
lending institutions that are not CreditRevue licensees to receive applications
transmitted electronically from third parties by means other than the
CreditConnection service is not similarly restricted.
The Company is also marketing CreditConnection LenderLink(TM), which
facilitates the electronic transfer of credit applications and decisions between
lending institutions through the CreditConnection network. Using
CreditConnection LenderLink, a prime lender can automatically forward credit
applications which it has declined to a sub-prime lender. The sub-prime lender
can return a decision electronically to the prime lender,
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which then communicates the decision to the credit originator. CreditConnection
LenderLink benefits all three parties, the credit originator, the prime lender
and the sub-prime lender. The credit originator gets a higher rate of approvals
since applications declined by the prime lender have additional opportunities to
be approved. The prime lender gets a referral fee from the sub-prime lender, and
the sub-prime lender gets a source for additional customers. Additionally, the
Company receives a transaction-based fee for each application transmitted to a
sub-prime lender using CreditConnection LenderLink.
CreditConnection for Microsoft Corporation's Windows operating system is a
graphical, client/server version of the dealer software that connects to the
CreditConnection host using the Internet or a private network. This new software
is designed to reduce communication costs and provides easier deployment, an
improved user interface and additional functionality. CreditConnection for
Microsoft Corporation's Windows operating system became commercially available
in 1997.
In addition, the Company is developing CreditConnection Online(TM), which
will allow consumers to use the World Wide Web to apply for loans and receive
online decisions from lenders subscribing to CreditConnection. Consumers will be
able to enter applications at the Company's Web site, a subscribing lender's Web
site or a third-party remarketer's Web site. CreditConnection Online, originally
developed in 1997, was used initially to originate automobile loans from ADP's
AutoConnect(TM) Web site and forward those loans to NationsBank through
CreditConnection. Following the initial development and pilot market test,
CreditConnection Online is being re-engineered to support multiple lenders using
browser development technology.
CUSTOMERS
The Company's customers are categorized by product type. With respect to
the CreditRevue product, the Company has over 35 customers, including banks,
savings and loan associations, finance companies, sub-prime lenders, leasing
companies, student lenders and a telecommunications company. The Company intends
to continue to focus on the financial services industry and to target the
student lending, insurance, utilities and healthcare industries. With regards to
its CreditConnection service, at December 31, 1997 the Company had contractual
relationships with 22 lenders. The Company has developed electronic connections
linking 14 financial institutions to the CreditConnection service. The Company's
alliance with Dun & Bradstreet has resulted in 117 customers for the OneScore
service as of December 31, 1997.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a discussion of those customers who have accounted
for 10% or more of the Company's revenues in any of the past three years.
PRODUCT DEVELOPMENT
Since its inception, the Company has made substantial investments in
product development and has a dedicated product development organization which
periodically releases new products and enhancements to existing products. The
Company believes that its future performance will depend in large part on the
Company's ability to enhance its current products and services and to develop
new products 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. While the
Company anticipates that certain new products and services will be developed
internally, the Company may, based on timing and cost considerations, acquire or
license technology or software from third parties when appropriate. For a
discussion of certain risks associated with the Company's product development
program, see "-- Risk Factors -- Rapid Technological Change; Risk Associated
with New Products, Services or Enhancements" and "-- Risk Factors -- Risk of
Defects, Development Delays and Lack of Market Acceptance."
As of December 31, 1997, the Company's product development staff consisted
of 23 employees. The Company anticipates that it will continue to commit
resources to product development in the future.
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CUSTOMER SERVICE AND SUPPORT
The Company believes that its success is dependent in part upon its ability
to provide customers with responsive, prompt and efficient support and training.
Each customer has a maintenance agreement, which is typically coterminous with
the license agreement, providing for service, support and product enhancements.
The Company offers its clients a wide range of support services to assist its
customers in deriving the most effective use of the Company's products and
services, including technical support, formalized training and a user hotline.
The Company's services also include implementation planning and assistance,
software installation, software operations training and software maintenance.
As of December 31, 1997, the Company's dedicated customer service and
support team included 22 employees. CMSI's support personnel are available to
its customers 24 hours a day, seven days a week through a hotline. The Company
tracks each customer's service history to identify trends or problem areas and
to recommend solution strategies. Most customer support questions are answered
during the initial call. The Company can access a customer's system through a
modem to diagnose the situation and implement corrective measures, if necessary.
The Company also makes on-site visits for emergency or serious problem
situations.
The Company believes that its customers typically base their decisions to
purchase the Company's products and services partly on the support and
maintenance offered with such products and services. The Company intends to
continue to strengthen its support team and reputation by adding professional
personnel with significant experience in the financial services and software
industries.
SALES AND MARKETING
As of December 31, 1997, the Company's sales and marketing organization
consisted of 17 employees based at the Company's corporate headquarters in
Columbia, Maryland. To support its sales force, the Company conducts
comprehensive marketing programs, which include direct mail, public relations,
seminars, trade shows and ongoing customer communications programs. The Company
also sponsors an annual users' group meeting for its CreditRevue customers.
The Company sells its CreditRevue products through a direct sales
organization. The sales cycle begins with the generation of a sales lead or the
receipt of a request for proposals from a prospective customer. While the sales
cycle varies substantially from customer to customer, it typically requires six
to eight months.
The sales effort for CreditConnection comprises both direct and indirect
marketing activities. Direct sales efforts are concentrated on selling the
service to financial institutions, automobile superstores, independent
dealerships, and finance and insurance systems providers. Direct sales efforts
are supported by participation in both financial and automotive trade shows and
conferences, financial press relations, telemarketing, advertising campaigns,
and targeted mailings. The Company also supports the indirect sales efforts of
the sales organizations of certain financial institutions which have
well-established relationships with many of the automobile dealerships in the
United States. The Company supports its indirect sales channels through a
variety of marketing communications efforts including the development of
brochures and direct mail pieces, production of sales videos, participation in
trade shows and conferences, support for bank dealer focus groups, advertising,
press relations and seminar support.
In November 1996, the Company entered into an agreement to form a strategic
alliance with the Dealer Services Group of ADP. Under the terms of the
agreement, the Company and ADP have agreed to integrate CreditConnection with
ADP's automated dealership management and operations systems so that ADP can
remarket and license CreditConnection to ADP's automobile dealer customers. In
exchange for its services, ADP is entitled to a percentage of the net revenues
from transactions generated by ADP's dealers. In addition, pursuant to the
agreement, ADP has the right to name one director to the Company's Board of
Directors. In August 1997, the Company entered into an agreement to form a
strategic alliance with Universal Computer Systems, Inc. ("UCS") whereby UCS can
remarket and license CreditConnection to UCS's automobile dealer customers.
While the Company has also initiated discussions with other dealer system
vendors and
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intends to establish relationships with such vendors to expand the market
presence of CreditConnection, no such additional relationships have been
finalized.
BACKLOG
At December 31, 1997, the Company had entered into contracts for its
services for which $4.3 million of revenues will be recognized in future
periods. At December 31, 1996, the comparable amount was $3.5 million.
COMPETITION
The credit processing software and services industry is intensely
competitive and rapidly changing. The Company believes its ability to compete
depends upon many factors within and outside its control, including the timing
and market acceptance of new products and services and enhancements developed by
the Company and its competitors, including (i) application software companies,
(ii) management information systems departments of potential customers, (iii)
third-party professional services organizations, and (iv) computer services
outsourcing providers which offer service bureau-based credit processing
solutions. Competitors for CreditRevue include American Management Systems,
Inc., Appro Systems, Inc., CFI ProServices, Inc., Fair, Isaac and Company, Inc.,
Affinity Technology Group, Inc and Corporate Solutions International, Inc. While
at the outset of 1997 The Reynolds & Reynolds Company ("Reynolds"), and
International Business Machines Corporation ("IBM"), each separately marketed
solutions competitive with the CreditConnection, it is not clear that either
Reynolds or IBM is continuing or plans to continue marketing these solutions in
1998. Many of the Company's competitors are substantially larger than the
Company and have significantly greater financial, technical and marketing
resources and established, extensive direct and indirect channels of
distribution. As a result, they may be able to respond more quickly to new or
emerging technologies and changes in customer requirements, or to devote greater
resources to the development, promotion and sale of their products and services
than the Company.
As is typical in the software industry, many actual or potential customers
of the Company may become competitors by developing competitive technology
internally. Due to the relatively low barriers to entry in the software market,
the Company expects additional competition from other established and emerging
companies as the credit processing software market continues to develop and
expand. The Company also expects that competition will increase as a result of
software industry consolidations. The Company anticipates that its competitors
may develop or acquire products or services that provide functionality that is
similar to that produced by the Company's products and services, and that such
products and services may be offered at a significantly lower price or bundled
with other products and services. In addition, current and potential competitors
have established or may establish cooperative relationships among themselves or
with third parties to increase the ability of their products to address the
needs of the Company's prospective customers. Accordingly, it is possible that
new competitors or alliances among competitors may emerge and rapidly acquire
significant market share.
Increased competition is likely to result in price reductions, reduced
gross margins and loss of market share, any of which would have a material
adverse effect on the Company's business, results of operations and financial
condition. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that competitive pressures
will not have a material adverse effect on the Company's business, results of
operations and financial condition.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company's success is heavily dependent upon its proprietary technology.
The Company regards its software products and services as proprietary, and
relies primarily on a combination of contract, copyright and trademark law,
trade secrets, confidentiality agreements and contractual provisions to protect
its proprietary rights. The Company has no patents on its products currently in
commercial use, and existing trade secrets and copyright laws afford only
limited protection. The Company has applied for a United States patent on
portions of CreditConnection. There can be no assurance that a patent will be
granted pursuant to the Company's
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application or that, if granted, such patent would survive a legal challenge to
its validity or provide adequate protection. Furthermore, there can be no
assurance that others will not design around any patents issued to the Company.
It is the Company's policy to enter into confidentiality and assignment
agreements with its employees. Despite the Company's efforts to protect its
proprietary rights, unauthorized parties may attempt to copy or otherwise obtain
and use the Company's products or technology without authorization, to obtain
and use information that the Company regards as proprietary, or to develop
similar or superior products or technology independently. Policing unauthorized
use of the Company's products is difficult, and while the Company is unable to
determine the extent to which piracy of its software products exists, software
piracy can be expected to be a persistent problem, particularly in international
markets and as a result of the growing use of the Internet. The source code for
the Company's proprietary software is protected both as a trade secret and as a
copyrighted work. The Company has in the past and may in the future make source
code for one or more of its products available to certain of its customers and
strategic partners which may increase the likelihood of misappropriation or
other misuse of the Company's software. In addition, the laws of some foreign
countries do not protect the Company's proprietary rights to the same extent as
do the laws of the United States. There can be no assurance that the steps taken
by the Company to protect its proprietary rights will be adequate or that the
Company's competitors will not independently develop technologies that are
substantially equivalent or superior to the Company's technologies.
"CreditRevue," "CreditConnection" and "INCredit" are registered trademarks
of the Company. "CrossSell," "CreditRevue Service Bureau," "CreditRevue Student
Lending," "CreditRevue Data Server," "CreditRevue Maestro," "CreditConnection
Online," "CreditConnection LenderLink" and the Company logo are trademarks of
the Company. The Company is not aware that any of its products, services,
trademarks or other proprietary rights infringes the proprietary rights of third
parties. However, there can be no assurance that third parties will not assert
infringement claims against the Company in the future with respect to current or
future products or services. As the number of software products and services in
the industry increases and the functionality of these products and services
further overlaps, the Company believes that software developers may become
increasingly subject to infringement claims. Furthermore, there can be no
assurance that former employers of the Company's present and future employees
will not assert claims that such employees have improperly disclosed
confidential or proprietary information to the Company. Any such claims, with or
without merit, can be time consuming and expensive to defend, cause product and
service delays, or require the Company to enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to the Company, or at all, which could have a
material adverse effect on the Company's business, results of operations and
financial condition.
EMPLOYEES
As of December 31, 1997, the Company had 212 full time employees, including
23 in product development, 127 in technical operations, 17 in sales and
marketing and 23 in finance and administration. The Company's employees are not
covered by any collective bargaining agreements. The Company has experienced no
work stoppages and believes that its relations with its employees are good.
RISK FACTORS
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 success of the
Company's relationships with third party remarketers of CreditConnection, the
successful transition from predominantly license fee-based revenue to
predominantly transaction fee-based revenue, the timing of new product and
service 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
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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 develop and 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, cancellation 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. See "-- Market Acceptance of Credit Connection; Transition to
Transaction-Based Revenue" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Quarterly Information."
Dependence on CreditRevue Product Line
License fees, maintenance fees and third-party computer hardware sales
associated with licenses and installations of CreditRevue accounted for
substantially all of the Company's revenues through December 31, 1997. Although
the Company introduced its CreditConnection service in the fourth quarter of
1996, 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. To date, CreditConnection
has generated approximately $666,500 in revenues. 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. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
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
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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. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
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. To date,
CreditConnection has generated approximately $666,500 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. 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.
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 relationships will be
successful on an on-going basis. Moreover, 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 leverage and 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. See "-- Sales and
Marketing."
In addition, the Company has formed strategic alliances with ADP and 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
8
<PAGE> 10
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. See "-- Sales and Marketing."
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 co-terminous 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,
termination of orders by any customer, 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. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
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. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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 commercial
release of CreditConnection in 1996. Such changes have placed and may continue
to place a significant strain upon the Company's management, systems and
resources. As of December 31, 1997, the Company had grown to 212 employees from
140 employees at December 31, 1996. 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, budgeting
and forecasting capabilities on a timely basis, expand its sales and marketing
work force and train and manage its employee work force. There can be no
assurance that the Company, or the Company's current management, 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. See "-- Sales and Marketing."
9
<PAGE> 11
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 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 managerial, sales, technical, and
customer support 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. The Company has in the past and may in the future
experience significant delays in product development. There can be no assurance
that these new products and services, if developed, 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. See "-- Product Development."
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 the planning stages of acquiring and
implementing a back-up, off-site processing system capable of fully supporting
its operations
10
<PAGE> 12
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 significant 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 and may result in additional
development costs. 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. The Company may continue to
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. See
"-- Products and Services" and "-- Product Development."
Future Capital Needs; Uncertainty of Additional Financing
The Company currently anticipates that its available cash resources
combined with anticipated funds from operations and its bank line of credit will
be sufficient to meet its presently anticipated working capital and capital
expenditure and debt repayment requirements through 1998. 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 complimentary 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
11
<PAGE> 13
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. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
Government Regulation and Uncertainties of Future Regulation
The Company's current and prospective customers, which consist of state and
federally chartered banks, savings 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 may not itself be 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
60% 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 the
terms are approved by such stockholders.
Possible Volatility of Stock Price
The trading price of the Company's Common Stock has in the past and may in
the future be subject to significant fluctuations in response to variations in
quarterly operating results, changes in earning estimates by analysts, the gain
or loss of significant orders, 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 to 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; Antitakeover 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
12
<PAGE> 14
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.
ITEM 2. PROPERTIES.
The Company's principal executive offices are located in Columbia, Maryland
in a leased facility consisting of approximately 55,000 square feet of office
space under several leases that expire in 2002, subject to five or six year
renewal options, respectively. The Company has a right of first refusal on
additional office space in the same building. The Company has entered into a
lease for approximately 70,000 sq. ft. of new office space in the Annapolis
Junction, Maryland area and expects to commence occupancy of these new offices
during the third quarter of 1998. The Company will be implementing a program to
sublet its existing office space in Columbia, Maryland. However, no assurance
can be given that such program will be successful, or, if successful, that the
Company will be able to sublet its existing office space on commercially
reasonable terms.
ITEM 3. LEGAL PROCEEDINGS.
The Company filed a complaint on January 26, 1998 in the Circuit Court for
Howard County, Maryland, asserting claims against The Money Store Auto Finance,
Inc. and The Money Store Service Corporation (collectively, the "Money Store").
The Money Store unilaterally terminated a contract under which CMSI was
developing software to be licensed by the Money Store. Repeated efforts by CMSI
to obtain settlement which would avoid litigation have failed. The original
software license price was $1.5 million. To date, the Money Store has paid
$375,000 to the Company, which was recognized as revenues for the third quarter
of 1997. The Company will vigorously seek to enforce its rights regarding this
dispute, however there can be no assurance that this litigation will be
successful.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
(d) Not applicable.
13
<PAGE> 15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "CMSS." The following table sets forth, for the calendar periods
indicated, the range of high and low bid quotations as reported by the Nasdaq
National Market. These quotations reflect inter-dealer prices, without retail
mark-up, markdown or commission and may not necessarily represent actual
transactions.
<TABLE>
<CAPTION>
STOCK PRICE
---------------
HIGH LOW
------ ------
<S> <C> <C>
CALENDAR YEAR 1996:
December 18, 1996-December 31, 1996.................... $14.50 $11.50
CALENDAR YEAR 1997:
First Quarter.......................................... $20.25 $10.25
Second Quarter......................................... $13.50 $ 9.00
Third Quarter.......................................... $18.25 $10.25
Fourth Quarter......................................... $19.38 $ 9.75
CALENDAR YEAR 1998:
First Quarter (through March 25, 1998)................. $13.19 $ 7.75
</TABLE>
On March 25, 1998, the last reported sales price for the Company's Common
Stock on the Nasdaq National Market was $7.75 per share.
HOLDERS
As of March 25, 1998, the approximate number of registered stockholders of
record of the Common Stock was 192.
DIVIDENDS
The Company does not anticipate paying any cash dividends in the
foreseeable future. The Company currently intends to retain any future earnings
for use in its business. In addition, the Company's bank line of credit
prohibits the payment of cash dividends without the bank's prior written
consent.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The consolidated statement of operations data set forth below for the
fiscal years ended December 31, 1993, 1994, 1995, 1996, and 1997 and the
consolidated balance sheet data at December 31, 1993, 1994, 1995, 1996 and 1997
have been derived from the audited consolidated financial statements of the
Company. The consolidated balance sheets at December 31, 1996 and 1997, and the
consolidated statement of operations for each of the years in the three year
period ended December 31, 1997, together with the notes thereto and the related
report of Ernst & Young LLP, are included elsewhere in this Report. The selected
financial data set forth below are qualified in their entirety by, and should be
read in conjunction with, the consolidated financial
14
<PAGE> 16
statements, the related notes thereto and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere in this
Report.
<TABLE>
<CAPTION>
YEAR END DECEMBER 31,
-------------------------------------------------------------------
1993 1994 1995 1996 1997
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
REVENUES
License and software
development fees............ $ 2,911,539 $ 2,934,450 $ 7,207,581 $10,101,377 $11,549,378
Maintenance fees.............. 375,510 700,861 1,170,447 2,045,258 3,311,013
Computer hardware sales....... 81,019 316,145 1,853,424 2,106,634 1,656,530
Service bureau revenues....... -- -- -- -- 640,818
----------- ----------- ----------- ----------- -----------
3,368,068 3,951,456 10,231,452 14,253,269 17,157,739
COST OF REVENUES
Cost of license and software
development fees............ 785,622 1,482,036 3,559,798 5,095,814 7,329,091
Cost of maintenance fees...... 40,776 151,346 280,176 452,559 880,360
Cost of computer hardware
sales....................... 77,979 315,262 1,500,816 1,782,166 1,504,915
Cost of service bureau........ -- -- -- -- 2,085,543
Selling, general and
administrative expenses..... 2,234,816 2,244,031 3,966,265 6,126,494 8,537,967
Research and development
costs....................... 131,203 167,152 165,366 526,521 1,790,709
----------- ----------- ----------- ----------- -----------
3,270,396 4,359,827 9,472,421 13,983,554 22,128,585
----------- ----------- ----------- ----------- -----------
Income (loss) from
operations.................. 97,672 (408,371) 759,031 269,715 (4,970,846)
OTHER INCOME (EXPENSE)
Interest income (expense)
net......................... (32,774) (41,310) (105,849) (78,009) 1,181,411
Amortization of excess of
assigned value of
Identifiable assets over
cost of an acquired
Interest.................... 253,959 304,750 304,750 304,749 50,792
----------- ----------- ----------- ----------- -----------
Income (loss) before income
taxes.................... 221,185 263,440 198,901 226,740 1,232,203
Income tax expense............ -- -- -- 201,487 --
----------- ----------- ----------- ----------- -----------
Net income (loss)............. $ 318,857 $ (144,931) $ 957,932 $ 294,968 $(3,738,643)
=========== =========== =========== =========== ===========
Basic earnings (loss) per
common share................ $ 0.07 $ (0.03) $ 0.20 $ 0.06 $ (0.49)
Diluted earnings (loss) per
common share................ $ 0.07 $ (0.03) $ 0.20 $ 0.05 $ (0.49)
</TABLE>
<TABLE>
<CAPTION>
YEAR END DECEMBER 31,
-------------------------------------------------------------------
1993 1994 1995 1996 1997
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents..... $ 108,554 $ 75,840 $ 120,255 $23,501,633 $20,569,300
Working capital (deficit)..... (246,748) (1,073,896) (1,362,539) 21,056,337 19,502,516
Total assets.................. 797,465 1,581,751 4,035,323 28,451,530 28,956,723
Long term debt, less current
portion..................... 237,288 416,136 408,806 220,341 101,390
Stockholders' equity
(deficit)................... (1,232,479) (1,482,410) (576,978) 22,587,896 23,211,385
</TABLE>
15
<PAGE> 17
ITEM 7. 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 results
of operations and financial condition. The discussion should be read in
conjunction with the audited consolidated financial statements of the Company
and notes thereto. 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
"Business -- Risk Factors."
GENERAL
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, the Company's online credit
information and processing service, became commercially available in July 1996
and, through December 31, 1997, has generated approximately $666,500 in
revenues. Fees from licenses of CreditRevue and related maintenance fees and
resales of third-party computer hardware and software associated with
installations of CreditRevue accounted for substantially all of the Company's
revenue through December 31, 1997. See "Business -- Risk Factors -- Dependence
on CreditRevue Product Line."
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 costs to completion. For a description of certain
risks associated with the lengthy implementation time associated with
installations of CreditRevue, see "Business -- Risk Factors -- Lengthy Sales and
Implementation Cycle." 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 year ended December 31,
1997, revenues from third-party hardware and software sales accounted for 9.7%
and 8.4% of total revenues, respectively. Revenues from resales of third-party
computer hardware and software are recognized at the time of shipment and
installation, respectively.
Certain of the Company's products and services, including CreditConnection,
CreditRevue Service Bureau and Dun & Bradstreet's OneScore, 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, CreditRevue
Service Bureau, or Dun & Bradstreet's OneScore, the occurrence of any
significant technological problems, such as a system failure incurred prior to
the implementation of a
16
<PAGE> 18
fully functioning 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.
See "Business -- Risk Factors -- Market Acceptance of CreditConnection;
Transition to Transaction-Based Revenue" and "-- System Interruption and
Security Risks; Potential Liability; Possible Lack of Adequate Insurance; and
System Inadequacy."
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 December 31, 1997, the Company had 17 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
The following table sets forth certain operating data as a percentage of
total revenues for the periods indicated (subtotals not adjusted for rounding):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Percentages of Total Revenues
Revenues
License and software development fees.................. 70.5% 70.9% 67.3%
Maintenance fees....................................... 11.4 14.3 19.3
Computer hardware sales................................ 18.1 14.8 9.7
Service bureau fees.................................... -- -- 3.7
----- ----- -----
100.0 100.0 100.0
----- ----- -----
Costs and Expenses
Cost of license and software development fees.......... 34.8 35.8 42.7
Cost of maintenance fees............................... 2.7 3.2 5.1
Cost of computer hardware sales........................ 14.7 12.5 8.8
Cost of service bureau fees............................ -- -- 12.2
Selling, general and administrative expenses........... 38.8 43.0 49.8
Research and development costs......................... 1.6 3.7 10.4
----- ----- -----
92.6 98.2 129.0
----- ----- -----
Income (loss) from operations............................... 7.4 1.8 (29.0)
Other income (expense)
Interest income (expense), net.............................. (1.0) (0.5) 6.9
Amortization of excess of assigned value of
identifiable assets over the cost of an acquired
interest............................................. 3.0 2.1 .3
----- ----- -----
2.0 1.6 7.2
----- ----- -----
Income (loss) before income taxes........................... 9.4 3.4 (21.8)
Income tax expense..................................... -- 1.4
----- ----- -----
Net income (loss)...................................... 9.4% 2.0% (21.8)%
===== ===== =====
</TABLE>
17
<PAGE> 19
Total Revenues
Total revenues increased 39.3% from $10.2 million in 1995 to $14.3 million
in 1996 and 20.4% from $14.3 million in 1996 to $17.2 million in 1997. The
Company's revenues are derived from four sources: license and software
development fees, maintenance fees, computer hardware sales, and service bureau
fees. The Company's 10 largest customers accounted for 65.1% and 48.8% of total
revenues in 1996 and 1997, respectively. None of the Company's customers
accounted for 10% or more of total revenues in 1997 or 1996. Two of the
Company's customers accounted for 19.8% and 12.9% of total revenues,
respectively, in 1995.
License and Software Development Fees
CreditRevue accounted for virtually all of the Company's license and
software development fee revenue through December 31, 1997. License and software
development fees increased 40.1% from $7.2 million in 1995 to $10.1 million in
1996, and 14.3% from $10.1 million in 1996 to $11.5 million in 1997. The
increases during these periods resulted from increased market acceptance of
CreditRevue.
Maintenance Fees
Maintenance fees include fees from software maintenance agreements.
Maintenance fees increased 74.7% from $1.2 million in 1995 to $2.0 million in
1996, and 61.9% from $2.0 million in 1996 to $3.3 million in 1997. The growth in
these revenues during the periods presented 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 13.7% from $1.9 million in 1995
to $2.1 million in 1996, and decreased 21.4% from $2.1 million in 1996 to $1.7
million in 1997. 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. The fluctuation in 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 CreditConnection transaction and
interface fees, and from Dun & Bradstreet OneScore transaction fees. The
CreditConnection service was commercially released in 1996 and generated $48,500
in revenues from inception through December 31, 1996. During 1997,
CreditConnection generated approximately $618,000 in revenues from transaction
fees, interface fees, monthly service and telecommunication fees. The Dun &
Bradstreet OneScore service was commercially released in the fourth quarter of
1997 and through December 31, 1997, generated approximately $23,000 in
transaction fee revenues. The CreditRevue service bureau was released
commercially in January 1998 through the strategic alliance with AnyTime Access,
Inc., and therefore did not generate any revenues during 1997.
Cost of License and Software Development Fees
Cost of license and software development fees consist primarily of salaries
and benefits for in-house programmers and the cost of temporary contract labor.
Cost of license and software development fees increased 43.1% from $3.6 million
in 1995 to $5.1 million in 1996, and 43.8% from $5.1 million in 1996 to $7.3
million in 1997. As a percentage of license and software development fees, cost
of license and software development fees were 49.4%, 50.4% and 63.5% in 1995,
1996 and 1997, respectively. The 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 hourly
labor costs associated with temporary contractors during periods in which the
Company experienced increased demand for its products; and (2) 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
18
<PAGE> 20
amount incurred by the Company for its in-house technical personnel. In late
1996 and into 1997, the Company increased internal staffing levels commensurate
with the expected growth in revenues. These increased staffing levels are
expected to reduce the dependency on temporary contractors upon the completion
of their training in the Company's proprietary products and services and
technology, resulting in a corresponding increase in the margins related to
these revenues. 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.
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 61.5%
from $0.3 million in 1994 to $0.5 million in 1996, and 94.5% from $0.5 million
in 1996 to $.9 million in 1997. As a percentage of maintenance fee revenue, cost
of maintenance fees was 23.9%, 22.1% and 26.6% in 1995, 1996 and 1997,
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 1995, 1996
and 1997 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.
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 18.7% from $1.5 million in 1995 to
$1.8 million in 1996, and decreased 15.6% from $1.8 million in 1996 to $1.5
million in 1997. As a percentage of computer hardware sales revenue, cost of
computer hardware sales was 81.0%, 84.6% and 90.8% in 1995, 1996 and 1997,
respectively. The dollar fluctuation in the cost of computer hardware sales
reflects the fluctuation in computer hardware sales during the periods
presented. 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 for all of 1997. 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 for the year ended December
31, 1997 were $2.1 million. Cost of service bureau revenues during 1997 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.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 54.5% from $4.0
million in 1995 to $6.1 million in 1996, and 39.4% from $6.1 million in 1996 to
$8.5 million in 1997. The $2.4 million increase during 1997 relates primarily to
recruiting and professional development, outside consultant services,
depreciation, travel,
19
<PAGE> 21
telephone, office administrative expenses, sales, marketing and advertising
expenses. The Company's total staffing level increased from 140 full time
employees at December 31, 1996 to 212 full time employees at December 31, 1997.
This increase in staffing, while not concentrated in the S,G&A area, resulted in
increased administrative operating expenses. Additionally, selling, general and
administrative expenses includes (i) salaries, commissions and bonuses paid to
sales and marketing personnel, as well as travel and promotional expenses, and
(ii) salaries of administrative, executive and financial personnel, and (iii)
outside professional fees. The increase in such expenses was a result of an
increase in sales and marketing staff from 10 at December 31, 1996 to 17 at
December 31, 1997.
Research and Development Costs
Research and development costs consist primarily of salaries and benefits
of in-house programmers. These costs increased $1.3 million during the year
ended December 31, 1997 as compared to the year ended December 31, 1996 due
primarily to the addition of seven programmers in 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 1997 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.
Amortization of Assigned Value Over Cost of an Acquired Interest
From September 1988 through March 1993, the Company was the sole general
partner of a limited partnership. In March 1993, the Company purchased the other
partner's limited partnership interest for $0.2 million. The acquisition was
accounted for as an acquisition of a minority interest using the purchase method
of accounting. The assigned value of the identifiable net assets acquired over
the cost of the acquired interest was $1.2 million. This amount has been
amortized into income using the straight-line method over four years.
Interest Income (Expense)
Interest expense was $0.1 million in 1995 and 1996. In 1997 interest income
was $1.2 million. The interest expense reported in 1995 and 1996 relates to
borrowings under the Company's line of credit and obligations under the capital
lease. The interest income reported in 1997 and 1996 results from invested
proceeds from the Company's initial public offering.
INCOME TAX EXPENSE
From its inception in 1987 until its reincorporation in Delaware in
November 1996, the Company had been treated for income tax purposes as a
corporation subject to federal and state taxation under Subchapter S of the
Internal Revenue Code of 1986, as amended (the "Code") and comparable state
laws. As a result, for federal and state income tax purposes, the Company's
earnings had been taxed directly to the Company's stockholders. Upon termination
of the Company's Subchapter S status in November 1996, the Company determined
the differences between the financial reporting and income tax bases of its
assets and liabilities, and recorded at that date the resulting deferred tax
liability and income tax expense. Income tax amounts and balances are accounted
for in accordance with Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes. The Company's income tax expense for the year ended
December 31, 1996 approximates the income tax expense that would have been
recognized had the Company terminated its Subchapter S status at January 1,
1996. During the two months ended December 31, 1996, the Company incurred a loss
for federal income tax purposes of approximately $756,000, caused principally by
a tax deduction of $650,000 related to the exercise of certain nonqualified
stock options by officers of the Company. At December 31, 1997, the Company had
a net operating loss carryforward of approximately $4,590,000 which will expire
in 2011 and 2012. See Note 2 to the Consolidated Financial Statements for more
information regarding the Company's income tax status.
20
<PAGE> 22
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its working capital needs and investments in
property and equipment from operating cash flows and approximately $22.1 million
of net proceeds from the Company's initial public offering completed in December
1996. During the years ended December 31, 1995 and 1996 the Company generated
net cash from operating activities of $0.8 million and $1.9 million,
respectively. During 1997, the Company's operations consumed $4.1 million of
cash. This cash flow capital deficiency is primarily caused by operating losses
and an increase in accounts receivable.
The Company's cash used for investing activities consists principally of
investments in property and equipment and capitalized software development
costs. During the years ended December 31, 1995, 1996 and 1997, the Company
invested a total of $0.7 million, $0.5 million and $2.4 million, respectively,
in property and equipment and capitalized software development costs. These
investments were directly attributable to the Company's growth in operations.
The Company did not have any material commitments for the purchase of property
and equipment at December 31, 1997.
The Company has 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 $22.1 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 December
31, 1997. The bank 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. On May 15, 1997
the Company repaid to Mr. James R. DeFrancesco, the Company's President and
Chief Executive Officer, $0.2 million of loans bearing interest at 7% per annum.
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 1998.
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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by the item is incorporated herein by reference to
the consolidated financial statements listed in Item 14 below.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
21
<PAGE> 23
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The Company incorporates herein by reference the information concerning
directors and executive officers in its Notice of Annual Stockholders' Meeting
and Proxy Statement to be filed within 120 days after the end of the Company's
fiscal year (the "1997 Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION.
The Company incorporates herein by reference the information concerning
executive compensation contained in the 1997 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The Company incorporates herein by reference the information concerning
security ownership of certain beneficial owners and management contained in the
1997 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company incorporates herein by reference the information concerning
certain relationships and related transactions contained in the 1997 Proxy
Statement.
22
<PAGE> 24
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
PAGE
NUMBER
------
<S> <C> <C>
(a) Index to Consolidated Financial Statements
Index....................................................... F-1
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets as of December 31, 1997 and
1996...................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996
and 1995.................................................. F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended December 31, 1997, 1996 and 1995...... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996
and 1995.................................................. F-6
Notes to Consolidated Financial Statements.................. F-7
(b) Financial Statement Schedules
All schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange
Commission are not required under the related instruction or
are inapplicable and therefore have been omitted.
(c) Reports on Form 8-K
None
(d) Exhibits
3.1 Certificate of Incorporation of the Company*
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 CreditConnection Lender Agreement (for CreditRevue
Licensees)*
10.6 Form of CreditConnection Lender Agreement (for
non-CreditRevue Licensees)*
10.7 Form of CreditConnection 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*
10.16 1997 Credit Management Solutions, Inc. Stock Incentive
Plan**
23 Consent of Independent Auditors
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
27.3 Restated Financial Data Schedule
27.4 Restated 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.
** Incorporated by reference to the Company's 1997 Proxy Statement, File No.
000-21735.
23
<PAGE> 25
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) 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.
By: /s/ JAMES R. DEFRANCESCO
------------------------------------
JAMES R. DEFRANCESCO
PRESIDENT, CHIEF EXECUTIVE OFFICER
AND
CHAIRMAN OF THE BOARD OF DIRECTORS
(PRINCIPAL EXECUTIVE OFFICER)
MARCH 30, 1998
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<C> <C> <S>
By: /s/ JAMES R. DEFRANCESCO President, Chief Executive March 30, 1998
------------------------------------------------- Officer and Chairman of the
JAMES R. DEFRANCESCO Board of Directors
(Principal Executive Officer)
By: /s/ SCOTT L. FREIMAN Executive Vice President and March 30, 1998
------------------------------------------------- Director
SCOTT L. FREIMAN
By: /s/ MILES H. GRODY Senior Vice President, March 30, 1998
------------------------------------------------- Secretary, General Counsel and
MILES H. GRODY Director
By: /s/ ROBERT P. VOLLONO Senior Vice President, March 30, 1998
------------------------------------------------- Treasurer, Chief Financial
ROBERT P. VOLLONO Officer and Director (Principal
Financial and Accounting
Officer)
By: /s/ STEPHEN X. GRAHAM Director March 30, 1998
-------------------------------------------------
STEPHEN X. GRAHAM
By: /s/ JOHN J. MCDONNELL, JR. Director March 30, 1998
-------------------------------------------------
JOHN J. MCDONNELL, JR.
By: /s/ PETER M. LEGER Director March 30, 1998
-------------------------------------------------
PETER M. LEGER
</TABLE>
24
<PAGE> 26
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statements of Stockholders' Equity............. F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 27
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Credit Management Solutions, Inc.
We have audited the accompanying consolidated balance sheets of Credit
Management Solutions, Inc. and subsidiary as of December 31, 1997 and 1996, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Credit Management Solutions, Inc. and subsidiary at December 31, 1997 and 1996,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
--------------------------------------
Ernst & Young LLP
Baltimore, Maryland
January 23, 1998
F-2
<PAGE> 28
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $20,569,300 $23,501,633
Accounts receivable, net of allowance of $194,856 and
$168,590 in 1997 and 1996, respectively............... 3,550,927 1,948,420
Costs and estimated earnings in excess of billings on
uncompleted contracts................................. 503,875 483,255
Prepaid expenses and other current assets.............. 463,849 657,017
Deferred income taxes.................................. 58,513 58,513
----------- -----------
Total current assets........................................ 25,146,464 26,648,838
Property and equipment:
Computer equipment and software........................ 3,442,792 1,919,160
Office furniture and equipment......................... 941,733 397,185
Leasehold improvements................................. 499,404 131,399
----------- -----------
4,883,929 2,447,744
Accumulated depreciation and amortization................... (1,677,138) (1,033,394)
----------- -----------
3,206,791 1,414,350
Software development costs, net of accumulated amortization
of $178,583 and $58,861 in 1997 and 1996, respectively.... 179,582 299,304
Other assets................................................ 423,886 89,038
----------- -----------
Total assets................................................ $28,956,723 $28,451,530
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................... $ 2,225,745 $ 2,730,015
Accrued payroll and related expenses................... 1,059,177 889,263
Billings in excess of costs and estimated earnings on
uncompleted Contracts................................. 588,522 124,364
Deferred revenue....................................... 1,632,339 1,379,695
Stockholder loans...................................... -- 229,513
Current portion of long-term debt and capital lease
obligations........................................... 138,165 239,651
----------- -----------
Total current liabilities................................... 5,643,948 5,592,501
LONG-TERM DEBT
Capital lease obligations, less current portion............. 101,390 220,341
Other liabilities........................................... -- 50,792
Commitments and contingent liabilities...................... -- --
----------- -----------
Total liabilities........................................... 5,745,338 5,863,634
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;
7,615,510 and 7,210,100 shares issued and outstanding at
December 31, 1997 and 1996, respectively.................. 76,155 72,101
Additional paid-in capital.................................. 26,645,247 22,287,169
Retained earnings (deficit)................................. (3,510,017) 228,626
----------- -----------
Total stockholders' equity.................................. 23,211,385 22,587,896
----------- -----------
Total liabilities and stockholders' equity.................. $28,956,723 $28,451,530
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 29
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
----------- ----------- ----------
<S> <C> <C> <C>
REVENUES
License and software development fees.................. $11,549,378 $10,101,377 $7,207,581
Maintenance fees....................................... 3,311,013 2,045,258 1,170,447
Computer hardware sales................................ 1,656,530 2,106,634 1,853,424
Service bureau revenues................................ 640,818 -- --
----------- ----------- ----------
17,157,739 14,253,269 10,231,452
COSTS OF REVENUES
Cost of license and software development fees.......... 7,329,091 5,095,814 3,559,798
Cost of maintenance fees............................... 880,360 452,559 280,176
Cost of computer hardware sales........................ 1,504,915 1,782,166 1,500,816
Cost of service bureau................................. 2,085,543 -- --
----------- ----------- ----------
11,799,909 7,330,539 5,340,790
----------- ----------- ----------
Gross profit........................................... 5,357,830 6,922,730 4,890,662
OTHER OPERATING EXPENSES
Selling, general and administrative expenses........... 8,537,967 6,126,494 3,966,265
Research and development costs......................... 1,790,709 526,521 165,366
----------- ----------- ----------
10,328,676 6,653,015 4,131,631
Income (loss) from operations.......................... (4,970,846) 269,715 759,031
OTHER INCOME (EXPENSE)
Interest expense....................................... (56,171) (109,207) (106,245)
Interest income........................................ 1,237,582 31,198 396
Amortization of excess of assigned value of
identifiable assets over cost of an acquired
interest............................................. 50,792 304,749 304,750
----------- ----------- ----------
1,232,203 226,740 198,901
----------- ----------- ----------
Income (loss) before income taxes...................... (3,738,643) 496,455 957,932
Income tax expense..................................... -- 201,487 --
----------- ----------- ----------
Net income (loss)...................................... $(3,738,643) $ 294,968 $ 957,932
=========== =========== ==========
Basic earnings (loss) per common share................. $ (0.49) $ 0.06 $ 0.20
=========== =========== ==========
Diluted earnings (loss) per common share............... $ (0.49) $ 0.05 $ 0.20
=========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 30
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
COMMON STOCK
-------------------- ADDITIONAL RETAINED
NUMBER PAID-IN EARNINGS
OF SHARES AMOUNT CAPITAL (DEFICIT) TOTAL
---------- ------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1995........ 4,910,100 $49,101 $ -- $(1,531,511) $(1,482,410)
Net income for 1995.......... -- -- -- 957,932 957,932
Distributions to
stockholders............... -- -- -- (52,500) (52,500)
---------- ------- ----------- ----------- -----------
Balance at December 31, 1995...... 4,910,100 49,101 -- (626,079) (576,978)
Exercise of options to
purchase common stock at $5
per share.................. 100,000 1,000 499,000 -- 500,000
Issuance of common stock, net
of offering costs of
$3,190,094................. 2,200,000 22,000 22,087,906 -- 22,109,906
Income tax benefit from
exercise of options to
purchase common stock...... -- -- 260,000 -- 260,000
Reclassification of
Subchapter S accumulated
deficit to additional
paid-in capital upon
termination of Subchapter S
status..................... -- -- (559,737) 559,737 --
Net income for 1996.......... -- -- -- 294,968 294,968
---------- ------- ----------- ----------- -----------
Balance at December 31, 1996...... 7,210,100 72,101 22,287,169 228,626 22,587,896
Issuance of common stock, net
of offering costs of
$263,537................... 390,000 3,900 4,217,563 -- 4,221,463
Issuance of common stock
under employee stock
purchase plan.............. 14,546 145 136,204 -- 136,349
Exercise of options to
purchase common stock at $5
per share.................. 864 9 4,311 -- 4,320
Net loss for 1997............ -- -- -- (3,738,643) (3,738,643)
---------- ------- ----------- ----------- -----------
Balance at December 31, 1997...... 7,615,510 $76,155 $26,645,247 $(3,510,017) $23,211,385
========== ======= =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 31
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
----------- ----------- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)...................................... $(3,738,643) $ 294,968 $ 957,932
Adjustments:
Depreciation...................................... 649,399 393,929 265,772
Deferred income taxes............................. -- 201,487 --
Amortization of excess of assigned value of
identifiable assets over cost of an acquired
Interest........................................ (50,792) (304,749) (304,750)
Amortization of software development costs........ 119,722 59,861 --
Loss (gain) on disposal of property and
equipment....................................... (6,431) -- 3,972
Changes in operating assets and liabilities
Accounts receivable, net..................... (1,602,507) (131,454) (986,602)
Prepaid expenses and other current assets.... 193,168 (406,041) (243,342)
Accounts payable............................. (504,270) 1,357,399 1,245,568
Accrued payroll and related expenses......... 169,914 274,387 229,810
Net billings in excess of costs and estimated
earnings on uncompleted contracts.......... 443,538 (687,983) (512,445)
Deferred revenue............................. 252,644 790,800 162,221
Accrued interest on stockholder loans........ 6,025 15,015 8,094
----------- ----------- ----------
Net cash provided by (used in) operating activities.... (4,068,233) 1,857,619 826,230
INVESTING ACTIVITIES
Capitalized software development costs................. -- (91,036) (218,576)
Proceeds from sale of property and equipment........... 7,995 -- 86,824
Purchases of property and equipment.................... (2,416,838) (448,721) (492,333)
Increase in other assets............................... (334,848) (55,185) (23,183)
----------- ----------- ----------
Net cash used in investing activities.................. (2,743,691) (594,942) (647,268)
FINANCING ACTIVITIES
Net short-term borrowings (repayments)................. -- (250,000) 120,000
Repayments of stockholder loans........................ (235,538) -- --
Payments under capital lease obligations............... (235,311) (224,725) (184,013)
Repayments of long-term debt........................... (11,692) (16,480) (18,034)
Proceeds from exercise of stock options................ 4,320 500,000 --
Proceeds from issuance of common stock................. 4,357,812 22,109,906 --
Distributions to stockholders.......................... -- -- (52,500)
----------- ----------- ----------
Net cash provided by (used in) financing activities.... 3,879,591 22,118,701 (134,547)
----------- ----------- ----------
Net change in cash and cash equivalents................ (2,932,333) 23,381,378 44,415
Cash and cash equivalents at beginning of year......... 23,501,633 120,255 75,840
----------- ----------- ----------
Cash and cash equivalents at end of year............... $20,569,300 $23,501,633 $ 120,255
=========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 32
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION OF FINANCIAL STATEMENTS
Description of Business
Credit Management Solutions, Inc. (the "Company") develops and provides
software solutions and services for automating the consumer and small business
credit analysis, decisioning and funding process. The Company also operates an
automated service bureau which electronically assembles and transmits between
merchants and credit grantors credit applications of the merchants' customers.
The Company's customers are primarily banks and other financial institutions
located throughout the United States.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiary, CreditConnection, Inc. All material
intercompany accounts and transactions have been eliminated upon consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
SIGNIFICANT ACCOUNTING POLICIES
Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
Property and Equipment
Property and equipment is stated at cost and depreciated using the
straight-line method based on estimated useful lives of between three and seven
years. Amortization of leasehold improvements is provided using the
straight-line method over the lesser of the life of the improvement or the
remaining term of the lease. Assets held under capital leases are stated at the
lesser of the present value of future minimum payments using the Company's
incremental borrowing rate at the inception of the lease or the fair value of
the property at the inception of the lease. The assets recorded under capital
leases are amortized over the lesser of the lease term or the estimated useful
life of the assets in a manner consistent with the Company's depreciation policy
for owned assets.
Software Development Costs
Software development costs consist of direct labor and applicable overhead
related to the development of a software product named "CreditConnection." These
costs were capitalized beginning in September 1994 upon the determination that
the software was technologically feasible. CreditConnection was commercially
released in July 1996 and amortization over the estimated useful life of three
years commenced at that date. Amortization is included in costs of license and
software development fees.
Revenue Recognition
Revenues from long-term software license contracts are recognized on the
percentage-of-completion method, measured generally on a cost incurred basis.
Costs consist primarily of direct labor and applicable
F-7
<PAGE> 33
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
overhead. Contracts in-progress are reviewed periodically as the work
progresses, and revenues and earnings are adjusted in current accounting periods
based on revisions in contract value and estimates to complete.
The Company recognizes revenue for software maintenance fees pro rata over
the term of the agreements, which generally have a one-year term. Revenues from
sales of hardware and software are recognized at time of shipment and when
collection of the receivable is probable. Payments received in advance of
revenue recognition for these services and product sales are included in
deferred revenue.
In December 1997 the Accounting Standards Executive Committee ("AcSEC")
issued Statement of Position (SOP) 97-2, Software Revenue Recognition, which is
effective for transactions entered into in fiscal years beginning after December
15, 1997. The SOP supercedes SOP 91-1, Software Revenue Recognition, and
provides revised and expanded guidance on when revenue should be recognized and
in what amounts for licensing, selling, leasing, or otherwise marketing computer
software. Management has not completed a full analysis of the new standard, but
does not anticipate that upon adoption of the SOP in 1998, there will be a
material effect on future results of operations or financial position.
Advertising Costs
All advertising costs are expensed when incurred. Costs which are included
in selling, general and administrative expense for the years ended December 31,
1997, 1996 and 1995 are $265,404, $156,686, and $101,741, respectively.
Income Taxes
Prior to November 1996, the stockholders elected under Subchapter S of the
Internal Revenue Code to include the Company's income in their personal income
tax returns for Federal and state income tax purposes. Accordingly, the Company
was not subject to Federal and state income taxes prior to November 1996. Upon
termination of the Company's Subchapter S status in November 1996, the Company
determined the differences between the financial reporting and income tax bases
of its assets and liabilities, and recorded at that date the resulting deferred
tax liability and income tax expense. Income tax amounts and balances are
accounted for in accordance with Statement of Financial Accounting Standards No.
109, Accounting for Income Taxes.
Reclassifications
Certain amounts in the 1996 financial statements have been reclassified to
conform with the current year presentation.
Comprehensive Income
In December 1997, the Financial Accounting Standards Boards issued
Statement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income ("Statement No. 130"), that establishes standards for the reporting and
display of comprehensive income and its components in a full set of
general-purpose financial statements. Statement No. 130 only impacts display as
opposed to actual amounts recorded. Other comprehensive income includes all
non-owner changes in equity that are excluded from net income. This Statement
does not apply to an enterprise that has no items of other comprehensive income
in any period presented. During all years presented, the Company had no items of
other comprehensive income.
F-8
<PAGE> 34
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INCOME TAXES
The significant items comprising the Company's net deferred tax assets are
as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1997 1996
---------- --------
<S> <C> <C>
DEFERRED TAX ASSETS:
Net operating loss carryforwards............................ $1,831,400 $299,341
Accrued expenses............................................ 102,038 125,664
Provision for bad debts..................................... 77,942 67,436
Revenue recognition......................................... 33,859 --
---------- --------
Total deferred tax assets................................... 2,045,239 492,441
DEFERRED TAX LIABILITIES:
Software development costs.................................. 71,833 119,722
Revenue recognition......................................... -- 143,556
Depreciation................................................ 292,580 170,650
---------- --------
Total deferred tax liabilities.............................. 364,410 433,928
---------- --------
Net future income tax benefit............................... 1,680,838 58,513
Valuation allowance for deferred tax assets................. (1,622,325) --
---------- --------
Net deferred tax asset...................................... $ 58,513 $ 58,513
========== ========
</TABLE>
Income tax expense consists of the following for the year ended December
31, 1996:
<TABLE>
<S> <C>
CURRENT:
Federal................................................ $ --
State.................................................. --
--------
--
DEFERRED:
Federal................................................ 171,263
State.................................................. 30,224
--------
201,487
--------
$201,487
========
</TABLE>
The Company's income tax expense for the year ended December 31, 1996
approximates the income tax expense that would have been recognized had the
Company terminated its Subchapter S status at January 1, 1996. A reconciliation
of income tax expense computed at the U.S. Federal statutory rate to the
recorded amount of income tax expense is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1997 1996
------------ ---------
<S> <C> <C>
Tax expense at U.S. statutory rate.......................... $(1,271,138) $168,795
Effect of permanent differences............................. 5,876 (7,137)
Expense recorded upon termination of Subchapter S status.... -- 39,829
Change in allocation of net loss in 1996
Between C Corporation and Subchapter S Corporation..... (132,744) --
State income taxes, net of federal benefit.................. (224,319) --
Effect of valuation allowance for Deferred tax assets....... 1,622,325 --
----------- --------
Total....................................................... $ - $201,487
=========== ========
</TABLE>
F-9
<PAGE> 35
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INCOME TAXES -- (CONTINUED)
At December 31, 1997 the Company had a net operating loss carryforward of
approximately $4,580,000 which will expire in 2011 and 2012.
3. EARNINGS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings Per Share. Statement No. 128 replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. Earnings per share amounts for all periods have been
presented, and where appropriate, restated, to conform to the Statement No. 128
requirements.
The following table summarizes the computations of basic and diluted
earnings (loss) per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Numerator for basic and diluted earnings (loss)
per common share:
Net income (loss)............................... $(3,738,643) $ 294,968 $ 957,932
=========== ========== ==========
Denominator:
Denominator for basic earnings (loss) per common
share -- weighted average shares.............. 7,597,368 4,998,319 4,910,100
Effect of dilutive employee stock options....... -- 605,131 --
----------- ---------- ----------
Denominator for diluted earnings (loss) per
common share -- weighted-average shares and
assumed conversions........................... 7,597,368 5,603,450 4,910,100
----------- ---------- ----------
Basic earnings (loss) per common share.......... $ (0.49) $ 0.06 $ 0.20
=========== ========== ==========
Diluted earnings (loss) per common share........ $ (0.49) $ 0.05 $ 0.20
=========== ========== ==========
</TABLE>
Dilutive loss per common share is equal to basic loss per common share in
1997 because if potentially dilutive securities were included in the
computation, the result would be anti-dilutive. These potentially dilutive
securities consist of the stock options described in Note 9.
In 1997 the Company adopted the provisions of Staff Accounting Bulletin No.
98, ("SAB 98"), issued by the SEC staff in February 1998. SAB 98 requires that
registrants in initial public offerings consider all potentially dilutive
securities issued for nominal consideration outstanding for all periods. Under
the previous SEC regulations in SAB 83, the Company considered all potentially
dilutive securities issued within a twelve month period prior to the initial
public offering date at a price below the initial public offering price as
outstanding for all periods. The 1996 and 1995 basic and diluted earnings per
common share amounts have been restated to conform to the provisions of SAB 98.
The effect of this adoption was to increase basic and diluted earnings per
common share in 1995 by $.05 and to increase basic earnings per common share in
1996 by $.01. The adoption of SAB 98 in 1997 had no effect on basic and diluted
loss per common share in 1997.
4. SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Capital lease obligations of $26,565, $77,779, and $538,324 were incurred
when the Company entered into leases for new equipment during the years ended
December 31, 1997, 1996, and 1995 respectively.
F-10
<PAGE> 36
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING
ACTIVITIES -- (CONTINUED)
Interest paid during the years ended December 31, 1997, 1996 and 1995 was
$56,171, $109,207 and $105,576, respectively. The Company paid no amounts
related to income taxes during the three years ended December 31, 1997.
5. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
Uncompleted contracts consist of the following components:
<TABLE>
<CAPTION>
BALANCE SHEET CAPTION
--------------------------------
COSTS AND
ESTIMATED BILLINGS IN
EARNINGS EXCESS OF
IN EXCESS COSTS AND
OF BILLINGS ESTIMATED EARNINGS TOTAL
----------- ------------------ ----------
<S> <C> <C> <C>
December 31, 1996:
Costs and estimated earnings............. $3,972,143 $2,205,872 $6,178,015
Billings................................. 3,488,888 2,330,236 5,819,124
---------- ---------- ----------
$ 483,255 $ (124,364) $ 358,891
========== ========== ==========
December 31, 1997:
Costs 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)
========== ========== ==========
</TABLE>
All receivables on contracts in-progress are expected to be collected
within twelve months.
6. BANK LINE OF CREDIT
The Company has a revolving line of credit with a bank which allows for
aggregate borrowings of $1.5 million through the expiration date of June 1,
1998. Borrowings under the line of credit are secured by the Company's accounts
receivable, property and equipment, and bear interest at the bank's prime rate
(8.50% at December 31, 1997). Under the terms of the loan agreement, the Company
is required to comply with certain covenants including a restriction on assuming
additional indebtedness without the prior written consent of the Bank. The
Company had no borrowings outstanding under this line of credit as of December
31, 1997 and 1996.
7. STOCKHOLDER LOANS
Stockholder loans in 1996 consisted of amounts due to the Company's
principal stockholder and Chairman of the Board of Directors. The loans accrued
interest at 7% per annum and were paid in full on May 15, 1997.
F-11
<PAGE> 37
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. CAPITAL LEASE OBLIGATIONS
The Company leases equipment under capital leases. Property and equipment
includes the following amounts for leases that have been capitalized:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
-------- --------
<S> <C> <C>
Computer equipment.......................................... $419,746 $639,058
Office furniture and equipment.............................. 265,338 265,337
-------- --------
685,084 904,395
Less accumulated amortization............................... 291,511 274,793
-------- --------
$393,573 $629,602
======== ========
</TABLE>
Amortization of leased assets is included in depreciation expense.
Future minimum payments under capital lease obligations consist of the
following at December 31, 1997:
<TABLE>
<S> <C>
1998........................................................ $159,062
1999........................................................ 82,799
2000........................................................ 28,144
--------
Total minimum lease payments................................ $270,005
Less amounts representing interest.......................... 30,450
--------
Present value of minimum capital lease payments (including
current portion of $138,165).............................. $239,555
========
</TABLE>
9. STOCK OPTIONS
The Company records compensation expense for all stock-based compensation
plans using the intrinsic value method prescribed by APB Opinion 25, Accounting
for Stock Issued to Employees ("APB No. 25"). Under APB No. 25, if the exercise
price of the Company's employee stock options equals the estimated fair value of
the underlying stock on the date of grant, no compensation expense is generally
recognized. The Financial Accounting Standards Board Statement No. 123,
Accounting for Stock-Based Compensation ("Statement No. 123") encourages
companies to recognize expense for stock-based awards based on their estimated
value on the date of grant. Statement No. 123 requires the disclosure of pro
forma income and earnings per share data in the notes to the financial
statements if the fair value method is not elected. The Company accounts for its
stock-based compensation plans using the intrinsic value method, and
supplementally discloses in these financial statements the pro forma information
as if the fair value method has been adopted.
In 1996, the Company adopted the 1996 Credit Management Solutions, Inc
Non-Qualified Stock Option Plan (the "1996 Plan"). The 1996 Plan provides for
the granting of non-qualified options to purchase an aggregate of up to
2,750,000 shares of common stock to employees of the Company. In 1997, the
Company adopted the 1997 Stock Incentive Plan (the "1997 Plan"). The 1997 Plan
provides for the granting of either non-qualified or qualified options to
purchase an aggregate of up to 3,400,000 shares of common stock, subject to
adjustment, to employees of the Company and others. All options granted under
the 1996 Plan were transferred to the 1997 Plan and the 1996 Plan was
terminated. The 1997 Plan includes a discretionary option grant program, a
salary investment option grant program, a stock issuance program, an automatic
option grant program and a director fee option grant program.
F-12
<PAGE> 38
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STOCK OPTIONS -- (CONTINUED)
A summary of the Company's stock options activity and related information
is as follows:
<TABLE>
<CAPTION>
1996 1997
---------------------------- ----------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
--------- ---------------- --------- ----------------
<S> <C> <C> <C> <C>
Outstanding -- beginning of year......... -- $ -- 2,462,800 $5.37
Granted.................................. 2,562,800 5.36 266,560 9.93
Exercised................................ (100,000) 5.00 (864) 5.00
Forfeited................................ -- -- (36,652) 7.90
--------- ----- --------- -----
Outstanding -- end of year............... 2,462,800 $5.37 2,691,844 $5.79
========= ===== ========= =====
Exercisable at end of year............... 560,760 $5.15 1,071,572 $5.26
========= ===== ========= =====
Weighted-average fair value of options
granted during the year................ $ 0.82 $ 6.03
========= =========
</TABLE>
Exercise prices for options outstanding as of December 31, 1997 ranged from
$5.00 to $12.38 as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
EXERCISE OPTIONS OPTIONS REMAINING
PRICE OUTSTANDING EXERCISABLE CONTRACTUAL LIFE
- -------- ----------- ----------- ----------------
<S> <C> <C> <C>
$ 5.00 2,248,644 1,010,926 8.5 years
9.50 97,360 -- 9.3 years
9.60 198,640 57,246 8.8 years
9.75 105,200 -- 9.9 years
10.50 17,000 3,400 9.9 years
12.38 25,000 -- 9.5 years
</TABLE>
All options granted under the Plan are subject to vesting provisions at the
discretion of the Board of Directors. Options granted to date vest in varying
percentages through 2002.
For the year ended December 31, 1997, pro forma net loss and loss per share
information required by Statement No. 123 has been determined as if the Company
had accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions: risk-free interest rate of 5.5%; dividend yield of 0%; volatility
factor of the expected market price of the Company's common stock of .67; and a
weighted-average expected life of the options of five years.
For the year ended December 31, 1996, pro forma net loss and loss per share
information required by Statement No. 123 has been determined using the minimum
value method. The minimum value method calculates the fair value of options as
the excess of the estimated fair value of the underlying stock at the date of
grant over the present value of both the exercise price and the expected
dividend payments, each discounted at the risk-free rate, over the expected life
of the option. In determining the estimated fair value of granted stock options
under the minimum value method, the risk-free interest rate was assumed to be
6%, the dividend yield was estimated to be 0%, an the expected life of granted
options was assumed to be 2.5 to 3.5 years.
Because changes in the subjective input assumptions can materially affect
the fair value estimate, in management's opinion, both the minimum value method
and the Black-Scholes method, as well as other methods prescribed by Statement
No. 123, do not necessarily provide a single measure of the fair value of its
employee stock options.
F-13
<PAGE> 39
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STOCK OPTIONS -- (CONTINUED)
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting periods. The Company's
pro forma information follows:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Pro forma net loss......................................... $(4,426,431) $(1,386,032)
=========== ===========
Pro forma earnings per share:
Basic and diluted..................................... $ (0.58) $ (0.28)
=========== ===========
</TABLE>
The effect of compensation expense from stock options on 1996 pro forma net
loss reflects only the vesting of 1996 awards, which vest in varying percentages
through 2001. Similarly, 1997 pro forma net loss per share reflects only the
compensation expense attributable to options vesting in 1997, including 1997
grants which vest through 2002. Because most of the options granted vest over a
five-year period, not until 2001 is the full effect of recognizing compensation
expense for stock options representative of the possible effects on pro forma
net income for future years.
10. PROFIT SHARING PLAN
The Company maintains a 401(k) profit sharing plan which covers all
employees with at least six months of service. In addition to elective salary
deferrals, the Company may make discretionary contributions based on each
eligible participant's compensation. Participant contributions vest immediately
and employer contributions vest over a six year period. In January 1996, the
Company began matching 20% per annum of the first $1,000 contributed to the plan
by each employee. Employer contributions for the years ended December 31, 1997
and 1996 were $23,315 and $14,414, respectively.
11. CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of accounts receivable and costs
and estimated earnings in excess of billings on uncompleted contracts.
To date, these financial instruments have been derived from revenues earned
primarily from banks and other financial institutions located in the United
States. The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. The Company maintains reserves for
potential credit losses; historically, such losses have been insignificant and
within management's expectations. At December 31, 1997, 22% of accounts
receivable was due from two customers. At December 31, 1996, 24% of accounts
receivable was due from one customer.
The following table summarizes the percentage contribution of revenues by
customer when sales to such customers exceeded 10% of net revenues.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Customer A.................................................. -- -- 20%
Customer B.................................................. -- -- 13%
</TABLE>
F-14
<PAGE> 40
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. OPERATING LEASES
The Company leases certain office space and equipment under non-cancelable
operating lease agreements which expire through 2002. Future minimum lease
payments at December 31, 1997 for leases with initial terms of one year or more
consist of the following:
<TABLE>
<S> <C>
1998........................................................ $1,093,579
1999........................................................ 846,747
2000........................................................ 847,426
2001........................................................ 835,419
2002........................................................ 81,565
----------
Total minimum lease payments................................ $3,704,736
==========
</TABLE>
Rent expense under all operating leases for the years ended December 31,
1997, 1996 and 1995 was $891,360, $472,455, and $398,530, respectively.
13. SEGMENT REPORTING
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information ("Statement No. 131"). Statement No. 131
supercedes Financial Accounting Standards Board Statement No. 14, Financial
Reporting for Segments of a Business Enterprise ("Statement No. 14"), and
establishes new standards for the way that public business enterprises report
selected information about operating segments in annual and interim financial
statements. It also established standards for related disclosures about products
and services, geographical areas, and major customers. Statement No. 131 is
effective for financial statements for fiscal years beginning after December 15,
1997.
The Company has not completed its review of Statement No. 131 to determine
the required disclosures, and intends to adopt the new standard in 1998. Under
Statement No. 14, which is effective until the Company adopts Statement No. 131
in 1998, the Company operates predominately in a single segment.
During 1997, the Company generated revenues of $14,860,393 from
CreditRevue, a software product that analyzes credit applications for lending
institutions. Revenues from the Company's CreditConnection service bureau, which
connects automobile dealers with multiple funding sources for expedited credit
approval, generated $617,935 of revenues in 1997.
F-15
<PAGE> 1
EXHIBIT 23
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-37151) pertaining to the 1997 Stock Incentive Plan and the
Registration Statement (Form S-8 No. 333-25969) pertaining to the 1996 Employee
Stock Purchase Plan and the 1996 Non-Qualified Stock Option Plan of Credit
Management Solutions, Inc. of our report dated January 23, 1998, with respect
to the consolidated financial statements of Credit Management Solutions, Inc.
included in the Annual Report (Form 10-K) for the year ended December 31, 1997.
/s/ Ernst & Young LLP
Baltimore, Maryland
March 23, 1998
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