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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A NO. 2
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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, 1998
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)
135 NATIONAL BUSINESS PARKWAY, ANNAPOLIS JUNCTION, MD 20701
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (301) 362-6000
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 26, 1999, Credit Management Solutions, Inc. had 7,649,770 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 26, 1999 (based upon the average bid and asked
prices of such Common Stock on the Nasdaq National Market on March 26, 1999)
held by non-affiliates was approximately $13.1 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 1999 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, 1999.
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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 November
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), automates the entire credit application process from the entry
of the credit application to the credit decision through funding to the transfer
of the funding information to the lenders servicing system. 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.
In February, 1999, the Company introduced its Internet lending
solution -- CreditOnline(R) -- a service that enables consumers and automobile
dealers to originate indirect auto loans over the World Wide Web. Designed as a
complete automobile financing solution, CreditOnline harnesses the power of the
Internet to provide dealers with a real-time, online mechanism, to offer their
customers the ability to submit a credit application electronically through the
lenders or dealers web site and forward that application electronically to
lenders.
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, student loans, telecommunications services 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 Student Lending 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 is a product designed to work in conjunction with
a client's existing credit origination order entry system providing
complete background credit analysis, decisioning and pricing
capabilities based on client defined criteria. This product is
currently in development and is scheduled for delivery in Q2 1999.
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- CreditRevue Service Bureau, is a product designed to allow lenders to
connect multiple terminals or personal computers to a service bureau
system in order 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 intends to 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. To date the Company
has entered into alliances with AnyTime Access, Outsource Financial
and M&I Services, Inc.
- 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 the 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.
- Dun & Bradstreet Portfolio Monitoring Service allows businesses to
proactively manage individual small business credit relationships,
automate various credit analyses and reporting functions, and
effectively seize cross-sales opportunities. The service is based on
Dun & Bradstreet's standard and custom credit scoring services and the
Company's data integration and systems capabilities. The service
offers standard and custom management reports and can forward
processed portfolio accounts to a customer's internal data warehouse.
The standard monitoring service uses OneScore(TM). Customers can also
use custom scorecards to process their internal account performance
data with external commercial and/or consumer data. The advanced
statistical scorecard provides a business with a personalized view of
the changing risk profiles in its small business portfolio. This is a
transaction fee oriented service for which the Company receives fees
based upon the number of small business accounts monitored, the
monitoring frequency and the amount of custom development work
selected.
The Company previously marketed a version of CreditRevue referred to as
CreditRevue 2000(TM). This version was designed to allow the software to be
configured without extensive coding and at one time was targeted as a possible
replacement for the Company's traditional CreditRevue offering. Due to the
extensive flexibility designed into the product, the resulting performance
characteristics could not surpass the traditionally custom designed CreditRevue
systems. CreditRevue 2000 is the ideal platform for supporting the Company's
CreditRevue Service Bureau offering. At this time, CreditRevue 2000 will only be
offered to CreditRevue Service Bureau alliance partners as the CreditRevue
Service Bureau software.
CreditConnection(R)
The CreditConnection service and network offers connectivity between points
of credit origination, such as automobile dealers, and multiple funding sources.
The CreditConnection service 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. If 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 workflow management tools, payment calculator 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 originator.
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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 establishing
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. It is the Company's understanding that 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 through technology which permits
the credit application to be transmitted to multiple lenders. 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 then return a decision electronically to the prime lender, 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.
The version of the CreditConnection software 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. The CreditConnection software for Microsoft Corporation's Windows
operating system became commercially available in 1997.
CreditOnline(R)
In February, 1999, the Company introduced CreditOnline, its Internet
lending solution. It has long been a part of the Company's E-commerce strategy
to leverage its CreditConnection network to allow consumers to apply for loans
with CreditConnection lenders over the Internet. Prior to CreditOnline, the
Company introduced CreditConnection Online.
Through its CreditConnection service the Company has established a standard
portal to the credit origination systems of many leading lending institutions.
This connectivity enables the Company to offer a comprehensive Internet strategy
for online financing designed to service three types of clients -- lenders,
dealers, and consumers.
- In the Lender Centric model consumers would typically apply for credit
using the lender's Web site. In this model the lender directly
controls the loan process. The fees for this service are both
transaction and license fee based.
- In the Dealer & Vehicle Aggregator Centric model consumers would
typically apply for credit via the dealer or aggregators' Web site. In
this model the dealer and/or the aggregator controls the loan process.
The Company is in effect viewed as the gateway and portal between the
deal-
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ers/vehicle aggregators and lenders. In this model, both the dealer
and lender pay transaction and/or subscription fees.
- In the Consumer Centric model the consumer is in control of the
process. Unlike other online financing options, which usually provide
consumers with an offer from only one lender, consumers can receive
multiple offers within minutes using the CMSI technology and network.
Under this model, the lender pays a transaction fee as well as a fee
on a closed loan basis. Dealers enrolled in this model may pay a lead
generation fee to receive qualified consumers and a subscription fee
for CreditConnection.
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 re-engineered to
support multiple lenders using browser development technology resulting in the
new CreditOnline Service.
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, telecommunications, utilities and healthcare
industries. With regards to its CreditConnection service, at December 31, 1998
the Company had contractual relationships with 27 lenders. The Company has
developed electronic connections linking 21 financial institutions to the
CreditConnection service. The Company's alliance with Dun & Bradstreet has
resulted in 292 customers for the OneScore service and 2 customers for the
Portfolio Monitoring service as of December 31, 1998.
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, 1998, the Company's product development staff consisted
of 27 employees. The Company anticipates that it will continue to commit
resources to product development in the future.
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 them
in deriving the most effective use of the Company's products and services,
including technical support, formalized training and a user
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hotline. The Company's services also include implementation planning and
assistance, software installation, software operations training and software
maintenance.
As of December 31, 1998, the Company's dedicated customer service and
support team included 21 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, 1998, the Company's sales and marketing organization
consisted of 21 employees, 17 of whom are based at the Company's corporate
headquarters in Annapolis Junction, 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 users' group meetings 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 conducted by a direct sales
organization and 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 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, 1998, the Company had entered into contracts for its
services for which $2.5 million of revenues will be recognized in future
periods. At December 31, 1997, the comparable amount was $4.3 million.
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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.
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 copyright protection, and patent
protection, trade secrets protection, confidentiality agreements and contractual
provisions to protect its proprietary rights. The Company has no patents on its
CreditRevue products currently in commercial use, and existing trade secrets,
copyright laws and contractual provisions afford only limited protection. In
March of 1999, the U.S. Patent and Trademark Office issued the Company U.S.
Patent 5,878,403 on the technology supporting its CreditConnection service.
There can be no assurance this 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
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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" and "CreditOnline" are
registered trademarks of the Company. "CrossSell," "CreditRevue Service Bureau,"
"CreditRevue Student Lending," "CreditRevue Data Server," "CreditRevue Maestro,"
"CreditConnection Online," "CreditConnection LenderLink", "CreditOnline" and the
Company logo are trademarks or registered tradenames 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, 1998, the Company had 205 full time employees, including
27 in product development, 114 in technical operations, 21 in sales and
marketing and 22 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, CreditRevue Service Bureau,
CreditRevue Maestro and CreditOnline products, 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
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,
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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, 1998. Although
the Company introduced its CreditConnection service in the fourth quarter of
1996, its Dun & Bradstreet OneScore Service in the fourth quarter of 1997, and
its CreditRevue Service Bureau in January 1998, the Company expects that
revenues generated from licenses and installations of CreditRevue will continue
to account for a significant portion of the Company's revenues for the
foreseeable future. The 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 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
8
<PAGE> 10
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,
the Company's CreditOnline service was introduced in February, 1999, and the
Company's CreditRevue Service Bureau service was commercially introduced through
strategic alliance partner, AnyTime Access, in January, 1998. The
CreditConnection service, the CreditOnline 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. The failure of the Company to generate demand for CreditConnection,
CreditOnline 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 and subscription fees charged to credit originators and
financial institutions for transactions originated through the CreditConnection,
CreditOnline 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 D&B for the marketing of OneScore.
There can be no assurance that these relationships will be successful. Moreover,
there can be no assurance that these companies will actively remarket
CreditConnection or OneScore. The failure by the Company to leverage and
maintain its existing relationships with ADP, UCS and D&B, 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."
9
<PAGE> 11
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 55.4% and 48.8% of total revenues in 1998 and 1997, respectively. 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 such 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, including
changes 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. 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."
Dependence on Key Personnel
The Company's future performance depends in significant part upon the
continued service of its key technical, sales and senior management personnel,
particularly James R. DeFrancesco, Chairman and Chief Executive Officer, Peter
M. Leger, President and Chief Operating Officer and Scott L. Freiman, Executive
Vice President. The Company has obtained key-person life insurance on the lives
of each of Messrs. DeFrancesco and Freiman although the Company does not believe
that such insurance is adequate to compensate for the loss of either executive.
The loss of the services of one or more of the Company's executive
10
<PAGE> 12
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. Except
with respect to Mr. Leger, the Company has no employment agreements and does not
intend to enter into any additional 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 process of acquiring and implementing a
back-up, off-site processing system capable of fully supporting its operations
in the event of system failure. During 1997, the Company implemented a limited
redundant data center. The Company relocated operations to new leased facilities
in Annapolis Junction, MD in late 1998. The new facilities, which include a
state of the art data center, will become the primary production center for the
Company's data processing needs. The Company also renewed its lease on its
former data center located in Columbia, Maryland. This former center will,
during 1999, become a back-up center capable of fully supporting operations in
the event of failure of the new production center. Prior to full implementation
of the
11
<PAGE> 13
new facility and the back up facility, 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 or 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 1999. Thereafter, the
Company may need to raise additional funds. The Company may need to raise
additional funds sooner in order to fund more rapid expansion, to develop new or
enhanced products and services, to respond to competitive pressures or to
acquire 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
12
<PAGE> 14
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.
Year 2000 Issue
The Year 2000 issue is a result of computer programs which store or process
date-related information using only two digits to represent the year. These
programs may not be able to properly distinguish between a year in the 1900's
and a year in the 2000's. Failure of these programs to distinguish between the
two centuries could cause the programs to yield erroneous results or even to
fail. See "Management's Discussion and Analysis of Financial Condition -- Year
2000 Compliance."
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.
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<PAGE> 15
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 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 Annapolis
Junction, Maryland in a leased facility consisting of approximately 71,000
square feet of office space under lease that expires in 2008. The Company
additionally has the right to either one five-year or one three-year renewal
option. The Company has a right of first refusal on additional office space in
the same building. The Company previously occupied approximately 55,000 square
feet of office space in Columbia, Maryland under several leases that expire in
2002. As of December 31, 1998, the Company remained liable for approximately
20,000 square feet of the 55,000 square feet previously occupied. The Company is
actively attempting to sublet the remaining former space, but 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. At year end 1998 the Company recorded a liability of
approximately $1.2 million representing the future minimum lease payments under
the leases.
Additionally, the Company entered into a new five year lease for
approximately 4,000 square feet of data center space at its former offices in
Columbia, Maryland. This data center will serve as a back-up facility which,
when fully operational in mid 1999, will be capable of fully supporting
operations in the event of failure of the Company's primary production center in
Annapolis Junction, Maryland.
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 failed. The original software
license price was $1.5 million. The Money Store originally paid $375,000 to the
Company, which was recognized as revenues for the third quarter of 1997.
Effective June 30, 1998, The Money Store was acquired by First Union
Corporation. In July, 1998, First Union Corporation entered into an agreement to
license CreditRevue and enrolled in the CreditConnection Service. At the time
that First Union entered into these agreements, The Money Store paid the Company
$283,750 in full settlement of the complaint filed by the Company against The
Money Store.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
(d) Not applicable.
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Not applicable
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PART II
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.......................................... $13.19 $ 7.50
Second Quarter......................................... $ 8.50 $ 5.25
Third Quarter.......................................... $ 9.50 $ 5.63
Fourth Quarter......................................... $ 7.38 $ 4.06
CALENDAR YEAR 1999:
First Quarter (through March 26, 1999)................. $ 5.50 $ 3.88
</TABLE>
On March 26, 1999, the last reported sales price for the Company's Common
Stock on the Nasdaq National Market was $4.13 per share.
HOLDERS
As of March 26, 1999, the approximate number of registered stockholders of
record of the Common Stock was 227.
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, 1994, 1995, 1996, 1997 and 1998 and the
consolidated balance sheet data at December 31, 1994, 1995, 1996, 1997 and 1998
have been derived from the audited consolidated financial statements of the
Company. The consolidated balance sheets at December 31, 1997 and 1998, and the
consolidated statement of operations for each of the years in the three year
period ended December 31, 1998, 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
15
<PAGE> 17
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 ENDED DECEMBER 31,
-------------------------------------------------------------------
1994 1995 1996 1997 1998
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
REVENUES
License and software
development fees............ $ 2,934,450 $ 7,207,581 $10,101,377 $11,549,378 $10,186,421
Maintenance fees.............. 700,861 1,170,447 2,045,258 3,311,013 4,294,572
Computer hardware sales....... 316,145 1,853,424 2,106,634 1,656,530 776,790
Service bureau revenues....... -- -- -- 640,818 1,644,991
----------- ----------- ----------- ----------- -----------
3,951,456 10,231,452 14,253,269 17,157,739 16,902,774
COSTS OF REVENUES
Cost of license and software
development fees............ 1,482,036 3,559,798 5,095,814 7,329,091 6,988,649
Cost of maintenance fees...... 151,346 280,176 452,559 880,360 1,108,367
Cost of computer hardware
sales....................... 315,262 1,500,816 1,782,166 1,504,915 952,662
Cost of service bureau........ -- -- -- 2,085,543 3,398,453
Selling, general and
administrative expenses..... 2,244,031 3,966,265 6,126,494 8,537,967 12,823,909
Research and development
costs....................... 167,152 165,366 526,521 1,790,709 1,964,057
----------- ----------- ----------- ----------- -----------
4,359,827 9,472,421 13,983,554 22,128,585 27,236,097
----------- ----------- ----------- ----------- -----------
Income (loss) from
operations.................. (408,371) 759,031 269,715 (4,970,846) (10,333,323)
OTHER INCOME (EXPENSE)
Interest income (expense)
net......................... (41,310) (105,849) (78,009) 1,181,411 763,292
Amortization of excess of
assigned value of
Identifiable assets over
cost of an acquired
interest.................... 304,750 304,750 304,749 50,792 --
----------- ----------- ----------- ----------- -----------
263,440 198,901 226,740 1,232,203 (9,570,031)
----------- ----------- ----------- ----------- -----------
Income (loss) before income
taxes.................... (144,931) 957,932 496,455 (3,738,643) (9,750,031)
Income tax expense............ -- -- 201,487 -- --
----------- ----------- ----------- ----------- -----------
Net income (loss)............. $ (144,931) $ 957,932 $ 294,968 $(3,738,643) $(9,750,031)
=========== =========== =========== =========== ===========
Basic earnings (loss) per
common share................ $ (0.03) $ 0.20 $ 0.06 $ (0.49) $ (1.25)
Diluted earnings (loss) per
common share................ $ (0.03) $ 0.20 $ 0.05 $ (0.49) $ (1.25)
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1994 1995 1996 1997 1998
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents..... $ 75,840 $ 120,255 $23,501,633 $20,569,300 $ 3,090,565
Investments available for
sale........................ -- -- -- -- 6,482,021
Working capital (deficit)..... (1,073,896) (1,362,539) 21,056,337 19,502,516 5,146,706
Total assets.................. 1,581,751 4,035,323 28,451,530 28,956,723 25,109,676
Long term debt, less current
portion..................... 416,136 408,806 220,341 101,390 761,092
Stockholders' equity
(deficit)................... (1,482,410) (576,978) 22,587,896 23,211,385 13,849,643
</TABLE>
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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 Chairman and
Chief Executive Officer, and Scott L. Freiman, the Company's Executive Vice
President, while they were employed by American Financial Corporation ("AFC"),
an automobile finance servicing company owned by Mr. DeFrancesco. AFC was
acquired in October 1987 by Perpetual Savings Bank, FSB. Mr. DeFrancesco and Mr.
Freiman retained ownership of AFC's credit processing software which formed the
basis for CreditRevue. CreditRevue was initially released in 1988. Since its
initial release, the Company has continually enhanced CreditRevue in response to
the needs of its customers. CreditConnection, the Company's online credit
information and processing service, became commercially available in July 1996.
The Dun & Bradstreet OneScore product was commercially released in October 1997,
CreditRevue Service Bureau was introduced in January 1998, Dun & Bradstreet
Portfolio Monitoring was introduced in June 1998 and the CreditOnline Service,
the Company's Internet lending solution was announced in February, 1999. In
March 1999, the Company introduced CreditRevue Maestro, an automated analysis
engine for evaluating and decisioning consumer and small business credit
applications. 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, 1998. 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 from software maintenance
contracts 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, 1998, revenues from third-party hardware and software sales accounted for
4.6% and 4.1% 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.
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<PAGE> 19
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, Dun & Bradstreet's OneScore, Dun &
Bradstreet Portfolio Monitoring, CreditOnline, CreditRevue Maestro, the
occurrence of any significant technological problems, such as a system failure
incurred prior to the implementation of a 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.
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,
------------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Percentages of Total Revenues
Revenues
License and software development fees.................. 70.9% 67.3% 60.3%
Maintenance fees....................................... 14.3 19.3 25.4
Computer hardware sales................................ 14.8 9.7 4.6
Service bureau fees.................................... -- 3.7 9.7
----- ----- -----
100.0 100.0 100.0
----- ----- -----
Costs and Expenses
Cost of license and software development fees.......... 35.8 42.7 41.3
Cost of maintenance fees............................... 3.2 5.1 6.6
Cost of computer hardware sales........................ 12.5 8.8 5.6
Cost of service bureau fees............................ -- 12.2 20.1
Selling, general and administrative expenses........... 43.0 49.8 75.9
Research and development costs......................... 3.7 10.4 11.6
----- ----- -----
98.2 129.0 161.1
----- ----- -----
Income (loss) from operations............................... 1.8 (29.0) (61.1)
Other income (expense)
Interest income (expense), net.............................. (0.5) 6.9 4.5
Amortization of excess of assigned value of
identifiable assets over the cost of an acquired
interest............................................. 2.1 .3 --
----- ----- -----
1.6 7.2 4.5
----- ----- -----
Income (loss) before income taxes........................... 3.4 (21.8) (56.6)
Income tax expense..................................... 1.4
----- ----- -----
Net income (loss)...................................... 2.0% (21.8)% (56.6)%
===== ===== =====
</TABLE>
Total Revenues
Total revenues increased 20.4% from $14.3 million in 1996 to $17.2 million
in 1997 and decreased 1.5% from $17.2 million in 1997 to $16.9 million in 1998.
The Company's revenues are derived from four sources:
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<PAGE> 20
license and software development fees, maintenance fees, computer hardware
sales, and service bureau fees. The Company's 10 largest customers accounted for
48.8% and 55.4% of total revenues in 1997 and 1998, respectively. During 1998,
the Company experienced longer than expected sales cycles for its CreditRevue
product resulting in lower CreditRevue related revenues and correspondingly
lower total revenues. Also, for the first time, the Company experienced contract
disputes including its dispute with The Money Store, which had an adverse impact
on CreditRevue revenues and contributed to the decline in total revenues.
License and Software Development Fees
CreditRevue accounted for virtually all of the Company's license and
software development fee revenue through December 31, 1998. License and software
development fees increased 14.3% from $10.1 million in 1996 to $11.5 million in
1997, and decreased 11.8% from $11.5 million in 1997 to $10.2 million in 1998.
The increase in 1997 was the result of increased market acceptance of
CreditRevue. The decrease in 1998 was the result of longer than expected sales
cycles for the CreditRevue product and certain contract disputes. By late 1998,
sales performance improved as a result of signing 9 new contracts for
CreditRevue with an aggregate contract value of approximately $7 million.
Maintenance Fees
Maintenance fees include fees from software maintenance agreements.
Maintenance fees increased 61.9% from $2.0 million in 1996 to $3.3 million in
1997, and 29.7% from $3.3 million in 1997 to $4.3 million in 1998. 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. Enhancements to previously installed
CreditRevue systems are also subject to maintenance and contribute to growth in
maintenance revenues.
Computer Hardware Sales
Computer hardware sales revenue decreased 21.5% from $2.1 million in 1996
to $1.7 million in 1997, and 53.1% from $1.7 million in 1997 to $0.8 million in
1998. Computer hardware sales revenue consists of revenues received from resales
of third-party hardware in connection with the license and installation of the
Company's software. 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, from Dun & Bradstreet OneScore and Portfolio Monitoring
transaction fees and CreditRevue Service Bureau fees. CreditConnection related
revenues increased 99.0% from $0.6 million in 1997 to $1.3 million in 1998. The
CreditConnection Service was commercially released in 1996 and generated $49
thousand from inception through December 31, 1996. CreditConnection revenues
increased to $618 thousand in 1997 from $49 thousand in 1996 and increased 206%
to $1.3 million in 1998 from $0.6 million in 1997. Revenue increases are the
result of increases in the number of dealers and lenders enrolled in the
CreditConnection Service. At December 1998 there were approximately 150 dealers
enrolled in the service compared to approximately 40 dealers at December 1997.
As of December 1998 there were approximately 21 lenders connected to the
CreditConnection network compared to approximately 14 at December 1997. Dun &
Bradstreet related revenues increased to $203 thousand in 1998 up from $23
thousand in 1997. The Dun & Bradstreet OneScore service was commercially
released in the fourth quarter of 1997 and the Portfolio Monitoring Service was
released in June of 1998. The CreditRevue Service Bureau was released in January
1998, through a strategic alliance with Anytime Access, but did not go into full
production until January 1999. Accordingly, only nominal revenues were recorded
in 1998 from CreditRevue Service Bureau related services.
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<PAGE> 21
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 43.8% from $5.1 million
in 1996 to $7.3 million in 1997, and decreased 4.6% from $7.3 million in 1997 to
$7.0 million in 1998. As a percentage of license and software development fees,
cost of license and software development fees were 50.4%, 63.5% and 68.6% in
1996, 1997 and 1998, respectively. The cost of license and software fees as a
percentage of license and software development fees over these periods is
related to 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. With respect to temporary
contractors, the Company's costs on a full-time equivalent basis for these
contractors is generally twice the amount incurred by the Company for its
in-house technical personnel. 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, services and technology, resulting in a corresponding
increase in the margins related to these revenues. However, while license
related revenues increased in 1997, the costs of increased staffing and
temporary contractors exceeded revenue growth. In 1998 efforts at staff
reduction were curtailed by certain contract disputes and prolonged sales
cycles. The sales cycle for license software is often difficult to predict
accurately. The skills and knowledge required to perform the licensed software
implementation requires the Company to maintain certain levels of specialized
staffing occasionally creating production capacity in excess of sales demand
which can result in higher costs and lower margins.
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 94.5%
from $0.5 million in 1996 to $0.9 million in 1997, and 25.9% from $0.9 million
in 1997 to $1.1 million in 1998. As a percentage of maintenance fee revenue,
cost of maintenance fees was 22.1%, 26.6% and 25.8% in 1996, 1997 and 1998,
respectively. The dollar increase in the cost of maintenance fees reflects the
growth in license fees for CreditRevue during the periods presented and the
resultant increase in the number of installations. The fluctuation in the
percentage of cost of maintenance fees to maintenance fee revenues in 1996, 1997
and 1998 results from incremental increases in staffing for maintenance
personnel as maintenance revenues have increased. Staffing utilization
efficiencies will vary based on the timing and training of additions to
maintenance staff personnel.
Cost of Computer Hardware Sales
Cost of computer hardware sales consists of (i) the Company's cost of
computer hardware resold to the Company's customers that are licensing
CreditRevue and (ii) salaries and benefits for systems integration employees.
Cost of computer hardware sales decreased 15.6% from $1.8 million in 1996 to
$1.5 million in 1997, and decreased 36.7% from $1.5 million in 1997 to $1.0
million in 1998. As a percentage of computer hardware sales revenue, cost of
computer hardware sales was 84.6%, 90.8% and 122.6% in 1996, 1997 and 1998,
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. In certain instances, hardware revenues may
not be large enough to offset both the direct cost and the hardware being sold
as well as certain fixed costs associated with the salaries and benefits for
systems integration employees thereby resulting in negative margins.
Cost of Service Bureau Revenues
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. Services
bureau costs were not separately identified in 1996. Service Bureau costs
increased 63.0% from $2.1 million in 1997 to $3.4 million in 1998. Of the three
primary sources of service bureau revenues, CreditConnection, Dun &
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<PAGE> 22
Bradstreet related services and CreditRevue Service Bureau, only
CreditConnection was operational for all of 1997. The increases in service
bureau costs are related to increased staffing required for operations and
support for both CreditConnection and the Dun & Bradstreet related services
increased communication expenses associated with the expanding CreditConnection
network.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 39.4% from $6.1
million in 1996 to $8.5 million in 1997, and 50.2% from $8.5 million in 1997 to
$12.8 million in 1998. The $2.4 million increase during 1997 relates primarily
to recruiting and professional development, outside consultant services,
depreciation, travel, telephone, office administrative expenses, sales,
marketing and advertising expenses. The $4.3 million increase during 1998
relates to one time expenses and reserves associated with the Company's
relocation to Annapolis Junction and increases in payroll costs, communications
expenses, depreciation and other general sales and administrative expenses. Of
the total 1998 increase, approximately $2.8 million relate to facilities and
equipment expenses. As a result of the relocation of the Company's operations, a
liability of approximately $1.2 million was recorded to recognize future minimum
lease payments due under leases for the Company's former offices. Other one time
charges associated with the move include the write-off of certain leasehold
improvements of approximately $0.3 million and certain lease termination fees
and moving expenses of approximately $0.2 million. Additionally, increases in
communication and depreciation expenses represent approximately $1.0 million of
the 1998 increase. Payroll related expenses increased approximately $0.8 million
and the balance of the increase was in the area of general selling and
administrative expenses including: advertising, travel, legal and accounting
fees. Increases in payroll relate primarily to increases in sales and marketing
staffing.
Research and Development Costs
Research and development costs consist primarily of salaries and benefits
of in-house programmers. These costs increased $0.2 million during the year
ended December 31, 1998 as compared to the year ended December 31, 1997, due
primarily to the addition of four programmers in 1998. The increased staffing
was required to address a number of strategic development efforts underway
during 1998, including on going efforts for CreditConnection, CreditRevue 2000,
Dun & Bradstreet Portfolio Monitoring, CreditRevue service bureau and
CreditRevue Maestro projects. During 1997, all development activities were
expensed. During 1998, approximately $0.3 million of costs associated with the
development of CreditRevue Maestro were capitalized. The capitalized expenses
include the direct payroll costs of certain programmers and certain third party
development expenses. See Note 1 to the 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 1996 and 1997. In 1998 interest income
was $0.8 million. The interest expense reported in 1996 and 1997 relates to
borrowings under the Company's line of credit and obligations under the capital
lease. The interest income reported in 1998 and 1997 results from invested
proceeds from the Company's initial public offering.
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<PAGE> 23
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, 1998, the Company had
net operating loss carryforwards of approximately $14.4 million which will
expire in 2011, 2012 and 2013. See Note 2 to the Consolidated Financial
Statements for more information regarding the Company's income tax status.
SEGMENT REPORTING
From inception through 1996, the Company operated predominantly in a single
segment. With the introduction of new products and services commencing in 1997
the Company has adopted, effective in 1998, a matrix oriented "line of business"
organizational structure. Under this structure, products and services have been
organized into three distinct business lines, Credit Decisioning Systems (CDS),
E-Commerce and Service Bureau Alliances (SBA). The CDS business line which
includes the CreditRevue software product and related services represents the
Company's historical single segment and through 1996 was responsible for
virtually all of the Company's revenues and profits or losses. The E-Commerce
business line includes the CreditConnection, LenderLink, and CreditOnline
services. The SBA business line includes the OneScore product, the Portfolio
Monitoring service and the CreditRevue Service Bureau offerings.
The Company evaluates performance and allocated resources based on
operating income before depreciation and amortization, corporate general and
administrative expenses, and income taxes. Assets are not apportioned by segment
and are not reviewed by the Chief Operating Decision Maker in reviewing segment
performance. The accounting policies used by the reportable segments are the
same as those used by the Company and described in Note 1 to the financial
statements. There are no intercompany sales or transfers. The segments are
managed separately by Business Line Managers who are most familiar with segment
operations.
The Company has since 1996, introduced new products and services which have
led to the formation of the three segments the Company currently operates. The
CDS segment is the most established and mature of the three segments and
continues to be the segment with the highest profitability. The E-Commerce
segment, introduced in 1997, continues to require considerable investment in
sales, marketing, development and infrastructure. As the E-Commerce products and
services gain greater market acceptance, revenues are expected to grow and
segment profitability is expected to improve. During 1998, E-Commerce revenues
increased 99% to $1.3 million from $0.6 million in 1997. Revenue growth during
1998 contributed directly to the lower losses reported in 1998. The SBA segment,
introduced in 1998, also requires continued investment in sales, marketing,
development and infrastructure before becoming profitable. Until revenues for
E-Commerce and SBA segments exceed costs of operations for each respective
segment, it is expected that CDS will continue to contribute the majority of
segment profits.
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
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offering completed in December 1996. During the year ended December 31, 1996,
the Company generated net cash from operating activities of $1.9 million. During
1997 and 1998, the Company's operations consumed cash of $4.1 million and $7.3
million, respectively. This cash flow 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, 1996, 1997 and 1998, the Company
invested a total of $0.5 million, $2.4 million and $4.3 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, 1998.
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, 1998. 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 Chairman 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 1999.
YEAR 2000 COMPLIANCE
State of Readiness
The Company recognizes the significance of the year 2000 issue and has
implemented a formal year 2000 program to minimize the impact of the year 2000
on the Company and its customers ("year 2000 Program"). The year 2000 Program
addresses both information technology ("IT") and non-IT systems, for systems
used by the Company as well as those provided by the Company to its customers.
Non-IT systems are primarily used by the Company in the operation of its
facilities. The year 2000 Program is implemented by a year 2000 Team which
includes members from all levels of management and all functional areas of the
Company, as follows:
- Executive Sponsor -- The Executive Sponsor works with the Senior
Technology Executive on budgeting and resources management and other
major year 2000 issues, and reports on Year 2000 Program status to the
Executive Management of the Company as well as the Board of Directors.
- Senior Technology Executive -- The Senior Technology Executive manages
the Project Managers-Company Wide. Issues relating to budgeting and
resources are escalated to the Senior Technology Executive. The Senior
Technology Executive also has the authority to prioritize Year 2000 tasks
over other project tasks.
- Project Managers-Company Wide -- The Project Managers-Company Wide share
responsibility for determining the Year 2000 tasks that need to be
completed, and monitoring the completion of the tasks on schedule. The
Project Managers-Company Wide are responsible for collecting,
coordinating and disseminating information within the Company about the
Year 2000 Program and its status.
- System Project Managers -- A project manager is assigned to each of the
primary areas of the Company. Each System Project Manager is responsible
for ensuring that the Year 2000 tasks relating to his/her area are
completed on schedule.
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- Product Project Managers -- A project manager is assigned to each
specific product. Each Product Project Manager is responsible for
ensuring that the Year 2000 tasks relating to that specific product are
completed on schedule.
- System Analysts -- System Analysts review individual products to identify
Year 2000 issues.
- Developers -- Developers perform coding modifications to address year
2000 issues.
- Testers -- Testing is performed under the guidance of the Quality
Services department to ensure that any Year 2000 issues have been
properly addressed.
Individual members of the Year 2000 Team communicate frequently with
respect to Year 2000 issues. The Year 2000 Team meets as a group and reports
status bi-weekly. Subgroups of the Year 2000 Team meet as needed to address
specific issues.
The Company is using employees of the Company to identify and address Year
2000 issues. The Year 2000 Program involves six basic stages: (1) inventory of
all potentially affected software products and software-related services, (2)
analysis of such products and services to identify any areas that require change
or replacement, (3) change or replacement of the identified areas, (4) testing,
(5) implementation of the changes or replacements, and (6) contingency plans.
Because the Company is not only a user of software products and software-related
services, but also provides software products and software-related services to
its customers, the Company's Year 2000 Program addresses both software products
and software-related services used by the Company and those provided by the
Company to its customers.
The Company has established written Year 2000 coding standards which have
been distributed to the Company's system analysts, developers and testers. The
Company has also conducted training for its system analysts, developers and
testers to ensure that they are familiar with the Company's Year 2000 coding
standards.
For purposes of the Year 2000 Program, the Company has classified into the
following three major categories the software products and software-related
services provided by the Company to its customers: credit decisioning systems
(existing systems and new systems), e-commerce systems, and service bureau
systems.
Credit Decisioning Systems (Existing). For existing credit decisioning
systems (i.e., systems which customers were using in production at the time the
Year 2000 Program was applied to the system), the Company performs the following
activities:
1. The customer's credit decisioning system is analyzed to identify any
Year 2000 issues and to determine whether any modifications to the code
are required. The analysis is conducted in accordance with detailed
procedures which were developed internally by the Company for Year 2000
analysis of its credit decisioning systems.
2. The Year 2000 modifications are made.
3. The modifications are tested. The customer also has an opportunity to
test the modifications.
4. Following the testing, the modifications are installed in the customer's
system.
5. Any enhancements to the customers' credit decisioning system since the
completion of the procedures described in items 1-4 above were developed
and implemented by the Company under its Year 2000 Coding Standards. As
an extra safeguard, however, the Company conducts a follow-up Year 2000
analysis of these enhancements.
Credit Decisioning Systems (New). For new credit decisioning systems
(i.e., system which were not used by customers until after the Year 2000 Program
was applied to the system), the Company performs the following activities:
1. Each new credit decisioning system starts with a "base" system. The base
system is analyzed for Year 2000 issues.
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<PAGE> 26
2. Enhancements are made to the base system based on the functional
specifications agreed to between the Company and the customer, and the
enhanced system is delivered to the customer for user acceptance
testing.
3. Before or concurrent with the user acceptance testing, the Company
reviews the code enhancements for compliance with the Company's Year
2000 coding standards.
4. The Company implements required modifications on the test system at the
Company's site, and tests the modifications.
5. Upon completion of testing of the changes by the Company, the software
changes are reported to the customer and installed in the customer's
system for further testing by the customer.
6. With respect to any enhancements to the credit decisioning system after
acceptance by the customer of the system, the Company performs the
enhancements in a test environment. The enhancements are then analyzed
and tested for Year 2000 issues following the above approach.
E-Commerce Systems. For e-commerce systems, the Company performs the
following activities:
1. The Company analyzes the software programs supporting the e-commerce
system to identify any Year 2000 issues and determines whether any
modifications are required. The Company also coordinates with the vendor
of any hardware and other equipment supporting the e-commerce system to
request Year 2000 information regarding the applicable product and to
determine whether any patches, upgrades or replacements are necessary.
The Company also tests the third party product where necessary,
appropriate and feasible.
2. Any necessary modifications are made to the software programs supporting
the e-commerce system. In addition, any necessary patches or upgrades
to, or replacements of, third party products are installed.
3. The Company analyzes and tests the modifications, patches, upgrades and
replacements. The Company makes the Year 2000 version of the software
programs supporting the e-commerce system available to its customers in
a Year 2000 environment for testing of the modifications. The customer
schedules the testing with the Company.
4. The modifications, patches, upgrades and replacements are placed into
production.
5. With respect to any subsequent enhancements to the e-commerce system,
the enhancements are performed in a test environment. The enhancements
are then analyzed and tested for Year 2000 issues following the above
approach prior to being placed into production.
Service Bureau Systems. For service bureau systems, the Company performs
the following activities:
1. The "base" service bureau system is analyzed for compliance with the
Company's Year 2000 coding standards.
2. The Year 2000 modifications are made.
3. The modifications are tested.
4. For any subsequent releases, the Company analyzes the changes for
compliance with the Company's Year 2000 coding standards. The Company
makes any required modifications to the code.
5. The Company tests the modifications.
6. Following the testing, the release is ready to be delivered to the
customer.
As of December 31, 1998, approximately 80% of the analysis, remediation and
testing had been completed, collectively, for the Company's customers' credit
decisioning systems. The implementation phase for the credit decisioning
customers is largely dependent on the customers' schedules, and for those
customers which have not implemented the necessary changes to their credit
decisioning systems, the Company is working with those customers to implement
the changes as soon as possible. As of December 31, 1998,
25
<PAGE> 27
approximately 30% of the analysis, remediation, testing and implementation had
been completed for the software and systems comprising the Company's e-commerce
systems, which is scheduled to be completed during the second quarter of 1999.
As of December 31, 1998, approximately 65% of the analysis, remediation, testing
and implementation had been completed for the Company's service bureau systems,
which is also scheduled to be completed during the second quarter of 1999. The
Company has also implemented analysis and testing procedures to ensure that any
enhancements to a system following the completion of the analysis, remediation,
testing and implementation of that system do not contain any year 2000 issues.
In most cases, the software products and software-related services provided
by the Company interface to third party systems. In cases where a third party
has provided Year 2000 interface specifications, the Company is developing,
testing and implementing new interface code to comply with those specifications.
All new interface code is scheduled to be completed and implemented during the
second quarter of 1999.
Infrastructure. For products and systems used by the Company internally,
the Company performs one or more of the following activities:
1. The Company contacts the provider of the product or system in writing to
request information regarding the Year 2000 readiness of its product or
system, and evaluates the response for reasonableness and acceptability,
based on CMSI's knowledge of the product or system.
2. The Company obtains Year 2000 compliance information from the third
party's web site and evaluates the response for reasonableness and
acceptability based on the Company's knowledge of the product or system.
3. The Company tests the product or system where appropriate and possible.
4. For any third party products or systems that require modifications, the
Company works with the vendor to ensure that the modifications are
completed in an acceptable time frame.
As the Company does not have any control over the third party providers of
products and systems, the Company cannot guarantee that such third party
products and systems will not suffer any adverse effects due to the Year 2000.
The Year 2000 activities described above relating to credit decisioning
systems, e-commerce systems, service bureau systems and third party products and
systems represent the standard procedures applied to the applicable system. In
certain circumstances, the Company may make changes to or deviate from these
procedures.
Costs
As of December 31, 1998, all expenses have been associated with the
opportunity cost of time spent by employees of the Company on the Year 2000
Program, particularly on the analysis, development, testing and implementation
relating to software products and software-related services provided to
customers. The Company estimates that the opportunity cost incurred as of
December 31, 1998 is approximately $1 million. This cost can be allocated as
follows: $465,000 to credit decisioning systems, $160,000 to e-commerce systems,
$75,000 to service bureau systems, and $300,000 to Year 2000 Program management,
project oversight, and client and vendor communications. To complete the Year
2000 Program, in addition to the opportunity costs of employees' time, the
Company may also need to purchase replacement products. The Company's projected
costs of the entire Year 2000 Program is $2.3 million.
Risks
If a product or service provided by the Company is found to cause damage or
injury to a customer of the Company due to a failure of such product or service
to operate without any adverse effect due to date related processing associated
with the year 2000, the Company could be liable to such customer for a breach of
warranty, depending on the specific contractual arrangement between the Company
and such customer. Although the Company's contractual arrangement with each of
its customers generally limits the Company's liability to such customer, the
Company cannot accurately predict whether or to what extent any legal claims
26
<PAGE> 28
will be brought against the Company, or whether the Company will otherwise be
adversely affected by such claims.
In addition, a failure by the Company to make its products year 2000
compliant could result in a decrease in sales of the Company's products, delays
in the development of other of the Company's products, an increase in the costs
associated with year 2000 remediation, and an increase in litigation costs. The
year 2000 issue may also have an indirect effect on the Company's business and
operations to the extent that potential customers of the Company may be using
significant resources to address year 2000 issues, and therefore may have fewer
resources to evaluate and purchase other products and services such as the
products and services offered by the Company. If a material third party product
or system which the Company uses or interfaces to fails to operate properly due
to the year 2000, such failure could have a material adverse effect on the
Company's business and results of operations.
Contingency Plans
The Company will have a dedicated year 2000 support staff which will be
prepared to address year 2000 issues. The Company is currently in the process of
investigating and developing additional contingency plans which will be
implemented if necessary. The Company expects to complete development of the
contingency plans by the end of the third quarter of 1999.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk related to changes in interest rates.
The Company invests its excess cash balances in cash equivalents and municipal,
commercial and government agency obligations which are interest rate sensitive.
However, the maturities of these obligations is less than one year, mitigating
their sensitivity to interest rates. The Company believes that the effect, if
any, of reasonably possible near-term changes in interest rates on the Company's
financial position, results of operations and cash flows is not material.
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.
27
<PAGE> 29
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 "1998 Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION.
The Company incorporates herein by reference the information concerning
executive compensation contained in the 1998 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
1998 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 1998 Proxy
Statement.
28
<PAGE> 30
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, 1998 and
1997...................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996.......................... F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended December 31, 1998, 1997 and 1996...... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.......................... 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
</TABLE>
<TABLE>
<C> <S> <C>
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***
</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.
*** Incorporated by reference to the Company's 1998 Form 10-K, file no.
000-21735.
29
<PAGE> 31
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
CHAIRMAN, CHIEF EXECUTIVE OFFICER
AND
CHAIRMAN OF THE BOARD OF DIRECTORS
(PRINCIPAL EXECUTIVE OFFICER)
MAY 26, 1999
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
<S> <C> <C>
By: /s/ JAMES R. DEFRANCESCO Chief Executive Officer May 26, 1999
------------------------------------------------- and Chairman of the Board of
JAMES R. DEFRANCESCO Directors (Principal Executive
Officer)
By: /s/ PETER M. LEGER President, Chief Operating May 26, 1999
------------------------------------------------- Officer
PETER M. LEGER and Director
By: /s/ SCOTT L. FREIMAN Executive Vice President May 26, 1999
------------------------------------------------- and Director
SCOTT L. FREIMAN
By: /s/ MILES H. GRODY Senior Vice President and May 26, 1999
------------------------------------------------- Director
MILES H. GRODY
By: /s/ ROBERT P. VOLLONO Senior Vice President, May 26, 1999
------------------------------------------------- Treasurer,
ROBERT P. VOLLONO Chief Financial Officer and
Director (Principal Financial
and
Accounting Officer)
By: /s/ STEPHEN X. GRAHAM Director May 26, 1999
-------------------------------------------------
STEPHEN X. GRAHAM
By: /s/ JOHN J. MCDONNELL, JR. Director May 26, 1999
-------------------------------------------------
JOHN J. MCDONNELL, JR.
</TABLE>
30
<PAGE> 32
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> 33
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, 1998 and 1997, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Credit
Management Solutions, Inc. and subsidiary at December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
Baltimore, Maryland
February 22, 1999
F-2
<PAGE> 34
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................... $ 3,090,565 $20,569,300
Investments available-for-sale.......................... 6,482,021 --
Accounts receivable, net of allowance of $352,664 and
$194,856 in 1998 and 1997, respectively............... 5,487,202 3,550,927
Costs and estimated earnings in excess of billings on
uncompleted contracts................................. 246,831 503,875
Prepaid expenses and other current assets............... 280,515 463,849
Deferred income taxes................................... 58,513 58,513
----------- -----------
Total current assets........................................ 15,645,647 25,146,464
Property and equipment:
Computer equipment and software......................... 7,306,811 3,442,792
Office furniture and equipment.......................... 1,657,294 941,733
Leasehold improvements.................................. 2,661,291 499,404
----------- -----------
11,625,396 4,883,929
Accumulated depreciation and amortization................... (2,549,451) (1,677,138)
----------- -----------
9,075,945 3,206,791
Software development costs, net of accumulated amortization
of $298,304 and $178,583 in 1998 and 1997, respectively... 338,724 179,582
Other assets................................................ 49,360 423,886
----------- -----------
Total assets................................................ $25,109,676 $28,956,723
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses................... $ 5,798,379 $ 2,225,745
Accrued payroll and related expenses.................... 668,630 1,059,177
Billings in excess of costs and estimated earnings on
uncompleted contracts................................. 1,044,015 588,522
Deferred revenue........................................ 2,921,923 1,632,339
Current portion of capital lease obligations............ 65,994 138,165
----------- -----------
Total current liabilities................................... 10,498,941 5,643,948
LONG-TERM DEBT
Capital lease obligations, less current portion............. 28,966 101,390
Other lease obligations, less current portion............... 732,126 --
----------- -----------
Total liabilities........................................... 11,260,033 5,745,338
Commitments and contingencies............................... -- --
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;
7,649,770 and 7,615,510 shares issued and outstanding at
December 31, 1998 and 1997, respectively.................. 76,497 76,155
Additional paid-in capital.................................. 26,853,194 26,645,247
Accumulated deficit......................................... (13,080,048) (3,510,017)
----------- -----------
Total stockholders' equity.................................. 13,849,643 23,211,385
----------- -----------
Total liabilities and stockholders' equity.................. $25,109,676 $28,956,723
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 35
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------
1998 1997 1996
------------ ----------- -----------
<S> <C> <C> <C>
REVENUES
License and software development fees................ $ 10,186,421 $11,549,378 $10,101,377
Maintenance fees..................................... 4,294,572 3,311,013 2,045,258
Computer hardware sales.............................. 776,790 1,656,530 2,106,634
Service bureau revenues.............................. 1,644,991 640,818 --
------------ ----------- -----------
16,902,774 17,157,739 14,253,269
COSTS OF REVENUES
Cost of license and software development fees........ 6,988,649 7,329,091 5,095,814
Cost of maintenance fees............................. 1,108,367 880,360 452,559
Cost of computer hardware sales...................... 952,662 1,504,915 1,782,166
Cost of service bureau............................... 3,398,453 2,085,543 --
------------ ----------- -----------
12,448,131 11,799,909 7,330,539
------------ ----------- -----------
Gross profit......................................... 4,454,643 5,357,830 6,922,730
OTHER OPERATING EXPENSES
Selling, general and administrative expenses......... 12,823,909 8,537,967 6,126,494
Research and development costs....................... 1,964,057 1,790,709 526,521
------------ ----------- -----------
14,787,966 10,328,676 6,653,015
------------ ----------- -----------
Income (loss) from operations........................ (10,333,323) (4,970,846) 269,715
OTHER INCOME (EXPENSE)
Interest expense..................................... (24,965) (56,171) (109,207)
Interest income...................................... 788,257 1,237,582 31,198
Amortization of excess of assigned value of
identifiable assets over cost of an acquired
interest........................................... -- 50,792 304,749
------------ ----------- -----------
763,292 1,232,203 226,740
------------ ----------- -----------
Income (loss) before income taxes.................... (9,570,031) (3,738,643) 496,455
Income tax expense................................... -- -- 201,487
------------ ----------- -----------
Net income (loss).................................... $ (9,570,031) $(3,738,643) $ 294,968
============ =========== ===========
Basic earnings (loss) per common share............... $ (1.25) $ (0.49) $ 0.06
============ =========== ===========
Diluted earnings (loss) per common share............. $ (1.25) $ (0.49) $ 0.05
============ =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 36
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<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, 1996........ 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 program........... 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
Issuance of common stock
under employee stock
purchase program........... 19,572 196 134,653 -- 134,849
Exercise of options to
purchase common stock at $5
per share.................. 14,688 146 73,294 -- 73,440
Net loss for 1998............ -- -- -- (9,570,031) (9,570,031)
--------- ------- ----------- ------------ -----------
Balance at December 31, 1998...... 7,649,770 $76,497 $26,853,194 $(13,080,048) $13,849,643
========= ======= =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 37
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------
1998 1997 1996
------------ ----------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss).................................... $ (9,570,031) $(3,738,643) $ 294,968
Adjustments:
Depreciation.................................... 1,199,194 649,399 393,929
Deferred income taxes........................... -- -- 201,487
Amortization of excess of assigned value of
identifiable assets over cost of an acquired
interest...................................... -- (50,792) (304,749)
Amortization of software development costs...... 119,721 119,722 59,861
Loss (gain) on disposal of property and
equipment..................................... 302,878 (6,431) --
Changes in operating assets and liabilities:
Accounts receivable, net................... (1,936,275) (1,602,507) (131,454)
Prepaid expenses and other current
assets................................... 183,334 193,168 (406,041)
Accounts payable and accrued expenses...... 102,200 (504,270) 1,357,399
Accrued payroll and related expenses....... (390,547) 169,914 274,387
Net billings in excess of costs and
estimated earnings on uncompleted
contracts................................ 712,537 443,538 (687,983)
Deferred revenue........................... 1,289,584 252,644 790,800
Accrued interest on stockholder loans...... -- 6,025 15,015
Other lease obligations.................... 732,126 -- --
------------ ----------- -----------
Net cash provided by (used in) operating
activities......................................... (7,255,279) (4,068,233) 1,857,619
INVESTING ACTIVITIES:
Capitalized software development costs............... (278,863) -- (91,036)
Proceeds from sale of property and equipment......... 162,672 7,995 --
Purchases of property and equipment.................. (4,063,464) (2,416,838) (448,721)
Decrease (increase) in other assets.................. 374,526 (334,848) (55,185)
Purchase of investments available-for-sale........... (6,482,021) -- --
------------ ----------- -----------
Net cash used in investing activities................ (10,287,150) (2,743,691) (594,942)
FINANCING ACTIVITIES:
Repayments of short term borrowings.................. -- -- (250,000)
Repayments of stockholder loans...................... -- (235,538) --
Payments under capital lease obligations............. (144,595) (235,311) (224,725)
Repayments of long-term debt......................... -- (11,692) (16,480)
Proceeds from exercise of stock options.............. 73,440 4,320 500,000
Proceeds from issuance of common stock............... 134,849 4,357,812 22,109,906
------------ ----------- -----------
Net cash provided by financing activities............ 63,694 3,879,591 22,118,701
------------ ----------- -----------
Net change in cash and cash equivalents.............. (17,478,735) (2,932,333) 23,381,378
Cash and cash equivalents at beginning of period..... 20,569,300 23,501,633 120,255
------------ ----------- -----------
Cash and cash equivalents at end of period........... $ 3,090,565 $20,569,300 $23,501,633
============ =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 38
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 processes. 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; Credit Connection, Inc. The
subsidiary operates an automated service bureau which electronically assembles
and transmits between merchants and credit grantors credit applications of the
merchants' customers. 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. The cost of these
investments is equivalent to fair value.
Investments
Available-for-sale securities are carried at fair value, as measured on
quoted exchanges, with unrealized security holding gains and losses recognized
in comprehensive income. Realized gains and losses and declines in value judged
to be other than temporary on available-for-sale securities are included in
interest income. Unrealized security holding gains are recognized in
comprehensive income.
At December 31, 1998, available-for-sale securities consisted of municipal,
corporate, and government agency obligations, the cost of which approximates
fair value. The Company has not had significant realized or unrealized gains or
losses on its investments during the periods presented. These investments are
classified as current, as all maturities are less than one year.
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.
Included in computer equipment and software are direct costs of computer
software developed for internal use. Costs incurred are capitalized and
amortized over periods not exceeding three 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.
F-7
<PAGE> 39
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Software Development Costs
Costs related to conceptual formulation and design of Company products are
expensed as incurred. Costs incurred subsequent to establishment of
technological feasibility, but prior to the product being available for general
release to customers, are capitalized and amortized over estimated productive
lives, generally three years. The Company evaluates its investment in product
development as events or changes in circumstances may arise, for the purpose of
determining whether the carrying amount of such assets may exceed the net
realizable value of the products. In the event that capitalized costs of a
product exceed the estimated net realizable value of the product, such excess
amount is expensed.
Revenue Recognition
In October 1997, the Accounting Standards Executive Committee ("AcSEC")
issued Statement of Position (SOP) 97-2, Software Revenue Recognition. SOP 97-2
provides revised and expanded guidance on when revenue should be recognized and
in what amounts for licensing, selling, leasing, or otherwise marketing computer
software. The adoption of SOP 97-2 in 1998 had no material impact on the
Company's results of operations in 1998.
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 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 from software maintenance contracts pro rata
over the term of the agreements, generally one-year. 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.
Advertising Costs
All advertising costs are expensed when incurred. Costs which are included
in selling, general and administrative expense for the year ended December 31,
1998, 1997 and 1996 are $384,863, $265,404 and $156,686, 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 using the liability method.
F-8
<PAGE> 40
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,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Net operating loss carryforwards........................... $ 5,764,162 $ 1,831,400
Accrued expenses........................................... 128,892 102,038
Provision for bad debts.................................... 141,058 77,942
Revenue recognition........................................ 318,874 33,859
----------- -----------
6,352,986 2,045,239
Software development costs................................. 135,490 71,833
Depreciation............................................... 732,880 292,568
----------- -----------
Total deferred tax liabilities............................. 868,370 364,401
Net future income tax benefit.............................. 5,484,616 1,680,838
----------- -----------
Valuation allowance for deferred tax assets................ (5,426,103) (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.................................................. --
--------
Total Current..................................... --
DEFERRED:
Federal................................................ 171,263
State.................................................. 30,224
--------
Total Deferred.................................... 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 on 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>
DECEMBER 31,
------------------------------------
1998 1997 1996
----------- ----------- --------
<S> <C> <C> <C>
Tax expense at U.S. statutory rate............... $(3,253,811) $(1,271,138) $168,795
Effect of permanent differences.................. 24,235 5,876 (7,137)
Change in allocation of net loss in 1996 between
C Corporation and Subchapter S Corporation..... -- (132,744) --
Expense recorded upon termination of Subchapter S
status......................................... -- 39,829
State income taxes............................... (574,202) (224,319) --
Effect of change in valuation allowance for
deferred tax assets............................ 3,803,778 1,622,325 --
----------- ----------- --------
Total............................................ $ -- $ -- $201,487
=========== =========== ========
</TABLE>
F-9
<PAGE> 41
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INCOME TAXES -- (CONTINUED)
At December 31, 1998 the Company had net operating loss carryforwards of
$14,410,404 which will begin to expire in 2011.
3. EARNINGS (LOSS) PER SHARE
The following table summarizes the computations of basic and diluted
earnings (loss) per common share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Numerator for basic and diluted earnings (loss)
per common share:
Net income (loss).............................. $(9,570,031) $(3,738,643) $ 294,968
=========== =========== ==========
Denominator:
Denominator for basic earnings (loss) per
common share -- Weighted-average shares...... 7,636,217 7,597,368 4,998,319
Effect of dilutive employee stock options...... -- -- 605,131
----------- ----------- ----------
Denominator for diluted earnings (loss) per
common share................................. 7,636,217 7,597,368 5,603,450
----------- ----------- ----------
Basic earnings (loss) per common share......... $ (1.25) $ (0.49) $ 0.06
=========== =========== ==========
Diluted earnings (loss) per common share....... $ (1.25) $ (0.49) $ 0.05
=========== =========== ==========
</TABLE>
Dilutive loss per share is equal to basic loss per share in 1998 and 1997
because if potentially dilutive securities were included in the computation, the
result would be anti-dilutive. These potentially dilutive securities consist of
stock options as 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 prices as
outstanding for all periods. The 1996 basic and diluted earnings per common
share amounts have been restated to conform to the provisions of SAB 98. The
effect of the adoption was 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 1998 and 1997.
4. SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Capital lease obligations of $26,565, and $77,779 were incurred when the
Company entered into leases for new equipment during the years ended December
31, 1997 and 1996, respectively. In 1998, the Company acquired equipment with a
fair market value of $3,470,434 that was included in accounts payable at
December 31, 1998.
Interest paid during the year ended December 31, 1998, 1997 and 1996 was
$24,965, $56,171 and $109,207, respectively. The Company paid no amounts related
to income taxes during the three years ended December 31, 1998.
F-10
<PAGE> 42
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
Uncompleted contracts consist of the following components:
<TABLE>
<CAPTION>
BALANCE SHEET CAPTION
------------------------------------------
COSTS AND BILLINGS IN EXCESS OF
ESTIMATED EARNINGS COSTS AND
IN EXCESS OF ESTIMATED
BILLINGS EARNINGS TOTAL
------------------ --------------------- ----------
<S> <C> <C> <C>
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)
========== =========== ==========
December 31, 1998:
Costs and estimated earnings....... $1,573,861 $ 3,236,349 $4,810,210
Billings........................... 1,327,030 4,280,364 5,607,394
---------- ----------- ----------
$ 246,831 $(1,044,015) $ (797,184)
========== =========== ==========
</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,
1999. Borrowings under the line of credit are secured by the Company's accounts
receivable and property and equipment, and bear interest at the bank's prime
rate (8.50% at December 31, 1998). 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, 1998 and 1997.
7. 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,
-------------------
1998 1997
-------- --------
<S> <C> <C>
Computer equipment.......................................... $220,119 $419,746
Office furniture and equipment.............................. 183,350 265,338
-------- --------
403,469 685,084
Less: accumulated amortization.............................. 235,635 291,511
-------- --------
$167,834 $393,573
======== ========
</TABLE>
Amortization of leased assets is included in depreciation expense.
F-11
<PAGE> 43
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. CAPITAL LEASE OBLIGATIONS -- (CONTINUED)
Future minimum payments under capital lease obligations consist of the
following at December 31, 1998:
<TABLE>
<S> <C>
1999........................................................ $ 79,973
2000........................................................ 24,412
--------
Total minimum lease payments................................ 104,385
Less: amounts representing interest......................... 9,425
--------
Present value of minimum capital lease payments (including
current portion of $65,994)............................... $ 94,960
========
</TABLE>
8. OTHER LEASE OBLIGATIONS
During 1998, the Company relocated its corporate headquarters, and remains
obligated under operating leases for unutilized space at the former
headquarters. Accordingly, in 1998 the Company estimated the present value of
its future minimum obligations and recorded $1,062,425 of expense. At December
31, 1998, approximately $330,299 is classified in accounts payable and accrued
expenses and $732,126 is classified as other lease obligations. Repayment of
these obligations is over the remaining contractual life of the leases and are
as follows:
<TABLE>
<S> <C>
1999........................................................ $ 386,536
2000........................................................ 394,068
2001........................................................ 396,718
----------
Total minimum lease payments................................ 1,177,322
Less: amounts representing interest......................... 114,897
----------
Present value of minimum lease payments (including current
portion of $330,299)...................................... $1,062,425
==========
</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. 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 has 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> 44
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>
1998 1997 1996
--------------------- --------------------- ---------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding --
beginning of year..... 2,691,844 $5.79 2,462,800 $5.37 -- $ --
Granted................. 1,201,880 7.33 266,560 9.93 2,562,800 5.36
Exercised............... (14,688) 7.70 (864) 5.00 (100,000) 5.00
Forfeited............... (209,388) 5.00 (36,652) 7.90 -- --
--------- ----- --------- ----- --------- -----
Options
outstanding -- end of
year.................. 3,669,648 $6.33 2,691,844 $5.79 2,462,800 $5.37
========= ===== ========= ===== ========= =====
Exercisable at end of
year.................. 1,583,228 $5.32 1,071,572 $5.26 560,760 $5.15
========= ===== ========= ===== ========= =====
Weighted-average fair
value of options
granted during the
year at market
value................. $4.33 $6.03 $0.82
===== ===== =====
Weighted average fair
value of options
granted during the
year at greater than
market value.......... $2.41 N/A N/A
===== ===== =====
</TABLE>
Exercise prices for options outstanding as of December 31, 1998 ranged from
$4.06 to $13.13 as follows:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
OPTIONS OPTIONS REMAINING LIFE IN WEIGHTED-AVERAGE
EXERCISE PRICE OUTSTANDING EXERCISABLE YEARS EXERCISE PRICE
-------------- ----------- ----------- ----------------- ----------------
<S> <C> <C> <C> <C>
$ 4.06 to $5.38 2,324,068 1,445,778 7.64 $5.00
$ 6.00 to $8.00 750,100 0 8.15 6.95
$ 8.25 to $9.60 255,380 95,030 8.24 9.34
$ 9.75 to $10.50 300,100 22,420 5.63 9.95
$12.38 to $13.13 40,000 20,000 8.75 12.66
--------- ---------
$ 4.06 to $13.13 3,669,648 1,583,228 7.63 6.19
========= =========
</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 2003.
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. The fair value of options granted in 1998
and 1997 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% in 1998 and 1997; dividend yield of 0% in 1998 and 1997; volatility
factor of the expected market price of the Company's common stock of .81 and .67
in 1998 and 1997, respectively; and a weighted-average expected life of the
options of five years in 1998 and 1997.
For the year ended December 31, 1996, pro forma net loss and loss per share
information required by Statement No. 123 was determined using the minimum value
method, due to the lack of sufficient information
F-13
<PAGE> 45
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STOCK OPTIONS -- (CONTINUED)
to calculate the fair value of granted options using Black-Scholes. 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 granted options was assumed to be five
years.
Because changes in the subjective input assumptions can materially affect
the fair value estimate, in management's opinion, the minimum value method and
other methods prescribed by Statement No. 123 do not necessarily provide a
single measure of the fair value of its employee stock options.
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>
1998 1997 1996
------------ ----------- -----------
<S> <C> <C> <C>
Pro forma net loss........................... $(11,068,442) $(4,426,431) $(1,386,032)
============ =========== ===========
Pro forma earnings per share:
Basic and diluted....................... $ (1.45) $ (0.58) $ (0.28)
============ =========== ===========
</TABLE>
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, the Company may make
a discretionary contribution 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. Contributions for the
years ended December 31, 1998 and 1997 were $33,189 and $23,315, 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, 1998, 23% of accounts
receivable was due from one customer. At December 31, 1997, 22% of accounts
receivable was due from two customers. For the year ended December 31, 1998, one
customer accounted for 10% of total revenues.
12. OPERATING LEASES
The Company leases certain office space and equipment under non-cancelable
operating lease agreements which expire through 2003. Future minimum lease
payments at December 31, 1998 for leases with
F-14
<PAGE> 46
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. OPERATING LEASES -- (CONTINUED)
initial terms of one year or more consist of the following, excluding the former
headquarters lease described in Note 8:
<TABLE>
<S> <C>
1999........................................................ $ 1,588,075
2000........................................................ 1,565,257
2001........................................................ 1,593,216
2002........................................................ 1,564,146
2003........................................................ 1,532,434
Thereafter.................................................. 7,335,083
-----------
Total minimum lease payments................................ $15,178,211
===========
</TABLE>
Rent expense under all operating leases for the year ended December 31,
1998, 1997 and 1996 was $2,359,666, $891,360 and $472,455, 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
supersedes 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 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 adopted Statement No. 131 in 1998, and accordingly the
disclosures for all periods have been presented to conform to Statement No. 131
requirements.
From inception through 1996, the Company operated predominantly in a single
segment. With the introduction of new products and services commencing in 1997
the Company has adopted, effective in 1998, a matrix oriented 'line of business'
organizational structure. Under this structure, products and services have been
organized into three distinct business lines, Credit Decisioning Systems (CDS),
E-Commerce and Service Bureau Alliances (SBA). The CDS business line, which
includes the CreditRevue software product and related services, represents the
Company's historical single segment and through 1996 was responsible for
virtually all of the Company's revenues and profits or losses. The E-Commerce
business line includes the CreditConnection, LenderLink, and CreditOnline
services. The SBA business line includes the OneScore product, the Portfolio
Monitoring service and the CreditRevue Service Bureau offerings.
The Company evaluates performance and allocated resources based on income
from operations before depreciation and amortization, corporate general and
administrative expenses. Assets are not apportioned by segment and are not
reviewed by the Chief Operating Decision Maker in reviewing segment performance.
The accounting policies used by the reportable segments are the same as those
used by the Company and described in Note 1 to the consolidated financial
statements. There are no intercompany sales or transfers. The segments
F-15
<PAGE> 47
CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. SEGMENT REPORTING -- (CONTINUED)
are managed separately by Business Line Managers who are most familiar with
segment operations. The following table sets forth information on the Company's
reportable segments:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-----------------------------------------------------
CDS E-COMMERCE SBA TOTAL
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues.......................... $15,257,783 $ 1,275,020 $ 369,971 $16,902,774
----------- ----------- ----------- -----------
Segment profit (loss)............. 4,792,685 (3,718,657) (1,170,070) (96,042)
----------- ----------- ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
---------------------------------------
CDS E-COMMERCE TOTAL
----------- ----------- -----------
<S> <C> <C> <C>
Revenues...................................... $16,516,921 $ 640,818 $17,157,739
----------- ----------- -----------
Segment profit (loss)......................... 5,526,528 (4,105,753) 1,420,775
----------- ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
-------------------------
CDS TOTAL
----------- -----------
<S> <C> <C>
Revenues................................................... $14,253,269 $14,253,269
----------- -----------
Segment profit (loss)...................................... 4,094,355 4,094,355
----------- -----------
</TABLE>
A reconciliation of segment profit for all segments to income before income
taxes is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING PROFIT:
Total segment profit (loss)................... $ (96,042) $ 1,420,775 $ 4,094,355
----------- ----------- -----------
Corporate, general and administrative
expenses.................................... (8,919,266) (5,673,292) (3,675,599)
----------- ----------- -----------
Depreciation and amortization................. (1,318,915) (718,329) (149,041)
----------- ----------- -----------
Net interest income........................... 763,292 1,232,203 226,740
----------- ----------- -----------
Income (loss) before income taxes............. (9,570,931) (3,738,643) 496,455
----------- ----------- -----------
</TABLE>
Substantially all of the revenue and assets of the Company's reportable
segments are attributed to or located in the United States.
F-16
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-37151) pertaining to the Credit Management Solutions, Inc.
1998 Stock Incentive Plan, of our report dated February 22, 1999 with respect
to the consolidated financial statements of Credit Management Solutions, Inc.
included in the Annual Report (Form 10-K/A) for the year ended December 31,
1998.
/s/ Ernst & Young LLP
Baltimore, Maryland
May 21, 1999
