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UNITED STATES
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-21980
CFI PROSERVICES, INC.
(Exact name of registrant as specified in its charter)
Oregon 93-0704365
(State or other jurisdiction of (I.R.S. Employer
incorporation Identification No.)
or organization)
400 SW Sixth Avenue, Portland, Oregon 97204
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 503-274-7280
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common stock without par value 5,032,594
(Class) (Outstanding at November 10,
1998)
The index to exhibits appears on page 19 of this document.
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<PAGE>
CFI PROSERVICES, INC.
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 1998 and December 2
31, 1997
Consolidated Statements of Income - Three Months Ended
September 30, 1998 and 1997 and Nine Months Ended September 3
30, 1998 and 1997
Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 1998 and 1997 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 8
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
1
<PAGE>
<TABLE>
CFI PROSERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<CAPTION>
September 30, December 31,
1998 1997
------------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 2,475 $ 20
Receivables, net of allowances of $2,458 and $2,880 27,280 32,059
Inventory 272 297
Deferred tax asset 1,307 1,307
Prepaid expenses and other current assets 1,682 1,928
---------- ----------
Total Current Assets 33,016 35,611
Property and Equipment, net of accumulated
depreciation of $9,337 and $7,855 4,663 5,211
Software Development Costs, net of accumulated
amortization of $2,586 and $735 9,059 9,856
Other Intangibles, net of accumulated amortization
of $4,501 and $3,227 4,896 5,689
Other Assets 1,097 1,175
========== ==========
Total Assets $ 52,731 $ 57,542
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,704 $ 2,119
Accrued expenses 4,250 5,362
Deferred revenues 6,938 12,498
Customer deposits 1,784 1,715
Current portion of bank line of credit - 5,310
Current portion of long-term debt 257 295
Income taxes payable 814 1,125
---------- ----------
Total Current Liabilities 15,747 28,424
Deferred Tax Liability 197 197
Long-Term Debt, less current portion 5,761 2,232
---------- ----------
Total Liabilities 21,705 30,853
Mandatory Redeemable Class A Preferred Stock 740 746
Shareholders' Equity:
Series preferred stock, 5,000,000 shares authorized,
none issued and outstanding - -
Common stock, no par value, 10,000,000
shares authorized and 5,032,594 and 4,925,423
shares issued and outstanding 19,688 18,865
Retained earnings 10,598 7,078
---------- ----------
Total Shareholders' Equity 30,286 25,943
---------- ----------
Total Liabilities and Shareholders' Equi$y 52,731 $ 57,542
========== ==========
The accompanying notes are an integral part of these consolidated balance
sheets.
</TABLE>
2
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<TABLE>
CFI PROSERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
--------- --------- ------- -------
<S> <C> <C> <C> <C>
Revenue
Software license fees $ 14,528 $ 9,770 $ 34,979 $ 28,055
Service and support 7,434 6,772 21,941 20,152
Other 1,224 1,352 4,319 3,568
-------- --------- ------- -------
Total Revenue 23,186 17,894 61,239 51,775
Cost of Revenue 7,773 6,986 21,688 18,626
-------- --------- ------- -------
Gross Profit 15,413 10,908 39,551 33,149
Operating Expenses
Sales and marketing 5,203 3,993 14,054 11,243
Product development 4,129 3,151 10,467 9,092
General and administrative 2,794 2,306 7,430 6,095
Amortization of intangibles 297 315 890 944
-------- --------- ------- -------
Total Operating Expenses 12,423 9,765 32,841 27,374
-------- --------- ------- -------
Income from Operations 2,990 1,143 6,710 5,775
Non-operating Income (Expense)
Interest expense (118) (122) (337) (329)
Interest income 80 33 209 135
Cancelled stock offering costs - - - (487)
Gain on sale of operating division - 628 - 628
Other, net (64) (10) (168) (51)
-------- --------- ------- -------
Total Non-operating Income
(Expense), net (102) 529 (296) (104)
-------- --------- ------- -------
Income Before Provision for
Income Taxes 2,888 1,672 6,414 5,671
Provision for Income Taxes 1,271 735 2,822 2,495
-------- --------- ------- -------
Net Income 1,617 937 3,592 3,176
Preferred Stock Dividend 24 24 72 72
-------- --------- ------- -------
Net Income Applicable to
Common Shareholders $ 1,593 $ 913 $ 3,520 $ 3,104
======== ========= ======= =======
Basic Net Income Per Share $ 0.32 $ 0.19 $ 0.70 $ 0.63
======== ========= ======= =======
Diluted Net Income Per Share $ 0.31 $ 0.18 $ 0.68 $ 0.61
======== ========= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
3
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<TABLE>
CFI PROSERVICES, INC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<CAPTION>
Nine months ended September 30,
--------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income applicable to common shareholders $ 3,520 $ 3,104
Adjustments to reconcile net income applicable to common
shareholders to cash provided by operating activities:
Depreciation and amortization 4,889 5,295
Gain on sale of operating division - (628)
Deferred income taxes - (50)
Interest accreted on note payable 70 70
Accretion on mandatory redeemable preferred stock 72 72
Equity in losses attributable to joint venture 248 -
(Increase) decrease in assets
Receivables, net 4,779 1,892
Inventory, net 25 (15)
Prepaid expenses and other assets 351 5
Increase (decrease) in liabilities
Drafts payable - (425)
Accounts payable (415) (1,096)
Accrued expenses (1,593) (2,359)
Deferred revenues (5,560) (3,560)
Customer deposits 69 589
Income taxes payable (255) 1,080
------------ ------------
Net cash provided by operating activities 6,200 3,974
Cash flows from investing activities:
Expenditures for property and equipment (1,216) (2,257)
Software development costs capitalized (1,054) (3,785)
Proceeds from long-term note receivable 235 -
Proceeds from sale of operating division - 87
Investment in joint venture (510) -
------------ ------------
Net cash used in investing activity (2,545) (5,955)
Cash flows from financing activities:
Net proceeds from (payments on) line of credit (1,310) 3,091
Payments on other long-term debt (579) (1,583)
Payments on mandatory redeemable preferred stock (78) (78)
Proceeds from issuance of common stock 767 650
------------ ------------
Net cash provided by (used in) financing activity (1,200) 2,080
------------ ------------
Increase in cash and cash equivalents 2,455 99
Cash and cash equivalents:
Beginning of period 20 -
------------ ------------
End of period $ 2,475 $ 99
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
4
<PAGE>
CFI PROSERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in thousands, except per share amounts
or as otherwise indicated)
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
The financial information included herein for the three and nine month periods
ended September 30, 1998 and 1997 is unaudited; however, such information
reflects all adjustments consisting only of normal recurring adjustments which
are, in the opinion of management, necessary for a fair presentation of the
financial position, results of operations and cash flows for the interim
periods. The financial information as of December 31, 1997 is derived from the
audited financial statements contained in the Annual Report on Form 10-K as
filed by CFI ProServices, Inc. (the "Company"). The interim consolidated
financial statements should be read in conjunction with the consolidated
financial statements and the notes thereto included in the Company's 1997 Annual
Report on Form 10-K. The results of operations for the interim periods presented
are not necessarily indicative of the results to be expected for the full year.
NOTE 2. LINE OF CREDIT
Effective March 1, 1998, the Company negotiated to increase the amount of credit
available under its line of credit from (a) the lesser of 50% of accounts
receivable or $9.0 million to (b) the lesser of 50% of accounts receivable or
$10 million, and to change the expiration date to May 1, 2000. Total borrowings
under the line of credit at September 30, 1998 were $4.0 million. The $4.0
million balance has been classified as long-term debt as the Company does not
intend to repay this portion within the next 12 months.
NOTE 3. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosure of cash flow information is as follows:
Nine Months Ended September 30,
-------------------------------
1998 1997
------------ ------------
Cash paid during the period for income
taxes $ 3,076 $ 1,464
Cash paid during the period for interest
and dividends 346 359
Noncash investing and financing activities were as follows:
Nine Months Ended September 30,
-------------------------------
1998 1997
------------ ------------
Tax benefit from exercise of nonqualified
stock options and disqualifying
dispositions $ 56 $ 424
Increase in goodwill for accrued acquisition
related contingent royalties 481 347
Reclassification of bank line of credit
to long-term debt 4,000 --
Note receivable received in connection with
the sale of remittance processing division -- 788
5
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NOTE 4. EARNINGS PER SHARE
Basic earnings per share (EPS) and diluted EPS are computed using the methods
prescribed by Statement of Financial Accounting Standards No. 128, "Earnings Per
Share" ("SFAS 128"). Basic EPS is calculated using the weighted average number
of common shares outstanding for the period and diluted EPS is computed using
the weighted average number of common shares and dilutive common equivalent
shares outstanding. Prior period amounts have been restated to conform with the
presentation requirements of SFAS No. 128. Following is a reconciliation of
basic EPS and diluted EPS:
Three Months Ended
September 30, 1998 1997
--------------------------- -------------------- --------------------
(in thousands, except per
share data) Per Per
Share Share
Income Shares Amount Income Shares Amount
BASIC EPS -------------------- --------------------
Net income applicable to
common shareholders $ 1,593 5,017 $ 0.32 $ 913 4,936 $ 0.19
====== ======
Effect of dilutive securities
Stock options - 117 - 187
------------- --------------
DILUTED EPS
Net income applicable to
common shareholders $ 1,593 5,134 $ 0.31 $ 913 5,123 $ 0.18
====== ======
Nine Months Ended
September 30, 1998 1997
--------------------------- -------------------- --------------------
(in thousands, except per
share data) Per Per
Share Share
Income Shares Amount Income Shares Amount
BASIC EPS -------------------- --------------------
Net income applicable to
common shareholders $ 3,520 5,005 $ 0.70 $ 3,104 4,907 $ 0.63
====== ======
Effect of dilutive securities
Stock options - 174 - 232
------------- --------------
DILUTED EPS
Net income applicable to
common shareholders $ 3,520 5,179 $ 0.68 $ 3,104 5,139 $ 0.61
====== ======
The number of options to purchase shares of common stock that were excluded from
the table above (as the effect would have been anti-dilutive) were 447,400 and
100,000 for the three months ended September 30, 1998 and 1997, respectively,
and 298,700 and 100,000 for the nine months ended September 30, 1998 and 1997,
respectively.
6
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NOTE 5. SUBSEQUENT EVENT
Effective October 1, 1998, CFI acquired certain operations from Mortgage
Dynamics, Inc. for $2.7 million in cash plus certain contingent royalties tied
to future revenue production. The operations acquired consisted primarily of two
software products in development which automate secondary marketing and document
tracking functions for mortgage lenders. CFI is in the process of determining
the allocation of the purchase price. CFI expects to write off in the fourth
quarter of 1998 a portion of the purchase price as in-process research and
development. CFI expects that a portion of the remainder of the purchase price
will be allocated to goodwill and will be amortized ratably over seven years.
The transaction will be accounted for as a purchase.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO SHOULD BE READ IN
CONJUNCTION WITH THE FOLLOWING DISCUSSION. THIS DISCUSSION CONTAINS CERTAIN
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THE
CAUTIONARY STATEMENTS MADE IN THIS DISCUSSION SHOULD BE READ AS BEING APPLICABLE
TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS FILING.
THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED HERE.
FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE
DISCUSSED IN THIS FILING, AS WELL AS IN THE COMPANY'S REPORTS ON FORM 10-Q FOR
THE PERIODS ENDED MARCH 31, 1998 AND JUNE 30, 1998, ON FORM 10-K FOR THE YEAR
ENDED DECEMBER 31, 1997 AND IN OTHER FILINGS BY THE COMPANY WITH THE SECURITIES
AND EXCHANGE COMMISSION.
OVERVIEW
CFI ProServices, Inc., ("CFI" or the "Company") is a leading provider of
customer service software products and services to financial institutions. The
Company combines its technology, banking and legal expertise to deliver
knowledge-based software solutions that enable institutions to simplify key
business processes such as sales and service, improve productivity, strengthen
customer relationships and maintain compliance with both internal business
policies and external government regulations. More than 5,500 financial
institutions have licensed one or more of the Company's products.
During 1993 substantially all of the Company's revenue was derived from the
Company's Laser Pro and Deposit Pro products. Today, the Company licenses more
than 20 products organized into three product groups: lending, retail delivery
and connectivity software. Due to its product diversification efforts, the
Company is now less reliant on the Laser Pro and Deposit Pro products. For the
nine months ended September 30, 1998, approximately 42% of the Company's revenue
came from products other than Laser Pro and Deposit Pro.
CFI generates recurring revenue from software maintenance agreements. For the
three month and nine month periods ended September 30, 1998, service and support
fees revenue accounted for approximately 32% and 36% of total revenue,
respectively. Substantially all software customers subscribe to the Company's
service and support programs, which provide ongoing product enhancements and,
where applicable, regulatory compliance updates.
The Company's cost structure is relatively fixed and the cost of generating
revenue, in aggregate, does not vary significantly with changes in revenue. As a
result, the Company typically generates greater profit margins from incremental
sales once fixed costs are covered. Conversely, any failure to achieve revenue
targets in a particular period would adversely affect profit margins for that
period.
The Company believes that sales to larger banks will constitute a higher
percentage of total revenue in future periods. Transactions with these larger
banks are typically of greater scope, usually involve a greater sales effort
over a longer period of time, and require more customization and prolonged
acceptance testing. This project oriented business tends to
8
<PAGE>
cause growth in unbilled accounts receivable resulting from the use of
percentage of completion contracts, deferred payment terms and increased
collection times for billed accounts receivable. These factors, in turn, result
in higher days sales outstanding (DSO) in accounts receivable.
The Company's backlog as of September 30, 1998, was approximately $12.0 million,
as compared to approximately $12.0 million and $9.2 million as of September 30,
1997 and 1996, respectively. CFI's backlog consists of firm signed orders taken
and not yet converted to revenue, but expected to be converted to revenue within
the next 12 months. Orders constituting the Company's backlog are subject to
changes in delivery schedules or to cancellation at the option of the purchaser
without significant penalty. The stated backlog is not necessarily indicative of
the Company's revenue for any future period.
RESULTS OF OPERATIONS
The following table sets forth statements of income data of the Company
expressed as a percentage of total revenue for the periods indicated:
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
Revenue
Software license fees 62.6 % 54.6 % 57.1 % 54.2 %
Service and support 32.1 37.8 35.8 38.9
Other 5.3 7.6 7.1 6.9
---------- --------- --------- --------
Total revenue 100.0 100.0 100.0 100.0
Gross profit 66.5 61.0 64.6 64.0
Operating expenses
Sales and marketing 22.4 22.3 22.9 21.7
Product development 17.8 17.6 17.1 17.6
General and administrative 12.1 12.9 12.1 11.8
Amortization of intangibles 1.3 1.8 1.5 1.8
---------- --------- --------- --------
Total operating expenses 53.6 54.6 53.6 52.9
---------- --------- --------- --------
Income from operations 12.9 6.4 11.0 11.1
Non-operating income (expense) (0.4) 2.9 (0.5) (0.2)
---------- --------- --------- --------
Income before income taxes 12.5 9.3 10.5 10.9
Provision for income taxes 5.5 4.1 4.6 4.8
Preferred stock dividend 0.1 0.1 0.1 0.1
---------- --------- --------- --------
Net income applicable to
common shareholders 6.9 5.1 % 5.8 % 6.0 %
========== ========= ========= ========
9
<PAGE>
The following table sets forth percentage changes period over period in the
statements of income data of the Company:
Three Months Ended Nine Months Ended
September 30,1998 over September 30, 1998 over
September 30, 1997 September 30, 1997
---------------------- -----------------------
Revenue
Software license fees 48.7 % 24.7 %
Service and support 9.8 8.9
Other (9.5) 21.1
--------- ---------
Total revenue 29.6 18.3
Gross profit 41.3 19.3
Operating expenses
Sales and marketing 30.3 25.0
Product development 31.0 15.1
General and administrative 21.2 21.9
Amortization of intangibles (5.7) (5.7)
--------- ---------
Total operating expenses 27.2 20.0
--------- ---------
Income from operations 161.6 16.2
Non-operating income (expense) NM (1) (186) (1)
--------- ---------
Income before income taxes 72.7 (1) 13.1 (1)
Provision for income taxes (72.9) (1) (13.1) (1)
Preferred stock dividend -- --
========= =========
Net income applicable to
common shareholders 74.5 % (1) 13.4 %(1)
========= =========
1)Not meaningful. Results for the three months and nine months ended September
30, 1997 included a $0.6 million gain on the sale of an operating division as
non-operating income. Absent that gain, changes to non-operating income
(expense), income before income taxes, provision for income taxes and net
income applicable to common shareholders would have been 3.0%, 176.6%, 176.9%
and 183.9%, respectively, for the three months ended September 30, 1998 and
60.6%, 27.2%, 27.2% and 27.9%, respectively, for the nine months ended
September 30, 1998.
REVENUE
Total revenue increased $5.3 million, or 30%, to $23.2 million for the three
months ended September 30, 1998 compared to $17.9 million in the comparable
period in 1997. Total revenue increased $9.5 million, or 18%, to $61.2 million
for the nine months ended September 30, 1998 compared to $51.8 million in the
comparable period in 1997.
SOFTWARE LICENSE FEES. Software license fees include sales of software to
customers, fees for software customization and fees related to implementing
software and systems at customer sites. Software license fees increased $4.7
million, or 49%, to $14.5 million and increased $6.9 million, or 25%, to $35.0
million for the three month and nine month periods ended September 30, 1998,
respectively, compared to the same periods in 1997. The increases were led by
lending products, offset in part by lower retail delivery product revenues.
10
<PAGE>
Revenues from the 1997 periods also included results from the Company's
RPxpress! remittance processing division, which was sold in September 1997.
PERCENTAGE OF SOFTWARE LICENSE FEES
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
1998 1997 1998 1997
---- ---- ---- ----
Lending Products 65 % 47 % 63 % 50 %
Retail Delivery Products 28 50 31 46
Connectivity Products 7 3 6 4
------------ ------------ ------------ ------------
Total 100 % 100 % 100 % 100 %
LENDING PRODUCTS. Lending products license revenue increased $4.8 million,
or 103%, to $9.4 million for the three months ended September 30, 1998, and
increased $8.1 million, or 57%, to $22.2 million for the nine months ended
September 30, 1998 over the respective comparable periods in 1997. The increases
resulted primarily from sales of products in the Laser Pro lending suite
(particularly of the Company's new Windows-based products) and Laser Pro
Mortgage, and were offset in part by decreased revenues from the Company's two
fisCAL products and from Laser Pro Application Manager. As a percentage of total
license fee revenues, lending products increased to 65% for the third quarter of
1998 and to 63% year-to-date, compared to 47% and 50% for the respective
comparable periods in 1997.
Lending products include Laser Pro Closing, Laser Pro Application, Laser Pro
SBA, Laser Pro Credit Line, Laser Pro Application Manager, Laser Pro fisCAL
Analyzer, Laser Pro fisCAL Online and Laser Pro Mortgage.
RETAIL DELIVERY PRODUCTS. Retail delivery product license revenue
decreased $0.8 million, or 17%, to $4.0 million for the three months ended
September 30, 1998, and decreased $2.1 million, or 16%, to $10.9 million for the
nine months ended September 30, 1998, from the respective comparable periods in
1997. In the third quarter of 1998, increased revenues from Deposit Pro and
Encore! Desktop were offset by decreased revenues from Encore! Branch
Automation, Encore! Call Center and Encore! Personal Branch. Revenues from
Online Branch Automation were lower in the first nine months of 1998 than in the
comparable 1997 period, and were approximately the same in the three months
ended September 30, 1998 and 1997. The Company expects declines in Online Branch
Automation revenues as it decreases its emphasis on the older DOS-based product
and transitions to its Windows-based Encore! branch automation products. As a
percentage of total license revenue, retail delivery products revenue declined
to 28% in the third quarter of 1998 and to 31% for the first nine months of 1998
compared to 50% and 46% for the same respective periods in 1997.
Retail delivery products include Encore! Teller, Encore! Platform,
Flextran, OnLine Branch Automation, Deposit Pro, Encore! Desktop, Encore!
Call Center, Encore! Personal Branch and Pro Active CRA .
CONNECTIVITY PRODUCTS. License fees from the sale of connectivity products
were $1.1 million and $1.9 million for the three and nine month periods ended
September 30, 1998,
11
<PAGE>
respectively. These revenues were approximately $0.8 million higher in each of
the 1998 periods than in the comparable 1997 periods. As a percentage of Company
license fee revenue, connectivity products accounted for 7% in the third quarter
of 1998 and 6% year-to-date, compared to 3% and 4% for the same respective
periods in 1997. Connectivity products include StarGate middleware, Laser Pro
interfaces and Deposit Pro interfaces.
SERVICE AND SUPPORT FEES. Service and support fees consist primarily of
recurring software support charges and revenue from training customers in the
use of the Company's products. Substantially all of the Company's software
customers subscribe to its support services, which provide for the payment of
annual or quarterly maintenance fees. Service and support fees increased $0.7
million, or 10%, to $7.4 million and $1.8 million, or 9%, to $21.9 million for
the three month and nine month periods ended September 30, 1998, respectively,
compared to the same periods in 1997.
OTHER REVENUE. Other revenue includes Vendor Payment Systems processing fees,
sales of preprinted forms and supplies and certain consulting revenue. Other
revenue decreased $0.1 million, or 10%, to $1.2 million and increased $0.8
million, or 21%, to $4.3 million for the three month and nine month periods
ended September 30, 1998, respectively, compared to the same periods in 1997.
The increase in other revenue in the nine month period was led by sales of Laser
Pro font cartridges. Other revenue was 5% and 7% of total revenue for the three
and nine month periods of 1998, respectively, compared to 8% and 7%,
respectively, for the comparable periods in 1997.
COST OF REVENUE
Cost of revenue primarily consists of amortization of software development
costs, royalty payments, compliance warranty insurance premiums, software
production costs, costs of product support, training and implementation, costs
of software customization, materials costs for forms and supplies and bill
payment processing costs.
Cost of revenue increased $0.8 million, or 11%, to $7.8 million and $3.1
million, or 16%, to $21.7 million for the three and nine month periods ended
September 30, 1998, respectively, compared to the same periods in 1997. The
increases are primarily attributable to additional personnel required to support
the increased installed base of customers, higher implementation costs
associated with the increased number of large financial institution projects,
and increased royalties and materials costs associated with increased revenues.
As the breadth of the Company's product offerings has expanded, the complexity
and cost of providing high quality customer service and support has increased.
Amortization of software development costs decreased $0.2 million, to $0.8
million, for the third quarter of 1998 and decreased $0.5 million, to $1.9
million, for the first nine months of 1998 compared to the same periods in 1997.
Amortization of software development costs will increase in future periods as
certain product development projects that had been capitalized in past periods
were completed during the second quarter of 1998. Amortization of the
capitalized software costs associated with those products commenced in the third
quarter of 1998.
12
<PAGE>
As a result of CFI's acquisitions, costs resulting from royalty payments will
increase in future periods. The Company is obligated to pay royalties ranging
from 3% to 18% of revenue related to certain products acquired in the various
acquisitions since June 1994. In addition, the Company is obligated to pay the
seller a fixed amount per OnLine Branch Automation customer converted to the
Company's products. The royalty obligations generally extend three to five years
from the acquisition date.
Gross margin was 66% and 65% for the three and nine month periods ended
September 30, 1998, respectively, compared to 61% and 64% in each of the
respective same periods in 1997. Operating margin was 13% and 11% for the three
and nine month periods in 1998, respectively, compared to 6% and 11%,
respectively, in 1997. The increases in gross margin and in operating margin
were due primarily to cost management and achievement of the Company's revenue
targets. The operating margins for the 1998 periods also reflect expensing of
more development costs in 1998 as the Company's current product development
cycle ended during the second quarter of 1998. The Company capitalized no
software development costs in the three months ended September 30, 1998, and
capitalized $1.1 million of such costs in the first nine months of 1998,
compared to $0.8 million and $3.8 million in the same respective periods in
1997. Capitalized software development costs net of accumulated amortization
were $9.1 million as of September 30, 1998.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expenses increased to $5.2 million, or
22% of revenue, for the three month period and to $14.1 million, or 23% of
revenue, for the nine month period ended September 30, 1998 compared to $4.0
million, or 22% of revenue, and $11.2 million, or 22% of revenue, in the
respective comparable periods of 1997. The increases in dollar amount resulted
principally from salary increases, additional personnel and increased
commissions associated with increased revenues.
PRODUCT DEVELOPMENT. Product development expenses include costs of maintaining
and enhancing existing products and developing new products. Product development
expenses increased to $4.1 million, or 18% of revenue, for the three month
period and to $10.5 million, or 17% of revenue, for the nine month period ended
September 30, 1998, compared to $3.2 million and $9.1 million, or 18% of
revenue, respectively, in the same periods in 1997. The increases in dollar
amount were principally the result of reduced capitalization of software
development costs in the 1998 periods and increased staffing in the development
areas of the Company.
With the completion of the current product development cycle in the quarter
ended June 30, 1998, the Company does not presently anticipate needing to
capitalize additional software development costs. Consequently, the Company
anticipates that the dollar amount of product development expenses in future
periods may be higher than in comparable prior periods when certain product
development expenses were being capitalized.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $2.8
million and $7.4 million, or 12% of revenue, respectively for the three and nine
month periods ended September 30, 1998, compared to $2.3 million, or 13% of
revenue, and $6.1 million, or 12% of revenue, respectively, for the same periods
in 1997. The increases in dollar amount primarily
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resulted from an increased allowance for bad debts associated with increased
revenues, higher salaries and increased personnel.
AMORTIZATION OF INTANGIBLES. Intangibles include acquisition payments assigned
to goodwill, noncompetition agreements and customer lists. These costs are
amortized over lives ranging from five to seven years. Amortization of
intangibles was $0.3 million and $0.9 million, respectively, for the three month
and nine month periods ended September 30, 1998 and 1997.
NON-OPERATING EXPENSE
Non-operating expense was $0.1 million in the three months ended September 1998
compared to non-operating income of $0.5 million in the comparable 1997 period.
The Company sold its remittance processing division in September 1997 and
recorded a gain of $0.6 million during the third quarter of 1997. Excluding such
gain, other net non-operating expense, which consists primarily of interest
income and expense, was $0.1 million for the three months ended September 30,
1997. Non-operating expense was $0.3 million for the nine months ended September
30, 1998 compared to $0.1 million in the comparable 1997 period.
In November 1997 the Company made a 50% investment in Lori Mae, L.L.C., a
company that will securitize small business loans originated by community banks.
The Company uses the equity method to account for its investment in Lori Mae.
Non-operating expense attributable to Lori Mae was $0.1 million and $0.2 million
for the three and nine month periods ended September 30, 1998, respectively. No
expense was attributable to Lori Mae in 1997.
PROVISION FOR INCOME TAXES
The effective tax rate for the three month and nine month periods ended
September 30, 1998 and 1997 was 44%.
YEAR 2000
The Year 2000 issue identifies problems that may arise in computer equipment and
software, as well as embedded electronic systems, because of the way these
systems are programmed to interpret certain dates that will occur around the
change in century. In the computer industry this is primarily the result of
computer programs being designed and developed using or reserving only two
digits in date fields (rather than four digits) to identify the century, without
considering the ability of the program to properly distinguish the upcoming
century change in the Year 2000. In addition, the Year 2000 is a special-case
leap year, and some programs may drop February 29th from their internal
calendars. Likewise, other dates may present problems because of the way the
digits are interpreted. Because the Company's business is based on the licensing
of applications software, the Company's business would be impacted if its
products or its internal systems experience problems associated with the century
change. This issue also potentially affects the software programs and systems
used by the Company in its operations.
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INTERNAL SYSTEMS. Some of the Computer programs and systems used by the Company
require date-sensitive information to accurately and adequately process
information critical to the Company's business. Inaccuracies or other errors in
this information could have a material, adverse affect on the Company's
business. Furthermore, non-compliance in these programs could cause a system
failure or interruption, either of which could also materially adversely affect
the Company. In addition to computer software, some machines and devices used by
the Company and others may contain embedded technology that is not Year 2000
compliant, which could result in a malfunction or failure of such devices.
The Company is in the process of verifying that its internal computer systems,
as well as critical third party software and systems used by the Company, are
Year 2000 compliant. The scope of the Year 2000 readiness effort includes
addressing (i) information technology such as software and hardware, (ii)
non-information systems or embedded technology contained in various equipment,
safety systems, facilities and utilities and (iii) readiness of mission critical
third-party suppliers. The Company is communicating with its significant
suppliers and vendors to understand their ability to continue providing services
and products through the millenium change and to determine the extent to which
the Company may be vulnerable in the event of a failure by them or their
services and products. With respect to mission critical systems, such as the
Company's accounting system, the Company is seeking statements of compliance
from each vendor. These statements may be directly received or may be posted on
a public electronic bulletin board or in government databases.
The review and assessment of the Company's internal systems and third party
systems is not yet complete. Based on information gathered to date, the Company
is not presently aware of any Year 2000 issue that could materially affect the
Company's operations, either self-originating or caused by third-party service
vendors or providers. Management believes that all mission critical systems will
be compliant by the Year 2000. Nevertheless, there can be no assurance that the
Company will not experience some operating difficulties as a result of Year 2000
issues. If they occur, these difficulties could require the Company to incur
unanticipated costs to remedy the problems and, either individually or
collectively, have a material adverse effect on the Company's business
operations and financial results. The Company has not yet determined the cost of
completing its investigation or the cost of any modification or remediation that
may be required to correct Year 2000 issues. Costs incurred to date to assess
Year 2000 issues have not been significant and have been funded through
operating cash flows. The Company intends to develop contingency plans for its
significant systems that can be implemented on or after January 1, 2000 in the
event of a system failure resulting from the century change.
COMPANY DEVELOPED SOFTWARE. The Company develops software programs for use by
financial institutions to automate various transactions and processes. These
programs often are highly dependent upon historical or dynamic financial and
other data that, if the programs are not able to distinguish between the Year
2000 and other century-end years, could be misreported or misinterpreted and
cause significant resulting calculation errors. This data is often acquired from
other systems that may or may not be Year 2000 compliant, further exacerbating
the problem. The Company's financial institution customers are subject to
regulatory scrutiny; any such errors could subject them to civil or regulatory
action, or both, resulting in large fines, penalties or other costs.
15
<PAGE>
Additional consequences of the Year 2000 issue for the Company's financial
institution customers may include systems failures and business process
interruption, including, among other things, a temporary inability to process
transactions, satisfy regulatory obligations, or engage in similar normal
business activities. In addition, the impact of Year 2000 issues may severely
impair the ability of the Company's customers to purchase the Company's
products, or to make payments on software or services previously purchased.
Concern over Year 2000 issues is permeating the financial services industry, and
management expects that the resolution of these concerns will likely absorb a
substantial portion of financial institution information technology budgets and
attention in the near term (with a concomitant decreased focus on other business
initiatives, including purchase decisions with respect to the Company's
software). Year 2000 issues faced by its customers could materially and
adversely affect the Company's operations and financial results through the Year
2000.
The Federal Financial Institutions Examination Council (the "FFIEC") has issued
a series of Statements beginning in June 1996 requiring that the various
financial institutions regulated by FFIEC member agencies provide assurance that
they will be capable of conducting business as usual in 2000 and into the 21st
century. To this end, and among other obligations, each institution is to survey
its systems and operations, including software and vendor supplied services,
determine any deficiencies, remediate to correct deficiencies, test mission
critical third party software and services to confirm their Year 2000 readiness
after remediation, and develop contingency plans against the event that a
mission critical item, service or process fails to be Year 2000 compliant.
Further information on the FFIEC mandate and related matters can be found at the
FFIEC's website, www.ffiec.gov/y2k. In support of its customers' obligations
resulting from the FFEIC's Statements, the Company has made the Year 2000 issue
a significant priority and assigned a task force with responsibility for an
ongoing effort to minimize Year 2000-related risks relative to the Company's
products.
The Company has completed its review of all of its software products for Year
2000 compliance, and has determined that most of the Company's standard software
products are Year 2000 compliant. The Company has not undertaken, and does not
intend to undertake, a review of the many customized versions of software
products that it has provided customers. The Company has developed a plan to
discontinue some of its standard products prior to December 31, 1999, and the
Year 2000 issue has been one of the factors considered in those decisions. For
those products that will not continue to be offered, generally a Year 2000
compliant replacement product currently exists.
For standard products that will continue to be offered, but are not currently
Year 2000 compliant, the Company has developed a plan for resolving such
compliance-related issues. The Company is now in the process of executing its
plan to remediate the products it will carry into the next century and expects
these software programs to be Year 2000 compliant by December 31, 1998. A matrix
describing the Company's product compliance (including a comprehensive
definition to determine such compliance) has been
16
<PAGE>
communicated to the Company's customers and is available for review on the
Company's Website. The financial impact of making the required changes to the
software programs is not expected to be material to the Company's consolidated
financial position, results of operations or cash flows.
Information on the Company's Website is provided to customers for the sole
purpose of assisting them in planning for the transition to the Year 2000 and
includes the Company's definition of Year 2000 compliance, product compliance
status, and, in the case of the Laser Pro Closing/Lending product, includes test
guides. This information is updated at least quarterly so that the Company's
customers can access current information on the Year 2000 compliance status of
the Company's products. The matrix does not provide certification of Year 2000
compliance and customers are cautioned that they should independently confirm
Year 2000 compliance of the Company's products.
The Company has developed a standard Year 2000 compliance warranty and is
offering it to customers with respect to those products that will continue to be
offered into the next century. This warranty is consistent with the Company's
standard product warranties, extends no indeminities, and maintains the
liability cap applying otherwise in its licenses.
Financial institutions, financial institution regulators, and the many vendors
supplying the financial services industry have not developed a consistent and
comprehensive definition of what constitutes "compliance" with the Year 2000.
This, coupled with the different combinations of software, firmware, and
hardware used by customers may lead to disputes against the Company regarding
the operation of its software. The outcome of such disputes and the impact on
the Company are not estimable at this time.
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased $10.1 million to $17.3 million at September 30, 1998
from $7.2 million at December 31, 1997. The increase resulted principally from
enhanced efforts by the Company to improve cash collections, and from a net
reduction in short-term debt of $5.3 million and an increase in long-term debt
of $4.0 million in connection with a renegotiation of the Company's bank line of
credit facility.
Net cash provided by operations was $6.2 million for the nine month period ended
September 30, 1998 compared to $4.0 million in 1997. The principal contributors
to cash in the first nine months of 1998 were a decline in accounts receivable
of $4.8 million and net income, excluding depreciation and amortization, of $8.4
million. The major operating uses of funds during the first nine months of 1998
included $1.6 million attributable to a decline in accrued expenses due
primarily to the payment of bonus and commission amounts for 1997 and an
additional $5.6 million related to the seasonal decline in deferred revenue that
results from the Company's annual maintenance billing pattern for certain
products.
Net cash used in investing activities was $2.5 million for the nine months ended
September 30, 1998 compared to $6.0 million for the same period in 1997. The
decrease in cash used in
17
<PAGE>
investing activities is due principally to lower capitalization of software
development costs and lower expenditures for property and equipment.
Net cash used in financing activities of $1.2 million during the nine months
ended September 30, 1998 was primarily attributable to net payments of $1.3
million on the Company's bank line of credit facility. In addition, $0.6 million
was used for payments on acquisition related debt, offset by $0.8 million in
cash provided by issuance of common stock upon exercise of stock options.
Days sales outstanding (DSO) in accounts receivable, including both billed and
unbilled accounts receivable, was 105 days at September 30, 1998 compared to 108
days at June 30, 1998, 106 days at December 31, 1997 (excluding the distorting
impact of annual maintenance invoices) and 104 days at September 30, 1997.
Project-oriented business often requires unbilled accounts receivable and
milestone billings, both of which often have longer collection cycles. Unbilled
accounts receivable were $6.9 million, or 25% of total accounts receivable, at
September 30, 1998 compared to $4.9 million, or 24% of total accounts
receivable, at September 30, 1997.
Future cash requirements could include, among other things, purchases of
companies, products or technologies, expenditures for internal software
development, capital expenditures necessary to the expansion of the business,
and installment payments on debt related to acquisitions. Effective October 1,
1998, CFI acquired certain operations from Mortgage Dynamics, Inc. for $2.7
million in cash plus certain contingent royalties tied to future revenue
production. Available cash resources include cash generated by the Company's
operations and a revolving line of credit up to the lesser of $10.0 million or
50% of accounts receivable, of which $6.0 million was available at September 30,
1998. Long-term debt, less current portion, of $5.8 million at September 30,
1998 includes $4.0 million drawn on the line of credit. The interest rate on the
line of credit borrowings was 7.2% at September 30, 1998. The line of credit
expires May 1, 2000.
The Company believes that funds expected to be generated from existing
operations and borrowings under its revolving line of credit will provide the
Company with sufficient funds to finance its operations. The Company may require
additional funds to support its working capital requirements, future
acquisitions or for other purposes and may seek to raise such additional funds
through one or more public or private financings of debt or equity, or from
other sources. No assurance can be given that additional financing will be
available or that, if available, such financing will be obtainable on terms
favorable to the Company or its shareholders.
From time to time the Company receives contract claims from its customers and
other parties, including requests for full or partial refunds of moneys paid,
and initiates contract claims against its customers and other parties, including
claims for payment of unpaid invoices. Although there can be no assurance that
such claims, either alone or in the aggregate, will not have a material adverse
effect on the Company's results of operations or financial position, the Company
believes that as of the date of this filing no such claims will have such an
effect.
18
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The exhibits filed as part of this report are listed below:
EXHIBIT NUMBER AND DESCRIPTION
27 Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended September 30,
1998.
19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 13, 1998 CFI PROSERVICES, INC.
By: /s/ MATTHEW W. CHAPMAN
Matthew W. Chapman
Chairman and Chief Executive Officer
(Principal Executive Officer)
By: /s/ KURT W. RUTTUM
Kurt W. Ruttum
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
20
<PAGE>
Exhibit Index
27 Financial Data Schedule for nine months ended September 30, 1998
21
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