-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ea8RHjAbb/oDggCPxGZ+GeWoldrGfH5mlmg6krE1LIw7L7UyJMsq0GJGkcP61+IT fEu/mYjwxyeYJ7WUs/rnIw== 0000950133-96-002738.txt : 19961206 0000950133-96-002738.hdr.sgml : 19961206 ACCESSION NUMBER: 0000950133-96-002738 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 11 FILED AS OF DATE: 19961205 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CREDIT MANAGEMENT SOLUTIONS INC CENTRAL INDEX KEY: 0001024339 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING SERVICES [7371] IRS NUMBER: 521549401 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-14007 FILM NUMBER: 96676465 BUSINESS ADDRESS: STREET 1: 5950 SYMPHONY WOODS RD CITY: COLUMBIA STATE: MD ZIP: 21044 BUSINESS PHONE: 4107401000 MAIL ADDRESS: STREET 1: 5950 SYMPHONY WOODS RD STREET 2: SUITE 301 CITY: COLUMBIA STATE: MD ZIP: 21044 S-1/A 1 AMENDMENT #3 TO FORM S-1 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 5, 1996 REGISTRATION NO. 333-14007 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 3 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ CREDIT MANAGEMENT SOLUTIONS, INC. ------------------------ (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MARYLAND 7371 52-1549401 (STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER OF CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER) INCORPORATION OR ORGANIZATION)
5950 SYMPHONY WOODS ROAD COLUMBIA, MARYLAND 21044 (410)740-1000 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES AND PRINCIPAL PLACE OF BUSINESS) ------------------------ JAMES R. DEFRANCESCO PRESIDENT AND CHIEF EXECUTIVE OFFICER CREDIT MANAGEMENT SOLUTIONS, INC. 5950 SYMPHONY WOODS ROAD COLUMBIA, MARYLAND 21044 (410) 740-6712 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: PETER R. GILBERT, ESQ. MANATT, PHELPS & PHILLIPS, LLP 1501 M STREET, N.W. WASHINGTON, D.C. 20005 ALEXANDER D. LYNCH, ESQ. BROBECK, PHLEGER & HARRISON LLP 1301 AVENUE OF THE AMERICAS NEW YORK, NEW YORK 10019 ------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this registration statement becomes effective. ------------------------ If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 of the Securities Act of 1933, check the following box: [ ] ------------ If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] ------------ If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] ------------ If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ CALCULATION OF REGISTRATION FEE
- ---------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------- PROPOSED MAXIMUM PROPOSED MAXIMUM TITLE OF EACH CLASS AMOUNT TO BE OFFERING PRICE AGGREGATE AMOUNT OF OF SECURITIES TO BE REGISTERED REGISTERED(1) PER SHARE(2) OFFERING PRICE(2) REGISTRATION FEE - ---------------------------------------------------------------------------------------------------------------- Common Stock, $.01 par value................ 2,990,000 shares $13.00 $38,870,000.00 $11,779 - ---------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------
(1) Includes 390,000 shares that may be purchased by the Underwriters to cover over-allotments, if any. (2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457. ----------------------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED DECEMBER 5, 1996 PROSPECTUS CREDIT MANAGEMENT SOLUTIONS, INC. [CMSI LOGO] 2,600,000 Shares of Common Stock Of the 2,600,000 shares of Common Stock, $.01 par value per share (the "Common Stock"), offered hereby, 2,200,000 shares are being sold by Credit Management Solutions, Inc. ("CMSI" or the "Company") and 400,000 shares are being sold by certain stockholders (collectively, the "Selling Stockholders") of the Company (collectively, the "Shares"). The Company will not receive any of the proceeds from the sale of the shares by the Selling Stockholders. See "Principal and Selling Stockholders." Prior to this offering (the "Offering"), there has been no public market for the Common Stock, and there can be no assurance that an active public market for the Common Stock will develop or be sustained after the Offering. It is currently estimated that the initial public offering price will be between $11.00 and $13.00 per share. See "Underwriting" for a discussion of the factors to be considered in determining the initial public offering price. The Company has applied to have the Common Stock approved for quotation on the Nasdaq National Market under the symbol "CMSS." SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SHARES. --------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
UNDERWRITING PROCEEDS TO PRICE TO COMMISSIONS AND PROCEEDS TO THE THE SELLING PUBLIC DISCOUNTS(1) COMPANY(2)(3) STOCKHOLDERS - ------------------------------------------------------------------------------------------------- Per Share.................... $ $ $ $ - ------------------------------------------------------------------------------------------------- Total........................ $ $ $ $ - ------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------
(1) See "Underwriting" for indemnification arrangements with the several Underwriters. (2) Before deducting expenses payable by the Company estimated at $900,000. (3) The Company has granted to the Underwriters a 30-day option to purchase up to an aggregate of 390,000 additional shares of Common Stock at the Price to Public, less the Underwriting Commissions and Discounts, solely to cover over-allotments, if any. If the Underwriters exercise such option in full, the total Price to Public, Underwriting Commissions and Discounts and Proceeds to the Company will be $ , $ and $ , respectively. See "Underwriting." The Shares are offered subject to receipt and acceptance by the Underwriters, to prior sale and to the Underwriters' right to reject any order in whole or in part and to withdraw, cancel or modify the offer without notice. It is expected that delivery of the Shares will be made at the office of Friedman, Billings, Ramsey & Co., Inc., Arlington, Virginia, or through the facilities of The Depository Trust Company, on or about , 1996. --------------------------------------------- FRIEDMAN, BILLINGS, RAMSEY UNTERBERG HARRIS & CO., INC. THE DATE OF THIS PROSPECTUS IS , 1996. 3 [A SCHEMATIC DIAGRAM WILL BE PROVIDED THAT GRAPHICALLY ILLUSTRATES THE UTILIZATION OF THE COMPANY'S CREDITREVUE PRODUCT IN CONJUNCTION WITH THE COMPANY'S CREDIT CONNECTION SERVICE] IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED IN THE OVER-THE-COUNTER MARKET (INCLUDING THE NASDAQ NATIONAL MARKET) OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. 4 PROSPECTUS SUMMARY THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED INFORMATION, INCLUDING "RISK FACTORS" AND THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO, APPEARING ELSEWHERE IN THIS PROSPECTUS. EXCEPT AS OTHERWISE NOTED, ALL INFORMATION IN THIS PROSPECTUS (I) ASSUMES THE FILING OF AN AMENDMENT TO THE ARTICLES OF INCORPORATION OF THE COMPANY PRIOR TO THE CONSUMMATION OF THE OFFERING WHICH, AMONG OTHER THINGS, WILL INCREASE THE NUMBER OF AUTHORIZED SHARES OF COMMON STOCK, (II) ASSUMES THE REINCORPORATION OF THE COMPANY IN DELAWARE PRIOR TO THE CONSUMMATION OF THE OFFERING, AND (III) ASSUMES NO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION. ALL SHARE TOTALS STATED HEREIN REFLECT THE COMPANY'S 32,734-FOR-1 STOCK SPLIT EFFECTED IN OCTOBER 1996. THE COMPANY CMSI is a developer and provider of software solutions and services for automating the consumer and small business credit analysis, decisioning and funding process. Drawing upon over 10 years of experience in the credit processing industry, the Company has developed and provides open-architecture software products and services which manage volume-intensive credit operations over wide-area networks. 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. These products and services are designed to enable credit originators, such as automobile dealerships and retailers, and lenders, such as banks and finance companies, to improve operating efficiencies by increasing productivity, enhance customer satisfaction by reducing turnaround time on credit decisions, and decrease portfolio risk by applying consistent underwriting standards. The Company's core product, CreditRevue, analyzes credit applications by automatically accessing third-party credit bureau reports, consulting the lending institution's internal loan guidelines and incorporating the loan "scorecards" used by lending institutions. Using CreditRevue, decision response time generally ranges from a matter of seconds for automated decisions to several minutes in cases where review by a credit analyst is required. The Company's CreditRevue customers include some of the largest financial institutions and finance companies in the United States, such as NationsBank Corp., Banc One Corp., Wells Fargo Bank and The Associates Bancorp, Inc. In addition, the Company has introduced CreditRevue to the telecommunications industry through a joint venture between AirTouch Cellular, Inc. and US West New Vector Group, Inc. To further support the needs of the lending industry, the Company developed Credit Connection, which became commercially available in July 1996. Credit Connection, 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. The Company is introducing Credit Connection to the marketplace through the Company's sales force, the sales forces of lending institutions and various remarketers. To date, Credit Connection has generated approximately $27,000 in revenues. The Company recently entered into an agreement to form a strategic alliance with the Dealer Services Group of ADP, Inc. ("ADP") to remarket Credit Connection. This division of ADP is one of the largest providers of computing and consulting services for automobile and truck dealers worldwide. By facilitating the flow of applications to multiple funding sources through Credit Connection, and by automating the credit application analysis, decisioning and funding process through CreditRevue, the Company believes it is well positioned to capitalize on the growth in the consumer and small business credit markets. The Company's products have been designed to work together and complement each other to provide a seamless credit application process. The Company believes that its CreditRevue customer base and proposed strategic alliance with ADP will enhance its marketing efforts for the Credit Connection service. In addition, the Company believes that the implementation of Credit Connection will create new marketing opportunities for CreditRevue. The Company's objective is to be the leading provider of software solutions for automating the credit analysis, decisioning and funding process and for electronically transmitting credit related transactions between points of origination and multiple funding sources. 3 5 The Company was incorporated in 1987 as a Maryland corporation and intends to reincorporate in Delaware prior to the consummation of the Offering. The Company's principal executive offices are located at 5950 Symphony Woods Road, Columbia, Maryland 21044 and its telephone number is (410) 740-1000. RISK FACTORS An investment in the shares of Common Stock offered hereby involves a high degree of risk. Risk factors that should be considered by prospective investors include uncertainty of future results of operations, fluctuations in quarterly results of operations, dependence on CreditRevue product line, lengthy sales and implementation cycle, market acceptance of Credit Connection, transition to transaction-based revenue, and reliance on certain relationships. See "Risk Factors" for a discussion of these and other risks. THE PUBLIC OFFERING Common Stock offered by the Company.......... 2,200,000 shares(1) Common Stock offered by the Selling Stockholders............................... 400,000 shares Common Stock to be outstanding after the Offering................................... 7,210,100 shares(2) Use of Proceeds.............................. The Company intends to use the net proceeds from the Offering for expansion of the Company's sales, marketing and customer support organizations, capital expenditures and other general corporate and working capital purposes. Proposed Nasdaq National Market symbol....... CMSS
- --------------- (1) Excludes 390,000 shares of Common Stock subject to the Underwriters' over-allotment option granted by the Company. (2) Excludes (i) an aggregate of 2,447,800 shares of Common Stock issuable upon exercise of stock options at a weighted-average exercise price of $5.35 per share, of which options to purchase 560,760 shares of Common Stock will be exercisable after the Offering, (ii) 202,200 additional shares of Common Stock reserved for future issuance under the Company's Stock Option Plan, (iii) 250,000 shares reserved for issuance under the Company's Employee Stock Purchase Plan and (iv) 750,000 shares reserved for issuance under the Company's Long-Term Incentive Plan. At November 14, 1996, an aggregate of 2,547,800 shares of Common Stock were issuable upon exercise of stock options, of which options to purchase 100,000 shares will be exercised by certain Selling Stockholders immediately prior to the consummation of the Offering. See "Management -- Stock Option Plan," "-- Long-Term Incentive Plan" and "-- Employee Stock Purchase Plan." 4 6 SUMMARY CONSOLIDATED FINANCIAL DATA
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------------- -------------------------- 1993 1994 1995 1995 1996 ---------- ---------- ----------- ---------- ---------- STATEMENT OF OPERATIONS DATA: Revenues......................... $3,368,068 $3,951,456 $10,231,452 $6,728,859 $9,035,485 Income (loss) from operations.... 97,672 (408,371) 759,031 763,030 (200,273) Historical net income (loss)..... 318,857 (144,931) 957,932 908,563 (52,923) Pro forma net income(1).......... 737,314 45,005 Pro forma net income per share... $ 0.12 $ 0.01 Shares used in pro forma net income per share calculations................... 6,293,720 6,293,720
AS OF SEPTEMBER 30, 1996 ------------------------------------------------- PRO FORMA AS ACTUAL PRO FORMA(1) ADJUSTED(2) ----------- ------------ -------------- BALANCE SHEET DATA: Working capital (deficit).............................. $(1,690,612) $(1,561,671) $ 22,590,329 Total assets........................................... 5,188,599 5,392,540 29,544,540 Stockholder loans and capital lease obligations, less current portion...................................... 469,145 469,145 469,145 Total stockholders' equity (deficit)................... (629,901) (835,387) 23,316,613
- --------------- (1) The Company has operated as a Subchapter S Corporation for federal and state income tax purposes since its inception in 1987, and, therefore, the historical financial statements do not include a provision for federal and state income taxes for such periods. Pro forma net income (loss) has been computed as if the Company had been subject to federal and state income taxes based on the tax laws in effect during the respective periods. See Note 2 of Notes to Consolidated Financial Statements. (2) Adjusted to reflect (i) the sale by the Company of 2,200,000 shares of Common Stock offered by the Company hereby, assuming an initial public offering price of $12.00 per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by the Company, and (ii) the exercise of options to purchase 100,000 shares of Common Stock by certain Selling Stockholders immediately prior to the consummation of this Offering resulting in proceeds to the Company of $500,000. See "Use of Proceeds," "Capitalization" and "Underwriting." ------------------------ "CreditRevue," "Credit Connection" and "INCredit" are registered trademarks of the Company. "CrossSell," "CreditRevue Service Bureau," "CreditRevue Data Server," "Credit Connection for Windows," "Credit Connection Online," "Credit Connection LenderLink" and the Company logo are trademarks of the Company. This Prospectus also includes the trademarks and tradenames of companies other than the Company. 5 7 RISK FACTORS IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE COMPANY AND ITS BUSINESS BEFORE PURCHASING SHARES OF THE COMMON STOCK OFFERED HEREBY. THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO FUTURE EVENTS OR FUTURE FINANCIAL PERFORMANCE OF THE COMPANY. PROSPECTIVE INVESTORS ARE CAUTIONED THAT SUCH STATEMENTS ARE ONLY PREDICTIONS AND THAT EVENTS OR RESULTS MAY DIFFER MATERIALLY. IN EVALUATING SUCH STATEMENTS, PROSPECTIVE INVESTORS SHOULD SPECIFICALLY CONSIDER THE FOLLOWING FACTORS AND OTHER FACTORS SET FORTH IN THIS PROSPECTUS WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS. 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 Credit Connection and CreditRevue Service Bureau, the demand for the Company's products and services, the successful transition from predominantly license fee-based revenue to predominantly transaction fee-based revenue, the timing of new product and service 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 or delay of individual orders, therefore, would have a significant impact on the Company's revenue and quarterly results of operations. The timing of revenue is difficult to predict because of the length and variability of the Company's sales cycle, which has ranged to date from two to 18 months from initial customer contact to the execution of a license agreement. In addition, since a substantial portion of the Company's revenue is recognized on a percentage-of-completion basis, the timing of revenue recognition for its licenses may be materially and adversely affected by delays or deferrals of customer implementations. Such delays or deferrals may also increase expenses associated with such implementations which would materially and adversely affect related operating margins. The Company's operating expenses are based in part on planned product and service introductions and anticipated revenue trends and, because a high percentage of these expenses are relatively fixed, a delay in the recognition of revenue from a limited number of transactions could cause significant variations in operating results from quarter-to-quarter and could result in operating losses. To the extent such expenses precede, or are not subsequently followed by, increased revenues, the Company's results of operations would be materially and adversely affected. As a result of these and other factors, revenues for any quarter are subject to significant variation, and the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. There can be no assurance that the Company will be profitable in any future quarter or that such fluctuations in results of operations will not result in volatility in the price of the Company's Common Stock. Due to all of the foregoing factors, it is likely that in some future quarter the Company's results of operations will be below the expectations of public market analysts and investors. In such event, the market price of the Company's Common Stock will be materially and adversely affected. See "-- Market Acceptance of Credit Connection; Transition to Transaction-Based Revenue" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Quarterly Information." DEPENDENCE ON CREDITREVUE PRODUCT LINE License fees, maintenance fees and third-party computer hardware sales associated with licenses and installations of CreditRevue accounted for virtually all of the Company's revenues through September 30, 1996. Although the Company has recently introduced its Credit Connection service, the Company expects that 6 8 revenues generated from licenses and installations of CreditRevue will continue to account for a significant portion of the Company's revenues for the foreseeable future. To date, Credit Connection has generated approximately $27,000 in revenues. The life cycles of the Company's products and services are difficult to predict due to the effect of new product and service introductions or software enhancements by the Company or its competitors, market acceptance of new and enhanced versions of the Company's products and services, and competition in the Company's marketplace. A decline in the demand for CreditRevue, whether as a result of competition, technological change, price reductions or otherwise, would have a material adverse effect on the Company's business, results of operations and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." LENGTHY SALES AND IMPLEMENTATION CYCLE The licensing of the Company's software products and services is often an enterprise-wide decision by prospective customers and generally requires the Company to provide a significant level of education to prospective customers regarding the use and benefits of the Company's products and services. In addition, the implementation of the Company's software products involves a significant commitment of resources by prospective customers and is commonly accompanied by substantial reengineering efforts and a review of the customer's credit analysis, decisioning and funding processes. The cost to the customer of the Company's products and services is typically only a portion of the related hardware, software, development, training and integration costs associated with implementing a large-scale automated credit origination information system. For these and other reasons, the period between initial customer contact and the implementation of the Company's products is often lengthy (ranging from between two and 18 months) and is subject to a number of significant delays over which the Company has little or no control. The Company's implementation cycle could be lengthened by increases in the size and complexity of its license transactions and by delays or deferrals in its customers' implementation of appropriate interfaces and networking capabilities. Delays in the sale or implementation of a limited number of license transactions could have a material adverse effect on the Company's business, results of operations and financial condition and cause the Company's results of operations to vary significantly from quarter to quarter. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." MARKET ACCEPTANCE OF CREDIT CONNECTION; TRANSITION TO TRANSACTION-BASED REVENUE The Company's Credit Connection service has recently been commercially introduced and the Company's CreditRevue Service Bureau service is under development and is expected to be introduced in late 1997. These services 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 Credit Connection or CreditRevue Service Bureau or the occurrence of any significant technological problems with such services would have a material adverse effect on the Company's business, results of operations and financial condition. Historically, virtually all of the Company's revenues have been derived from license fees, maintenance fees and hardware sales associated with licenses and installations of CreditRevue. Under the terms of its license agreements, a majority of the Company's revenues are realized during the configuration and installation of CreditRevue. However, the Company anticipates that a significant portion of the Company's future revenues will be derived from per-usage transaction-based fees charged to credit originators and financial institutions for transactions originated from the Credit Connection 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. 7 9 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 and has also entered into an agreement to form a strategic alliance with ADP for remarketing Credit Connection. There can be no assurance that these companies, most of which have significantly greater financial and marketing resources than the Company, will not develop or market products and services which will compete with the Company's products and services in the future. Furthermore, since many of these relationships are informal in nature, they are terminable by either party at will. Other relationships are terminable by either party after a relatively short notice period. There can be no assurance that these companies will not otherwise discontinue their relationships with or support of the Company. The failure by the Company to maintain its existing relationships or to establish new relationships in the future, because of a divergence of interests, acquisition of one or more of these third parties or other reasons, could have a material adverse effect on the Company's business, results of operations and financial condition. See "Business -- Strategic Alliance with ADP." DEPENDENCE ON LARGE LICENSE FEE CONTRACTS AND CUSTOMER CONCENTRATION A relatively small number of customers have accounted for a significant percentage of the Company's revenues. License fees for CreditRevue are based on a percentage-of-completion method on a cost-incurred basis with the final installment being paid in full upon acceptance of the Company's software. The Company receives continuing revenues on CreditRevue from annual maintenance agreements which commence upon acceptance of the software by the customer. Maintenance agreements are renewable annually by the customer, and the license agreements are generally co-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 77.4% and 73.4% of total revenues in 1995 and the first nine months of 1996, respectively. Two of the Company's customers accounted for 19.9% and 12.9% of total revenues, respectively, in 1995. The Company expects that a limited number of customers will continue to account for a significant percentage of revenue for the foreseeable future. The loss of any major customer or any reduction or delay in orders by any such customer, delay or deferral in configurations or enhancements by such customers or the failure of the Company to successfully market its products or services to new customers, could have a material adverse effect on the Company's business, results of operations and financial condition. 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." 8 10 MANAGEMENT OF CHANGING BUSINESS The Company has experienced significant changes in its business, such as an expansion in the Company's staff and customer base and the development of new products, services and enhancements to its software, including the recent commercial release of Credit Connection. Such changes have placed and may continue to place a significant strain upon the Company's management, systems and resources. As of September 30, 1996, the Company had grown to 133 employees from 106 employees at December 31, 1995. The Company's ability to compete effectively and to manage future changes will require the Company to continue to improve its financial and management controls, reporting systems and procedures and budgeting and forecasting capabilities on a timely basis and expand its sales and marketing work force, and train and manage its employee work force. There can be no assurance that the Company will be able to manage such changes successfully. The Company's failure to do so could have a material adverse effect upon the Company's business, results of operations and financial condition. See "Business -- 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, President and Chief Executive Officer, and Scott L. Freiman, Executive Vice President. The Company intends to acquire key- person life insurance on the lives of each of Messrs. DeFrancesco and Freiman. The loss of the services of one or more of the Company's executive officers could have a material adverse effect on the Company's business, results of operations and financial condition. The Company retains its key employees through the use of equity incentive programs, including stock option plans, employee stock purchase plans, and competitive compensation packages. The Company has no employment agreements and does not intend to enter into any such agreements in the foreseeable future. The Company's future success also depends on its continuing ability to attract and retain highly qualified technical, customer support, sales and managerial personnel. In particular, the Company has encountered difficulties in hiring sufficient numbers of programmers and technical personnel. Competition for qualified personnel is intense, and there can be no assurance that the Company will be able to retain its key technical, sales and managerial employees or that it can attract, assimilate or retain other highly qualified technical, sales and managerial personnel in the future. See "Management." RAPID TECHNOLOGICAL CHANGE; RISK ASSOCIATED WITH NEW PRODUCTS, SERVICES OR ENHANCEMENTS The credit processing software products and services industry in which the Company competes is characterized by rapid technological change, frequent introductions of new products and services, changes in customer demands and evolving industry standards. The introduction or announcement of new products, services or enhancements by the Company or one or more of its competitors embodying new technologies or changes in industry standards or customer requirements could render the Company's existing products or services obsolete or unmarketable. Accordingly, the life cycles of the Company's products are difficult to estimate. The Company's future results of operations will depend, in part, upon its ability to enhance its products and services and to develop and introduce new products and services on a timely and cost-effective basis that will keep pace with technological developments and evolving industry standards, as well as address the increasingly sophisticated needs of the Company's customers. There can be no assurance that these new products and services will gain market acceptance or that the Company will be successful in developing and marketing new products or services that respond to technological change, evolving industry standards and changing customer requirements, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products or services, or that its new products or services will adequately meet the requirements of the marketplace and achieve any significant degree of market acceptance. In addition, a majority of the Company's current products operate in the UNIX operating system. Although the Company's software is designed to work with other operating environments, a requirement to port to a different operating system could be costly and time consuming and could have a material adverse effect on the Company's business, results of operations and financial condition. Failure of the Company to develop and introduce, for technological or other reasons, new products and services in a timely and cost-effective manner could have a material adverse effect on the Company's business, results of 9 11 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 "Business -- Product Development." SYSTEM INTERRUPTION AND SECURITY RISKS; POTENTIAL LIABILITY; POSSIBLE LACK OF ADEQUATE INSURANCE; AND SYSTEM INADEQUACY The Company's operations are dependent, in part, on its ability to protect its system from interruption by damage from fire, earthquake, power loss, telecommunication failure, unauthorized entry or other events beyond the Company's control. The Company's computer equipment constituting its central computer system, including its processing operations, is located at a single site. The Company is currently in the planning stages of acquiring and implementing a back-up, off-site processing system capable of supporting its operations in the event of system failure. The Company intends to have such system operational by the second quarter of 1997. Prior to such implementation, the Company's operations are subject to substantial risks, including temporary interruptions resulting from damage caused by any one or more of the foregoing factors or due to other causes including computer viruses, hackers or similar disruptive problems. The Company has not purchased any business interruption insurance to cover the risk of system failure or interruption. While the Company maintains a $0.5 million property insurance policy, a $1.0 million errors and omissions insurance policy and a $3.0 million umbrella insurance policy, such insurance may not be adequate to compensate the Company for all losses that may occur or to provide for costs associated with 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, security systems and accounting procedures to prevent unauthorized employee access, it is possible that, despite such safeguards, an employee of the Company could obtain access, which would also expose the Company to a risk of loss or litigation and possible liability to users. The Company attempts to limit its liability to customers, including liability arising from the failure of the security features contained in the Company's system and services, through contractual provisions. However, there can be no assurance that such limitations will be enforceable. There can be no guarantee that the growth of the Company's customer base will not strain or exceed the capacity of its computer and telecommunications systems and lead to degradations in performance or system failure. Any damage, failure or delay that causes interruptions in the Company's operations could have a material adverse effect on the Company's business, results of operations and financial condition. RISK OF DEFECTS, DEVELOPMENT DELAYS AND LACK OF MARKET ACCEPTANCE Software products and services as sophisticated as those offered by the Company often encounter development delays and may contain defects or failures when introduced or when new versions are released. The Company has in the past and may in the future experience delays in the development of software and has discovered, and may in the future discover, software defects in certain of its products. Such delays and defects may result in lost revenues during the time corrective measures are being taken. Although the Company has not experienced material adverse effects resulting from any such defects to date, there can be no assurance that, despite testing by the Company, errors will not be found in its existing software in future releases or enhancements, or that the Company will not experience development delays, resulting in delays in the commercial release of new products and services, the loss of market share or the failure to achieve market acceptance. Any such occurrence could have a material adverse effect upon the Company's business, results of operations and financial condition. See "Business -- Products and Services" and "-- Product Development." 10 12 FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING The Company currently anticipates that its available cash resources combined with the net proceeds of this Offering, as well as anticipated funds from operations, will be sufficient to meet its presently anticipated working capital and capital expenditure requirements through 1997. Thereafter, the Company may need to raise additional funds. The Company may need to raise additional funds sooner in order to fund more rapid expansion, to develop new or enhanced products and services, to respond to competitive pressures or to acquire complementary businesses or technologies. If additional funds are raised through the issuance of equity securities, the percentage ownership of the stockholders of the Company will be reduced, stockholders may experience additional dilution, or such equity securities may have rights, preferences or privileges senior to those of the holders of the Company's Common Stock. There can be no assurance that additional financing will be available when needed on terms favorable to the Company or at all. If adequate funds are not available or are not available on acceptable terms, the Company may be unable to develop or enhance its products and services, take advantage of future opportunities or respond to competitive pressures, which could have a material adverse effect on the Company's business, results of operations and financial condition. See "Dilution" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." DEPENDENCE ON PROPRIETARY RIGHTS; RISKS OF INFRINGEMENT The Company's success is heavily dependent upon its proprietary technology. The Company regards its software products and services as proprietary, and relies primarily on a combination of contract, copyright and trademark law, trade secrets, confidentiality agreements and contractual provisions to protect its proprietary rights. The Company has no patents on its products currently in commercial use, and existing trade secrets and copyright laws afford only limited protection. The Company has applied for a United States patent on portions of Credit Connection. There can be no assurance that a patent will be granted pursuant to the Company's application or that, if granted, such patent would survive a legal challenge to its validity or provide adequate protection. Furthermore, there can be no assurance that others will not design around any patents issued to the Company. It is the Company's policy to enter into confidentiality and assignment agreements with its employees. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use the Company's products or technology without authorization, to obtain and use information that the Company regards as proprietary, or to develop similar or superior products or technology independently. Policing unauthorized use of the Company's products is difficult, and while the Company is unable to determine the extent to which piracy of its software products exists, software piracy can be expected to be a persistent problem, particularly in international markets and as a result of the growing use of the Internet. The source code for the Company's proprietary software is protected both as a trade secret and as a copyrighted work. The Company has in the past and may in the future make source codes 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. The Company is not aware that any of its products, services, trademarks or other proprietary rights infringe 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. The Company has obtained a perpetual, worldwide license for the use of the registered trademark Credit Connection. 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 11 13 a material adverse effect on the Company's business, results of operations and financial condition. See "Business -- Intellectual Property and Other Proprietary Rights." COMPETITION; FUTURE PRICE EROSION 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. and Affinity Technology Group, Inc. Competitors for Credit Connection include The Reynolds & Reynolds Company and International Business Machines Corporation ("IBM"), which has recently announced a system for processing automobile loans over the Internet in conjunction with The Chase Manhattan Bank. 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's 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 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. See "Business -- Competition." GOVERNMENT REGULATION AND UNCERTAINTIES OF FUTURE REGULATION The Company's current and prospective customers, which consist of state and federally chartered banks, saving and loan associations, credit unions, consumer finance companies and other consumer lenders, as well as customers in the industries that the Company may target in the future, operate in markets that are subject to extensive and complex federal and state regulations. While the Company is not itself directly subject to such regulations, the Company's products and services must be designed to work within the extensive and evolving regulatory constraints in which its customers operate. These constraints include federal and state truth-in-lending disclosure rules, state usury laws, the Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Community Reinvestment Act. Furthermore, some consumer groups have expressed concern regarding the privacy and security of automated credit processing, the use of automated credit scoring tools in credit underwriting, and whether electronic lending is a desirable technological development in light of the current level of consumer debt. The failure by the Company's products and services to support customers' compliance with current regulations and to address changes in customers' regulatory environment, or to adapt to such changes in an efficient and cost-effective manner, could have a material adverse effect on the Company's business, results of operations and financial condition. See "Business -- Government Regulation." 12 14 DISCRETION AS TO USE OF PROCEEDS The primary purposes of this Offering are to create a public market for the Company's Common Stock, to facilitate future access to public markets and to obtain additional working capital. Prior to this Offering, there has been no market for the Common Stock, and there can be no assurance that an active public market for the Common Stock will develop or be sustained after the Offering. As of the date of this Prospectus, the Company has no specific plans to use the net proceeds from this Offering other than for expenses relating to the expansion of the Company's sales, marketing, technical and customer support organizations, capital expenditures and other general corporate and working capital purposes. Accordingly, the Company's management will retain broad discretion as to the allocation of the net proceeds from this Offering. Pending any such uses, the Company plans to invest the net proceeds in investment-grade, interest-bearing securities. See "Use of Proceeds." CONTROL BY EXISTING STOCKHOLDERS Upon completion of this Offering, 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, will collectively own 63.9% of the outstanding shares of Common Stock (60.6% if the Underwriters' over-allotment option is exercised in full). 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. See "Principal and Selling Stockholders." SHARES ELIGIBLE FOR FUTURE SALE Sales of a substantial number of shares of Common Stock in the public market following this Offering could adversely affect the market price of the Common Stock. Upon completion of the Offering, the Company will have outstanding an aggregate of 7,210,100 shares of Common Stock, assuming no exercise of the Underwriters' over-allotment option. Of these shares, all of the shares sold in this Offering will be freely tradeable without restriction or further registration under the Securities Act of 1933, as amended (the "Securities Act"), unless such shares are purchased by "affiliates" of the Company, as that term is defined in Rule 144 under the Securities Act ("Affiliates"). The remaining 4,610,100 shares of Common Stock are held by Messrs. DeFrancesco and Freiman and are "restricted securities" as that term is defined in Rule 144 under the Securities Act ("Restricted Shares"). Restricted Shares may be sold in the public market only if registered or if they qualify for an exemption from registration under Rules 144, 144(k) or 701 under the Securities Act. As a result of contractual restrictions and subject to the provisions of Rules 144 and 701, additional shares will be available for sale in the public market as follows: (i) no Restricted Shares will be eligible for immediate sale on the date of this Prospectus, (ii) 1,536,700 Restricted Shares (plus shares of Common Stock issuable to employees pursuant to stock options that are then vested) will be eligible for sale upon expiration of the lock-up agreements 180 days after the date of this Prospectus, (iii) an additional 1,536,700 Restricted Shares will be eligible for sale pursuant to the terms of the lock-up agreements 360 days after the date of this Prospectus, and (iv) the remaining 1,536,700 Restricted Shares will be eligible for sale pursuant to the terms of the lock-up agreements 540 days after the date of this Prospectus. The Company intends to file a registration statement on Form S-8 following the date of this Prospectus registering a total of 3,650,000 shares of Common Stock subject to outstanding stock options, or reserved for issuance under the Company's stock option plan. Shares issued after the effective date of the registration statement on Form S-8 will be eligible for resale by non-affiliates in the public market without limitation, subject to contractual restrictions, and by Affiliates subject to the requirements set forth in Rule 144, except for the holding period limitation of Rule 144. See "Management -- Stock Option Plan," "-- Long-Term Incentive Plan," "-- Employee Stock Purchase Plan," "Shares Eligible for Future Sale" and "Underwriting." 13 15 NO PRIOR PUBLIC MARKET FOR COMMON STOCK; POSSIBLE VOLATILITY OF STOCK PRICE Prior to this Offering, there has been no public market for the Common Stock, and there can be no assurance that an active public market for the Common Stock will develop or be sustained after the Offering. The initial public offering price will be determined through negotiations between the Company, the representatives of the Selling Stockholders and the Underwriters. See "Underwriting" for a discussion of the factors to be considered in determining the initial public offering price. The trading price of the Company's Common Stock could be subject to significant fluctuations in response to variations in quarterly operating results, the gain or loss of significant orders, changes in earning estimates by analysts, announcements of technological innovations or new products by the Company or its competitors, general conditions in the consumer lending and software industries, credit processing software and services and other events or factors. In addition, the stock market in general has experienced extreme price and volume fluctuations which have affected the market price for many companies in industries similar or related to that of the Company and which have been unrelated to the operating performance of these companies. These market fluctuations may adversely affect the market price of the Company's Common Stock. EFFECT OF CERTAIN CHARTER PROVISIONS; ANTITAKEOVER EFFECTS OF CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE LAW Following the consummation of this Offering, the Company's Board of Directors will have 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. See "Description of Capital Stock." IMMEDIATE AND SUBSTANTIAL DILUTION New investors participating in this Offering will incur immediate and substantial dilution of $8.79 per share from the initial public offering price. To the extent outstanding options to purchase the Common Stock are exercised, there will be further dilution. See "Dilution" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." ABSENCE OF DIVIDENDS The Company has never paid or declared any cash dividends and 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. See "Dividend Policy." 14 16 USE OF PROCEEDS The net proceeds to the Company from the sale of the 2,200,000 shares of the Common Stock offered by the Company hereby are estimated to be approximately $23.7 million ($28.0 million if the Underwriters' over-allotment option is exercised in full) after deducting underwriting discounts and commissions and estimated offering expenses payable by the Company and assuming an initial public offering price of $12.00 per share. The primary purposes of this Offering are to create a public market for the Common Stock, to facilitate future access by the Company to public markets and obtain additional working capital. Prior to this Offering, there has been no market for the Common Stock, and there can be no assurance that an active public market for the Common Stock will develop or be sustained after the Offering. The Company will not receive any proceeds from the sale of the shares of the Common Stock by the Selling Stockholders. The Company expects to use the net proceeds for the expansion of the Company's sales, marketing and customer support organizations, capital expenditures (including purchases of test and development hardware and installation of redundant systems) and other general corporate and working capital purposes. The amounts actually expended by the Company will vary significantly depending upon a number of factors, including future revenue growth and the amount of cash generated by the Company's operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Furthermore, the Company expects from time to time to evaluate the acquisition of products, businesses and technologies which complement the Company's business, for which a portion of the net proceeds may be used. Currently, however, the Company does not have any understandings, commitments or agreements and is not in any negotiations with respect to any such acquisitions. Pending such uses, the Company intends to invest the net proceeds in United States government securities and in short-term, interest-bearing investment grade securities. In addition, the Company will receive proceeds of $500,000 from the exercise of options to purchase 100,000 shares of Common Stock by certain Selling Stockholders immediately prior to the consummation of the Offering. DIVIDEND POLICY The Company has been a Subchapter S Corporation for federal and state income tax purposes since its inception in 1987. As a result, the net income of the Company for federal and state income tax purposes was reported by, and taxed directly to, the Company's stockholders. The Company made distributions to its current stockholders of $105,000 in 1994 and $52,500 in 1995 to fund stockholder tax liabilities resulting from the Company's status as a Subchapter S Corporation. In connection with the termination of the Company's Subchapter S Corporation status upon the Company's reincorporation in Delaware, the Company estimates that approximately $75,000 will be distributed to the current stockholders for their estimated federal and state income tax liabilities. The Company currently intends to retain its earnings following the Offering for use in its business. Consequently, the Company currently does not anticipate paying any cash dividends in the foreseeable future. In addition, the Company's bank line of credit prohibits the payment of cash dividends without the bank's prior written consent. The Company expects to enter into an agreement (the "Tax Indemnification Agreement") with certain persons who were stockholders of the Company while it was a Subchapter S Corporation (the "Existing Stockholders") providing for, among other things, the indemnification of the Company by such stockholders for any federal and state income taxes (including interest) incurred by the Company if for any reason the Company is deemed to be treated as a Subchapter C Corporation during any period which it reported its taxable income as Subchapter S Corporation. The Tax Indemnification Agreement further provides for the cross-indemnification of the Company and of each Existing Stockholder for any losses or liabilities with respect to certain additional taxes (including interest and, in the case of Existing Stockholders, penalties) resulting from the Company's operations during the period in which it was Subchapter S Corporation. See "Certain Transactions." 15 17 CAPITALIZATION The following table sets forth as of September 30, 1996 (i) the actual capitalization of the Company, (ii) the pro forma capitalization of the Company after giving effect to the termination of the Company's S Corporation status and (iii) the capitalization of the Company as adjusted to give effect to the sale of the shares of Common Stock offered by the Company hereby at an assumed initial public offering price of $12.00 per share, the application of the estimated net proceeds to the Company therefrom as described under "Use of Proceeds," and the receipt of $500,000 from certain Selling Stockholders in connection with the exercise of options to purchase 100,000 shares immediately prior to the consummation of the Offering. This information is qualified in its entirety by, and should be read in conjunction with, the consolidated financial statements of the Company, and related notes thereto, appearing elsewhere in this Prospectus.
AT SEPTEMBER 30, 1996 ------------------------------------- ACTUAL PRO FORMA AS ADJUSTED --------- --------- ----------- Current portion of long-term debt and capital lease obligations............................................ $ 240,777 $ 240,777 $ 240,777 ========== ========== ========== Stockholder loans and capital lease obligations, less current portion........................................ $ 469,145 $ 469,145 $ 469,145 Stockholders' equity (deficit): Preferred Stock, par value $0.01: 1,000,000 shares authorized (as adjusted only); no shares outstanding..................................... -- -- -- Common Stock, par value $0.01: 10,000,000 shares authorized, actual and pro forma, 40,000,000 shares authorized as adjusted; 4,910,100 shares outstanding, actual and pro forma; 7,210,100 shares outstanding, as adjusted(1)(2).................. 49,101 49,101 72,101 Additional paid-in capital............................... -- -- 24,129,000 Accumulated (deficit).................................... (679,002) (884,488) (884,488) ---------- ---------- ---------- Total stockholders' equity (deficit)................ (629,901) (835,387) 23,316,613 ---------- ---------- ---------- Total capitalization........................... $(160,756) $(366,242) $23,785,758 ========== ========== ==========
- --------------- (1) Excludes 390,000 shares of Common Stock subject to the Underwriters' over-allotment option granted by the Company. (2) Excludes (i) an aggregate of 2,447,800 shares of Common Stock issuable upon exercise of stock options at a weighted-average exercise price of $5.35 per share, of which options to purchase 560,760 shares of Common Stock will be exercisable after the Offering, (ii) 202,200 additional shares of Common Stock reserved for future issuance under the Company's stock option plan, (iii) 250,000 shares reserved for issuance under the Employee Stock Purchase Plan and (iv) 750,000 shares reserved for issuance under the Long-Term Incentive Plan. At November 14, 1996, an aggregate of 2,547,800 shares of Common Stock were issuable upon exercise of stock options, of which options to purchase 100,000 shares will be exercised by certain Selling Stockholders immediately prior to the consummation of the Offering. See "Management -- Stock Option Plan," "-- Long-Term Incentive Plan" and "-- Employee Stock Purchase Plan." 16 18 DILUTION The net tangible book value (deficit) of the Company as of September 30, 1996 was $(832,156), or $(0.17) per share of Common Stock. Net tangible book value (deficit) per share of Common Stock is determined by dividing the Company's tangible net worth (deficit) by the number of shares of Common Stock outstanding. The pro forma net tangible book value (deficit), after giving effect to the net deferred income tax liability recorded as a result of the termination of the Company's Subchapter S Corporation status, would be a deficit of $(1,037,642) or $(0.21) per share. After giving effect to the sale by the Company of 2,200,000 shares of Common Stock in this Offering (at an assumed initial public offering price of $12.00 per share), the application of the estimated net proceeds therefrom, and the receipt of $500,000 from certain Selling Stockholders in connection with the exercise of options to purchase 100,000 shares immediately prior to the consummation of the Offering, the pro forma net tangible book value of the Company as of September 30, 1996 would have been $23,114,358 or $3.21 per share. This represents an immediate increase in pro forma net tangible book value of $3.42 per share to existing stockholders and an immediate dilution in pro forma net tangible book value of $8.79 per share to new investors purchasing shares of Common Stock in the Offering. The following table illustrates the per share dilution: Assumed initial public offering price per share of Common Stock...................................................... $12.00 Net tangible book value (deficit) per share at September 30, 1996................................................ (0.17) Pro forma adjustments (see above).......................... (0.04) ------ Pro forma net tangible book value (deficit) per share as of September 30, 1996......................................... (0.21) Increase in net tangible book value (deficit) per share of Common Stock attributable to new investors................. 3.42 ------ Pro forma net tangible book value per share of Common Stock after the Offering......................................... 3.21 ------ Dilution per share to new investors.......................... $ 8.79 ======
The following table summarizes, on a pro forma basis as of September 30, 1996, the differences between existing stockholders and the new investors with respect to the number of shares of Common Stock purchased from the Company, the total consideration paid to the Company and the average price per share paid:
SHARES OWNED AFTER THE PUBLIC OFFERING TOTAL CONSIDERATION AVERAGE --------------------- ----------------------- PRICE PER NUMBER PERCENT AMOUNT PERCENT SHARE --------- ------- ----------- ------- --------- Existing stockholders(1)............... 4,910,100 69.1% $ 2,500 -- $ 0.00 New investors(1)(2).................... 2,200,000 30.9% 26,400,000 100.0% 12.00 ---------- ------ ----------- ------ Total........................ 7,110,100 100.0% $26,402,500 100.0% ========== ====== =========== ======
- --------------- (1) Sales by Selling Stockholders in this Offering will reduce the number of shares held by existing stockholders to 4,610,100 or 63.9% of the total number of shares of Common Stock outstanding after this Offering (60.7% if the Underwriters' over-allotment option is exercised in full), and will increase the number of shares held by new investors to 2,600,000 or 36.1% of the total number of shares of Common Stock outstanding after the Offering (39.4% if the Underwriters' over-allotment option is exercised in full). See "Principal and Selling Stockholders." (2) Excludes 100,000 shares of Common Stock sold by certain Selling Stockholders in the Offering. These shares will be acquired by the certain Selling Stockholders immediately prior to the consummation of the Offering through the exercise of stock options that will result in $500,000 of cash proceeds to the Company. The foregoing tables exclude (i) an aggregate of 2,447,800 shares of Common Stock issuable upon exercise of stock options at a weighted-average exercise price of $5.35 per share, of which options to purchase 560,760 shares of Common Stock will be exercisable after the Offering, (ii) 202,200 additional shares of Common Stock reserved for future issuance under the Company's stock option plan, (iii) 250,000 shares reserved for issuance under the Employee Stock Purchase Plan and (iv) 750,000 shares reserved for issuance under the Long-Term Incentive Plan. At November 14, 1996, an aggregate of 2,547,800 shares of Common Stock were issuable upon exercise of stock options, which 100,000 shares will be exercised by Selling Stockholders in connection with the Offering. See "Management -- Stock Option Plan," "-- Long-Term Incentive Plan" and "-- Employee Stock Purchase Plan." To the extent outstanding options are exercised, there will be further dilution to new investors. 17 19 SELECTED CONSOLIDATED FINANCIAL DATA The consolidated statement of operations data set forth below for the fiscal years ended December 31, 1993, 1994 and 1995, and the nine months ended September 30, 1996, and the consolidated balance sheet data at December 31, 1993, 1994 and 1995 and September 30, 1996 are derived from, and should be read in conjunction with, the audited consolidated financial statements of the Company, and the notes thereto, which are included elsewhere in this Prospectus. The consolidated statements of operations data for the fiscal years ended December 31, 1991 and 1992 and the consolidated balance sheet data at December 31, 1991 and 1992 are derived from unaudited consolidated financial statements of the Company not included herein. The selected financial data at September 30, 1995 and for the nine months ended September 30, 1995 are derived from unaudited consolidated financial statements included elsewhere in this Prospectus. The unaudited consolidated financial statements include all adjustments (consisting only of normal recurring adjustments and accruals) that in the opinion of management are necessary for a fair presentation of the financial information set forth therein. Operating results for the nine months ended September 30, 1996 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 1996. The selected financial data set forth below are qualified in their entirety by, and should be read in conjunction with, the consolidated financial statements, the related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Prospectus.
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------------------------------------- ------------------------- 1991 1992 1993 1994 1995 1995 1996 ----------- ----------- ----------- ----------- ----------- ----------- ----------- STATEMENT OF OPERATIONS DATA: REVENUES License and software development fees........................... $ 1,274,659 $ 1,781,619 $ 2,911,539 $ 2,934,450 $ 7,207,581 $ 4,778,059 $ 6,453,243 Maintenance fees................. 131,548 157,371 375,510 700,861 1,170,447 874,076 1,433,190 Computer hardware sales.......... 65,161 9,851 81,019 316,145 1,853,424 1,076,724 1,149,052 ----------- ----------- ----------- ----------- ----------- ----------- ----------- 1,471,368 1,948,841 3,368,068 3,951,456 10,231,452 6,728,859 9,035,485 COSTS AND EXPENSES Cost of license and software development fees............... 572,180 819,929 785,622 1,482,036 3,559,798 2,186,040 3,519,921 Cost of maintenance fees......... -- 32,347 40,776 151,346 280,176 214,320 324,387 Cost of computer hardware sales.......................... 8,777 1,509 77,979 315,262 1,500,816 842,407 998,876 Selling, general and administrative expenses........ 900,446 1,379,929 2,234,816 2,244,031 3,966,265 2,631,749 4,048,248 Research and development costs... -- -- 131,203 167,152 165,366 91,313 344,326 ----------- ----------- ----------- ----------- ----------- ----------- ----------- 1,481,403 2,233,714 3,270,396 4,359,827 9,472,421 5,965,829 9,235,758 Income (loss) from operations.... (10,035) (284,873) 97,672 (408,371) 759,031 763,030 (200,273) OTHER INCOME (EXPENSE) Interest expense................. (205,653) (80,034) (32,774) (41,310) (105,849) (83,029) (81,212) Minority interest share of loss........................... 115,451 181,676 -- -- -- -- -- Amortization of excess of assigned value of identifiable assets over cost of an acquired interest....................... -- -- 253,959 304,750 304,750 228,562 228,562 ----------- ----------- ----------- ----------- ----------- ----------- ----------- (90,202) 101,642 221,185 263,440 198,901 145,533 147,350 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Net income (loss)................ $ (100,237) $ (183,231) $ 318,857 $ (144,931) $ 957,932 $ 908,563 $ (52,923) =========== =========== =========== =========== =========== =========== =========== Pro forma data (unaudited)(1): Historical income (loss)....... $ 957,932 $ (52,923) Pro forma income tax expense (benefit).................... 220,618 (97,928) ----------- ----------- Pro forma net income........... $ 737,314 $ 45,005 =========== =========== Pro forma net income per share........................ $ 0.12 $ 0.01 =========== =========== Shares used in pro forma net income per share calculations................. 6,293,720 6,293,720
AS OF DECEMBER 31, AS OF SEPTEMBER 30, ------------------------------------------------------------------- ------------------------- 1991 1992 1993 1994 1995 1996 1996 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ACTUAL PRO ----------- FORMA(1) ----------- BALANCE SHEET DATA: Cash and cash equivalents........ $ 46,516 $ 253,092 $ 108,554 $ 75,840 $ 120,255 $ 8,433 $ 8,433 Working capital (deficit)........ (15,508) (317,015) (246,748) (1,073,896) (1,181,894) (1,690,612) (1,561,671) Total assets..................... 898,320 637,678 797,465 1,581,751 4,035,323 5,188,599 5,392,540 Long term debt, capital lease obligations and stockholder loans, less current portion.... 649,231 778,710 237,288 416,136 623,304 469,145 469,145 Stockholders' deficit............ (1,389,753) (1,551,336) (1,232,479) (1,482,410) (576,978) (629,901) (835,387)
- --------------- (1) The Company has operated as a Subchapter S Corporation for federal and state income tax purposes since its inception in 1987, and, therefore, the historical financial statements do not include a provision for federal and state income taxes for such periods. Pro forma net income (loss) has been computed as if the Company had been subject to federal and state income taxes based on the tax laws in effect during the respective periods. See Note 2 of Notes to Consolidated Financial Statements. 18 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Prospectus contains forward-looking statements relating to future events or the future financial performance of the Company. Prospective investors are cautioned that such statements are only predictions and that events or results may differ materially. In evaluating such statements, prospective investors should specifically consider the various factors identified in this Prospectus, including the matters set forth under the caption "Risk Factors," which could cause actual results to differ materially from those indicated by such forward-looking statements. GENERAL Overview The Company was incorporated in 1987 to commercialize an automated credit processing system developed by James R. DeFrancesco, the Company's President and Chief Executive Officer, and Scott L. Freiman, the Company's Executive Vice President, while they were employed by American Financial Corporation ("AFC"), an automobile finance servicing company owned by Mr. DeFrancesco. AFC was acquired in October 1987 by Perpetual Savings Bank, FSB. Mr. DeFrancesco and Mr. Freiman retained ownership of AFC's credit processing software which formed the basis for CreditRevue. CreditRevue was initially released in 1988. Since its initial release, the Company has continually enhanced CreditRevue in response to the needs of its customers. Credit Connectionbecame commercially available in July 1996 and, to date, has generated approximately $27,000 in revenues. Fees from licenses of CreditRevue and related maintenance fees and resales of third-party computer hardware and software associated with installations of CreditRevue accounted for virtually all of the Company's revenue through September 30, 1996. See "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 time to completion. For a description of certain risks associated with the lengthy implementation time associated with installations of CreditRevue, see "Risk Factors -- Lengthy Sales and Implementation Cycle." The Company recognizes revenue for maintenance fees pro rata over the term of the related agreement, which is generally one year. Maintenance fees received in advance of revenue recognition are included in deferred maintenance fees. 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 nine months ended September 30, 1996, revenues from third-party hardware and software sales accounted for 12.7% and 2.3% of total revenues, respectively. Revenues from resales of third-party computer hardware and software are recognized at the time of shipment and installation. Certain of the Company's products and services, including Credit Connection and CreditRevue Service Bureau, are, or will be, charged on a per transaction basis. As a result, the Company anticipates that transaction-based revenue will be an increasing proportion of the Company's revenue. The Company's sales and marketing efforts will no longer be exclusively targeted at generating license-based revenue but will be increasingly focused on generating transaction-based revenue from prospective customers. The Company's anticipated future growth is based, in large part, on the success of these products and services and the transition to a transaction-based revenue stream. Accordingly, the failure by the Company to generate demand for Credit Connection or CreditRevue Service Bureau, the occurrence of any significant technological problems, such as a system failure incurred prior to the implementation of a back-up computer system, the Company's lack of systems failure or interruption insurance, 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 19 21 Company's business, results of operations and financial condition. See "Risk Factors -- Market Acceptance of Credit Connection; Transition to Transaction-Based Revenue" and "-- System Interruption and Security Risks; Potential Liability; Possible Lack of Adequate Insurance; and System Inadequacy." Since 1987, the Company has continually invested in the development and introduction of new products, services and enhancements to its software. Research and development expenditures are expensed as incurred. Certain software development costs are capitalized subsequent to the establishment of technological feasibility in accordance with Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed. Based on the Company's current research and development process, technological feasibility is established upon completion of a working model. The Company intends to continue to expend substantial resources on developing new products and services and enhancements to its software to incorporate technological developments and satisfy evolving customer needs. As of September 30, 1996, the Company had nine employees in its sales and marketing organization. The Company intends to hire a significant number of additional sales and marketing personnel in the future to help the Company expand its market presence. Competition for such personnel is intense, and there can be no assurance that the Company can retain its existing sales personnel or that it can attract, assimilate or retain additional highly qualified sales persons in the future. If the Company is unable to hire such personnel on a timely basis, the Company's business, results of operations and financial condition could be materially and adversely affected. The Company operates as a Subchapter S Corporation and, therefore, does not accrue federal corporate taxes on its earnings. Upon reincorporation in Delaware, the Company's Subchapter S Corporation status will terminate and the Company will be subject to federal and state income tax at the corporate level. The Company does not expect this change in status to have a significant impact on its cash flows as it previously made distributions to its stockholders for the payment of income taxes. See Note 2 to the Consolidated Financial Statements included elsewhere in this Prospectus. 20 22 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):
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ----------------------- --------------- 1993 1994 1995 1995 1996 ----- ----- ----- ----- ----- Percentages of Total Revenues Revenues License and software development fees.............. 86.5% 74.3% 70.5% 71.0% 71.4% Maintenance fees................................... 11.1 17.7 11.4 13.0 15.9 Computer hardware sales............................ 2.4 8.0 18.1 16.0 12.7 ----- ----- ----- ----- ----- 100.0 100.0 100.0 100.0 100.0 ----- ----- ----- ----- ----- Costs and Expenses Cost of license and software development fees...... 23.3 37.5 34.8 32.5 39.0 Cost of maintenance fees........................... 1.2 3.8 2.7 3.2 3.6 Cost of computer hardware sales.................... 2.3 8.0 14.7 12.5 11.1 Selling, general and administrative expenses....... 66.4 56.8 38.8 39.1 44.8 Research and development costs..................... 3.9 4.2 1.6 1.4 3.8 ----- ----- ----- ----- ----- 97.1 110.3 92.6 88.7 102.3 Income (loss) from operations........................... 2.9 (10.3) 7.4 11.3 (2.3) Other income (expense) Interest expense................................... (1.0) (1.0) (1.0) (1.2) (0.9) Amortization of excess of assigned value of identifiable assets over the cost of an acquired interest......................................... 7.6 7.6 3.0 3.4 2.5 ----- ----- ----- ----- ----- 6.6 6.6 2.0 2.2 1.6 ----- ----- ----- ----- ----- Net income (loss)....................................... 9.5% (3.7)% 9.4% 13.5% (0.7)% ===== ===== ===== ===== ===== Pro forma data (unaudited): Historical income (loss).............................. 9.4% (0.7)% Pro forma income tax expense (benefit)................ 2.2 (1.1) ----- ----- Pro forma net income.................................. 7.2% 0.6% ===== =====
Total Revenues Total revenues increased 34.3% from $6.7 million in the nine months ended September 30, 1995 to $9.0 million in the nine months ended September 30, 1996. Total revenues increased 17.3% from $3.4 million in 1993 to $4.0 million in 1994 and 158.9% to $10.2 million in 1995. The Company's revenues are derived from three sources: license and software development fees, maintenance fees and computer hardware sales. The Company's 10 largest customers accounted for 77.3% and 73.4% of total revenues in 1995 and the first nine months of 1996, respectively. One of the Company's customers accounted for 10.8% of total revenues in the first nine months of 1996. Two of the Company's customers accounted for 19.8% and 12.9% of total revenues, respectively, in 1995. Four of the Company's customers accounted for 17.4%, 15.9%, 12.4% and 10.2% of total revenues, respectively, in 1994. Six of the Company's customers accounted for 18.3%, 15.9%, 13.0%, 11.8%, 11.1% and 11.0% of total revenues, respectively, in 1993. License and Software Development Fees CreditRevue accounted for virtually all of the Company's license and software development fee revenue through September 30, 1996. License and software development fees increased 35.1% from $4.8 million in the nine months ended September 30, 1995 to $6.5 million in the nine months ended September 30, 1996. License and software development fees remained constant at $2.9 million in 1993 and 1994 and increased 145.6% to $7.2 million in 1995. The increases during these periods resulted from increased market acceptance of CreditRevue. 21 23 Maintenance Fees Maintenance fees include fees from software maintenance agreements. Maintenance fees increased by 64.0% from $0.9 million in the nine months ended September 30, 1995 to $1.4 million in the nine months ended September 30, 1996. Maintenance fees increased 86.6% from $0.4 million in 1993 to $0.7 million in 1994 and 67.0% to $1.2 million in 1995. The growth in these revenues during the periods presented was the result of increased maintenance fees associated with the increased number of licenses of CreditRevue outstanding during such periods. Computer Hardware Sales Computer hardware sales revenue was virtually unchanged in the nine months ended September 30, 1995 as compared to the nine months ended September 30, 1996. Computer hardware sales revenue increased 290.2% from $0.1 million in 1993 to $0.3 million in 1994 and 486.3% to $1.9 million in 1995. 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 increase in such revenues during these periods reflects the increase in the number of licenses and installations of the Company's CreditRevue software. 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 by 61.0% from $2.2 million in the nine months ended September 30, 1995 to $3.5 million in the nine months ended September 30, 1996. Cost of license and software development fees increased by 88.6% from $0.8 million in 1993 to $1.5 million in 1994 and 140.2% to $3.6 million in 1995. As a percentage of license fee and software development revenue, cost of license and software development fees were 27.0%, 50.5%, 49.4%, 53.6%, 56.5%, 45.8% and 54.5% in 1993, 1994, 1995, the three months ended September 30, 1995, the three months ended December 31, 1995, and the nine months ended September 30, 1995 and 1996, respectively. The variability of the cost of license and software fees as a percentage of license and software development fees over these periods is primarily related to the fluctuation in the Company's quarterly revenues and higher hourly labor costs associated with temporary contractors during periods in which the Company experienced increased demand for its products. The Company's costs on a full-time equivalent basis for temporary contractors is generally twice the amount incurred by the Company for its in-house technical personnel. In late 1995 and into 1996, the Company increased internal staffing levels commensurate with the expected growth in revenues. These increased staffing levels are expected to reduce the dependency on temporary contractors upon the completion of their training in the Company's proprietary products and services and technology, resulting in a corresponding increase in the margins related to these revenues. Total labor costs as a percentage of revenue are also expected to decrease as the Company and its customers move to a greater level of product standardization. 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 from $0.2 million in the nine months ended September 30, 1995 to $0.3 million in the nine months ended September 30, 1996. Cost of maintenance fees increased from $0.1 million in 1993 to $0.2 million in 1994 to $0.3 million in 1995. As a percentage of maintenance fee revenue, cost of maintenance fees was 10.9%, 21.6%, 23.9%, 24.5% and 22.6% in 1993, 1994, 1995 and the nine months ended September 30, 1995 and 1996, 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 decrease in the percentage of cost of maintenance fees to maintenance fee revenue in the nine months ended September 30, 1996 as compared to September 30, 1995 resulted from better efficiencies in the utilization of maintenance personnel as maintenance revenues have increased. 22 24 Cost of Computer Hardware Sales Cost of computer hardware sales consists of (i) the Company's cost of computer hardware resold to the Company's customers that are licensing CreditRevue and (ii) salaries and benefits for systems integration employees. Cost of computer hardware sales increased by 18.6% from $0.8 million in the nine months ended September 30, 1995 to $1.0 million in the nine months ended September 30, 1996. Cost of computer hardware sales increased from $0.1 million in 1993 to $0.3 million in 1994 and to $1.5 million in 1995. As a percentage of computer hardware sales revenue, cost of computer hardware sales was 96.2%, 99.7%, 81.0%, 78.2% and 86.9% in 1993, 1994, 1995 and the nine months ended September 30, 1995 and 1996, respectively. The dollar increase in the cost of computer hardware sales reflects the increase 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. Selling, General and Administrative Expenses Selling, general and administrative expenses increased 53.8% from $2.6 million in the nine months ended September 30, 1995 to $4.0 million in the nine months ended September 30, 1996. Of this $1.4 million increase, approximately $0.9 million related to payroll expenses which resulted primarily from an increase in the Company's administrative staff, including $0.2 million of expense related to severance payments made to a former officer of the Company, and approximately $0.5 million of the increase related to non-salary based administrative expenses. Selling, general and administrative expenses remained relatively constant at $2.2 million in 1993 and 1994 and increased 76.7% to $4.0 million in 1995. Selling, general and administrative expenses includes (i) salaries, commissions and bonuses paid to sales and marketing personnel, as well as travel and promotional expenses, and (ii) salaries of administrative, executive and financial personnel, and (iii) outside professional fees. The increase in these expenses is attributable to several factors. The increase in such expenses was a result of an increase in sales and marketing staff from three in 1993 to eight at September 30, 1996. In addition, such expenses increased due to an increase in administrative staff from 14 in 1993 to 30 at September 30, 1996, and expenses associated with the growth of the Company and an increase in legal fees associated with the protection of the Company's proprietary intellectual property. Research and Development Costs Research and development costs consist primarily of salaries and benefits of in-house programmers. These costs increased $0.3 million during the nine months ended September 30, 1996 as compared to the nine months ended September 30, 1995 due primarily to the addition of four programmers in 1996 and the commercial release of Credit Connection in July 1996. During the period from September 1994 through June 1996, the direct payroll costs of certain programmers were capitalized as software development costs. See Note 1 to Notes to Consolidated Financial Statements. During the third quarter of 1996, the direct payroll costs of these programmers were included in research and development costs. 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 is being amortized into income using the straight-line method over four years. Interest Expense Interest expense was $0.1 million in the nine months ended September 30, 1995 and $0.1 million in the nine months ended September 30, 1996. Interest expense was $32,774, $41,310 and $0.1 million in 1993, 1994 and 1995, respectively. The increase in interest expense over such periods resulted from increased borrowings under the Company's line of credit and an increase in capital lease obligations. 23 25 PRO FORMA ADJUSTMENTS FOR INCOME TAXES From its inception in 1987, the Company has 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 have been taxed directly to the Company's stockholders. The pro forma adjustments for income taxes were calculated as if the Company were subject to tax under the federal and state income tax laws in effect for the respective periods using the criteria established under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." See Note 2 to "Notes to Consolidated Financial Statements," included elsewhere in this Prospectus. 24 26 QUARTERLY INFORMATION The following tables set forth certain unaudited quarterly consolidated financial information for each of the four quarters in 1995 and for each of the three quarters in the nine months ended September 30, 1996. The Company believes that this information has been presented on the same basis as the audited consolidated financial statements appearing elsewhere in this Prospectus and all necessary adjustments (consisting only of normal recurring adjustments) have been included in the amounts stated below to present fairly the unaudited quarterly results when read in conjunction with the audited consolidated financial statements of the Company and related notes thereto included elsewhere in this Prospectus. The operating results for any quarter are not necessarily indicative of the operating results for any future period.
THREE MONTHS ENDED ------------------------------------------------------------------------------------------------ MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, 1995 1995 1995 1995 1996 1996 1996 ---------- ---------- ------------- ------------ ---------- ---------- ------------- Revenues License and software development fees......... $1,187,692 $1,762,835 $ 1,827,532 $2,429,522 $1,776,593 $2,233,388 $ 2,443,262 Maintenance fees........... 221,908 251,585 400,583 296,371 418,237 432,774 582,179 Computer hardware sales.... 288,971 392,521 395,232 776,700 404,388 5,074 739,590 ---------- ---------- ----------- ---------- ---------- ---------- ----------- Total 1,698,571 2,406,941 2,623,347 3,502,593 2,599,218 2,671,236 3,765,031 ---------- ---------- ----------- ---------- ---------- ---------- ----------- Costs and Expenses Cost of license and software development fees..................... 755,404 451,718 978,918 1,373,758 1,071,257 1,276,823 1,171,841 Cost of maintenance fees... 74,176 70,046 70,098 65,856 110,591 97,993 115,803 Cost of computer hardware sales.................... 181,292 244,098 417,017 658,409 336,025 35,186 627,665 Selling, general and administrative expenses................. 542,633 1,274,818 814,298 1,334,516 1,353,402 1,026,897 1,667,949 Research and development costs.................... 20,160 14,053 57,100 74,053 90,667 90,681 162,978 ---------- ---------- ----------- ---------- ---------- ---------- ----------- 1,573,665 2,054,733 2,337,431 3,506,592 2,961,942 2,527,580 3,746,236 ---------- ---------- ----------- ---------- ---------- ---------- ----------- Income (loss) from operations................... 124,906 352,208 285,916 (3,999) (362,724) 143,656 18,795 Other income (expense) Interest expense........... (20,810) (31,013) (31,206) (22,820) (31,147) (29,400) (20,665) Amortization of excess of assigned value of identifiable assets over cost of an acquired interest................. 76,188 76,186 76,188 76,188 76,187 76,188 76,187 ---------- ---------- ----------- ---------- ---------- ---------- ----------- 55,378 45,173 44,982 53,368 45,040 46,788 55,522 ---------- ---------- ----------- ---------- ---------- ---------- ----------- Net income (loss).............. $ 180,284 $ 397,381 $ 330,898 $ 49,369 $ (317,684) $ 190,444 $ 74,317 ========== ========== =========== ========== ========== ========== =========== Pro forma data (unaudited): Historical income (loss)..... $ 180,284 $ 397,381 $ 330,898 $ 49,369 $ (317,684) $ 190,444 $ 74,317 Pro forma income tax expense (benefit).................. 41,465 91,397 76,401 11,355 (263,678) 157,905 7,845 ---------- ---------- ----------- ---------- ---------- ---------- ----------- Pro forma net income (loss)..................... $ 138,819 $ 305,984 $ 254,497 $ 38,014 $ (54,006) $ 32,539 $ 66,472 ========== ========== =========== ========== ========== ========== ===========
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 Credit Connection and CreditRevue Service Bureau, the demand for the Company's products and services, the successful transition from predominantly license fee-based revenue to predominantly transaction fee-based revenue, the timing of new product and service 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 or delay of individual orders, therefore, would have a significant impact on the Company's revenue and quarterly results of 25 27 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 of 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 "Risk Factors -- Uncertainty of Future Results of Operations; Fluctuations in Quarterly Results of Operations." LIQUIDITY AND CAPITAL RESOURCES The Company has historically funded its working capital needs and investments in property and equipment from operating cash flows. During the years ended December 31, 1993, 1994 and 1995 the Company generated net cash from operating activities of $0.3 million, $0.3 million and $0.8 million, respectively. For the nine-month periods ended September 30, 1995 and 1996, net cash provided by operating activities was $0.5 million and $0.4 million, respectively. Despite these positive net cash flows from operating activities, the Company reported a working capital deficiency of $1.2 million and $1.7 million at December 31, 1995 and September 30, 1996, respectively. This working capital deficiency is primarily caused by the deferral for financial reporting purposes of certain billings on contracts to develop software, and deferred revenue related to maintenance contracts and computer hardware and software sales. Net deferred revenue of these items at December 31, 1995 and September 30, 1996 was $0.9 million and $2.0 million, respectively. 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, 1993, 1994 and 1995, the Company invested a total of $0.5 million, $0.3 million, and $0.7 million, respectively, in property and equipment and capitalized software development costs. During the nine-month periods ended September 30, 1995 and 1996 these investments totaled $0.5 million and $0.4 million, respectively. These investments were directly attributable to the Company's growth in operations. The Company does not have any material commitments for the purchase of property and equipment at September 30, 1996. The Company has historically relied principally on its bank line of credit for its limited financing needs. The Company maintains a secured bank line of credit in the amount of $0.5 million, $0.3 million of which was outstanding at September 30, 1996. The line of credit bears interest at the bank's prime rate plus 1% per annum (9.25% at September 30, 1996). Further, the bank's line of credit requires the bank's written consent prior to, among other things, (i) the payment of cash dividends, (ii) the Company's engagement in a substantially different business activity, or (iii) the purchase by the Company of any interest in another enterprise or entity. The Company is obligated to Mr. James R. DeFrancesco, the Company's President and Chief Executive Officer, for $0.2 million of loans bearing interest at 7% per annum and due on demand after October 1, 1997. The Company currently anticipates that its available cash resources, expected cash flows from operations, and its bank line of credit, combined with the net proceeds of the Offering, will be sufficient to meet its presently anticipated working capital, capital expenditure and debt repayment requirements through 1997. 26 28 BUSINESS GENERAL CMSI is a developer and provider of software solutions and services for automating the consumer and small business credit analysis, decisioning and funding process. Drawing upon over 10 years of experience in the credit processing industry, the Company has developed and provides open-architecture software products and services which manage volume-intensive credit operations over wide-area networks. 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. These products and services are designed to enable credit originators, such as automobile dealerships and retailers, and lenders, such as banks and finance companies, to improve operating efficiencies by increasing productivity, enhance customer satisfaction by reducing turnaround time on credit decisions, and decrease portfolio risk by applying consistent underwriting standards. The Company's core product, CreditRevue, analyzes credit applications by automatically accessing third-party credit bureau reports, consulting the lending institution's internal loan guidelines and incorporating the loan "scorecards" used by lending institutions. Using CreditRevue, decision response time generally ranges from a matter of seconds for automated decisions to several minutes in cases where review by a credit analyst is required. The Company's CreditRevue customers include some of the largest financial institutions and finance companies in the United States, such as NationsBank Corp., BancOne Corp., Wells Fargo Bank and The Associates Bancorp, Inc. In addition, the Company has introduced CreditRevue to the telecommunications industry through a joint venture between AirTouch Cellular, Inc. and US West New Vector Group, Inc. To further support the needs of the lending industry, the Company developed Credit Connection, which became commercially available in July 1996. Credit Connection, a software-based service, links sources of credit origination through an online network that allows applications to be transmitted to multiple funding sources and credit decisions to be delivered back to the point of origin in a matter of minutes. To date, Credit Connection has generated approximately $27,000 in revenues. The Company's strategy is to introduce Credit Connection to the marketplace through the Company's sales force, the sales forces of lending institutions and various remarketers. The Company's agreements with each lending institution that subscribes to the Credit Connection 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 Credit Connection service. Currently, NationsBank, First Merchants and another sub-prime lender have executed such Credit Connection lender agreements. The Company also has been pursuing remarketing arrangements for the Credit Connection service with vendors that provide automated systems for dealership management and operations. The Company recently signed an agreement to form a strategic alliance with the Dealer Service Group of ADP to remarket Credit Connection. This division of ADP is one of the largest providers of computing and consulting services for automobile and truck dealers worldwide. To date, ADP is the only remarketer to have entered into an agreement with the Company. The Company's agreements with lending institutions that are licensees of CreditRevue require that the Credit Connection service be utilized as the exclusive interface between CreditRevue software and applications transmitted electronically from third parties. The ability of Credit Connection lending institutions that are not CreditRevue licensees to receive applications transmitted electronically from third parties by means other than the Credit Connection service is not similarly restricted. Lending institutions benefit from transactions transmitted over the Credit Connection primarily from increased volumes of credit applications expected by this delivery method. Remarketers benefit by sharing in a percentage of the transactions revenues associated with their remarketing and dealership support efforts. The agreement with ADP provides for ADP to offer the Credit Connection service as its standard approach to establish electronic interfaces between dealerships and financial institutions. Under certain limited circumstances, ADP may provide an interface which is different from the Company's. ADP does not currently remarket any third party products or services which compete with the Credit Connection service. See "-- Strategic Alliance with ADP." 27 29 By facilitating the flow of applications to multiple funding sources through Credit Connection, and by automating the credit application analysis, decisioning and funding process through CreditRevue, the Company believes it is well positioned to capitalize on the growth in the consumer and small business credit markets. The Company's products have been designed to work together and complement each other to provide a seamless credit application process. The Company believes that its CreditRevue customer base and proposed strategic alliance with ADP will enhance its marketing efforts for the Credit Connection service. In addition, the Company believes that the implementation of Credit Connection will create new marketing opportunities for CreditRevue. INDUSTRY OVERVIEW According to a study commissioned by the Federal Reserve Board, the dollar volume of consumer credit transactions increased from $811 billion in 1990 to $1.13 trillion in 1995. Consumer credit transactions include automobile loans, small business loans, home equity loans, credit cards, cellular telephone service activations, student loans and equipment and automobile leasing. The funding sources in these transactions include banks, savings and loan associations, finance companies, sub-prime lenders, leasing companies and student lenders. Sources of credit origination include automobile dealers, retailers and telecommunications companies as well as the branch networks of banks and finance companies. Several factors have influenced the growth in consumer credit. New types of consumer credit have developed and gained widespread acceptance. For example, automobile leasing has become an increasingly popular automobile financing alternative, resulting in the introduction of automobile leasing programs by many financial institutions and automobile dealers. In addition, the use of credit analysis is spreading to new industries, such as telecommunications, insurance, utilities and health care. Moreover, new types of credit providers have entered the market, in particular, sub-prime finance companies that target borrowers who are unable or unwilling to obtain credit from traditional sources. Lastly, credit providers have established new access channels for credit, designed to make credit more easily obtainable by consumers. Credit applications can be received over the telephone, through kiosks that function like automated teller machines and via computers through home banking software and the Internet. Each consumer credit transaction begins with the completion of a credit application by a borrower. The credit application is sent from a branch office of a lending institution or from the source of credit origination, such as an automobile dealer or retailers, to a credit processing department. The application is then assigned to a credit analyst who retrieves reports from one or more credit bureaus, verifies employment and income and obtains a home appraisal, as appropriate, and then examines the information and computes key ratios, such as debt-to-income and loan-to-value. The information and ratios are then compared to one or more scorecards developed by the lender or a third party to determine if the applicant meets predetermined criteria. The credit application is then compared to the lending institution's underwriting guidelines. The analyst then approves or denies the request for credit and the decision is communicated to the consumer. If approved, the credit analyst produces and prints the loan documents, verifies such documents for completeness and accuracy and has the applicant's information entered into the financial institution's accounting or loan servicing system. This labor-intensive and manual process, which may take up to several days depending on the complexity of the loan request and the sophistication of the borrower, may be carried out multiple times for a transaction as the applicant seeks credit from multiple sources. As the dollar volume of consumer credit transactions has increased, competition among lenders has also increased. Accordingly, lenders are seeking to shorten application processing time and lower the cost of credit processing while maintaining their qualifying criteria and complying with the extensive federal and state regulations applicable to credit transactions. Lenders are also seeking to increase market share while decreasing overall portfolio risk. As a result, lenders are moving from a manual credit application process to an automated process. Through automation, a lender can reduce the overall time to render a credit decision while reducing risk and improving customer service. Automating the credit application process is both complex and difficult and lending institutions must implement sophisticated systems which enhance efficiency and cost effectiveness while providing adaptability 28 30 to continually evolving technologies. Existing software solutions are generally mainframe-based or PC-based. Mainframe-based solutions are functionally limited, expensive to maintain and not easily adaptable to new business requirements. PC-based solutions are also functionally limited and impractical for large volume credit operations. Furthermore, existing solutions may not be sufficient to address emerging industry trends. These trends include cross-selling loan products, sub-prime lending and rate-to-risk pricing, which involves the adjustment of a loan's interest rate to reflect the relative credit risk. Automobile dealers and retail establishments typically maintain relationships with a number of lending institutions to service customers with varying credit histories. The ability to send credit applications to those multiple funding sources is critical to their business, especially during non-bank hours, such as evenings and weekends. Many automobile manufacturer-based credit companies (often referred to as "captive lenders") are directly connected to their automobile dealerships. However, these proprietary systems do not allow dealers to send credit applications to non-captive lenders. This issue of connectivity is not limited to retail establishments. For example, prime lenders often send their declined credit applications and receive credit decisions from multiple sub-prime finance companies, a process which can increase overhead to both types of institutions in the absence of an electronic connection. THE CMSI SOLUTION CMSI provides software products and services for automating the credit analysis, decisioning and funding process and for connecting credit originators with multiple funding sources. The Company's original product, CreditRevue, automates and streamlines the credit origination process and eliminates paperwork by automatically accessing credit bureau reports and consulting the lender's underwriting guidelines, incorporating one or more scorecards utilized by the lender, analyzing and verifying the application and facilitating the funding of the loan. Credit Connection links a credit originator with multiple funding sources through an online network that transmits credit applications which can then be evaluated using CreditRevue or another credit automation system. The Company's 10 years of experience in developing information systems, software and services for automating consumer credit transactions has provided the Company with significant insight into the credit application process and the needs of credit originators and lenders which is reflected in both the design of its products and the quality of its customer service. CMSI's family of products and services incorporates the following key attributes: - Streamlined Credit Decisioning and Funding Process CreditRevue and Credit Connection reduce credit application processing and decision time to a matter of minutes. In addition, they facilitate the process for funding and initiating the servicing of the loan. The Company believes that this results in greater consumer satisfaction and increased productivity in the credit processing departments of lenders. Customers utilizing CreditRevue and Credit Connection can reduce the personnel and overhead costs of their credit application processing departments while increasing the number of credit applications that can be processed and funded. - Extensive Connectivity Credit Connection offers connectivity between any number of credit originators and multiple funding sources. Using Credit Connection, credit originators, such as automobile dealers and retailers, can route a single credit application to multiple funding sources to increase the likelihood that the credit application will be approved and to accelerate the credit application process. Credit Connection also provides connectivity between prime and sub-prime lending sources. A single interface between the funding source and Credit Connection is sufficient to communicate with any number and type of credit originators. - Enhanced Risk Management Capabilities By automating credit application processing, CreditRevue enables lenders to use specific, consistent criteria and scoring for evaluating various types of credit applications. The software checks each application for completeness and fraud. In addition, CreditRevue automatically accesses reports from consumer and business credit bureaus and utilizes vehicle valuation and identification data to 29 31 further reduce the risk management profile of each transaction. The credit score given each application can be used to determine the recommended credit decision, qualify the customer for specific products and apply a rate-to-risk pricing matrix. - Sophisticated Tracking and Reporting Functionality CreditRevue and Credit Connection track each stage of the credit application process. CreditRevue routes applications to senior analysts when the dollar amount of the loan exceeds the authority of the original analyst or when the loan does not meet the lender's credit policy. Both CreditRevue and Credit Connection incorporate extensive reporting capabilities which enhance the customer's financial reporting functions and support regulatory compliance. - Targeted Solutions CreditRevue can be configured to meet each lender's needs. The Company offers versions of CreditRevue that are targeted at lending institutions with higher volumes of credit applications that require a full range of features and functionality. The Company is developing a solution for small to medium lending institutions that do not require the same degree of configuration as a large institution. The Company also designs interfaces between CreditRevue and the lender's other systems, including branch automation software, customer information repositories and loan servicing software. - Scalability and Interoperability CreditRevue is designed to support any size financial institution from a single location to multiple distributed locations with hundreds of users. The underlying open architecture of CreditRevue is designed to operate across multiple hardware and software platforms. In addition, the open nature of CreditRevue also enables users to access information regardless of the computing environment in which it resides. CreditRevue is typically deployed in an enterprise which has heterogeneous computing platforms. STRATEGY The Company's objective is to be the leading provider of software solutions for automating the credit analysis, decisioning and funding process and for electronically transmitting credit related transactions between points of origination and multiple funding sources. In pursuit of these objectives, the Company has adopted the following key strategies: Expand Presence in the Credit Automation Market The Company has established a presence with leading institutions in the consumer lending market, including banks, finance companies, leasing companies and other lenders. The Company intends to expand its sales and marketing efforts to leverage and expand its established presence in these market segments. The Company believes that its customer base of more than 25 financial services companies represents an important source of references for new customers as the Company seeks to expand market acceptance of its products and services in the telecommunications, utilities and healthcare industries. The Company's next version of CreditRevue, expected to be released in mid-1997, is being designed to allow the Company to reduce configuration and installation time and provide more flexible pricing and product options to appeal to a broader customer base. Continue the Rollout of Credit Connection In July 1996, the Company commercially released Credit Connection to its existing financial services clients as well as other financial institutions and automobile dealers. The Company is introducing Credit Connection to the marketplace through the Company's own sales force, the sales forces of lending institutions and various remarketers. The Company's strategic alliance with ADP will allow the Company to leverage ADP's worldwide automobile and truck dealer customer base to complement the Company's own marketing efforts in the rollout of Credit Connection. The Company also intends to establish 30 32 relationships with other dealer business systems vendors and the dealer services sales divisions of lending institutions to expand the market presence of Credit Connection. Increase Transaction-Based Revenues as a Percentage of Total Revenue Historically, the Company's revenues have been generated from license fees and services. Credit Connection revenues are transaction-based. The Company is developing CreditRevue Service Bureau which will allow customers to access CreditRevue on a per transaction basis while minimizing the up- front investment in hardware and software costs of an in-house system. As a result of Credit Connection and CreditRevue Service Bureau, the Company anticipates that transaction-based revenue will increase as a percentage of total revenue. Leverage Key Relationships In addition to its strategic alliance with ADP, the Company has developed relationships with automated scorecard companies, hardware vendors and credit bureaus. The Company believes that these relationships accelerate the introduction and market acceptance of its products and services, extend its product and service offerings, increase the functionality of its products and services, and facilitate the development of new products and services. The Company intends to continually identify potential strategic relationship opportunities in the future. Extend Technology Leadership The Company intends to continue to extend its position as a technology leader in developing and marketing credit processing software and services. CMSI's products and services are based on its software technology, which is enhanced regularly to address the evolving needs of the consumer credit industry. The Company has designed, developed and implemented an open architecture programming interface and related software specifically to enable the Company to provide flexible, fully integrated solutions to customers with specialized needs and to interface with other software. The Company is focused on continually upgrading its current products to enhance their features, functionality and performance and to incorporate technological developments to meet its customers' needs. CUSTOMERS The Company has over 25 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 insurance, utilities and healthcare industries. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of those customers who have accounted for more than 10% of the Company's revenues in any of the past three years. The following representative list of the Company's customers with active licenses or contracts as of September 30, 1996 consists of customers which have generated over $50,000 of license and maintenance fee revenue since January 1, 1995: AFSA Data Corp. Airtouch/US West The Associates Bancorp, Inc. BancOne Corp. Bank One Financial Services, Inc. Boatmens Bancshares, Inc. Circuit City Stores, Inc. The CIT Group, Inc. Citizens Bank (of Maryland) Citizens Bank (of Rhode Island) Comerica Bank Dauphin Deposit Corp. First Merchants Acceptance Corporation NationsBank Corp. Nellie Mae, Inc. Oxford Resources Corp. US Bancorp Wachovia Corp. Wells Fargo Bank Western Financial Bank, FSB 31 33 The following examples illustrate how the Company's products are being utilized by some of its customers. The benefits achieved by these customers will not necessarily be achieved by every customer. NationsBank, a large financial institution which processes over 100,000 credit applications per month, decided to replace its in-house mainframe system with CreditRevue to address its need to more efficiently deliver immediate and consistent credit application decisions. Since the installation of CreditRevue, the bank has significantly increased the number of credit applications processed and improved the efficiency of its credit application process while handling an increase in NationsBank's overall loan volume. The ease of use of CreditRevue also reduced the bank's underwriter training time. In addition, the bank piloted Credit Connection commencing in January 1996 until its commercial introduction in July 1996. Banc One, a financial institution with a large consumer lending business, required a centrally administered processing system for credit automation of all of its consumer loans. The organization installed CreditRevue which provided a centrally administered flexible solution which was designed to allow Banc One to effectively and efficiently manage its numerous remote affiliates and its high application processing volume. AirTouch Cellular and US WEST NewVector Group, Inc. desired an automated credit processing system for the cellular operations of their domestic cellular joint venture, which could review up to 5,000 credit applications per hour, including credit bureau retrieval, policy checking, and setting of an appropriate deposit level. In response, the Company developed a version of CreditRevue specifically designed for the telecommunications industry and licensed this version to the telecommunications company. A sub-prime lender, which finances the purchase of automobiles from multiple locations, selected CreditRevue to automate its national indirect lending, underwriting, contract booking and funding operations. Recently, this lender has agreed to use Credit Connection to receive sub-prime applications from prime lending institutions. PRODUCTS AND SERVICES CreditRevue The cornerstone of the Company's product line is CreditRevue, a UNIX-based software solution designed to automate the entire credit application process from the entry of the credit application to the credit decision and through the transfer of the funding information to the lender's servicing system. Using CreditRevue, a lender can automate the analysis of a wide range of consumer lending products, including vehicle loans and leases, home equity loans and credit cards. Before CreditRevue is installed, the Company completes a review of the customer's credit application processing environment. CreditRevue is then configured to address the lender's specifications, including the lender's underwriting, approval and funding processes. The Company designs interfaces to the lender's other related systems, such as their branch automation software, customer information repository, and loan servicing software. 32 34 The credit analysis, decisioning and funding process using CreditRevue is illustrated in the following diagram: [CREDIT REVUE CHART] Key features of CreditRevue include the following: - Supports large credit operations with multiple products and lending divisions - Centralizes control over policies and procedures for each division or product - Facilitates a logical workflow for the entire application decisioning process - Automates the retrieval and analysis of consumer and business credit bureau reports - Provides built in fraud checks and tracks regulatory compliance - Incorporates multiple scorecards and the lender's policies and procedures - Audits the contract administration and funding process - Streamlines the retrieval and analysis of home appraisals, flood insurance verifications, title reports and document preparation - Interfaces with other lender systems such as branch automation software, customer information repositories and loan servicing software - Generates a comprehensive set of standard and custom management reports 33 35 The Company markets the following supplemental CreditRevue products: CrossSell adds call center management to the credit origination process. With CrossSell, a lender can design in-bound or out-bound telemarketing scripts for use by customer service representatives to market a variety of products to potential customers. INCredit automates credit origination for loans to small businesses. With INCredit, application and credit details can be gathered, scored and analyzed for both the business and its principals or guarantors. CreditRevue Data Server enables the lender's other software applications to communicate with CreditRevue. CreditRevue Data Server is used by the Company's customers to connect CreditRevue to the Credit Connection, as well as bank branches, order entry systems and voice response units. In addition to these products, the Company is developing CreditRevue Service Bureau, which will allow lenders to connect multiple terminals or personal computers to the Company's service bureau system to access CreditRevue. CreditRevue Service Bureau will be targeted to small and medium sized financial institutions seeking to minimize the up-front hardware and software costs of an in-house system. The Company will charge an initial set up fee for CreditRevue Service Bureau and transaction fees for each credit application processed. Additional charges will be assessed for other value-added services, such as reporting. CreditRevue Service Bureau is expected to be available in late 1997. The Company is designing a new version of CreditRevue that will allow the software to be configured without extensive coding. The Company believes this will reduce the current implementation time from eight to 10 months to four to six months. The new version will also allow the Company to improve the way its existing products are leveraged to create new applications for other markets. The Company expects that the new version will be completed in the third quarter of 1997. Credit Connection Credit Connection offers connectivity between points of credit origination, such as automobile dealers, and multiple funding sources. Credit Connection 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 credit decisions online. When the lending institution supports automated funding, the dealer can have the funds for the loan transferred to the dealer's bank account without having to wait for the actual contract to arrive at the funding source. Credit Connection provides several other features to dealerships, including online vehicle valuation guides and funding source news. For the funding source, Credit Connection provides a single interface to communicate with any number and type of credit originators. 34 36 The following diagram illustrates the architecture of Credit Connection: [CONNECTION CHART] Key features of Credit Connection include the following: - Supports instantaneous transmission of credit applications from the dealer to funding sources during normal or off hours, and immediate online response to the dealer once the credit decision is made - Allows for application data to be entered into the system only once and routed to the appropriate funding sources as directed by the dealer - Automates application tracking and manages workflow - Includes sophisticated credit analysis tools to aid a dealer in reviewing consumer credit quality - Expedites online funding provided by the lender to the dealer - Integrates vehicle valuation guides and other third-party services - Provides online news facility, allowing lenders to publish information regarding rates, sales promotions and other pertinent data The Company is also marketing Credit Connection LenderLink, which facilitates the electronic transfer of credit applications and decisions between lending institutions through the Credit Connection network. Using Credit Connection LenderLink, a prime lender can automatically forward credit applications which it has declined to a sub-prime lender. The sub-prime lender can return a decision electronically to the prime lender, which then communicates the decision to the credit originator. Credit Connection LenderLink benefits all 35 37 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. In addition, the Company is developing the following Credit Connection products and services: Credit Connection for Windows is a graphical, client/server version of the dealer software that connects to the Credit Connection host using the Internet or a private network. This new software reduces communication costs and provides easier deployment, an improved user interface and additional functionality. The Company expects that Credit Connection for Windows will become commercially available in the second quarter of 1997. Credit Connection Online will allow consumers to use the World Wide Web to apply for loans and receive online decisions from lenders subscribing to Credit Connection. Consumers can enter applications at the Company's Web site, a subscribing lender's Web site or a third-party remarketer's Web site. Credit Connection Online will be used initially to originate automobile loans from ADP's AutoConnect(TM) Web site and forward those loans to NationsBank through Credit Connection. The Company expects to release this service in the second quarter of 1997. STRATEGIC ALLIANCE WITH ADP In November 1996, the Company entered into an agreement to form a strategic alliance with the Dealer Services Group of ADP. This division of ADP is one of the largest providers of computing and consulting services for automobile and truck dealers worldwide. Under the terms of the agreement, the Company and ADP will work to integrate Credit Connection with ADP's automated dealership management and operations systems. ADP will cooperate with the Company to remarket Credit Connection to ADP's automobile dealer customers, and will provide direct sales efforts to remarket Credit Connection as well as installation, training and customer support services to its dealers. In exchange for its services, ADP will be entitled to a percentage of the net revenues from transactions generated by ADP's dealers. ADP has also proposed to promote Credit Connection Online through its AutoConnect(TM) Web site. In addition, pursuant to the agreement, ADP will have the right to name one Director to the Company's Board of Directors. The agreement may be terminated by either party without penalty. 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. The Company plans to introduce and market several new products and services and enhancements to its existing products and services in 1997, including a new version of CreditRevue, CreditRevue Service Bureau, Credit Connection for Windows and Credit Connection Online. See "Business -- Products and Services." 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. There can be no assurance 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. 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. 36 38 Software products and services as sophisticated as those offered by the Company often encounter development delays and may contain defects or failures when introduced or when new versions are released. The Company has in the past and may in the future experience delays in the development of software and has discovered, and may in the future discover, software defects in certain of its products. Such delays and defects may result in lost revenues during the time corrective measures are being taken. Although the Company has not experienced material adverse effects resulting from any such defects to date, there can be no assurance that, despite testing by the Company, errors will not be found in its existing software in future releases or enhancements, or that the Company will not experience development delays, resulting in delays in the commercial release of new products or services, the loss of market share or the failure to achieve market acceptance, each of which could have a material adverse effect on the Company's business, results of operations or financial condition. As of September 30, 1996, the Company's product development staff consisted of nine 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 its customers in deriving the most effective use of the Company's products and services, including technical support, formalized training and a user hotline. The Company's services also include implementation planning and assistance, software installation, software operations training and software maintenance. As of September 30, 1996, the Company's dedicated customer service and support team included nine 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 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 Company's sales and marketing organization consists of seven employees based at the Company's corporate headquarters in Columbia, Maryland. To support its sales force, the Company conducts comprehensive marketing programs, which include direct mail, public relations, seminars, trade shows and ongoing customer communications programs. The Company also sponsors an annual users' group meeting for its CreditRevue customers. The sales effort for Credit Connection comprises both direct and indirect marketing activities. Direct sales efforts are concentrated on selling the service to financial institutions, automobile superstores 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 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 37 39 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. Through its strategic alliance with ADP, ADP will remarket Credit Connection to ADP's customer base of automobile and truck dealers and to new customers developed jointly by ADP and CMSI. 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 Credit Connection, the Company has taken no material steps to establish such relationships. See "-- Strategic Alliance with ADP." BACKLOG At September 30, 1996, the Company had entered into contracts for its services for which $5.4 million of revenues will be recognized in future periods. At September 30, 1995, this comparable amount was $7.0 million. COMPETITION The credit processing software and services industry is intensely competitive and rapidly changing. The Company believes its ability to compete depends upon many factors within and outside its control, including the timing and market acceptance of new products and services and enhancements developed by the Company and its competitors, including (i) application software companies, (ii) management information systems departments of potential customers, (iii) third-party professional services organizations, and (iv) computer services outsourcing providers which offer service bureau-based credit processing solutions. Competitors for CreditRevue include American Management Systems, Inc., Appro Systems, Inc., CFI ProServices, Inc., Fair, Isaac and Company, Inc. and Affinity Technology Group, Inc. Competitors for Credit Connection include The Reynolds & Reynolds Company and IBM, which has recently announced a system for processing automobile loans over the Internet in conjunction with The Chase Manhattan Bank. 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. See "Risk Factors -- Competition; Future Price Erosion." 38 40 INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS The Company's success is heavily dependent upon its proprietary technology. The Company regards its software products and services as proprietary, and relies primarily on a combination of contract, copyright and trademark law, trade secrets, confidentiality agreements and contractual provisions to protect its proprietary rights. The Company has no patents on its products currently in commercial use, and existing trade secrets and copyright laws afford only limited protection. The Company has applied for a United States patent on portions of Credit Connection. There can be no assurance that a patent will be granted pursuant to the Company's application or that, if granted, such patent would survive a legal challenge to its validity or provide adequate protection. Furthermore, there can be no assurance that others will not design around any patents issued to the Company. It is the Company's policy to enter into confidentiality and assignment agreements with its employees. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use the Company's products or technology without authorization, to obtain and use information that the Company regards as proprietary, or to develop similar or superior products or technology independently. Policing unauthorized use of the Company's products is difficult, and while the Company is unable to determine the extent to which piracy of its software products exists, software piracy can be expected to be a persistent problem, particularly in international markets and as a result of the growing use of the Internet. The source code for the Company's proprietary software is protected both as a trade secret and as a copyrighted work. The Company has in the past and may in the future make source code for one or more of its products available to certain of its customers and strategic partners which may increase the likelihood of misappropriation or other misuse of the Company's software. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that the steps taken by the Company to protect its proprietary rights will be adequate or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technologies. The Company has obtained a perpetual worldwide license for the use of the registered trademark Credit Connection. "CreditRevue" and "INCredit" are registered trademarks of the Company. "Cross Sell," "CreditRevue Service Bureau," "CreditRevue Data Server," "Credit Connection for Windows," "Credit Connection Online," "Credit Connection LenderLink" and the Company logo are trademarks of the Company. The Company is not aware that any of its products, services, trademarks or other proprietary rights infringe 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. See "Risk Factors -- Dependence on Proprietary Rights; Risks of Infringement." GOVERNMENT REGULATION The Company's current and prospective customers, which consist of state and federally chartered banks, saving and loan associations, credit unions, consumer finance companies and other consumer lenders, as well as customers in the industries that the Company may target in the future, operate in markets that are subject to extensive and complex federal and state regulations. While the Company is not itself directly subject to such regulations, the Company's products and services must be designed to work within the extensive and evolving regulatory constraints in which its customers operate. These constraints include federal and state truth-in-lending disclosure rules, state usury laws, the Equal Credit Opportunity Act, the Fair Credit 39 41 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. See "Risk Factors -- Government Regulation and Uncertainties of Future Regulation." EMPLOYEES As of September 30, 1996, the Company had 133 full time employees, including nine in product development, 100 in technical operations, nine in sales and marketing and 15 in finance and administration. The Company's employees are not covered by any collective bargaining agreements. The Company believes that its relations with its employees are good. FACILITIES The Company's principal executive offices are located in Columbia, Maryland in a leased facility consisting of approximately 34,600 square feet of office space under several leases that expire in 1998, subject to five and six year renewal options, respectively. The Company has a right of first refusal on additional office space in the same building. The Company believes that its existing facilities are adequate to meet its current needs and that suitable additional space will be available in the future, if necessary, on commercially reasonable terms. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings. 40 42 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The directors and executive officers of the Company are as follows:
NAME AGE POSITION WITH THE COMPANY - ------------------------------------------ --- -------------------------------- James R. DeFrancesco...................... 48 President, Chief Executive Officer and Chairman of the Board of Directors Scott L. Freiman.......................... 34 Executive Vice President and Director James C. Alsobrook, Jr. .................. 41 Senior Vice President, Credit Connection Miles H. Grody............................ 40 Senior Vice President, Secretary, General Counsel and Director Charles F. Riordan........................ 41 Senior Vice President, Software Sales Robert P. Vollono......................... 48 Senior Vice President, Treasurer, Chief Financial Officer and Director Nancy L. Weil............................. 52 Senior Vice President, Marketing Stephen X. Graham......................... 43 Director John J. McDonnell, Jr. ................... 58 Director Peter M. Leger............................ 45 Director
James R. DeFrancesco, co-founder of the Company, has served as the Company's President, Chief Executive Officer and Chairman of the Board of Directors since 1987. From 1987 to 1992, Mr. DeFrancesco served as President of Perpetual Leasing Services, Inc., the automobile leasing subsidiary of Perpetual Savings Bank, FSB to which American Financial Corporation was sold. From 1976 to 1987, Mr. DeFrancesco founded and served as President and Chief Executive Officer of American Financial Corporation, an automobile finance/leasing company. Scott L. Freiman, co-founder of the Company, has served as the Company's Executive Vice President and a Director since 1987. From 1985 to 1987, Mr. Freiman served as Technology Director of American Financial Corporation, an automobile finance/leasing company, where he worked with Mr. DeFrancesco to develop the Company's credit origination software. Prior to 1985, Mr. Freiman served as a development engineer for IBM and AT&T Bell Laboratories. James C. Alsobrook, Jr. has served as the Company's Senior Vice President, Credit Connection since December 1994. From April 1994 to November 1994, Mr. Alsobrook served as Director of Sales and Marketing of ILC Holding Corp., a computer software company. From 1984 to February 1994, Mr. Alsobrook served in several officer capacities for Disc Incorporated, a computer software company, including Vice President North American Sales, Vice President Banking Sales and Regional Manager, ACCESS Products Group. From 1979 to 1984, Mr. Alsobrook served as Senior Account Manager for NCR Corporation, Data Processing Center Division. Miles H. Grody has served as the Company's Senior Vice President and General Counsel since June 1995, and as the Company's Secretary and a Director since October 1996. From January 1993 to June 1995, Mr. Grody served as Chief Operating Officer of Tomahawk II, Inc., a document imaging and conversion services company. From January 1992 to January 1993, Mr. Grody was a partner in the law firm of Rowan & Grody, P.C. From 1988 to January 1992, Mr. Grody served as Corporate Counsel for Perot Systems Corporation. Charles F. Riordan has served as the Company's Senior Vice President, Software Sales since February 1989. From 1985 to February 1989, Mr. Riordan served as Vice President, Sales Representative for MTech Corp/Electronic Data System. Robert P. Vollono has served as the Company's Senior Vice President and Chief Financial Officer since April 1995 and as the Company's Treasurer and a Director since October 1996. From 1988 to April 1995, 41 43 Mr. Vollono served as Vice President and Chief Financial Officer of Carey International, Inc. a transportation services company. From 1986 to 1988, Mr. Vollono served as Vice President and Chief Financial Officer of Commercial Office Environments, Inc. Nancy Weil has served as the Company's Senior Vice President, Marketing since February 1994. From 1984 to February 1994, Ms. Weil served as Manager, Product Marketing for Intelus Corp., a systems integration company. From 1981 to 1984, Ms. Weil served as Manager, Product Marketing Communications for the Manufacturing Division of Martin Marietta Data Systems. Stephen X. Graham has served as a Director since October 1996. Since 1988, he has been the President and Chief Executive Officer of Graham, Hamilton & Dwyer, Inc., a private investment banking firm. From 1982 to 1988, Mr. Graham was a Vice President of Kidder, Peabody & Co. John J. McDonnell, Jr. has served as a Director since November 1996. Mr. McDonnell has served as President, Chief Executive Officer and a director of Transaction Network Systems, Inc., a nationwide communications network company specializing in transaction-oriented data services, since founding Transaction Network Systems, Inc. in 1990. From 1987 to 1989, Mr. McDonnell served as President and Chief Executive Officer of Digital Radio Networks, Inc., a local access bypass carrier for point-of-sale transactions. Mr. McDonnell has previously served as Group Vice President for the Information Technologies and Telecommunications Group of the Electronic Industries Association (EIA); Vice President, International Operations and Vice President, Sales, for Tymnet, Inc. with responsibility for both private network sales and public network services; and Director of Technology and Telecommunications for the National Commission on Electronic Funds Transfer. Mr. McDonnell was one of the founding members and is currently Chairman of the Executive Committee of the Board of Directors of the Electronics Funds Transfer Association. Peter M. Leger has served as a Director since December 1996. Since March 1992, Mr. Leger has served in various capacities with ADP, currently as President of ADP's Dealer Service Group. Prior to joining ADP, Mr. Leger served in various capacities with Reuters Limited PLC, a worldwide information provider and systems integrator in computer solutions and services for the banking and brokerage community, most recently as President of Reuters Systems Integration Division. Mr. Leger was elected to the Board of Directors pursuant to the terms of an agreement between the Company and ADP. See "Business -- Strategic Alliance with ADP." Each executive officer serves at the discretion of the Board of Directors. Each of the Company's executive officers and employee Directors devotes substantially all of his or her time to the affairs of the Company. The Company's Bylaws permit the Board of Directors to establish by resolution the authorized number of Directors, and the Company currently has seven Directors authorized. There are no family relationships among any of the Directors or executive officers of the Company. At present, all Directors are elected annually and serve until the next annual meeting of the stockholders or until the election and qualification of their successors. Prior to the consummation of the Offering, the Company will be reincorporated in Delaware and the Certificate of Incorporation will provide that the Board of Directors will be divided into three classes with each class of Directors serving for a staggered three-year term. Thereafter, at each annual meeting of stockholders, Directors will be re-elected or elected for a full term of three years to succeed those Directors whose terms are expiring. See "Description of Capital Stock -- Delaware Law and Certain Charter and Bylaw Provisions." COMMITTEES OF THE BOARD OF DIRECTORS Prior to the consummation of the Offering, the Board of Directors intends to appoint a Compensation Committee and an Audit Committee. The Compensation Committee will be responsible for recommending to the Board of Directors the Company's executive compensation policies for senior officers. The Audit Committee will be responsible for recommending independent auditors, reviewing the audit plan, the adequacy of internal controls, the audit report and management letter, and performing such other duties as the Board of Directors may from time to time prescribe. 42 44 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During 1995, the Company did not have a Compensation Committee or other committee of the Board of Directors performing similar functions. Decisions concerning executive officer compensation for 1995 were made by the Board of Directors of the Company, consisting of Messrs. DeFrancesco and Freiman, each of whom was and continues to be an executive officer of the Company. Prior to the consummation of this Offering, the Board of Directors of the Company intends to establish a Compensation Committee to address compensation issues relating to executive officers of the Company. See "-- Committees of the Board of Directors." DIRECTOR COMPENSATION Directors are not currently compensated by the Company for service as Directors other than reimbursement for ordinary and necessary travel expenses related to such Director's attendance at Board of Directors and committee meetings. In the future, the Company intends to pay each nonemployee Director a $2,000 fee for each meeting of the Board of Directors or any committee thereof attended. In addition, such nonemployee Directors shall be granted a non-qualified stock option to purchase 15,000 shares of Common Stock pursuant to the Company's Stock Option Plan. Such options will vest ratably over a three year period commencing on the date of grant . EXECUTIVE COMPENSATION The following table summarizes all the compensation paid by the Company during the fiscal year ended December 31, 1995 to the Company's Chief Executive Officer and the two other most highly compensated executive officers (collectively, the "Named Executive Officers") whose salary and bonus for services rendered in all capacities to the Company exceeded $100,000 during such fiscal year. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION FISCAL ------------ ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY COMPENSATION - ---------------------------------------------------------- ------ ------------ --------------- James R. DeFrancesco...................................... 1995 $186,750 $45,741(1) President, Chief Executive Officer and Chairman of the Board Scott L. Freiman.......................................... 1995 $187,300 $32,396(2) Executive Vice President and Director Charles F. Riordan........................................ 1995 $157,376 $ 4,800(3) Senior Vice President, Software Sales
- --------------- (1) Includes $35,000 distributed by the Company to Mr. DeFrancesco to fund the payment of federal and state taxes owed by Mr. DeFrancesco by virtue of the Company's status as a Subchapter S Corporation for federal and state income tax purposes, $5,941 for premiums on health insurance for Mr. DeFrancesco's benefit, and an automobile allowance of $4,800. (2) Includes $17,500 distributed by the Company to Mr. Freiman to fund the payment of federal and state taxes owed by Mr. Freiman by virtue of the Company's status as a Subchapter S Corporation for federal and state income tax purposes, $10,096 for premiums on health insurance for Mr. Freiman's benefit, and an automobile allowance of $4,800. (3) Consists of an automobile allowance of $4,800. During 1995, no options or stock appreciation rights were granted to the Named Executive Officers. In addition, the Named Executive Officers have not exercised any options to date. For a discussion of options granted to the Named Executive Officers, see "-- Stock Option Plan." 43 45 STOCK OPTION PLAN In June 1996, the Company's Board of Directors and stockholders adopted a Non-Qualified Stock Option Plan (the "Stock Option Plan"). The Company has reserved for issuance 2,750,000 shares of Common Stock pursuant to the terms and conditions of the Stock Option Plan (the "Options"). The purpose of the Stock Option Plan is to provide incentives to Directors and employees through the opportunity to acquire an ownership interest in the Company. The Stock Option Plan has a term of 10 years, subject to early termination by the Board of Directors. If Options should expire, become unexercisable or be forfeited for any reason without having been exercised or having become vested in full, the shares of Common Stock subject to such Options would be available for the grant of additional Options under the Stock Option Plan. The Stock Option Plan is being administered by a committee of at least two Directors of the Company (the "Option Committee") which has the authority to determine to whom Options are granted, the number of shares to be subject to such Options, and the terms and conditions of such Options. The Option Committee consists of Messrs. DeFrancesco and Freiman. It is intended that Options granted under the Stock Option Plan will not qualify for favorable tax treatment to recipients pursuant to Section 422 of the Code. In the case of non-qualified stock options, no income is generally recognized by the optionee at the time of the grant of the option. Under present law, the optionee will generally recognize ordinary income at the time the nonqualified stock option is exercised equal to the aggregate fair market value of the shares acquired less the option price. Ordinarily income from a non-qualified stock option will constitute compensation for which reporting or withholding is required under federal and state law. The Company will generally be entitled to a deduction equal to the ordinary income (i.e., compensation) portion of the gain recognized by the optionee in connection with the exercise of a non-qualified stock option provided the Company complies with any reporting or withholding requirements of federal and state law. The exercise price for any particular Option may not be less than 100% of the fair market value of a share of Common Stock on the date of the grant. The Stock Option Plan permits the Option Committee to impose transfer restrictions, such as a right of first refusal, on the Common Stock that optionees may purchase. No Option shall be exercisable after the expiration of 10 years from the date it is granted. An otherwise unexpired Option shall, unless otherwise determined by the Option Committee, cease to be exercisable upon (i) an employee's or Director's termination of employment or directorship for "just cause" (as defined in the Stock Option Plan), (ii) the date three months after an employee terminates service for a reason other than just cause, death or disability, (iii) the date two years after an employee terminates service due to disability, or (iv) the date two years after termination of such service due to the employee's death. Options granted to Directors or employees at the time of the implementation of the Stock Option Plan are expected to become exercisable at the rate the Option Committee may provide. No Option is assignable or transferable except by will or the laws of descent and distribution, or pursuant to the terms of a "qualified domestic relations order" (within the meaning of Section 414(p) of the Code and the regulations and rulings thereunder). The Company will receive no monetary consideration for the granting of Options under the Stock Option Plan, and will receive no monetary consideration other than the Option exercise price for each share issued to optionees upon the exercise of Options. The Option exercise price may be paid in cash or Common Stock or a combination of cash and Common Stock or by promissory note. The exercise of Options will be subject to such terms and conditions established by the Option Committee as are set forth in a written agreement between the Option Committee and the optionee. In June 1996, the Option Committee granted stock options under the Stock Option Plan to purchase an aggregate of 2,362,540 shares of Common Stock to certain of the Company's executive officers, including Messrs. Alsobrook, Grody, Riordan and Vollono and Ms. Weil, and to certain employees (the "June Options"). Of the June Options, 332,640 options vest at the rate of 10% at the time of grant, 20% on each of the first, second, third and fourth anniversaries of December 15, 1996, and 10% on the fifth anniversary of December 15, 1996. The remaining June Options vest at the rate of 30% at the time of grant, 20% on each of the first and second anniversaries of December 15, 1996 and 10% on each of the third, fourth and fifth anniversaries of December 15, 1996. The June Options have an exercise price of $5.00 per share. In October and November 1996, the Option Committee granted 185,260 stock options under the Stock 44 46 Option Plan (the "Autumn Options"). The Autumn Options have an exercise price of $9.60 per share and vest at a rate of 10% at the time of grant, 20% on each of the second, third and fourth anniversaries of December 15, 1996 and 10% on the fifth anniversary of December 15, 1996. LONG-TERM INCENTIVE PLAN In November 1996, the Company's Board of Directors and stockholders approved the 1996 Long-Term Incentive Plan (the "LTIP" or "Plan"). 750,000 shares of the Company's Common Stock are authorized for issuance under the LTIP. No awards will be made under the LTIP prior to completion of this Offering. The LTIP was adopted to promote and advance the interests of the Company and its stockholders by providing a means by which key employees of the Company and its subsidiaries could be given an opportunity to acquire stock in the Company and other incentive-based awards, to assist in attracting and retaining the services of employees holding key positions, and to provide incentives for such key employees to exert maximum efforts toward results that are in the best interest of all stockholders. The LTIP provides for the grant of incentive stock options intended to qualify within the meaning of Section 422 of the Code. However, if an option granted pursuant to the Plan fails to qualify as an incentive stock option for any reason, it will be treated as a nonqualified stock option. The LTIP will be administered by the Compensation Committee of the Board of Directors and options granted thereunder are subject to final ratification of the full Board of Directors of the Company. The Compensation Committee shall be composed solely of individuals who are "outside directors" within the meaning of Section 162(m)(4)(C) of the Code and "disinterested persons" for securities law purposes. Incentive stock options may be granted under the LTIP only to key employees (including Directors if they are also key employees) of the Company and its subsidiaries. Such persons similarly are eligible to receive stock appreciation rights, restricted awards, performance awards and other awards under the LTIP. No option may be granted under the LTIP to any person who, at the time of the grant, owns (or is deemed to own) stock possessing more than 10% of the total combined voting power of the Company or any subsidiary of the Company, unless the option exercise price is at least 110% of the fair market value of the stock subject to the option on the date of the grant and the term of the option does not exceed five years from the date of the grant. For incentive stock options granted under the LTIP, the aggregate fair market value, determined at the time of the grant, of the shares of Common Stock with respect to which such options are exercisable for the first time by an optionee during any calendar year (under all such plans of the Company and its subsidiaries) may not exceed $100,000. As a result of enactment of Section 162(m) of the Code, and to give the Compensation Committee flexibility in structuring awards, the LTIP states that in the case of stock options and stock appreciation rights, no person may receive in any year a stock option to purchase more than 100,000 shares or a stock appreciation right measured by more than 100,000 shares. The following is a description of the types of grants and awards and the permissible terms under the LTIP. Individual option grants and share awards may be more restrictive as to any or all of the permissible terms described below. Stock options may be granted as incentive options, but any option that fails to qualify as an incentive option will not be invalidated thereby, but rather will be treated as a nonstatutory (nonqualified) option. Stock appreciation rights ("SARs") may be granted specifying a period of time for which increases in share price shall be measured, with the grantee eligible to receive stock or cash at the end of such period based upon increases in such share price. Restricted awards may be granted specifying a period of time (the "Restriction Period") applicable to such award, which shall be not less than three (3) years, but may be more than that and may vary at the discretion of the Compensation Committee. Common Stock awarded pursuant to a restricted stock award shall entitle the holder to enjoy all the stockholder rights during the restriction period except that certain limitations with respect to dividends and to disposition of such stock shall prevail. Other restricted awards may be paid out in cash upon expiration of the Restriction Period. 45 47 Performance awards may be granted specifying a number of performance shares or a monetary amount to be credited to an account on behalf of the recipient. Such awards may be subject to both time and Company performance objectives that are specified at the time of such award at the discretion of the Compensation Committee. Other awards may be granted under the Plan that are not in the categories discussed above because the Plan gives the Compensation Committee flexibility in designing compensation programs. The exercise price of stock options under the LTIP may not be less than the fair market value of the Common Stock subject to the option on the date of the option grant and in some cases may not be less than 110% of such fair market value. Similarly, stock appreciation rights are based upon the fair market value of a share of Common Stock on the date of the grant compared with the fair market value of a share at the end of the measuring period. The sole basis for compensation under such awards is an increase in the stock's fair market value. Restricted stock awards are payable in stock upon satisfaction of the restrictions imposed with respect to the award. The Compensation Committee has the discretion to pay other awards in cash, in shares of Common Stock or a combination of both. The Plan is structured so that the Compensation Committee may make awards that qualify as "performance-based compensation" within the meaning of Section 162(m) of the Code, as such section was enacted in 1993. However, the Plan is flexible so that the Compensation Committee also has the discretion to make awards that are not described in that section. Section 162(m) provides a limit of $1,000,000 on deductions for compensation paid to certain corporate executives on a year-by-year basis. However, "performance-based compensation" is excluded from that limitation. Whether any particular award under the Plan will qualify as "performance-based compensation" will depend upon the terms of the award and compliance with certain other procedural requirements under Section 162(m). The Compensation Committee will take into account the overall tax and business objectives of the Company in structuring awards under the Plan. Not every amount paid as compensation for services is currently deductible. For example, depending upon the services rendered, some compensation payments must be capitalized or added to inventory costs. Two restrictions potentially applicable to deductions for executive compensation payments are the restriction on deduction of so-called "excess parachute payments" and the deduction limit of $1,000,000 per year for certain executive compensation. Whether any such restrictions will apply to specific payments of compensation by the Company cannot be predicted at this time. The maximum term of the LTIP is ten (10) years, except that the Board may terminate the Plan earlier. The Board may amend the LTIP at any time and from time to time without stockholder approval, except that such amendment may not, without stockholder approval, (a) increase the number of shares authorized for issuance under the LTIP except as a result of an adjustment through merger, consolidation, stock split or otherwise, or (b) materially modify the requirements as to eligibility for participation in the Plan, or (c) materially increase the benefits accruing to participants under the Plan. EMPLOYEE STOCK PURCHASE PLAN In November 1996, the Company's Board of Directors and stockholders approved an Employee Stock Purchase Plan (the "ESP Plan"). The Company has reserved for issuance 250,000 shares of Common Stock pursuant to the terms and conditions of the ESP Plan. The purpose of the ESP Plan is to provide eligible employees with the opportunity to acquire a proprietary interest in the Company through a payroll-deduction based plan. Any employee of the Company, or any subsidiary, who is expected to render more than 20 hours of service per week for more than five months may elect to participate in the ESP Plan after he or she has completed 90 days of service. Employees can elect to deduct up to a maximum of fifteen percent (15%) of their earnings to be used to purchase shares of the Company's Common Stock. Purchases will be made on a quarterly basis on the last business day of each quarter, and the purchase price will be equal to eighty-five 46 48 percent (85%) of the lower of (a) the fair market value per share of the Company's Common Stock on the first day of the quarterly purchase period or (b) the fair market value per share on the purchase date. The purchase price will be paid directly to the Company in exchange for the issuance of shares under the ESP Plan. The ESP Plan is administered by a committee of at least two Directors of the Company who have full authority to adopt rules and regulations and to administer the ESP Plan. The ESP Plan will continue in effect for a term of 10 years unless terminated earlier in accordance with its provisions. 401(K) PLAN The Company participates in a tax-qualified employee savings and retirement plan (the "401(k) Plan") which covers all of the Company's employees with six months of service. Pursuant to the 401(k) Plan, employees may elect to contribute to the 401(k) Plan up to 15% of their current compensation, subject to statutorily prescribed limitations. The 401(k) Plan also permits the Company to provide a 20% matching contribution, up to the first $1,000 contributed by such employees, subject to statutory limitations. The 401(k) Plan is intended to qualify under Section 401(k) of the Code, so that contributions by employees or by the Company and the income earned on plan contributions, are not taxable to employees until withdrawn from the 401(k) Plan, and so that contributions by the Company, if any, will be deductible by the Company when made. All employee contributions to the 401(k) Plan are fully vested at all times and Company contributions, if any, vest ratably over a six year period based on the participant's years of service. Benefits under the 401(k) Plan are paid upon a participant's retirement, death, disability or termination of employment and are based upon the amount of participant contributions and vested employer contributions, as adjusted for gains, losses and earnings. CERTAIN TRANSACTIONS On December 31, 1995, the Company borrowed $214,498 from James R. DeFrancesco, the Company's President and Chief Executive Officer, pursuant to a demand promissory note due on or after October 1, 1997. Interest on the note accrues at the rate of 7% per annum. The Company believes that the interest rate payable to Mr. DeFrancesco is comparable to the rate the Company would have otherwise paid on comparable indebtedness from unaffiliated parties. Mr. DeFrancesco owns 50% of the outstanding stock of Business Liner, Inc., a company which leases an airplane to the Company for business travel. The Company pays an hourly fee for its use of the airplane and a portion of the monthly cost of maintaining the airplane. The Company believes that the amounts paid for the lease of the airplane are comparable to the amounts the Company would have otherwise paid for comparable services from unaffiliated parties. For the fiscal year ended December 31, 1995, the Company paid Business Liner, Inc. $50,857 under this leasing arrangement. Miles H. Grody, the Company's Senior Vice President and General Counsel, performed legal services for the Company prior to his employment in June 1995. The Company believes that the amounts paid to Mr. Grody are comparable to the amounts the Company would have otherwise paid for comparable services from unaffiliated parties. For the fiscal year ended December 31, 1995, fees paid to Mr. Grody did not exceed 5% of his income during that year. In August 1996, the Company entered into a settlement agreement and general release with a former officer of the Company. The agreement provides that the Company will pay the former officer his salary for a period of one year. In addition, the agreement requires the Company to pay the former officer $240,000 if a change in control of the Company occurs before January 18, 1997 or $120,000 if a change in control occurs before July 18, 1997. If the Offering is consummated prior to a change in control, the agreement provides that the Company will pay the former officer $240,000 if the Offering is consummated prior to January 18, 1997, or $120,000 if the Offering is consummated prior to July 18, 1997. At the Company's discretion, any payments required to be made to the former officer may be in the form of cash or stock. 47 49 The Company distributed $35,000 and $17,500 to each of Messrs. DeFrancesco and Freiman, respectively, for the payment of federal and state income taxes owed by each of them by virtue of the Company's status as a Subchapter S Corporation in 1995 and $70,000 and $35,000 to each of Messrs. DeFrancesco and Freiman, respectively, for such purposes in 1994. The Company expects to enter into a Tax Indemnification Agreement prior to the consummation of the Offering with its Existing Stockholders providing for, among other things, the indemnification of the Company by such stockholders for any federal and state income taxes (including interest) incurred by the Company if for any reason the Company is deemed to be treated as a Subchapter C Corporation during any period for which it reported its earnings to the taxing authorities as a Subchapter S Corporation. The Tax Indemnification Agreement further provides for the cross-indemnification of the Company and of each Existing Stockholder for certain additional taxes (including interest and, in the case of Existing Stockholders, penalties) resulting from the Company's operations during the period in which it was a Subchapter S Corporation. For information concerning stock options granted to certain of the Company's executive officers, see "Management -- Stock Option Plan." 48 50 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock as of September 30, 1996, and as adjusted to reflect the sale of the shares of Common Stock offered hereby, assuming no exercise of the Underwriters' over-allotment option, (i) by each of the Named Executive Officers, (ii) by each of the Company's directors, (iii) by each Selling Stockholder, and (iv) by all current executive officers and directors as a group. Other than as shown in the table, no person beneficially owns 5% or more of the Common Stock.
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED PRIOR TO THE OWNED AFTER THE OFFERING(1) OFFERING(1) --------------------- SHARES BEING --------------------- BENEFICIAL OWNER NUMBER PERCENT OFFERED NUMBER PERCENT - -------------------------------------- --------- ------- ------------ --------- ------- NAMED EXECUTIVE OFFICERS AND DIRECTORS James R. DeFrancesco................ 3,273,400 65.34% 200,000 3,073,400 42.63% Scott L. Freiman.................... 1,636,700 32.67% 100,000 1,536,700 21.31% Charles F. Riordan(2)............... 121,794 2.42% 20,000 101,794 1.39% Miles H. Grody(3)................... 121,794 2.42% 20,000 101,794 1.39% Robert P. Vollono(4)................ 121,794 2.42% 20,000 101,794 1.39% Stephen X. Graham................... -- * -- -- * John J. McDonnell, Jr. ............. -- * -- -- * Peter M. Leger...................... -- * -- -- * OTHER SELLING STOCKHOLDERS James C. Alsobrook, Jr.(5).......... 121,794 2.42% 20,000 101,794 1.39% Nancy L. Weil(6).................... 121,794 2.42% 20,000 101,794 1.39% All executive officers and Directors as a group (10 persons)(7).......... 5,519,070 100% 400,000 5,119,070 66.32%
- --------------- * Less than one percent. (1) Gives effect to the shares of Common Stock issuable within 60 days of September 30, 1996 upon the exercise of all options and other rights beneficially owned by the indicated stockholders on that date. Unless otherwise indicated, the persons named in the table have sole voting and sole investment control with respect to all shares beneficially owned. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and includes voting and investment power with respect to shares. (2) Consists of 121,794 shares of Common Stock issuable upon exercise of a stock option. (3) Consists of 121,794 shares of Common Stock issuable upon exercise of a stock option. (4) Consists of 121,794 shares of Common Stock issuable upon exercise of a stock option. (5) Consists of 121,794 shares of Common Stock issuable upon exercise of a stock option. (6) Consists of 121,794 shares of Common Stock issuable upon exercise of a stock option. (7) See Notes (2) through (6). 49 51 DESCRIPTION OF CAPITAL STOCK GENERAL The following description of the Company's capital stock does not purport to be complete and is subject in all respects to applicable Delaware law and to the provisions of the Company's Certificate of Incorporation and Bylaws, copies of which have been filed as exhibits to the Registration Statement of which this Prospectus is a part. Upon consummation of this Offering, the authorized capital stock of the Company will consist of 40,000,000 shares of Common Stock and 1,000,000 shares of Preferred Stock, par value $0.01 per share. COMMON STOCK Holders of Common Stock are entitled to receive ratably such dividends as may be declared by the Board of Directors out of funds legally available therefor. See "Dividend Policy." Each holder of Common Stock is entitled to one vote for each share held of record by him or her. In the event of a liquidation, dissolution or winding up of the Company, holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities. Holders of Common Stock have no preemptive rights and have no rights to convert their Common Stock into any other securities and there are no redemption provisions with respect to such shares. All of the outstanding shares of Common Stock are fully paid and non-assessable. PREFERRED STOCK 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, without any further vote or action by the Company's stockholders. The rights of the holders of the 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, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, 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. The Company has no current plans to issue shares of Preferred Stock. DELAWARE LAW AND CERTAIN CHARTER AND BYLAW PROVISIONS The Company is subject to Section 203 of the Delaware General Corporation Law ("Section 203"), which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that such stockholder became an interested stockholder, unless: (i) prior to such date, the board of directors of the corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned by persons who are directors and also officers and by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or (iii) on or subsequent to such date, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66 2/3% of the outstanding voting stock that is not owned by the interested stockholder. Section 203 defines business combination to include: (i) any merger or consolidation involving the corporation and the interested stockholder; (ii) any sale, transfer, pledge or other disposition of 10% or more of the assets of the corporation involving the interested stockholder; (iii) subject to certain exceptions, any transaction that results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder; (iv) any transaction involving the corporation that has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or (v) the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, 50 52 pledges or other financial benefits provided by or through the corporation. In general, Section 203 defines an interested stockholder as any entity or person beneficially owning 15% or more of the outstanding voting stock of the corporation and any entity or person affiliated with or controlling or controlled by such entity or person. Certain provisions in the Certificate of Incorporation and the Bylaws could have the effect of delaying, deferring or preventing changes in control of the Company. Among other things, upon the Company's reincorporation in Delaware prior to the consummation of the Offering, the Certificate of Incorporation will divide the members of the Board of Directors into three different classes of Directors who are elected by holders of the Common Stock and who serve three-year staggered terms, require advance notice of stockholder proposals and nominations of Directors and authorize the issuance of "blank check" Preferred Stock. See "Risk Factors -- Effect of Certain Charter Provisions; Antitakeover Effects of Certificate of Incorporation, Bylaws and Delaware Law." TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Common Stock is American Stock Transfer and Trust Company. SHARES ELIGIBLE FOR FUTURE SALE Sales of a substantial number of shares of Common Stock in the public market could adversely affect the market price of the Common Stock. Upon completion of this Offering, the Company will have outstanding an aggregate of 7,210,100 shares of Common Stock, assuming no exercise of the Underwriters' over-allotment option. Of these shares, the 2,600,000 shares sold in the Offering will be freely tradeable without restriction or further registration under the Securities Act, except for any of such shares which may be purchased by Affiliates. The remaining 4,610,100 shares of Common Stock are held by Messrs. DeFrancesco and Freiman and were issued and sold by the Company in reliance on Section 4(2) of the Securities Act. All such outstanding shares will be subject to the "lock-up" agreements described below on the date of this Prospectus. Upon expiration of lock-up agreements 180 days, 360 days and 540 days after the date of this Prospectus, 1,536,700, 1,536,700 and 1,536,700 shares will become eligible for sale, respectively, subject to the limitations of Rule 144. As of November 14, 1996, there were a total of 2,520,440 shares of Common Stock subject to outstanding options, 660,760 of which were exercisable. Of these 660,760 shares, options to purchase 100,000 shares will be exercised immediately prior to the consummation of the Offering and an additional 511,706 shares underlying such options are subject to lock-up agreements. In general, under Rule 144 as currently in effect, a person (or person whose shares are aggregated) who has beneficially owned shares for at least two years (including the holding period of any prior owner except an affiliate) is entitled to sell in "broker's transactions" or to market makers, within any three-month period commencing 90 days after the date of this prospectus, a number of shares that does not exceed the greater of (i) 1% of the number of shares of Common Stock then outstanding (approximately 72,101 shares immediately after this Offering) or (ii) generally, the average weekly trading volume in the Common Stock during the four calendar weeks preceding the required filing of a Form 144 with respect to such sale. Sales under Rule 144 are generally subject to the availability of current public information about the Company. Under Rule 144(k), a person who is deemed not to have been an Affiliate at any time during the 90 days preceding a sale, and who has beneficially owned the shares proposed to be sold for at least three years, is entitled to sell such shares without having to comply with the manner of sale, public information, volume limitation or notice filing provisions of Rule 144. Under Rule 701 under the Securities Act, persons who purchase shares upon exercise of options granted prior to the effective date of this Offering are entitled to sell such shares 90 days after the effective date of this Offering in reliance on Rule 144, without having to comply with the holding period and notice filing requirements of Rule 144 and, in the case of non-affiliates, without having to comply with the public information, volume limitation or notice filing provisions of Rule 144. 51 53 The Company intends to file a registration statement on Form S-8 after the effective date of the Offering to register shares of Common Stock reserved for issuance under the Stock Option Plan, thus permitting the resale of such shares by non-affiliates and by Affiliates, subject to contractual restrictions and Rule 144 volume limitations applicable thereto, in the public market without restrictions under the Securities Act. Such registration statement will become effective immediately upon filing. All existing stockholders of the Company have agreed that they will not, subject to certain limited exceptions, directly or indirectly, offer, sell or otherwise dispose of a certain number of shares of Common Stock or any securities convertible into or exchangeable or exercisable for any such shares for a period of 180 days, 360 days and 540 days, respectively, from the date of this Prospectus without the prior written consent of Friedman, Billings, Ramsey & Co., Inc. 52 54 UNDERWRITING Subject to the terms and conditions set forth in the underwriting agreement between the Company, the Selling Stockholders and the Underwriters (the "Underwriting Agreement"), the Company and the Selling Stockholders have agreed to sell to each of the Underwriters named below, and the Underwriters, for whom Friedman, Billings, Ramsey & Co., Inc. and Unterberg Harris are acting as representatives (collectively, the "Representatives"), have severally agreed to purchase from the Company and the Selling Stockholders, the respective number of shares of Common Stock set forth opposite their respective name. Under the Underwriting Agreement, the Underwriters are obligated to purchase all of the 2,600,000 shares of Common Stock offered hereby if any are purchased.
NUMBER OF NAME SHARES -------------------------------------------------------------------------- --------- Friedman, Billings, Ramsey & Co., Inc..................................... Unterberg Harris.......................................................... ------- =======
The Underwriters have advised the Company and the Selling Stockholders that the Underwriters propose to initially offer the shares of Common Stock to the public at the initial public offering price set forth on the cover page of this Prospectus and to certain dealers at such price less a concession not in excess of $ per share. After the shares of Common Stock have been released for sale to the public, the price to the public and such concessions may be changed. The Company has granted the Underwriters an option, exercisable for 30 days after the date on this Prospectus, to purchase up to 390,000 additional shares of Common Stock solely to cover over-allotments, if any, at the initial public offering price, less the underwriting discount and commission, shown on the cover page of this Prospectus. The Representatives have informed the Company that the Underwriters do not intend to confirm sales to any account over which they exercise discretionary authority. The Company, its directors, officers and holders of its Common Stock, and certain holders of options to purchase its Common Stock, have each agreed, not to offer, sell, contract to sell or otherwise dispose of any shares of Common Stock, or any security convertible into or exercisable for shares of Common Stock, for a period of 180 days after the date of this Prospectus without the prior written consent of the Representatives. In the Underwriting Agreement, the Company has agreed to indemnify the Underwriters against certain liabilities, including civil liabilities under the Securities Act. Each of the Underwriters may be deemed to be an "underwriter" for purposes of the Securities Act in connection with the Offering. The Company will reimburse the Underwriters for their reasonable out-of-pocket expenses, including legal fees and expenses, incurred in connection with the Offering. Prior to this Offering, there has been no public market for the Common Stock. The initial public offering price will be determined by negotiation between the Company, the representatives of the Selling Stockholders and the Underwriters. Among the factors to be considered in determining the initial public offering price will be prevailing market and economic conditions, revenues and earnings of the Company, market valuations of other companies engaged in activities similar to the Company, estimates of the business potential and prospects of the Company, the present state of the Company's business operations, the Company's management and other factors deemed relevant. Additionally, consideration will be given to the status of the securities markets, market conditions for new offerings of securities and the prices of similar securities of comparable companies. The Company intends to apply to include the Common Stock for quotation in the Nasdaq National Market under the symbol "CMSS." In order to meet one of the requirements for including the Common Stock on the Nasdaq National Market, the Underwriters have undertaken to sell shares of Common Stock to a minimum of 400 beneficial holders. There can be no assurance, however, that the Company will be able to 53 55 maintain the inclusion of the Common Stock in the Nasdaq National Market or that an active trading market will develop. The Company has also engaged Graham, Hamilton & Dwyer, Inc. ("Graham, Hamilton") as its financial advisor in connection with this Offering and other matters. As compensation, the Company has paid to Graham, Hamilton a nonrefundable engagement fee of $50,000 and has agreed to pay Graham, Hamilton a fee of 1% of the net proceeds of this Offering, such fee not to exceed $400,000. The Company has also agreed to indemnify Graham, Hamilton against liabilities resulting from the performance of its duties as financial advisor, except for any liability resulting from Graham, Hamilton's gross negligence or willful misconduct. LEGAL MATTERS The validity of the securities offered hereby will be passed upon for the Company by Manatt, Phelps & Phillips, LLP, Washington, D.C. Certain legal matters in connection with this Offering will be passed upon for the Underwriters by Brobeck, Phleger & Harrison LLP, New York, New York. EXPERTS The consolidated financial statements of the Company at December 31, 1994, December 31, 1995, and September 30, 1996 and for each of the three years in the period ended December 31, 1995 and the nine months ended September 30, 1996 appearing in this Prospectus and the Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the Commission a Registration Statement on Form S-1 under the Securities Act, of which this Prospectus is a part, with respect to the Common Stock offered hereby. This Prospectus omits certain information contained in the Registration Statement, and reference is made to the Registration Statement for further information with respect to the Company and the Common Stock offered hereby. Statements contained herein concerning the provisions of documents are necessarily summaries of such documents and when any such document is an exhibit to the Registration Statement, each such statement is qualified in its entirety by reference to the copy of such document filed with the Commission. The Registration Statement, including the exhibits and schedules thereto, may be inspected without charge at the principal office of the Commission at 450 Fifth Street, N.W., Washington D.C. 20549, and the Commission's Regional Offices at 75 Park Place, Room 1288, New York, New York 10017, and Northwest Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60621-2511, and copies may be obtained at prescribed rates from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. The Registration Statement, including all exhibits and schedules, and such reports and other information may also be accessed electronically by means of the Commission's site on the World Wide Web, at http://www.sec.gov. 54 56 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Auditors........................................................ F-2 Consolidated Balance Sheets........................................................... F-3 Consolidated Statements of Operations................................................. F-4 Consolidated Statements of Stockholders' Deficit...................................... F-5 Consolidated Statements of Cash Flows................................................. F-6 Notes to Consolidated Financial Statements............................................ F-7
F-1 57 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, 1994 and 1995, and September 30, 1996, and the related consolidated statements of operations, stockholders' deficit and cash flows for each of the three years in the period ended December 31, 1995 and the nine-month period ended September 30, 1996. 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, 1994 and 1995 and September 30, 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 and the nine-month period ended September 30, 1996, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Baltimore, Maryland October 28, 1996 F-2 58 CREDIT MANAGEMENT SOLUTIONS, INC. CONSOLIDATED BALANCE SHEETS
DECEMBER 31, PRO FORMA ---------------------------- SEPTEMBER 30, SEPTEMBER 30, 1994 1995 1996 1996 ------------ ------------ ------------- ------------------ (UNAUDITED--NOTE 2) ASSETS Current assets: Cash and cash equivalents...................... $ 75,840 $ 120,255 $ 8,433 $ 8,433 Accounts receivable, net of allowance of $0, $98,095 and $100,000 in 1994, 1995 and September 30, 1996, respectively............. 830,364 1,816,966 2,072,695 2,072,695 Costs and estimated earnings in excess of billings on uncompleted contracts............ -- 263,365 592,081 592,081 Prepaid expenses and other current assets...... 7,634 250,976 738,555 738,555 Deferred income taxes.......................... -- -- -- 203,941 ------------ ------------ ------------- ------------------ Total current assets................... 913,838 2,451,562 3,411,764 3,615,705 Property and equipment: Computer equipment and software................ 804,318 1,464,421 1,751,439 1,751,439 Office furniture and equipment................. 170,101 360,319 396,098 396,098 Leasehold improvements......................... 23,933 96,504 102,249 102,249 ------------ ------------ ------------- ------------------ 998,352 1,921,244 2,249,786 2,249,786 Accumulated depreciation and amortization...... (390,662) (639,465) (913,098) (913,098) ------------ ------------ ------------- ------------------ 607,690 1,281,779 1,336,688 1,336,688 Software development costs, net of accumulated amortization of $0, $0 and $29,930 in 1994, 1995 and September 30, 1996, respectively.... 49,553 268,129 329,234 329,234 Other assets................................... 10,670 33,853 110,913 110,913 ------------ ------------ ------------- ------------------ Total assets........................... $ 1,581,751 $4,035,323 $ 5,188,599 $5,392,540 ============ ============ ============== =================== LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable............................... $ 127,048 $1,372,616 $ 1,318,766 $1,393,766 Accrued payroll and related expenses........... 385,066 614,876 665,576 665,576 Billings in excess of costs and estimated earnings on uncompleted contracts............ 841,537 592,457 884,468 884,468 Deferred revenue............................... 426,674 588,895 1,688,308 1,688,308 Short-term borrowings.......................... 130,000 250,000 304,481 304,481 Current portion of long-term debt and capital lease obligations............................ 77,409 214,612 240,777 240,777 ------------ ------------ ------------- ------------------ Total current liabilities.............. 1,987,734 3,633,456 5,102,376 5,177,376 Deferred income taxes.......................... -- -- -- 334,427 Stockholder loans.............................. 206,404 214,498 225,760 225,760 Capital lease obligations, less current portion...................................... 180,241 397,011 243,385 243,385 Long-term debt, less current portion........... 29,491 11,795 -- -- Excess of assigned value of identifiable assets over cost of an acquired interest, net of accumulated amortization of $558,709, $863,459 and $1,092,021 in 1994, 1995 and September 30, 1996, respectively............. 660,291 355,541 126,979 126,979 Commitments and contingent liabilities......... -- -- 120,000 120,000 ------------ ------------ ------------- ------------------ Total liabilities.............................. 3,064,161 4,612,301 5,818,500 6,227,927 Stockholders' deficit: Common stock, $.01 par value; 10,000,000 shares authorized; 4,910,100 shares issued and outstanding at December 31, 1994, December 31, 1995 and September 30, 1996, respectively....................... 49,101 49,101 49,101 49,101 Additional paid-in capital................. -- -- -- (884,488) Accumulated deficit........................ (1,531,511) (626,079) (679,002) -- ------------ ------------ ------------- ------------------ Total stockholders' deficit.................... (1,482,410) (576,978) (629,901) (835,387) ------------ ------------ ------------- ------------------ Total liabilities and stockholders' deficit.... $ 1,581,751 $4,035,323 $ 5,188,599 $5,392,540 ============ ============ ============== ===================
The accompanying notes are an integral part of these financial statements. F-3 59 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED NINE MONTHS ENDED DECEMBER 31, SEPTEMBER 30, -------------------------------------- -------------------------- 1993 1994 1995 1995 1996 ---------- ---------- ---------- ----------- ----------- (UNAUDITED) Revenues: License and software development fees............ $2,911,539 $2,934,450 $7,207,581 $ 4,778,059 $ 6,453,243 Maintenance fees.............. 375,510 700,861 1,170,447 874,076 1,433,190 Computer hardware sales....... 81,019 316,145 1,853,424 1,076,724 1,149,052 ---------- ---------- ---------- ----------- ----------- 3,368,068 3,951,456 10,231,452 6,728,859 9,035,485 ---------- ---------- ---------- ----------- ----------- Costs and expenses: Costs of license and software development fees............ 785,622 1,482,036 3,559,798 2,186,040 3,519,921 Cost of maintenance fees...... 40,776 151,346 280,176 214,320 324,387 Cost of computer hardware sales....................... 77,979 315,262 1,500,816 842,407 998,876 Selling, general and administrative expenses..... 2,234,816 2,244,031 3,966,265 2,631,749 4,048,248 Research and development costs....................... 131,203 167,152 165,366 91,313 344,326 ---------- ---------- ---------- ----------- ----------- 3,270,396 4,359,827 9,472,421 5,965,829 9,235,758 ---------- ---------- ---------- ----------- ----------- Income (loss) from operations...... 97,672 (408,371) 759,031 763,030 (200,273) Other income (expense): Interest expense.............. (32,774) (41,310) (105,849) (83,029) (81,212) Amortization of excess of assigned value of identifiable assets over cost of an acquired interest................. 253,959 304,750 304,750 228,562 228,562 ---------- ---------- ---------- ----------- ----------- 221,185 263,440 198,901 145,533 147,350 ---------- ---------- ---------- ----------- ----------- Net income (loss).................. $ 318,857 $ (144,931) $ 957,932 $ 908,563 $ (52,923) ========== ========== ========== =========== =========== Pro forma data (unaudited -- Note 2): Historical income (loss)...... $ 957,932 $ (52,923) Pro forma income tax expense (benefit)................... 220,618 (97,928) ---------- ----------- Pro forma net income.......... $ 737,314 $ 45,005 ========== =========== Pro forma net income per share....................... $ 0.12 $ 0.01 ========== ===========
The accompanying notes are an integral part of these financial statements. F-4 60 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
COMMON STOCK -------------------- NUMBER ACCUMULATED OF SHARES AMOUNT DEFICIT TOTAL --------- ------- ----------- ----------- Balance at January 1, 1993...................... 4,910,100 $49,101 $(1,600,437) $(1,551,336) Net income for 1993........................ -- -- 318,857 318,857 --------- ------- ----------- ----------- Balance at December 31, 1993.................... 4,910,100 49,101 (1,281,580) (1,232,479) Net loss for 1994.......................... -- -- (144,931) (144,931) Distributions to stockholders.............. -- -- (105,000) (105,000) --------- ------- ----------- ----------- Balance at December 31, 1994.................... 4,910,100 49,101 (1,531,511) (1,482,410) Net income for 1995........................ -- -- 957,932 957,932 Distributions to stockholders.............. -- -- (52,500) (52,500) --------- ------- ----------- ----------- Balance at December 31, 1995.................... 4,910,100 49,101 (626,079) (576,978) Net loss for the nine months ended September 30, 1996....................... -- -- (52,923) (52,923) --------- ------- ----------- ----------- Balance at September 30, 1996................... 4,910,100 $49,101 $ (679,002) $ (629,901) ========= ======= =========== ===========
The accompanying notes are an integral part of these financial statements. F-5 61 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED NINE MONTHS ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------ -------------------------- 1993 1994 1995 1995 1996 --------- --------- ---------- ----------- ----------- (UNAUDITED) Operating activities: Net income (loss).................... $ 318,857 $(144,931) $ 957,932 $ 908,563 $ (52,923) Adjustments: Depreciation....................... 66,882 136,847 265,772 198,632 273,634 Amortization of excess of assigned value of identifiable assets over cost of an acquired interest........................ (253,959) (304,750) (304,750) (228,562) (228,562) Amortization of software development costs............... -- -- -- -- 29,930 Loss on disposal of property and equipment....................... -- 11,272 3,972 9,242 -- Changes in operating assets and liabilities: Accounts receivable, net........ (382,725) (358,251) (986,602) (541,549) (255,729) Prepaid expenses and other current assets................ 5,945 (7,434) (243,342) (186,475) (487,579) Other assets.................... 15,850 (5,928) (23,183) (10,349) (77,060) Accounts payable................ 150,600 (96,041) 1,245,568 514,020 (53,850) Accrued payroll and related expenses...................... 238,575 (7,443) 229,810 (36,713) 50,700 Net billings in excess of costs and estimated gross profit on uncompleted contracts......... 97,267 781,505 (512,445) (332,645) (36,705) Deferred revenue................ 59,901 288,792 162,221 219,629 1,099,413 Accrued interest on stockholder loans......................... 12,600 13,804 8,094 10,836 11,262 Accrued contingent liability.... -- -- -- -- 120,000 --------- --------- ---------- ---------- ---------- Net cash provided by operating activities......................... 329,793 307,442 803,047 524,629 392,531 Investing activities: Capitalized software development costs.............................. -- (49,553) (218,576) (171,025) (91,035) Proceeds from sale of property and equipment.......................... -- 1,300 86,824 -- -- Purchases of property and equipment.......................... (198,448) (236,016) (492,333) (298,140) (295,115) Payment for acquired interest........ (150,000) -- -- -- -- --------- --------- ---------- ---------- ---------- Net cash used in investing activities......................... (348,448) (284,269) (624,085) (469,165) (386,150) Financing activities: Net short-term borrowings............ -- 130,000 120,000 30,000 54,481 Repayments of stockholder loans...... (110,855) -- -- -- -- Payments under capital lease obligations........................ -- (66,784) (184,013) (106,861) (160,439) Repayments of long-term debt......... (15,028) (14,103) (18,034) (11,292) (12,245) Distributions to stockholders........ -- (105,000) (52,500) -- -- --------- --------- ---------- ---------- ---------- Net cash used in financing activities......................... (125,883) (55,887) (134,547) (88,153) (118,203) --------- --------- ---------- ---------- ---------- Net change in cash and cash equivalents........................ (144,538) (32,714) 44,415 (32,689) (111,822) Cash and cash equivalents at beginning of period................ 253,092 108,554 75,840 75,840 120,255 --------- --------- ---------- ---------- ---------- Cash and cash equivalents at end of period............................. $ 108,554 $ 75,840 $ 120,255 $ 43,151 $ 8,433 ========= ========= ========== ========== ==========
The accompanying notes are an integral part of these financial statements. F-6 62 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (INFORMATION FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 IS UNAUDITED) 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION OF FINANCIAL STATEMENTS Description of Business Credit Management Solutions, Inc. (the "Company") develops and provides software solutions and services for automating the consumer and small business credit analysis, decisioning and funding process. The Company's customers are primarily banks and other financial institutions located throughout the United States. Principles of Consolidation The accompanying 1995 and 1996 consolidated financial statements include the accounts of the Company and its subsidiary, Credit Connection LLC. The subsidiary was established on January 5, 1995 to operate 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. The accompanying 1993 consolidated financial statements include the accounts of the Company and CMSI Group Limited Partnership through March 4, 1993, the date the partnership was terminated upon the purchase of the minority partnership interest (see Note 5). Unaudited Interim Financial Statements The consolidated financial statements for the nine months ended September 30, 1995 have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission for interim financial reporting. These statements are unaudited but, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments and accruals) necessary for a fair presentation of the financial information set forth herein. The operating results for the nine months ended September 30, 1996 are not necessarily indicative of the results that may be expected for the year ending December 31, 1996. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. SIGNIFICANT ACCOUNTING POLICIES Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Property and Equipment Property and equipment is stated at cost and depreciated using the straight-line method based on estimated useful lives of between three and seven years. Amortization of leasehold improvements is provided using the straight-line method over the lesser of the life of the improvement or the remaining term of the lease. Assets held under capital leases are stated at the lesser of the present value of future minimum payments using the Company's incremental borrowing rate at the inception of the lease or the fair value of the property at the F-7 63 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) inception of the lease. The assets recorded under capital leases are amortized over the lesser of the lease term or the estimated useful life of the assets in a manner consistent with the Company's depreciation policy for owned assets. Software Development Costs Software development costs consist of direct labor and applicable overhead related to the development of a software product named "Credit Connection." These costs were capitalized beginning in September 1994 upon the determination that the software was technologically feasible. Credit Connection was commercially released in July 1996 and amortization over the estimated useful life of three years commenced at that date. Amortization is included in costs of license and software development fees. Revenue Recognition Revenues from long-term software license contracts are recognized on the percentage-of-completion method, measured generally on a cost incurred basis. Costs consist primarily of direct labor and applicable overhead. Contracts in progress are reviewed periodically as the work progresses, and revenues and earnings are adjusted in current accounting periods based on revisions in contract value and estimates to complete. The Company recognizes revenue for software maintenance fees pro rata over the term of the agreement, which generally have a one-year term. Revenues from sales of hardware and software are recognized at time of shipment and when collection of the receivable is probable. Payments received in advance of revenue recognition for these services and product sales are included in deferred revenue. Advertising Costs All advertising costs are expensed when incurred. Costs which are included in selling, general and administrative expense for the years ended December 31, 1993, December 31, 1994 and December 31, 1995 and for the nine months ended September 30, 1995 and September 30, 1996 are $64,242, $62,594, $101,741, $116,152 and $102,191, respectively. Income Taxes The stockholders have 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 during the periods presented. The Company currently anticipates completing an initial public offering of its common stock in late 1996, which will result in the termination of the Company's Subchapter S status. 2. PRO FORMA INFORMATION (UNAUDITED) Pro Forma Balance Sheet Upon completion of its initial public offering, the Company's S Corporation status will terminate and the Company will be subject to income tax at the corporate level. The pro forma balance sheet of the Company as of September 30, 1996 reflects the deferred tax asset and liability which would have been recorded by the Company if its S Corporation status was terminated at that date and a distribution payable to the stockholders for estimated personal income tax obligations resulting from the Company's reported income for income tax purposes (estimated at $75,000 as of September 30, 1996). The pro forma deferred tax asset and liability represent the tax effect of the cumulative differences between the financial reporting and income tax bases of certain assets and liabilities as of September 30, 1996. The actual deferred tax asset and liability recorded will be adjusted to reflect the effect of operations of the Company for the period from October 1, 1996 through the date immediately preceding the termination of its S Corporation status. The pro forma balance sheet also F-8 64 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) reflects the reclassification of the accumulated deficit to additional paid-in capital, which will occur upon the termination of S Corporation status. The significant items comprising the Company's pro forma net deferred tax liability as of September 30, 1996 are as follows: Pro forma deferred tax assets: Revenue recognition......................................................... $ 112,920 Accrued vacation............................................................ 53,138 Provision for bad debts..................................................... 37,883 --------- Total pro forma deferred tax assets.............................................. 203,941 Pro forma deferred tax liabilities: Capitalized software development costs...................................... (127,150) Depreciation................................................................ (207,277) --------- Total pro forma deferred tax liabilities......................................... (334,427) --------- Pro forma net deferred tax liability............................................. $(130,486) =========
Pro Forma Statement of Operations Data Upon the closing of the public offering, the Company will terminate its status as an S Corporation and will be subject to federal and state income taxes thereafter. Accordingly, for informational purposes, the accompanying statements of operations data for the year ended December 31, 1995 and the nine months ended September 30, 1996 include an unaudited pro forma adjustment for income taxes which would have been recorded if the Company had not been an S Corporation, based on the tax laws in effect during the respective periods. Pro forma income tax expense (benefit) consists of the following:
NINE MONTHS YEAR ENDED ENDED DECEMBER 31, SEPTEMBER 30, 1995 1996 ------------ ------------- Current: Federal........................................................ $ -- $ -- State.......................................................... -- -- ------------ ------------- -- -- Deferred: Federal........................................................ 180,630 (80,178) State.......................................................... 39,988 (17,750) ------------ ------------- 220,618 (97,928) ------------ ------------- Pro forma income tax expense (benefit).............................. $220,618 $ (97,928) ========== ==========
F-9 65 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company's pro forma expense (benefit) for income taxes would result in effective tax rates that vary from the statutory federal income tax rate as follows:
NINE MONTHS YEAR ENDED ENDED DECEMBER 31, SEPTEMBER 30, 1995 1996 ------------ ------------- Expected federal income tax provision (benefit) at 34%.............. $325,697 $ (17,994) Income not recognizable for tax purposes............................ (89,878) (68,219) State income taxes, net of federal benefit.......................... (15,201) (11,715) ------------ ------------- $220,618 $ (97,928) ========== ==========
Pro Forma Earnings Per Share The following table summarizes the computations of share amounts used in the computation of pro forma earnings per share presented in the accompanying statements of operations:
NINE MONTHS YEAR ENDED ENDED DECEMBER 31, SEPTEMBER 30, 1995 1996 ------------ ------------- Weighted average number of shares of common stock outstanding during the period........................................................ 4,910,100 4,910,100 Effect of options to purchase common stock issued within one year of registration statement............................................ 1,383,620 1,383,620 ------------ ------------- Total common and common equivalent shares of stock considered outstanding during the period..................................... 6,293,720 6,293,720 ========== ==========
Pro forma earnings per common and common equivalent share is based on the average number of shares of common stock outstanding during each period. As required by the Securities and Exchange Commission, all options to purchase common stock issued by the Company at exercise prices below the expected initial public offering price during the twelve-month period prior to the anticipated offering date have been included in the computations as if they were outstanding for all periods presented using the treasury stock method, even if the result is anti-dilutive. F-10 66 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. HISTORICAL EARNINGS (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE The following table summarizes the computations of historical earnings (loss) per common and common equivalent share.
YEAR ENDED NINE MONTHS ENDED DECEMBER 31, SEPTEMBER 30, ----------------------------------- ---------------------- 1993 1994 1995 1995 1996 --------- --------- --------- --------- --------- Net income (loss)...................... $ 318,857 $(144,931) $ 957,932 $ 908,563 $ (52,923) ======== ========= ======== ======== ======== Weighted average number of shares outstanding.......................... 4,910,100 4,910,100 4,910,100 4,910,100 4,910,100 Effect of options to purchase common stock issued within one year of registration statement............... 1,383,620 1,383,620 1,383,620 1,383,620 1,383,620 --------- --------- --------- --------- --------- Total common and common equivalent shares of stock considered outstanding during the period........ 6,293,720 6,293,720 6,293,720 6,293,720 6,293,720 ======== ========= ======== ======== ======== Earnings (loss) per common and common equivalent share..................... $ 0.05 $ (0.02) $ 0.15 $ 0.14 $ (0.01) ======== ========= ======== ======== ========
Earnings (loss) per common and common equivalent share is based on the average number of shares of common stock outstanding during each period. As required by the Securities and Exchange Commission, all options to purchase common stock issued by the Company at exercise prices below the expected initial public offering price during the twelve-month period prior to the anticipated offering date have been included in the computations as if they were outstanding for all periods presented using the treasury stock method, even if the result is anti-dilutive. 4. SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES As discussed in Note 5, in 1993 the Company purchased a limited partner's interest in a partnership for $225,000, of which $75,000 was financed through the issuance of a note payable. In connection with the purchase, an excess of assigned value of the identifiable net assets over the cost of an acquired interest was recorded as follows: Acquired interest............................................................... $ 758,000 Forgiveness of debt............................................................. 813,000 Reduction of noncurrent assets to zero.......................................... (127,000) Issuance of note payable........................................................ (75,000) Cash paid....................................................................... (150,000) ---------- Excess of assigned value of identifiable assets over cost of an acquired interest...................................................................... $1,219,000 =========
Capital lease obligations of $309,228, $538,324, $274,422 and $33,417 were incurred when the Company entered into leases for new equipment during the years ended December 31, 1994 and December 31, 1995 and the nine months ended September 30, 1995 and September 30, 1996, respectively. Interest paid for the years ended December 31, 1993, 1994 and 1995 was $6,750, $40,313 and $105,576, respectively. Interest paid for the nine months ended September 30, 1995 and September 30, 1996 totaled $86,126 and $79,855 respectively. F-11 67 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. PARTNERSHIP INTEREST IN CMSI GROUP LIMITED PARTNERSHIP From September 1988 through March 4, 1993 the Company was the sole general partner of CMSI Group Limited Partnership, a partnership which conducted what are now the Company's principal operations. During this period, the Company's ownership interest in the partnership varied between 49% and 67%, and it accounted for the partnership as a consolidated subsidiary in its financial statements. In March 1993 the Company purchased the other partner's limited partnership interest for $225,000. The Company accounted for the acquisition of the limited partner's interest as the acquisition of a minority interest and used the purchase method of accounting. The assigned value of the identifiable net assets acquired over the cost of the acquired interest was $1,219,000, after reducing intangible assets and property and equipment to zero for the portion of those assets represented by the acquired interest. This amount is being amortized into income using the straight-line method over four years. 6. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS Uncompleted contracts consist of the following components:
BALANCE SHEET CAPTION ------------------------ COSTS AND ESTIMATED BILLINGS EARNINGS IN IN EXCESS OF EXCESS COSTS AND OF ESTIMATED BILLINGS EARNINGS TOTAL ---------- ---------- ---------- December 31, 1994: Costs and estimated earnings........................ $ -- $1,826,899 $1,826,899 Billings............................................ -- 2,668,436 2,668,405 ========= ========= ========= $ -- $ (841,537) $ (841,537) ---------- ---------- ---------- December 31, 1995: Costs and estimated earnings........................ $1,552,292 $2,044,454 $3,596,701 Billings............................................ 1,288,927 2,636,911 3,925,793 ---------- ---------- ---------- $ 263,365 $ (592,457) $ (329,092) ========= ========= ========= September 30, 1996: Costs and estimated earnings........................ $1,682,353 $2,880,568 $4,562,921 Billings............................................ 1,090,272 3,765,036 4,856,308 ---------- ---------- ---------- $ 592,081 $ (884,468) $ (292,387) ========= ========= =========
All receivables on contracts in-progress are expected to be collected within twelve months. 7. SHORT-TERM BORROWINGS At December 31, 1994, December 31, 1995 and September 30, 1996 the Company maintained a short-term line of credit arrangement with a bank which allowed for aggregate borrowings of $500,000. Borrowings under this arrangement, which are personally guaranteed by the stockholders of the Company, are secured by essentially all of the Company's assets and bear interest at the bank's prime rate plus 1% per annum (weighted average borrowing rate of 9.4%, 9.8% and 9.3% for the year ended December 31, 1994, 1995 and the nine months ended September 30, 1996, respectively). Under the terms of the credit arrangement, the Company is required to comply with certain covenants including a restriction on the payment of cash dividends without the prior written consent of the bank. 8. STOCKHOLDER LOANS Amounts due to stockholders accrue interest at 7% per annum and are payable on demand after October 1, 1997. F-12 68 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. CAPITAL LEASE OBLIGATIONS The Company leases equipment under capital leases. Property and equipment includes the following amounts for leases that have been capitalized:
DECEMBER 31 -------------------- SEPTEMBER 30 1994 1995 1996 -------- -------- ------------ Computer equipment.......................................... $227,240 $561,279 594,698 Office furniture and equipment.............................. 81,988 265,337 265,335 -------- -------- -------- 309,228 826,616 860,033 Less: accumulated amortization.............................. 27,851 188,155 247,509 -------- -------- -------- $281,377 $638,461 $612,524 ======== ======== ========
Amortization of leased assets is included in depreciation expense. Future minimum payments under capital lease obligations consist of the following at September 30, 1996: Three months ended December 31, 1996.............................. $ 68,151 1997.............................................................. 257,880 1998.............................................................. 139,546 1999.............................................................. 61,206 2000 and thereafter............................................... 25,754 -------- Total minimum lease payments...................................... $552,537 Less amounts representing interest................................ 84,303 -------- Present value of minimum capital lease payments (including current portion of $224,849)............................................ $468,234 ========
10. STOCK OPTIONS The Company has elected to record compensation expense for all stock-based compensation plans using the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"). Under APB 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. In October 1995, the Financial Accounting Standards Board issued FASB Statement No. 123, Accounting for Stock-Based Compensation ("Statement 123"), which encourages, but does not require, companies to recognize expense for stock-based awards based on their estimated fair value on the date of grant. Under the provisions of Statement 123, companies are required to supplementally disclose pro forma net income and earnings per share information as if the fair value method had been adopted. In 1996 the Company adopted the 1996 Credit Management Solutions, Inc. Non-Qualified Stock Option Plan (the "Plan"). The 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 and directors of the Company. In June 1996 the Company granted options to purchase 2,362,540 shares of common stock for an exercise price of $5.00 per share, the estimated fair value of a share of common stock on the date of grant as determined by an independent appraisal. These options have a term of 10 years, and at September 30, 1996, 642,234 options are vested and exercisable. In October 1996 the Company granted options to purchase an additional 27,360 shares of common stock for an exercise price of $9.60 per share, the estimated fair value of a share of common stock at the date of grant. All options granted under the Plan are subject to vesting provisions at the discretion of the Board of Directors. Options granted through October 1996 vest in varying percentages through 2001. F-13 69 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Pro forma net income and earnings per share information required by Statement 123 has been determined using the minimum value method. The minimum value method calculates the fair value of options as the excess of the estimated fair value of the underlying stock at the date of grant over the present value of both the exercise price and the expected dividend payments, each discounted at the risk-free rate, over the expected life of the option. In determining the estimated fair value of granted stock options under the minimum value method, the risk-free interest rate was assumed to be 6%, the dividend yield was estimated to be 0%, and the expected life of all granted options was assumed to be 5 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 123 do not necessarily provide a single measure of the fair value of its employee stock options. For example, if the expected life of the options was changed from 5 to 4 years, the amount of total compensation expense recognized using the minimum value method would decrease by approximately $600,000, or 18%. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma net loss for the nine months ended September 30, 1996 is $1,120,000 greater than the historical net loss of $52,923, or $1,172,923. Pro forma loss per share is $(0.19). 11. 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 nine months ended September 30, 1996 were $12,317. 12. 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, 1995, 31% of accounts receivable was due from one customer and at September 30, 1996, 44% of accounts receivable was due from three customers. F-14 70 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following table summarizes the percentage contribution of revenues by customer when sales to such customers exceeded 10% of net revenues.
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------ -------------- 1993 1994 1995 1995 1996 ---- ---- ---- ---- ---- Customer A........................................... 11% -- -- -- -- Customer B........................................... 13% -- -- -- -- Customer C........................................... 16% -- -- -- -- Customer D........................................... 11% -- -- -- -- Customer E........................................... 18% -- -- -- -- Customer F........................................... 12% -- -- -- 11% Customer G........................................... -- 17% 20% 19% 10% Customer H........................................... -- 10% -- -- -- Customer I........................................... -- 12% -- -- -- Customer J........................................... -- 17% -- -- -- Customer K........................................... -- -- 13% 16% 10% Customer L........................................... -- -- -- -- 10%
13. OPERATING LEASES The Company leases certain office space and equipment under non-cancelable operating lease agreements which expire through 2007. Future minimum lease payments at September 30, 1996 for leases with initial terms of one year or more consist of the following: Three months ended December 31, 1996............................ $ 166,432 1997............................................................ 667,502 1998............................................................ 648,060 1999............................................................ 269,729 2000 and thereafter............................................. 207,489 ---------- Total minimum lease payments.................................... $1,959,212 =========
Rent expense under all operating leases for the years ended December 31, 1993, December 31, 1994 and December 31, 1995 and the nine months ended September 30, 1995 and September 30, 1996 was $26,985, $171,346, $398,530, $319,779 and $414,301, respectively. 14. COMMITMENT AND CONTINGENT LIABILITY In August 1996, the Company entered into a settlement agreement and general release with a former officer of the Company. The agreement provides that the Company will pay the former officer as severance his monthly salary for a period of one year. In addition, the agreement requires the Company to pay the former officer a total of $240,000, including the aforementioned salary payments, if a change in control of the Company occurs before January 18, 1997, or $120,000 if a change in control occurs before July 18, 1997. If an initial public offering of the Company's common stock is consummated prior to a change in control, the agreement provides that the Company will pay the former officer a total of $240,000 if the offering is consummated prior to January 18, 1997, or $120,000 if the offering occurs before July 18, 1997. At the Company's discretion, any payments required to be made to the former officer may be in the form of cash or stock. The Company has expensed $240,000 related to this arrangement, the amount it is likely to ultimately pay the former officer. The Company has accrued $120,000 as a contingent liability at September 30, 1996, based on an assessment that it is probable that this contingent amount will be payable in the future to this former officer. Included in accrued payroll and related taxes at September 30, 1996 is $86,461 for the unpaid portion of the monthly payments due through August 1997. F-15 71 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 15. SUBSEQUENT EVENT On October 10, 1996, the Board of Directors approved a 32,734 for 1 stock split of the Company's common stock. All references in the accompanying financial statements to share and per share amounts have been retroactively restated to reflect the stock split. F-16 72 - ------------------------------------------------------ - ------------------------------------------------------ NO PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS, AND ANY INFORMATION OR REPRESENTATIONS NOT CONTAINED HEREIN MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, ANY SELLING STOCKHOLDER OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON OR BY ANYONE IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF. ------------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary.................... 3 Risk Factors.......................... 6 Use of Proceeds....................... 15 Dividend Policy....................... 15 Capitalization........................ 16 Dilution.............................. 17 Selected Consolidated Financial Data................................ 18 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 19 Business.............................. 27 Management............................ 41 Certain Transactions.................. 47 Principal and Selling Stockholders.... 49 Description of Capital Stock.......... 50 Shares Eligible for Future Sale....... 51 Underwriting.......................... 53 Legal Matters......................... 54 Experts............................... 54 Additional Information................ 54 Index to Consolidated Financial Statements.......................... F-1
------------------------ UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS) ALL DEALERS EFFECTING TRANSACTIONS IN THE SHARES OF COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. - ------------------------------------------------------ - ------------------------------------------------------ - ------------------------------------------------------ - ------------------------------------------------------ 2,600,000 SHARES CREDIT MANAGEMENT SOLUTIONS, INC. [CMSI LOGO] COMMON STOCK --------------------- PROSPECTUS --------------------- FRIEDMAN, BILLINGS, RAMSEY & CO., INC. UNTERBERG HARRIS , 1996 ------------------------------------------------------ ------------------------------------------------------ 73 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table sets forth the expenses and costs (other than underwriting discounts and commissions) expected to be incurred in connection with the issuance and distribution of the securities registered hereby. The Company is responsible for the payment of all fees and expenses incurred by the Selling Stockholders in connection with the sale of their respective shares in this Offering. All the amounts shown are estimates except for the registration fee, the NASD filing fee and the Nasdaq National Market application fee: Securities and Exchange Commission registration fee............... $ 11,779 NASD filing fee................................................... 4,387 Nasdaq National Market listing fee................................ 20,525 Commissions payable to Graham, Hamilton & Dwyer, Inc.............. 200,000 Legal fees and expenses........................................... 300,000 Blue Sky fees and expenses........................................ 25,000 Accounting fees and expenses...................................... 125,000 Printing and engraving fees....................................... 125,000 Transfer agent and registrar fees................................. 10,000 Miscellaneous..................................................... 78,309 -------- Total................................................... $900,000 ========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. (a) The Articles of Incorporation of the Registrant, consistent with Maryland law, provides that the Registrant shall indemnify its past, present and future directors and officers from judgments, fines, penalties, settlements and defense costs and expenses (including reasonable attorneys' fees) incurred in threatened, pending or completed actions, suits or proceedings against him or her, whether civil, criminal, administrative or investigative, to which such person was or is a party or threatened to be made a party by reason of his or her being or having been a director or officer of the Registrant or, at the Registrant's request, or any other corporation, partnership or enterprise and from which he or she is not otherwise entitled to be indemnified. The Registrant shall advance expenses in the investigation and defense of any such proceeding, provided the director or officer agrees to reimburse the Registrant if it is found that the director or officer did not act in good faith, that the director or officer did not reasonably believe that his or her acts or omissions were not opposed to the best interests of the Registrant, that the acts or omissions of the director or officer were not the result of active and deliberate dishonesty, or that the acts or omissions of the director or officer did not result in the receipt by him or her of an improper personal benefit. If the director or officer is alleged to have defrauded the Registrant or to have derived an improper personal benefit, no indemnification shall be afforded unless a disinterested majority of the stockholders or of the Board of Directors determines that such indemnification is appropriate or it is adjudged in the proceeding that the director or officer did not defraud the Registrant or receive an improper benefit. (b) The Registrant intends to reincorporate in Delaware prior to the consummation of this Offering. The Registrant's Certificate of Incorporation, together with its Bylaws, will provide that the Registrant shall indemnify officers and directors, and may indemnify its other employees and agents, to the fullest extent permitted by law. The laws of the State of Delaware permit, and in some cases require, corporations to indemnify officers, directors, agents and employees who are or have been a party to or are threatened to be made a party to litigation against judgments, fines, settlements and reasonable expenses under certain circumstances. II-1 74 The Registrant's Certificate of Incorporation will limit the liability of its directors and officers to the fullest extent permitted by the laws of the State of Delaware. Under the Registrant's Certificate of Incorporation, and as permitted by the laws of the State of Delaware, a director or officer will not be liable to the Registrant or its stockholders for damages for breach of fiduciary duty. Such limitations of liability will not affect liability for (i) breach of the director's duty of loyalty to the corporation or its stockholders, (ii) acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law, (iii) any transaction from which the director derived an improper personal benefit, or (iv) the payment of any unlawful distribution. Under the form of Underwriting Agreement, to be filed as Exhibit 1.1, the Underwriters are obligated, under certain circumstances, to indemnify directors and officers of the Registrant against certain liabilities, including liabilities under the Securities Act of 1933, as amended (the "Securities Act"). The Registrant intends to purchase a general liability insurance policy which covers certain liabilities of directors and officers of the Registrant arising out of claims based on acts or omissions in their capacity as directors or officers. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. In June 1996, the Option Committee granted stock options to purchase an aggregate of 2,362,540 shares of Common Stock to certain of the Company's executive officers, including Messrs. Alsobrook, Grody, Riordan and Vollono and Ms. Weil, and to certain employees, at an exercise price of $5.00 per share (the "June Options"). Of the June Options, 332,640 options vest at the rate of 10% at the time of grant, 20% on each of the first, second, third and fourth anniversaries of December 15, 1996, and 10% on the fifth anniversary of December 15, 1996. The remaining June Options vest at a rate of 30% at the time of grant, 20% on each of the first and second anniversaries of December 15, 1996, and 10% on each of the third, fourth and fifth anniversaries of December 15, 1996. In October and November 1996, the Option Committee granted 185,260 stock options under the Stock Option Plan (the "Autumn Options"). The Autumn Options have an exercise price of $9.60 per share and vest at a rate of 10% at the time of grant, 20% on each of the second, third and fourth anniversaries of December 15, 1996 and 10% on the fifth anniversary of December 15, 1996. The Options were granted pursuant to exemption from registration by virtue of Section 4(2) of the Securities Act and Rule 701 promulgated under the Securities Act. Certain Selling Stockholders intend to exercise 100,000 of the Executive Options immediately prior to the consummation of the Offering. Such exercise will result in proceeds to the Company of $500,000. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) The Exhibits filed as part of this Registration Statement are as follows:
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------ ---------------------------------------------------------------------------------- 1 Form of Underwriting Agreement 3.1 Certificate of Incorporation of the Company 3.2 Bylaws of the Company 4 Specimen certificate for Common Stock of the Company 5 Opinion of Manatt, Phelps & Phillips, LLP regarding legality of the securities being registered 10.1 Form of Project Commencement Agreement+ 10.2 Form of Software License Agreement+ 10.3 Form of Software Maintenance Agreement+ 10.4 Form of Professional Services Agreement+ 10.5 Form of Credit Connection Lender Agreement (for CreditRevue Licensees)+ 10.6 Form of Credit Connection Lender Agreement (for non-CreditRevue Licensees)+ 10.7 Form of Credit Connection Dealer Subscription Agreement+ 10.8.1 Office Building Lease between Symphony Woods Limited Partnership and the Company dated October 29, 1993+ 10.8.2 Office Building Lease between Symphony Woods Limited Partnership and the Company dated February 10, 1995+ 10.8.3 First Amendment to Lease dated March 29, 1995+
II-2 75
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------ ---------------------------------------------------------------------------------- 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 21 Subsidiaries of the Company+ 23.1 Consent of Ernst & Young LLP 23.2 Consent of Manatt, Phelps & Phillips, LLP (included in Exhibit 5) 24 Power of Attorney+ 27 Financial Data Schedule+
- --------------- + Previously filed. (b) Schedules have been omitted because of the absence of the conditions under which they are required or because the required information is included in the financial statements or notes thereto. ITEM 17. UNDERTAKINGS. The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as a part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. The undersigned registrant hereby undertakes to provide to the underwriter at the closing specified in the underwriting agreements, certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser. II-3 76 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this Amendment No. 3 to the registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Columbia, State of Maryland, on December 4, 1996. CREDIT MANAGEMENT SOLUTIONS, INC. By: /s/ SCOTT L. FREIMAN ------------------------------------ Scott L. Freiman Executive Vice President Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the dates indicated. * President, Chief Executive December 4, 1996 - --------------------------------------------- Officer and Chairman of the James R. DeFrancesco Board of Directors (Principal Executive Officer) /s/ SCOTT FREIMAN Executive Vice President and December 4, 1996 - --------------------------------------------- Director Scott L. Freiman * Senior Vice President, December 4, 1996 - --------------------------------------------- Secretary, General Counsel Miles H. Grody and Director /s/ ROBERT P. VOLLONO Senior Vice President, December 4, 1996 - --------------------------------------------- Treasurer, Chief Financial Robert P. Vollono Officer and Director (Principal Financial and Accounting Officer) * Director December 4, 1996 - --------------------------------------------- Stephen X. Graham * Director December 4, 1996 - --------------------------------------------- John J. McDonnell, Jr. *By: /s/ SCOTT L. FREIMAN - --------------------------------------------- Scott L. Freiman Attorney-in-Fact
II-4 77 EXHIBIT INDEX
PAGE AT WHICH EXHIBIT APPEARS IN EXHIBIT SEQUENTIALLY NUMBER DOCUMENT NUMBERED COPY ------- -------------------------------------------------------------------- ------------- 1 Form of Underwriting Agreement...................................... 3.1 Certificate of Incorporation of the Company......................... 3.2 Bylaws of the Company............................................... 4 Specimen certificate for Common Stock of the Company................ 5 Opinion of Manatt, Phelps & Phillips, LLP regarding legality of the securities being registered......................................... 10.1 Form of Project Commencement Agreement+............................. 10.2 Form of Software License Agreement+................................. 10.3 Form of Software Maintenance Agreement+............................. 10.4 Form of Professional Services Agreement+............................ 10.5 Form of Credit Connection Lender Agreement (for CreditRevue Licensees)+......................................................... 10.6 Form of Credit Connection Lender Agreement (for non-CreditRevue Licensees)+......................................................... 10.7 Form of Credit Connection Dealer Subscription Agreement+............ 10.8.1 Office Building Lease between Symphony Woods Limited Partnership and the Company dated October 29, 1993+................................. 10.8.2 Office Building Lease between Symphony Woods Limited Partnership and the Company dated February 10, 1995+................................ 10.8.3 First Amendment to Lease dated March 29, 1995+...................... 10.8.4 Second Amendment to Lease dated August 12, 1996+.................... 10.9 Promissory Note dated December 31, 1995 given by the Company to James R. DeFrancesco+............................................... 10.10 Business Loan Agreement between The Columbia Bank and the Company dated June 10, 1994+................................................ 10.11 1996 Credit Management Solutions, Inc. Non-Qualified Stock Option Plan+............................................................... 10.12 1996 Credit Management Solutions, Inc. Employee Stock Purchase Plan................................................................ 10.13 1996 Credit Management Solutions, Inc. Long-Term Incentive Plan..... 10.14 Form of Tax Indemnification Agreement............................... 10.15 1996 Credit Management Solutions, Inc. Non-Qualified Stock Option Plan................................................................ 21 Subsidiaries of the Company+........................................ 23.1 Consent of Ernst & Young LLP........................................ 23.2 Consent of Manatt, Phelps & Phillips, LLP (included in Exhibit 5)... 24 Power of Attorney+.................................................. 27 Financial Data Schedule+............................................
- --------------- + Previously filed. EX-1 2 FORM OF UNDERWRITING AGREEMENT 1 EXHIBIT 1 CREDIT MANAGEMENT SOLUTIONS, INC. 2,600,000 SHARES(1) COMMON STOCK FORM OF UNDERWRITING AGREEMENT December __, 1996 FRIEDMAN, BILLINGS, RAMSEY & CO., INC. UNTERBERG HARRIS as Representatives of the Several Underwriters c/o Friedman, Billings, Ramsey & Co., Inc. Potomac Tower 1001 Nineteenth Street North Arlington, Virginia 22209 Ladies and Gentlemen: Credit Management Solutions, Inc., a Delaware corporation (the "Company"), and the stockholders of the Company named in Schedule II hereto (collectively, the "Selling Securityholders"), hereby confirm their agreement with the several underwriters named in Schedule I hereto (the "Underwriters"), for whom you have been duly authorized to act as representatives (in such capacity, the "Representatives"), as set forth below. If you are the only Underwriters, all references herein to the Representatives shall be deemed to be to the Underwriters. 1. Securities. Subject to the terms and conditions herein contained, the Company proposes to issue and sell to the several Underwriters an aggregate of 2,200,000 shares (the "Company Firm Securities") of the Company's Common Stock, $0.01 par value per share (the "Common Stock"), and the Selling Securityholders propose to sell to the several Underwriters an aggregate of 400,000 shares of Common Stock (collectively with the Company Firm Shares, the "Firm Securities"). The Company also proposes to grant to the several Underwriters an option to purchase up to an aggregate of 390,000 additional shares of Common Stock (the "Option Securities" and collectively with the Firm Securities, the "Securities") if requested by the Representatives as provided in Section 3 of this Agreement. The Common Stock is more fully described in the Registration Statement and the Prospectus hereinafter mentioned. 2. Representations and Warranties of the Company and the Selling Securityholders (a) The Company hereby represents and warrants to, and agrees with, each of the several Underwriters and the Selling Securityholders that: (i) A registration statement on Form S-1 (File No. 333-14007) with respect to the Securities, including a prospectus subject to completion, has been filed by the Company with the Securities and Exchange Commission (the "Commission") under the Securities Act of 1933, as amended (the "Act"), and one or more amendments to such registration statement have been so filed, if applicable. Copies of such registration statement and of each amendment thereto, if any, including the related preliminary prospectus (meeting the requirements of Rule 430A under the Act) heretofore filed by the Company with the Commission have been delivered to you. After the execution of this Agreement, the Company will file with the Commission either (i) if such registration statement, as it may have been amended, has been declared by the Commission to be effective under the Act, either (A) if the Company relies on Rule 434 under the Act, a Term Sheet (as hereinafter defined) relating to the Securities, that shall identify the Preliminary Prospectus (as hereinafter defined) that it supplements containing such information as is required or permitted by Rules 434, 430A and 424(b) under the Act, or (B) if the Company does not rely - --------------------- (1) Plus an option to purchase from the Company up to 390,000 additional shares to cover over-allotments, if any. 2 on Rule 434 under the Act, a prospectus in the form most recently included in an amendment to such registration statement (or, if no such amendment shall have been filed, in such registration statement), with such changes or insertions as are required by Rule 430A under the Act or permitted by Rule 424(b) under the Act, and in the case of either clause (i)(A) or (i)(B) of this sentence, as have been provided to and approved by the Representatives prior to the execution of this Agreement, or (ii) if such registration statement, as it may have been amended, has not been declared by the Commission to be effective under the Act, an amendment to such registration statement, including a form of prospectus, a copy of which amendment has been furnished to and approved by the Representatives prior to the execution of this Agreement. The Company may also file a related abbreviated registration statement with the Commission pursuant to Rule 462(b) under the Act for the purpose of registering certain additional Securities, which registration statement shall be effective upon filing with the Commission. If the Company has elected to rely on Rule 462(b) under the Act and the Rule 462(b) Registration Statement (as hereinafter defined) has not been declared effective: (i) the Company has filed a Rule 462(b) Registration Statement in compliance with the Act and the rules and regulations of the Commission promulgated thereunder and that the Rule 462(b) Registration Statement is effective upon filing pursuant to Rule 462(b) under the Act and the Company has received confirmation of its receipt and (ii) the Company has given irrevocable instructions for transmission of the applicable filing fee in connection with the filing of the Rule 462(b) Registration Statement, in compliance with Rule 111 promulgated under the Act or the Commission has received payment of such filing fee. As used in this Agreement, the term "Original Registration Statement" means the registration statement initially filed relating to the Securities, as amended at the time when it was or is declared effective, including all financial schedules and exhibits thereto and including any information omitted therefrom pursuant to Rule 430A under the Act and included in the Prospectus (as hereinafter defined); the term "Rule 462(b) Registration Statement" means any abbreviated registration statement filed with the Commission pursuant to Rule 462(b) under the Act (including the Registration Statement and any Preliminary Prospectus or Prospectus incorporated therein at the time such Registration Statement becomes effective); the term "Registration Statement" includes both the Original Registration Statement and any Rule 462(b) Registration Statement; the term "Preliminary Prospectus" means each prospectus subject to completion filed with such registration statement or any amendment thereto (including the prospectus subject to completion, if any, included in the Registration Statement or any amendment thereto at the time it was or is declared effective); the term "Prospectus" means: (A) if the Company relies on Rule 434 under the Act, the Term Sheet relating to the Securities that is first filed pursuant to Rule 424(b)(7) under the Act, together with the Preliminary Prospectus identified therein that such Term Sheet supplements; (B) if the Company does not rely on Rule 434 under the Act, the prospectus first filed with the Commission pursuant to Rule 424(b) under the Act; or (C) if the Company does not rely on Rule 434 under the Act and if no prospectus is required to be filed pursuant to Rule 424(b) under the Act, the prospectus included in the Registration Statement; and the term "Term Sheet" means any term sheet that satisfies the requirements of Rule 434 under the Act. Any reference herein to the "date" of a Prospectus that includes a Term Sheet shall mean the date of such Term Sheet. (ii) The Commission has not issued any order preventing or suspending the use of any Preliminary Prospectus or instituted proceedings for such purpose. When any Preliminary Prospectus was filed with the Commission it: (A) contained all statements required to be stated therein in accordance with, and complied in all material respects with the requirements of, the Act and the rules and regulations of the Commission promulgated thereunder, and (B) did not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. When the Registration Statement or any amendment thereto was or is declared effective, it (A) contained all statements required to be stated therein in accordance with, and complied in all material respects with the requirements of, the Act and the rules and regulations of the Commission promulgated thereunder, and (B) did not include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein not misleading. When the Prospectus or any Term Sheet that is a part thereof or any amendment or supplement to the Prospectus is filed with the Commission pursuant to Rule 424(b) (or, if the Prospectus or any part thereof or such amendment or supplement is not required to be so filed, when the Registration Statement or the 3 amendment thereto containing such amendment or supplement to the Prospectus was or is declared effective) and on the Firm Closing Date and any Option Closing Date (both as hereinafter defined), the Prospectus or any Term Sheet, if applicable, as amended or supplemented at any such time, (A) contained all statements required to be stated therein in accordance with, and complied in all material respects with the requirements of, the Act and the rules and regulations of the Commission promulgated thereunder and (B) did not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. The foregoing provisions of this paragraph (ii) do not apply to statements in, or omissions from, any Preliminary Prospectus, the Registration Statement or any amendment thereto or the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with written information furnished to the Company by or on behalf of the Underwriters specifically for use therein. (iii) Each of the Company and its subsidiary has been duly incorporated and is validly existing and in good standing under the laws of its jurisdiction of organization and is duly qualified to transact business as a foreign entity and is in good standing under the laws of all other jurisdictions where the ownership or leasing of its properties or the conduct of its businesses requires such qualification, except where the failure to be so qualified would not have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole. (iv) Each of the Company and its subsidiary has the power (corporate and other) and authority to own or lease its properties and conduct its businesses as described in the Registration Statement and the Prospectus; and the Company has the legal right, power (corporate and other) and authority to enter into this Agreement and to perform the transactions contemplated hereby. (v) All issued and outstanding shares of the Company's subsidiary have been duly authorized and validly issued, are fully paid and nonassessable, and have not been issued in violation of or subject to any preemptive right, co-sale right, registration right, right of first refusal or other similar right and are owned by the Company free and clear of any pledge, security interests, liens, encumbrances, claims or equitable interests. The Company does not own or control, directly or indirectly, any corporation, association or other entity other than Credit Connection, Inc. (vi) The Company has an authorized, issued and outstanding capitalization as set forth in the Prospectus under the caption "Capitalization." All of the issued and outstanding shares of capital stock of the Company (including the Securities to be sold by the Selling Securityholders) have been duly authorized and validly issued and are fully paid and nonassessable, have been issued in compliance with all Federal and state securities laws, and were not issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase securities. The Company Firm Securities and the Option Securities have been duly authorized for issuance and sale to the Underwriters pursuant to this Agreement, and at the Firm Closing Date or the related Option Closing Date (as the case may be), when issued and delivered by the Company after payment therefor in accordance herewith, will be duly and validly issued, fully paid and nonassessable, and will be sold free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest; and no preemptive right, co-sale right, registration right, right of first refusal or other similar right of stockholders exists with respect to any of the Common Stock hereunder or the issuance and sale thereof other than those that have been expressly waived prior to the date hereof and those that will automatically expire upon the consummations of the transactions contemplated by this Agreement. No further approval or authorization of any stockholder, the Board of Directors of the Company or others is required for the issuance of the Company Firm Securities or the Option Securities except as may be required under the Act or state securities or Blue Sky laws. 3 4 (vii) The capital stock of the Company conforms to the description thereof and statements relating thereto contained in the Prospectus (and such statements correctly state the substance of the instruments defining the capitalization of the Company). (viii) Except as disclosed in the Prospectus, there are no outstanding (A) securities or obligations of the Company or its subsidiary convertible into or exchangeable for any capital stock or ownership interests of the Company or its subsidiary, (B) warrants, rights or options to subscribe for or purchase from the Company or its subsidiary any such capital stock or ownership interest or any such convertible or exchangeable securities or obligations, or (C) obligations of the Company or its subsidiary to issue any shares of capital stock or any ownership interests, any such convertible or exchangeable securities or obligations, or any such warrants, rights or options. The description of the Company's stock option and purchase plans, and the options or other rights granted and exercised thereunder, set forth in the Prospectus accurately and fairly presents the information required to be shown with respect to such plans, arrangements, options and rights. (ix) The audited consolidated financial statements of the Company and its subsidiary, together with the related schedules and notes, and the unaudited consolidated financial information, included in the Registration Statement and the Prospectus present fairly the financial position of the Company and its subsidiary, the results of operations and changes in financial condition as of the dates and periods therein specified. Such financial statements and schedules have been prepared in accordance with generally accepted accounting principles consistently applied throughout the periods involved (except as otherwise noted therein). The consolidated and summary financial and statistical data included in the Registration Statement present fairly the information included therein and have been compiled on a basis consistent with the audited financial statements presented therein. No other financial statements or schedules are required to be included in the Registration Statement. (x) Ernst & Young LLP, who have certified certain consolidated financial statements of the Company and its subsidiary and delivered their report with respect to the audited consolidated financial statements, together with the related schedules and notes, included in the Registration Statement and the Prospectus are independent accountants within the meaning of the Act and the applicable rules and regulations thereunder. (xi) The execution and delivery of this Agreement have been duly authorized by the Company, and this Agreement has been duly executed and delivered by the Company and is the valid and binding agreement of the Company, enforceable against the Company in accordance with its terms, except as rights to indemnification and contribution hereunder may be limited by applicable law and except as the enforcement hereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally, or by general equitable principles. (xii) No legal or governmental action, suit, claim or other proceedings are pending to which the Company or its subsidiary is a party or to which the property of the Company or its subsidiary is subject that would have a material adverse effect in the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, and no such actions, suits or proceedings have been threatened against the Company or its subsidiary or with respect to any of their respective properties or is required to be described in the Registration Statement or the Prospectus and is not so described; and no contract or other document is required to be described in the Registration Statement or the Prospectus or to be filed as an exhibit to the Registration Statement that is not described therein or filed as required and any such description of such contracts or agreements conforms in all material respects to the terms of such contracts or agreements. 4 5 (xiii) Neither the Company nor its subsidiary is (i) in violation of its certificate of incorporation or bylaws, or (ii) in default in the performance or observance of any obligation, agreement, covenant or condition contained in any bond, debenture, note or other evidence of indebtedness, which default would have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, or (iii) in default in the performance or observance of any contract, indenture, mortgage, loan agreement, joint venture or other agreement or instrument to which it is a party or by which it or any of its properties are bound, which default would have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, or (iv) in violation of any law, order, rule, regulation, writ, injunction, judgment or decree of any court or governmental agency or body to which the Company is subject. (xiv) The issuance, offering and sale of the Securities to the Underwriters by the Company pursuant to this Agreement, the compliance and performance by the Company with the other provisions of this Agreement and the consummation of the other transactions herein contemplated do not and will not (A) require the consent, approval, authorization, registration or qualification of or with any governmental authority, domestic or foreign, except such as have been obtained, or such as may be required under the Act, the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or under state securities or blue sky laws, all of which requirements have been satisfied, or (B) result in a breach or violation of any of the terms and provisions of, or constitute a default under the certificate of incorporation or bylaws of the Company, or (C) result in a breach or violation of any of the terms and provisions of, or constitute a default under any obligation, agreement, covenant or condition contained in any bond, debenture, note or other evidence of indebtedness, which default would have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, or (D) result in a breach or violation of any of the terms and provisions of, or constitute a default under any law, order, rule, regulation, writ, injunction, judgment or decree of any court or governmental agency or body to which the Company is subject. (xv) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, there has not been (a) any material adverse change in the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, (b) any transaction that is material to the Company and its subsidiary, taken as a whole, except transactions entered into in the ordinary course of business, (c) any obligation, direct or contingent, that is material to the Company and its subsidiary, taken as a whole, incurred by the Company or its subsidiary, except obligations incurred in the ordinary course of business, (d) any change in the capital stock or outstanding indebtedness of the Company or its subsidiary that is material to the Company and its subsidiary, taken as a whole, (e) any dividend or distribution of any kind declared, paid or made on the capital stock of the Company or its subsidiary, or (f) any loss or damage (whether or not insured) to the property of the Company or its subsidiary which has been sustained or will have been sustained which has a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole. (xvi) The Company has not directly or indirectly, (i) taken any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Securities, or (ii) since the filing of the Registration Statement (A) other than amounts to be paid to the Underwriters pursuant to the terms hereof, sold, bid for, purchased, or paid anyone any compensation for soliciting purchases of, the Securities, or (B) paid or agreed to pay to any person any compensation for soliciting another to purchase any other securities of the Company. 5 6 (xvii) Neither the Company nor its subsidiary have at any time during the last five (5) years (i) made any unlawful contribution to any candidate for foreign office or failed to disclose fully any contribution in violation of law, or (ii) made any payment to any federal or state governmental officer or official, or other person charged with similar public or quasi-public duties, other than payments required or permitted by the laws of the United States or any jurisdiction thereof. (xviii) (a) The Company and its subsidiary possess all certificates, authorizations, licenses, franchises and permits issued by the appropriate Federal, state or foreign regulatory authorities necessary to own, lease and operate their respective properties and to conduct their respective businesses described in the Prospectus, and (b) neither the Company nor its subsidiary has received any notice of proceedings relating to, the revocation or modification of any such certificate, authorization, license, franchise or permit, except as described in the Prospectus. Except as described in the Prospectus, none of the Company's or its subsidiary's certificates, authorizations, licenses, franchises or permits contain any restrictions that, if effective, would result in any material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole. (xix) The Company is familiar with the Investment Company Act of 1940, as amended, and has in the past conducted its affairs, and will in the future conduct its affairs, in such a manner to ensure that the Company was not and will not be an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940, as amended, and the rules and regulations thereunder. (xx) The Company and its subsidiary have timely filed all foreign, Federal, state and local tax returns that are required to be filed and have paid all taxes and assessments required to be paid by them and any other assessment, fine or penalty levied against them. Prior to its reincorporation in Delaware, the Company had validly elected to be treated as a Subchapter S Corporation for Federal and state income tax purposes since its inception and continued to qualify as a Subchapter S Corporation until the termination of its Subchapter S Corporation status for Federal and state income tax purposes upon its reincorporation in Delaware. (xxi) Except for the shares of its subsidiary owned by the Company, neither the Company nor its subsidiary owns any shares of stock or any other equity securities of any corporation or has any equity interest in any firm, partnership, association or other entity. (xxii) Each of the Company and its subsidiary maintain a system of internal accounting controls sufficient to provide reasonable assurance that: (A) transactions are executed in accordance with management's general or specific authorizations; (B) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain asset accountability; (C) access to assets is permitted only in accordance with management's general or specific authorization; and (D) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (xxiii) Except as described in the Registration Statement and the Prospectus, (i) the agreements to which the Company or its subsidiary is a party described in the Registration Statement and Prospectus are valid agreements, enforceable by the Company and its subsidiary (as applicable), except as the enforcement thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles and the other contracting party or parties thereto are not in breach or default under any of such agreements, and (ii) no default exists, and no event has occurred which, with notice or lapse of time or both, would constitute a default, in the due performance and observance of any term, covenant or condition of any 6 7 indenture, mortgage, deed of trust, lease, contract, loan agreement, joint venture or other agreement or instrument to which the Company or its subsidiary is a party or by which the Company or its subsidiary or any of their respective properties is bound or may be affected, in any respect which would result in any material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole. (xxiv) The Company has not distributed and will not distribute, prior to the later of (A) the Firm Closing Date, or any date on which the Option Securities are to be purchased, as the case may be, and (B) the completion of the distribution of the Securities, any offering material in connection with the offering and sale of the Securities other than any Preliminary Prospectus, the Prospectus, the Registration Statement or Term Sheet or any amendment or supplement thereto, or other materials, if any, permitted by the Act. (xxv) Except as set forth in the Registration Statement and Prospectus, (i) each of the Company and its subsidiary has good and marketable title to all properties and assets described in the Registration Statement and Prospectus as owned by it, free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest, other than such as would not have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary taken as a whole, and (iii) each of the Company and its subsidiary has valid and enforceable leases for all properties described in the Registration Statement and Prospectus as leased by it, except as the enforcement thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles. Except as set forth in the Registration Statement and Prospectus, the Company and its subsidiary owns or leases all such properties as are necessary to its operations as now conducted or as proposed to be conducted. (xxvi) No labor dispute or disturbance with the employees of the Company or its subsidiary exists or, to the Company's knowledge, is threatened or imminent except as described in the Prospectus; and the Company has no actual knowledge of any existing or imminent labor disturbance by the employees of any of its principal subcontractors or processors that might be expected to result in any material adverse change in the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole. No collective bargaining agreement exists with any of the Company's or its subsidiary's employees and no such agreement is imminent. (xxvii) The Company and its subsidiary own or possess adequate rights to use all material patents, patent rights, licenses, inventions, copyrights, know-how (including trade secrets and other unpatented and/or unpatentable proprietary or confidential information, systems or procedures), trademarks, service marks and trade names currently employed by them in connection with the business now operated by them; the expiration of any of the foregoing would not have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole; and neither the Company nor its subsidiary has received any notice of infringement of or conflict with asserted rights of any third party with respect to any of the foregoing which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would result in a material adverse change in the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole. (xxviii) The Company and its subsidiary maintain insurance with insurers of recognized financial responsibility against such losses and risks and in such amounts as are prudent and customary in the businesses in which they are engaged, including, but not limited to, insurance covering real and personal property owned or leased by the Company against theft, damage, destruction, errors and omissions, system interruption and acts of vandalism; neither the Company nor its subsidiary has been 7 8 refused any insurance coverage sought or applied for; and neither the Company nor its subsidiary has any reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business at a cost that would result in any material adverse change in the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, except as described in the Prospectus. (xxix) Each certificate signed by any officer of the Company and delivered to the Representatives or counsel for the Underwriters shall be deemed to be a representation and warranty by the Company and the Selling Securityholders to each Underwriter as to the matters covered thereby. (xxx) The Securities to be issued and sold by the Company and the Securities to be transferred and sold by the Selling Securityholders have been approved for quotation on the Nasdaq National Market, subject to official notice of issuance. (xxxi) Except as set forth in the Registration Statement and Prospectus, (i) the Company and its subsidiary are in material compliance with all rules, laws and regulations relating to the use, treatment, storage and disposal of toxic substances and protection of health or the environment ("Environmental Laws") which are applicable to their respective businesses, (ii) the Company and its subsidiary have received no notice from any governmental authority or third party of an asserted claim under Environmental Laws, which claim is required to be disclosed in the Registration Statement and the Prospectus, (iii) the Company and its subsidiary have no reason to believe that either of them will be required to make future material capital expenditures to comply with Environmental Laws and (iv) no property which is owned, leased or occupied by the Company or its subsidiary has been designated as a Superfund site pursuant to the Comprehensive Response, Compensation, and Liability Act of 1980, as amended (42 U.S.C. Section 9601, et seq.), or otherwise designated as a contaminated site under applicable state or local law. (xxxii) The Company has complied with all provisions of Section 517.075, Florida Statutes, relating to doing business with the Government of Cuba or with any person or affiliate located in Cuba. (xxxiii) There are no outstanding loans, advances (except normal advances for business expenses in the ordinary course of business) or guarantees of indebtedness by the Company to or for the benefit of any of the officers or directors of the Company or any of the members of the families of any of them, except as disclosed in the Prospectus. (b) Each of the Selling Securityholders hereby represents and warrants to and agrees with each of the several Underwriters that: (i) Such Selling Securityholder now has, and on the Firm Closing Date will have, good and marketable title to all the shares of Securities to be sold by such Selling Securityholder hereunder, free and clear of all liens, encumbrances, equities, security interests and claims whatsoever, with full right and authority to deliver the same hereunder, subject, in the case of each Selling Securityholder, to the rights of Manatt, Phelps & Phillips, LLP, as Custodian (the "Custodian"), and that upon the delivery of and payment for such shares of the Securities hereunder, the several Underwriters will receive good and marketable title thereto, free and clear of all liens, encumbrances, equities, security interests and claims whatsoever. (ii) Certificates in negotiable form for the shares of the Securities to be sold by such Selling Securityholder under this Agreement, together with a stock power or powers endorsed in blank by 8 9 such Selling Securityholder, have been placed in custody under an agreement (the "Custody Agreement") for delivery under this Agreement with the Custodian, which Custody Agreement constitutes a valid and binding agreement on the part of such Selling Securityholder, enforceable in accordance with its terms, except as the enforcement thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles; such Selling Securityholder specifically agrees that the shares of the Securities represented by the certificates so held in custody for such Selling Securityholder are subject to the interests of the several Underwriters and the Company, that the arrangements made by such Selling Securityholder for such custody, including the power of attorney provided for in such Custody Agreement (the "Power of Attorney"), are to that extent irrevocable, and that the obligations of such Selling Securityholder shall not be terminated by any act of such Selling Securityholder or by operation of law, whether by the death or incapacity of such Selling Securityholder or the occurrence of any other event; if any such death, incapacity, dissolution, liquidation or other such event should occur before the delivery of such shares of the Securities hereunder, certificates for such shares of the Securities shall be delivered by the Custodian in accordance with the terms and conditions of this Agreement as if such death, incapacity, dissolution, liquidation or other event had not occurred, regardless of whether the Custodian shall have received notice of such death, incapacity, dissolution, liquidation or other event. (iii) Each of the Selling Securityholders' respective attorneys-in-fact (the "Attorneys") acting alone, is authorized to execute and deliver this Agreement and the certificate referred to in Section 3 hereof on behalf of the Selling Securityholder, to determine the purchase price to be paid by the several Underwriters to such Selling Securityholders as provided in Section 3 hereof, to authorize the delivery of the Securities to be sold by the Selling Securityholder under this Agreement and to duly endorse (in blank or otherwise) the certificate or certificates representing such Securities or a stock power or powers with respect thereto, to accept payment therefor, and otherwise to act on behalf of such Selling Securityholder in connection with this Agreement. (iv) Such Selling Securityholder has reviewed the Registration Statement and Prospectus and, on the Effective Date, the Registration Statement did not contain and, on the Firm Closing Date and any later date on which Option Securities are to be purchased will not contain, any untrue statement of a material fact or did not omit or will not omit to state any material fact required to be stated therein or necessary in order to make the statements therein not misleading; and, on the Effective Date, the Prospectus did not contain and, on the Firm Closing Date and any later date on which Option Securities are to be purchased, will not contain any untrue statement of a material fact or omitted or omits to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. (v) All consents, approvals, authorizations and orders required for the execution and delivery by such Selling Securityholder of the Power of Attorney and the Custody Agreement, the execution and delivery by or on behalf of such Selling Securityholder of this Agreement and the sale and delivery of the Securities to be sold by such Selling Securityholder under this Agreement, other than, at the time of the execution hereof (if the Registration Statement has not yet been declared effective by the Commission), the issuance of the order of the Commission declaring the Registration Statement effective and such consents, approvals, authorizations or orders as may be necessary under state or other securities or Blue Sky laws have been obtained and are in full force and effect; and such Selling Securityholder has full legal right, power and authority to enter into and perform its obligations under this Agreement and such Power of Attorney and Custody Agreement, and to sell, assign, transfer and deliver the Securities to be sold by such Selling Securityholder under this Agreement. (vi) Except for the Securities to be sold by such Selling Securityholder to the Underwriters hereunder, such Selling Securityholder will not, during the 180 day period following the date 9 10 of the Prospectus, other than with respect to Messrs. DeFrancesco and Freiman who have agreed to lock-up certain percentages of their holdings for a period extending to 540 days following the date of the Prospectus (the "Lock-up Period"), directly or indirectly, sell, offer, contract to sell, transfer the economic risk of ownership in, make any short sale, pledge or otherwise dispose of any share of Common Stock or any securities convertible into or exchangeable or exercisable for or any other rights to purchase or acquire Common Stock, without the prior written consent of the Representatives, otherwise than as a bona fide gift or gifts, or by will or intestacy, to such Selling Securityholder's immediate family, provided the recipient thereof agrees in writing to be bound by this restriction. The foregoing restriction is expressly agreed to preclude the holder of the Securities from engaging in any hedging or other transaction which is designed to or reasonably expected to lead to or result in a disposition of Securities during the Lock-up Period, even if such Securities would be disposed of by someone other than the Selling Securityholder. Such prohibited hedging or other transactions would include, without limitation, any short sale (whether or not against the box) or any purchase, sale or grant of any right (including, without limitation, any put or call option) with respect to any Securities or with respect to any security (other than a broad-based market basket or index) that includes, relates to or derives any significant part of its value from Securities. Such Selling Securityholder also agrees and consents to the entry of stop transfer instructions with the Company's transfer agent against the transfer of the securities held by such Selling Securityholder except in compliance with this restriction. (vii) This Agreement is a valid and binding agreement of each Selling Securityholder, enforceable in accordance with its terms, except as rights to indemnification hereunder may be limited by applicable law and except as the enforcement hereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles; and the performance of this Agreement and the consummation of the transactions contemplated hereby will not result in a breach or violation of any of the terms and provisions of or constitute a default under any bond, debenture, note or other evidence of indebtedness, or under any lease, contract, indenture, mortgage, deed of trust, loan agreement, joint venture or other agreement or instrument to which such Selling Securityholder is a party or by which such Selling Securityholder, or any Securities to be sold by such Selling Securityholder hereunder, may be bound or result in any violation of any law, order, rule, regulation, writ, injunction, judgment or decree of any court, government or governmental agency or body, domestic or foreign, having jurisdiction over such Selling Securityholder or over the properties of such Selling Securityholder. (viii) All information furnished by or on behalf of such Selling Securityholder relating to such Selling Securityholder and the Securities that is contained in the representations and warranties of such Selling Securityholder in such Selling Securityholder's Power of Attorney is, and at the time the Registration Statement became or becomes, as the case may be, effective and at all times subsequent thereto up to and on the Firm Closing Date, and on any later date on which Option Securities are to be purchased, was or will be, true, correct and complete, and does not, and at the time the Registration Statement became or becomes, as the case may be, effective and at all times subsequent thereto up to and on the Firm Closing Date, and on any later date on which Option Securities are to be purchased, will not, contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make such information not misleading. (ix) Such Selling Securityholder will review the Prospectus and will comply with all agreements and satisfy all conditions on its part to be complied with or satisfied pursuant to this Agreement on or prior to the Firm Closing Date, or any later date on which Option Securities are to be purchased, as the case may be, and will advise one of its Attorneys and the Representatives prior to the Firm Closing Date or such later date on which Option Securities are to be purchased, as the case may be, if any statement to be made on behalf of such Selling Securityholder in the certificate contemplated by Section 7(f) 10 11 hereof would be inaccurate if made as of the Firm Closing Date or such later date on which Option Securities are to be purchased, as the case may be. (x) Such Selling Securityholder is not aware (without having conducted any investigation or inquiry) that any of the representations and warranties of the Company set forth in Section 2(a) above is untrue or inaccurate in any material respect. (xi) Such Selling Securityholder does not have, or has waived prior to the date hereof, any preemptive right, co-sale right or right of first refusal or other similar right to purchase any of the Securities that are to be sold by the Company or any of the other Selling Securityholders to the Underwriters pursuant to this Agreement; such Selling Securityholder does not have, or has waived prior to the date hereof, any registration right or other similar right to participate in the offering made by the Prospectus, other than such rights of participation as have been satisfied by the participation of such Selling Securityholder in the transactions to which this Agreement relates in accordance with the terms of this Agreement; and such Selling Securityholder does not own any warrants, options or similar rights to acquire, and does not have any right or arrangement to acquire, any capital stock, rights, warrants, options or other securities from the Company, other than those described in the Registration Statement and the Prospectus. (xii) The Selling Securityholders have not directly or indirectly (i) taken any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Securities, or (ii) since the filing of the Registration Statement (A) sold, bid for, purchased, or paid anyone any compensation for soliciting purchases of, the Securities, or (B) paid or agreed to pay to any person any compensation for soliciting another to purchase any other securities of the Company. (xiii) The Selling Securityholders have not at any time during the last five (5) years (i) made any unlawful contribution to any candidate for foreign office or failed to disclose fully any contribution in violation of law, or (ii) made any payment to any federal or state governmental officer or official, or other person charged with similar public or quasi-public duties, other than payments required or permitted by the laws of the United States or any jurisdiction thereof. (xiv) The Selling Securityholders have not distributed and will not distribute, prior to the later of (A) the Firm Closing Date, or any date on which the Option Securities are to be purchased, as the case may be, and (B) the completion of the distribution of the Securities, any offering material in connection with the offering and sale of the Securities other than any Preliminary Prospectus, the Prospectus, the Registration Statement or Term Sheet or any amendment or supplement thereto, or other materials, if any, permitted by the Act. 3. Purchase, Sale and Delivery of the Securities. (a) On the basis of the representations, warranties, agreements and covenants herein contained and subject to the terms and conditions herein set forth, the Company and each of the Selling Securityholders agree, severally and not jointly, to sell to each of the Underwriters, and each of the Underwriters, severally and not jointly, agrees to purchase from the Company and from each of the Selling Securityholders, at a purchase price of $____ per share, the number of Firm Securities set forth opposite the name of such Underwriter in Schedule I hereto. One or more certificates in definitive form for the Firm Securities that the several Underwriters have agreed to purchase hereunder, and in such denomination or denominations and registered in such name or names as the Representative request upon notice to the Company at least 48 hours prior to the Firm Closing Date, shall be delivered by or on behalf of the Company and the Selling Securityholders to the Representatives for the respective accounts of the Underwriters, against payment by or on behalf of the Underwriters of the aggregate purchase price therefor by wire 11 12 transfer in same day funds to the respective accounts of the Company and the Selling Securityholders. Such delivery of and payment for the Firm Securities shall be made at the offices of Brobeck, Phleger & Harrison LLP, 1633 Broadway, New York, New York 10019 at 9:30 a.m., New York City time, on ________, 1996, or at such other place, time or date as the Representatives and the Company may agree upon or as the Representatives may determine pursuant to Section 9 hereof, such time and date of delivery against payment being herein referred to as the "Firm Closing Date." The Company and the Selling Securityholders will make such certificate or certificates for the Firm Securities available for checking and packaging by the Representatives at the offices in New York, New York of the Company's transfer agent or registrar at least 24 hours prior to the Firm Closing Date. (b) For the purpose of covering any over-allotments in connection with the distribution and sale of the Firm Securities as contemplated by the Prospectus, the Company hereby grants to the several Underwriters an option to purchase, severally and not jointly, the Option Securities. The purchase price to be paid for any Option Securities shall be the same price per share as the price per share for the Firm Securities set forth above in paragraph (a) of this Section 3. The option granted hereby may be exercised as to all or any part of the Option Securities from time to time within thirty days after the date of the Prospectus (or, if such 30th day shall be a Saturday or Sunday or a holiday, on the next business day thereafter when the New York Stock Exchange is open for trading). The Underwriters shall not be under any obligation to purchase any of the Option Securities prior to the exercise of such option. The Representatives may from time to time exercise the option granted hereby by giving notice in writing or by telephone (confirmed in writing) to the Company setting forth the aggregate number of Option Securities as to which the several Underwriters are then exercising the option and the date and time for delivery of and payment for such Option Securities. Any such date of delivery shall be determined by the Representatives but shall not be earlier than two (2) business days or later than five (5) business days after such exercise of the option and, in any event, shall not be earlier than the Firm Closing Date. The time and date set forth in such notice, or such other time on such other date as the Representatives and the Company may agree upon or as the Representative may determine pursuant to Section 9 hereof, is herein called the "Option Closing Date" with respect to such Option Securities. Upon exercise of the option as provided herein, the Company shall become obligated to sell to each of the several Underwriters, and, subject to the terms and conditions herein set forth, each of the Underwriters (severally and not jointly) shall become obligated to purchase from the Company, the same percentage of the total number of the Option Securities as to which the several Underwriters are then exercising the option as such Underwriter is obligated to purchase of the aggregate number of Firm Securities, as adjusted by the Representatives in such manner as they deem advisable to avoid fractional shares. If the option is exercised as to all or any portion of the Option Securities, one or more certificates in definitive form for such Option Securities, and payment therefor, shall be delivered on the related Option Closing Date in the manner, and upon the terms and conditions, set forth in paragraph (a) of this Section 3, except that reference therein to the Firm Securities and the Firm Closing Date shall be deemed, for purposes of this paragraph 3(b), to refer to such Option Securities and Option Closing Date, respectively. (c) It is understood that you, individually and not as the Representatives, may (but shall not be obligated to) make payment on behalf of any Underwriter or Underwriters for any of the Securities to be purchased by such Underwriter or Underwriters. No such payment shall relieve such Underwriter or Underwriters from any of its or their obligations hereunder. (d) Each of the Company and the Selling Securityholders hereby acknowledges that the wire transfer by or on behalf of the Underwriters of the purchase price for any Securities does not constitute closing of a purchase and sale of the Securities. Only execution and delivery of a receipt for the Securities by the Underwriters indicates completion of the closing of a purchase of the Securities from the Company or the Selling Securityholders, as the case may be. Furthermore, in the event that the Underwriters wire funds to the Company or the Selling Securityholders prior to the completion of the closing of a purchase of Securities, each of the Company and the Selling Securityholders hereby acknowledges that until the Underwriters execute and deliver a receipt for the Securities, by facsimile or otherwise, the Company or the Selling Securityholders, as the case may be, will not be entitled to the wired funds and shall return the wired funds to the Underwriters as soon as practicable 12 13 (by wire transfer of same-day funds) upon demand. In the event that the closing of a purchase of Securities is not completed and the wire funds are not returned by the Company or the Selling Securityholders, as the case may be, to the Underwriters on the same day the wired funds were received by the Company or the Selling Securityholders, as the case may be, each of the Company and the Selling Securityholders agrees to pay to the Underwriters in respect of each day the wire funds are not returned by it, in same-day funds, interest on the amount of such wire funds in an amount representing the Underwriters' cost of financing as reasonably determined by the Representatives. 4. Offering by the Underwriters. Upon your authorization of the release of the Firm Securities, the several Underwriters propose to offer the Firm Securities for sale to the public upon the terms set forth in the Prospectus. The Underwriters may from time to time change the public offering price after the closing of the initial public offering and increase or decrease the concessions and discounts to dealers as they may determine. 5. Covenants of the Company and the Selling Securityholders. The Company (with respect only to paragraphs 5(a) through and including 5(n) below) and the Selling Securityholders (with respect only to paragraphs 5(o) and 5(p) below) covenant and agree with each of the Underwriters that: (a) The Company will use its best efforts to cause any amendments to the Registration Statement to become effective as promptly as possible. The Company will file the Prospectus or any Term Sheet and any amendment or supplement thereto with the Commission in the manner and within the time period required by Rules 424(b) and 434 under the Act. During any time when a prospectus relating to the Securities is required to be delivered under the Act, the Company (i) will comply with all requirements imposed upon it by the Act and the rules and regulations of the Commission thereunder to the extent necessary to permit the continuance of sales of or dealings in the Securities in accordance with the provisions hereof and of the Prospectus, as then amended or supplemented, and (ii) will not file with the Commission the Prospectus, Term Sheet or the amendment referred to in the second sentence of Section 2(a) hereof, any amendment or supplement to such Prospectus, Term Sheet or any amendment to the Registration Statement or any Rule 462(b) Registration Statement of which the Representatives shall not previously have been advised and furnished with a copy for a reasonable period of time prior to the proposed filing and as to which filing the Representatives shall not have given their consent. The Company will prepare and file with the Commission, in accordance with the rules and regulations of the Commission, promptly upon request by the Representatives or counsel for the Underwriters, any amendments to the Registration Statement or amendments or supplements to the Prospectus that may be necessary or advisable in connection with the distribution of the Securities by the several Underwriters, and will use its best efforts to cause any such amendment to the Registration Statement to be declared effective by the Commission as promptly as possible. The Company will advise the Representatives, promptly after receiving notice thereof, of the time when the Registration Statement or any amendment thereto has been filed or declared effective or the Prospectus or any amendment or supplement thereto has been filed and will provide to the Representative copies of each such filing. (b) The Company will advise the Representatives, promptly after receiving notice or obtaining knowledge thereof, of (i) the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or any Rule 462(b) Registration Statement or any amendment thereto or any order preventing or suspending the use of any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, (ii) the suspension of the qualification of the Securities for offering or sale in any jurisdiction, (iii) the institution, threatening or contemplation of any proceeding for any such purpose, or (iv) any request made by the Commission for amending the Original Registration Statement or any Rule 462(b) Registration Statement, for amending or supplementing the Prospectus or for additional information. The Company will use its best efforts to prevent the issuance of any such stop order and, if any such stop order is issued, to obtain the withdrawal thereof as promptly as possible. (c) The Company will cooperate with you and your counsel to qualify or register the Securities for offering and sale under the securities or blue sky laws of such jurisdictions as the Representatives may 13 14 designate and will continue such qualifications in effect for as long as may be necessary to complete the distribution of the Securities; provided, however, that in connection therewith the Company shall not be required to qualify as a foreign corporation or to execute a general consent to service of process in any jurisdiction. (d) If, at any time prior to the later of (i) the final date when a prospectus relating to the Securities is required to be delivered under the Act, or (ii) the Option Closing Date, any event occurs as a result of which the Prospectus, as then amended or supplemented, would include any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if for any other reason it is necessary at any time to amend or supplement the Prospectus to comply with the Act or the rules or regulations of the Commission thereunder, the Company will promptly notify the Representatives thereof and, subject to Section 5(a) hereof, will prepare and file with the Commission, at the Company's expense, an amendment to the Registration Statement or an amendment or supplement to the Prospectus that corrects such statement or omission or effects such compliance. (e) The Company will, without charge, provide (i) to the Representatives and to counsel for the Underwriters a signed copy of the Original Registration Statement filed with respect to the Securities and each amendment thereto (in each case including exhibits thereto) and any Rule 462(b) Registration Statement, (ii) to each other Underwriter, a conformed copy of such registration statement and any Rule 462(b) Registration Statement and each amendment thereto (in each case without exhibits thereto) and (iii) so long as a prospectus relating to the Securities is required to be delivered under the Act, as many copies of each Preliminary Prospectus or the Prospectus or any amendment or supplement thereto as the Representatives may reasonably request; without limiting the application of clause (iii) of this sentence, the Company, not later than (A) 6:00 p.m., New York City time, on the date of determination of the initial public offering price, if such determination occurred at or prior to 10:00 a.m., New York City time, on such date or (B) 12:00 noon, New York City time, on the business day following the date of determination of the initial public offering price, if such determination occurred after 10:00 a.m., New York City time, on such date, will deliver to the Underwriters, without charge, as many copies of the Prospectus and any amendment or supplement thereto as the Representatives may reasonably request for purposes of confirming orders that are expected to settle on the Firm Closing Date. The Company will provide or cause to be provided to each of the Representatives, and to each Underwriter that so requests in writing, a copy of each report on Form SR filed by the Company as required by Rule 463 under the Act. (f) If the Company elects to rely on Rule 462(b), the Company shall both file a Rule 462(b) Registration Statement with the Commission in compliance with Rule 462(b) and pay the applicable fees in accordance with Rule 111 promulgated under the Act by the earlier of (i) 10:00 p.m., New York City time, on the date of this Agreement and (ii) the time confirmations are sent or given, as specified by Rule 462(b)(2). (g) The Company, as soon as practicable, will make generally available to its securityholders and to the Representatives a consolidated earnings statement of the Company and its subsidiaries that satisfies the provisions of Section 11(a) of the Act and Rule 158 thereunder. (h) During a period of five (5) years after the date hereof, the Company, within the periods prescribed by applicable law, will furnish to its stockholders annual reports (including financial statements audited by independent certified public accountants) and will furnish to its stockholders unaudited quarterly reports of operations for each of the first three quarters of the fiscal year as required of companies with a class of securities registered under the Exchange Act, and will furnish to you and the other several Underwriters hereunder (i) concurrently with making such reports available to its stockholders, statements of operations of the Company for each of the first three quarters in the form made available to the Company's stockholders; (ii) concurrently with the furnishing thereof to its stockholders, a balance sheet of the Company as of the end of such fiscal year, together with statements of operations, of stockholders' equity and of cash flow of the Company for such fiscal year, accompanied by a copy of the certificate or report thereon of nationally recognized independent certified public accountants; (iii) concurrently with the furnishing of such reports to its stockholders, copies of all reports (financial 14 15 or other) mailed to stockholders; (iv) as soon as they are available, copies of all reports and financial statements furnished to or filed with the Commission, any securities exchange or the Nasdaq National Market by the Company (except for documents for which confidential treatment is requested); and (v) every material press release and every material news item or article in respect of the Company or its affairs which was generally released to stockholders or prepared for general release by the Company. During such five (5) year period, if the Company shall have any active subsidiaries, the foregoing financial statements shall be on a consolidated basis to the extent that the accounts of the Company are consolidated with any subsidiaries, and shall be accompanied by similar financial statements for any significant subsidiary that is not so consolidated. (i) The Company will apply the net proceeds from the sale of the Company Firm Securities substantially as set forth under "Use of Proceeds" in the Prospectus. (j) The Company will not, directly or indirectly, without the prior written consent of the Representatives, on behalf of the Underwriters, offer, sell, offer to sell, contract to sell, pledge, grant any option to purchase or otherwise sell or dispose (or announce any offer, sale, offer of sale, contract of sale, pledge, grant of any option to purchase or other sale or disposition) of any shares of Common Stock or any securities convertible into, or exchangeable or exercisable for, shares of Common Stock for a period of 180 days after the effective date of the Registration Statement except pursuant to this Agreement and except for issuances pursuant to the exercise of warrants or employee stock options outstanding on the date hereof, or pursuant to the terms of convertible securities of the Company outstanding on the date hereof. (k) The Company will not, directly or indirectly, (i) take any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Securities, or (ii)(A) sell, bid for, purchase, or pay anyone any compensation for soliciting purchases of, the Securities or (B) pay or agree to pay to any person any compensation for soliciting another to purchase any other securities of the Company (except for the sale of Securities by the Selling Securityholders under this Agreement). (l) The Company will obtain the lockup agreements described in Section 7(g) hereof prior to the Firm Closing Date. (m) If at any time during the 25-day period after the Registration Statement becomes effective or the period prior to the Option Closing Date, any rumor, publication or event relating to or affecting the Company shall occur as a result of which in your reasonable opinion the market price of the Common Stock has been or is likely to be materially affected (regardless of whether such rumor, publication or event necessitates a supplement to or amendment of the Prospectus), the Company will, after written notice from you advising the Company to the effect set forth above, and in accordance with applicable law and the rules and policies of The Nasdaq Stock Market, Inc., forthwith prepare, consult with you concerning the substance of, and disseminate a press release or other public statement, reasonably satisfactory to you, your counsel and counsel to the Company responding to or commenting on such rumor, publication or event. (n) The Company will cause the Securities to be duly included for quotation on the Nasdaq National Market prior to the Firm Closing Date. The Company will use its best efforts to ensure that the Securities remain included for quotation on the Nasdaq National Market following the Firm Closing Date. (o) The Selling Securityholders will not, directly or indirectly, without the prior written consent of the Representatives, on behalf of the Underwriters, offer, sell, offer to sell, contract to sell, pledge, grant any option to purchase or otherwise sell or dispose of (or announce any offer, sale, offer of sale, contract of sale, pledge, grant of any option to purchase or other sale or disposition) any Securities legally or beneficially owned by 15 16 such Selling Securityholders or any securities convertible into, or exchangeable or exercisable for, Securities during the Lock-Up Period. (p) The Selling Securityholders will not, directly or indirectly, (i) take any action designed to cause or result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Securities or (ii) (A) sell, bid for, purchase, or pay anyone any compensation for soliciting purchases of, the Securities or (B) pay or agree to pay to any person any compensation for soliciting another to purchase any other securities of the Company (except for the sale of Securities by the Selling Securityholders under this Agreement). 6. Expenses. The Company will pay all costs and expenses incident to the performance of its obligations under this Agreement, whether or not the transactions contemplated herein are consummated or this Agreement is terminated pursuant to Section 11 hereof, including all costs and expenses incident to (i) the printing or other production of documents with respect to the transactions, including any costs of printing the Registration Statement originally filed with respect to the Securities and any amendment thereto, any Rule 462(b) Registration Statement, any Preliminary Prospectus and the Prospectus and any amendment or supplement thereto, this Agreement and any blue sky memoranda and a reasonable quantity of prospectuses or offering circulars as determined by the Representatives, (ii) all arrangements relating to the delivery to the Underwriters of copies of the foregoing documents, (iii) the fees and disbursements of its counsel, the accountants and any other experts or advisors retained by the Company, (iv) the reasonable fees and disbursements of the Underwriters' counsel, (v) the preparation, issuance and delivery to the Underwriters of any certificates evidencing the Securities, including transfer agent's and registrar's fees, (vi) the qualification of the Securities under state securities and blue sky laws, including filing fees and reasonable fees and disbursements of counsel for the Underwriters relating thereto, (vii) the filing fees of the Commission and the National Association of Securities Dealers, Inc. relating to the Securities, (viii) the filing and other fees of securing quotation of the Securities on the Nasdaq National Market, (ix) any meetings with prospective investors in the Securities (other than as shall have been specifically approved by the Representatives to be paid for by the Underwriters) and (x) advertising relating to the offering of the Securities (other than as shall have been specifically approved by the Representatives to be paid for by the Underwriters). If the sale of the Securities provided for herein is not consummated because any condition to the obligations of the Underwriters set forth in Section 7 hereof is not satisfied, because this Agreement is terminated pursuant to Section 11 hereof or because of any failure, refusal or inability on the part of the Company or the Selling Securityholders to perform all obligations and satisfy all conditions on its part to be performed or satisfied hereunder other than by reason of a default by any of the Underwriters, the Company will reimburse the Underwriters severally upon demand for their documented out-of-pocket expenses (not including counsel fees) that shall have been incurred by them in connection with the proposed purchase and sale of the Securities up to a maximum of $100,000. The Company shall not in any event be liable to any of the Underwriters for the loss of anticipated profits from the transactions covered by this Agreement. 7. Conditions of the Underwriters' Obligations. The obligations of the several Underwriters to purchase and pay for the Firm Securities shall be subject, in the Representatives' sole discretion, to the accuracy of the representations and warranties of the Company and the Selling Securityholders contained herein as of the date hereof and as of the Firm Closing Date, as if made on and as of the Firm Closing Date, to the accuracy of the statements of the Company's officers made pursuant to the provisions hereof, to the performance by the Company of its covenants and agreements hereunder and to the following additional conditions: (a) If the Original Registration Statement or any amendment thereto filed prior to the Firm Closing Date has not been declared effective as of the time of execution hereof, the Registration Statement or such amendment, and if the Company has elected to rely upon Rule 462(b), the Rule 462(b) Registration Statement, shall have been declared effective not later than the earlier of: (i) 11:00 a.m., New York City time, on the date on which the amendment to the Registration Statement originally filed with respect to the Securities or to the Registration 16 17 Statement, as the case may be, containing information regarding the initial public offering price of the Securities has been filed with the Commission, and (ii) the time confirmations are sent or given as specified by Rule 462(b) or, with respect to the Original Registration Statement, such later time and date as shall have been consented to by Representative; if required, the Prospectus or any Term Sheet that constitutes a part thereof and any amendment or supplement thereto shall have been filed with the Commission in the manner and within the time period required by Rules 434 and 424(b) under the Act; no stop order suspending the effectiveness of the Registration Statement or any amendment thereto shall have been issued, and no proceedings for that purpose shall have been instituted or threatened or, to the knowledge of the Company or the Selling Securityholders, shall be contemplated by the Commission; and the Company shall have complied to the satisfaction of Underwriters' Counsel with any request of the Commission for additional information (to be included in the Registration Statement or the Prospectus or otherwise). (b) The Representatives shall have received an opinion, dated the Firm Closing Date, of Manatt, Phelps & Phillips, LLP, counsel for the Company, to the effect that: (i) each of the Company and its subsidiary, Credit Connection, Inc. (the "Subsidiary"), has been duly incorporated and is validly existing and in good standing under the laws of its jurisdiction of organization and is duly qualified to transact business as a foreign entity and is in good standing under the laws of all other jurisdictions where the ownership or leasing of its properties or the conduct of its businesses requires such qualification, except where the failure to be so qualified would not have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole; (ii) each of the Company and the Subsidiary has the power (corporate and other) and authority to own or lease its properties and conduct its businesses as described in the Registration Statement and the Prospectus; and the Company has the legal right, power (corporate and other) and authority to enter into this Agreement and to perform the transactions contemplated hereby; (iii) the issued and outstanding shares of the Subsidiary have been duly authorized and validly issued, are fully paid and nonassessable, and have not been issued in violation of or subject to any preemptive right, co-sale right, registration right, right of first refusal or other similar right and are owned by the Company free and clear of any pledge, security interests, liens, encumbrances, claims or equitable interests. The Company does not own or control, directly or indirectly, any corporation, association or other entity other than the Subsidiary; (iv) the Company has an authorized, issued and outstanding capitalization as set forth in the Prospectus. All of the issued and outstanding shares of capital stock of the Company (including the Securities to be sold by the Selling Securityholders) have been duly authorized and validly issued and are fully paid and nonassessable, have been issued in compliance with all Federal and state securities laws, and were not issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase securities. The Company Firm Securities and the Option Securities have been duly authorized for issuance and sale to the Underwriters pursuant to this Agreement, and at the Firm Closing Date, when issued and delivered by the Company after payment therefor in accordance herewith, will be duly and validly issued, fully paid and nonassessable, and will be sold free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest; and no preemptive right, co-sale right, registration right, right of first refusal, registration rights, or other similar right of stockholders exists with respect to any of the Common Stock hereunder or the issuance and sale thereof other than those that have been expressly waived prior to the date hereof and those that will automatically expire upon the consummations of the transactions contemplated by this Agreement. No further approval or authorization of any stockholder, the Board of Directors of the Company or others is required for the issuance of the Company Firm Securities 17 18 or the Option Securities except as may be required under the Act or state securities or Blue Sky laws; the Securities have been approved for quotation on the Nasdaq National Market, subject to official notice of issuance; (v) the statements set forth under the heading "Description of Capital Stock" in the Prospectus, insofar as such statements purport to summarize certain provisions of the capital stock and the stock option and purchase plans of the Company, provide a fair summary of such provisions; and the statements set forth under the heading "Business -- Intellectual Property and Other Proprietary Rights," "Business -- Government Regulation," "Shares Eligible for Future Sale" and "Certain Transactions" in the Prospectus, insofar as such statements constitute a summary of the legal matters, documents or proceedings referred to therein, provide a fair summary of such legal matters, documents and proceedings in all material respects; (vi) the execution and delivery of this Agreement have been duly authorized by all necessary corporate action of the Company and this Agreement has been duly executed and delivered by the Company and, assuming due authorization, execution and delivery by you, is a valid and binding agreement of the Company, enforceable in accordance with its terms, except as rights to indemnification and contribution hereunder may be limited by applicable law and except as the enforcement hereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally, or by general equitable principles; (vii) to the best of such counsel's knowledge, there are no legal or governmental actions, suits, claims or other proceedings pending or threatened against or affecting the Company, its subsidiary or any of their properties, which are required, individually or in the aggregate, to be disclosed in the Registration Statement or the Prospectus, other than those disclosed therein; (viii) to the best of such counsel's knowledge, there are no contracts, indentures, mortgages, agreements, notes, leases or other instruments required to be described or referred to in the Registration Statement or Prospectus or to be filed as exhibits to the Registration Statement other than those described or referred to therein or filed as exhibits thereto, and any description of or reference to any such instrument in the Registration Statement or Prospectus conforms in all material respects to the terms of such instrument; (ix) neither the Company nor its subsidiary is (i) in violation of its certificate of incorporation or bylaws, or (ii) to the best of such counsel's knowledge, in default in the performance or observance of any obligation, agreement, covenant or condition contained in any bond, debenture, note or other evidence of indebtedness to which the Company or its subsidiary is a party or pursuant to which the Company's or the subsidiary's properties are bound, which default would have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, or, which default would have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, or (iii) in default in the performance or observance of any contract, indenture, mortgage, loan agreement, joint venture or other agreement or instrument to which the Company or its subsidiary is a party or by which the Company's or its subsidiary's properties are bound, which default would have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, or (iv) in violation of any law, order, rule, regulation, writ, injunction, judgment or decree of any court or governmental agency or body to which the Company is subject; 18 19 (x) the issuance, offering and sale of the Securities to the Underwriters by the Company pursuant to this Agreement, the compliance and performance by the Company with the other provisions of this Agreement and the consummation of the other transactions herein contemplated do not and will not (A) require the consent, approval, authorization, registration or qualification of or with any governmental authority, domestic or foreign, except such as have been obtained, such as may be required under the Act, the Exchange Act, or under state securities or blue sky laws, all of which requirements have been satisfied, or (B) result in a breach or violation of any of the terms and provisions of, or constitute a default under the certificate of incorporation or bylaws of the Company, or (C) to the best of such counsel's knowledge, result in a breach or violation of any of the terms and provisions of, or constitute a default under any obligation, agreement, covenant or condition contained in any bond, debenture, note or other evidence of indebtedness to which the Company or its subsidiary is a party or pursuant to which the Company's or the subsidiary's properties are bound, which default would have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, or (D) result in a breach or violation of any of the terms and provisions of, or constitute a default under any law, order, rule, regulation, writ, injunction, judgment or decree of any court or governmental agency or body to which the Company is subject; (xi) (a) to the best of such counsel's knowledge, the Company and its subsidiary possess all certificates, authorizations, licenses, franchises and permits issued by the appropriate Federal, state or foreign regulatory authorities necessary to own, lease and operate their respective properties and to conduct their respective businesses described in the Prospectus, and (b) neither the Company nor its subsidiary has received any notice of proceedings relating to, the revocation or modification of any such certificate, authorization, license, franchise or permit, except as described in the Prospectus, except for such certificates, authorizations, licenses, franchises and permits, the loss of which would not have a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole. To the best of such counsel's knowledge, except as described in the Prospectus, none of the Company's or its subsidiary's certificates, authorizations, licenses, franchises or permits contain any restrictions that, if effective, would result in any material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole; (xii) the Registration Statement is effective under the Act; any required filing of the Prospectus, or any Term Sheet that constitutes a part thereof, pursuant to Rules 424(b) and 434 has been made in the manner and within the time period required by Rules 424(b) and 434; and no stop order suspending the effectiveness of the Registration Statement or any amendment thereto has been issued, and no proceedings for that purpose have been instituted or to the best of such counsel's knowledge, threatened by the Commission; (xiii) the Registration Statement originally filed with respect to the Securities and each amendment thereto, any Rule 462(b) Registration Statement and the Prospectus (in each case, other than the financial statements and other financial and statistical information contained therein, as to which such counsel need express no opinion) comply as to form in all material respects with the applicable requirements of the Act and the rules and regulations of the Commission thereunder; (xiv) if the Company elects to rely on Rule 434, the Prospectus is not "materially different," as such term is used in Rule 434, from the prospectus included in the Registration Statement at the time of its effectiveness or an effective post-effective amendment thereto (including such information that is permitted to be omitted pursuant to Rule 430A); 19 20 (xv) the issuances and sales by the Company of the securities described in Item 15 of the Registration Statement were exempt from the registration requirements of the Act, and, to such counsel's knowledge, no event (including, without limitation, the offering and sale of the Securities) has occurred or is contemplated by the Company which has rendered or will render such exemptions unavailable; (xvi) the Company is not, and the transactions contemplated by this Agreement will not cause the Company to become, an investment company subject to registration under the Investment Company Act of 1940, as amended; and (xvii) the specimen stock certificate of the Company filed as an exhibit to the Registration Statement is in due and proper form to evidence shares of Common Stock, has been duly authorized and approved by the Board of Directors of the Company and complies with all legal requirements applicable under the corporate laws of the State of Delaware; Such counsel shall also state that they have no reason to believe that the Registration Statement, as of its effective date and the date of such opinion, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading, or that the Prospectus, as of its date and the date of such opinion, included or includes any untrue statement of a material fact or omitted or omits to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. In rendering any such opinion, such counsel may rely, as to matters of fact, to the extent such counsel deem(s) proper, on certificates of responsible officers of the Company and public officials. References to the Registration Statement and the Prospectus in this paragraph (b) shall include any amendment or supplement thereto at the date of such opinion. (c) The Representatives shall have received an opinion, dated the Firm Closing Date, of Manatt, Phelps & Phillips, LLP, counsel to the Selling Securityholders, to the effect that: (i) each of the Selling Securityholders has full power to enter into this Agreement, the Custody Agreement and the Power-of-Attorney and to sell, transfer and deliver the Securities being sold by such Selling Securityholder hereunder in the manner provided in this Agreement and to perform their obligations under the Custody Agreement; the execution and delivery of this Agreement, the Custody Agreement and the Power-of-Attorney has been duly authorized by all necessary action of each of the Selling Securityholders; this Agreement, the Custody Agreement and the Power-of-Attorney have been duly executed and delivered by each of the Selling Securityholders or their respective Attorneys; assuming due authorization, execution and delivery by the Custodian, the Custody Agreement and the Power-of-Attorney are the legal, valid, binding and enforceable instruments of each of the Selling Securityholders, except as the enforcement thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally, or by general equitable principles; (ii) the delivery by each of the Selling Securityholders to the several Underwriters of certificates for the Securities being sold hereunder by the Selling Securityholders against payment therefor as provided herein, will convey good and marketable title to such Securities to the several Underwriters, free and clear of any pledge, security interests, liens, encumbrances, claims or equitable interests; and 20 21 (iii) the sale of the Securities to the Underwriters by each of the Selling Securityholders pursuant to this Agreement, the compliance by each of the Selling Securityholders with the other provisions of this Agreement and the Custody Agreement, and the consummation of the other transactions herein contemplated do not (a) require the consent, approval, authorization, registration or qualification of or with any governmental authority, domestic or foreign, except such as have been obtained, such as may be required under the Act, the Exchange Act, or under state securities or blue sky laws, all of which requirements have been satisfied, or (b) to the best of such counsel's knowledge, result in a breach or violation of any of the terms and provisions of, or constitute a default under any obligation, agreement, covenant or condition contained in any bond, debenture, note or other evidence of indebtedness to which any of the Selling Securityholders are a party or by which any of the Selling Securityholders or any of their respective properties are bound, or any statute, judgment, decree, order, rule or regulation of any court or other governmental authority or any arbitrator applicable to the Selling Securityholders. In rendering any such opinion, such counsel may rely, as to matters of fact, to the extent such counsel deem(s) proper, on certificates of the Selling Securityholders or of the Company and of the representations of the Company and the Selling Securityholders contained herein, in the Custody Agreement, or in the Power-of-Attorney.. References to the Registration Statement and the Prospectus in this paragraph (c) shall include any amendment or supplement thereto at the date of such opinion. (d) The Representatives shall have received from Ernst & Young LLP a letter or letters dated, respectively, the date hereof and the Firm Closing Date, in form and substance satisfactory to the Representatives, to the effect that: (i) they are independent public accountants with respect to the Company and its consolidated subsidiary within the meaning of the Act and the applicable rules and regulations thereunder; (ii) in their opinion, the audited consolidated financial statements and schedules examined by them and included in the Registration Statement and the Prospectus comply in form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations; (iii) on the basis of carrying out certain specified procedures (which do not constitute an examination made in accordance with generally accepted auditing standards) that would not necessarily reveal matters of significance with respect to the comments set forth in this paragraph (iii), a reading of the minute books of the stockholders, the Board of Directors and any committees thereof of the Company and its consolidated subsidiary, and inquiries of certain officials of the Company and its consolidated subsidiary who have responsibility for financial and accounting matters, nothing came to their attention that caused them to believe that at a specific date not more than five business days prior to the date of such letter, there were any changes in the capital stock or long-term debt of the Company and its consolidated subsidiary or any decreases in net current assets or stockholders' equity of the Company and its consolidated subsidiary, in each case compared with amounts shown on the December 31, 1995 consolidated balance sheet included in the Registration Statement and the Prospectus, or for the period from January 1, 1996 to such specified date there are any decreases, as compared to total revenues, net income or pro forma net income per share, respectively, of the Company and its consolidated subsidiary, except in all instances for changes, decreases or increases set forth in such letter; and (iv) they have carried out certain specified procedures, not constituting an audit, with respect to certain amounts, percentages and financial information that are derived from the general 21 22 accounting records of the Company and its consolidated subsidiary and are included in the Registration Statement and the Prospectus, and have compared such amounts, percentages and financial information with such records of the Company and its consolidated subsidiary and with information derived from such records and have found them to be in agreement, excluding any questions of legal interpretation. In the event that the letters referred to above set forth any such changes, decreases or increases, it shall be a further condition to the obligations of the Underwriters that (A) such letters shall be accompanied by a written explanation of the Company as to the significance thereof, unless the Representatives deem such explanation unnecessary, and (B) such changes, decreases or increases do not, in the sole judgment of the Representatives, make it impractical or inadvisable to proceed with the purchase and delivery of the Securities as contemplated by the Registration Statement, as amended as of the date hereof. References to the Registration Statement and the Prospectus in this paragraph (d) with respect to either letter referred to above shall include any amendment or supplement thereto at the date of such letter. (e) The Representatives shall have received a certificate, dated the Firm Closing Date, of the principal executive officer, the principal financial or accounting officer, respectively, of the Company to the effect that: (i) the representations and warranties of the Company in this Agreement are true and correct as if made on and as of the Firm Closing Date and the Company has performed all covenants and agreements and satisfied all conditions on its part to be performed or satisfied at or prior to the Firm Closing Date; (ii) no stop order suspending the effectiveness of the Registration Statement or any amendment thereto has been issued, and no proceedings for that purpose have been instituted or threatened or, to the best of the Company's knowledge, are contemplated by the Commission; and (iii) when the Registration Statement or any amendment thereto was declared effective, and at all times subsequent thereto up to the delivery of such certificate, the Registration Statement and the Prospectus, and any amendments or supplements thereto, contained all statements required to be stated therein in accordance with, and complied in all material respects with the requirements of, the Act and the rules and regulations of the Commission promulgated thereunder, the Registration Statement, and any amendment or supplement thereto, did not and does not include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein not misleading, the Prospectus, and any amendment or supplement thereto, did not and does not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading, and since the effective date of the Registration Statement, there has occurred no event required to be set forth in an amended or supplemented Prospectus which has not been so set forth; and (iv) subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, there has not been (a) any material adverse change in the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, (b) any transaction that is material to the Company and its subsidiary, taken as a whole, except transactions entered into in the ordinary course of business, (c) any obligation, direct or contingent, that is material to the Company and its subsidiary, taken as a whole, incurred by the Company or its subsidiary, except obligations incurred in the ordinary course of business, (d) any change in the capital stock or outstanding indebtedness of the Company or its subsidiary that is material to the Company and its subsidiary, taken as a whole, (e) any dividend or distribution of any kind declared, paid 22 23 or made on the capital stock of the Company or its subsidiary, or (f) any loss or damage (whether or not insured) the property of the Company or its subsidiary which has been sustained or will have been sustained which has a material adverse effect on the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole. (f) The Representatives shall have received a certificate, dated the Firm Closing Date, of the Attorneys for each of the Selling Securityholders to the effect that the representations and warranties of such Selling Securityholder in this Agreement are true and correct as if made on and as of the Firm Closing Date; the Registration Statement, as amended as of the Firm Closing Date, does not include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein not misleading, and the Prospectus, as amended or supplemented as of the Firm Closing Date, does not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; and such Selling Securityholder has performed all covenants and agreements on his or her part to be performed or satisfied at or prior to the Closing Date. (g) The Representatives shall have received from each person who is a director or officer of the Company an agreement to the effect that such person will not, except to the extent otherwise specifically permitted by the terms of each such person's agreement, directly or indirectly, without the prior written consent of the Representatives, offer, sell, offer to sell, contract to sell, pledge, grant any option to purchase or otherwise sell or dispose (or announce any offer, sale, offer of sale, contract of sale, pledge, grant of an option to purchase or other sale or disposition) of any shares of Common Stock or any securities convertible into, or exchangeable or exercisable for, shares of Common Stock during the Lock-Up Period. (h) The Representatives shall have received from each of Mr. James R. DeFrancesco and Mr. Scott L. Freiman tax indemnification agreements providing that such individuals will indemnify the Company for any taxes payable by the Company as a result of the Company's termination of its Subchapter S Corporation status. (i) The Representatives and counsel for the Underwriters shall have received such further certificates, documents or other information as they may have reasonably requested from the Company and the Selling Securityholders. (j) Prior to the commencement of the offering of the Securities, the Securities shall have been approved for quotation on the Nasdaq National Market, subject to official notice of issuance. (k) The Representatives shall have received an opinion, dated the Firm Closing Date, of Brobeck, Phleger & Harrison LLP, counsel for the Underwriters, with respect to the issuance and sale of the Firm Securities, the Registration Statement and Prospectus, and such other related matters as the Representatives may reasonably require, and the Company shall have furnished to such counsel such documents as they may reasonably request for the purpose of enabling them to pass upon such matters. All opinions, certificates, letters and documents delivered pursuant to this Agreement will comply with the provisions hereof only if they are reasonably satisfactory in all material respects to the Representatives and counsel for the Underwriters. The Company shall furnish to the Representatives such conformed copies of such opinions, certificates, letters and documents in such quantities as the Representatives and counsel for the Underwriters shall reasonably request. The respective obligations of the several Underwriters to purchase and pay for any Option Securities shall be subject, in their discretion, to each of the foregoing conditions to purchase the Firm Securities, except that all references to the Firm Securities and the Firm Closing Date shall be deemed to refer to such Option Securities and the related Option Closing Date, respectively. 23 24 8. Indemnification and Contribution. (a) The Company and the Selling Securityholders, but in the case of each Selling Securityholder only to the extent of the proceeds received by such Selling Securityholder from the sale of his or her Securities hereunder, jointly and severally agree to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of Section 15 of the Act or Section 20 of the Exchange Act against any losses, claims, damages or liabilities, joint or several, to which such Underwriter or such controlling person may become subject under the Act and the Exchange Act, or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon: (i) any untrue statement or alleged untrue statement made by the Company in Section 2(a) of this Agreement; (ii) any untrue statement or alleged untrue statement made by the Selling Securityholders in Section 2(b) of this Agreement; (iii) any untrue statement or alleged untrue statement of any material fact contained in (A) the Registration Statement or any amendment thereto, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto and including any Rule 462(b) Registration Statement, or (B) any application or other document, or any amendment or supplement thereto, executed by the Company or Selling Securityholders or based upon written information furnished by or on behalf of the Company or Selling Securityholders filed in any jurisdiction in order to qualify the Securities under the securities or blue sky laws thereof or filed with the Commission or any securities association or securities exchange (each an "Application"); (iv) the omission or alleged omission to state in the Registration Statement or any amendment thereto, a material fact required to be stated therein or necessary to make the statements therein not misleading, or any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, or any Application a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; or (v) any untrue statement or alleged untrue statement of any material fact contained in any audio or visual materials used in connection with the marketing of the Securities, including without limitation, slides, videos, films, tape recordings, and will reimburse, as incurred, each Underwriter and each such controlling person for any legal or other expenses reasonably incurred by such Underwriter or such controlling person in connection with investigating, defending against or any other proceeding in connection with any such loss, claim, damage, liability or action; provided, however, that the Company and Selling Securityholders will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in such Registration Statement or any amendment thereto, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto or any Application in reliance upon and in conformity with written information furnished to the Company by such Underwriter through the Representative specifically for use therein; and provided, further, that neither the Company nor any of the Selling Securityholders will be liable to any Underwriter or any person controlling such Underwriter with respect to any such untrue statement or omission made in any Preliminary Prospectus that is corrected in the Prospectus (or any amendment or supplement thereto) if the person asserting any such loss, claim, damage or liability purchased Securities from such Underwriter but was not sent or given a copy of the Prospectus (as amended or supplemented) at or prior to the written confirmation of the sale of such Securities to such person in any case where such delivery of the 24 25 Prospectus (as amended or supplemented) is required by the Act, unless such failure to deliver the Prospectus (as amended or supplemented) was a result of noncompliance by the Company with this Agreement. This indemnity agreement will be in addition to any liability which the Company and Selling Securityholders may otherwise have. Neither the Company nor Selling Securityholders will, without the prior written consent of the Underwriter or Underwriters purchasing, in the aggregate, more than 50% of the Securities, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action, suit or proceeding in respect of which indemnification may be sought hereunder (whether or not any such Underwriter or any person who controls any such Underwriter within the meaning of Section 15 of the Act or Section 20 of the Exchange Act is a party to such claim, action, suit or proceeding), unless such settlement, compromise or consent includes an unconditional release of all of the Underwriters and such controlling persons from all liability arising out of such claim, action, suit or proceeding. (b) Each Underwriter, severally and not jointly, will indemnify and hold harmless the Company, each of its directors, each of its officers who signed the Registration Statement, each of the Selling Securityholders and each person, if any, who controls the Company within the meaning of Section 15 of the Act or Section 20 of the Exchange Act against any losses, claims, damages or liabilities to which the Company or any such director, officer of the Company, Selling Securityholder or controlling person of the Company may become subject under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement or any amendment thereto, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, or any Application or (ii) the omission or the alleged omission to state therein a material fact required to be stated in the Registration Statement or any amendment thereto, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, or any Application or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company by such Underwriter through the Representative specifically for use therein; and, subject to the limitation set forth immediately preceding this clause, will reimburse, as incurred, any legal or other expenses reasonably incurred by the Company or any such director, officer or controlling person or Selling Securityholder in connection with investigating or defending any such loss, claim, damage, liability or any action in respect thereof. This indemnity agreement will be in addition to any liability which such Underwriter may otherwise have. (c) Promptly after receipt by an indemnified party under this Section 8 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this Section 8, notify the indemnifying party of the commencement thereof, but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party otherwise than under this Section 8. In case any such action is brought against any indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party; provided, however, that if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be one or more legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, the indemnifying party shall not have the right to direct the defense of such action on behalf of such indemnified party or parties and such indemnified party or parties shall have the right to select separate counsel to defend such action on behalf of such indemnified party or parties. After notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof and approval by such indemnified party of counsel appointed to defend such action, the indemnifying party will not be liable to such indemnified party under this Section 8 for any legal or other expenses, other than reasonable costs of investigation, subsequently incurred by such indemnified party in connection with the defense thereof, unless (i) the indemnified party shall have employed separate counsel 25 26 in accordance with the proviso to the next preceding sentence (it being understood, however, that in connection with such action the indemnifying party shall not be liable for the expenses of more than one separate counsel (in addition to local counsel) in any one action or separate but substantially similar actions in the same jurisdiction arising out of the same general allegations or circumstances, designated by the Representative in the case of paragraph (a) of this Section 8, representing the indemnified parties under such paragraph (a) who are parties to such action or actions) or (ii) the indemnifying party does not promptly retain counsel satisfactory to the indemnified party or (iii) the indemnifying party has authorized the employment of counsel for the indemnified party at the expense of the indemnifying party. After such notice from the indemnifying party to such indemnified party, the indemnifying party will not be liable for the costs and expenses of any settlement of such action effected by such indemnified party without the consent of the indemnifying party. (d) In circumstances in which the indemnity agreement provided for in the preceding paragraphs of this Section 8 is unavailable or insufficient, for any reason, to hold harmless an indemnified party in respect of any losses, claims, damages or liabilities (or actions in respect thereof), each indemnifying party, in order to provide for just and equitable contribution, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect (i) the relative benefits received by the indemnifying party or parties on the one hand and the indemnified party on the other from the offering of the Securities or (ii) if the allocation provided by the foregoing clause (i) is not permitted by applicable law, not only such relative benefits but also the relative fault of the indemnifying party or parties on the one hand and the indemnified party on the other in connection with the statements or omissions or alleged statements or omissions that resulted in such losses, claims, damages or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Company and Selling Securityholders on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total proceeds from the offering (before deducting expenses) received by the Company and Selling Securityholders bear to the total underwriting discounts and commissions received by the Underwriters. The relative fault of the parties shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company, Selling Securityholders or the Underwriters, the parties' relative intents, knowledge, access to information and opportunity to correct or prevent such statement or omission, and any other equitable considerations appropriate in the circumstances. The Company, Selling Securityholders and the Underwriters agree that it would not be equitable if the amount of such contribution were determined by pro rata or per capita allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation that does not take into account the equitable considerations referred to above in this paragraph (d). Notwithstanding any other provision of this paragraph (d), no Underwriter shall be obligated to make contributions hereunder that in the aggregate exceed the total public offering price of the Securities purchased by such Underwriter under this Agreement, less the aggregate amount of any damages that such Underwriter has otherwise been required to pay in respect of the same or any substantially similar claim, and no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations to contribute hereunder are several in proportion to their respective underwriting obligations and not joint, and contributions among Underwriters shall be governed by the provisions of the Representative's Master Agreement Among Underwriters. For the purposes of this paragraph 8(d), each person, if any, who controls an Underwriter within the meaning of Section 15 of the Act or Section 20 of the Exchange Act shall have the same rights to contribution as such Underwriter, and each director of the Company, each officer of the Company who signed the Registration Statement, and each person, if any, who controls the Company or Selling Securityholders within the meaning of Section 15 of the Act or Section 20 of the Exchange Act, shall have the same rights to contribution as the Company or Selling Securityholders, as the case may be. 26 27 (e) The liability of each of the Selling Securityholders under this Section 8 shall not exceed an amount equal to the initial public offering price of the stock sold by such Selling Securityholder to the Underwriter. 9. Default of Underwriters. If one or more Underwriters default in their obligations to purchase Firm Securities or Option Securities hereunder and the aggregate number of such Securities that such defaulting Underwriter or Underwriters agreed but failed to purchase is ten percent or less of the aggregate number of Firm Securities or Option Securities to be purchased by all of the Underwriters at such time hereunder, then the other Underwriters may make arrangements satisfactory to the Representative for the purchase of such Securities by other persons (who may include one or more of the non-defaulting Underwriters, including the Representative), but if no such arrangements are made by the Firm Closing Date or the related Option Closing Date, as the case may be, the other Underwriters shall be obligated severally in proportion to their respective commitments hereunder to purchase the Firm Securities or Option Securities that such defaulting Underwriter or Underwriters agreed but failed to purchase. If one or more Underwriters so default with respect to an aggregate number of Securities that is more than ten percent of the aggregate number of Firm Securities or Option Securities, as the case may be, to be purchased by all of the Underwriters at such time hereunder, and if arrangements satisfactory to the Representative are not made within 36 hours after such default for the purchase by other persons (who may include one or more of the non-defaulting Underwriters, including the Representative) of the Securities with respect to which such default occurs, this Agreement will terminate without liability on the part of any non-defaulting Underwriter or the Company other than as provided in Section 10 hereof. In the event of any default by one or more Underwriters as described in this Section 9, the Representative shall have the right to postpone the Firm Closing Date or the Option Closing Date, as the case may be, established as provided in Section 3 hereof for not more than seven business days in order that any necessary changes may be made in the arrangements or documents for the purchase and delivery of the Firm Securities or Option Securities, as the case may be. As used in this Agreement, the term "Underwriter" includes any person substituted for an Underwriter under this Section 9. Nothing herein shall relieve any defaulting Underwriter from liability for its default. 10. Survival. The respective representations, warranties, agreements, covenants, indemnities and other statements of the Company, its officers, Selling Securityholders and the several Underwriters set forth in this Agreement or made by or on behalf of them, respectively, pursuant to this Agreement shall remain in full force and effect, regardless of (i) any investigation made by or on behalf of the Company, any of its officers or directors, Selling Securityholders, any Underwriter or any controlling person referred to in Section 8 hereof and (ii) delivery of and payment for the Securities. The respective agreements, covenants, indemnities and other statements set forth in Sections 6 and 8 hereof shall remain in full force and effect, regardless of any termination or cancellation of this Agreement. 11. Termination. (a) This Agreement may be terminated with respect to the Firm Securities or any Option Securities in the sole discretion of the Representatives by notice to the Company given prior to the Firm Closing Date or the related Option Closing Date, respectively, in the event that the Company shall have failed, refused or been unable to perform all obligations and satisfy all conditions on its part to be performed or satisfied hereunder at or prior thereto or, if at or prior to the Firm Closing Date or, with respect to the Company, such Option Closing Date, respectively: (i) the Company or its subsidiary shall have, in the sole judgment of the Representatives, sustained any material loss or interference with their respective businesses or properties from fire, flood, hurricane, accident or other calamity, whether or not covered by insurance, or from any labor dispute or any legal or governmental proceeding or there shall have been any material adverse change, or any development involving a prospective material adverse change (including without limitation 27 28 a material change in management or control of the Company), in the business, properties, business prospects, financial condition or results of operations of the Company and its subsidiary, taken as a whole, except in each case as described in or contemplated by the Prospectus (exclusive of any amendment or supplement thereto); (ii) trading in the Common Stock shall have been suspended by the Commission or the Nasdaq National Market or trading in securities generally on the New York Stock Exchange or Nasdaq National Market shall have been suspended or minimum or maximum prices shall have been established on either such exchange or market system; (iii) a banking moratorium shall have been declared by New York or United States authorities; (iv) the enactment, publication, decree or other promulgation of any Federal or state statute, regulation, rule or order of, or commencement of any proceeding or investigation by, any court, legislative body, agency or other government authority which in the Underwriters' sole opinion materially and adversely affects or will materially or adversely affect the business or operations of the Company; or (v) there shall have been (A) an outbreak or escalation of hostilities between the United States and any foreign power, (B) an outbreak or escalation of any other insurrection or armed conflict involving the United States or (C) any other calamity or crisis or material adverse change in general economic, political or financial conditions having an effect on the U.S. financial markets that, in the sole judgment of the Representatives, makes it impractical or inadvisable to proceed with the public offering or the delivery of the Securities as contemplated by the Registration Statement, as amended as of the date hereof. (b) Termination of this Agreement pursuant to this Section 11 shall be without liability of any party to any other party except as provided in Section 10 hereof. 12. Information Supplied by Underwriters. The statements set forth (i) in the last paragraph on the front cover page, (ii) under the heading "Underwriting" in any Preliminary Prospectus or the Prospectus and (iii) on page 2 in any Preliminary Prospectus or the Prospectus pertaining to stabilization (to the extent such statements relate to the Underwriters) constitute the only information furnished by any Underwriter through the Representative to the Company for the purposes of Sections 2(b) and 8 hereof. The Underwriters confirm that such statements (to such extent) are correct. 13. Notices. All communications hereunder shall be in writing and, if sent to any of the Underwriters, shall be delivered or sent by mail, telex or facsimile transmission and confirmed in writing to Friedman, Billings, Ramsey & Co., Inc., Potomac Tower, 1001 Nineteenth Street North, Arlington, Virginia 22209, Attention: Mr. Robert Hartheimer, with a copy to Brobeck, Phleger & Harrison LLP, 1633 Broadway, 47th Floor, New York, New York 10019, Attention: Alexander D. Lynch, Esq.; and if sent to the Company, shall be delivered or sent by mail, telex or facsimile transmission and confirmed in writing to the Company at 5950 Symphony Woods Road, Suite 301, Columbia, Maryland 21044, Attention: Chief Executive Officer with a copy to Manatt, Phelps & Phillips, LLP, 1501 M Street, N.W., Suite 700, Washington, D.C. 20005, Attention: Peter R. Gilbert, Esq.; and if sent to Selling Securityholders, shall be delivered or sent by mail, telex or facsimile transmission and confirmed in writing to Selling Securityholders at 5950 Symphony Woods Road, Suite 301, Columbia, Maryland 21044, Attention: Chief Executive Officer, with a copy to Manatt, Phelps & Phillips, LLP, 1501 M Street, N.W., Suite 300, Washington, D.C. 20005, Attention: Peter R. Gilbert, Esq. 28 29 14. Successors. This Agreement shall inure to the benefit of and shall be binding upon the several Underwriters, the Company, Selling Securityholders and their respective successors and legal representatives, and nothing expressed or mentioned in this Agreement is intended or shall be construed to give any other person any legal or equitable right, remedy or claim under or in respect of this Agreement, or any provisions herein contained, this Agreement and all conditions and provisions hereof being intended to be and being for the sole and exclusive benefit of such persons and for the benefit of no other person except that (i) the indemnities of the Company and Selling Securityholders contained in Section 8 of this Agreement shall also be for the benefit of any person or persons who control any Underwriter within the meaning of Section 15 of the Act or Section 20 of the Exchange Act and (ii) the indemnities of the Underwriters contained in Section 8 of this Agreement shall also be for the benefit of the directors of the Company, the officers of the Company who have signed the Registration Statement, Selling Securityholders and any person or persons who control the Company or Selling Securityholders within the meaning of Section 15 of the Act or Section 20 of the Exchange Act. No purchaser of Securities from any Underwriter shall be deemed a successor because of such purchase. 15. Applicable Law. The validity and interpretation of this Agreement, and the terms and conditions set forth herein, shall be governed by and construed in accordance with the laws of the State of Delaware, without giving effect to any provisions relating to conflicts of laws. 16. Consent to Jurisdiction and Service of Process. All judicial proceedings arising out of or relating to this Agreement may be brought in any state or federal court of competent jurisdiction in the State of Delaware, and by execution and delivery of this Agreement, the Company and Selling Securityholders each accepts for itself and in connection with their respective properties, generally and unconditionally, the nonexclusive jurisdiction of the aforesaid courts and waives any defense of forum non conveniens and irrevocably agree to be bound by any judgment rendered thereby in connection with this Agreement. The Selling Securityholders designate and appoint Miles H. Grody, and the Company designates and appoints Miles H. Grody and such other persons as may hereafter be selected by the Company or Selling Securityholders irrevocably agreeing in writing to so serve, as their respective agents to receive on its behalf service of all process in any such proceedings in any such court, such service being hereby acknowledged by the Company and Selling Securityholders to be effective and binding service in every respect. A copy of any such process so served shall be mailed by registered mail to the Company and/or Selling Securityholders at their respective addresses provided in Section 13 hereof; provided, however, that, unless otherwise provided by applicable law, any failure to mail such copy shall not affect the validity of service of such process. If any agent appointed by the Company or Selling Securityholders refuses to accept service, the Company and Selling Securityholders each hereby agrees that service of process sufficient for personal jurisdiction in any action against the Company or Selling Securityholders in the State of Delaware may be made by registered or certified mail, return receipt requested, to the Company and/or Selling Securityholders, as applicable, at their respective addresses provided in Section 13 hereof, and Selling Securityholders and the Company each hereby acknowledge that such service shall be effective and binding in every respect. Nothing herein shall affect the right to serve process in any other manner permitted by law or shall limit the right of any Underwriter to bring proceedings against the Company and Selling Securityholders in the courts of any other jurisdiction. 17. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 29 30 If the foregoing correctly sets forth our understanding please indicate your acceptance thereof in the space provided below for that purpose, whereupon this letter shall constitute an agreement binding the Company, the Selling Securityholders and each of the several Underwriters. Very truly yours, CREDIT MANAGEMENT SOLUTIONS, INC. By -------------------------------------- James R. DeFrancesco President and Chief Executive Officer SELLING SECURITYHOLDERS ----------------------------------------- [Attorney-in-Fact] ----------------------------------------- [Attorney-in-Fact] The foregoing Agreement is hereby confirmed and accepted as of the date first above written. FRIEDMAN, BILLINGS, RAMSEY & CO., INC. By: By: -------------------------------- Name: Title: For itself and as the Representative. 30 31 Schedule I UNDERWRITERS
Underwriting Number of Firm Securities to be Purchased - ------------ ----------------------------------------- Friedman, Billings, Ramsey & Co., Inc. . . . . . . . . . . Unterberg Harris . . . . . . . . . . . . . . . . . . . . . _________ Total . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,600,000 =========
31 32 Schedule II SELLING SECURITYHOLDERS
Name Number of Shares to be Sold - ---- --------------------------- James R. DeFrancesco 200,000 Scott L. Freiman 100,000 Charles F. Riordan 20,000 Miles H. Grody 20,000 Robert P. Vollono 20,000 James C. Alsobrook, Jr. 20,000 Nancy L. Weil 20,000 ------- Total 400,000
32 EX-3.1 3 CERTIFICATE OF INCORPORATION OF THE COMPANY 1 EXHIBIT 3.1 CERTIFICATE OF INCORPORATION OF CREDIT MANAGEMENT SOLUTIONS, INC. ARTICLE I Name The name of the corporation is Credit Management Solutions, Inc. (herein the "Corporation"). ARTICLE II Registered Office The address of the Corporation's registered office in the State of Delaware is 1013 Centre Road, City of Wilmington, County of New Castle 19805. The name of the Corporation's registered agent at such address is Corporation Service Company. ARTICLE III Powers The purpose for which the Corporation is organized is to engage in any lawful business for which corporations may be incorporated pursuant to the laws of the State of Delaware. The Corporation shall have all the powers of a corporation organized under the General Corporation Law of the State of Delaware. ARTICLE IV Term The Corporation is to have perpetual existence. 2 ARTICLE V Incorporator The name and mailing address of the Incorporator are as follows: Name Mailing Address ---- --------------- Peter R. Gilbert 1501 M. Street, N.W. Suite 700 Washington, D.C. 20005 ARTICLE VI Initial Directors The number of directors constituting the initial Board of Directors of the Corporation is seven (7) and the names and addresses of the persons who are to serve as directors until their successors are elected and qualified together with the classes of directorships to which such persons have been assigned are:
Name Address Class ---- ------- ----- James R. DeFrancesco 5950 Symphony Woods Road, Suite 301 III Columbia, MD 21044 Stephen X. Graham 1700 K Street, N.W. II Washington, D.C. 20006 Scott L. Freiman 5950 Symphony Woods Road, Suite 301 II Columbia, MD 21044 Miles H. Grody 5950 Symphony Woods Road, Suite 301 II Columbia, MD 21044 Robert P. Vollono 5950 Symphony Woods Road, Suite 301 I Columbia, MD 21044
2 3 ARTICLE VII Capital Stock The aggregate number of shares of all classes of capital stock which the Corporation has authority to issue is 41,000,000 of which 40,000,000 are to be shares of common stock, $.01 par value per share, and of which 1,000,000 are to be shares of serial preferred stock, $.01 par value per share. The shares may be issued by the Corporation from time to time as approved by the Board of Directors of the Corporation without the approval of the stockholders except as otherwise provided in this Article VII or the rules of a national securities exchange if applicable. The consideration for the issuance of the shares shall be paid to or received by the Corporation in full before their issuance and shall not be less than the par value per share. The consideration for the issuance of the shares shall be cash, services rendered, personal property (tangible or intangible), real property, leases of real property or any combination of the foregoing. In the absence of actual fraud in the transaction, the judgment of the Board of Directors as to the value of such consideration shall be conclusive. Upon payment of such consideration, such shares shall be deemed to be fully paid and nonassessable. In the case of a stock dividend, the part of the surplus of the Corporation which is transferred to stated capital upon the issuance of shares as a stock dividend shall be deemed to be the consideration for their issuance. A description of the different classes and series (if any) of the Corporation's capital stock, and a statement of the relative powers, designations, preferences and rights of the shares of each class and series (if any) of capital stock, and the qualifications, limitations or restrictions thereof, are as follows: A. Common Stock. Except as provided in this Certificate, the holders of the common stock shall exclusively possess all voting power. Each holder of shares of common stock shall be entitled to one vote for each share held by such holder, except as otherwise expressly set forth in this Certificate. Whenever there shall have been paid or declared and set aside for payment to the holders of the outstanding shares of any class of stock having preference over the common stock as to the payment of dividends, the full amount of dividends and sinking fund or retirement fund or other retirement payments, if any, in which such holders are respectively entitled in preference to the common stock, then dividends may be paid on the common stock, and on any class or series of stock entitled to participate therewith as to dividends, out of any assets legally available for the payment of dividends, but only when and as declared by the Board of Directors of the Corporation. In the event of any liquidation, dissolution or winding up of the Corporation, after there shall have been paid or declared and set aside for payment, to the holders of the outstanding shares of any class having preference over the common stock in any such event, the full preferential amounts to which they are respectively entitled, the holders of the common 3 4 stock and of any class or series of stock entitled to participate therewith, in whole or in part, as to distribution of assets shall be entitled, after payment or provision for payment of all debts and liabilities of the Corporation, to receive the remaining assets of the Corporation available for distribution, in cash or in kind. Each share of common stock shall have the same relative powers, preferences and rights as, and shall be identical in all respects with, all the other shares of common stock of the Corporation, except as otherwise expressly set forth in this Certificate. B. Serial Preferred Stock. Except as provided in this Certificate, the Board of Directors of the Corporation is authorized, by resolution or resolutions from time to time adopted to provide for the issuance of serial preferred stock in series and to fix and state the powers, designations, preferences and relative, participating, optional or other special rights of the shares of each such series, and the qualifications, limitations or restrictions thereof, including, but not limited to determination of any of the following; (1) the distinctive serial designation and the number of shares constituting such series; (2) the dividend rates or the amount of dividends to be paid on the shares of such series, whether dividends shall be cumulative and, if so, from which date or dates, the payment date or dates for dividends, and the participating or other special rights, if any, with respect to dividends; (3) the voting powers, full or limited, if any, of the shares of such series; (4) whether the shares of such series shall be redeemable and, if so, the price or prices at which, and the terms and conditions upon which such shares may be redeemed; (5) the amount or amounts payable upon the shares of such series in the event of voluntary or involuntary liquidation, dissolution or winding up of the Corporation; (6) whether the shares of such series shall be entitled to the benefits of a sinking or retirement fund to be applied to the purchase or redemption of such shares, and, if so entitled, the amount of such fund and the manner of its application, including the price or prices at which such shares may be redeemed or purchased through the application of such funds; (7) whether the shares of such series shall be convertible into, or exchangeable for, shares of any other class or classes or any other series of the same or any other class or classes of stock of the Corporation and, if so convertible or exchangeable, the conversion price or prices, or the rate or rates of exchange, 4 5 and the adjustments thereof, if any, at which such conversion or exchange may be made, and any other terms and conditions of such conversion or exchange; (8) the subscription or purchase price and form of consideration for which the shares of such series shall be issued; and (9) whether the shares of such series which are redeemed or converted shall have the status of authorized but unissued shares of serial preferred stock and whether such shares may be reissued as shares of the same or any other series of serial preferred stock. Each share of each series of serial preferred stock shall have the same relative powers, preferences and rights as and shall be identical in all respects with all the other shares of the Corporation of the same series, except as otherwise expressly set forth in this Certificate. ARTICLE VIII Preemptive Rights No holder of any of the shares of any class or series of stock or of options, warrants or other rights to purchase shares of any class or series of stock or of other securities of the Corporation shall have any preemptive right to purchase or subscribe for any unissued stock of any class or series, or any unissued bonds, certificates or indebtedness, debentures or other securities convertible into or exchangeable for stock of any class or series or carrying any right to purchase stock of any class or series; but any such unissued stock, bonds, certificates or indebtedness, debentures or other securities convertible into or exchangeable for stock or carrying any right to purchase stock may be issued pursuant to resolution of the Board of Directors of the Corporation to such persons, firms, corporations or associations, whether or not holders thereof, and upon such terms as may be deemed advisable by the Board of Directors in the exercise of its sole discretion. ARTICLE IX Repurchase of Shares The Corporation may from time to time, pursuant to authorization by the Board of Directors of the Corporation and without action by the stockholders, purchase or otherwise acquire shares of any class, bonds, debenture, notes, script, warranties, obligations, evidences of indebtedness or other securities of the Corporation in such manner, upon such terms, and in such amounts as the Board of Directors shall determine: subject, however, to such limitations or restrictions, if any, as are contained in the express terms of any class of shares of the Corporation outstanding at the time of the purchase or acquisition in question or as are imposed by law, 5 6 ARTICLE X Meetings of Stockholders; Cumulative Voting A. Notwithstanding any other provision of this Certificate or the bylaws of the Corporation, no action required to be taken or which may be taken at any annual or special meeting of stockholders of the Corporation may be taken without a meeting, and the power of stockholders to consent in writing, without a meeting, to the taking of any action is specifically denied. B. Special meetings of the stockholders of the Corporation for any purpose or purposes may be called at any time by the Board of Directors of the Corporation, or by a committee of the Board of Directors which has been duly designated by the Board of Directors and whose powers and authorities, as provided in a resolution of the Board of Directors or in the bylaws of the Corporation, include the power and authority to call such meetings, but such special meetings may not be called by any other person or persons. C. There shall be no cumulative voting by stockholders of any class or series in the election of directors of the Corporation. D. Meetings of stockholders may be held at such place as the bylaws may provide. ARTICLE XI Notice for Nominations and Proposals A. Nominations for the election of directors and proposals for any new business to be taken up at any annual or special meeting of stockholders may be made by the Board of Directors of the Corporation or by any stockholder of the Corporation entitled to vote generally in the election of directors. In order for a stockholder of the Corporation to make any such nominations and/or proposals, he or she shall give notice thereof in writing, delivered or mailed by first class United States mail, postage prepaid, to the Secretary of the Corporation not less than thirty days nor more than sixty days prior to the date of any such meeting; provided, however, that if less than forty days notice of the meeting is given to stockholders, such written notice shall be delivered or mailed, as prescribed, to the Secretary of the Corporation not later than the close of business on the tenth day following the day on which notice of the meeting was mailed to stockholders. Each such notice given by a stockholder with respect to nominations for the election of directors shall set forth (i) the name, age, business address and, if known, residence address of each nominee proposed in such notice; (ii) the principal occupation or employment of such nominee; and (iii) the number of shares of stock of the Corporation which are beneficially owned by each such nominee. In addition, the stockholder making such nomination shall promptly provide any other information reasonably requested by the Corporation. 6 7 B. Each such notice given by a stockholder to the Secretary with respect to business proposals to be brought before a meeting shall set forth in writing as to each matter: (i) a brief description of the business desired to be brought before the meeting and the reasons for conducting such business at the meeting; (ii) the name and address, as they appear on the Corporation's books, of the stockholder proposing such business; (iii) the class and number of shares of the Corporation which are beneficially owned by the stockholder; and (iv) any material interest of the stockholder in such business. Notwithstanding anything in this Certificate to the contrary, no new business shall be conducted at the meeting except in accordance with the procedures set forth in this Article. C. The Chairman of the annual or special meeting of stockholders may, if the facts warrant, determine and declare to such meeting that a nomination or proposal was not made in accordance with the foregoing procedure, and, if he should so determine, he shall so declare to the meeting and the defective nomination or proposal shall be disregarded and laid over for action at the next succeeding special or annual meeting of the stockholders taking place thirty days or more thereafter. This provision shall not require the holding of any adjourned or special meeting of stockholders for the purpose of considering such defective nomination or proposal. ARTICLE XII Directors A. Number; Vacancies. The number of directors of the Corporation shall be such number, not less than five (5) nor more than fifteen (15) (exclusive of directors, if any, to be elected by holders of preferred stock of the Corporation, voting separately as a class), as shall be set forth from time to time in the bylaws, provided that no action shall be taken to decrease or increase the number of directors unless at least two-thirds of the directors then in office shall concur in said action. Vacancies in the Board of Directors of the Corporation, however caused, and newly created directorships shall be filled by a vote of two-thirds of the directors then in office, whether or not a quorum, and any director so chosen shall hold office for a term expiring at the annual meeting of stockholders at which the term of the class to which the director has been chosen expires and when the director's successor is elected and qualified. B. Classified Board. The Board of Directors of the Corporation shall be divided into three classes of directors which shall be designated Class I, Class II and Class III. The members of each class shall be elected for a term of three years and until their successors are elected and qualified. Such classes shall be as nearly equal in number as the then total number of directors constituting the entire Board of Directors shall permit, with the terms of office of all members of one class expiring each year. Subject to the provisions of this Article XII, should the number of directors not be equally divisible by three, the excess director or directors shall be assigned to Classes I or II as follows: (i) if there shall be an excess of one directorship over a number equally divisible by three, such extra directorship shall be classified in Class II; and (ii) if there shall be an excess of two directorships over a number 7 8 equally divisible by three, one shall be classified in Class I and the other in Class II. At the first annual meeting of stockholders, directors of Class I shall be elected to hold office for a term expiring at the third succeeding annual meeting thereafter. At the second annual meeting of stockholders, directors of Class II shall be elected to hold office for a term expiring at the third succeeding annual meeting thereafter. At the third annual meeting of stockholders, directors of Class III shall be elected to hold office for a term expiring at the third succeeding annual meeting thereafter. Thereafter, at each succeeding annual meeting, directors of each class shall be elected for three year terms. Notwithstanding the foregoing, the director whose term shall expire at any annual meeting shall continue to serve until such time as his successor shall have been duly elected and shall have qualified unless his position on the Board of Directors shall have been abolished by action taken to reduce the size of the Board of Directors prior to said meeting. Should the number of directors of the Corporation be reduced, the directorship(s) eliminated shall be allocated among classes as appropriate so that the number of directors in each class is as specified in the immediately preceding paragraph. The Board of Directors shall designate, by the name of the incumbent(s), the position(s) to be abolished. Notwithstanding the foregoing, no decrease in the number of directors shall have the effect of shortening the term of any incumbent director. Should the number of directors of the Corporation be increased, the additional directorships shall be allocated among the classes as appropriate so that the number of directors in each class is as specified in the immediately preceding paragraph. Whenever the holders of any one or more series of preferred stock of the Corporation shall have the right, voting separately as a class, to elect one or more directors of the Corporation, the Board of Directors shall consist of said directors so elected in addition to the number of directors fixed as provided in this Article XII. Notwithstanding the foregoing, and except as otherwise may be required by law or by the terms and provisions of the preferred stock of the Corporation, whenever the holders of any one or more series of preferred stock of the Corporation shall have the right, voting separately as a class, to elect one or more directors of the Corporation, the terms of the director or directors elected by such holders shall expire at the next succeeding annual meeting of stockholders. ARTICLE XIII Removal of Directors Notwithstanding any other provisions of this Certificate or the bylaws of the Corporation, any director or the entire Board of Directors of the Corporation may be removed, at anytime, but only for cause and only by the affirmative vote of the holders of not less than 66.67% of the outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors (considered for this purpose as one class) cast at a meeting of the stockholders called for that purpose. Notwithstanding the foregoing, whenever the holders of any one or more series of preferred stock of the Corporation shall have the right, voting 8 9 separately as a class, to elect one or more directors of the Corporation, the preceding provisions of this Article XIII shall not apply with respect to the director or directors elected by such holders of preferred stock. ARTICLE XIV Indemnification The Corporation may, to the fullest extent permitted by Section 145 of the General Corporation Law of Delaware, as amended from time to time, indemnify each person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that he is or was, or has agreed to become, a director or officer of the Corporation, is or was serving, or has agreed to serve, at the request of the Corporation, as a director, officer or trustee of, or in a similar capacity with, another corporation, partnership, joint venture, trust or other enterprise (including any employee benefit plan) (all such persons being referred to hereafter as an "Indemnitee"), or by reason of any action alleged to have been taken or omitted in such capacity, against all expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him or on his behalf in connection with such action, suit or proceeding and any appeal therefrom. Indemnification may include payment by the Corporation of expenses in defending an action or proceeding in advance of the final disposition of such action or proceeding upon receipt of an undertaking by the Indemnitee to repay such payment if it is ultimately determined that such person is not entitled to indemnification under this Article XIV, which undertaking may be accepted without reference to the financial ability of such person to make such repayment. The Corporation shall not indemnify any such person seeking indemnification in connection with a proceeding (or part thereof) initiated by such person unless the initiation thereof was approved by the Board of Directors of the Corporation. The indemnification rights provided in this Article XIV (i) shall not be deemed exclusive of any other rights to which Indemnitees may be entitled under any law, agreement or vote of stockholders or disinterested directors or otherwise, and (ii) shall inure to the benefit of the heirs, executors and administrators of such persons. The Corporation may, to the extent authorized from time to time by its Board of Directors, grant Indemnification rights to other employees or agents of the Corporation or other persons serving the corporation and such rights may be equivalent to, or greater than or less than, those set forth in this Article XIV. 9 10 ARTICLE XV Limitations on Directors' Liability A director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except: (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions that are not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the General Corporation Law of the State of Delaware, or (iv) for any transaction from which the director derived any improper personal benefit. If the General Corporation Law of the State of Delaware or other Delaware law is amended or enacted after the date of filing of this Certificate to further eliminate or limit the personal liability of directors, then the liability of a director of the Corporation shall be eliminated or limited to the fullest extent permitted by the General Corporation Law of the State of Delaware, as so amended, or such other Delaware law. Any repeal or modification of the foregoing paragraph by the stockholders of the Corporation shall not adversely affect any right or protection of a director of the Corporation existing at the time of such repeal or modification. ARTICLE XVI Amendment of Bylaws In furtherance and not in limitation of the powers conferred by statute, the Board of Directors of the Corporation is expressly authorized to adopt, repeal, alter, amend and rescind the bylaws of the Corporation. ARTICLE XVII Amendment of Certificate of Incorporation The Corporation reserves the right to repeal, alter, amend or rescind any provision contained in this Certificate in the manner now or hereafter prescribed by law, and all rights conferred on stockholders herein are granted subject to this reservation. Notwithstanding the foregoing, the provisions set forth in Articles X, XI, XII, XIII, XIV, XV, XVI and this Article XVII may not be repealed, altered, amended or rescinded in any respect unless the same is approved by the affirmative vote of the holders of not less than 80% of the outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors (considered for this purpose as a single class) cast at a meeting of the stockholders called for that purpose (provided that notice of such proposed repeal, alteration, amendment or rescission is included in the notice of such meeting); except that such repeal, alteration, amendment or rescission may be made by the affirmative vote of the holders of a majority of the outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors 10 11 (consideration for this purpose as a single class) if the same is first approved by a majority of the directors of the Corporation. I, THE UNDERSIGNED, being the incorporator hereinafter named, for the purpose of forming a corporation pursuant to the General Corporation Law of the State of Delaware, do make this Certificate, hereby declaring and certifying that this is my act and deed and the facts herein stated are true, and accordingly have hereunto set my hand this 6th day of November, 1996. /s/ Peter R. Gilbert -------------------- Peter R. Gilbert Incorporator City of Washington ) ) ss: District of Columbia ) BE IT REMEMBERED, that on the 6th day of November, 1996, before me, a Notary Public duly authorized to take acknowledgements of deeds by the laws of the place where the foregoing Certificate of Incorporation was signed, personally appeared the undersigned, Peter R. Gilbert, the incorporator who signed the foregoing Certificate of Incorporation, known to me personally to be such, and who acknowledged the same to be his act and deed, and the facts therein stated are true. /s/Joseph Chalen ---------------------------- Notary Public My Commission Expires My Commission expires: 8-31-00 ----------------------- [SEAL] 11 EX-3.2 4 BYLAWS OF THE COMPANY 1 EXHIBIT 3.2 (A DELAWARE CORPORATION) BYLAWS OF CREDIT MANAGEMENT SOLUTIONS, INC. ARTICLE I Principal Executive Office The principal executive office of Credit Management Solutions, In. (the "Corporation") shall be at 5950 Symphony Woods Road, Suite 301, Columbia, Maryland 21044. The Corporation may also have offices at such other places within or without the State of Maryland as the board of directors shall from time to time determine. ARTICLE II Stockholders SECTION 1. Place of Meetings. All annual and special meetings of stockholders shall be held at the principal executive office of the Corporation or at such other place within or without the State of Delaware as the board of directors may determine and as designated in the notice of such meeting. SECTION 2. Annual Meeting. A meeting of the stockholders of the Corporation for the election of directors and for the transaction of any other business of the Corporation shall be held annually at such date and time as the board of directors may determine. SECTION 3. Special Meeting. Special meetings of the stockholders for any purpose or purposes may be called at any time by the board of directors or by a committee of the board of directors in accordance with the provisions of the Corporation's Certificate of Incorporation. SECTION 4. Conduct of Meetings. Annual and special meetings shall be conducted in accordance with these Bylaws or as otherwise prescribed by the board of directors. The chairman or the chief executive officer of the Corporation shall preside at such meetings. SECTION 5. Notice of Meeting. Written notice stating the place, day and hour of the meeting and the purpose or purposes for which the meeting is called shall be mailed by the secretary or the officer performing his duties, not less than ten days nor more than fifty days before the meeting to each stockholder of record entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail addressed to the stockholder at his address as it appears on the stock transfer books or records of the 2 Corporation as of the record date prescribed in Section 6, with postage thereon prepaid. If a stockholder is present at a meeting, or in writing waives notice thereof before or after the meeting, notice of the meeting to such stockholder shall be unnecessary. When any stockholders' meeting either annual or special is adjourned for thirty days or more, notice of the adjourned meeting shall be given as in the case of an original meeting. It shall not be necessary to give any notice of the time and place of any meeting adjourned for less than thirty days or of the business to be transacted at such adjourned meeting, other than an announcement at the meeting at which such adjournment is taken. SECTION 6. Fixing of Record Date. For the purpose of determining stockholders entitled to notice of or to vote at any meeting of stockholders, or any adjournment thereof, or stockholders entitled to receive payment of any dividend, or in order to make a determination of stockholders for any other proper purpose, the board of directors shall fix in advance a date as the record date for any such determination of stockholders. Such date in any case shall be not more than sixty days, and in case of a meeting of stockholders not less than ten days, prior to the date on which the particular action requiring such determination of stockholders, is to be taken. When a determination of stockholders entitled to vote at any meeting of stockholders has been made as provided in this section, such determination shall apply to any adjournment thereof. SECTION 7. Voting Lists. The officer or agent having charge of the stock transfer books for shares of the Corporation shall make, at least ten days before each meeting of stockholders, a complete record of the stockholders entitled to vote at such meeting or any adjournment thereof, with the address of and the number of shares held by each. The record, for a period of ten days before such meeting, shall be kept on file at the principal office of the Corporation whether within or outside the State of Michigan, and shall be subject to inspection by any stockholder for any purpose germane to the meeting at any time during usual business hours. Such record shall also be produced and kept open at the time and place of the meeting, and shall be subject to the inspection of any stockholder for any purpose germane to the meeting during the whole time of the meeting. The original stock transfer books shall be prima facie evidence as to who are the stockholders entitled to examine such record or transfer books or to vote at any meeting of stockholders. SECTION 8. Quorum. A majority of the outstanding shares of the Corporation entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of stockholders. If less than a majority of the outstanding shares are represented at a meeting, a majority of the shares so represented may adjourn the meeting from time to time without further notice. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. The stockholders present at a duly organized meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum. 2 3 SECTION 9. Proxies. At all meetings of stockholders, a stockholder may vote by proxy executed in writing by the stockholder or by his duly authorized attorney in fact. Proxies solicited on behalf of the management shall be voted as directed by the stockholder or, in the absence of such direction, as determined by a majority of the board of directors. No proxy shall be valid after eleven months from the date of its execution unless otherwise provided in the proxy. SECTION 10. Voting. At each election for directors and for every other matter requiring a vote to stockholders, every stockholder entitled to vote at such election shall be entitled to one vote for each share of stock held. Unless otherwise provided by the Certificate of Incorporation, by statute, or by these Bylaws, a majority of those votes cast by stockholders at a lawful meeting shall be sufficient to pass on a transaction or matter, except in the election of directors, which election shall be determined by a plurality of the votes of the shares present in person or by proxy at the meeting and entitled to vote on the election of directors. SECTION 11. Voting of Shares in the Name of Two or More Persons. When ownership of stock stands in the name of two or more persons, in the absence of written directions to the Corporation to the contrary, at any meeting of the stockholders of the Corporation any one or more of such stockholders may cast, in person or by proxy, all votes to which such ownership is entitled. In the event an attempt is made to cast conflicting votes, in person or by proxy, by the several persons in whose name shares of stock stand, the vote or votes to which these persons are entitled shall be cast as directed by a majority of those holding such stock and present in person or by proxy at such meeting, but no votes shall be cast for such stock if a majority cannot agree. SECTION 12. Voting of Shares by Certain Holders. Shares standing in the name of another corporation may be voted by any officer, agent or proxy as the bylaws of such corporation may prescribe, or, in the absence of such provision, as the board of directors of such corporation may determine. Shares held by an administrator, executor, guardian or conservator may be voted by him, either in person or by proxy, without a transfer of such shares into his name. Shares standing in the name of a trustee may be voted by him, either in person or by proxy, but no trustee shall be entitled to vote shares held by him without a transfer of such shares into his name. Shares standing in the name of a receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such receiver without the transfer thereof into his name if authority to do so is contained in an appropriate order of the court or other public authority by which such receiver was appointed. A stockholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee and thereafter the pledgee shall be entitled to vote the shares so transferred. Neither treasury shares of its own stock held by the Corporation, nor shares held by another corporation, if a majority of the shares entitled to vote for the election of directors of such other corporation are held by the Corporation, shall be voted at any meeting or counted in 3 4 determining the total number of outstanding shares at any given time for purposes of any meeting. SECTION 13. Inspectors of Election. In advance of any meeting of stockholders, the chairman of the board or the board of directors may appoint any persons, other than nominees for office, as inspectors of election to act at such meeting or any adjournment thereof. The number of inspectors shall be either one or three. If the board of directors so appoints either one or three inspectors, that appointment shall not be altered at the meeting. If inspectors of election are not so appointed, the chairman of the board may make such appointment at the meeting. In case any person appointed as inspector fails to appear or fails or refuses to act, the vacancy may be filled by appointment in advance of the meeting or at the meeting by the chairman of the board or the president. Unless otherwise prescribed by applicable law, the duties of such inspectors shall include: determining the number of shares of stock and the voting power of each share, the shares of stock represented at the meeting, the existence of a quorum, the authenticity, validity and effect of proxies; receiving votes, ballots or consents, hearing and determining all challenges and questions in any way arising in connection with the right to vote; counting and tabulating all votes or consents; determining the result; and such acts as may be proper to conduct the election or vote with fairness to all stockholders. SECTION 14. Nominating Committee. The board of directors or a committee appointed by the board of directors shall act as a nominating committee for selecting the management nominees for election as directors. Except in the case of a nominee substituted as a result of the death or other incapacity of a management nominee, the nominating committee shall deliver written nominations to the secretary at least twenty days prior to the date of the annual meeting. Provided such committee makes such nominations, no nominations for directors except those made by the nominating committee shall be voted upon at the annual meeting unless other nominations by stockholders are made in writing and delivered to the secretary of the Corporation in accordance with the provisions of the Corporation's Certificate of Incorporation. SECTION 15. New Business. Any new business to be taken up at the annual meeting shall be stated in writing and filed with the secretary of the Corporation in accordance with the provisions of the Corporation's Certificate of Incorporation. This provision shall not prevent the consideration and approval or disapproval at the annual meeting of reports of officers, directors and committees, but in connection with such reports no new business shall be acted upon at such annual meeting unless stated and filed as provided in the Corporation's Certificate of Incorporation. 4 5 ARTICLE III Board of Directors SECTION 1. General Powers. The business and affairs of the Corporation shall be under the direction of its board of directors. The chairman shall preside at all meetings of the board of directors. SECTION 2. Number, Term and Election. The board of directors shall consist of not less than five (5) nor more than fifteen (15) members and the number of directors constituting the whole board shall be established by resolution of the Board of Directors. The board shall be divided into three classes as nearly equal in number as possible. The members of each class shall be elected for a term of three years and until their successors are elected or qualified. The board of directors shall be classified in accordance with the provisions of the Corporation's Certificate of Incorporation. SECTION 3. Regular Meetings. A regular meeting of the board of directors shall be held at such time and place as shall be determined by resolution of the board of directors without other notice than such resolution. SECTION 4. Special Meetings. Special meetings of the board of directors may be called by or at the request of the chairman, the chief executive officer or one-third of the directors. The person calling the special meeting of the board of directors may fix any place as the place for holding any special meeting of the board of directors called by such person. SECTION 5. Telephonic Meetings. Members of the board of directors may participate in regular or special meetings by means of conference telephone or similar communications equipment by which all persons participating in the meeting can hear each other. Such participation shall constitute presence in person. SECTION 6. Notice. Written notice of any special meeting shall be given to each director at least two days previous thereto delivered personally or by telegram or at least seven days previous thereto delivered by mail at the address at which the director is most likely to be reached. Such notice shall be deemed to be delivered when deposited in the United States mail so addressed, with postage thereon prepaid if mailed or when delivered to the telegraph company if sent by telegram. Any director may waive notice of any meeting by a writing filed with the secretary. The attendance of a director at a meeting shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express purpose of objecting to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, not the purpose of, any meeting of the board of directors need be specified in the notice or waiver of notice of such meeting. SECTION 7. Quorum. A majority of the number of directors fixed by Section 2 shall constitute a quorum for the transaction of business at any meeting of the board of directors, 5 6 but if less than such majority is present at a meeting, a majority of the directors present may adjourn the meeting from time to time. Notice of any adjourned meeting shall be given in the same manner as prescribed by Section 6 of this Article III. SECTION 8. Manner of Acting. The act of the majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors, unless a greater number is prescribed by these Bylaws, the Certificate of Incorporation, or the General Corporation Law of the State of Delaware. SECTION 9. Action Without a Meeting. Any action required or permitted to be taken by the board of directors at a meeting may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the directors. SECTION 10. Resignation. Any director may resign at any time by sending a written notice of such resignation to the home office of the Corporation addressed to the chairman. Unless otherwise specified therein such resignation shall take effect upon receipt thereof by the chairman. SECTION 11. Vacancies. Any vacancy occurring in the board of directors and any directorship to be filled by reason of an increase in the number of directors may be filled by the affirmative vote of two-thirds of the directors then in office. The term of such director shall be in accordance with the provisions of the Corporation's Certificate of Incorporation. SECTION 12. Removal of Directors. Any director or the entire board of directors may be removed only in accordance with the provisions of the Corporation's Certificate of Incorporation. SECTION 13. Compensation. Directors, as such, may receive compensation for service on the board of directors. Members of either standing or special committees may be allowed such compensation as the board of directors may determine. ARTICLE IV Committees of the Board of Directors The board of directors may, by resolution passed by a majority of the whole board, designate one or more committees, as they may determine to be necessary or appropriate for the conduct of the business of the Corporation, and may prescribe the duties, constitution and procedures thereof. Each committee shall consist of one or more directors of the Corporation appointed by a majority of the whole board. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. 6 7 The board shall have power at any time to change the members of, to fill vacancies in, and to discharge any committee of the board. Any member of any such committee may resign at any time by giving notice to the Corporation; provided, however, that notice to the board, the chairman of the board, the chief executive officer, the chairman of such committee, or the secretary shall be deemed to constitute notice to the Corporation. Such resignation shall take effect upon the receipt of such notice or at any later time specified therein; and, unless otherwise specified therein, acceptance of such resignation shall not be necessary to make it effective. Any member of any such committee may be removed at any time, either with or without cause, by the affirmative vote of a majority of the authorized number of directors at any meeting of the board called for that purpose. ARTICLE V Officers SECTION 1. Position. The officers of the Corporation shall be a chairman, a president, one or more vice presidents, a secretary and a treasurer, each of whom shall be elected by the board of directors. The board of directors may designate one or more vice presidents as executive vice president or senior vice president. The board of directors may also elect or authorize the appointment of such other officers as the business of the Corporation may require. The officers shall have such authority and perform such duties as the board of directors may from time to time authorize or determine. In the absence of action by the board of directors, the officers shall have such powers and duties as generally pertain to their respective offices. SECTION 2. Election and Term of Office. The officers of the Corporation shall be elected annually by the board of directors at the first meeting of the board of directors held after each annual meeting of stockholders. If the election of officers is not held at such meeting, such election shall be held as soon thereafter as possible. Each officer shall hold office until his successor shall have been duly elected and qualified or until his death or until he shall resign or shall have been removed in the manner hereinafter provided. Election or appointment of an officer, employee or agent shall not of itself create contract rights. The board of directors may authorize the Corporation to enter into an employment contract with any officer in accordance with state laws, but no such contract shall impair the right of the board of directors to remove any officer at any time in accordance with Section 3 of this Article V. SECTION 3. Removal. Any officer may be removed by vote of two-thirds of the board of directors whenever, in its judgment, the best interests of the Corporation will be served thereby, but such removal, other than for cause, shall be without prejudice to the contract rights, if any, of the person so removed. 7 8 SECTION 4. Vacancies. A vacancy in any office because of death, resignation, removal, disqualification or otherwise, may be filled by the board of directors for the unexpired portion of the term. SECTION 5. Remuneration. The remuneration of the officers shall be fixed from time to time by the board of directors, and no officer shall be prevented from receiving such salary by reason of the fact that he is also a director of the Corporation. ARTICLE VI Contracts, Loans, Checks and Deposits SECTION 1. Contracts. To the extent permitted by applicable law, and except as otherwise prescribed by the Corporation's Certificate of Incorporation or these Bylaws with respect to certificates for shares, the board of directors or the executive committee may authorize any officer, employee or agent of the Corporation to enter into any contract or execute and deliver any instrument in the name of and on behalf of the Corporation. Such authority may be general or confined to specific instances. SECTION 2. Loans. No loans shall be contracted on behalf of the Corporation and no evidence of indebtedness shall be issued in its name unless authorized by the board of directors. Such authority may be general or confined to specific instances. SECTION 3. Checks, Drafts, Etc. All checks, drafts, or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation shall be signed by one or more officers, employees or agents of the Corporation in such manner, including in facsimile form, as shall from time to time be determined by resolution of the board of directors. SECTION 4. Deposits. All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in any of its duly authorized depositories as the board of directors may select. ARTICLE VII Certificates for Shares and Their Transfer SECTION 1. Certificates for Shares. The shares of the Corporation shall be represented by certificates signed by the chairman of the board of directors or the president or a vice president and by the treasurer or an assistant treasurer or the secretary or an assistant secretary of the Corporation, and may be sealed with the seal of the Corporation or a facsimile thereof. Any or all of the signatures upon a certificate may be facsimiles if the certificate is countersigned by a transfer agent, or registered by a registrar, other than the Corporation itself or an employee of the Corporation. If any officer who has signed or whose facsimile signature 8 9 has been placed upon such certificate shall have ceased to be such officer before the certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer at the date of its issue. SECTION 2. Form of Share Certificates. All certificates representing shares issued by the Corporation shall set forth upon the face or back that the Corporation will furnish to any stockholder upon request and without charge a full statement of the designations, preferences, limitations, and relative rights of the shares of each class authorized to be issued, the variations in the relative rights and preferences between the shares of each such series so far as the same have been fixed and determined, and the authority of the board of directors to fix and determine that relative rights and preferences of subsequent series. Each certificate representing shares shall state upon the face thereof: That the Corporation is organized under the laws of the State of Delaware; the name of the person to whom issued; the number and class of shares, the designation of the series, if any, which such certificate represents; the par value of each share represented by such certificate, or a statement that the shares are without par value. Other matters in regard to the form of the certificates shall be determined by the board of directors. SECTION 3. Payment for Shares. No certificate shall be issued for any share until such share is fully paid. SECTION 4. Form of Payment for Shares. The consideration for the issuance of shares shall be paid in accordance with the provisions of the Corporation's Certificate of Incorporation. SECTION 5. Transfer of Shares. Transfer of shares of capital stock of the Corporation shall be made only on its stock transfer books. Authority for such transfer shall be given only the holder of record thereof or by his legal representative, who shall furnish proper evidence of such authority, or by his attorney thereunto authorized by power of attorney duly executed and filed with the Corporation. Such transfer shall be made only on surrender for cancellation of the certificate for such shares. The person in whose name shares of capital stock stand on the books of the Corporation shall be deemed by the Corporation to be the owner thereof for all purposes. SECTION 6. Lost Certificates. The board of directors may direct a new certificate to be issued in place of any certificate theretofore issued by the Corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of a new certificate, the board of directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate, or his legal representative, to give the Corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen or destroyed. 9 10 ARTICLE VIII Fiscal Year, Annual Audit The fiscal year of the Corporation shall end on the last day of December of each year. The Corporation shall be subject to an annual audit as of the end of its fiscal year by independent public accountants appointed by and responsible to the board of directors. ARTICLE IX Dividends Dividends upon the stock of the Corporation, subject to the provisions of the Certificate of Incorporation, if any, may be declared by the board of directors at any regular or special meeting, pursuant to law. Dividends may be paid in cash, in property or in the Corporation's own stock. ARTICLE X Corporate seal The corporate seal of the Corporation shall be in such form as the board of directors shall prescribe. ARTICLE XI Amendments These Bylaws may be be repealed, altered, amended or rescinded by the stockholders of the Corporation by vote of not less than 66.67% of the outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors (considered for this purpose as one class) cast at a meeting of the stockholders called for that purpose (provided that notice of such proposed repeal, alteration, amendment or rescission is included in the notice of such meeting). In addition, in accordance with the Corporation's Certificate of Incorporation the board of directors may repeal, alter, amend or rescind these Bylaws by vote of two-thirds of the board of directors at a legal meeting held in accordance with the provisions of these Bylaws. 10 EX-4 5 SPECIMEN CERTIFICATE FOR COMMON STOCK OF THE CO. 1 EXHIBIT 4 ================================================================================ COMMON STOCK CREDIT MANAGEMENT SOLUTIONS, INC. CUSIP CERTIFICATE NO. INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE SEE REVERSE FOR CERTAIN DEFINITIONS THIS CERTIFIES THAT: IS THE OWNER OF: FULLY PAID AND NONASSESSABLE SHARES OF COMMON STOCK, $0.01 PAR VALUE PER SHARE OF Credit Management Solutions, Inc. The shares represented by this certificate are transferable only on the stock transfer books of the corporation by the holder of record hereof in person, or by his duly authorized attorney or legal representative, upon the surrender of this certificate properly endorsed. This certificate and the shares represented hereby are issued and shall be held subject to all the provisions contained in the corporation's official corporate papers filed with the Secretary of the State of Delaware (copies of which are on file with the Transfer Agent), to all of the provisions the holder by acceptance hereof, assents. This certificate is not valid unless countersigned and registered by the Transfer Agent and Registrar. In Witness Whereof, Credit Management Solutions, Inc. has caused this certificate to be executed by the facsimile signatures of its duly authorized officers and has caused a facsimile of its corporate seal to be hereunto affixed. DATED: - ------------------------------- ----------------------------- PRESIDENT SECRETARY SEAL Incorporated 1996 ================================================================================ 2 CREDIT MANAGEMENT SOLUTIONS, INC. The Board of Directors of the corporation is authorized by resolution(s), from time to time adopted, to provide for the issuance of serial preferred stock in series and to fix and state the voting powers, designations, preferences, and relative, participating, optional, or other special rights of the shares of each such series and the qualifications, limitations, and restrictions thereof. The corporation will furnish to any shareholder upon request and without charge a full description of each class of stock and any series thereof. The shares represented by this certificate may not be cumulatively voted in the election of directors of the corporation. The affirmative vote of not less than 80% of the corporation's voting stock is required to amend the provisions of the Certificate of Incorporation. The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations: TEN COM - as tenants in common UNIF GIFT MIN ACT - Custodian --------------- --------------- (Cus) (Minor) under Uniform Gifts to Minors Act ----------------------- (State) TEN ENT - as tenants by the entireties JT TEN - as joint tenants with right of survivorship and not as tenants in common Additional abbreviations may also be used though not in the above list. FOR VALUE RECEIVED ________________________ hereby sell, assign and transfer unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS INCLUDING ZIP CODE OF ASSIGNEE) - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- shares of the common stock represented by the within certificate and do hereby irrevocably constitute and appoint - ------------------------------------------------------------------------------- Attorney to transfer the said shares on the books of the within named corporation with full power of substitution in the premises. Dated X --------------------- ----------------------------------------- X ----------------------------------------- NOTICE: The signatures to this assignment must correspond with the name(s) as written upon the face of the certificate in every particular, without alteration or enlargement or any change whatever. SIGNATURE(S) GUARANTEED: --------------------------------------------- THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS, AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM) PURSUANT TO S.E.C. RULE 17Ad-15. 3 Countersigned and Registered: Transfer Agent and Registrar - ------------------------------ Authorized Signature EX-5 6 OPINION OF MANATT, PHELPS & PHILLIPS 1 EXHIBIT 5 MANATT PHELPS PHILLIPS A T T O R N E Y S A T L A W A Professional Corporation December 4, 1996 Board of Directors Credit Management Solutions, Inc. 5950 Symphony Woods Road Suite 301 Columbia, Maryland 21044 Re: Registration Statement Under the Securities Act of 1933 Ladies and Gentlemen: We have acted as counsel for Credit Management Solutions, Inc., a Delaware corporation (the "Company"), in connection with the proposed offer and sale by the Company of up to 2,990,000 shares of the Company's common stock, $0.01 par value per share (the "Common Stock"), by means of a Registration Statement on Form S-1 (Registration No. 333-14007). We have examined such documents, records, and matters of law as we have deemed necessary for purposes of this opinion. We have also obtained from officers of the Company such advice as we considered necessary for the purposes of this opinion and insofar as our opinion is based on matters of fact upon which conclusions of law are expressed, we have relied upon such advice. Based on the foregoing, we are of the opinion that the shares of Common Stock of the Company covered by the aforesaid Registration Statement will, when issued in accordance with the terms of the offering against full payment therefor, be validly issued, fully paid, and non-assessable shares of Common Stock of the Company. This opinion is given as of the date hereof and we assume no obligation to advise you of changes that may hereafter be brought to our attention. We hereby consent to the filing of this opinion as an exhibit to the aforementioned Registration Statement on Form S-1 which is being filed by the Company in connection with the registration of the Common Stock under the Securities Act of 1933, as amended. We also consent to the reference to this firm and this opinion under the heading "Legal Matters" and in the prospectus comprising a part of such Registration Statement and any amendment thereto. Very Truly Yours, /s/ MANATT, PHELPS, & PHILLIPS, LLP ----------------------------------- Manatt, Phelps, & Phillips, LLP M A N A T T , P H E L P S & P H I L L I P S , L L P 1501 M Street N.W., Suite 700 Washington, D.C. 20005-1702 - 202-463-4300 - FAX 202-463-4394 L o s A n g e l e s - W a s h i n g t o n , D . C . - N a s h v i l l e EX-10.12 7 1996 CMSI EMPLOYEE STOCK PURCHASE PLAN 1 EXHIBIT 10.12 1996 CREDIT MANAGEMENT SOLUTIONS, INC. EMPLOYEE STOCK PURCHASE PLAN I. PURPOSE OF THE PLAN This Employee Stock Purchase Plan is intended to promote the interests of Credit Management Solutions, Inc. (the "Corporation") by providing eligible employees with the opportunity to acquire a proprietary interest in the Corporation through participation in a payroll-deduction based employee stock purchase plan designed to qualify under Section 423 of the Code. Capitalized terms herein shall have the meanings assigned to such terms in the attached Appendix. II. ADMINISTRATION OF THE PLAN The Plan Administrator shall have full authority to interpret and construe any provision of the Plan and to adopt such rules and regulations for administering the Plan as it may deem necessary in order to comply with the requirements of Code Section 423. Decisions of the Plan Administrator shall be final and binding on all parties having an interest in the Plan. III. STOCK SUBJECT TO PLAN A. Number of Shares Subject to Purchase. The stock purchaseable under the Plan shall be shares of the Corporation's authorized but unissued or reacquired Common Stock, including shares of Common Stock purchased on the open market. The maximum number of shares of Common Stock which may be issued over the term of the Plan shall not exceed 250,000 shares. B. Adjustments Upon Changes in Capitalization. Should any change be made to the Common Stock by reason of any stock split, stock dividend, recapitalization, combination of shares, exchange of shares or other change affecting the outstanding Common Stock as a class without the Corporation's receipt of consideration, appropriate adjustments shall be made to (i) the maximum number and class of securities issuable under the Plan, and (ii) the number and class of securities and the price per share in effect under each outstanding purchase right in order to prevent the dilution or enlargement of benefits thereunder. IV. PURCHASE PERIODS A. General. Shares of Common Stock shall be offered for purchase under the Plan through a series of successive purchase periods until such time as (i) the maximum number of shares of Common Stock available for issuance under the Plan shall have been purchased or (ii) the Plan shall have been sooner terminated. 2 B. Quarterly Purchase Periods. Each purchase period shall have a duration of three (3) months. Purchase periods shall run from the first day of each calendar quarter to the last day of that calendar quarter. The first purchase period shall begin on January 1, 1997, and end on the last business day in March 31, 1997. V. ELIGIBILITY A. As of the Effective Date. Each individual who is an Eligible Employee as of the Effective Date shall be eligible to participate in the Plan for the initial purchase period. B. Following Effective Date. Each individual who becomes an Eligible Employee after the Effective Date shall be eligible to participate in the Plan as of the purchase period beginning on the January 1 or July 1 immediately following the individual's completion of ninety (90) days of Service. C. Enrollment Procedure. To participate in the Plan for a particular purchase period, an Eligible Employee must complete the enrollment forms prescribed by the Plan Administrator (including a stock subscription agreement and a payroll deduction authorization form) and file such forms with the Plan Administrator (or its designate) on or before the start date of the purchase period. VI. PAYROLL DEDUCTIONS A. Maximum Deductions/Change in Rate of Deductions. The payroll deduction authorized by the Participant for purposes of acquiring shares of Common Stock under the Plan may be any multiple of one percent (1%) of the Eligible Earnings paid to the Participant during each purchase period, up to a maximum of fifteen percent (15%). Payroll deductions will be made in whole percentages only. The deduction rate so authorized shall continue in effect for the entire purchase period and each successive purchase period unless and until terminated or changed by the Participant. The Participant may not increase his or her rate of payroll deduction during a purchase period. However, the Participant may, at any time during the purchase period, reduce his or her rate of payroll deduction to become effective as soon as possible after filing the appropriate form with the Plan Administrator. The Participant may not, however, effect more than one (1) such reduction per purchase period. B. Holding of Deductions. Payroll deductions shall begin on the first pay day following the start date of the purchase period and shall (unless sooner terminated by the Participant) continue through the pay day ending with or immediately prior to the last day of the purchase period. The amounts so collected shall be credited to the Participant's book account under the Plan, but no interest shall be paid on the balance from time to time outstanding in such account. The amounts collected from the Participant shall not be held in any segregated account or trust fund and may be commingled with the general assets of the Corporation and used for general corporate purposes. A Participant may not make any additional payments into his account. 2 3 C. Cessation of Payroll Deductions. Payroll deductions shall automatically cease upon the termination of the Participant's purchase right in accordance with the provisions of the Plan. D. Effect on Future Participation. The Participant's acquisition of Common Stock under the Plan on any Purchase Date shall neither limit nor require the Participant's acquisition of Common Stock on any subsequent Purchase Date. VII. PURCHASE RIGHTS A. Grant of Purchase Right. A Participant shall be granted a separate purchase right on the start date of each purchase period in which he or she participates. The purchase right shall provide the Participant with the right to purchase shares of Common Stock on the Purchase Date upon the terms set forth below. The Participant shall execute a stock subscription agreement embodying such terms and such other provisions (not inconsistent with the Plan) as the Plan Administrator may deem advisable. Under no circumstances shall purchase rights be granted under the Plan to any Eligible Employee if such individual would, immediately after the grant, own (taking into account stock owned by any person whose stock would be attributed to such Eligible Employee within the meaning of Code Section 424(d)) or hold outstanding options or other rights to purchase, stock possessing five percent (5%) or more of the total combined voting power or value of all classes of stock of the Corporation or any Corporate Affiliate. B. Exercise of the Purchase Right. Each purchase right shall be automatically exercised on the Purchase Date, and shares of Common Stock shall accordingly be purchased on behalf of each Participant (other than any Participant whose payroll deductions have previously been refunded in accordance with the Termination of Purchase Right provisions below) on such date. The purchase shall be effected by applying the Participant's payroll deductions for the purchase period ending on such Purchase Date to the purchase of shares of Common Stock at the purchase price in effect for that purchase period, and the shares will be held by the Corporation for the benefit of the Participant, unless delivery of the shares is requested by the Participant. No fractional shares will be purchased. C. Purchase Price. The purchase price per share at which Common Stock will be purchased on the Participant's behalf on each Purchase Date shall be equal to eighty-five percent (85%) of the lower of (i) the Fair Market Value per share of Common Stock on the start date of the purchase period or (ii) the Fair Market Value per share of Common Stock on that Purchase Date. D. Delivery. Upon receipt of a request from a Participant after each Purchase Date on which a purchase of shares occurs, the Corporation shall arrange for the delivery to each Participant, as appropriate, of a certificate representing the shares purchased on behalf of the 3 4 Participant for such purchase period. Shares to be delivered to a Participant under the Plan shall be registered in the name of the Participant or in the name of the Participant and the Participant's spouse. E. Number of Purchasable Shares. The number of shares of Common Stock purchasable by a Participant on each Purchase Date shall be the number of shares obtained by dividing the amount collected from the Participant through payroll deductions during the purchase period ending with that Purchase Date by the purchase price in effect for that Purchase Date. F. Excess Payroll Deductions. Any payroll deductions accumulated in a Participant's account which are not sufficient to purchase a full share shall be carried over to the next purchase period, if the Participant elects to participate in the next purchase period, or returned to the Participant if he terminates participation. Any amount remaining in the Participant's account at the close of any Purchase Date caused by any reason other than a surplus due to fractional shares shall be refunded to the Participant in cash. G. Exercise of Purchase Right During Participant's Life. During an Participant's lifetime, the Participant's right to purchase shares under the Plan is exercisable only by the Participant. H. Termination of Purchase Right. The following provisions shall govern the termination of outstanding purchase rights: 1. A Participant may, at any time prior to the last day of the purchase period, terminate his or her outstanding purchase right by filing the appropriate form with the Plan Administrator (or its designate), and no further payroll deductions shall be collected from the Participant with respect to the terminated purchase right. Any payroll deductions collected during the purchase period in which such termination occurs shall be refunded as soon as practicable. 2. The termination of a purchase right shall be irrevocable, and a Participant may not subsequently rejoin the purchase period for which the terminated purchase right was granted. In order to resume participation in any subsequent purchase period, such individual must re-enroll in the Plan (by making a timely filing of the prescribed enrollment forms) on or before the start date of the new purchase period. 3. Should a Participant cease to remain an Eligible Employee for any reason (other than death or disability) while his or her purchase right remains outstanding, then that purchase right shall immediately terminate, and all of the Participant's payroll deductions for the purchase period in which the purchase right so terminates shall be refunded to the Participant as soon as practicable. Should the Participant cease to remain an Eligible Employee by reason of death or disability while his or her purchase right remains outstanding, then that purchase right shall 4 5 immediately terminate and the Participant (or, in the event of the Participant's death, the personal representative of the Participant's estate) shall have the right to (a) withdraw the payroll deductions collected during such purchase period or (b) have such funds held for the purchase of shares at the next scheduled Purchase Date. If no such election is made prior to the next Purchase Date, then the payroll deductions collected with respect to the terminated right shall be refunded to the Participant or to the personal representative of the Participant's estate in the event of the Participant's death as soon as practicable. 4. Should the Participant cease to remain in active service by reason of an approved unpaid leave of absence, then the Participant shall have the right, exercisable up until the last business day of the purchase period in which such leave commences, to (a) withdraw the payroll deductions collected during such purchase period or (b) have such funds held for the purchase of shares at the next scheduled Purchase Date. In no event, however, shall any additional payroll deductions be collected on the Participant's behalf during such leave. Upon the Participant's return to active service, his or her payroll deductions under the Plan shall automatically resume at the rate in effect at the time the leave began. I. Corporate Transaction. Each outstanding purchase right shall automatically be exercised, immediately prior to the effective date of any Corporate Transaction, by applying the payroll deductions of each Participant for the purchase period in which such Corporate Transaction occurs to the purchase of shares of Common Stock at a purchase price per share equal to eighty-five percent (85%) of the lower of (i) the Fair Market Value per share of Common Stock on the start date of the purchase period in which such Corporate Transaction occurs or (ii) the Fair Market Value per share of Common Stock immediately prior to the effective date of such Corporate Transaction. The Corporation shall use its best efforts to provide at least ten (10) days' prior written notice of the occurrence of any Corporate Transaction, and Participants shall, following the receipt of such notice, have the right to terminate their outstanding purchase rights prior to the effective date of the Corporate Transaction. J. Proration of Purchase Rights. Should the total number of shares of Common Stock which are to be purchased pursuant to outstanding purchase rights on any particular date exceed the number of shares then available for issuance under the Plan, the Plan Administrator shall make a pro-rata allocation of the available shares on a uniform and nondiscriminatory basis, and the payroll deductions of each Participant, to the extent in excess of the aggregate purchase price payable for the Common Stock pro-rated to such individual, shall be refunded. K. Assignability. The purchase right shall be exercisable only by the Participant and shall not be assignable or transferable by the Participant. 5 6 I. Stockholder Rights. A Participant shall have no stockholder rights with respect to the shares subject to his or her outstanding purchase right until the shares are purchased on the Participant's behalf in accordance with the provisions of the Plan and the Participant has become a holder of record of the purchased shares. VIII. ACCRUAL LIMITATIONS A. General Rule-$25,000 Limitation. No Participant shall be entitled to accrue rights to acquire Common Stock pursuant to any purchase right outstanding under this Plan if and to the extent such accrual, when aggregated with (i) rights to purchase Common Stock accrued under any other purchase right granted under this Plan and (ii) similar rights accrued under other employee stock purchase plans (within the meaning of Code Section 423) of the Corporation or any Corporate Affiliate, would otherwise permit such Participant to purchase more than Twenty-Five Thousand Dollars ($25,000) worth of stock of the Corporation or any Corporate Affiliate (determined on the basis of the Fair Market Value of such stock on the date or dates such rights are granted) for each calendar year such rights are at any time outstanding. B. Specific Application. For purposes of applying such accrual limitations, the following provisions shall be in effect: (i) The right to acquire Common Stock under each outstanding purchase right shall accrue on the Purchase Date in effect for the purchase period for which such right is granted. (ii) No right to acquire Common Stock under any outstanding purchase right shall accrue to the extent a Participant has already accrued in the same calendar year the right to acquire Common Stock under one (1) or more other purchase rights at a rate equal to Twenty-Five Thousand Dollars ($25,000) worth of Common Stock (determined on the basis of the Fair Market Value per share on the date or dates of grant) for each calendar year such rights were at any time outstanding. C. Refund to Participant. If by reason of such accrual limitations, any purchase right of a Participant does not accrue for a particular purchase period, then the payroll deductions which the Participant made during that purchase period with respect to such purchase right shall be refunded to the Participant as soon as practicable. D. Effect of Conflicting Terms in Plan. In the event there is any conflict between the provisions of this Article and one or more provisions of the Plan or any instrument issued thereunder, the provisions of this Article shall be controlling. IX. ADMINISTRATION 6 7 A. Administrative Body. The Plan shall be administered by the Plan Administrator, which shall have full and exclusive discretionary authority to construe, interpret and apply the terms of the Plan, to determine eligibility and to adjudicate all disputed claims filed under the Plan. Every finding, shall, to the full extent permitted by law, be final and binding upon all parties. X. DESIGNATION OF BENEFICIARY A. General Rule. Each Participant will file a written designation of a beneficiary who is to receive any shares and cash, if any, from the Participant's account under the Plan in the event of such Participant's death subsequent to a Purchase Date on which the purchase right is exercised but prior to delivery to such Participant of such shares and cash. In addition, a Participant may file a written designation of a beneficiary who is to receive any cash from the Participant's account under the Plan in the event of such Participant's death prior to exercise of the option. If a Participant is married and the designated beneficiary is not the spouse, written spousal consent shall be required for such designation to be effective. B. Change of Beneficiary. A Participant may change his or her designation of beneficiary at anytime by written notice, subject to the written consent of the Participant's spouse if the new beneficiary is someone other than the Participant's spouse. In the event of the death of a Participant and in the absence of a beneficiary validly designated under the Plan who is living at the time of such Participant's death the Corporation shall deliver such shares and/or cash to the executor or administrator of the estate of the Participant, or if no such executor or administrator has been appointed (to the knowledge of the Corporation), the Corporation, in its discretion, may deliver such shares and/or cash to the spouse or to any one or more dependents or relatives of the Participant, or if no spouse, dependent or relative is known to the Corporation, then to such other person as the Corporation may designate. XI. AMENDMENT OR TERMINATION A. Termination. The Board of Directors may at any time and for any reason terminate or amend the Plan. No such termination can affect purchase rights previously granted, provided that a purchase period may be terminated by the Board on any Purchase Date if the Board determines that the termination of the Plan is in the best interests of the Corporation and its shareholders. Except as provided in Section III.B, no amendment may make any change in any purchase right theretofore granted which adversely affects the rights of any Participant. To the extent necessary to comply with Rule 16b-3 promulgated under the Securities Exchange Act of 1934, as amended ("Rule 16b-3") or Section 423 of the Code (or any successor rule or provision or any other applicable law or regulation), the Corporation shall obtain shareholder approval in such a manner and to such a degree as required. B. Amendment. Without shareholder consent and without regard to whether any Participant rights may be considered to have been adversely affected, the Board of Directors shall be entitled to change the purchase periods, limit the frequency and/or number of changes in the 7 8 amount withheld during purchase periods, establish the exchange ratio applicable to amounts withheld in a currency other than U.S. dollars, permit payroll withholding in excess of the amount designated by a Participant in order to adjust for delays or mistakes in the Corporation's processing of properly completed withholding elections, establish reasonable waiting and adjustment periods and/or accounting and crediting procedures to ensure that amounts applied toward the purchase of Common Stock for each Participant properly correspond with amounts withheld from the Participant's Eligible Earnings, and establish such other limitations or procedures as the Board (or its committee) determines in its sole discretion advisable which are consistent with the Plan. XII. GENERAL PROVISIONS A. Transferability. Neither payroll deductions credited to a Participant's account nor any rights with regard to the exercise of a purchase right or to receive shares under the Plan may be assigned, transferred, pledged or otherwise disposed of in any way (other than by will, the laws of descent and distribution or as provided in Section X hereof) by the Participant. Any such attempt at assignment, transfer, pledge or other disposition shall be without effect, except that the Corporation may treat such act as an election to terminate participation in accordance with Section VII.H. B. Annual Statement. Individual accounts will be maintained for each Participant in the Plan. Statements of account will be given to each Participant at least annually, which statements will set forth the Purchase Price, the number of shares purchased and the remaining cash balance, if any. C. Conditions Upon Issuance of Shares. Shares shall not be issued with respect to a purchase right unless the exercise of such right and the issuance and delivery of such shares pursuant thereto shall comply with all applicable provisions of law, domestic or foreign, including, without limitation, the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, the rules and regulations promulgated thereunder, and the requirements of any stock exchange upon which the shares may then be listed, and shall be further subject to the approval of counsel for the Corporation with respect to such compliance. As a condition to the exercise of purchase rights, the Corporation may require the person exercising such option to represent and warrant at the time of any such exercise that the shares are being purchased only for investment and without any present intention to sell or distribute such shares if, in the opinion of counsel for the Corporation, such a representation is required by any of the aforementioned applicable provisions of law. D. Term of Plan. The Plan shall become effective upon the earlier to occur of its adoption by the Board of Directors or its approval by the shareholders of the Corporation. It shall continue in effect for a term of ten (10) years unless sooner terminated under Section XI.A. 8 9 E. Additional Restrictions Of Rule 16b-3. The terms and conditions of purchase rights granted hereunder to, and the purchase of shares by, persons subject to Section 16 of the Exchange Act shall comply with the applicable provisions of Rule 16b-3. This Plan shall be deemed to contain, and such purchase rights shall contain, and the shares issued upon exercise thereof shall be subject to, such additional conditions and restrictions as may be required by Rule 16b-3 to qualify for the maximum exemption from Section 16 of the Exchange Act with respect to Plan transactions. F. Shareholder Approval. Continuance of the Plan shall be subject to approval by the shareholders of the Corporation within twelve (12) months before or after the date the Plan is adopted. If such shareholder approval is obtained at a duly held shareholders' meeting, the Plan must be approved by a majority of the votes cast at such shareholders' meeting at which is a quorum representing a majority of all outstanding voting stock of the Corporation is, either in person or by proxy, present and voting on the plan, or, if such shareholder approval is obtained by written consent, it must be obtained by the written consent of the holders of a majority of all outstanding voting stock of the Corporation; provided, however, that approval at a meeting or by written consent may be obtained by a lesser degree of shareholder approval if the Board determines, in its discretion after consultation with the Corporation's legal counsel, that such a lesser degree of shareholder approval will comply with all applicable laws and will not adversely affect the qualification of the Plan under Section 423 of the Code. G. No Employment Rights. The Plan does not, directly or indirectly, create any right for the benefit of any employee or class of employees to purchase any shares under the Plan, or create in any employee or class of employees any right with respect to continuation of employment by the Corporation, and it shall not be deemed to interfere in any way with the Corporation's right to terminate, or otherwise modify, an employee's employment at any time. H. Effect of Plan. The provisions of the Plan shall, in accordance with its terms, be binding upon, and inure to the benefit of, all successors of each employee participating in the Plan, including, without limitation, such employee's estate and the executors, administrators or trustees thereof, heirs and legatees, and any receiver, trustee in bankruptcy or representative of creditors of such employee. I. Notices. All notices or other communications by a Participant to the Corporation under or in connection with the Plan shall be deemed to have been duly given when received in the form specified by the Corporation at the location, or by the person, designated by the Corporation for the receipt thereof. J. Expenses. All costs and expenses incurred in the administration of the Plan shall be paid by the Corporation. K. Governing Law. The laws of the State of Delaware will govern all matters relating to this Plan. 9 10 APPENDIX The following definitions shall be in effect under the Plan: A. Board shall mean the Corporation's Board of Directors. B. Code shall mean the Internal Revenue Code of 1986, as amended. C. Common Stock shall mean the Corporation's common stock. D. Corporate Affiliate shall mean any parent or subsidiary corporation of the Corporation (as determined in accordance with Code Section 424, whether now existing or subsequently established. E. Corporate Transaction shall mean either of the following stockholder approved transactions to which the Corporation is a party: (i) a merger or consolidation in which securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation's outstanding securities are transferred to a person or persons different from the persons holding those securities immediately prior to such transaction, or (ii) the sale, transfer or other disposition of all or substantially all of the assets of the Corporation in complete liquidation or dissolution of the Corporation. F. Corporation shall mean Credit Management Solutions, Inc., a Delaware corporation, and any corporate successor to all or substantially all of the assets or voting stock of Credit Management Solutions, Inc. which shall by appropriate action adopt the Plan. G. Effective Date shall mean the earlier to occur of the Plan's adoption by the Corporation's Board of Directors or the Plan's approval by the shareholders. Any Corporate Affiliate which becomes a Participating Corporation after such Effective Date shall designate a subsequent Effective Date with respect to its employee-Participants. H. Eligible Earnings shall mean the (i) regular base salary paid to a Participant by one or more Participating Corporations during such individual's period of participation in the Plan, plus (ii) any pre-tax contributions made by the Participant to any Code Section 401(k) salary deferral plan or any code Section 125 cafeteria benefit program now or hereafter established by the Corporation or any Corporate Affiliate, plus (iii) all of the following amounts to the extent paid in cash overtime payments, bonuses, commissions, profit-sharing distributions and other incentive-type payments. However, Eligible Earnings shall not include any contributions (other than Code Section 401(k) or Code Section 125 contributions) made on the Participant's behalf by the Corporation or A-1 11 any Corporate Affiliate to any deferred compensation plan or welfare benefit program now or hereafter established. L. Eligible Employee shall mean any person, including members of the Board of Directors, who is employed by the Corporation's Participating Corporation on a basis under which he or she is regularly expected to render more than twenty (20) hours of service per week for more than five (5) months per calendar year for earnings considered wages under Code Section 3401(a). J. Fair Market Value per share of Common stock on any relevant date shall be determined in accordance with the following provisions: (i) If the Common stock is at the time traded on the Nasdaq National Market, then the Fair Market Value shall be the closing selling price per share of Common Stock on the date in question, as such price is reported by the National Association of Securities Dealers on the Nasdaq National Market or any successor system. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists. (ii) If the Common Stock is at the time listed on any Stock Exchange, the Fair Market Value shall be the closing selling price per share of Common Stock on the date in question on the Stock Exchange determined by the Plan Administrator to be the primary market for the Common Stock, as such price is officially quoted in the composite tape of transactions on such exchange. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists. (iii) For purposes of the initial purchase period which begins at the Effective Date, the Fair Market Value shall be deemed to be equal to the price per share at which the Common Stock is sold in the initial public offering pursuant to the Underwriting Agreement. K. 1933 Act shall mean the Securities Act of 1933, as amended. L. Participant shall mean any Eligible Employee of a Participating Corporation who is actively participating in the Plan. M. Participating Corporation shall mean the Corporation and such Corporate Affiliate or Affiliates as may be authorized form time to time by the Board to extend the benefits of the Plan to their Eligible Employees. The Participating Corporations in the Plan as of the Effective Date are listed in attached Schedule A. A-2 12 N. Plan shall mean the Corporation's Employee Stock Purchase Plan, as set forth in this document. O. Plan Administrator shall mean the committee of two (2) or more members of the Board of Directors appointed by the Board to administer the Plan. P. Purchase Date shall mean the last business day of each purchase period. Q. Reserves shall mean the number of shares of Common Stock covered by each purchase right under the Plan which have not yet been exercised and the number of shares of Common Stock which have been authorized for issuance under the Plan but not yet placed under purchase. R. Service shall mean an individual's performance of services for the Corporation or any Corporate Affiliate as an employee, subject to the control and direction of the employer entity as to both the work to be performed and the manner and method of performance. S. Stock Exchange shall mean either the American Stock Exchange or the New York Stock Exchange. A-3 13 SCHEDULE A CORPORATIONS PARTICIPATING IN EMPLOYEE STOCK PURCHASE PLAN AS OF THE EFFECTIVE DATE ------------------------ Credit Management Solutions, Inc. Credit Connection, Inc. EX-10.13 8 1996 CMSI LONG-TERM INCENTIVE PLAN 1 EXHIBIT 10.13 1996 CREDIT MANAGEMENT SOLUTIONS, INC. LONG-TERM INCENTIVE PLAN Credit Management Solutions, Inc., a Delaware corporation (the "Company"), by action of both its Compensation Committee and its Board as a whole, hereby adopts the 1996 Long-Term Incentive Plan (the "Plan") with the following provisions: 1. PURPOSE. The purpose of the Plan is to promote and advance the interests of the Company and its shareholders by enabling the Company and its Subsidiaries to attract, retain and reward managerial and other key employees, and to strengthen the mutuality of interests between such employees and the Company's shareholders. The Plan is designed to meet this intent by offering performance-based stock and cash incentives and other equity-based incentive awards, thereby providing a proprietary interest in pursuing the long-term growth, profitability and financial success of the Company. 2. DEFINITIONS. For purposes of this Plan, the following terms shall have the meanings set forth below: (a) "Award" or "Awards" means an award or grant made to a Participant under Sections 6 through 10, inclusive, of the Plan. (b) "Board" means the Board of Directors of the Company. (c) "Code" means the Internal Revenue Code of 1986, as in effect from time to time or any successor thereto, together with rules, regulations and authoritative interpretations promulgated thereunder. (d) "Committee" means the Compensation Committee of the Board that is provided for in Section 3 of the Plan. (e) "Common Stock" means the Common Stock of the Company or any security of the Company issued in substitution, exchange or lieu thereof. (f) "Company " means Credit Management Solutions, Inc., a Delaware corporation, or a Subsidiary or successor corporation, within the meaning of Code Section 424(e). (g) "Date of Grant" means the date the Committee (or the Board, as the case may be) takes formal action designating that a Participant shall receive an Award, notwithstanding the date the Participant accepts the Award, the date the Company and the Participant enter into a written agreement with respect to the Award, or any other date. 2 (h) "Disability" means permanent and total disability as determined by the Committee in accordance with the standards under Section 22(e)(3) of the Code. (i) "Effective Date" means the date the Plan is approved by the holders of a majority of the shares of Common Stock represented and voting and entitled to vote at a meeting of the shareholders of the Company or by written consent of a majority of the outstanding shares of Common Stock, provided such approval of the shareholders of the Company occurs within twelve (12) months before or after the Committee and the Board both adopt the Plan. Awards may be granted prior to the Effective Date, but payment under such Awards is contingent upon shareholder approval as provided above in this definition. In the event the Company does not obtain shareholder approval of the Plan, any Awards granted pursuant to the Plan shall be rescinded automatically. (j) "34 Act" means the Securities Exchange Act of 1934, as amended and in effect from time to time, or any successor statute. (k) "Fair Market Value" means on any given date, the closing price for the Common Stock on such date, or, if the Common Stock was not traded on such date, on the next preceding day on which the Common Stock was traded, determined in accordance with the following rules. (i) If the Common Stock is admitted to trading or listing on a national securities exchange registered under the '34 Act, the closing price for any day shall be the last reported sale price regular way, or in the case no such reported sale takes place on such date, the average of the last reported bid and ask prices regular way, in either case on the principal national securities exchange on which the Common Stock is admitted to trading or listed, or (ii) If not listed or admitted to trading on any national securities exchange, the last sale price of the Common Stock on the National Association of Securities Dealers Automated Quotation National Market System ("NMS") or, in case no such reported sale takes place, the average of the closing bid and ask prices on such date, or (iii) If not quoted on the NMS, the average of the closing bid and ask prices of the Common Stock on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") or any comparable system, or (iv) If the Common Stock is not listed on NASDAQ or any comparable system, the closing bid and ask prices as furnished by any member of the National Association of Securities Dealers, Inc., selected from time to time by the Company for that purpose. 2 3 (l) "Incentive Stock Option" means any Stock Option granted pursuant to the provisions of Section 6 of the Plan that is intended to be and is specifically designated as an "incentive stock option" within the meaning of Section 422 of the Code. (m) "Participant" means a salaried senior executive of the Company or a Subsidiary who is granted an Award under the Plan. (n) "Performance Award" means an Award granted pursuant to the provisions of Section 9 of the Plan, the vesting of which is contingent on the attainment of specified performance criteria. (o) "Performance Share Grant" means an Award of units representing shares of Common Stock granted pursuant to the provisions of Section 9 of the Plan. (p) "Performance Unit Grant" means an Award of monetary units granted pursuant to the provisions of Section 9 of the Plan. (q) "Plan" means this 1996 Credit Management Solutions, Inc. Long-Term Incentive Plan, as set forth herein and as it may be hereafter amended and from time to time in effect. (r) "Restricted Award" means an Award granted pursuant to the provisions of Section 8 of the Plan. (s) "Restricted Stock Grant" means an Award of shares of Common Stock granted pursuant to the provisions of Section 8 of the Plan. (t) "Restricted Unit Grant" means an Award of units representing shares of Common Stock granted pursuant to the provisions of Section 8 of the Plan. (u) "Retirement" means retirement from active employment with the Company and its Subsidiaries on or after the normal retirement date specified in the Company's retirement plan or such earlier retirement date as approved by the Committee for purposes of this Plan. (v) "Stock Appreciation Right" means an Award to benefit from the appreciation of Common Stock granted pursuant to the provisions of Section 7 of the Plan. (w) "Stock Option" means an Award to purchase shares of Common Stock granted pursuant to the provisions of Section 6 of the Plan. (x) "Subsidiary" means any corporation or entity which is a subsidiary of the Company within the meaning of Section 424(f) of the Code (or successor sections). 3 4 (y) "Ten Percent Shareholder" means a person who owns (after taking into account the constructive ownership rules of Section 424(d) of the Code or successor sections) more than ten percent (1 0 %) of the stock of the Company. 3. ADMINISTRATION. (a) The Plan is being established and shall be administered by the Compensation Committee to be appointed from time to time by the Board. The Committee shall be comprised solely of not less than two persons who are "outside directors" within the meaning of Section 162(m)(4)(C) of the Code and not less than the minimum number (if any) of members of the Board required by Rule 16b-3 of the '34 Act (or any successor rule). All Committee members must also be "disinterested persons" for securities law purposes. Members of the Committee shall serve at the pleasure of the Board and the Board may from time to time remove members from, or add members to, the Committee. No person who is not an "outside director" within the meaning of Section 162(m)(4)(C) of the Code and a "disinterested person" may serve on the Committee. Appointment to the Committee of any person who is not an "outside director" and a "disinterested person" shall automatically be null and void, and any person on the Committee who ceases to be an "outside director" for purposes of Section 162(m)(4)(C) of the Code and a "disinterested person" shall automatically and without further action cease to be a member of the Committee. (b) A majority of the members of the Committee shall constitute a quorum for the transaction of business. Action approved in writing by a majority of the members of the Committee then serving shall be as effective as if the action had been taken by unanimous vote at a meeting duly called and held. Two Committee members have signed the original Plan document below signifying that the Committee, as well as the Board as a whole, has adopted and established this Plan. (c) The Committee is authorized to construe and interpret the Plan, to promulgate, amend, and rescind rules and procedures relating to the implementation of the Plan, and to make all other determinations necessary or advisable for the administration of the Plan. Any determination, decision, or action of the Committee in connection with the construction, interpretation, administration, or application of the Plan shall be binding upon all Participants and any person claiming under or through any Participant. Although the Committee is anticipated to make certain Awards that constitute "performance-based compensation" within the meaning of Section 162(m)(4)(C) of the Code, the Committee is also expressly authorized to make Awards that do not constitute "performance-based compensation" within the meaning of that provision. By way of example, and not by way of limitation, the Committee, in its sole and absolute discretion, may issue an Award that is not based on a performance goal, as set forth in (g) below, but is based solely on continued service to the Company. (d) The Committee may employ or retain persons other than members of the Committee to assist the Committee to carry out its responsibilities under such conditions and limitations as it may prescribe, except that the Committee may not delegate its authority with regard to selection for participation of and the granting of Awards to persons subject to Section 16 of the 4 5 '34 Act or with regard to any of the duties of the Committee under Section 162(m) of the Code necessary for awards under this Plan to qualify as "performance-based compensation" for purposes of Section 162(m)(4)(C) of the Code. (e) The Committee is expressly authorized to make such modifications to the Plan as are necessary to effectuate the intent of the Plan as a result of any changes in the income tax, accounting, or securities law treatment of Participants and the Plan. (f) The Company shall effect the granting of Awards under the Plan in accordance with the determinations made by the Committee, by execution of instruments in writing in such form as approved by the Committee. (g) The Committee, in the case of each Award, shall establish in writing at the time of making the Award the business criterion or criteria (if any) that must be satisfied for payment pursuant to the Award and the amount payable upon satisfaction of those standards. Those standards are also referred to herein as performance goals. Such criterion or criteria (if any) shall be established prior to the Participant rendering the services to which they relate and while the outcome is substantially uncertain. In carrying out these duties, the Committee shall use objective written standards for establishing both the performance goal and the amount of compensation such that a third party with knowledge of the relevant facts would be able to determine whether and to what extent the goal has been satisfied and the amount of compensation payable. The Committee shall provide a copy of the document setting forth such standards to the affected Participant and shall retain such written material in its permanent books and records. (h) The Committee may not increase an Award once granted, although it may grant additional Awards to the same Participant. (i) The Committee shall keep the Board informed as to its actions and make available to the Board its books and records. Although the Compensation Committee has the authority to establish and administer the Plan, the Board reserves the right at any time to abolish the Committee and administer the Plan itself. (j) In the case of remuneration that is intended to qualify as performance-based compensation for purposes of Code Section 162(m)(4)(C), the Committee and the Board shall disclose to the shareholders of the Company the material terms under which such remuneration is to be paid under the Plan, and shall seek approval of the shareholders by a majority vote in a separate shareholder vote before payment of such remuneration. For these purposes, the material terms include the individuals (or class of individuals) eligible to receive such compensation, a description of the business criterion or criteria on which the performance goal is based, either the maximum amount of the compensation to be paid thereunder or the formula used to calculate the amount of compensation if the performance goal is attained, and such other terms as required under Code Section 162(m)(4)(C) and the Treasury Regulations thereunder determined from time to time. The foregoing actions shall be undertaken in conformity with the rules of Code Section 162(m)(4)(C)(ii) 5 6 and Treasury Regulations promulgated thereunder. Such remuneration shall not be payable under this Plan in the absence of such an approving shareholder vote. In the case of remuneration that is not intended to qualify as performance-based compensation under Code Section 162(m)(4)(C), the Committee and the Board shall make such disclosures to and seek such approval from the shareholders of the Company as they reasonably determine are required by law. (k) To the extent required under Code Section 162(m)(4)(C), before any payment of remuneration under this Plan, the Committee must certify in writing that the performance goals and any other material terms of the Award were in fact satisfied. Such certification shall be kept with the permanent books and records of the Committee, and the Committee shall provide the affected Participant with a copy of such certification. (l) The Committee shall use its good faith best efforts to comply with the requirements of Section 162(m)(4)(C) of the Code for Awards that are intended to qualify under that section as "performance-based compensation, " but shall have no liability to the Company or any recipient in the event one or more Awards do not so qualify. 4. DURATION OF AND COMMON STOCK SUBJECT TO THE PLAN. (a) TERM. The Plan shall terminate automatically on the tenth (10th) anniversary date of the date of adoption of the Plan by the Committee, the date of adoption of the Plan by the Board, or the tenth (10th) anniversary date of the date of shareholder approval of the Plan, whichever is earlier (subject to earlier termination by action of the Board), except with respect to Awards then outstanding. (b) SHARES OF COMMON STOCK SUBJECT TO THE PLAN. The maximum total number of shares of Common Stock with respect to which aggregate stock Awards may be granted under the Plan shall be Seven Hundred and Fifty Thousand (750,000). (i) In no event shall more than Seven Hundred and Fifty Thousand (750,000) shares of Common Stock be available for Awards of Incentive Stock Options under the Plan. (ii) All of the amounts stated in this Paragraph (b) are subject to adjustment as provided in Section 15 below and are subject to the rules of Section 6(g). (iii) For the purpose of computing the total number of shares of Common Stock available for Awards under the Plan, there shall be counted against the foregoing limitations the number of shares of Common Stock subject to issuance upon exercise or used for payment or settlement of Awards. 6 7 (iv) If any Awards are forfeited, terminated, expire unexercised, settled or paid in cash in lieu of stock or exchanged for other Awards, the shares of Common Stock which were theretofore subject to such Awards shall again be available for Awards under the Plan to the extent of such forfeiture or expiration of such Awards. (v) Any shares of Common Stock which are used as full or partial payment to the Company by a Participant of the purchase price of shares of Common Stock upon exercise of a Stock Option shall again be available for Awards under the Plan, as shall any shares covered by Stock Appreciation Rights which are not issued as payment upon exercise. (c) SOURCE OF COMMON STOCK. Common Stock which may be issued under the plan may be either authorized and unissued shares or issued shares which have been reacquired by the Company. No fractional shares of Common Stock shall be issued under the Plan. 5. ELIGIBILITY. Persons eligible for Awards under the Plan shall consist of salaried senior executives of the Company or its Subsidiaries, who hold positions of significant responsibilities or whose performance or potential contribution, in the judgment of the Committee, will benefit the Company. 6. STOCK OPTIONS. Stock Options granted under the Plan shall be in the form of Incentive Stock Options (referred to as "Stock Options"). Stock Options shall be subject to the terms and conditions set forth below. Each written Stock Option agreement shall contain such additional terms and conditions, not inconsistent with the express provisions of the Plan, as the Committee shall deem desirable. (a) GRANT. Stock Options shall be granted under the Plan on such terms and conditions not inconsistent with the provisions of the Plan and pursuant to written agreements with the optionee in such form as the Committee may from time to time approve in its sole and absolute discretion. The terms of individual Stock Option agreements need not be identical. Each Stock Option agreement shall state specifically that it is intended to be an Incentive Stock Option agreement. Stock Options may be granted alone or in addition to other Awards under the Plan. Only common law employees may receive grants of Incentive Stock Options. No person may be granted (in any calendar year) options to purchase more than one hundred thousand (100,000) shares of Common Stock (subject to adjustment pursuant to Section 15). The foregoing sentence is an annual limitation on grants and not a cumulative limitation. Any Stock Options repriced during a year shall count against this annual limitation. (b) STOCK OPTION PRICE. The exercise price per share of Common Stock purchasable under a Stock Option shall be determined by the Committee at the time of grant. In no event shall the exercise price of a Stock Option be less than one hundred percent (100%) of the Fair Market Value of the Common Stock on the date of the grant of such Stock Option. In the case of 7 8 a Ten Percent Shareholder, the exercise price shall be not less than one hundred ten percent (110%) of the Fair Market Value of the Common Stock on the date of its grant. (c) OPTION TERM. The term of each Stock Option shall be fixed by the Committee. However, the term of any Stock Option shall not exceed ten (10) years after the date such Stock Option is granted. Furthermore, the term of an Incentive Stock Option granted to a Ten Percent Shareholder shall not exceed five (5) years after the date of its grant. (d) EXERCISABILITY. A Stock Option shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Committee at the date of grant and set forth in the written Stock Option agreement. However, no Stock Option shall be exercisable during the first six (6) months after the date such Stock Option is granted. A written Stock Option agreement may, if permitted pursuant to its terms, become exercisable in full upon the occurrence of events selected by the Committee that are beyond the control of the Participant (including, but not limited to, a Change in Control of the Company as set forth in Section 16 below). (e) METHOD OF EXERCISE. A Stock Option may be exercised, in whole or in part, by giving written notice of exercise to the Company specifying the number of shares to be purchased. Such notice shall be accompanied by payment in full of the purchase price (i) in cash or (ii) if acceptable to the Committee, in shares of Common Stock already owned by the Participant or a combination thereof. The Committee may also permit Participants, either on a selective or aggregate basis, to simultaneously exercise Options and sell the shares of Common Stock thereby acquired, pursuant to a brokerage or similar arrangement, approved in advance by the Committee, and use the proceeds from such sale as payment of part or all of the purchase price of such shares. (f) SPECIAL RULE FOR INCENTIVE STOCK OPTIONS. With respect to Incentive Stock Options granted under the Plan, the aggregate Fair Market Value (determined as of the date the Incentive Stock Option is granted) of the number of shares with respect to which Incentive Stock Options are exercisable for the first time by a Participant during any calendar year (under this Plan and all other incentive stock option plans of this Company or its Subsidiaries) shall not exceed one hundred thousand dollars ($100,000) or such other limit as may be required by the Code. (g) SPECIAL REGULATORY RESTRICTIONS FOR STOCK OPTIONS. In conformity to certain guidelines issued by the Commissioner with respect to stock options, the following rules apply and override any rules in the Plan relating to Stock Options that otherwise may be deemed inconsistent herewith: (i) The maximum number of shares issuable under all stock option plans of the Company shall not exceed twenty percent (20%) of the Company's total outstanding shares, as determined from time to time. (ii) No Stock Options may be issued to a non-employee director. 8 9 (iii) Any resolution of the Board of Directors or the Compensation Committee (as the case may be) establishing the number of Stock Options to be granted to a particular employee director shall not be voted upon by that director. (iv) The maximum number of shares subject to options that may be granted to any one individual pursuant to all stock option plans of the Company is ten percent (10%) of the total outstanding shares of the Company, as determined from time to time. (v) For purposes of valuing shares subject to options on the date of grant, Fair Market Value is defined in Section 2(k), but may not be less than eighty-five percent (85 %) of the book value of a share of Common Stock, or if the shares of Common Stock are traded on a national exchange or over the counter, Fair Market Value shall be no less than the price of a share of Common Stock as of the close of business on the day prior to the date of grant of the option. (vi) A director shall not be entitled to vote on any resolution fixing the Fair Market Value of the Common Stock subject to his or her option or used as the exercise consideration for such option. (vii) Section 15 of the Plan shall be administered in order to prevent dilution or enlargement of the rights granted to an optionee in the case of a stock split, stock dividend, recapitalization, reorganization, merger, consolidation, combination or similar transaction. (viii) A Stock Option is not assignable or transferable except in the event of the death of the optionee. (ix) In the case of Stock Options, the restrictions in this Section 6(g) apply in addition to any other restrictions under the terms of the Plan, not in substitution for them. 7. STOCK APPRECIATION RIGHTS. The grant of Stock Appreciation Rights under the Plan shall be subject to the following terms and conditions. Furthermore, the Stock Appreciation Rights shall contain such additional terms and conditions, not inconsistent with the express terms of the Plan, as the Committee shall deem desirable. The terms of each Stock Appreciation Right granted shall be set forth in a written agreement between the Company and the Participant receiving such grant. The terms of such agreements need not be identical. (a) STOCK APPRECIATION RIGHTS. A Stock Appreciation Right is an Award determined by the Committee entitling a Participant to receive an amount equal to the excess of the Fair Market Value of a share of Common Stock on a fixed date, which shall be the date concluding a measuring period set by the Committee upon granting the Stock Appreciation Right, over the Fair 9 10 Market Value of a share of Common Stock on the date of grant of the Stock Appreciation Right, multiplied by the number of shares of Common Stock subject to the Stock Appreciation Right. No Stock Appreciation Rights granted in any year to any person may be measured by an amount of shares of Common Stock in excess of one hundred thousand (100,000) shares, subject to adjustment under Section 15 below. The foregoing sentence is an annual limitation on grants and not a cumulative limitation. (b) GRANT. A Stock Appreciation Right may be granted in addition to or completely independent of a Stock Option or any other Award under the Plan. Upon grant of a Stock Appreciation Right, the Committee shall select and inform the Participant regarding the number of shares of Common Stock subject to the Stock Appreciation Right and the date that constitutes the close of the measuring period. (c) MEASURING PERIOD. A Stock Appreciation Right shall accrue in value from the date of grant over a time period established by the Committee, except that in no event shall a Stock Appreciation Right be payable within the first six (6) months after the date of grant. In the written Stock Appreciation Right agreement, the Committee may also provide (but is not required to provide) that a Stock Appreciation Right shall be automatically payable on one or more specified dates prior to the normal end of the measuring period upon the occurrence of events selected by the Committee (including, but not limited to, a Change in Control of the Company as set forth in Section 16 below) that are beyond the control of the Participant. The Committee may provide (but is not required to provide) in the Stock Appreciation Right agreement that in the case of a cash payment such acceleration in payment shall also be subject to discounting of the payment to reasonably reflect the time value of money using any reasonable discount rate selected by the Committee in accordance with Treasury Regulations under Code Section 162(m). (d) FORM OF PAYMENT. Payment pursuant to a Stock Appreciation Right may be made (i) in cash, (ii) in shares of Common Stock, or (iii) in any combination of the above, as the Committee shall determine in its sole and absolute discretion. The Committee may elect to make this determination either at the time the Stock Appreciation Right is granted, at the time of payment or at any time in between such dates. However, any Stock Appreciation Right paid upon or subsequent to the occurrence of a Change in Control (as defined in Section 16) shall be paid in cash. 8. RESTRICTED AWARDS. Restricted Awards granted under the Plan may be in the form of either Restricted Stock Grants or Restricted Unit Grants. Restricted Awards shall be subject to the following terms and conditions. Furthermore, the Restricted Awards shall be pursuant to a written agreement executed both by the Company and the Participant, which agreement shall contain such additional terms and conditions, not inconsistent with the express provisions of the Plan, as the Committee shall deem desirable in its sole and absolute discretion. The terms of such written agreements need not be identical. 10 11 (a) RESTRICTED STOCK GRANTS. A Restricted Stock Grant is an Award of shares of Common Stock transferred to a Participant subject to such terms and conditions as the Committee deems appropriate, as set forth in Paragraph (d) below. (b) RESTRICTED UNIT GRANTS. A Restricted Unit Grant is an Award of units (with each unit having a value equivalent to one share of Common Stock) granted to a Participant subject to such terms and conditions as the Committee deems appropriate, including, without limitation, the requirement that the Participant forfeit all or a portion of such units upon termination of employment for specified reasons within a specified period of time, and restrictions on the sale, assignment, transfer or other disposition of such units. (c) GRANTS OF AWARDS. Restricted Awards may be granted under the Plan in such form and on such terms and conditions as the Committee may from time to time approve. Restricted Awards may be granted alone or in addition to other Awards under the Plan. Subject to the terms of the Plan, the Committee shall determine the number of Restricted Awards to be granted to a Participant and the Committee may impose different terms and conditions (including performance goals) on any particular Restricted Award made to any Participant. Each Participant receiving a Restricted Stock Grant shall be issued a stock certificate in respect of such shares of Common Stock. Such certificate shall be registered in the name of such Participant, shall be accompanied by a stock power duly executed by such Participant, and shall bear an appropriate legend referring to the terms, conditions and restrictions applicable to such Award. The certificate evidencing the shares shall be held in custody by the Company until the restrictions imposed thereon shall have lapsed or been removed. (d) RESTRICTION PERIOD. Restricted Awards shall provide that in order for a Participant to vest in such Awards, the Participant must continuously provide services to the Company or its Subsidiaries, subject to relief for specified reasons, for a period of not less than three (3) years commencing on the date of the Award and ending on such later date or dates, subject to the three (3) year minimum, as the Committee may designate at the time of the Award ("Restriction Period"). If the Committee so provides in the written agreement with the Participant, a Restricted Award may also be subject to satisfaction of such performance goals as are set forth in such agreement. During the Restriction Period, a Participant may not sell, assign, transfer, pledge, encumber, or otherwise dispose of shares of Common Stock received under a Restricted Stock Grant. The Committee, in its sole discretion, may provide for the lapse of restrictions during the Restriction Period upon the occurrence of events selected by the Committee that are beyond the control of the Participant (including, but not limited to, a Change in Control of the Company under Section 16). The Committee may provide (but is not required to provide) in the written agreement with the recipient that in the case of a cash payment such acceleration in payment shall also be subject to discounting of the payment to reasonably reflect the time value of money using any reasonable discount rate selected by the Committee in accordance with Treasury Regulations under Code Section 162(m). Upon expiration of the applicable Restriction Period (or lapse of restrictions during the Restriction Period where the restrictions lapse in installments or by action of the Committee), the 11 12 Participant shall be entitled to receive his or her Restricted Award or portion thereof, as the case may be. (e) PAYMENT OF AWARDS. A Participant who receives a Restricted Stock Grant shall be paid solely by release of the restricted shares at the termination of the Restriction Period (whether in one payment, in installments or otherwise). A Participant shall be entitled to receive payment for a Restricted Unit Grant (or portion thereof) in an amount equal to the aggregate Fair Market Value of the shares of Common Stock covered by such Award upon the expiration of the applicable Restriction Period. Payment in settlement of a Restricted Unit Grant shall be made as soon as practicable following the conclusion of the specified Restriction Period (i) in cash, (ii) in shares of Common Stock equal to the number of units granted under the Restricted Unit Grant with respect to which such payment is made, or (iii) in any combination of the above, as the Committee shall determine in its sole and absolute discretion. The Committee may elect to make this determination either at the time the Award is granted, at the time of payment or at any time in between such dates. (f) RIGHTS AS A SHAREHOLDER. A Participant shall have, with respect to the shares of Common Stock received under a Restricted Stock Grant, all of the rights of a shareholder of the Company, including the right to vote the shares, and the right to receive any cash dividends. Such cash dividends shall be withheld, however, until their release upon lapse of the restrictions under the Restricted Award. Stock dividends issued with respect to the shares covered by a Restricted Grant shall be treated as additional shares under the Restricted Grant and shall be subject to the same restrictions and other terms and conditions that apply to shares under the Restricted Grant with respect to which the dividends are issued. 9. PERFORMANCE AWARDS. Performance Awards granted under the Plan may be in the form of either Performance Share Grants or Performance Unit Grants. Performance Awards shall be subject to the terms and conditions set forth below. Furthermore, the Performance Awards shall be subject to written agreements which shall contain such additional terms and conditions, not inconsistent with the express provisions of the Plan, as the Committee shall deem desirable in its sole and absolute discretion. Such agreements need not be identical. (a) PERFORMANCE SHARE GRANTS. A Performance Share Grant is an Award of units (with each unit equivalent in value to one share of Common Stock) granted to a Participant subject to such terms and conditions as the Committee deems appropriate, including, without limitation, the requirement that the Participant forfeit such units (or a portion of such units) in the event certain performance criteria are not met within a designated period of time. (b) PERFORMANCE UNIT GRANTS. A Performance Unit Grant is an Award of units (with each unit representing such monetary amount as designated by the Committee) granted to a Participant subject to such terms and conditions as the Committee deems appropriate, including, without limitation, the requirement that the Participant forfeit such units (or a portion of such units) in the event certain performance criteria are not met within a designated period of time. 12 13 (c) GRANTS OF AWARDS. Performance Awards shall be granted under the Plan pursuant to written agreements with the Participant in such form as the Committee may from time to time approve. Performance Awards may be granted alone or in addition to other Awards under the Plan. Subject to the terms of the Plan, the Committee shall determine the number of Performance Awards to be granted to a Participant and the Committee may impose different terms and conditions on any particular Performance Award made to any Participant. (d) PERFORMANCE GOALS AND PERFORMANCE PERIODS. Performance Awards shall provide that, in order for a Participant to vest in such Awards, the Company must achieve certain performance goals ("Performance Goals") over a designated performance period ("Performance Period") having a minimum duration of three (3) years. The Performance Goals and Performance Period shall be established by the Committee, in its sole and absolute discretion. The Committee shall establish Performance Goals for each Performance Period before the commencement of the Performance Period and while the outcome is substantially uncertain. The Committee shall also establish a schedule or schedules for such Performance Period setting forth the portion of the Performance Award which will be earned or forfeited based on the degree of achievement of the Performance Goals actually achieved or exceeded. In setting Performance Goals, the Committee may use such measures as return on equity, earnings growth, revenue growth, comparisons to peer companies, or such other measure or measures of performance in such manner as it deems appropriate. (e) PAYMENT OF AWARDS. In the case of a Performance Share Grant, the Participant shall be entitled to receive payment for each unit earned in an amount equal to the aggregate Fair Market Value of the shares of Common Stock covered by such Award as of the end of the Performance Period. In the case of a Performance Unit Grant, the Participant shall be entitled to receive payment for each unit earned in an amount equal to the dollar value of each unit times the number of units earned. The Committee, pursuant to the written agreement with the Participant, may make such Performance Awards payable in whole or in part upon the occurrence of events selected by the Committee that are beyond the control of the Participant (including, but not limited to, a Change in Control of the Company as set forth in Section 16 below). The Committee may provide (but is not required to provide) in the written agreement with the recipient that, in the case of a cash payment, acceleration in payment of a Performance Award shall also be subject to discounting to reasonably reflect the time value of money using any reasonable discount rate selected by the Committee in accordance with Treasury Regulations under Code Section 162(m). Payment in settlement of a Performance Award shall be made as soon as practicable following the conclusion of the Performance Period (i) in cash, (ii) in shares of Common Stock, or (iii) in any combination of the above, as the Committee may determine in its sole and absolute discretion. The Committee may elect to make this determination either at the time the Award is granted, at the time of payment, or at any time in between such dates. 13 14 10. OTHER STOCK-BASED AND COMBINATION AWARD. (a) The Committee may grant other Awards under the Plan pursuant to which Common Stock is or may in the future be acquired, or Awards denominated in stock units, including ones valued using measures other than market value. Such other stock-based grants may be granted either alone or in addition to any other type of Award granted under the Plan. (b) The Committee may also grant Awards under the Plan in combination with other Awards or in exchange of Awards, or in combination with or as alternatives to grants or rights under any other employee plan of the Company, including the plan of any acquired entity. (c) Subject to the provisions of the Plan, the Committee shall have authority to determine the individuals to whom and the time or times at which the Awards shall be made, the number of shares of Common Stock to be granted or covered pursuant to such Awards, and any and all other conditions and/or terms of the Awards. 11. DEFERRAL ELECTIONS. The Committee may permit a Participant to elect to defer his or her receipt of the payment of cash or the delivery of shares of Common Stock that would otherwise be due to such Participant by virtue of the exercise, earn out or vesting of an Award made under the Plan. If any such election is permitted, the Committee shall establish rules and procedures for such payment deferrals, including the possible (a) payment or crediting of reasonable interest on such deferred amounts credited in cash, and (b) the payment or crediting of dividend equivalents in respect of deferrals credited in units of Common Stock. The Company and the Committee shall not be responsible to any person in the event that the payment deferral does not result in deferral of income for tax purposes. 12. DIVIDEND EQUIVALENTS. Awards of Stock Options, Stock Appreciation Rights, Restricted Unit Grants, Performance Share Grants, and other Stock-Based Awards may, in the sole and absolute discretion of the Committee, earn dividend equivalents. In respect of any such Award which is outstanding on a dividend record date for Common Stock, the Participant may be credited with an amount equal to the amount of cash or stock dividends that would have been paid on the shares of Common Stock covered by such Award had such shares been issued and outstanding on such dividend record date. The Committee shall establish such rules and procedures governing the crediting of dividend equivalents, including the timing, form of payment, and payment contingencies of such dividend equivalents, as it deems appropriate or necessary. 13. TERMINATION OF EMPLOYMENT. The terms and conditions under which an Award may be exercised after a Participant's termination of employment shall be determined by the Committee and reflected in the written agreement with the Participant concerning the Award, except that in the event a Participant's employment with the Company or a Subsidiary terminates for any reason within six (6) months of the date of grant of any Award held by the Participant, the Award shall expire as of the date of such termination of employment and the Participant and the Participant's legal representative or beneficiary shall forfeit any and all rights pertaining to such Award. 14 15 14. NON-TRANSFERABILITY OF AWARDS. No Award under the Plan, and no rights or interest therein, shall be assignable or transferable by a Participant except by will or the laws of descent and distribution. During the lifetime of a Participant, Awards are exercisable only by, and payments in settlement of Awards will be payable only to, the Participant or his or her legal representative. 15. ADJUSTMENTS UPON CHANGE IN CAPITALIZATION, ETC. (a) The existence of the Plan and the Awards granted hereunder shall not affect or restrict in any way the right or power of the Board or the shareholders of the Company to make or authorize any adjustment, recapitalization, reorganization or other change in the Company's capital structure or its business, any merger or consolidation of the Company, any issue of bonds, debentures, preferred or prior preference stocks ahead of or affecting the Company's Common Stock or the rights thereof, the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding. (b) In the event of any change in capitalization affecting the Common Stock of the Company after the Effective Date, such as a stock dividend, stock split, recapitalization, merger, consolidation, split-up, combination, exchange of shares, other form of reorganization, or any other change affecting the Common Stock, such proportionate adjustments, if any, as the Board in its discretion may deem appropriate to reflect such change shall be made with respect to (i) the aggregate number of shares of Common Stock for which Awards in respect thereof may be granted under the Plan, (ii) the maximum number of shares of Common Stock which may be sold or awarded to any Participant, (iii) the number of shares of Common Stock covered by each outstanding Award, and (iv) the price per share in respect of outstanding Awards. (c) The Committee may also make such adjustments in the number of shares covered by, and the price or other value of any outstanding Awards in the event of a spin-off or other distribution (other than normal cash dividends) of Company assets to shareholders. In the event that another corporation or business entity is being acquired by the Company, and the Company agrees to assume outstanding employee stock options and/or stock appreciation rights and/or the obligation to make future grants of options or rights to employees of the acquired entity, the aggregate number of shares of Common Stock available for Awards under Section 4 of the Plan may be increased accordingly, except that no change shall be made to the maximum number of shares eligible for Incentive Stock Options under Section 4(b)(i) based solely upon such an event. 16. CHANGE IN CONTROL. (a) In the event of a Change in Control (as defined in Paragraph (b) below) of the Company, and except as otherwise provided in Award agreements: (i) All Stock Options or Stock Appreciation Rights then outstanding shall become fully exercisable as of the date of the Change in Control (and shall terminate at such time as specified in the Award agreement); 15 16 (ii) All restrictions and conditions of all Restricted Stock Grants and Restricted Unit Grants then outstanding shall be deemed satisfied as of the date of the Change in Control; and (iii) All Performance Share Grants and Performance Unit Grants shall be deemed to have been fully earned as of the date of the Change in Control; subject to the limitation that any Award which has been outstanding less than six (6) months on the date of the Change in Control shall not be afforded such treatment. (b) A "Change in Control" shall be deemed to have occurred upon the occurrence of any one (or more) of the following events: (i) Any person, including a group as defined in Section 13(d)(3) of the '34 Act, becomes the beneficial owner of shares of the Company with respect to which 25 % or more of the total number of votes for the election of the Board may be cast; (ii) As a result of, or in connection with, any cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, or combination of the foregoing, persons who were directors of the Company just prior to such event shall cease to constitute a majority of the Board; (iii) The shareholders of the Company shall approve an agreement providing either for a transaction in which the Company will cease to be an independent publicly owned corporation or for a sale or other disposition of all or substantially all the assets of the Company; or (iv) A tender offer or exchange offer is made for shares of the Company's Common Stock (other than one made by the Company) and shares of Common Stock are acquired thereunder ("Offer"). However, the acceleration of the exercisability of outstanding options upon the occurrence of an Offer shall be within the discretion of the Committee. (v) Formation of a holding company for the Company in which the shareholdings of the holding company after its formation are substantially the same as for the Company prior to the holding company formation does not constitute a Change in Control for purposes of this Plan. (c) In the event that any payment under this Plan (alone or in conjunction with other payments) would otherwise constitute an "excess parachute payment" under Section 28OG of the Code (in the sole judgment of the Company), such payment shall be reduced or eliminated to the extent the Company determines necessary to avoid deduction disallowance under Section 28OG of 16 17 the Code or the imposition of excise tax under Section 4999 of the Code. The Company may consult with a Participant regarding the application of Section 28OG and/or Section 4999 to payments otherwise due to such Participant under the Plan, but the judgment of the Company as to applicability of those provisions, the degree to which a payment must be reduced to avoid those provisions, and which Awards shall be reduced, is final. The Compensation Committee shall act on behalf of the Company in interpreting and administering this limitation. 17. AMENDMENT AND TERMINATION. Without further approval of the shareholders, the Board may at any time terminate the Plan, or may amend it from time to time in such respects as the Board may deem advisable. However, the Board may not, without approval of the shareholders, make any amendment which would (a) increase the aggregate number of shares of Common Stock which may be issued under the Plan (except for adjustments pursuant to Section 15 of the Plan), (b) materially modify the requirements as to eligibility for participation in the Plan, or (c) materially increase the benefits accruing to Participants under the Plan. Notwithstanding the above, the Board may amend the Plan to take into account changes in applicable securities laws, federal income tax laws and other applicable laws. Further, should the provisions of Rule 16b-3, or any successor rule, under the '34 Act be amended, the Board may amend the Plan in accordance with any modifications to that rule without the need for shareholder approval. Notwithstanding the foregoing, the provisions of Section 1 1 may not be amended more than once every six months other than to comply with the changes in the Code or the Employee Retirement Income Security Act of 1974 ("ERISA"). 18. MISCELLANEOUS MATTERS. (a) TAX WITHHOLDING. The Company shall have the right to deduct from any payment, including the delivery of shares, made under the Plan any federal, state, or local taxes of any kind required by law to be withheld with respect to such payments or to take such other action as may be necessary in the opinion of the Company to satisfy all obligation for the payment of such taxes. If Common Stock is used to satisfy tax withholding, such stock shall be valued based on the Fair Market Value when the tax withholding is required to be made. (b) NO RIGHT TO EMPLOYMENT. Neither the adoption of the Plan nor the granting of any Award shall confer upon any employee of the Company or any Subsidiary any right to continued employment with the Company or any Subsidiary, as the case may be, nor shall it interfere in any way with the right of the Company or a Subsidiary to terminate the employment of any of its employees at any time, with or without cause. (c) UNFUNDED PLAN. The Plan shall be unfunded and the Company shall not be required to segregate any assets that may at any time be represented by Awards under the Plan. Any liability of the Company to any person with respect to any Award under the Plan shall be based solely upon any written contractual obligations that may be effected pursuant to the Plan. No such obligation of the Company shall be deemed to be secured by any pledge of, or other encumbrance on, any property of the Company. 17 18 (d) ANNULMENT OF AWARDS. The grant of any Award under the Plan payable in cash is provisional until cash is paid in settlement thereof. The grant of any Award payable in Common Stock is provisional until the Participant becomes entitled to the certificate in settlement thereof. Payment under any Awards granted pursuant to the Plan is wholly contingent upon shareholder approval of the Plan as well as Commissioner approval of the Plan and issuance of a permit as set forth in Section 2(i) above. Where approval for an award sought pursuant to Section 162(m)(4)(C)(ii) is not granted by the Company's shareholders, the Award shall be annulled automatically. In the event the employment of a Participant is terminated for cause (as defined below), any Award which is provisional shall be annulled as of the date of such termination for cause. For purposes of the Plan, the term "terminated for cause" means any discharge because of personal dishonesty, willful misconduct, breach of fiduciary duty involving personal profit, continuing intentional or habitual failure to perform stated duties, violation of any law (other than minor traffic violations or similar misdemeanor offenses not involving moral turpitude), or rule or regulation adopted by the Office of Thrift Supervision, California Department of Savings and Loan or Federal Deposit Insurance Corporation, or material breach of any provision of an employment agreement with the Company. (e) OTHER COMPANY BENEFIT AND COMPENSATION PROGRAMS. Payments and other benefits received by a Participant under an Award made pursuant to the Plan shall not be deemed a part of a Participant's regular, recurring compensation for purposes of the termination indemnity or severance pay law of any state. Furthermore, such benefits shall not be included in, nor have any effect on, the determination of benefits under any other employee benefit plan or similar arrangement provided by the Company or a Subsidiary unless expressly so provided by such other plan or arrangement, or except where the Committee expressly determines that inclusion of an Award or portion of an Award should be included. Awards under the Plan may be made in combination with or in addition to, or as alternatives to, grants, awards or payments under any other Company or Subsidiary plans. The Company or any Subsidiary may adopt such other compensation programs and additional compensation arrangements (in addition to this Plan) as it deems necessary to attract, retain, and reward employees for their service with the Company and its Subsidiaries. (f) SECURITIES LAW RESTRICTIONS. No shares of Common Stock shall be issued under the Plan unless counsel for the Company shall be satisfied that such issuance will be in compliance with applicable federal and state securities laws. Certificates for shares of Common Stock delivered under the Plan may be subject to such stock-transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations, and other requirements of the Securities and Exchange Commission, any stock exchange upon which the Common Stock is then listed, and any applicable federal or state securities law. The Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. (g) AWARD AGREEMENT. Each Participant receiving an Award under the Plan shall enter into a written agreement with the Company in a form specified by the Committee agreeing to the terms and conditions of the Award and such related matters as the Committee shall, in its sole and absolute discretion, determine. 18 19 (h) COSTS OF PLAN. The costs and expenses of administering the Plan shall be borne by the Company. (i) GOVERNING LAW. The Plan and all actions taken thereunder shall be governed by and construed in accordance with the laws of the State of Delaware. CREDIT MANAGEMENT SOLUTIONS, INC., a Delaware Corporation Date: , 1996 By: ----------- ----------------------------------- James R. DeFrancesco, Chairman 19 20 CERTIFICATE OF COMPENSATION COMMITTEE The undersigned two persons, being members of the Compensation Committee and "outside directors" within the meaning of Section 162(m)(4)(C)(i) of the Internal Revenue Code of 1986, hereby certify that the foregoing 1996 Credit Management Solutions, Inc. Long-Term Incentive Plan was adopted and established by the Compensation Committee on __________, 1996. Date: , 1996 ----------------- ----------------------------------- Compensation Committee Member Date: , 1996 ----------------- ----------------------------------- Compensation Committee Member CERTIFICATE OF SECRETARY The undersigned, being the Corporate Secretary of Credit Management Solutions, Inc., a Delaware corporation, hereby certifies that the foregoing 1996 Credit Management Solutions, Inc. Long-Term Incentive Plan (the "Plan") was, pursuant to the Articles and Bylaws of the Corporation, duly adopted by the Compensation Committee on __________, 1996 and by the Board of Directors as a whole on __________, 1996. The Plan was approved by the sole shareholder of the Corporation on _________ 1996. Date: ----------------- ---------------------------------- Miles H. Grody, Corporate Secretary 20 EX-10.14 9 FORM OF TAX INDEMNIFICATION AGREEMENT 1 EXHIBIT 10.14 TAX INDEMNIFICATION AGREEMENT This TAX INDEMNIFICATION AGREEMENT (the "Agreement") is entered into as of December __, 1996 between Credit Management Solutions, Inc., a Delaware corporation (the "Company"), and the persons listed on Schedule A attached hereto (individually a "Stockholder" and collectively the "Stockholders"). Capitalized terms not otherwise defined have the meanings ascribed to them in Section 1.1. WHEREAS, the Company and the Stockholders have entered into this Agreement as a condition to the Public Offering; WHEREAS, the Company has been an "S corporation" (as defined in Section 1361(a)(1) of the Code) for federal tax purposes since its inception in 1987; WHEREAS, the Company's election to be treated as an S corporation terminated upon the reincorporation of the Company in Delaware (the "Termination Date"), and as a result the Company has been a "C corporation" (as defined in Section 1361(a)(2) of the Code) since the Termination Date; WHEREAS, the Company will declare the AAA Dividend, a portion of which will be payable on the Closing Date and the balance of which will be payable on or before the Balance Payment Date; WHEREAS, the Company and the Stockholders wish to provide for certain tax related payments in connection with the Company's status as an S corporation and for the adjustment of the amount of the AAA Dividend in certain events; and WHEREAS, the Company and the Stockholders wish to terminate this Agreement such that it has no effect should the Pubic Offering not occur. NOW, THEREFORE, the parties agree as follows: ARTICLE I DEFINITIONS 1.1 Definitions. the following terms, as used herein, have the following meanings: "AAA" means the Company's "Accumulated adjustments account," as defined in Section 1368(e)(1) of the Code, as of the close of business on the day before the Termination Date. 2 "AAA Dividend" means the dividend to be declared by the Company in an amount equal to the Company's undistributed S corporation earnings to the stockholders of record one day prior to the Termination Date. "AAA Settlement Date" means the last day of one of the following periods, whichever is applicable: (i) the "post-termination transition period," as defined in Section 1377(b) of the Code, of the Company, in the case where the AAA is determined to be greater than determined on the Balance Payment Date, or (ii) the calendar year of the Closing Date, in the case where the AAA is determined to be less than determined on the Balance Payment Date. "Adjustment Amount" means the net increase in taxable income of one or more of the Stockholders or the Company based on a Final Determination and which gives rise to a payment pursuant to Section 3.3 or Section 3.4 hereof. "Affected Stockholder" means a stockholder whose tax returns are adjusted in a manner which gives rise to an obligation of the Company pursuant to Section 3.3 hereof. "Balance AAA Dividend" means the portion of the AAA Dividend payable to the Stockholders of record as of one day prior to the Termination Date in an amount equal to the balance of the AAA on the Termination Date minus the Initial AAA Dividend. "Balance Payment Date" means January 15, 1997. "Blended Rate" means a percentage which equals the sum of the maximum marginal federal and state individual income tax rates for an individual residing in Maryland (after giving effect to the full deductibility of state income taxes for federal income tax purposes) in effect for the year of the adjustment to a tax return of the Company or such Stockholder that gives rise to a correlative adjustment to a tax return of such Stockholder or the Company, respectively. For example, if an adjustment that results in an amount due from the Stockholders hereunder, the year of the Company's return that was adjusted shall determine the Blended Rate to be used in computing the amount due. "Closing Date" means the date on which the Public Offering closes. "Code" means the Internal Revenue Code of 1986, as amended. "C Short Year" means that portion of the S Termination Year of the Company beginning on the Termination Date and ending on the last day of the S Termination Year. "C Taxable Year" means any taxable year (or portion thereof) of the Company during which it is a C corporation, including the C Short Year. 2 3 "Final Determination" means the earliest to occur of (i) the execution of a closing agreement between a Stockholder and a Taxing Authority or between the Company and a Taxing Authority, (ii) a decision of a court of law that is either nonappealable or with respect to which no appeal is taken, or (iii) any other event or agreement which establishes the tax treatment of an item to the reasonable satisfaction of both parties. "Initial AAA Dividend" means the portion of the AAA Dividend to be paid to the Stockholders of record as of one on or immediately after the Closing Date. "Public Offering" means the initial public offering of the Company's Common Stock pursuant to the Registration Statement on Form S-1 originally filed by the Company with the Securities and Exchange Commission on October 11, 1996. "S Short Year" means the portion of the S Termination Year beginning on the first day of such taxable year and ending on the day immediately preceding the Termination Date. "S Taxable Year" means any taxable year (or portion thereof) of the Company during which the Company was an S corporation for the entire year, including the S Short Year. "S Termination Year" shall mean the fiscal year of the Company that includes the Termination Date. "Taxing Authority" means the United States Internal Revenue Service and any comparable state or foreign taxing authority. ARTICLE II TERMINATION OF S CORPORATION STATUS, ALLOCATION OF INCOME AND ADJUSTMENT OF AAA DIVIDEND 2.1 Termination of S Corporation Status. Termination of the Company's S corporation status occurred upon the reincorporation of the Company in Delaware. 2.2 Declaration of AAA Dividend. On December 1, 1996 the Company shall declare the AAA Dividend. The AAA Dividend (including the Initial AAA Dividend and the Balance AAA Dividend and any adjustments thereto) shall be payable based upon the Stockholders ownership of common stock as of one day prior to the Termination Date. 2.3 Allocation Election. The Company shall be required to elect to allocate the items described in Section 1362(e) (2) (A) of the Code pursuant to Section 1362(e) (3) of the Code under "normal tax accounting rules," and the Stockholders agree to consent to such 3 4 election and to provide the Company with the statement of consent of all Stockholders described in Section 1.1362-6(b) of the Treasury Regulations. 2.4 Adjustment to AAA Dividend. (a) The parties acknowledge that the amount of the Initial AAA Dividend and the Balance AAA Dividend will be based on good faith determinations by the Company of the amount of AAA. (b) The parties agree that if the Company determines after the Termination Date and on or before the AAA Settlement Date that the amount of the AAA as of December 15, 1996 does not equal the amount of the sum of the Initial AAA Dividend and the Balance AAA Dividend, then: (i) if the amount of the sum of the Initial AAA Dividend and the Balance AAA Dividend exceeds the amount of the AAA as of December 15, 1996, the Stockholders who received the Initial AAA Dividend and the Balance AAA Dividend shall immediately thereafter remit to the Company their pro-rata share of such excess; and (ii) if the amount of the AAA as of December 15, 1996 exceeds the amount of the sum of the Initial AAA Dividend and the Balance AAA Dividend, the Company shall immediately thereafter distribute to the Stockholders of record as of one day prior to the Termination Date their pro-rata share of such excess. (c) The Company shall notify the Stockholders no later than five (5) days prior to the AAA Settlement Date in the event the Stockholders are required to remit any amount to the Company pursuant to this Section 2.4 (d) No payment shall be due, and no party shall have a claim against the other party, under this Agreement if the relevant determination of the AAA occurs after the applicable AAA Settlement Date. ARTICLE III OBLIGATIONS 3.1 Liability for Taxes Incurred During S Short Year. Each Stockholder covenants and agrees that: (i) the Stockholder will duly include, in his own federal and state income tax returns, all items of income, gain, loss, deduction, or credit attributable to the S Short Year in a manner consistent with the Form 1120S and the schedules thereto (and the corresponding state income tax forms and schedules) to be filed by the Company with respect to such period; (ii) such returns shall be filed no later than the due date (including extensions, 4 5 if any) for filing such returns; and (iii) each Stockholder shall pay any and all taxes required to be paid for its taxable year that includes the S Short Year. 3.2 Liability for Taxes Incurred During S Short Year and C Short Year. The Company covenants and agrees that: (i) the Company shall be responsible for and shall effect the filing of all federal and state income tax returns for the Company with respect to the S Short Year and the C Short Year; (ii) such Company returns shall be accurately prepared and timely filed; and (iii) the Company shall pay any and all taxes required to be paid by the Company for the periods covered by such returns as required by applicable law. 3.3 Company's Indemnification for Tax Liabilities. In the event of an adjustment to one or more tax returns of the Company for an S Taxable Year based on a Final Determination which results in a net increase in taxable income of a Stockholder and a corresponding adjustment to one or more tax returns of the Company for a C Taxable Year based on a Final Determination which results in a net decrease in taxable income of the Company, the Company shall pay to the Affected Stockholder an amount equal to the Adjustment Amount multiplied by the Blended Rate. In the event the Adjustment Amount differs from the adjustment to the income of the Company for a C Taxable Year, the Company shall be required to pay an amount to the Affected Stockholder equal to the lesser of the Adjusted Amount or the net decrease in the income of the Company for the C Taxable Year, multiplied by the Blended Rate. In addition, provided the Affected Stockholder originally reported its distributive share of income and other items of the Company from an S Taxable Year consistently with the Schedule K-1 provided to him by the Company, the Company shall pay to the Affected Stockholder any penalties or interest actually paid by the Affected Stockholder as a result of the adjustment to such items giving rise to the Company's liability hereunder. The Company shall pay the amount due to the Affected Stockholder within ten (10) business days of the later of (i) the later of the two Final Determinations referred to in this Section 3.3 or (ii) the date on which the Affected Stockholder provides proof reasonably satisfactory to the Company that it has paid the taxes arising from the Adjustment Amount. 3.4 Stockholders Indemnification for Tax Liabilities. (a) In the event of an adjustment to one or more tax returns of the Company for a C taxable year based on a Final Determination which results in a net increase in taxable income of the Company for a C Taxable Year and a corresponding adjustment to one or more tax returns of the Company for an S Taxable Year based on a Final Determination which results in a net decrease in taxable income of the Company for the S Taxable Year, the Stockholders agree to contribute to the capital of the Company an amount equal to the Adjustment Amount multiplied by the Blended Rate. In the event the Adjustment Amount differs from the adjustments to the income of the Company for the S Taxable year, the Stockholder shall be required to contribute to the capital of the Company an amount equal to the lesser of the Adjustment Amount or net decrease in the income of the Stockholder, multiplied by the Blended Rate. In addition, each Stockholder shall contribute to the capital of the Company an amount 5 6 equal to interest actually paid by the Company as a result of the adjustment giving rise to the Stockholder's liability hereunder. (b) If based on a Final Determination the Company is deemed to have been a C corporation for federal, state or local income tax purposes during any period in which it reported (or intends to report) its taxable income as S corporation or is subject to the tax imposed by Section 1374 of the Code, each Stockholder agrees to contribute to the capital of the Company an amount necessary to hold the Company harmless from any taxes and interest arising from such Final Determination. The obligations of the Stockholders under this subsection (b) shall include all taxes and interest incurred by the Company as a C Corporation for periods ending before the Termination Date, other than any obligation arising from an adjustment to the Company's tax return for a period ending before the Termination Date which, if the Company had been an S corporation for such period, would have given rise to an obligation of the Company to the stockholders under Section 3.3 hereof. Each Stockholder's obligation under this Section 3.4(b) shall be limited to that percentage of the tax and interest due by the Company equal to the fraction, expressed as a percentage, the numerator of which is the total distributions to such Stockholder made by the Company from July 1, 1987 through and including December 15, 1996, plus the AAA Dividend and any adjustment thereto pursuant to this Agreement, and the denominator of which is the total distributions made by the Company to all Stockholders from July 1, 1987 through and including December 15, 1996, plus the AAA Dividend and any adjustment thereto pursuant to this Agreement. (c) The Stockholders shall contribute to the capital of the Company amounts set forth in this Section 3.4 within twenty-five (25) business days of the later of (i) the later of the two final Determinations referred to in Section 3.4(a) or the Final Determination referred to in Section 3.4(b), whichever is applicable, or (ii) the date on which the Company provides proof reasonably satisfactory to the Stockholder that it has paid the amounts given rise to such liability. 3.5 Limitation on Amended Returns and Claims for Refund. The parties acknowledge that the intent of this Agreement is to allocate the approximate cost of adjustments to the tax returns of the parties based on one or more examinations by a Taxing Authority and penalties and interest relating thereto. As a result, this Agreement will not apply to adjustments resulting from an amended tax return, claim for refund or similar action ("Unilateral Action") that is not reasonably necessary in order to effectuate an adjustment based on a Final Determination and resulting directly from an examination by a Taxing Authority, unless and to the extent both parties consent to such Unilateral Action. All calculations hereunder shall be made as if such Unilateral Action had not occurred, unless and to the extent both parties consented to the Unilateral Action. 3.6 Computational Rules. (a) The following rules shall apply in making the computations set forth in Section 3.3, and 3.4, and 3.8: 6 7 (i) In determining a net increase in the income of a Stockholder or the Company pursuant to Sections 3.3 and 3.4, effect shall be given to any reduction in taxable income of such party resulting from a Final Determination with respect to prior or future years arising from or directly relating to the item giving rise to the increase, provided that such increase or reduction can reasonably be anticipated to be realized within three taxable years of the corresponding adjustment. (ii) Capital gains and losses shall be treated the same as ordinary income. An increase or decrease in tax basis of any property owned by a party or an increase or decrease in a net operating or capital loss carryforward of a party shall be treated as an expense or income, respectively, of such party in the amount of such increase or decrease in the taxable year of such increase or decrease. (iii) There will be no increase or decrease in any payment based on time value of money or similar concepts, and no effect shall be given to the timing of the decrease in a party's taxable income in determining the amount of such decrease. (b) Notwithstanding subsection (a), the parties shall endeavor to agree to payments under Sections 3.3 and 3.4(a) that, to the extent reasonable in light of the complexities involved, place the parties in the same position that they would have been in had there been no Adjustment Amount, with a view toward minimizing the overall tax burden of the parties and minimizing, to the extent of a tax cost to another party, the amount of any benefit realized by a party as a result of an Adjustment Amount. 3.7 Contest/Cooperation. (a) Contests. Each of the Company and the Stockholders agree that (i) in the event that any of them receives notice, whether orally or in writing, of any federal, state, local or foreign tax examinations, claims, settlements, proposed adjustments or related matters that may affect in any way the liability of a party under this Agreement, it shall within ten days notify the other parties in writing thereof (provided that any failure to give such notice shall not reduce a party's right to indemnification under this Agreement except to the extent of actual damage incurred by the other parties as a result of such failure), and (ii) the party or parties (the "Indemnifying Party") who would be required to indemnify the other party or parties (the "Indemnified Party") shall be entitled at its reasonable discretion and sole expense to handle, control and compromise or settle the defense of any matter which may give rise to a liability under this Agreement, provided that the Indemnifying Party from time to time provides assurances reasonably satisfactory to the Indemnified Party that (1) the Indemnifying Party is financially capable of pursuing such defense to its conclusion, and (2) such defense is actually being pursued in a reasonable manner. (b) Cooperation. the parties will make available to one another, as reasonably requested, and to any taxing authority, all information, records or documents relating to the liability for taxes covered by this Agreement and will preserve such information, records 7 8 or documents until the expiration of any applicable statute of limitations or extensions thereof. The party requesting such information shall reimburse the other party for all reasonable out-of-pocket costs incurred in producing information. 3.8 Indemnification for Taxes on Payments. The parties agree that amounts paid or contributed hereunder (including pursuant to this Section 3.8) shall be net of any federal and state income tax imposed on the receipt of such amounts, but only to the extent of the federal and state income tax benefit to the Indemnifying Party from the payment to the Indemnified Party. The parties will determine by mutual agreement whether and the extent to which any amounts paid or contributed hereunder will be subject to tax, the amount of benefit received by a party, and the appropriate increase in such amount required by this Section 3.8. In the event the parties are unable to agree on any matter described in this Section 3.8, they shall select a firm of certified public accountants mutually acceptable to both parties to determine such matters, whose decisions shall be final and binding on the parties. 3.9 Cost. Except to the extent otherwise provided herein, each party shall bear its own costs in administering this Agreement. 3.10 Interest on Overdue Payments. Any payment pursuant to this Agreement not made when due under this Agreement shall bear interest at the rate of 10% per annum until paid. 3.11 Correction of a Final Determination. In the event a party makes a payment pursuant to this Agreement based on the expected outcome of a Final Determination which subsequently is determined to have been incorrect, the parties shall adjust the payments hereunder in order to reflect the subsequent determination as if it was the Final Determination upon which the original payment was based. ARTICLE IV MISCELLANEOUS 4.1 Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed an original, but all of which counterparts collectively shall constitute an instrument representing the Agreement between the parties hereto. 4.2 Construction of Terms. Nothing herein expressed or implied is intended, or shall be construed, to confer upon or give any person, firm or corporation, other than the parties hereto or their respective successors and assigns, any rights or remedies under or by reason of this Agreement. 4.3 Governing Law. This Agreement and the legal relations between the parties hereto shall be governed by and construed in accordance with the substantive laws of the State of Delaware without regard to Delaware choice of law rules. 8 9 4.4 Amendment and Modification. This Agreement may be amended, modified or supplemented only by a written agreement executed by the parties. 4.5 Assignment. This Agreement and all of the provisions hereof shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns, but neither this Agreement nor any of the rights, interests or obligations hereunder shall be assigned by any of the parties hereto without the prior written consent of the other parties, nor is this Agreement intended to confer upon any other person except the parties any rights or remedies hereunder. 4.6 Interpretation. The title, article and section headings contained in this Agreement are solely for the purpose of reference, are not part of the agreement of the parties and shall not in any way affect the meaning or interpretation of this Agreement. 4.7 Severability. In the event that any one or more of the provisions of this Agreement shall be held to be illegal, invalid or unenforceable in any respect, the same shall not in any respect affect the validity, legality or enforceability of the remainder of this Agreement, and the parties shall use their best efforts to replace such illegal, invalid or unenforceable provisions with an enforceable provision approximating, to the extent possible, the original intent of the parties. 4.8 Entire Agreement. This Agreement embodies the entire agreement and understanding of the parties hereto in respect to the subject matter contained herein. There are no representations, promises, warranties, covenants, or undertakings, other than those expressly set forth or referred to herein. This Agreement supersedes all prior agreements and the understandings between the parties with respect to such subject matter. 4.9 Fees. In any action or proceeding brought to enforce or interpret any provision of this Agreement (except with respect to matters described in Section 3.8 hereof) the successful party shall be entitled to reasonable fees of attorneys, accountants and other professionals as well as other costs incurred in connection with such action or proceeding. 4.10 Termination of Agreement. This Agreement shall terminate and be void, as if it never had been executed, if the Closing Date shall occur after January 15, 1997. 9 10 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. CREDIT MANAGEMENT SOLUTIONS, INC. ---------------------------------------- By: Name: Title: ---------------------------------------- James R. DeFrancesco ---------------------------------------- Scott L. Freiman 10 11 SCHEDULE A STOCKHOLDERS James R. DeFrancesco Scott L. Freiman 11 EX-10.15 10 NON-QUALIFIED STOCK OPTION PLAN 1 EXHIBIT 10.15 1996 CREDIT MANAGEMENT SOLUTIONS, INC. NON-QUALIFIED STOCK OPTION PLAN 1. PURPOSE OF THE PLAN. The purpose of this 1996 Credit Management Solutions, Inc. Non-Qualified Stock Option Plan (the "Plan") is to advance the interests of Credit Management Solutions, Inc., a Delaware corporation (the "Company"), by attracting and retaining non-Employee Directors and Employees who have significantly contributed, and will significantly contribute, to the growth and earnings of the Company by providing them with the opportunity to acquire Shares. By encouraging such stock ownership, the Company seeks to attract, retain and motivate the best available personnel for positions of substantial responsibility and to provide additional incentive to non-Employee Directors and Employees of the Company or any Affiliate to promote the success of the business. 2. DEFINITIONS. As used herein, the following definitions shall apply. (a) "Affiliate" shall mean any "parent corporation" or "subsidiary corporation" of the Company, as such terms are defined in Section 424(e) and (f), respectively, of the Code, and any other subsidiary corporations of a parent corporation of the Company. (b) "Agreement" shall mean a written agreement entered into in accordance with Paragraph 5(c) hereof. (c) "Board" shall mean the Board of Directors of the Company. (d) "Code" shall mean the Internal Revenue Code of 1986, as amended. (e) "Committee" shall mean the Stock Option Committee appointed by the Board in accordance with Paragraph 5(a) hereof. (f) "Common Stock" shall mean the common stock, par value $.01 per share, of the Company. (g) "Company" shall mean Credit Management Solutions, Inc. (h) "Continuous Service" shall mean the absence of any interruption or termination of service as an Employee or Director of the Company or an Affiliate. Continuous Service shall not be considered interrupted in the case of sick leave, military leave or any other leave of absence approved by the Company or in the case of transfers between payroll locations of the Company or between the Company, an Affiliate or a successor. (i) "Director" shall mean any member of the Board, and any member of the board of directors of any Affiliate that the Board has by resolution designated as being eligible for participation in this Plan. (j) "Effective Date" shall mean the date specified in Paragraph 12 hereof. 2 (k) "Employee" shall mean any person employed by the Company or an Affiliate who is an employee for federal tax purposes. (l) "Exercise Price" shall mean the price per Optioned Share at which an Option may be exercised. (m) "Market Value" shall mean the fair market value of the Common Stock, as determined under Paragraph 7(b) hereof. (n) "Option" means an option to purchase Common Stock. (o) "Optioned Shares" shall mean Shares granted pursuant to this Plan. (p) "Participant" shall mean any Employee or other person who receives an Option pursuant to the Plan. (q) "Share" shall mean one share of Common Stock. 3. TERM OF THE PLAN AND OPTIONS. (a) Term of the Plan. The Plan shall continue in effect for a term of 10 years from the Effective Date or the date the Plan is adopted by the Board (whichever period ends earlier), unless sooner terminated pursuant to Paragraph 14 hereof. No Option shall be granted under the Plan after such ten year term. (b) Term of Options. The term of each Option granted under the Plan shall be established by the Committee, but shall not exceed 10 years. 4. SHARES SUBJECT TO THE PLAN. Except as otherwise required by the provisions of Paragraph 9 hereof, the aggregate number of Shares deliverable pursuant to Options shall not exceed 2,750,000 Shares. Such Shares may either be authorized but unissued Shares or Shares held in treasury. If any Options should expire, become unexercisable, or be forfeited for any reason without having been exercised or become vested in full, the Optioned Shares shall, unless the Plan shall have been terminated, be available for the grant of additional Options under the Plan. 5. ADMINISTRATION OF THE PLAN. (a) Composition of the Committee. The Plan shall be administered by the Committee, which shall consist of not less than two (2) members of the Board. Members of the Committee shall serve at the pleasure of the Board. (b) Powers of the Committee. Except as limited by the express provisions of the Plan or by resolutions adopted by the Board, the Committee shall have sole and complete authority and discretion (i) to select Participants and grant Options, (ii) to determine the form and content of Options to be issued and the form of Agreements under the Plan, (iii) to interpret the Plan, (iv) to prescribe, amend and rescind rules and regulations relating to the Plan, and (v) to make other determinations necessary or advisable for the administration of the Plan. The Committee shall have and may exercise such other power and authority as may be delegated to it by the Board from time to time. A majority of the entire Committee shall constitute a quorum and the action of a majority of the members present at any meeting at which a quorum is present, or acts approved in writing by a majority of the Committee without a meeting, shall be deemed the action of the Committee. 2 3 (c) Agreement. Each Option shall be evidenced by a written agreement containing such provisions as may be approved by the Committee. Each such Agreement shall constitute a binding contract between the Company and the Participant, and every Participant, upon acceptance of such Agreement, shall be bound by the terms and restrictions of the Plan and of such Agreement. The terms of each such Agreement shall be in accordance with the Plan, but each Agreement may include such additional provisions and restrictions determined by the Committee, in its discretion, provided that such additional provisions and restrictions are not inconsistent with the terms of the Plan. In particular, the Committee shall set forth in each Agreement (i) the Exercise Price of an Option, (ii) the number of Shares subject to, and the expiration date of, the Option, (iii) the manner, time and rate (cumulative or otherwise) of exercise or vesting of such Option, and (iv) the restrictions, if any, to be placed upon such Option, or upon Shares which may be issued upon exercise of such Option. The Chairman of the Committee and such other Directors and officers of the Company as shall be designated by the Committee are hereby authorized to execute Agreements on behalf of the Company and to cause them to be delivered to the recipients of Options. (d) Effect of the Committee's Decisions. All decisions, determinations and interpretations of the Committee shall be final and conclusive on all persons affected thereby. (e) Indemnification. In addition to such other rights of indemnification as they may have, the members of the Committee shall be indemnified by the Company in connection with any claim, action, suit or proceeding relating to any action taken or failure to act under or in connection with the Plan or any Option, granted hereunder to the full extent provided for under the Company's governing instruments with respect to the indemnification of Directors. 6. GRANT OF OPTIONS. (a) Employees shall be eligible to receive discretionary grants of Options pursuant to the Plan. (b) Non-Employee Directors shall each receive an Option for 5,000 Option Shares at the commencement of each year of such person's directorship. 7. EXERCISE PRICE FOR OPTIONS. (a) Limits on Committee Discretion. The Exercise Price as to any particular Option shall not be less than 100% of the Market Value of the Optioned Shares on the date of grant. (b) Standards for Determining Exercise Price or Measurement Price. If the Common Stock is listed on a national securities exchange (including the NASDAQ National Market or Small Cap System) on the date in question, then the Market Value per Share shall be the average of the highest and lowest selling price on such exchange on such date, or if there were no sales on such date, then the Exercise Price shall be the mean between the bid and asked price on such date. If the Common Stock is traded otherwise than on a national securities exchange on the date in question, then the Market value per Share shall be the mean between the bid and asked price on such date, or, if there is no bid and asked price on such date, then on the next prior business day on which there was a bid and asked price. If no such bid and asked price is available, then the Market Value per Share shall be its fair market value as determined by the Committee, in its sole and absolute discretion. 3 4 8. EXERCISE OF OPTIONS. (a) Generally. Subject to (e) below, any Option granted hereunder shall be exercisable at such times and under such conditions as shall be permissible under the terms of the Plan and of the Agreement granted to a Participant. An Option may not be exercised for a fractional Share. (b) Procedure for Exercise. A Participant may exercise Options, subject to provisions relative to its termination and limitations on its exercise, only by (1) written notice of intent to exercise the option with respect to a specified number of Shares, and (2) payment to the Company (contemporaneously with delivery of such notice) in cash, in Common Stock, or a combination of cash and Common Stock, or in the sole discretion of the Committee, Participant's promissory note, for the amount of the Exercise Price for the number of Shares with respect to which the option is then being exercised. Each such notice (and payment where required) shall be delivered, or mailed by prepaid registered or certified mail, addressed to the Treasurer of the Company at the Company's executive offices. Common Stock utilized in full or partial payment of the Exercise Price for options shall be valued at its Market Value at the date of exercise. (c) Period of Exercisability. Except to the extent otherwise provided in more restrictive terms of an Agreement, an Option may be exercised by a Participant only with respect to the vested portion of such Option and only while he is an Employee or Director and has maintained Continuous Service from the date of the grant of the Option, or within three months after termination of such Continuous Service (but not later than the date on which the Option would otherwise expire), except if the Employee's or Director's Continuous Service terminates by reason of: (1) "Just Cause" which for purposes hereof shall have the meaning set forth in any unexpired employment agreement between the Participant and the Company (and, in the absence of any such agreement, shall mean termination because of the Employee's or Director's personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, willful violation of any law, rule or regulation, other than traffic violations or similar offenses) then the Participant's rights to exercise such Option shall expire on the date of such termination; (2) death, then all Options of the deceased Participant which have vested and which vest within two years of the date of death may be exercised within two years from the date of his death (but not later than the date on which the Option would otherwise expire) by the personal representatives of his estate or person or persons to whom his rights under such Option shall have passed by will or by laws of descent and distribution; (3) Permanent and Total Disability (as such term is defined in Section 22(e)(3) of the Code), then all Options of the disabled Participant which have vested and which vest within two years of the date of such disability may be exercised within one year from the date of such Permanent and Total Disability, but not later than the date on which the Option would otherwise expire. (d) Effect of the Committee's Decisions. The Committee's determination whether a Participant's Continuous Service has ceased, and the effective date thereof, shall be final and conclusive on all persons affected thereby. (e) Options shall vest and be exercisable as determined by the Committee subject to the foregoing. 4 5 9. EFFECT OF CHANGES IN COMMON STOCK SUBJECT TO THE PLAN. (a) Recapitalizations; Stock Splits, Etc. The number and kind of shares reserved for issuance under the Plan, and the number and kind of shares subject to outstanding Options (and the Exercise Price thereof) shall be proportionately adjusted for any increase, decrease, change or exchange of Shares for a different number or kind of shares or other securities of the Company which results from a merger, consolidation, recapitalization, reorganization, reclassification, stock dividend, split-up, combination of shares, or similar event in which the number or kind of shares is changed without the receipt or payment of consideration by the Company. (b) Transactions in which the Company Is Not the Surviving Entity. In the event of (i) the liquidation or dissolution of the Company, (ii) a merger or consolidation in which the Company is not the surviving entity, or (iii) the sale or disposition of all or substantially all of the Company's assets (any of the foregoing to be referred to herein as a "Transaction"), all outstanding Options shall be surrendered. With respect to each Option so surrendered as to which the holder has become vested, the Committee shall in its sole and absolute discretion, determine whether the holder of the vested surrendered Option shall receive: (1) for each Share then subject to an outstanding Option the number and kind of shares into which each outstanding Share (other than Shares held by dissenting stockholders) is changed or exchanged, together with an appropriate adjustment to the Exercise Price; or (2) a cash payment (from the Company or the successor corporation), in an amount equal to the Market Value of the Shares subject to the Option on the date of the Transaction, less the Exercise Price of the Option. (c) Conditions and Restrictions on New, Additional or Different Shares or Securities. If, by reason of any adjustment made pursuant to this Paragraph, a Participant becomes entitled to new, additional or different shares of stock or securities, such new, additional or different shares of stock or securities shall thereupon be subject to all of the conditions and restrictions which were applicable to the Shares pursuant to the Option before the adjustment was made. (d) Other Issuances. Except as expressly provided in this Paragraph, the issuance by the Company or an Affiliate of shares of stock of any class, or of securities convertible into Shares or stock of another class, for cash or property or for labor or services either upon direct sale or upon the exercise of rights or warrants to subscribe therefor, shall not affect, and no adjustment shall be made with respect to, the number, class or Exercise Price of Shares then subject to Options or reserved for issuance under the Plan. 10. NON-TRANSFERABILITY OF OPTIONS. Options may not be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner other than by will or by the laws of descent and distribution, or pursuant to the terms of a "qualified domestic relations order" (within the meaning of Section 414(p) of the Code and the regulations and rulings thereunder). An Option may be exercised only by a Participant, the Participant's personal representative or a permitted transferee. 11. TIME OF GRANTING OPTIONS. The date of grant of an Option shall, for all purposes, be the later of the date on which the Committee makes the determination of granting such Option, and the Effective Date. Notice of the determination shall be given to each Participant to whom an Option is so granted within a reasonable time after the date of such grant. 5 6 12. EFFECTIVE DATE. The Plan shall become effective as of June 27, 1996, the date it was authorized and established by the Board of Directors and stockholders of the Company. 13. MODIFICATION OF OPTIONS. At any time, and from time to time, the Board may authorize the Committee to direct execution of an instrument providing for the modification of any outstanding Option, provided no such modification shall confer on the holder of said Option any right or benefit which could not be conferred on him by the grant of a new Option at such time, or impair the Option without the consent of the holder of the Option. 14. AMENDMENT AND TERMINATION OF THE PLAN. The Board may from time to time amend the terms of the Plan and, with respect to any Shares at the time not subject to Options, suspend or terminate the Plan. Shareholder approval must be obtained for any amendment of the Plan that would change the number of Shares subject to the Plan (except in accordance with Section 9 above), change the category of persons eligible to be Participants, or materially increase the benefits under the Plan. No amendment, suspension or termination of the Plan shall, without the consent of any affected holders of an Option, alter or impair any rights or obligations under any Option theretofore granted. 15. CONDITIONS UPON ISSUANCE OF SHARES. (a) Compliance with Securities Laws. Shares of Common Stock shall not be issued with respect to any Option unless the issuance and delivery of such Shares shall comply with all relevant provisions of law, including, without limitation, the Securities Act of 1933, as amended, the rules and regulations promulgated thereunder, any applicable state securities law, and the requirements of any stock exchange upon which the Shares may then be listed. (b) Special Circumstances. The inability of the Company to obtain approval from any regulatory body or authority deemed by the Company's counsel to be necessary to the lawful issuance and sale of any Shares hereunder shall relieve the Company of any liability in respect of the non-issuance or sale of such Shares. As a condition to the exercise of an option, the Company may require the person exercising the Option to make such representations and warranties as may be necessary to assure the availability of an exemption from the registration requirements of federal or state securities law. (c) Committee Discretion. The Committee shall have the discretionary authority to impose in Agreements such restrictions on Shares as it may deem appropriate or desirable, including but not limited to the authority to impose a right of first refusal or to establish repurchase rights or both of these restrictions. (d) Restriction on Sale of Optioned Shares. For a period of 180 days commencing on the date of the Prospectus used in connection with the initial public offering of the Company's Shares pursuant to a Registration Statement on Form S-1 filed with the Securities and Exchange Commission, no Participant will directly or indirectly, sell, offer, contract to sell, transfer the economic risk of ownership in, make any short sale, pledge or otherwise dispose of any Option Shares without the prior written consent of the managing underwriter of such initial public offering or pursuant to the terms and conditions of that certain underwriting agreement to be entered into by and between the Company and the underwriters of such initial public offering. 6 7 16. RESERVATION OF SHARES. The Company, during the term of the Plan, will reserve and keep available a number of Shares sufficient to satisfy the requirements of the Plan. 17. WITHHOLDING TAX. The Company's obligation to deliver Shares upon exercise of Options shall be subject to the Participant's satisfaction of all applicable federal, state and local income and employment tax withholding obligations. The Committee, in its discretion, may permit the Participant to satisfy the obligation, in whole or in part, by irrevocably electing to have the Company withhold Shares, or to deliver to the Company Shares that he already owns, having a value equal to the amount required to be withheld. The value of Shares to be withheld, or delivered to the Company, shall be based on the Market Value of the Shares on the date the amount of tax to be withheld is to be determined. As an alternative, the Company may retain, or sell without notice, a number of such Shares sufficient to cover the amount required to be withheld. 18. NO EMPLOYMENT OR OTHER RIGHTS. In no event shall an Employee's or Director's eligibility to participate or participation in the Plan create or be deemed to create any legal or equitable right of the Employee, Director, or any other party to continue service with the Company or any Affiliate of such corporations. 7 EX-23.1 11 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" and to the use of our report dated October 28, 1996, in the Amendment No. 3 to the Registration Statement (Form S-1 No. 333-14007) and related Prospectus of Credit Management Solutions, Inc. for the registration of 2,600,000 shares of its common stock. /s/ Ernst & Young LLP Baltimore, Maryland December 5, 1996 -----END PRIVACY-ENHANCED MESSAGE-----