-----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, S/zeuLzF4vhjYMrn9d5yAhLvh9tIB7g05cTVRh/3TktTXvP6Qm5f9l7K8VZrESr2 2/+L6GPbYCAPc1tilkr4gw== 0000950133-99-001147.txt : 19990412 0000950133-99-001147.hdr.sgml : 19990412 ACCESSION NUMBER: 0000950133-99-001147 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CREDIT MANAGEMENT SOLUTIONS INC CENTRAL INDEX KEY: 0001024339 STANDARD INDUSTRIAL CLASSIFICATION: 7371 IRS NUMBER: 521549401 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-21735 FILM NUMBER: 99583608 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 10-K405 1 FORM 10-K DATED DECEMBER 31, 1998 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED [FEE REQUIRED] For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED [NO FEE REQUIRED] For the transition period from to ------------- ------------- Commission File Number 000-21735 CREDIT MANAGEMENT SOLUTIONS, INC. --------------------------------- (Exact Name of Registrant as Specified in Its Charter) Delaware 52-1549401 -------- ---------- (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 135 National Business Parkway, Annapolis Junction, MD 20701 - - ----------------------------------------------------- ----- (Address of Principal Executive Offices) (Zip Code)
(301) 362-6000 -------------- (Registrant's Telephone Number, Including Area Code) Securities registered pursuant to Section 12(b) of the Act: None ---- Securities registered pursuant to Section 12(g) of the Act: Title of each class ------------------- Common Stock, $0.01 par value Name of each exchange on which registered ----------------------------------------- Nasdaq National Market Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] 2 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] At March 26, 1999, Credit Management Solutions, Inc. had 7,649,770 shares of Common Stock, par value $0.01, outstanding. While it is difficult to determine the number of shares owned by non-affiliates, the registrant estimates that the aggregate market value of outstanding Common Stock on March 26, 1999 (based upon the average bid and asked prices of such Common Stock on the Nasdaq National Market on March 26, 1999) held by non-affiliates was approximately $13.1 million. For this computation, the registrant has excluded the market value of all shares of its Common Stock reported as beneficially owned by officers, directors and certain significant stockholders of the registrant. Such exclusion shall not be deemed to constitute an admission that any such stockholder is an affiliate of the registrant. DOCUMENTS INCORPORATED BY REFERENCE Items 10, 11, 12 and 13 of Part III of this Form 10-K are incorporated by reference from the registrant's definitive Proxy Statement to be furnished to stockholders in connection with the 1999 Annual Meeting of Stockholders. This Proxy Statement will be filed with the Securities and Exchange Commission pursuant to Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended, not later than April 30, 1999. -2- 3 DRAFT-03/29/99 PART I Item 1. Business. This report contains certain statements of a forward-looking nature relating to future events or the future financial performance of Credit Management Solutions, Inc. ("CMSI" or the "Company"). Investors are cautioned that such statements are only predictors and that actual events or results may differ materially. In evaluating such statements, investors should specifically consider the various factors identified in this Report which could cause actual results to differ materially from those indicated by such forward-looking statements, including the matters set forth in "-- Risk Factors." The Company was incorporated under the laws of the State of Maryland in 1987 and reincorporated under the laws of the State of Delaware in November 1996. CMSI is a developer and provider of software solutions and services for automating the consumer and small business credit analysis, decisioning and funding process. The Company's products and services allow its customers to automate the entire credit application process by enabling the rapid transmission of credit applications to multiple funding sources, expediting credit application analysis and decisioning and facilitating compliance with federal and state regulatory requirements. The Company's core product, CreditRevue(R), automates the entire credit application process form the entry of the credit application to the credit decision through the transfer funding to the lenders servicing system. To further support the needs of the lending industry, the Company developed CreditConnection(R), which became commercially available in July 1996. CreditConnection, a software-based service, links sources of credit origination through an online network that allows applications to be transmitted to multiple funding sources and credit decisions to be delivered back to the point of origin in a matter of minutes. In February, 1999, the Company introduced its Internet lending solution - CreditOnline(R) - a service that enables consumers and automobile dealers to originate indirect auto loans over the World Wide Web. Designed as a complete automobile financing solution, CreditOnline harnesses the power of the Internet to provide dealers with a real-time, online mechanism, to offer their customers the ability to submit a credit application electronically through the lenders or dealers web site and forward that application electronically to lenders. PRODUCTS AND SERVICES CreditRevue(R) CreditRevue is a UNIX-based software solution designed to automate the entire credit application process from the entry of the credit application to the credit decision and through the transfer of the funding information to the lender's servicing system. Using CreditRevue, a lender can automate the analysis of a wide range of consumer lending products, including vehicle loans and leases, home equity loans, student loans, telecommunications services and credit cards. Before CreditRevue is installed, the Company completes a review of the customer's credit application processing environment. CreditRevue is then configured to address the lender's specifications, including the lender's underwriting, approval and funding processes. The Company designs interfaces to the lender's other related systems, such as their branch automation software, customer information repository and loan servicing software. -3- 4 DRAFT-03/29/99 The Company markets the following supplemental CreditRevue products: - CreditRevue Student Lending is a specialized version of CreditRevue which, in addition to providing the full functionality of CreditRevue, is configured to support the requirements of the student lending marketplace. - CreditRevue Maestro is a product designed to work in conjunction with a client's existing credit origination order entry system providing complete background credit analysis, decisioning and pricing capabilities based on client defined criteria. This product is currently in development and is scheduled for delivery in Q2 1999. - CreditRevue Service Bureau, is a product designed to allow lenders to connect multiple terminals or personal computers to a service bureau system in order to access CreditRevue. CreditRevue Service Bureau is designed to be used by small and medium sized financial institutions seeking to minimize the up-front hardware and software costs of an in-house system. The Company intends to pursue strategic marketing alliances with established service bureau providers whereby such providers will be licensed to re-market CreditRevue Service Bureau to their existing clients on a transaction fee basis. To date the company has entered into alliances with AnyTime Access, Outsource Financial and M&I Services, Inc. - OneScore(TM) is a credit scoring product to assess small businesses. Using advanced statistical techniques, Dun & Bradstreet (D&B) has developed a blended scoring model that permits D&B's comprehensive commercial information to be intelligently combined with information on the principals of the business concerned. The consumer information is provided by independent consumer bureaus to help customers better assess credit risks in dealings with smaller businesses. The Company uses its proprietary credit processing system to implement the D&B model on behalf of D&B's customers. This is a transaction fee oriented service for which the Company receives a fee for each OneScore generated by a D&B client. - Dun & Bradstreet Portfolio Monitoring Service allows businesses to proactively manage individual small business credit relationships, automate various credit analyses and reporting functions, and effectively seize cross-sales opportunities. The service is based on Dun & Bradstreet's standard and custom credit scoring services and the Company's data integration and systems capabilities. The service offers standard and custom management reports and can forward processed portfolio accounts to a customer's internal data warehouse. The standard monitoring service uses OneScore(TM). Customers can also use custom scorecards to process their internal account performance data with external commercial and/or consumer data. The advanced statistical scorecard provides a business with a personalized view of the changing risk profiles in its small business portfolio. This is a transaction fee oriented service for which the Company receives fees based upon the number of small business accounts monitored, the monitoring frequency and the amount of custom development work selected. -4- 5 DRAFT-03/29/99 The Company previously marketed a version of CreditRevue referred to as CreditRevue 2000(TM). This version was designed to allow the software to be configured without extensive coding and at one time was targeted as a possible replacement for the Company's traditional CreditRevue offering. Due to the extensive flexibility designed into the product, the resulting performance characteristics could not surpass the traditionally custom designed CreditRevue systems. CreditRevue 2000 is the ideal platform for supporting the Company's CreditRevue Service Bureau offering. At this time, CreditRevue 2000 will only be offered to CreditRevue Service bureau alliance partners as the CreditRevue Service Bureau software. CreditConnection(R) The CreditConnection service and network offers connectivity between points of credit origination, such as automobile dealers, and multiple funding sources. The CreditConnection service allows a dealer to enter a credit application for a consumer loan or lease. The dealer can request one or more credit bureaus which can then be reviewed in several different formats. The dealer can select one or more lending institutions to which the credit application should be sent and can specify criteria which determines how the application is to be sequenced and automatically forwarded to secondary sources (e.g., if the first lending institution does not respond within 10 minutes). The dealer can then view the lenders' credit decisions online. If the lending institution supports automated funding, the dealer can have the funds for the loan transferred to the dealer's bank account without having to wait for the actual contract to arrive at the funding source. CreditConnection provides several other features to dealerships, including workflow management tools, payment calculator and broadcast news from participating funding sources. For the funding source, CreditConnection provides a single interface to communicate with any number and type of credit originator. The Company's agreements with each lending institution that subscribes to the CreditConnection service include a provision that the Company and the lending institution develop and implement a marketing plan describing how the lending institution will utilize its sales force to increase dealership subscriptions to the CreditConnection service. The Company also has been pursuing remarketing arrangements for the CreditConnection service with vendors that provide automated systems for dealership management and operations. The Company has signed agreements to form strategic alliances with the Dealer Service Group of ADP and Universal Computer Systems (UCS) to remarket CreditConnection. The agreements with ADP and UCS provide that such parties offer the CreditConnection service as their standard approach to establishing electronic interfaces between dealerships and financial institutions. Under certain limited circumstances, ADP and UCS may provide an interface which is different from the Company's. It is the Company's understanding that ADP and UCS do not currently remarket any third party products or services which compete with the CreditConnection service. See "-- Sales and Marketing." The Company's agreements with lending institutions that are licensees of CreditRevue typically require that the CreditConnection service be utilized as the exclusive interface between CreditRevue software and applications transmitted electronically from third parties through technology which permits the credit application to be transmitted to multiple lenders. The ability of CreditConnection lending institutions that are not CreditRevue licensees to receive applications transmitted electronically from -5- 6 DRAFT-03/29/99 third parties by means other than the CreditConnection service is not similarly restricted. The Company is also marketing CreditConnection LenderLink(TM), which facilitates the electronic transfer of credit applications and decisions between lending institutions through the CreditConnection network. Using CreditConnection LenderLink, a prime lender can automatically forward credit applications which it has declined to a sub-prime lender. The sub-prime lender can then return a decision electronically to the prime lender, which then communicates the decision to the credit originator. CreditConnection LenderLink benefits all three parties, the credit originator, the prime lender and the sub-prime lender. The credit originator gets a higher rate of approvals since applications declined by the prime lender have additional opportunities to be approved. The prime lender gets a referral fee from the sub-prime lender, and the sub-prime lender gets a source for additional customers. Additionally, the Company receives a transaction-based fee for each application transmitted to a sub-prime lender using CreditConnection LenderLink. The version of the CreditConnection software for Microsoft Corporation's Windows operating system is a graphical, client/server version of the dealer software that connects to the CreditConnection host using the Internet or a private network. This new software is designed to reduce communication costs and provides easier deployment, an improved user interface and additional functionality. The CreditConnection software for Microsoft Corporation's Windows operating system became commercially available in 1997. CreditOnline(R) In February, 1999, the Company introduced CreditOnline, its Internet lending solution. It has long been a part of the Company's E-commerce strategy to leverage its CreditConnection network to allow consumers to apply for loans with CreditConnection lenders over the Internet. Prior to CreditOnline, the Company introduced CreditConnection Online. Through its CreditConnection service the Company has established a standard portal to the credit origination systems of many leading lending institutions. This connectivity enables the Company to offer a comprehensive Internet strategy for online financing designed to service three types of clients - lenders, dealers, and consumers. - - - In the Lender Centric model consumers would typically apply for credit using the lender's Web site. In this model the lender directly controls the loan process. The fees for this service are both transaction and license fee based. - - - In the Dealer & Vehicle Aggregator Centric model consumers would typically apply for credit via the dealer or aggregators' Web site. In this model the dealer and/or the aggregator controls the loan process. The Company is in effect viewed as the gateway and portal between the dealers/vehicle aggregators and lenders. In this model, both the dealer and lender pay transaction and/or subscription fees. - - - In the Consumer Centric model the consumer is in control of the process. Unlike other online -6- 7 DRAFT-03/29/99 financing options, which usually provide consumers with an offer from only one lender, consumers can receive multiple offers within minutes using the CMSI technology and network. Under this model, the lender pays a transaction fee as well as a fee on a closed loan basis. Dealers enrolled in this model may pay a lead generation fee to receive qualified consumers and a subscription fee for CreditConnection. CreditConnection Online, originally developed in 1997, was used initially to originate automobile loans from ADP's AutoConnect(TM) Web site and forward those loans to NationsBank through CreditConnection. Following the initial development and pilot market test, CreditConnection Online re-engineered to support multiple lenders using browser development technology resulting in the new CreditOnline Service. CUSTOMERS The Company's customers are categorized by product type. With respect to the CreditRevue product, the Company has over 35 customers, including banks, savings and loan associations, finance companies, sub-prime lenders, leasing companies, student lenders and a telecommunications company. The Company intends to continue to focus on the financial services industry and to target the student lending, insurance, telecommunications, utilities and healthcare industries. With regards to its CreditConnection service, at December 31, 1998 the Company had contractual relationships with 27 lenders. The Company has developed electronic connections linking 21 financial institutions to the CreditConnection service. The Company's alliance with Dun & Bradstreet has resulted in 292 customers for the OneScore service and 2 customers for the Portfolio Monitoring service as of December 31, 1998. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of those customers who have accounted for 10% or more of the Company's revenues in any of the past three years. PRODUCT DEVELOPMENT Since its inception, the Company has made substantial investments in product development and has a dedicated product development organization which periodically releases new products and enhancements to existing products. The Company believes that its future performance will depend in large part on the Company's ability to enhance its current products and services and to develop new products on a timely and cost-effective basis that will keep pace with technological developments and evolving industry standards, as well as address the increasingly sophisticated needs of the Company's customers. While the Company anticipates that certain new products and services will be developed internally, the Company may, based on timing and cost considerations, acquire or license technology or software from third parties when appropriate. For a discussion of certain risks associated with the Company's product development program, see "- Risk Factors - Rapid Technological Change; Risk Associated with New Products, Services or Enhancements" and "- Risk Factors - Risk of Defects, Development Delays and Lack of Market Acceptance." As of December 31, 1998, the Company's product development staff consisted of 27 employees. The -7- 8 DRAFT-03/29/99 Company anticipates that it will continue to commit resources to product development in the future. CUSTOMER SERVICE AND SUPPORT The Company believes that its success is dependent in part upon its ability to provide customers with responsive, prompt and efficient support and training. Each customer has a maintenance agreement, which is typically coterminous with the license agreement, providing for service, support and product enhancements. The Company offers its clients a wide range of support services to assist them in deriving the most effective use of the Company's products and services, including technical support, formalized training and a user hotline. The Company's services also include implementation planning and assistance, software installation, software operations training and software maintenance. As of December 31, 1998, the Company's dedicated customer service and support team included 21 employees. CMSI's support personnel are available to its customers 24 hours a day, seven days a week through a hotline. The Company tracks each customer's service history to identify trends or problem areas and to recommend solution strategies. Most customer support questions are answered during the initial call. The Company can access a customer's system through a modem to diagnose the situation and implement corrective measures, if necessary. The Company also makes on-site visits for emergency or serious problem situations. The Company believes that its customers typically base their decisions to purchase the Company's products and services partly on the support and maintenance offered with such products and services. The Company intends to continue to strengthen its support team and reputation by adding professional personnel with significant experience in the financial services and software industries. SALES AND MARKETING As of December 31, 1998, the Company's sales and marketing organization consisted of 21 employees, 17 of whom are based at the Company's corporate headquarters in Annapolis Junction, Maryland. To support its sales force, the Company conducts comprehensive marketing programs, which include direct mail, public relations, seminars, trade shows and ongoing customer communications programs. The Company also sponsors an annual users' group meeting for its CreditRevue customers. The Company sells its CreditRevue products through a direct sales organization. The sales cycle begins with the generation of a sales lead or the receipt of a request for proposals from a prospective customer. While the sales cycle varies substantially from customer to customer, it typically requires six to eight months. The sales effort for CreditConnection comprises both direct and indirect marketing activities. Direct sales efforts are conducted by a direct sales organization and are concentrated on selling the service to financial institutions, automobile superstores, independent dealerships, and finance and insurance systems providers. Direct sales efforts are supported by participation in both financial and automotive trade shows and conferences, financial press relations, telemarketing, advertising campaigns and targeted mailings. The Company also supports the indirect sales efforts of the sales organizations of certain financial institutions which have well-established relationships with many of the automobile dealerships in the United States. The Company supports its indirect sales channels through a variety of marketing communications efforts including the development of brochures and direct mail pieces, production of sales videos, participation in trade shows and conferences, support for bank dealer focus -8- 9 DRAFT-03/29/99 groups, advertising, press relations and seminar support. In November 1996, the Company entered into an agreement to form a strategic alliance with the Dealer Services Group of ADP. Under the terms of the agreement, the Company and ADP have agreed to integrate CreditConnection with ADP's automated dealership management and operations systems so that ADP can remarket and license CreditConnection to ADP's automobile dealer customers. In exchange for its services, ADP is entitled to a percentage of the net revenues from transactions generated by ADP's dealers. In addition, pursuant to the agreement, ADP has the right to name one director to the Company's Board of Directors. In August 1997, the Company entered into an agreement to form a strategic alliance with Universal Computer Systems, Inc. ("UCS") whereby UCS can remarket and license CreditConnection to UCS's automobile dealer customers. While the Company has also initiated discussions with other dealer system vendors and intends to establish relationships with such vendors to expand the market presence of CreditConnection, no such additional relationships have been finalized. BACKLOG At December 31, 1998, the Company had entered into contracts for its services for which $2.5 million of revenues will be recognized in future periods. At December 31, 1997, the comparable amount was $4.3 million. COMPETITION The credit processing software and services industry is intensely competitive and rapidly changing. The Company believes its ability to compete depends upon many factors within and outside its control, including the timing and market acceptance of new products and services and enhancements developed by the Company and its competitors, including (i) application software companies, (ii) management information systems departments of potential customers, (iii) third-party professional services organizations, and (iv) computer services outsourcing providers which offer service bureau-based credit processing solutions. Competitors for CreditRevue include American Management Systems, Inc., Appro Systems, Inc., CFI ProServices, Inc., Fair, Isaac and Company, Inc., Affinity Technology Group, Inc and Corporate Solutions International, Inc. While at the outset of 1997 The Reynolds & Reynolds Company ("Reynolds"), and International Business Machines Corporation ("IBM"), each separately marketed solutions competitive with the CreditConnection, it is not clear that either Reynolds or IBM is continuing or plans to continue marketing these solutions. Many of the Company's competitors are substantially larger than the Company and have significantly greater financial, technical and marketing resources and established, extensive direct and indirect channels of distribution. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products and services than the Company. As is typical in the software industry, many actual or potential customers of the Company may become competitors by developing competitive technology internally. Due to the relatively low barriers to entry in the software market, the Company expects additional competition from other established and emerging companies as the credit processing software market continues to develop and expand. The Company also expects that competition will increase as a result of software industry consolidations. The Company anticipates that its competitors may develop or acquire products or services that provide functionality that is similar to that produced by the Company's products and services, and that such -9- 10 DRAFT-03/29/99 products and services may be offered at a significantly lower price or bundled with other products and services. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of the Company's prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any of which would have a material adverse effect on the Company's business, results of operations and financial condition. There can be no assurance that the Company will be able to compete successfully against current or future competitors or that competitive pressures will not have a material adverse effect on the Company's business, results of operations and financial condition. INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS The Company's success is heavily dependent upon its proprietary technology. The Company regards its software products and services as proprietary, and relies primarily on a combination of copyright protection, and patent protection, trade secrets protection, confidentiality agreements and contractual provisions to protect its proprietary rights. The Company has no patents on its CreditRevue products currently in commercial use, and existing trade secrets, copyright laws and contractual provisions afford only limited protection. In March of 1999, the U.S. Patent and Trademark Office issued the Company U.S. Patent 5,878,403 on the technology supporting its CreditConnection service. There can be no assurance this patent would survive a legal challenge to its validity or provide adequate protection. Furthermore, there can be no assurance that others will not design around any patents issued to the Company. It is the Company's policy to enter into confidentiality and assignment agreements with its employees. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use the Company's products or technology without authorization, to obtain and use information that the Company regards as proprietary, or to develop similar or superior products or technology independently. Policing unauthorized use of the Company's products is difficult, and while the Company is unable to determine the extent to which piracy of its software products exists, software piracy can be expected to be a persistent problem, particularly in international markets and as a result of the growing use of the Internet. The source code for the Company's proprietary software is protected both as a trade secret and as a copyrighted work. The Company has in the past and may in the future make source code for one or more of its products available to certain of its customers and strategic partners which may increase the likelihood of misappropriation or other misuse of the Company's software. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that the steps taken by the Company to protect its proprietary rights will be adequate or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technologies. "CreditRevue," "CreditConnection", and "INCredit" and "CreditOnline" are registered trademarks of the Company. "CrossSell," "CreditRevue Service Bureau," "CreditRevue Student Lending," "CreditRevue Data Server," "CreditRevue Maestro," "CreditConnection Online," "CreditConnection LenderLink", "CreditOnline" and the Company logo are trademarks or registered tradenames of the Company. The Company is not aware that any of its products, services, trademarks or other proprietary rights infringes the proprietary rights of third parties. However, there can be no assurance -10- 11 DRAFT-03/29/99 that third parties will not assert infringement claims against the Company in the future with respect to current or future products or services. As the number of software products and services in the industry increases and the functionality of these products and services further overlaps, the Company believes that software developers may become increasingly subject to infringement claims. Furthermore, there can be no assurance that former employers of the Company's present and future employees will not assert claims that such employees have improperly disclosed confidential or proprietary information to the Company. Any such claims, with or without merit, can be time consuming and expensive to defend, cause product and service delays, or require the Company to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company, or at all, which could have a material adverse effect on the Company's business, results of operations and financial condition. EMPLOYEES As of December 31, 1998, the Company had 205 full time employees, including 27 in product development, 114 in technical operations, 21 in sales and marketing and 22 in finance and administration. The Company's employees are not covered by any collective bargaining agreements. The Company has experienced no work stoppages and believes that its relations with its employees are good. RISK FACTORS Uncertainty of Future Results of Operations; Fluctuations in Quarterly Results of Operations Prior growth rates in the Company's revenue and net income should not be considered indicative of future results of operations. Future results of operations will depend upon many factors, including market acceptance of new services, including the Company's CreditConnection, CreditRevue Service Bureau, CreditRevue Maestro and CreditOnline products, the demand for the Company's products and services, the success of the Company's relationships with third party remarketers of CreditConnection, the successful transition from predominantly license fee-based revenue to predominantly transaction fee-based revenue, the timing of new product and service introductions and software enhancements by the Company or its competitors, the level of product, service and price competition, the length of the Company's sales cycle, the size and timing of individual transactions, the delay or deferral of customer implementations, the Company's success in expanding its customer support organization, direct sales force and indirect distribution channels, the nature and timing of significant marketing programs, the mix of products and services sold, the timing of new hires, the ability of the Company to develop and market new products and services and control costs, competitive conditions in the industry and general economic conditions. In addition, the decision to implement the Company's products or services typically involves a significant commitment of customer resources and is subject to the budget cycles of the Company's customers. Licenses of CreditRevue generally reflect a relatively high amount of revenue per order. The loss, cancellation or delay of individual orders, therefore, 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 -11- 12 DRAFT-03/29/99 percentage-of-completion basis, the timing of revenue recognition for its licenses may be materially and adversely affected by delays or deferrals of customer implementations. Such delays or deferrals may also increase expenses associated with such implementations which would materially and adversely affect related operating margins. The Company's operating expenses are based in part on planned product and service introductions and anticipated revenue trends and, because a high percentage of these expenses are relatively fixed, a delay in the recognition of revenue from a limited number of transactions could cause significant variations in operating results from quarter-to-quarter and could result in operating losses. To the extent such expenses precede, or are not subsequently followed by, increased revenues, the Company's results of operations would be materially and adversely affected. As a result of these and other factors, revenues for any quarter are subject to significant variation, and the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. There can be no assurance that the Company will be profitable in any future quarter or that such fluctuations in results of operations will not result in volatility in the price of the Company's Common Stock. Due to all of the foregoing factors, it is likely that in some future quarter the Company's results of operations will be below the expectations of public market analysts and investors. In such event, the market price of the Company's Common Stock will be materially and adversely affected. See "-- Market Acceptance of Credit Connection; Transition to Transaction-Based Revenue" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Quarterly Information." Dependence on CreditRevue Product Line License fees, maintenance fees and third-party computer hardware sales associated with licenses and installations of CreditRevue accounted for substantially all of the Company's revenues through December 31, 1998. Although the Company introduced its CreditConnection service in the fourth quarter of 1996, its Dun & Bradstreet OneScore Service in the fourth quarter of 1997, and its CreditRevue Service Bureau in January 1998, the Company expects that revenues generated from licenses and installations of CreditRevue will continue to account for a significant portion of the Company's revenues for the foreseeable future. The life cycles of the Company's products and services are difficult to predict due to the effect of new product and service introductions or software enhancements by the Company or its competitors, market acceptance of new and enhanced versions of the Company's products and services, and competition in the Company's marketplace. A decline in the demand for CreditRevue, whether as a result of competition, technological change, price reductions or otherwise, would have a material adverse effect on the Company's business, results of operations and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." -12- 13 DRAFT-03/29/99 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 CreditConnection; Transition to Transaction-Based Revenue The Company's CreditConnection service was commercially introduced in 1996, the Company's CreditOnline service was introduced in February, 1999, and the Company's CreditRevue Service Bureau service was commercially introduced through strategic alliance partner, AnyTime Access, in January, 1998. The CreditConnection service, the CreditOnline service and the CreditRevue Service Bureau service (as provided by AnyTime Access and other third parties to which the Company licenses the CreditRevue Service Bureau) are projected to account for a significant portion of the Company's revenues in the future. As a result, demand and market acceptance for these services are subject to a high level of uncertainty, and the Company will be heavily dependent on their market acceptance. There can be no assurance that these services will be commercially successful. The failure of the Company to generate demand for CreditConnection, CreditOnline or CreditRevue Service Bureau or the occurrence of any significant technological problems with such services would have a material adverse effect on the Company's business, results of operations and financial condition. Historically, virtually all of the Company's revenues have been derived from license fees, maintenance fees and hardware sales associated with licenses and installations of CreditRevue. Under the terms of its license agreements, a majority of the Company's revenues are realized during the configuration and installation of CreditRevue. However, the Company anticipates that a significant portion of the Company's future revenues will be derived from per-usage transaction-based fees and subscription fees charged to credit originators and financial institutions for transactions originated through the CreditConnection, CreditOnline and CreditRevue Service Bureau services. There can be no assurance that the Company will successfully manage the transition of a significant portion of its revenues from license-based revenue to transaction-based revenue. The failure of the Company to successfully manage the transition to a transaction-based revenue stream would have a material adverse effect on the Company's business, results of operations and financial condition. -13- 14 DRAFT-03/29/99 Reliance on Certain Relationships The Company has established relationships with a number of companies that it believes are important to its sales, marketing and support activities, as well as to its product, service and software development efforts. The Company has relationships with automated scorecard companies, hardware vendors and credit bureaus. There can be no assurance that these relationships will be successful on an on-going basis. Moreover, there can be no assurance that these companies, most of which have significantly greater financial and marketing resources than the Company, will not develop or market products and services which will compete with the Company's products and services in the future. Furthermore, since many of these relationships are informal in nature, they are terminable by either party at will. Other relationships are terminable by either party after a relatively short notice period. There can be no assurance that these companies will not otherwise discontinue their relationships with or support of the Company. The failure by the Company to leverage and maintain its existing relationships or to establish new relationships in the future, because of a divergence of interests, acquisition of one or more of these third parties or other reasons could have a material adverse effect on the Company's business, results of operations and financial condition. See "-- Sales and Marketing." In addition, the Company has formed strategic alliances with ADP and UCS for remarketing CreditConnection and with D&B for the marketing of OneScore. There can be no assurance that these relationships will be successful. Moreover, there can be no assurance that these companies will actively remarket CreditConnection or OneScore. The failure by the Company to leverage and maintain its existing relationships with ADP, UCS and D&B, or to establish new relationships in the future, because of a divergence of interests, acquisition of one or more of these third parties or other reasons, could have a material adverse effect on the Company's business, results of operations and financial condition. See "-- Sales and Marketing." Dependence on Large License Fee Contracts and Customer Concentration A relatively small number of customers have accounted for a significant percentage of the Company's revenues. License fees for CreditRevue are based on a percentage-of-completion method on a cost-incurred basis with the final installment being paid in full upon acceptance of the Company's software. The Company receives continuing revenues on CreditRevue from annual maintenance agreements which commence upon acceptance of the software by the customer. Maintenance agreements are renewable annually by the customer, and the license agreements are co-terminous with the maintenance agreements. Although the Company has experienced a high degree of customer loyalty, the Company cannot predict how many maintenance agreements will be renewed or the number of years of renewal. Revenues generated by the Company's 10 largest customers accounted for 55.4% and 48.8% of total revenues in 1998 and 1997, respectively. The Company expects that a limited number of customers will continue to account for a significant percentage of revenue for the foreseeable future. The loss of any major customer or any reduction or delay in orders by any such customer, delay or deferral in configurations or enhancements by such customers, termination of orders by any such customer, or the failure of the Company to successfully market its products or services to new customers, could have a material adverse effect on the Company's business, results of operations and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Dependence on Consumer Retail Lending Industry; Cyclical Nature of Consumer Lending -14- 15 DRAFT-03/29/99 The Company's business is currently concentrated in the consumer lending industry and is expected to be so concentrated for the foreseeable future, thereby making the Company susceptible to a downturn in the consumer lending industry. For example, a decrease in consumer lending could result in a smaller overall market for the Company's products and services. Furthermore, banks in the United States are continuing to consolidate, decreasing the overall potential number of customers for the Company's products and services. In addition, demand for consumer loans has been historically cyclical, in large part based on general economic conditions and cycles in overall consumer indebtedness levels. Changes in general economic conditions that adversely affect the demand for consumer loans, the willingness of financial institutions to provide funds for such loans, changes in interest rates and the overall consumer indebtedness level, as well as other factors affecting the consumer lending industry, could have a material adverse effect on the Company's business, results of operations and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Management of Changing Business The Company has experienced significant changes in its business, including changes in the Company's staff and customer base and the development of new products, services and enhancements to its software, including the commercial release of CreditConnection in 1996. Such changes have placed and may continue to place a significant strain upon the Company's management, systems and resources. The Company's ability to compete effectively and to manage future changes will require the Company to continue to improve its financial and management controls, reporting systems and procedures, budgeting and forecasting capabilities on a timely basis, expand its sales and marketing work force and train and manage its employee work force. There can be no assurance that the Company, or the Company's current management, will be able to manage such changes successfully. The Company's failure to do so could have a material adverse effect upon the Company's business, results of operations and financial condition. See "-- Sales and Marketing." Dependence on Key Personnel The Company's future performance depends in significant part upon the continued service of its key technical, sales and senior management personnel, particularly James R. DeFrancesco, Chairman and Chief Executive Officer, Peter M. Leger, President and Chief Operating Officer and Scott L. Freiman, Executive Vice President. The Company has obtained key-person life insurance on the lives of each of Messrs. DeFrancesco and Freiman although the Company does not believe that such insurance is adequate to compensate for the loss of either executive. The loss of the services of one or more of the Company's executive officers could have a material adverse effect on the Company's business, results of operations and financial condition. The Company retains its key employees through the use of equity incentive programs, including stock option plans, employee stock purchase plans, and competitive compensation packages. Except with respect to Mr. Leger, the Company has no employment agreements and does not intend to enter into any additional agreements in the foreseeable future. The Company's future success also depends on its continuing ability to attract and retain highly qualified managerial, sales, technical, and customer support personnel. In particular, the Company has encountered difficulties in hiring sufficient numbers of programmers and technical personnel. Competition for qualified personnel is intense, and there can be no assurance that the Company will be able to retain its key technical, sales and managerial employees or that it can attract, assimilate or retain other highly qualified technical, sales and managerial personnel in the future. -15- 16 DRAFT-03/29/99 Rapid Technological Change; Risk Associated with New Products, Services or Enhancements The credit processing software products and services industry in which the Company competes is characterized by rapid technological change, frequent introductions of new products and services, changes in customer demands and evolving industry standards. The introduction or announcement of new products, services or enhancements by the Company or one or more of its competitors embodying new technologies or changes in industry standards or customer requirements could render the Company's existing products or services obsolete or unmarketable. Accordingly, the life cycles of the Company's products are difficult to estimate. The Company's future results of operations will depend, in part, upon its ability to enhance its products and services and to develop and introduce new products and services on a timely and cost-effective basis that will keep pace with technological developments and evolving industry standards, as well as address the increasingly sophisticated needs of the Company's customers. The Company has in the past and may in the future experience significant delays in product development. There can be no assurance that these new products and services, if developed, will gain market acceptance or that the Company will be successful in developing and marketing new products or services that respond to technological change, evolving industry standards and changing customer requirements, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products or services, or that its new products or services will adequately meet the requirements of the marketplace and achieve any significant degree of market acceptance. In addition, a majority of the Company's current products operate in the UNIX operating system. Although the Company's software is designed to work with other operating environments, a requirement to port to a different operating system could be costly and time consuming and could have a material adverse effect on the Company's business, results of operations and financial condition. Failure of the Company to develop and introduce, for technological or other reasons, new products and services in a timely and cost-effective manner could have a material adverse effect on the Company's business, results of operations and financial condition. Furthermore, the introduction or announcement of new product or service offerings or enhancements by the Company or the Company's competitors may cause customers to defer or forgo purchases of the Company's products or services, which could have a material adverse effect on the Company's business, results of operations and financial condition. See "-- Product Development." System Interruption and Security Risks; Potential Liability; Possible Lack of Adequate Insurance; and System Inadequacy The Company's operations are dependent, in part, on its ability to protect its system from interruption by damage from fire, earthquake, power loss, telecommunication failure, unauthorized entry or other events beyond the Company's control. The Company's computer equipment constituting its central computer system, including its processing operations, is located at a single site. The Company is currently in the process of acquiring and implementing a back-up, off-site processing system capable of fully supporting its operations in the event of system failure. During 1997, the Company implemented a limited redundant data center. The Company relocated operations to new leased facilities in Annapolis Junction, MD in late 1998. The new facilities, which include a state of the art data center, will become the primary production center for the Company's data processing needs. The Company also renewed its lease on its former data center located in Columbia, Maryland. This former center will, during 1999, become a back-up center capable of fully supporting operations in the event of failure of the new production center. Prior to full implementation of the new facility and the back up facility, the -16- 17 DRAFT-03/29/99 Company's operations are subject to substantial risks, including temporary interruptions resulting from damage caused by any one or more of the foregoing factors or due to other causes including computer viruses, hackers or similar disruptive problems. While the Company maintains $1.6 million of property insurance coverage, business interruption insurance coverage, $2.0 million of errors and omissions insurance coverage and $10.0 million of umbrella insurance coverage, such insurance may not be adequate to compensate the Company for all losses that may occur or to provide for costs associated with system failure or business interruption. Any damage or failure that causes interruptions in the Company's operations could have a material adverse effect on the Company's business, results of operations and financial condition. Persistent problems continue to affect public and private data networks. For example, in a number of networks, hackers have bypassed firewalls and have appropriated confidential information. Such computer break-ins and other disruptions may jeopardize the security of information stored in and transmitted through the computer systems of the parties utilizing the Company's services, which may result in significant liability to the Company and also may deter potential customers from using the Company's services. In addition, while the Company attempts to be careful with respect to the employees it hires and maintain controls through software design and security systems to prevent unauthorized employee access, it is possible that, despite such safeguards, an employee of the Company could obtain access, which would also expose the Company to a risk of loss or litigation and possible liability to users. The Company attempts to limit its liability to customers, including liability arising from the failure of the security features contained in the Company's system and services, through contractual provisions. However, there can be no assurance that such limitations will be enforceable. There can be no guarantee that the growth of the Company's customer base will not strain or exceed the capacity of its computer and telecommunications systems and lead to degradations in performance or system failure. Any damage, failure or delay that causes interruptions in the Company's operations could have a material adverse effect on the Company's business, results of operations and financial condition. Risk of Defects, Development Delays and Lack of Market Acceptance Software products and services as sophisticated as those offered by the Company often encounter development delays and may contain defects or failures when introduced or when new versions are released. The Company has in the past and may in the future experience significant delays in the development of software and has discovered, and may in the future discover, software defects in certain of its products. Such delays and defects may result in lost revenues during the time corrective measures are being taken and may result in additional development costs. Although the Company has not experienced material adverse effects resulting from any such defects to date, there can be no assurance that, despite testing by the Company, errors will not be found in its existing software or in future releases or enhancements. The Company may continue to experience development delays, resulting in delays in the commercial release of new products and services, the loss of market share or the failure to achieve market acceptance. Any such occurrence could have a material adverse effect upon the Company's business, results of operations and financial condition. See "-- Products and Services" and "-- Product Development." Future Capital Needs; Uncertainty of Additional Financing The Company currently anticipates that its available cash resources combined with anticipated funds from operations and its bank line of credit will be sufficient to meet its presently anticipated working -17- 18 DRAFT-03/29/99 capital and capital expenditure and debt repayment requirements through 1999. Thereafter, the Company may need to raise additional funds. The Company may need to raise additional funds sooner in order to fund more rapid expansion, to develop new or enhanced products and services, to respond to competitive pressures or to acquire complimentary businesses or technologies. If additional funds are raised through the issuance of equity securities, the percentage ownership of the stockholders of the Company will be reduced, stockholders may experience additional dilution, or such equity securities may have rights, preferences or privileges senior to those of the holders of the Company's Common Stock. There can be no assurance that additional financing will be available when needed on terms favorable to the Company or at all. If adequate funds are not available or are not available on acceptable terms, the Company may be unable to develop or enhance its products and services, take advantage of future opportunities or respond to competitive pressures, which could have a material adverse effect on the Company's business, results of operations and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Government Regulation and Uncertainties of Future Regulation The Company's current and prospective customers, which consist of state and federally chartered banks, savings and loan associations, credit unions, consumer finance companies and other consumer lenders, as well as customers in the industries that the Company may target in the future, operate in markets that are subject to extensive and complex federal and state regulations. While the Company may not itself be directly subject to such regulations, the Company's products and services must be designed to work within the extensive and evolving regulatory constraints in which its customers operate. These constraints include federal and state truth-in-lending disclosure rules, state usury laws, the Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Community Reinvestment Act. Furthermore, some consumer groups have expressed concern regarding the privacy and security of automated credit processing, the use of automated credit scoring tools in credit underwriting and whether electronic lending is a desirable technological development in light of the current level of consumer debt. The failure by the Company's products and services to support customers' compliance with current regulations and to address changes in customers' regulatory environment, or to adapt to such changes in an efficient and cost-effective manner, could have a material adverse effect on the Company's business, results of operations and financial condition. Year 2000 Issue The Year 2000 issue is a result of computer programs which store or process date - - -related information using only two digits to represent the year. These programs may not be able to properly distinguish between a year in the 1900's and a year in the 2000's. Failure of these programs to distinguish between the two centuries could cause the programs to yield erroneous results or even to fail. See "Management's Discussion and Analysis of Financial Condition - Year 2000 Compliance." Control by Existing Stockholders Assuming no exercise of outstanding options, James R. DeFrancesco, the Company's President and Chief Executive Officer, and Scott L. Freiman, the Company's Executive Vice President, collectively beneficially own approximately 60% of the outstanding shares of Common Stock. As a result, these stockholders will be able to exercise control over matters requiring stockholder approval, including the election of directors, and the approval of mergers, consolidations and sales of all or substantially all of the assets of the Company. This may prevent or discourage tender offers for the Company's Common Stock unless the terms are approved by such stockholders. Possible Volatility of Stock Price -18- 19 DRAFT-03/29/99 The trading price of the Company's Common Stock has in the past and may in the future be subject to significant fluctuations in response to variations in quarterly operating results, changes in earning estimates by analysts, the gain or loss of significant orders, announcements of technological innovations or new products by the Company or its competitors, general conditions in the consumer lending and software industries, credit processing software and services, and other events or factors. In addition, the stock market in general has experienced extreme price and volume fluctuations which have affected the market price for many companies in industries similar to or related to that of the Company and which have been unrelated to the operating performance of these companies. These market fluctuations may adversely affect the market price of the Company's Common Stock. Effect of Certain Charter Provisions; Antitakeover Effects of Certificate of Incorporation, Bylaws and Delaware Law The Company's Board of Directors has the authority to issue up to 1,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights of those shares, without any further vote or action by the stockholders. The Preferred Stock could be issued with voting, liquidation, dividend and other rights superior to those of the Common Stock. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company. Further, certain provisions of the Company's Certificate of Incorporation, including provisions that create a classified Board of Directors, and certain provisions of the Company's Bylaws and of Delaware law could delay or make more difficult a merger, tender offer or proxy contest involving the Company. Item 2. Properties. The Company's principal executive offices are located in Annapolis Junction, Maryland in a leased facility consisting of approximately 71,000 square feet of office space under lease that expires in 2008. The Company additionally has the right to either one five-year or one three-year renewal option. The Company has a right of first refusal on additional office space in the same building. The Company previously occupied approximately 55,000 square feet of office space in Columbia, Maryland under several leases that expire in 2002. As of December 31, 1998, the Company remained liable for approximately 20,000 square feet of the 55,000 square feet previously occupied. The Company is actively attempting to sublet the remaining former space, but no assurance can be given that such program will be successful, or, if successful, that the Company will be able to sublet its existing office space on commercially reasonable terms. At year end 1998 the Company recorded a liability of approximately $1.2 million representing the future minimum lease payments under the leases. Additionally, the Company entered into a new five year lease for approximately 4,000 square feet of data center space at its former offices in Columbia, Maryland. This data center will serve as a back-up facility which, when fully operational in mid 1999, will be capable of fully supporting operations in the event of failure of the Company's primary production center in Annapolis Junction, Maryland. Item 3. Legal Proceedings. -19- 20 DRAFT-03/29/99 The Company filed a complaint on January 26, 1998 in the Circuit Court for Howard County, Maryland, asserting claims against The Money Store Auto Finance, Inc. and The Money Store Service Corporation (collectively, the "Money Store"). The Money Store unilaterally terminated a contract under which CMSI was developing software to be licensed by the Money Store. Repeated efforts by CMSI to obtain settlement which would avoid litigation failed. The original software license price was $1.5 million. The Money Store originally paid $375,000 to the Company, which was recognized as revenues for the third quarter of 1997. Effective June 30, 1998, The Money Store was acquired by First Union Corporation. In July, 1998, First Union Corporation entered into an agreement to license CreditRevue and enrolled in the CreditConnection Service. At the time that First Union entered into these agreements, The Money Store paid the Company $283,750 in full settlement of the complaint filed by the Company against The Money Store. Item 4. Submission of Matters to a Vote of Security Holders. (a) Not applicable. (b) Not applicable. (c) Not applicable. (d) Not applicable. Item 5. Market for Registrants Common Equity and Related Shareholder Matters Not applicable -20- 21 DRAFT-03/29/99 PART II MARKET INFORMATION The Company's Common Stock is traded on the Nasdaq National Market under the symbol "CMSS." The following table sets forth, for the calendar periods indicated, the range of high and low bid quotations as reported by the Nasdaq National Market. These quotations reflect inter-dealer prices, without retail mark-up, markdown or commission and may not necessarily represent actual transactions.
STOCK PRICE ----------- HIGH LOW ---- --- CALENDAR YEAR 1996: December 18, 1996-December 31, 1996 $14.50 $11.50 CALENDAR YEAR 1997: First Quarter $20.25 $10.25 Second Quarter $13.50 $ 9.00 Third Quarter $18.25 $10.25 Fourth Quarter $19.38 $ 9.75 CALENDAR YEAR 1998: First Quarter $13.19 $ 7.50 Second Quarter $ 8.50 $ 5.25 Third Quarter $ 9.50 $ 5.63 Fourth Quarter $ 7.38 $ 4.06 CALENDAR YEAR 1999: $ 5.50 $ 3.88 First Quarter (through March 26, 1999)
On March 26, 1999, the last reported sales price for the Company's Common Stock on the Nasdaq National Market was $4.13 per share. HOLDERS As of March 26, 1999, the approximate number of registered stockholders of record of the Common Stock was 227. DIVIDENDS The Company does not anticipate paying any cash dividends in the foreseeable future. The Company currently intends to retain any future earnings for use in its business. In addition, the Company's bank line of credit prohibits the payment of cash dividends without the bank's prior written consent. -21- 22 DRAFT-03/29/99 Item 6. Selected Consolidated Financial Data. The consolidated statement of operations data set forth below for the fiscal years ended December 31, 1994, 1995, 1996, 1997 and 1998 and the consolidated balance sheet data at December 31, 1994, 1995, 1996, 1997 and 1998 have been derived from the audited consolidated financial statements of the Company. The consolidated balance sheets at December 31, 1997 and 1998, and the consolidated statement of operations for each of the years in the three year period ended December 31, 1998, together with the notes thereto and the related report of Ernst & Young LLP, are included elsewhere in this Report. The selected financial data set forth below are qualified in their entirety by, and should be read in conjunction with, the consolidated financial statements, the related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Report.
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------------- 1994 1995 1996 1997 1998 STATEMENT OF OPERATIONS DATA: ---------- --------- ----------- ----------- ------------ REVENUES License and software development fees . . . . $2,934,450 $ 7,207,581 $10,101,377 $11,549,378 $ 10,186,421 Maintenance fees . . . . . . . . . . . . . . 700,861 1,170,447 2,045,258 3,311,013 4,294,572 Computer hardware sales . . . . . . . . . . . 316,145 1,853,424 2,106,634 1,656,530 776,790 Service bureau revenues -- -- -- 640,818 1,644,991 ----------- ---------- ----------- ----------- ------------ 3,951,456 10,231,452 14,253,269 17,157,739 16,902,774 COSTS OF REVENUES Cost of license and software development fees 1,482,036 3,559,798 5,095,814 7,329,091 6,988,649 Cost of maintenance fees . . . . . . . . . . 151,346 280,176 452,559 880,360 1,108,367 Cost of computer hardware sales . . . . . . . 315,262 1,500,816 1,782,166 1,504,915 952,662 Cost of service bureau . . . . . . . . . . . -- -- -- 2,085,543 3,398,453 Selling, general and administrative expenses 2,244,031 3,966,265 6,126,494 8,537,967 12,823,909 Research and development costs . . . . . . . 167,152 165,366 526,521 1,790,709 1,964,057 ----------- ---------- ----------- ----------- ------------ 4,359,827 9,472,421 13,983,554 22,128,585 27,236,097 ----------- ---------- ----------- ----------- ------------ Income (loss) from operations . . . . . . . . (408,371) 759,031 269,715 (4,970,846) (10,333,323) OTHER INCOME (EXPENSE) Interest income (expense) net . . . . . . . . (41,310) (105,849) (78,009) 1,181,411 763,292 Amortization of excess of assigned value of Identifiable assets over cost of an acquired Interest . . . . . . . . . . . . . . . . . 304,750 304,750 304,749 50,792 - ----------- ---------- ----------- ----------- ------------ 263,440 198,901 226,740 1,232,203 (9,570,031) ----------- ---------- ----------- ----------- ------------ Income (loss) before income taxes (144,931) 957,932 496,455 (3,738,643) (9,750,031) Income tax expense . . . . . . . . . . . . . -- -- 201,487 -- -- ----------- ---------- ----------- ----------- ------------ Net income (loss) . . . . . . . . . . . . . . $ (144,931) $ 957,932 $ 294,968 $(3,738,643) $ (9,750,031) =========== ========== =========== =========== ============ Basic earnings (loss) per common share $ (0.03) $ 0.20 $ 0.06 $ (0.49) $ (1.25) Diluted earnings (loss) per common share $ (0.03) $ 0.20 $ 0.05 $ (0.49) $ (1.25)
----------- ---------- ----------- ----------- ------------ 1994 1995 1996 1997 1998 ----------- ---------- ----------- ----------- ------------ BALANCE SHEET DATA: Cash and cash equivalents . . . . . . . . . . $ 75,840 $ 120,255 $23,501,633 $20,569,300 $3,090,565 Investments available for sale. . . . . . . . - - - - 6,482,021 Working capital (deficit) . . . . . . . . . . (1,073,896) (1,362,539) 21,056,337 19,502,516 5,146,706 Total assets . . . . . . . . . . . . . . . . 1,581,751 4,035,323 28,451,530 28,956,723 25,109,676 Long term debt, less current portion . . . . 416,136 408,806 220,341 101,390 761,092 Stockholders' equity (deficit) . . . . . . . (1,482,410) (576,978) 22,587,896 23,211,385 13,849,643
-22- 23 DRAFT-03/29/99 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the Company's results of operations and financial condition. The discussion should be read in conjunction with the audited consolidated financial statements of the Company and notes thereto. This report contains certain statements of a forward-looking nature relating to future events or the future financial performance of the Company. Investors are cautioned that such statements are only predictions and that actual events or results may differ materially. In evaluating such statements, investors should carefully consider the various factors identified in this Report which could cause actual results to differ materially from those indicated by such forward-looking statements, including the matters set forth in "Business -- Risk Factors." GENERAL Overview The Company was incorporated in 1987 to commercialize an automated credit processing system developed by James R. DeFrancesco, the Company's Chairman and Chief Executive Officer, and Scott L. Freiman, the Company's Executive Vice President, while they were employed by American Financial Corporation ("AFC"), an automobile finance servicing company owned by Mr. DeFrancesco. AFC was acquired in October 1987 by Perpetual Savings Bank, FSB. Mr. DeFrancesco and Mr. Freiman retained ownership of AFC's credit processing software which formed the basis for CreditRevue. CreditRevue was initially released in 1988. Since its initial release, the Company has continually enhanced CreditRevue in response to the needs of its customers. CreditConnection, the Company's online credit information and processing service, became commercially available in July 1996. The Dun & Bradstreet OneScore product was commercially released in October 1997, CreditRevue Service Bureau was introduced in January 1998, Dun & Bradstreet Portfolio Monitoring was introduced in June 1998 and the CreditOnline Service, the Company's Internet lending solution was announced in February, 1999. In March 1999, the Company introduced CreditRevue Maestro, an automated analysis engine for evaluating and decisioning consumer and small business credit applications. Fees from licenses of CreditRevue and related maintenance fees and resales of third-party computer hardware and software associated with installations of CreditRevue accounted for substantially all of the Company's revenue through December 31, 1998. See "Business -- Risk Factors - - -- Dependence on CreditRevue Product Line." License fees for CreditRevue are recognized based on a percentage-of-completion method, measured generally on a cost-incurred basis. The Company typically charges a nonrefundable fee of 25% of the preliminary estimate of the total license fee to develop an analysis of the customer's credit operations and a plan for the configuration and implementation of CreditRevue according to the customer's requirements. Costs consist primarily of direct labor and temporary contract labor. Contracts in progress are reviewed periodically, and revenues and earnings are adjusted based on revisions in contract value and estimated costs to completion. For a description of certain risks associated with the lengthy implementation time associated with installations of CreditRevue, see "Business -- Risk Factors -- Lengthy Sales and Implementation Cycle." The Company recognizes revenue from software maintenance contracts pro rata over the term of the related agreement, which is generally one year. Maintenance fees received in advance of revenue recognition are included in deferred revenue. In addition, as a convenience to its customers, the Company offers third-party computer hardware through various reseller arrangements. -23- 24 DRAFT-03/29/99 However, neither third-party hardware nor third-party software sales are a focus of the Company's overall marketing strategy. For the year ended December 31, 1998, revenues from third-party hardware and software sales accounted for 4.6% and 4.1% of total revenues, respectively. Revenues from resales of third-party computer hardware and software are recognized at the time of shipment and installation, respectively. Certain of the Company's products and services, including CreditConnection, CreditRevue Service Bureau and Dun & Bradstreet's OneScore, are charged on a per transaction basis. As a result, the Company anticipates that transaction-based revenue will represent an increasing proportion of the Company's revenue. The Company's sales and marketing efforts will no longer be exclusively targeted at generating license-based revenue but will be increasingly focused on generating transaction-based revenue from prospective customers. The Company's anticipated future growth is based, in large part, on the success of these products and services and the transition to a transaction-based revenue stream. Accordingly, the failure by the Company to generate demand for CreditConnection, CreditRevue Service Bureau, Dun & Bradstreet's OneScore, Dun & Bradstreet Portfolio Monitoring, CreditOnline, CreditRevue Maestro, the occurrence of any significant technological problems, such as a system failure incurred prior to the implementation of a fully functioning back-up computer system, any inadequacy of the Company's business interruption insurance to cover costs associated with system failure or business interruptions, or the failure of the Company to successfully manage the transition to a transaction-based revenue stream would have a material adverse effect on the Company's business, results of operations and financial condition. See "Business -- Risk Factors -- Market Acceptance of CreditConnection; Transition to Transaction-Based Revenue" and "-- System Interruption and Security Risks; Potential Liability; Possible Lack of Adequate Insurance; and System Inadequacy." Since 1987, the Company has continually invested in the development and introduction of new products, services and enhancements to its software. Research and development expenditures are expensed as incurred. Certain software development costs are capitalized subsequent to the establishment of technological feasibility in accordance with Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed. Based on the Company's current research and development process, technological feasibility is established upon completion of a working model. The Company intends to continue to expend substantial resources on developing new products and services and enhancements to its software to incorporate technological developments and satisfy evolving customer needs. -24- 25 DRAFT-03/29/99 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):
YEAR ENDED DECEMBER 31, --------------------------------------- 1996 1997 1998 --------- --------- ---------- Percentages of Total Revenues Revenues License and software development fees . . . . . . . . . . 70.9% 67.3% 60.3% Maintenance fees . . . . . . . . . . . . . . . . . . . . . 14.3 19.3 25.4 Computer hardware sales . . . . . . . . . . . . . . . . . 14.8 9.7 4.6 Service bureau fees. . . . . . . . . . . . . . . . . . . . --- 3.7 9.7 --------- --------- ---------- 100.0 100.0 100.0 --------- --------- ---------- Costs and Expenses Cost of license and software development fees . . . . . . 35.8 42.7 41.3 Cost of maintenance fees . . . . . . . . . . . . . . . . . 3.2 5.1 6.6 Cost of computer hardware sales . . . . . . . . . . . . . 12.5 8.8 5.6 Cost of service bureau fees . . . . . . . . . . . . . . . --- 12.2 20.1 Selling, general and administrative expenses . . . . . . . 43.0 49.8 75.9 Research and development costs . . . . . . . . . . . . . . 3.7 10.4 11.6 --------- --------- ---------- 98.2 129.0 161.1 --------- --------- ---------- Income (loss) from operations . . . . . . . . . . . . . . . . . 1.8 (29.0) (61.1) Other income (expense) Interest income (expense), net . . . . . . . . . . . . . (0.5) 6.9 4.5 Amortization of excess of assigned value of identifiable assets over the cost of an acquired interest . . . . . . . . . . . . . . . . . . . 2.1 .3 --- --------- --------- ---------- 1.6 7.2 4.5 --------- --------- ---------- Income (loss) before income taxes . . . . . . . . . . . . . . . 3.4 (21.8) (56.6) Income tax expense . . . . . . . . . . . . . . . . . . . . 1.4 --------- --------- ---------- Net income (loss) . . . . . . . . . . . . . . . . . . . . 2.0% (21.8)% (56.6)% ========= ========= ==========
Total Revenues Total revenues increased 20.4% from $14.3 million in 1996 to $17.2 million in 1997 and decreased 1.5% from $17.2 million in 1997 to $16.9 million in 1998. The Company's revenues are derived from four sources: license and software development fees, maintenance fees, computer hardware sales, and service bureau fees. The Company's 10 largest customers accounted for 48.8% and 55.4% of total revenues in 1997 and 1998, respectively. During 1998, the Company experienced longer than expected sales cycles for its CreditRevue product resulting in lower CreditRevue related revenues and correspondingly lower total revenues. Also, for the first time, the Company experienced contract disputes including its dispute with The Money Store, which had an adverse impact on CreditRevue revenues and contributed to the decline in total revenues. License and Software Development Fees CreditRevue accounted for virtually all of the Company's license and software development fee revenue through December 31, 1998. License and software development fees increased 14.3% from $10.1 million in 1996 to $11.5 million in 1997, and decreased 11.8% from $11.5 million in 1997 to $10.2 million in 1998. The increase in 1997 was the result of increased market acceptance of CreditRevue. The decrease in 1998 was the result of longer than expected sales cycles for the CreditRevue product and certain contract disputes. By late 1998, sales performance improved as a result of signing 9 new contracts for CreditRevue with an aggregate contract value of approximately $7 million. -25- 26 DRAFT-03/29/99 Maintenance Fees Maintenance fees include fees from software maintenance agreements. Maintenance fees increased 61.9% from $2.0 million in 1996 to $3.3 million in 1997, and 29.7% from $3.3 million in 1997 to $4.3 million in 1998. The growth in these revenues during the periods presented was the result of increased maintenance fees associated with the increased number of licenses of CreditRevue outstanding during such periods. Enhancements to previously installed CreditRevue systems are also subject to maintenance and contribute to growth in maintenance revenues. Computer Hardware Sales Computer hardware sales revenue decreased 21.5% from $2.1 million in 1996 to $1.7 million in 1997, and 53.1% from $1.7 million in 1997 to $0.8 million in 1998. Computer hardware sales revenue consists of revenues received from resales of third-party hardware in connection with the license and installation of the Company's software. The fluctuation in such revenues during these periods is the result of customer purchase preferences for computer hardware systems. In certain instances, CreditRevue customers have volume discount arrangements with hardware resellers making them eligible for discounts greater than those offered by the Company. Service Bureau Fees Service bureau revenues originate from CreditConnection transaction and interface fees, from Dun & Bradstreet OneScore and Portfolio Monitoring transaction fees and CreditRevue Service Bureau fees. CreditConnection related revenues increased 99.0% from $0.6 million in 1997 to $1.3 million in 1998. The CreditConnection Service was commercially released in 1996 and generated $49 thousand from inception through December 31, 1996. CreditConnection revenues increased to $618 thousand in 1997 from $49 thousand in 1996 and increased 206% to $1.3 million in 1998 from $0.6 million in 1997. Revenue increases are the result of increases in the number of dealers and lenders enrolled in the CreditConnection Service. At December 1998 there were approximately 150 dealers enrolled in the service compared to approximately 40 dealers at December 1997. As of December 1998 there were approximately 21 lenders connected to the CreditConnection network compared to approximately 14 at December 1997. Dun & Bradstreet related revenues increased to $203 thousand in 1998 up from $23 thousand in 1997. The Dun & Bradstreet OneScore service was commercially released in the fourth quarter of 1997 and the Portfolio Monitoring Service was released in June of 1998. The CreditRevue Service Bureau was released in January 1998, through a strategic alliance with Anytime Access, but did not go into full production until January 1999. Accordingly, only nominal revenues were recorded in 1998 from CreditRevue Service Bureau related services. Cost of License and Software Development Fees Cost of license and software development fees consist primarily of salaries and benefits for in-house programmers and the cost of temporary contract labor. Cost of license and software development fees increased 43.8% from $5.1 million in 1996 to $7.3 million in 1997, and decreased 4.6% from $7.3 million in 1997 to $7.0 million in 1998. As a percentage of license and software development fees, cost of license and software development fees were 50.4%, 63.5% and 68.6% in 1996, 1997 and 1998, respectively. The cost of license and software fees as a percentage of license and software development fees over these periods is related to the fluctuation in the Company's quarterly revenues and hourly labor costs associated with temporary contractors during periods in which the Company experienced increased demand for its products. With respect to temporary contractors, the Company's costs on a -26- 27 DRAFT-03/29/99 full-time equivalent basis for these contractors is generally twice the amount incurred by the Company for its in-house technical personnel. In late 1996 and into 1997, the Company increased internal staffing levels commensurate with the expected growth in revenues. These increased staffing levels are expected to reduce the dependency on temporary contractors upon the completion of their training in the Company's proprietary products, services and technology, resulting in a corresponding increase in the margins related to these revenues. However, while license related revenues increased in 1997, the costs of increased staffing and temporary contractors exceeded revenue growth. In 1998 efforts at staff reduction were curtailed by certain contract disputes and prolonged sales cycles. The sales cycle for license software is often difficult to predict accurately. The skills and knowledge required to perform the licensed software implementation requires the Company to maintain certain levels of specialized staffing occasionally creating production capacity in excess of sales demand which can result in higher costs and lower margins. Costs of Maintenance Fees Cost of maintenance fees consists primarily of personnel and related costs for customer maintenance and support. Cost of maintenance fees increased 94.5% from $0.5 million in 1996 to $0.9 million in 1997, and 25.9% from $0.9 million in 1997 to $1.1 million in 1998. As a percentage of maintenance fee revenue, cost of maintenance fees was 22.1%, 26.6% and 25.8% in 1996, 1997 and 1998, respectively. The dollar increase in the cost of maintenance fees reflects the growth in license fees for CreditRevue during the periods presented and the resultant increase in the number of installations. The fluctuation in the percentage of cost of maintenance fees to maintenance fee revenues in 1996, 1997 and 1998 results from incremental increases in staffing for maintenance personnel as maintenance revenues have increased. Staffing utilization efficiencies will vary based on the timing and training of additions to maintenance staff personnel. In certain instances, hardware revenues may not be large enough to offset both the direct cost and the hardware being sold as well as certain fixed costs associated with the salaries and benefits for systems integration employees thereby resulting in negative margins. Cost of Computer Hardware Sales Cost of computer hardware sales consists of (i) the Company's cost of computer hardware resold to the Company's customers that are licensing CreditRevue and (ii) salaries and benefits for systems integration employees. Cost of computer hardware sales decreased 15.6% from $1.8 million in 1996 to $1.5 million in 1997, and decreased 36.7% from $1.5 million in 1997 to $1.0 million in 1998. As a percentage of computer hardware sales revenue, cost of computer hardware sales was 84.6%, 90.8% and 122.6% in 1996, 1997 and 1998, respectively. The dollar fluctuation in the cost of computer hardware sales reflects the fluctuation in computer hardware sales during the periods presented. The Company's margin on computer hardware sales fluctuates based on changes in product sales mix, volume discounts to significant customers and negotiated mark-ups with customers. Cost of Service Bureau Revenues -27- 28 DRAFT-03/29/99 Cost of service bureau fees consist primarily of personnel costs associated with the operation and support of the service bureau. Other costs of service bureau revenues include equipment rental expenses, communications network costs from third parties and hardware and software pass through expenses. Services bureau costs were not separately identified in 1996. Service Bureau costs increased 63.0% from $2.1 million in 1997 to $3.4 million in 1998. Of the three primary sources of service bureau revenues, CreditConnection, Dun & Bradstreet related services and CreditRevue Service Bureau, only CreditConnection was operational for all of 1997. The increases in service bureau costs are related to increased staffing required for operations and support for both CreditConnection and the Dun & Bradstreet related services increased communication expenses associated with the expanding CreditConnection network. Selling, General and Administrative Expenses Selling, general and administrative expenses increased 39.4% from $6.1 million in 1996 to $8.5 million in 1997, and 50.2% from $8.5 million in 1997 to $12.8 million in 1998. The $2.4 million increase during 1997 relates primarily to recruiting and professional development, outside consultant services, depreciation, travel, telephone, office administrative expenses, sales, marketing and advertising expenses. The $4.3 million increase during 1998 relates to one time expenses and reserves associated with the Company's relocation to Annapolis Junction and increases in payroll costs, communications expenses, depreciation and other general sales and administrative expenses. Of the total 1998 increase, approximately $2.8 million relate to facilities and equipment expenses. As a result of the relocation of the Company's operations, a liability of approximately $1.2 million was recorded to recognize future minimum lease payments due under leases for the Company's former offices. Other one time charges associated with the move include the write-off of certain leasehold improvements of approximately $0.3 million and certain lease termination fees and moving expenses of approximately $0.2 million. Additionally, increases in communication and depreciation expenses represent approximately $1.0 million of the 1998 increase. Payroll related expenses increased approximately $0.8 million and the balance of the increase was in the area of general selling and administrative expenses including: advertising, travel, legal and accounting fees. Increases in payroll relate primarily to increases in sales and marketing staffing. Research and Development Costs Research and development costs consist primarily of salaries and benefits of in-house programmers. These costs increased $0.2 million during the year ended December 31, 1998 as compared to the year ended December 31, 1997, due primarily to the addition of four programmers in 1998. The increased staffing was required to address a number of strategic development efforts underway during 1998, including on going efforts for CreditConnection, CreditRevue 2000, Dun & Bradstreet Portfolio Monitoring, CreditRevue service bureau and CreditRevue Maestro projects. During 1997, all development activities were expensed. During 1998, approximately $0.3 million of costs associated with the development of CreditRevue Maestro were capitalized. The capitalized expenses include the direct payroll costs of certain programmers and certain third party development expenses. See Note 1 to the Consolidated Financial Statements. Amortization of Assigned Value Over Cost of an Acquired Interest From September 1988 through March 1993, the Company was the sole general partner of a limited partnership. In March 1993, the Company purchased the other partner's limited partnership interest for $0.2 million. The acquisition was accounted for as an acquisition of a minority interest using the purchase method of accounting. The assigned value of the identifiable net assets acquired over the cost of the acquired interest was $1.2 million. This amount has been amortized into income using the straight-line method over four years. -28- 29 DRAFT-03/29/99 Interest Income (Expense) Interest expense was $0.1 million in 1996 and 1997. In 1998 interest income was $0.8 million. The interest expense reported in 1996 and 1997 relates to borrowings under the Company's line of credit and obligations under the capital lease. The interest income reported in 1998 and 1997 results from invested proceeds from the Company's initial public offering. INCOME TAX EXPENSE From its inception in 1987 until its reincorporation in Delaware in November 1996, the Company had been treated for income tax purposes as a corporation subject to federal and state taxation under Subchapter S of the Internal Revenue Code of 1986, as amended (the "Code") and comparable state laws. As a result, for federal and state income tax purposes, the Company's earnings had been taxed directly to the Company's stockholders. Upon termination of the Company's Subchapter S status in November 1996, the Company determined the differences between the financial reporting and income tax bases of its assets and liabilities, and recorded at that date the resulting deferred tax liability and income tax expense. Income tax amounts and balances are accounted for in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The Company's income tax expense for the year ended December 31, 1996 approximates the income tax expense that would have been recognized had the Company terminated its Subchapter S status at January 1, 1996. During the two months ended December 31, 1996, the Company incurred a loss for federal income tax purposes of approximately $756,000, caused principally by a tax deduction of $650,000 related to the exercise of certain nonqualified stock options by officers of the Company. At December 31, 1998, the Company had net operating loss carryforwards of approximately $14.4 million which will expire in 2011, 2012 and 2013. See Note 2 to the Consolidated Financial Statements for more information regarding the Company's income tax status. SEGMENT REPORTING From inception through 1996, the Company operated predominantly in a single segment. With the introduction of new products and services commencing in 1997 the Company has adopted, effective in 1998, a matrix oriented 'line of business' organizational structure. Under this structure, products and services have been organized into three distinct business lines, Credit Decisioning Systems (CDS), E-Commerce and Service Bureau Alliances (SBA). The CDS business line which includes the CreditRevue software product and related services represents the Company's historical single segment and through 1996 was responsible for virtually all of the Company's revenues and profits or losses. The E-Commerce business line includes the CreditConnection, LenderLink, and CreditOnline services. The SBA business line includes the OneScore product, the Portfolio Monitoring service and the CreditRevue Service Bureau offerings. The Company evaluates performance and allocated resources based on operating income before depreciation and amortization, corporate general and administrative expenses, and income taxes. Assets are not apportioned by segment and are not reviewed by the Chief Operating Decision Maker in reviewing segment performance. The accounting policies used by the reportable segments are the same as those used by the Company and described in Note 1 to the financial statements. There are no intercompany sales or transfers. The segments are managed separately by Business Line Managers who are most familiar with segment operations. The Company has since 1996, introduced new products and services which have led to the formation of the three segments the Company currently operates. The CDS segment is the most established and mature of the three segments and continues to be the segment with the highest profitability. The E-Commerce segment, introduced in 1997, continues to require considerable investment in sales, marketing, development and infrastructure. As the E-Commerce products and services gain greater market acceptance, revenues are expected to grow and segment profitability is expected to improve. During 1998, E-Commerce revenues increased 99% to $1.3 million from $0.6 million in 1997. Revenue growth during 1998 contributed directly to the lower losses reported in 1998. The SBA segment, introduced in 1998, also requires continued investment in sales, marketing, development and infrastructure before becoming profitable. Until revenues for E-Commerce and SBA segments exceed costs of operations for each respective segment, it is expected that CDS will continue to contribute the majority of segment profits. LIQUIDITY AND CAPITAL RESOURCES The Company has funded its working capital needs and investments in property and equipment from operating cash flows and approximately $22.1 million of net proceeds from the Company's initial public offering completed in December 1996. During the year ended December 31, 1996, the Company generated net cash from operating activities of $1.9 million. During 1997 and 1998, the Company's operations consumed cash of $4.1 million and $7.3 million, respectively. This cash flow deficiency is primarily caused by operating losses and an increase in accounts receivable. The Company's cash used for investing activities consists principally of investments in property and equipment and capitalized software development costs. During the years ended December 31, 1996, 1997 and 1998, the Company invested a total of $0.5 million, $2.4 million and $4.3 million, respectively, in property and equipment and capitalized software development costs. These investments were directly attributable to the Company's growth in operations. The Company did not have any material commitments for the purchase of property and equipment at December 31, 1998. The Company has relied principally on its bank line of credit and proceeds from its initial public offering completed in December 1996 for its financing needs. The Company received $22.1 million of net proceeds from its initial public offering. The Company maintains a secured bank line of credit in the amount of $1.5 million, of which there was no balance outstanding at December 31, 1998. The bank line of credit requires the bank's written consent prior to, among other things, (i) the payment of cash dividends, (ii) the Company's engagement in a substantially different business activity, or (iii) the purchase by the Company of any interest in another enterprise or entity. On May 15, 1997 the Company repaid to Mr. James R. DeFrancesco, the Company's Chairman and Chief Executive Officer, -29- 30 DRAFT-03/29/99 $0.2 million of loans bearing interest at 7% per annum. The Company currently anticipates that its available cash resources, expected cash flows from operations and its bank line of credit will be sufficient to meet its presently anticipated working capital, capital expenditure and debt repayment requirements through 1999. YEAR 2000 COMPLIANCE State of Readiness The Company recognizes the significance of the year 2000 issue and has implemented a formal year 2000 program to minimize the impact of the year 2000 on the Company and its customers ("Year 2000 Program"). The Year 2000 Program addresses both information technology ("IT") and non-IT systems, for systems used by the Company as well as those provided by the Company to its customers. Non-IT systems are primarily used by the Company in the operation of its facilities. The Year 2000 Program is implemented by a Year 2000 Team which includes members from all levels of management and all functional areas of the Company, as follows: - Executive Sponsor - The Executive Sponsor works with the Senior Technology Executive on budgeting and resources management and other major year 2000 issues, and reports on Year 2000 Program status to the Executive Management of the Company as well as the Board of Directors. - Senior Technology Executive - The Senior Technology Executive manages the Project Managers-Company Wide. Issues relating to budgeting and resources are escalated to the Senior Technology Executive. The Senior Technology Executive also has the authority to prioritize Year 2000 tasks over other project tasks. - Project Managers-Company Wide - The Project Managers-Company Wide share responsibility for determining the Year 2000 tasks that need to be completed, and monitoring the completion of the tasks on schedule. The Project Managers-Company Wide are responsible for collecting, coordinating and disseminating information within the Company about the Year 2000 Program and its status. - System Project Managers - A project manager is assigned to each of the primary areas of the Company. Each System Project Manager is responsible for ensuring that the Year 2000 tasks relating to his/her area are completed on schedule. - Product Project Managers - A project manager is assigned to each specific product. Each Product Project Manager is responsible for ensuring that the Year 2000 tasks relating to that specific product are completed on schedule. - System Analysts - System Analysts review individual products to identify Year 2000 -30- 31 DRAFT-03/29/99 issues. - Developers - Developers perform coding modifications to address year 2000 issues. - Testers - Testing is performed under the guidance of the Quality Services department to ensure that any Year 2000 issues have been properly addressed. Individual members of the Year 2000 Team communicate frequently with respect to Year 2000 issues. The Year 2000 Team meets as a group and reports status bi-weekly. Subgroups of the Year 2000 Team meet as needed to address specific issues. The Company is using employees of the Company to identify and address Year 2000 issues. The Year 2000 Program involves six basic stages: (1) inventory of all potentially affected software products and software-related services, (2) analysis of such products and services to identify any areas that require change or replacement, (3) change or replacement of the identified areas, (4) testing, (5) implementation of the changes or replacements, and (6) contingency plans. Because the Company is not only a user of software products and software-related services, but also provides software products and software-related services to its customers, the Company's Year 2000 Program addresses both software products and software-related services used by the Company and those provided by the Company to its customers. The Company has established written Year 2000 coding standards which have been distributed to the Company's system analysts, developers and testers. The Company has also conducted training for its system analysts, developers and testers to ensure that they are familiar with the Company's Year 2000 coding standards. For purposes of the Year 2000 Program, the Company has classified into the following three major categories the software products and software-related services provided by the Company to its customers: credit decisioning systems (existing systems and new systems), e-commerce systems, and service bureau systems. CREDIT DECISIONING SYSTEMS (EXISTING). For existing credit decisioning systems (i.e., systems which customers were using in production at the time the Year 2000 Program was applied to the system), the Company performs the following activities: 1. The customer's credit decisioning system is analyzed to identify any Year 2000 issues and to determine whether any modifications to the code are required. The analysis is conducted in accordance with detailed procedures which were developed internally by the Company for Year 2000 analysis of its credit decisioning systems. 2. The Year 2000 modifications are made. 3. The modifications are tested. The customer also has an opportunity to test the modifications. 4. Following the testing, the modifications are installed in the customer's system. 5. Any enhancements to the customers' credit decisioning system since the completion of the procedures described in items 1-4 above were developed and implemented by the Company under its Year 2000 Coding Standards. As an extra safeguard, however, the Company conducts a follow-up Year 2000 analysis of these enhancements. Credit Decisioning Systems (New). For new credit decisioning systems (i.e., system which were not used by customers until after the Year 2000 Program was applied to the system), the Company -31- 32 DRAFT-03/29/99 performs the following activities: 1. Each new credit decisioning system starts with a "base" system. The base system is analyzed for Year 2000 issues. 2. Enhancements are made to the base system based on the functional specifications agreed to between the Company and the customer, and the enhanced system is delivered to the customer for user acceptance testing. 3. Before or concurrent with the user acceptance testing, the Company reviews the code enhancements for compliance with the Company's Year 2000 coding standards. 4. The Company implements required modifications on the test system at the Company's site, and tests the modifications. 5. Upon completion of testing of the changes by the Company, the software changes are reported to the customer and installed in the customer's system for further testing by the customer. 6. With respect to any enhancements to the credit decisioning system after acceptance by the customer of the system, the Company performs the enhancements in a test environment. The enhancements are then analyzed and tested for Year 2000 issues following the above approach. E-COMMERCE SYSTEMS. For e-commerce systems, the Company performs the following activities: 1. The Company analyzes the software programs supporting the e-commerce system to identify any Year 2000 issues and determines whether any modifications are required. The Company also coordinates with the vendor of any hardware and other equipment supporting the e-commerce system to request Year 2000 information regarding the applicable product and to determine whether any patches, upgrades or replacements are necessary. The Company also tests the third party product where necessary, appropriate and feasible. 2. Any necessary modifications are made to the software programs supporting the e-commerce system. In addition, any necessary patches or upgrades to, or replacements of, third party products are installed. 3. The Company analyzes and tests the modifications, patches, upgrades and replacements. The Company makes the Year 2000 version of the software programs supporting the e-commerce system available to its customers in a Year 2000 environment for testing of the modifications. The customer schedules the testing with the Company. 4. The modifications, patches, upgrades and replacements are placed into production. 5. With respect to any subsequent enhancements to the e-commerce system, the enhancements are performed in a test environment. The enhancements are then analyzed and tested for Year 2000 issues following the above approach prior to being placed into production. SERVICE BUREAU SYSTEMS. For service bureau systems, the Company performs the following activities: 1. The "base" service bureau system is analyzed for compliance with the Company's Year 2000 coding standards. 2. The Year 2000 modifications are made. 3. The modifications are tested. 4. For any subsequent releases, the Company analyzes the changes for compliance with the Company's Year 2000 coding standards. The Company makes any required modifications -32- 33 DRAFT-03/29/99 to the code. 5. The Company tests the modifications. 6. Following the testing, the release is ready to be delivered to the customer. As of December 31, 1998, approximately 80% of the analysis, remediation and testing had been completed, collectively, for the Company's customers' credit decisioning systems. The implementation phase for the credit decisioning customers is largely dependent on the customers' schedules, and for those customers which have not implemented the necessary changes to their credit decisioning systems, the Company is working with those customers to implement the changes as soon as possible. As of December 31, 1998, approximately 30% of the analysis, remediation, testing and implementation had been completed for the software and systems comprising the Company's e-commerce systems, which is scheduled to be completed during the second quarter of 1999. As of December 31, 1998, approximately 65% of the analysis, remediation, testing and implementation had been completed for the Company's service bureau systems, which is also scheduled to be completed during the second quarter of 1999. The Company has also implemented analysis and testing procedures to ensure that any enhancements to a system following the completion of the analysis, remediation, testing and implementation of that system do not contain any year 2000 issues. In most cases, the software products and software-related services provided by the Company interface to third party systems. In cases where a third party has provided Year 2000 interface specifications, the Company is developing, testing and implementing new interface code to comply with those specifications. All new interface code is scheduled to be completed and implemented during the second quarter of 1999. INFRASTRUCTURE. For products and systems used by the Company internally, the Company performs one or more of the following activities: 1. The Company contacts the provider of the product or system in writing to request information regarding the Year 2000 readiness of its product or system, and evaluates the response for reasonableness and acceptability, based on CMSI's knowledge of the product or system. 2. The Company obtains Year 2000 compliance information from the third party's web site and evaluates the response for reasonableness and acceptability based on the Company's knowledge of the product or system. 3. The Company tests the product or system where appropriate and possible. 4. For any third party products or systems that require modifications, the Company works with the vendor to ensure that the modifications are completed in an acceptable time frame. As the Company does not have any control over the third party providers of products and systems, the Company cannot guarantee that such third party products and systems will not suffer any adverse effects due to the Year 2000. The Year 2000 activities described above relating to credit decisioning systems, e-commerce systems, service bureau systems and third party products and systems represent the standard procedures applied to the applicable system. In certain circumstances, the Company may make changes to or deviate from these procedures. Costs As of December 31, 1998, all expenses have been associated with the opportunity cost of time spent by -33- 34 DRAFT-03/29/99 employees of the Company on the Year 2000 Program, particularly on the analysis, development, testing and implementation relating to software products and software-related services provided to customers. The Company estimates that the opportunity cost incurred as of December 31, 1998 is approximately $1 million. This cost can be allocated as follows: $465,000 to credit decisioning systems, $160,000 to e-commerce systems, $75,000 to service bureau systems, and $300,000 to Year 2000 Program management, project oversight, and client and vendor communications. To complete the Year 2000 Program, in addition to the opportunity costs of employees' time, the Company may also need to purchase replacement products. The Company's projected costs of the entire Year 2000 Program is $2.3 million. Risks If a product or service provided by the Company is found to cause damage or injury to a customer of the Company due to a failure of such product or service to operate without any adverse effect due to date related processing associated with the year 2000, the Company could be liable to such customer for a breach of warranty, depending on the specific contractual arrangement between the Company and such customer. Although the Company's contractual arrangement with each of its customers generally limits the Company's liability to such customer, the Company cannot accurately predict whether or to what extent any legal claims will be brought against the Company, or whether the Company will otherwise be adversely affected by such claims. In addition, a failure by the Company to make its products year 2000 compliant could result in a decrease in sales of the Company's products, delays in the development of other of the Company's products, an increase in the costs associated with year 2000 remediation, and an increase in litigation costs. The year 2000 issue may also have an indirect effect on the Company's business and operations to the extent that potential customers of the Company may be using significant resources to address year 2000 issues, and therefore may have fewer resources to evaluate and purchase other products and services such as the products and services offered by the Company. If a material third party product or system which the Company uses or interfaces to fails to operate properly due to the year 2000, such failure could have a material adverse effect on the Company's business and results of operations. Contingency Plans The Company will have a dedicated year 2000 support staff which will be prepared to address year 2000 issues. The Company is currently in the process of investigating and developing additional contingency plans which will be implemented if necessary. The Company expects to complete development of the contingency plans by the end of the third quarter of 1999. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company is exposed to market risk related to changes in interest rates. The Company invests its excess cash balances in cash equivalents and municipal, commercial and government agency obligations which are interest rate sensitive. However, the maturities of these obligations is less than one year, mitigating their sensitivity to interest rates. The Company believes that the effect, if any, of reasonably possible near-term changes in interest rates on the Company's financial position, results of operations and cash flows is not material. Item 8. Financial Statements and Supplementary Data. The information required by the item is incorporated herein by reference to the consolidated financial statements listed in Item 14 below. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. -34- 35 DRAFT-03/29/99 PART III Item 10. Directors and Executive Officers of the Registrant. The Company incorporates herein by reference the information concerning directors and executive officers in its Notice of Annual Stockholders' Meeting and Proxy Statement to be filed within 120 days after the end of the Company's fiscal year (the "1998 Proxy Statement"). Item 11. Executive Compensation. The Company incorporates herein by reference the information concerning executive compensation contained in the 1998 Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management. The Company incorporates herein by reference the information concerning security ownership of certain beneficial owners and management contained in the 1998 Proxy Statement. Item 13. Certain Relationships and Related Transactions. The Company incorporates herein by reference the information concerning certain relationships and related transactions contained in the 1998 Proxy Statement. -35- 36 DRAFT-03/29/99 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
Page Number (a) Index to Consolidated Financial Statements Index F-1 Report of Independent Auditors F-2 Consolidated Balance Sheets as of December 31, 1998 and 1997 F-3 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996 F-4 Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1998, 1997 and 1996 F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 F-6 Notes to Consolidated Financial Statements F-7 (b) Financial Statement Schedules All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under The related instruction or are inapplicable and therefore have been omitted. (c) Reports on Form 8-K None (d) Exhibits 3.1 Certificate of Incorporation of the Company* 3.2 Bylaws of the Company* 4.1 Specimen certificate for Common Stock of the Company* 4.2 See Exhibits 3.1 and 3.2 for provisions of the Certificate of Incorporation and Bylaws of the Company defining rights of holders of Common Stock of the Company 10.1 Form of Project Commencement Agreement* 10.2 Form of Software License Agreement* 10.3 Form of Software Maintenance Agreement* 10.4 Form of Professional Services Agreement*
-36- 37 DRAFT-03/29/99 10.5 Form of CreditConnection Lender Agreement (for CreditRevue Licensees)* 10.6 Form of CreditConnection Lender Agreement (for non-CreditRevue Licensees)* 10.7 Form of CreditConnection Dealer Subscription Agreement* 10.8.1 Office Building Lease between Symphony Woods Limited Partnership and the Company dated October 29, 1993* 10.8.2 Office Building Lease between Symphony Woods Limited Partnership and the Company dated February 10, 1995* 10.8.3 First Amendment to Lease dated March 29, 1995* 10.8.4 Second Amendment to Lease dated August 12, 1996* 10.9 Promissory Note dated December 31, 1995 given by the Company to James R. DeFrancesco* 10.10 Business Loan Agreement between The Columbia Bank and the Company dated June 10, 1994* 10.11 1996 Credit Management Solutions, Inc. Non-Qualified Stock Option Plan* 10.12 1996 Credit Management Solutions, Inc. Employee Stock Purchase Plan* 10.13 1996 Credit Management Solutions, Inc. Long-Term Incentive Plan* 10.14 Form of Tax Indemnification Agreement* 10.15 1996 Credit Management Solutions, Inc. Non-Qualified Stock Option Plan 10.16 1997 Credit Management Solutions, Inc. Stock Incentive Plan** 23 Consent of Independent Auditors 27.1 Financial Data Schedule 27.2 Restated Financial Data Schedule - - ------------------------- * Incorporated by reference to the Exhibits filed with the Company's Registration Statement on Form S-1, File No. 333-14007. ** Incorporated by reference to the Company's 1997 Proxy Statement, file no. 000-21735 -37- 38 DRAFT-03/29/99 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Credit Management Solutions, Inc. By: /s/ James R. DeFrancesco March 31, 1999 -------------------------------------------------------- James R. DeFrancesco Chairman, Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ James R. DeFrancesco March 31, 1999 ----------------------------- James R. DeFrancesco President, Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer) By: /s/ Peter M. Leger March 31, 1999 ------------------------------------ Peter M. Leger President, Chief Operating Officer and Director By: /s/ Scott L. Freiman March 31, 1999 ---------------------------------- Scott L. Freiman Executive Vice President and Director By: /s/ Miles H. Grody March 31, 1999 ----------------------------------- Miles H. Grody Senior Vice President and Director By: /s/ Robert P. Vollono March 31, 1999 ----------------------------------- Robert P. Vollono Senior Vice President, Treasurer, Chief Financial Officer and Director (Principal Financial and Accounting Officer) By: /s/ Stephen X. Graham March 31, 1999 ------------------------------- Stephen X. Graham Director By: /s/ John J. McDonnell, Jr. March 31, 1999 ------------------------------- John J. McDonnell, Jr. Director
-38- 39 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Consolidated Statements of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Consolidated Statements of Stockholders' Equity . . . . . . . . . . . . . . . . . . . . . . . . . 4 Consolidated Statements of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
40 DRAFT-03/29/99 Report Of Independent Auditors The Board of Directors and Stockholders Credit Management Solutions, Inc. We have audited the accompanying consolidated balance sheets of Credit Management Solutions, Inc. and subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Credit Management Solutions, Inc. and subsidiary at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Ernst & Young LLP Baltimore, Maryland February 22, 1999 1 41 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
DECEMBER 31 -------------------------------------- 1998 1997 -------------------------------------- ASSETS Current assets: Cash and cash equivalents $3,090,565 $ 20,569,300 Investments available-for-sale 6,482,021 - Accounts receivable, net of allowance of $352,664 and $194,856 in 1998 and 1997, respectively 5,487,202 3,550,927 Costs and estimated earnings in excess of billings on uncompleted contracts 246,831 503,875 Prepaid expenses and other current assets 280,515 463,849 Deferred income taxes 58,513 58,513 -------------------------------------- Total current assets 15,645,647 25,146,464 Property and equipment: Computer equipment and software 7,306,811 3,442,792 Office furniture and equipment 1,657,294 941,733 Leasehold improvements 2,661,291 499,404 -------------------------------------- 11,625,396 4,883,929 Accumulated depreciation and amortization (2,549,451) (1,677,138) -------------------------------------- 9,075,945 3,206,791 Software development costs, net of accumulated amortization of $298,304 and $178,583 in 1998 and 1997, respectively 338,724 179,582 Other assets 49,360 423,886 -------------------------------------- Total assets $25,109,676 $28,956,723 ====================================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $5,798,379 $ 2,225,745 Accrued payroll and related expenses 668,630 1,059,177 Billings in excess of costs and estimated earnings on uncompleted contracts 1,044,015 588,522 Deferred revenue 2,921,923 1,632,339 Current portion of capital lease obligations 65,994 138,165 -------------------------------------- Total current liabilities 10,498,941 5,643,948 Long-term debt: Capital lease obligations, less current portion 28,966 101,390 Other lease obligations, less current portion 732,126 - -------------------------------------- Total liabilities 11,260,033 5,745,338 Commitments and contingencies - - Stockholders' equity: Preferred stock, $.01 par value; 1,000,000 shares authorized; No shares issued or outstanding - - Common stock, $.01 par value; 40,000,000 shares authorized; 7,649,770 and 7,615,510 shares issued and outstanding at December 31, 1998 and 1997, respectively 76,497 76,155 Additional paid-in capital 26,853,194 26,645,247 Accumulated deficit (13,080,048) (3,510,017) -------------------------------------- Total stockholders' equity 13,849,643 23,211,385 -------------------------------------- Total liabilities and stockholders' equity $25,109,676 $28,956,723 ======================================
The accompanying notes are an integral part of these financial statements. 2 42 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31 ------------------------------------------------------------------ 1998 1997 1996 ------------------------------------------------------------------ REVENUES License and software development fees $ 10,186,421 $11,549,378 $10,101,377 Maintenance fees 4,294,572 3,311,013 2,045,258 Computer hardware sales 776,790 1,656,530 2,106,634 Service bureau revenues 1,644,991 640,818 - ------------------------------------------------------------------ 16,902,774 17,157,739 14,253,269 COSTS OF REVENUES Cost of license and software development fees 6,988,649 7,329,091 5,095,814 Cost of maintenance fees 1,108,367 880,360 452,559 Cost of computer hardware sales 952,662 1,504,915 1,782,166 Cost of service bureau 3,398,453 2,085,543 - ------------------------------------------------------------------ 12,448,131 11,799,909 7,330,539 ------------------------------------------------------------------ GROSS PROFIT 4,454,643 5,357,830 6,922,730 OTHER OPERATING EXPENSES: Selling, general and administrative expenses 12,823,909 8,537,967 6,126,494 Research and development costs 1,964,057 1,790,709 526,521 ------------------------------------------------------------------ 14,787,966 10,328,676 6,653,015 ------------------------------------------------------------------ INCOME (LOSS) FROM OPERATIONS (10,333,323) (4,970,846) 269,715 OTHER INCOME (EXPENSE): Interest expense (24,965) (56,171) (109,207) Interest income 788,257 1,237,582 31,198 Amortization of excess of assigned value of identifiable assets over cost of an acquired interest - 50,792 304,749 ------------------------------------------------------------------ 763,292 1,232,203 226,740 ------------------------------------------------------------------ INCOME (LOSS) BEFORE INCOME TAXES (9,570,031) (3,738,643) 496,455 Income tax expense - - 201,487 ------------------------------------------------------------------ NET INCOME (LOSS) $ (9,570,031) $(3,738,643) $ 294,968 ================================================================== Basic earnings (loss) per common share $ (1.25) $ (0.49) $ 0.06 ================================================================== Diluted earnings (loss) per common share $ (1.25) $ (0.49) $ 0.05 ==================================================================
The accompanying notes are an integral part of these financial statements. 3 43 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ----------------------- ADDITIONAL NUMBER PAID-IN OF SHARES AMOUNT CAPITAL ------------------------------------------ Balance at January 1, 1996 4,910,100 $49,101 $ - Exercise of options to purchase common stock at $5 per share 100,000 1,000 499,000 Issuance of common stock, net of offering costs of $3,190,094 2,200,000 22,000 22,087,906 Income tax benefit from exercise of options to purchase common stock - - 260,000 Reclassification of Subchapter S accumulated deficit to additional paid-in capital upon termination of Subchapter S status - - (559,737) Net income for 1996 - - - ------------------------------------------ Balance at December 31, 1996 7,210,100 72,101 22,287,169 Issuance of common stock, net of offering costs of $263,537 390,000 3,900 4,217,563 Issuance of common stock under employee stock purchase program 14,546 145 136,204 Exercise of options to purchase common stock at $5 per share 864 9 4,311 Net loss for 1997 - - - ------------------------------------------ Balance at December 31, 1997 7,615,510 76,155 26,645,247 Issuance of common stock under employee stock purchase 19,572 196 134,653 program Exercise of options to purchase common stock at $5 per 14,688 146 73,294 share Net loss for 1998 - - - ------------------------------------------ Balance at December 31, 1998 7,649,770 $76,497 $26,853,194 ========================================== RETAINED EARNINGS (DEFICIT) TOTAL ------------------------------ Balance at January 1, 1996 $ (626,079) $ (576,978) Exercise of options to purchase common stock at $5 per share - 500,000 Issuance of common stock, net of offering costs of $3,190,094 - 22,109,906 Income tax benefit from exercise of options to purchase common stock - 260,000 Reclassification of Subchapter S accumulated deficit to additional paid-in capital upon termination of Subchapter S status 559,737 - Net income for 1996 94,968 294,968 ------------------------------ Balance at December 31, 1996 228,626 22,587,896 Issuance of common stock, net of offering costs of $263,537 - 4,221,463 Issuance of common stock under employee stock purchase program - 136,349 Exercise of options to purchase common stock at $5 per share - 4,320 Net loss for 1997 (3,738,643) (3,738,643) ------------------------------ Balance at December 31, 1997 (3,510,017) 23,211,385 Issuance of common stock under employee stock purchase - 134,849 program Exercise of options to purchase common stock at $5 per - 73,440 share Net loss for 1998 (9,570,031) (9,570,031) ------------------------------ Balance at December 31, 1998 $(13,080,048) $13,849,643 ==============================
The accompanying notes are an integral part of these financial statements. 4 44 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 ------------------------------------------------ 1998 1997 1996 ------------------------------------------------ Operating activities: Net income (loss) $ (9,570,031) $(3,738,643) $ 294,968 Adjustments: Depreciation 1,199,194 649,399 393,929 Deferred income taxes - - 201,487 Amortization of excess of assigned value of identifiable assets over cost of an acquired interest - (50,792) (304,749) Amortization of software development costs 119,721 119,722 59,861 Loss (gain) on disposal of property and equipment 302,878 (6,431) - Changes in operating assets and liabilities: Accounts receivable, net (1,936,275) (1,602,507) (131,454) Prepaid expenses and other current assets 183,334 193,168 (406,041) Accounts payable and accrued expenses 102,200 (504,270) 1,357,399 Accrued payroll and related expenses (390,547) 169,914 274,387 Net billings in excess of costs and estimated earnings on uncompleted contracts 712,537 443,538 (687,983) Deferred revenue 1,289,584 252,644 790,800 Accrued interest on stockholder loans - 6,025 15,015 Other lease obligations 732,126 - - ------------------------------------------------ Net cash provided by (used in) operating activities (7,255,279) (4,068,233) 1,857,619 Investing activities: Capitalized software development costs (278,863) - (91,036) Proceeds from sale of property and equipment 162,672 7,995 - Purchases of property and equipment (4,063,464) (2,416,838) (448,721) Decrease (increase) in other assets 374,526 (334,848) (55,185) Purchase of investments available-for-sale (6,482,021) - - ------------------------------------------------ Net cash used in investing activities (10,287,150) (2,743,691) (594,942) Financing activities: Repayments of short term borrowings - - (250,000) Repayments of stockholder loans - (235,538) - Payments under capital lease obligations (144,595) (235,311) (224,725) Proceeds from exercise of stock options 73,440 4,320 500,000 Proceeds from issuance of common stock 134,849 4,357,812 22,109,906 ------------------------------------------------ Net cash provided by financing activities 63,694 3,879,591 22,118,701 ------------------------------------------------ Net change in cash and cash equivalents (17,478,735) (2,932,333) 23,381,378 Cash and cash equivalents at beginning of period 20,569,300 23,501,633 120,255 ------------------------------------------------ Cash and cash equivalents at end of period $ 3,090,565 $20,569,300 $23,501,633 ================================================
The accompanying notes are an integral part of these financial statements. 5 45 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Property and Equipment Property and equipment is stated at cost and depreciated using the straight-line method based on estimated useful lives of between three and seven years. Included in computer equipment and software are direct costs of computer software developed for internal use. Costs incurred are capitalized and amortized over periods not exceeding three years. Amortization of leasehold improvements is provided using the straight-line method over the lesser of the life of the improvement or the remaining term of the lease. Assets held under capital leases are stated at the lesser of the present value of future minimum payments using the Company's incremental borrowing rate at the inception of the lease or the fair value of the property at the inception of the lease. The assets recorded under capital leases are amortized over the lesser of the lease term or the estimated useful life of the assets in a manner consistent with the Company's depreciation policy for owned assets. Software Development Costs Costs related to conceptual formulation and design of Company products are expensed as incurred. Costs incurred subsequent to establishment of technological feasibility, but prior to the product being available for general release to customers, are capitalized and amortized over estimated productive lives, generally three years. The Company evaluates its investment in product development as events or changes in circumstances may arise, for the purpose of determining whether the carrying amount of such assets may exceed the net realizable value of the products. In the event that capitalized costs of a product exceed the estimated net realizable value of the product, such excess amount is expensed. Revenue Recognition In October 1997, the Accounting Standards Executive Committee ("AcSEC") issued Statement of Position (SOP) 97-2, Software Revenue Recognition. SOP 97-2 provides revised and expanded guidance on when revenue should be recognized and in what amounts for licensing, selling, leasing, or otherwise marketing computer software. The adoption of SOP 97-2 in 1998 had no material impact on the Company's results of operations in 1998. Revenues from long-term software license contracts are recognized on the percentage-of-completion method, measured generally on a cost incurred basis. Costs consist primarily of direct labor and applicable overhead. Contracts in progress are reviewed periodically as the work progresses, and revenues and earnings are adjusted in current accounting periods based on revisions in contract value and estimates to complete. The Company recognizes revenue from software maintenance contracts pro rata over the term of the agreements, generally one-year. Revenues from sales of hardware and software are recognized at time of shipment and when collection of the receivable is probable. Payments received in advance of revenue recognition for these services and product sales are included in deferred revenue. Advertising Costs All advertising costs are expensed when incurred. Costs which are included in selling, general and administrative expense for the year ended December 31, 1998, 1997 and 1996 are $384,863, $265,404 and $156,686, respectively. 46 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Income Taxes Prior to November 1996, the stockholders elected under Subchapter S of the Internal Revenue Code to include the Company's income in their personal income tax returns for Federal and state income tax purposes. Accordingly, the Company was not subject to Federal and state income taxes prior to November 1996. Upon termination of the Company's Subchapter S status in November 1996, the Company determined the differences between the financial reporting and income tax bases of its assets and liabilities, and recorded at that date the resulting deferred tax liability and income tax expense. Income tax amounts and balances are accounted for using the liability method. 2. INCOME TAXES The significant items comprising the Company's net deferred tax assets are as follows:
DECEMBER 31 ---------------------------------- 1998 1997 ---------------------------------- Net operating loss carry forwards $ 5,764,162 $ 1,831,400 Accrued expenses 128,892 102,038 Provision for bad debts 141,058 77,942 Revenue recognition 318,874 33,,859 ---------------------------------- 6,352,986 2,045,239 Software development costs 135,490 71,833 Depreciation 732,880 292,568 ---------------------------------- Total deferred tax liabilities 867,980 364,401 Net future income tax benefit 5,484,616 1,680,838 ---------------------------------- Valuation allowance for deferred tax assets (5,426,103) (1,622,325) ---------------------------------- Net deferred tax asset $ 58,513 $ 58,513 ==================================
Income tax expense consists of the following for the year ended December 31, 1996: Current: Federal $ - State - -------- Total Current - Deferred: Federal 171,263 State 30,224 -------- Total Deferred 201,487 ------- $ 201,487 =========
47 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company's income tax expense for the year ended December 31, 1996 approximates the income tax expense that would have been recognized had the Company terminated its Subchapter S status on January 1, 1996. A reconciliation of income tax expense computed at the U.S. Federal statutory rate to the recorded amount of income tax expense is as follows:
DECEMBER 31 --------------------------------------------------- 1998 1997 1996 --------------------------------------------------- Tax expense at U.S. statutory rate $ (3,253,811) $ (1,271,138) $ 168,795 Effect of permanent differences 24,235 5,876 (7,137) Change in allocation of net loss in 1996 between C Corporation and Subchapter S Corporation - (132,744) - Expense recorded upon termination of Subchapter S status - 39,829 State income taxes (574,202) (224,319) - Effect of change in valuation allowance for deferred tax assets 3,803,778 1,622,325 - --------------------------------------------------- Total $ - $ - $ 201,487 ===================================================
At December 31, 1998 the Company had net operating loss carryforwards of $14,410,404 which will begin to expire in 2011. 3. EARNINGS (LOSS) PER SHARE The following table summarizes the computations of basic and diluted earnings (loss) per common share:
YEAR ENDED DECEMBER 31 ------------------------------------------------------------ 1998 1997 1996 ------------------------------------------------------------ Numerator for basic and diluted earnings (loss) per common share: Net income (loss) $(9,570,031) $(3,738,643) $ 294,968 ============================================================ Denominator: Denominator for basic earnings (loss) per common share - Weighted-average shares 7,636,217 7,597,368 4,998,319 Effect of dilutive employee stock options - - 605,131 ------------------------------------------------------------ Denominator for diluted earnings (loss) per common share 7,636,217 7,597,368 5,603,450 ------------------------------------------------------------ Basic earnings (loss) per common share $ (1.25) $ (0.49) $ 0.06 ============================================================ Diluted earnings (loss) per common share $ (1.25) $ (0.49) $ 0.05 ============================================================
48 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Dilutive loss per share is equal to basic loss per share in 1998 and 1997 because if potentially dilutive securities were included in the computation, the result would be anti-dilutive. These potentially dilutive securities consist of stock options as described in Note 9. In 1997 the Company adopted the provisions of Staff Accounting Bulletin No. 98 ("SAB 98"), issued by the SEC staff in February 1998. SAB 98 requires that registrants in initial public offerings consider all potentially dilutive securities issued for nominal consideration outstanding for all periods. Under the previous SEC regulations in SAB 83, the Company considered all potentially dilutive securities issued within a twelve month period prior to the initial public offering date at a price below the initial public offering prices as outstanding for all periods. The 1996 basic and diluted earnings per common share amounts have been restated to conform to the provisions of SAB 98. The effect of the adoption was to increase basic earnings per common share in 1996 by $.01. The adoption of SAB 98 in 1997 had no effect on basic and diluted loss per common share in 1998 and 1997. 4. SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES Capital lease obligations of $26,565, and $77,779 were incurred when the Company entered into leases for new equipment during the years ended December 31 1997, and 1996, respectively. In 1998, the Company acquired equipment with a fair market value of $3,470,434 that was included in accounts payable at December 31, 1998. Interest paid during the year ended December 31, 1998, 1997 and 1996 was $24,965, $56,171 and $109,207, respectively. The Company paid no amounts related to income taxes during the three years ended December 31, 1998. 5. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS Uncompleted contracts consist of the following components:
BALANCE SHEET CAPTION ---------------------------------------- COSTS AND ESTIMATED EARNINGS BILLINGS IN EXCESS OF IN EXCESS OF COSTS AND ESTIMATED BILLINGS EARNINGS TOTAL ---------------------------------------------------------- December 31, 1997: Costs and estimated earnings $3,899,095 $ 272,953 $4,172,048 Billings 3,395,220 861,475 4,256,695 ---------------------------------------------------------- $ 503,875 $ (588,522) $ (84,647) ========================================================== December 31, 1998: Costs and estimated earnings $1,573,861 $ 3,236,349 $4,810,210 Billings 1,327,030 4,280,364 5,607,394 ---------------------------------------------------------- $ 246,831 $(1,044,015) $ (797,184) ==========================================================
All receivables on contracts in-progress are expected to be collected within twelve months. 49 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. BANK LINE OF CREDIT The Company has a revolving line of credit with a bank which allows for aggregate borrowings of $1.5 million through the expiration date of June 1, 1999. Borrowings under the line of credit are secured by the Company's accounts receivable and property and equipment, and bear interest at the bank's prime rate (8.50% at December 31, 1998). Under the terms of the loan agreement, the Company is required to comply with certain covenants including a restriction on assuming additional indebtedness without the prior written consent of the bank. The Company had no borrowings outstanding under this line of credit as of December 31, 1998 and 1997. 7. CAPITAL LEASE OBLIGATIONS The Company leases equipment under capital leases. Property and equipment includes the following amounts for leases that have been capitalized:
DECEMBER 31 -------------------------- 1998 1997 -------------------------- Computer equipment $220,119 $419,746 Office furniture and equipment 183,350 265,338 -------------------------- 403,469 685,084 Less: accumulated amortization 235,635 291,511 -------------------------- $167,834 $393,573 ==========================
Amortization of leased assets is included in depreciation expense. Future minimum payments under capital lease obligations consist of the following at December 31, 1998: 1999 $ 79,973 2000 24,412 ---------- Total minimum lease payments 104,385 Less: amounts representing interest 9,425 ---------- Present value of minimum capital lease payments (including current portion of $65,994) $ 94,960 ==========
50 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. Other Lease Obligations During 1998, the Company relocated its corporate headquarters, and remains obligated under operating leases for unutilized space at the former headquarters. Accordingly, in 1998 the Company estimated the present value of its future minimum obligations and recorded $1,062,425 of expense. At December 31, 1998, approximately $330,299 is classified in accounts payable and accrued expenses and $732,126 is classified as other lease obligations. Repayment of these obligations is over the remaining contractual life of the leases and are as follows: 1999 $ 386,536 2000 394,068 2001 396,718 -------------- Total minimum lease payments 1,177,322 Less: amounts representing interest 114,897 -------------- Present value of minimum lease payments (including current portion of $330,299) $ 1,062,425 ==============
9. STOCK OPTIONS The Company records compensation expense for all stock-based compensation plans using the intrinsic value method prescribed by APB Opinion 25, Accounting for Stock Issued to Employees. ("APB No. 25"). Under APB No. 25, if the exercise price of the Company's employee stock options equals the estimated fair value of the underlying stock on the date of grant, no compensation expense is generally recognized. Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation ("Statement No. 123"), encourages companies to recognize expense for stock-based awards based on their estimated value on the date of grant. Statement No. 123 requires the disclosure of pro forma income and earnings has per share data in the notes to the financial statements if the fair value method is not elected. The Company accounts for its stock-based compensation plans using the intrinsic value method, and supplementally discloses in these financial statements the pro forma information as if the fair value method has been adopted. In 1996, the Company adopted the 1996 Credit Management Solutions, Inc. Non-Qualified Stock Option Plan ("the 1996 Plan"). The 1996 Plan provides for the granting of non-qualified options to purchase an aggregate of up to 2,750,000 shares of common stock to employees of the Company. In 1997, the Company adopted the 1997 Stock Incentive Plan (the "1997 Plan"). The 1997 Plan provides for the granting of either non-qualified or qualified options to purchase an aggregate of up to 3,400,000 shares of common stock, subject to adjustment, to employees of the Company and others. All options granted under the 1996 Plan were transferred to the 1997 Plan and the 1996 Plan was terminated. The 1997 Plan includes a discretionary option grant program, a salary investment option grant program, a stock issuance program, an automatic option grant program and a director fee option grant program. 51 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. STOCK OPTIONS (CONTINUED) A summary of the Company's stock options activity and related information is as follows:
1998 1997 1996 ---------------------- ---------------------- ------------------------- WEIGHTED- WEIGHTED- WEIGHTED-A AVERAGE AVERAGE VERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE ---------------------- ---------------------- ------------------------- Options outstanding - beginning of year 2,691,844 $5.79 2,462,800 $5.37 - $ - Granted 1,201,880 7.33 266,,560 9.93 2,562,800 5.36 Exercised (14,688) 7.70 (864) 5.00 (100,000) 5.00 Forfeited (209,388) 5.00 (36,652) 7.90 - - -------------------------------------------------------------------------------- Options outstanding - end of year 3,669,648 $6.33 2,691,844 $5.79 2,462,800 $5.37 ====================== ====================== ========================= Exercisable at end of year 1,583,228 $5.32 1,071,572 $5.26 560,760 $5.15 ====================== ====================== ========================= Weighted-average fair value of options granted during the year at market value $4.33 $6.03 $0.82 ======== ============ =========== Weighted average fair value of options granted during the year at greater than market value $2.41 N/A N/A ======== ============ ===========
Exercise prices for options outstanding as of December 31, 1998 ranged from $4.06 to $13.13 as follows:
WEIGHTED-AVERAGE EXERCISE OPTIONS OPTIONS REMAINING LIFE IN WEIGHTED-AVERAGE PRICE OUTSTANDING EXERCISABLE YEARS EXERCISE PRICE ------------------------------------------------------------------------------------------------ $4.06 to $5.38 2,324,068 1,445,778 7.64 5.00 $6.00 to $8.00 750,100 0 8.15 6.95 $8.25 to $9.60 255,380 95,030 8.24 9.34 $9.75 to $10.50 300,100 22,420 5.66 9.95 $12.38 to $13.13 40,000 20,000 8.75 12.66 $4.06 to $13.13 3,669,648 1,583,228 7.63 6.19
All options granted under the Plan are subject to vesting provisions at the discretion of the Board of Directors. Options granted to date vest in varying percentages through 2003. Pro forma net loss and loss per share information required by Statement No. 123 has been determined as if the Company had accounted for its employee stock options under the fair value method. The fair value of options granted in 1998 and 1997 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest rate of 5.5% in 1998 and 1997; dividend yield of 0% in 1998 and 1997; volatility factor of the expected market price of the Company's common stock of .81 and .67 in 1998 and 1997, respectively; and a weighted-average expected life of the options of five years in 1998 and 1997. 52 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. STOCK OPTIONS (CONTINUED) For the year ended December 31, 1996, pro forma net loss and loss per share information required by Statement No. 123 was determined using the minimum value method, due to the lack of sufficient information to calculate the fair value of granted options using Black-Scholes. The minimum value method calculates the fair value of options as the excess of the estimated fair value of the underlying stock at the date of grant over the present value of both the exercise price and the expected dividend payments, each discounted at the risk-free rate, over the expected life of the option. In determining the estimated fair value of granted stock options under the minimum value method, the risk-free interest rate was assumed to be 6%, the dividend yield was estimated to be 0%, an the expected life granted options was assumed to be five years. Because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the minimum value method and other methods prescribed by Statement No. 123 do not necessarily provide a single measure of the fair value of its employee stock options. For the purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. The Company's pro forma information follows:
1998 1997 1996 ------------------------------------------------- Pro forma net loss $(11,068,442) $(4,785,660) $(1,386,032) Pro forma earnings per share: Basic and diluted $(1.45) $(0.63) $(0.28)
10. PROFIT SHARING PLAN The Company maintains a 401(k) profit sharing plan which covers all employees with at least six months of service. In addition, the Company may make a discretionary contribution based on each eligible participant's compensation. Participant contributions vest immediately and employer contributions vest over a six year period. In January 1996, the Company began matching 20% per annum of the first $1,000 contributed to the plan by each employee. Contributions for the years ended December 31, 1998 and 1997 were $33,189 and $23,315, respectively. 11. CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts. To date, these financial instruments have been derived from revenues earned primarily from banks and other financial institutions located in the United States. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses; historically, such losses have been insignificant and within management's expectations. At December 31, 1998, 23% of accounts receivable was due from one customer. At December 31, 1997, 22% of accounts receivable was due from two customers. For the year ended December 31, 1998, one customer accounted for 10% of total revenues. 53 CREDIT MANAGEMENT SOLUTIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. OPERATING LEASES The Company leases certain office space and equipment under non-cancelable operating lease agreements which expire through 2003. Future minimum lease payments at December 31, 1998 for leases with initial terms of one year or more consist of the following, excluding the former headquarters lease described in Note 8: 1999 $ 1,588,075 2000 1,565,257 2001 1,593,216 2002 1,564,146 2003 1,532,434 Thereafter 7,335,083 ------------ Total minimum lease payments $ 15,178,211 ============
Rent expense under all operating leases for the year ended December 31, 1998, 1997 and 1996 was $2,359,666, $891,360 and $472,455, respectively. 13. SEGMENT REPORTING In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information ("Statement No. 131"). Statement No. 131 supercedes Financial Accounting Standards Board Statement No. 14, Financial Reporting for Segments of a Business Enterprise ("Statement No. 14") and establishes new standards for the way public business enterprises report selected information about operating segments in annual and interim financial statements. It also established standards for related disclosures about products and services, geographical areas, and major customers. Statement No. 131 is effective for financial statements for fiscal years beginning after December 15, 1997. The Company adopted Statement No. 131 in 1998, and accordingly the disclosures for all periods have been presented to conform to Statement No. 131 requirements. From inception through 1996, the Company operated predominantly in a single segment. With the introduction of new products and services commencing in 1997 the Company has adopted, effective in 1998, a matrix oriented 'line of business' organizational structure. Under this structure, products and services have been organized into three distinct business lines, Credit Decisioning Systems (CDS), E-Commerce and Service Bureau Alliances (SBA). The CDS business line, which includes the CreditRevue software product and related services, represents the Company's historical single segment and through 1996 was responsible for virtually all of the Company's revenues and profits or losses. The E-Commerce business line includes the CreditConnection, LenderLink, and CreditOnline services. The SBA business line includes the OneScore product, the Portfolio Monitoring service and the CreditRevue Service Bureau offerings. The Company evaluates performance and allocated resources based on income from operations before depreciation and amortization, corporate general and administrative expenses. Assets are not apportioned by segment and are not reviewed by the Chief Operating Decision Maker in reviewing segment performance. The accounting policies used by the reportable segments are the same as those used by the Company and described in Note 1 to the consolidated financial statements. There are no intercompany sales or transfers. The segments are managed separately by Business Line Managers who are most familiar with segment operations. The following table sets forth information on the Company's reportable segments:
YEAR ENDED DECEMBER 31, 1998 ---------------------------------------------------------------------------------- CDS E-COMMERCE SBA TOTAL ---------------------------------------------------------------------------------- REVENUES 15,257,783 1,275,020 369,971 16,902,774 ---------------------------------------------------------------------------------- SEGMENT PROFIT (LOSS) 4,792,685 (3,718,657) (1,170,070) (96,042) ----------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1997 ------------------------------------------------------------- CDS E-COMMERCE TOTAL ------------------------------------------------------------- REVENUES 16,516,921 640,818 17,157,739 ------------------------------------------------------------- SEGMENT PROFIT (LOSS) 5,526,528 (4,105,753) 1,420,775 -------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1996 --------------------------------------------------- CDS TOTAL --------------------------------------------------- REVENUES 14,253,269 14,253,269 --------------------------------------------------- SEGMENT PROFIT (LOSS) 4,094,355 4,094,355 ---------------------------------------------------
A reconciliation of segment profit for all segments to income before income taxes is as follows:
----------------------------------------------------------------------------- 1998 1997 1996 ----------------------------------------------------------------------------- Operating profit: ----------------------------------------------------------------------------- Total segment profit (loss) (96,042) 1,420,775 4,094,355 ----------------------------------------------------------------------------- Corporate, general and administrative expenses (8,916,176) (5,672,292) (3,744,600) ----------------------------------------------------------------------------- Depreciation and amortization (1,321,105) (719,329) (80,040) ----------------------------------------------------------------------------- Net interest income 763,292 1,232,203 226,740 ----------------------------------------------------------------------------- Income (loss) before income taxes (9,570,931) (3,738,643) 496,455 -----------------------------------------------------------------------------
Substantially all of the revenue and assets of the Company's reportable segments are attributed to or located in the United States. EX-23 2 CONSENT OF ERNST AND YOUNG LLP 1 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-37151) pertaining to the Credit Management Solutions, Inc. 1998 Stock Incentive Plan, of our report dated February 22, 1999 with respect to the consolidated financial statements of Credit Management Solutions, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1998. /s/ Ernst & Young LLP Baltimore, Maryland March 31, 1999 EX-27 3 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 3,090,565 6,482,021 5,839,866 352,664 0 15,645,647 11,625,396 2,549,451 25,109,676 10,498,941 0 0 0 76,497 13,773,146 25,109,676 776,790 16,902,774 952,662 12,448,131 14,787,966 0 24,965 (9,570,031) 0 (9,570,031) 0 0 0 (9,570,031) (1.25) (1.25)
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