-----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, LZ74Y5kXqBLz2+Su1a9JKEcm2fj2MFWTARYtE2+3HxDzIHzzI8A9zg/oRi+NHoe/ zoxwFLxlovaFZ9Pzoltecg== 0000908180-99-000003.txt : 19990402 0000908180-99-000003.hdr.sgml : 19990402 ACCESSION NUMBER: 0000908180-99-000003 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CFI PROSERVICES INC CENTRAL INDEX KEY: 0000908180 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 930704365 STATE OF INCORPORATION: OR FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-21980 FILM NUMBER: 99581248 BUSINESS ADDRESS: STREET 1: 400 S W SIXTH AVE STREET 2: SUITE 200 CITY: PORTLAND STATE: OR ZIP: 97204 BUSINESS PHONE: 5032747280 MAIL ADDRESS: STREET 1: 400 S W SIXTH AVE STREET 2: STE 200 CITY: PORTLAND STATE: OR ZIP: 97204 10-K405 1 FORM 10-K405 ========================================================================== UNITED STATES 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 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 Commission file number 0-21980 CFI PROSERVICES, INC. (Exact name of registrant as specified in its charter) Oregon 93-0704365 (State or other jurisdiction of (I.R.S. Employer incorporation Identification No.) or organization) 400 SW Sixth Avenue, Portland, Oregon 97204 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 503-274-7280 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value (Title of Class) --------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ] Indicate 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 ] The aggregate market value of the voting stock held by non-affiliates of the Registrant is $44,109,296 as of February 26, 1999 based upon the last closing price as reported by the Nasdaq National Market System ($11.00). The number of shares outstanding of the Registrant's Common Stock as of February 26, 1999 was 5,083,527 shares. --------------- Documents Incorporated by Reference The Registrant has incorporated into Part III of Form 10-K by reference portions of its Proxy Statement for its 1999 Annual Meeting to be filed on or about April 7, 1999. ========================================================================== CFI PROSERVICES, INC. 1998 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS PART I Page Item 1. Business 2 Item 2. Properties 16 Item 3. Legal Proceedings 16 Item 4. Submission of Matters to a Vote of Security Holders 17 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 17 Item 6. Selected Financial Data 18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 7A. Quantitative and Qualitative Disclosures about Market Risk 35 Item 8. Financial Statements and Supplementary Data 35 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 35 PART III Item 10. Directors and Executive Officers of the Registrant 35 Item 11. Executive Compensation 35 Item 12. Security Ownership of Certain Beneficial Owners and 35 Management Item 13. Certain Relationships and Related Transactions 35 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 36 8-K Signatures 41 1 PART I ITEM 1. BUSINESS OVERVIEW CFI is a leading provider of integrated, PC-based software for financial institutions, including solutions for branch automation, loan origination, new account opening, call centers, cross selling of products and electronic banking. Beginning in 1999 with the Company's acquisition of Modern Computer Systems, Inc. (MCS), the Company will also offer hardware and software solutions for the back office accounting needs of community banks and credit unions. The Company combines its technology, banking and legal expertise to deliver knowledge-based solutions that enable institutions to simplify key business processes such as sales and service, improve productivity, strengthen customer relationships, and maintain compliance with both internal business policies and external government regulations. More than 6,000 financial institutions have licensed one or more of the Company's products. During 1993 substantially all of the Company's revenue was derived from its Laser Pro and Deposit Pro products. Today, the Company licenses more than 20 products organized into four product groups: lending, retail delivery, connectivity software and host processing. Due to its product diversification efforts, the Company is now less reliant on the Laser Pro and Deposit Pro products. In 1998 approximately 48% of the Company's revenue came from products other than Laser Pro and Deposit Pro. CFI generates recurring revenue from software maintenance agreements. In 1998 service and support fees, primarily for Laser Pro and Deposit Pro, accounted for approximately 35% of total revenue. Substantially all CFI customers subscribe to the Company's service and support programs, which provide ongoing product enhancements and, where applicable, updates to facilitate compliance with changing regulations. The Company's cost structure is relatively fixed and the cost of generating revenue, in aggregate, does not vary significantly with changes in revenue. As a result, the Company typically generates significantly greater profit margins from incremental sales once fixed costs are covered. In addition, any failure to achieve revenue targets in a particular period would adversely affect profit margins for that period. The Company believes that sales to larger financial institutions will constitute a higher percentage of total revenue in future periods. Transactions with these larger institutions are typically of greater scope, usually involve a greater sales effort over a longer period of time, and require more customization and prolonged acceptance testing. This project oriented business tends to cause growth in unbilled accounts receivable resulting from the use of percentage of completion accounting and deferred payment terms, and also results in increased collection times for billed accounts receivable. These factors, in turn, result in higher days sales outstanding (DSOs) in accounts receivable. 2 THE FINANCIAL SERVICES INDUSTRY The financial services industry is undergoing a period of rapid change characterized by increased competition. In response to this rapidly changing and increasingly competitive market, commercial banks are consolidating in order to achieve operational efficiencies and increased revenues. Financial institutions are embracing technological solutions that enable them to automate operations, redirect routine transactions to more cost-effective solutions such as electronic banking, and develop new service and sales delivery channels. CONSOLIDATION. Consolidation continues at a rapid pace within the financial services industry, particularly among larger banks. The Company believes that this trend is leading to an increasingly two-tiered market consisting of larger, multibank holding companies and smaller community banks. Both types of organizations face unique challenges. Large banks that have grown through acquisition often must integrate disparate host processing systems, which often lack the flexibility needed to easily utilize and deliver information across different systems. Bank customer service representatives often are limited in their ability to access comprehensive customer information on one screen, which limits their ability to cross-sell products and services. Banks must also be able to support customer transactions in a number of channels, such as electronic banking and telephone call centers. Accordingly, large banks increasingly find it necessary to centralize data from several disparate host processing systems. Interstate banking presents these institutions with additional and costly administrative and legal complexities relating to compliance with complex and changing regulatory requirements across states. Smaller community institutions face similar operational difficulties. Lacking the economies of scale of larger banks, smaller institutions find it increasingly necessary to exploit technological solutions that enable them to reduce operating costs, generate additional revenues from existing customers and focus on specific market niches. In addition, compliance with regulatory requirements can be more burdensome to these smaller institutions given their resource limitations. NEW DELIVERY CHANNELS. Banks of all sizes are increasingly recognizing that the value-added role of branch offices lies not in their traditional capacity as a transaction processor, but as a new sales channel for financial products and services. A study by a financial services consulting firm estimates that the average cost of a call center transaction is 35% of a branch transaction, an ATM transaction is 10% of a branch transaction, and a home banking transaction is 5% of a branch transaction. In order to make these new delivery channels attractive and user-friendly, the Company believes that consumers require access to consolidated information and services that are consistent across all delivery channels. CHANGING REGULATIONS. Financial institutions in the United States remain highly regulated with respect to compliance and other matters. To understand and remain in compliance with the numerous complex and changing interstate banking regulations, a regulated financial institution must invest significant resources in developing a compliance infrastructure. Because regulatory requirements are often triggered simply by the interaction between a financial institution and its customer, institutions are increasingly subject to compliance issues as they migrate their sales efforts to new forms of delivery channels, such as telephone and online 3 banking. Increasingly, these regulations extend beyond simple disclosure or form content requirements, and financial institutions must also focus on customer data collection and analysis as well as internal business procedures. This collection and analysis must be obtained from, and available to, multiple delivery channels. Data collection and analysis is complicated by the emergence of new channels for interacting with customers and potential customers. EVOLVING NETWORK TECHNOLOGY. Personal computer network technology is becoming increasingly integrated into all facets of the financial services business. Financial institutions are transitioning from mainframe-based systems to client/server computing for customer service applications, with continued reliance on mainframe technology for back-office functions. The growth of the Internet is expected to have a substantial impact on the banking industry. Not only are institutions themselves connected through local and wide area networks, but their customers are increasingly using the Internet to gain access to these institutions and financial data. The Company believes the rapidly growing network banking environment is demanding compatible software applications and connectivity. BACK OFFICE ("HOST") PROCESSING. Financial institutions use back office ("host") processing software and hardware solutions to perform accounting and general ledger tasks. Community banks and credit unions require host processing capabilities that are simple to operate and maintain because these institutions generally cannot afford highly trained in-house information systems personnel such as data base administrators. These institutions also require interconnectivity between their host processing solutions and the software used in branches and other points of customer contact. THE CFI SOLUTION The Company relies on a variety of knowledge-based and technical core competencies. The Company's vertical market focus on the financial services industry has enabled it to develop specialized knowledge and expertise pertaining to business processes and regulations affecting the industry. The Company incorporates this knowledge into its software solutions to automate lending, retail delivery and connectivity. Beginning in 1999 CFI also began offering host processing software and hardware solutions for community banks and credit unions. CFI's products and services are designed to meet the evolving needs of financial institutions by addressing a broad range of banking, technology and regulatory requirements. CFI's products provide a number of benefits to financial institutions by addressing regulatory requirements, system connectivity issues and internal business processes faced by institutions in the increasingly competitive financial services industry. Using CFI's solutions, these institutions are able to simplify sales and service processes and improve productivity through reduced operating costs and expanded capacity. The ability to view an entire customer account relationship on-screen enables financial institutions to strengthen relationships with their customers at each point of contact and across multiple delivery channels. CFI's products also enable institutions to comply with both internal business processes and external government regulations. CFI intends to begin offering hardware and software solutions that integrate host processing and application software functions for community banks and credit unions. The Company's products provide support and service solutions to both large and small financial institutions. CFI's products enable larger financial institutions to utilize data among disparate and often incompatible host processor platforms. The Company's suite of products also addresses 4 the preference of larger institutions to work with fewer vendors that provide comprehensive software solutions. Smaller institutions benefit through streamlined operations and enhanced cross-selling abilities, while ensuring cost-effective regulatory compliance. The Company has also developed substantial technological capabilities necessary to meet the evolving requirements of financial institutions. The Company has established substantial knowledge of host processing systems commonly used in the financial services industry. Through its StarGate connectivity software and other applications, the Company has developed the capability to retrieve, view and update data stored on these systems. The Company has established relationships with numerous service bureaus and turnkey host vendors such as International Business Machines Corporation ("IBM"). Fiserv, Inc. and The BISYS Group, Inc. Beginning in 1999 the Company also began offering hardware and software host processing solutions to community banks and credit unions. The Company intends to establish additional relationships with other leading service bureaus and turnkey host vendors. THE CFI STRATEGY The Company's strategic objective is to be a leading provider of technology solutions for the delivery of financial services, including customer service software solutions to financial institutions at key points of customer contact and host processing solutions. The Company intends to achieve this objective by combining its expertise in regulatory issues, banking and technology. Primary elements of the Company's strategy include: OFFERING A BROAD SUITE OF DELIVERY CHANNEL SOLUTIONS. The Company believes it is unique in its ability to offer solutions enabling financial institutions to perform transactions across multiple delivery channels, including branches, call centers, electronic banking and, beginning in 1999, host processing. By providing a broad suite of solutions, the Company believes it can address the need for consistent processes across delivery channels for an institution's products (such as loans and new accounts) and services (such as account inquiries or transfers). The Company's strategy is to establish long-term relationships with its customers and cross-sell multiple products throughout its customer base. The Company believes this ability provides an important market advantage over competitors who are able to address only a limited number of delivery channels or provide a limited number of products and services. ADDRESSING EXPANDING HOME BANKING MARKET. The Company is currently a leading provider of personal computer banking solutions in the United States, with more than 230 institutions offering private-dial or Internet banking services using the Company's solutions. The Company has licensed the Internet version of its home banking product to more than 50 financial institutions and believes that more than 500,000 bank customers use the Company's home banking products. The Company offers its home banking solutions on a private label basis, running on a server controlled by the financial institution. This approach permits the financial institution to retain its proprietary customer relationship and brand name identity. The Company's home banking solution also supports the financial institution's customers who use personal finance software such as Microsoft Money. The Company believes it was the first to support a consumer banking transaction through the Internet and to connect a home banking solution to Microsoft Money through Microsoft's Open Financial Connectivity specification. The Company has also created a service bureau alternative that provides financial institutions with an inexpensive method of initiating home banking services with their customers. 5 EXPANDING CUSTOMER BASE. Over 50% of U.S. commercial banks have licensed at least one of the Company's solutions. The Company believes its brand name and reputation as a provider of high-quality solutions are widely recognized in the financial institution community. The Company intends to expand its customer base through its direct sales force of more than 75 professionals. CFI seeks to enter into formal and informal arrangements whereby it makes its solutions compatible with the software and hardware solutions offered by leading technology vendors to the financial institutions, enabling those vendors to act as joint marketers of the Company's solutions. The Company has entered into such arrangements with more than 60 technology vendors, including IBM. In particular, the Company will continue its focus on expanding its market share with large banks through its own major account sales force and through formal and informal partnerships. The Company has entered into a strategic alliance with the CUNA Mutual Insurance Group, a key marketer and supplier of technology in the credit union market. The Company intends to increase its marketing and sales efforts to further penetrate the mortgage banking and thrift markets. LEVERAGING CUSTOMER RELATIONSHIPS. The Company builds long-term customer relationships by employing relationship selling techniques and through long-term service and support agreements. These techniques and such service and support relationships keep the Company in frequent contact with the customer, enabling the Company to sell additional products to its customers as they grow, cross-sell additional products and sell product upgrades. Substantially all of the Company's customers enter into service and support agreements. MAINTAINING LEADING KNOWLEDGE-BASED SOFTWARE TECHNOLOGY. The Company believes its proprietary software and service solutions are competitive strengths. Therefore, the Company intends to continue to invest in product development in order to maintain and strengthen its technology position and to improve its compatibility with other major applications. For example, the Company has migrated many of its software solutions to the Windows and Windows NT platforms. PROVIDING CONNECTIVITY SOLUTIONS. Financial institutions increasingly seek to integrate technology systems through networks and other connectivity solutions, so that operations at multiple locations and through multiple distribution channels can access common customer account and transaction data and processes. CFI entered the connectivity solutions market through its April 1995 acquisition of Texas/Southwest Technology Group, Inc. and is increasingly offering integrated connectivity solutions to its customer base. GROWING THROUGH STRATEGIC ACQUISITIONS. The Company has acquired 12 businesses or companies since June 1994. These transactions have enabled the Company to expand its product suite and customer base, leverage product cross-selling opportunities and add engineering expertise. The Company intends to continue to selectively pursue acquisitions of businesses, products or technologies that enhance its competitive position. 6 PRODUCTS LENDING PRODUCTS. CFI's lending products automate processes at nearly every step in the lending process for consumer, commercial, indirect and real estate lending lines of business. General business functions automated by CFI lending solutions include loan application and analysis, loan closing, portfolio analysis and workflow management, and risk management, as well as connectivity for interfaces to credit scoring and reporting systems and remote printing of loan documents. The Company engineers its lending products to operate with common user interfaces and databases. RETAIL DELIVERY PRODUCTS. CFI's retail delivery products automate the customer service, sales, and account opening functions for the branch office platform, teller station and telephone call center. These products provide a common view of the entire customer relationship, enabling service personnel to leverage selling opportunities. In 1998 CFI introduced a re-engineered call center product that is integrated more effectively with its branch sales and service products. CFI's electronic delivery products provide personal computer private-dial and Internet access to account inquiry and transaction capabilities, as well as ACH transaction management and remittance processing. The Company's home banking products provide over a dozen functions, including account balance, account history, bill payment and online loan applications. CFI's latest version of Personal Branch home banking software is a Windows NT client/server-based system that allows financial institutions to provide personal computer-based home banking services via private-dial or the Internet. This version is designed to improve performance and provide additional functionality and connectivity capabilities. CFI has also created a service bureau alternative that provides financial institutions with an inexpensive method of initiating home banking services with their customers. CONNECTIVITY PRODUCTS. Connectivity products and services enable institutions to transfer or exchange data between CFI software and host systems and across incompatible host systems. The Company's software connects back-office systems to front-end delivery systems, such as the home personal computer, branch office platform or telephone call center. HOST PROCESSING PRODUCTS. Beginning in 1999 with the Company's acquisition of MCS, the Company began offering hardware and software solutions for the back office accounting needs of community banks and credit unions. 7 REVENUE BY PRODUCT GROUP
Years Ended December 31, 1998 1997 1996 - ------------------------ ---------------- ----------------- ---------------- (Dollars in thousands) Amount Percent Amount Percent Amount Percent ------- ------- ------- -------- ------- ------- Lending Products $ 47,296 55.2% $ 36,820 50.7% $ 29,096 48.5% Retail Delivery 27,500 32.2 26,970 37.1 22,640 37.8 Products Connectivity Products 4,485 5.2 3,418 4.7 2,639 4.4 Other (1) 6,349 7.4 5,441 7.5 5,572 9.3 ------- ------- ------- -------- ------- ------- Total Revenue $ 85,630 100.0% $ 72,649 100.0% $ 59,947 100.0% ======= ======= ======= ======== ======= ======= (1)Other products include bill payment systems processing fees, sales of preprinted forms and supplies and certain consulting revenues.
Products by Product Group Lending Products
Date Introduced/ Product Acquired Description Benefits to Customer ------- ---------- ------------------------------ ------------------------ Laser Released Integrated, modular loan Standardizes lending Pro 1986 processing system for consumer, policies and products, Lending commercial, SBA, real estate streamlines processing, home equity and agricultural incorporates a national loans database of regulations Application Acquired Processes applications for Speeds the loan application Manager 1996 indirect consumer lending and approval process for indirect lenders LP Acquired Provides mortgage origination, Improves consistency of loan Mortgage 1996 processing and servicing processes, speeds capabilities origination, increases capacity SMarT Acquired Comprehensive risk and pipeline Automates complex analyses 1998 management system that necessary for ensuring automates secondary mortgage optimal mortgage loan pool marketing functions from sales registration through delivery of loans DocSMarT Acquired Automates the labor intensive Speeds process of preparing 1998 functions performed after a mortgage loans for sale mortgage loan is closed faster than manual methods, allowing lenders to take advantage of higher near term delivery prices LoansPlus Acquired Portfolio and credit risk Balances acceptable credit 1996 analysis system that uses risk and lending neural network technology and opportunities to recommend case-based reasoning credit decisions and manage portfolios
8 Retail Delivery Products
Date Introduced/ Product Acquired Description Benefits to Customer - ------- ---------- ------------------------------ ------------------------ Encore! Acquired Automates the teller station by Improves Teller 1995 providing comprehensive productivity and transaction automation, electronic facilitates sales journaling, store-and-forward referrals capabilities, simplified balancing, and access to the customer database Encore! Acquired Provides sales and service Opens accounts, Platform 1995 capabilities, including account enables opening screens, customer/product cross-selling and matching, customer contact fulfillment of histories, letter and fulfillment customer generation, and institution and information product information requests Encore! Acquired Integrates in a common and Enables Call Center 1994 consistent format customer, cross-selling and product and internal procedure improves service information Deposit Pro Acquired Automates and ensures regulatory Speeds account 1990 compliance in the account opening opening, ensures and cross-selling processes for compliance with checking, savings, certificates of regulations, deposit, and IRA accounts. improves the consistency of new account policies and practices Encore! Released Windows-based system that Allows customized Desktop 1996 graphically links each user to CFI arrangements of software and other business modules and access applications to customer information ProForms Released Generates laser printed forms used Eliminates the Laser 1994 daily by financial institutions need for costly inventories of preprinted forms, speeds form processing Personal Released Server-based system that allows Provides low-cost Branch 1993 institutions to provide personal service delivery computer-based home banking channel, services via private-dial or strengthens Internet channels customer relationships, extends institution branding, increases customer convenience Pro Active Released Collects, analyzes, reports and Simplifies the 1994 maps HDMA loan application process of meeting information, non-real estate loan fair lending and data, and community demographic community data reinvestment requirements ACH Manager Acquired Originates and receives ACH Cost-effective 1995 electronic payments and collections processes ACH business, monitors business for risk ACH Remote Acquired System licensed by financial Generates new fee 1995 institutions to its corporate income and customers for transmitting data simplifies files from the customer personal automated computer to the financial procedures institution's ACH system
9 Connectivity Products
Date Introduced/ Product Acquired Description Benefits to Customer ------- ---------- ------------------------------ ------------------------ StarGate Acquired Connectivity software system Allows institutions 1995 which transfers or exchanges to integrate data data between CFI products and from multiple host other host or client/server systems and present systems that data through networks to multiple front-end systems StarGate Acquired Connectivity software which Reduces costs, F/X 1995 enables institutions to print increases Laser Pro documents remotely transaction speed through their mainframe networks and productivity; enables institutions to centralize loan document preparation
Host Processing Products
Date Introduced/ Product Acquired Description Benefits to Customer ------- ---------- ------------------------------ ------------------------ BankServ Acquired Back office "host" processing Automates back room 1999 software for community banks accounting and servicing functions CuServ Acquired Back office "host" processing Automates back room 1999 software for credit unions accounting and servicing functions TeleServ Acquired 24-hour telephone banking module Improves customer 1999 for BankServ and CuServ that service supports account inquiries, fund transfers and loan payments OptiServ Acquired Laser optical disk storage and Improves document 1999 retrieval system storage and retrieval
PRODUCT DEVELOPMENT AND NEW PRODUCTS The Company's products enable institutions to increase sales capabilities, improve productivity, and remain in compliance with internal policies and government regulations. CFI ensures that its products meet customer requirements by conducting primary research and holding product user and focus group meetings. The Company also incorporates knowledge learned during the sales and installation process into development of new and enhanced products. CFI continues to invest significantly in its product development efforts. The Company intends to increase the ability of its products to operate in networked environments throughout the entire banking enterprise. Its integration strategy addresses the movement in the industry toward common user interfaces and databases driving consistent information to all points of customer contact. In addition to offering products that operate in the growing network-centric banking environment, CFI will continue developing the Internet capabilities of its product suite where appropriate. The Company believes that market acceptance of its products is based in significant part on the ability of the products to share information with a financial institution's host processor system or with the vendor providing processing services to such institution. The Company has developed 10 significant expertise with most available host processor systems and the methods necessary to transfer data to and from such systems. Although the Company generally is able to develop interfaces that allow its products to operate effectively with its customers' host systems, integration is optimized where the Company and the host processor provider cooperatively share information regarding the respective products' technologies, development schedules and enhancements. The Company's future success depends upon its ability to establish and maintain adequate relationships with important host processor providers. In 1999 the Company purchased a host system for community banks and credit unions. The Company believes that it will be able to integrate many of its application software products into this host processor. The Company has migrated its Laser Pro lending products to Windows and Windows NT operating environments. Many of its other lending products and most of its retail delivery and connectivity products also run on the Windows platform. The Company is currently supporting both DOS and Windows-based versions of several products, enabling its customers to upgrade easily and at a reasonable pace. SERVICE AND SUPPORT Substantially all of the Company's customers subscribe to maintenance agreements under which CFI provides periodic product updates reflecting evolving regulations, product enhancements and toll-free telephone support. Maintenance fees consist of per-item or per-user charges or are calculated based on a percentage of the current product list price or of the size of the customer. Furthermore, CFI provides training to its customers. The Company accounts for this revenue as service and support fees. Software service and support fees have grown significantly over the last three years. For the year ended December 31, 1998, such fees were $30.3 million, or 35.4% of the Company's total revenue. The Company installs, implements and customizes its software solutions at certain customer sites, particularly at larger institutions. As the Company's sales to larger institutions increase, the Company anticipates demand for these services to increase. Revenue from these services is accounted for as software license fees. CUSTOMERS CFI has licensed its software to over 6,000 financial institutions in the United States. In addition, the Company's acquisitions have opened limited opportunities in non-financial service industries and have added a small number of international institutions to CFI's customer base. CFI's target customer base includes commercial banks, thrifts and credit unions. No customer accounted for 10% or more of the Company's total revenues in 1998, 1997 or 1996. The Company's largest accounts include Bank of America (formerly NationsBank), The BISYS Group, Inc., Union Planters Bank, NCR Corporation, Banc One, PNC Bank, Citicorp and Central Carolina Bank & Trust. 11 SALES AND MARKETING CFI sells its products through two experienced, national direct field sales teams. One team is devoted exclusively to large financial institutions, and the other team focuses on all other accounts. Both teams are supported by a marketing group, product specialists and a telemarketing team. Telemarketing personnel contact institutions for lead generation and qualification, and sales support personnel are responsible for direct sales campaigns, trade media support and advertisements. The Company has a number of third-party reseller and co-marketing alliances, including agreements with some of the largest host processors and hardware vendors. For example, the Company has a relationship with IBM whose sales team resells a large portion of the Company's product line. Third-party reseller and co-marketing alliances provide access to institutions with which the Company would otherwise have no relationship. LEGAL NETWORK The Company maintains a network of independent legal counsel in all 50 states and the District of Columbia. This network, as well as the Company's internal legal staff, keeps the Company informed of changes in state and federal laws, changes in state and local documentation requirements, pending legislation and court actions affecting financial institution practices, as well as other information required to maintain regulatory compliance. The Company's management believes that the quality of this information, the Company's ability to effectively manage the continuous information flow provided by the network participants, and the capability of the Company to integrate this information into its software products provide the Company with a significant competitive advantage. The Company utilizes legal counsel in all jurisdictions, other than Louisiana, under agreements that are terminable at will by either party and that provide for compensation based on an hourly rate. The Company has entered into a long-term legal services agreement with a Louisiana law firm pursuant to which it pays legal fees based upon sales of the Company's products in Louisiana. ACQUISITIONS To remain competitive and to meet the changing needs of its customers, CFI pursues acquisitions of products, technologies and businesses as one part of its growth strategy. The Company continuously evaluates acquisition candidates that provide opportunities to expand its customer base, cross-sell products, and broaden its product offerings with proven solutions in a timely and cost-effective manner. Since 1994 the Company has made 12 acquisitions and believes that to date it has achieved its objectives of growth and broadening its product offerings through this acquisition program and intends to continue such activity in the future. Acquisitions of businesses or companies require the dedication of management resources in order to achieve the strategic objectives of the acquisitions. 12 RISK FACTORS AFFECTING THE COMPANY'S BUSINESS AND PROSPECTS POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS. The Company typically ships or installs many of its products within three months of receipt of an order. As a result, software license fees in any quarter are substantially dependent on orders booked in that quarter or the previous quarter. In addition, the Company has generally recognized a substantial portion of its revenue in the last month of each quarter, with this revenue concentrated in the last weeks of the quarter. The Company's results of operations may also be affected by seasonal trends, including the tendency of some customers to complete purchases of products in the quarter ended December 31 or not to implement new orders in the quarter ended March 31. Because the Company's operating expenses are based on anticipated revenue levels and a high percentage of these expenses are relatively fixed, a small variation in the timing of recognition of specific revenue items can cause significant variations in operating results from quarter to quarter. Due to all of the foregoing factors, the Company's quarterly operating results may differ from the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock would likely be affected. Accordingly, the Company believes that quarter-to-quarter comparisons of its results of operations should not be relied upon as an indication of future performance. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Quarterly Results. YEAR 2000. The Company's customers are regulated financial institutions located in the United States, including banks, credit unions and thrifts. These financial institutions are experiencing enhanced regulatory oversight with respect to their preparedness for the Year 2000. In response to pressure from regulators, or concerns about integration of new products into the institution's existing systems, the Company's customers may delay or defer purchases of the Company's products until after 1999. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Year 2000. TECHNOLOGICAL AND MARKET CHANGES. The market for the Company's software products and services is characterized by technological advances and evolving standards. In addition, changes in banking requirements and new product introductions and enhancements could render the Company's existing products unmarketable. Accordingly, the Company's future success depends upon its ability to enhance its current products in a timely fashion and to develop and introduce new products that keep pace with technological developments and changes in delivery channels such as electronic home banking and other changes in the financial services industry. Further, the Company's future success depends on the willingness of banks and other financial institutions to adopt new technologies required for acceptance in this evolving market. DEPENDENCE ON HOST PROCESSOR RELATIONSHIPS. Market acceptance of the Company's products depends on the Company's ability to ensure that its products operate together with other products offered by the Company, and with the products of other major service providers and vendors of hardware and software used in the financial services industry; in particular, those of vendors providing processing services to financial institutions. The Company has developed significant expertise with most available host processor systems and the methods necessary to transfer data to and from such systems; however, integration is optimized where the Company and the provider of a host processor system cooperatively share information regarding the respective products' technologies, development schedules and enhancements. CFI has had varying degrees of success in establishing such relationships with host providers. Furthermore, 13 providers of host processor systems or processing services have or may become competitors of the Company with respect to one or more of the Company's products. In such events the Company may not be able to obtain access to host system technology necessary for developing optimal third-party system integration. The Company's acquisition in January 1999 of host processor systems for community banks and credit unions may cause other host processors to view the Company as a direct competitor. The Company's future success depends on its ability to establish and maintain adequate relationships with important providers of host processor systems or processing services. POSSIBLE NEED FOR ADDITIONAL FINANCING. The Company believes that the funds expected to be generated by the Company's operations and its bank credit facilities will provide the Company with sufficient funds to finance its operations. However, if additional funds were needed to support working capital requirements, or to complete acquisitions, the Company would seek to raise such additional funds through one or more public or private financings of equity or debt, or from other sources. Additional financing may not be available or, if available, may not be obtainable on terms favorable to the Company or its shareholders. MANAGEMENT OF GROWTH. The growth in the size and complexity of the Company's business and the expansion of its product lines and its customer base have placed and are expected to continue to place a significant strain on all aspects of the Company's business. In particular, the Company's emphasis on selling to large institutions has placed significant additional demands on its installation and implementation operations, and the growing installed base and release of new products has placed additional demands on the customer support operation. To accommodate growth, the Company will be required to upgrade or implement a variety of operational and financial systems, procedures and controls. The Company's future success will depend on its ability to expand its support organization and infrastructure commensurate with its expanding base of installed products and on its ability to attract, hire and retain skilled personnel. DEPENDENCE ON KEY EMPLOYEES AND SOFTWARE ENGINEERS. The Company believes that its future success will depend to a significant extent upon the contributions of its executive officers and key sales, engineering, marketing and technical personnel. The Company does not have "key person" life insurance on any of its employees. Competition for highly skilled personnel, particularly qualified software development engineers and systems implementation experts, is intense and the Company has, at times, experienced difficulty in locating personnel with the requisite levels of expertise and experience. LENGTHY SALES AND IMPLEMENTATION CYCLES. The license of the Company's software products generally requires the Company to educate prospective customers regarding the use and benefits of the Company's products. In addition, the implementation of the Company's products involves a significant commitment of resources by prospective customers and can be associated with substantial changes in workflow, processing or the configuration of hardware and other software. The license of the Company's software products can often require a board-level or executive decision by prospective customers. For these and other reasons, the period between initial indications of interest by a customer in the Company's product and the ultimate sale and implementation of the Company's product to the customer can be lengthy (often ranging from three months to in excess of one year) and is subject to a number of significant delays over which the Company has little or no control. The Company's sales and implementation cycle could be lengthened by increases in the size and complexity of its license 14 transactions and by delays in its customers' implementation or upgrade of the necessary computing environments. COMPETITION. The market for the Company's products is intensely competitive and rapidly changing. A number of companies offer competitive products addressing certain of the Company's target markets, which include lending products, retail delivery products, connectivity products and host processing products. In addition, a number of prospective and existing customers of the Company have the internal capability to provide alternative solutions to the Company's products and may, therefore, be viewed as competing with the Company. Some of the Company's competitors have significantly greater financial, technical, sales and marketing resources than the Company. The Company believes that the primary competitive factors in this market include product quality, reliability, performance, price, vendor and product reputation, financial stability, features and functions, ease of use, interoperability with other applications or systems and quality of support. The Company believes it competes favorably in each of these categories. Further, because of the rapidly evolving nature of the industry, many of the Company's collaborative partners are current or potential competitors. The Company's entrance in 1999 into the host processing market may cause some of the Company's partners to view the Company more as a competitor than as a partner. PRODUCT CONCENTRATION. A significant portion of the Company's revenue is derived from a limited number of products. Revenue from the Company's Laser Pro products and Deposit Pro products represented approximately 52% of the Company's total revenue for the year ended December 31, 1998. The Company believes that although these products will continue to represent a significant percentage of the Company's revenue for the near term, an important part of the Company's business strategy depends upon the ability of the Company to continue to develop and market its other products. DEPENDENCE ON FINANCIAL SERVICES INDUSTRY. Substantially all of the Company's revenue is derived from licenses and services to banks and other financial institutions, and its future success is dependent on increased sales to the financial services industry. Demand for the Company's products and services could be disproportionately affected by instability or downturns in the financial services industry, which may cause existing or potential customers to exit the industry or delay, cancel or reduce planned expenditures for technology solutions, including those offered by the Company. Further, the financial services industry is currently experiencing consolidation that may affect demand for the Company's products. The financial services industry is highly regulated and changes in regulations affecting the financial services industry or the Company's products could have a significant effect on the Company. PRODUCT LIABILITY RISKS; SOFTWARE DEFECTS. The Company's software products are highly complex and sophisticated and could, from time to time, contain design defects or software errors that could be difficult to detect and correct. In addition, implementation of the Company's products may involve a significant amount of customer-specific customization and may involve integration with systems developed by third parties. Such errors could give rise to warranty or other liability of the Company, cause delays in product introduction and shipments, require design modifications, result in loss of or delay in market acceptance of the Company's products or loss of existing customers. DEPENDENCE UPON PROPRIETARY TECHNOLOGY; INTELLECTUAL PROPERTY RIGHTS. The Company's success and ability to compete are dependent in part upon its proprietary technology, including its 15 software. The Company relies primarily on a combination of copyright, trade secret and trademark laws, confidentiality procedures and contractual provisions to protect its proprietary rights. Despite the Company's efforts to protect its proprietary rights, other parties may attempt to reverse engineer, copy or otherwise engage in unauthorized use of the Company's proprietary information. Certain technology or proprietary information incorporated in the Company's products is licensed from third parties, generally on a non-exclusive basis. The termination of any such licenses, or the failure of the third-party licensors to adequately maintain or update their products, could result in delays in the Company's ability to ship certain of its products while it seeks to implement technology offered by alternative sources, and any required replacement licenses could prove costly. In addition, the integration of the Company's products with financial institutions' host systems is optimized if the Company has access to the host system technology. The parties controlling the host processor technologies may also be current or future competitors of the Company and as such may restrict access to such technologies. In some instances, the Company has not been able to obtain sufficient access to host system technology necessary for developing optimal system interfaces. While it may be necessary or desirable in the future to obtain rights to third party technology, there can be no assurance that the Company will be able to do so on commercially reasonable terms, or at all. EMPLOYEES As of December 31, 1998, the Company had 613 full-time employees. Of this number, 174 were engaged in product groups (primarily product development), 130 in customer service and support, 87 in sales and marketing, 125 in implementation and training, 28 in technology, research and development and 69 in general and administrative functions. ITEM 2. PROPERTIES The Company's corporate headquarters are located in Portland, Oregon in a leased facility consisting of approximately 79,800 square feet of office space occupied under leases that expire in 2003. Annual lease payments for the Company's corporate headquarters are approximately $1.3 million, with provisions for inflationary increases. The Company also leases office space in Atlanta, Georgia (52,678 square feet); Dayton, Ohio (15,151 square feet); Burnsville, Minnesota (18,392 square feet); Englewood Cliffs, New Jersey (6,148 square feet); Houston, Texas (7,565 square feet); Denver, Colorado (4,470 square feet); Charleston, South Carolina (2,500 square feet); McLean, Virginia (2,680 square feet); and Jericho, New York (1,140 square feet). These leases expire in 2000, 2006, 2000, 2002, 2002, 2004, 2003, 2001 and 2002, respectively. Annual lease payments for these additional facilities, in aggregate, are approximately $1.6 million. The Company believes the office space currently under lease is adequate to meet its needs for the next year. ITEM 3. LEGAL PROCEEDINGS The Company is involved in routine legal matters incidental to its business. The Company believes that the resolution of any such matters that are currently outstanding will not have a material effect on its financial condition or results of operations. However, no assurance can be given that the concurrent resolution of several of such matters in manners adverse to the 16 Company would not have a material adverse effect on the Company's financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company did not submit any matters to a vote of security holders during the quarter ended December 31, 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock trades on the Nasdaq National Market System under the symbol PROI. The high and low selling prices for the two years in the period ended December 31, 1998 were as follows:
1998 High Low ------------------------------- ------- ------ First Quarter $ 16.69 $ 12.25 Second Quarter 17.88 14.50 Third Quarter 16.88 9.38 Fourth Quarter 13.13 10.00 1997 High Low ------------------------------- ------- ------ First Quarter $ 20.88 $ 14.00 Second Quarter 20.25 14.25 Third Quarter 18.75 13.50 Fourth Quarter 16.50 10.00
The number of shareholders of record and the approximate number of beneficial holders of the Company's Common Stock on February 26, 1999 were 282 and 3,000, respectively. There were no cash dividends declared or paid on the Company's Common Stock in 1998 or 1997. The Company does not anticipate declaring cash dividends on its Common Stock in the foreseeable future. 17 ITEM 6. SELECTED FINANCIAL DATA
IN THOUSANDS: EXCEPT PER SHARE AMOUNTS 1998(1) 1997 1996(2) 1995(3) 1994 - ------------------------ --------- --------- --------- ---------- --------- CONSOLIDATED STATEMENT OF INCOME DATA Revenue: Software license fees $ 49,202 $ 40,475 $ 33,935 $ 18,918 $ 16,781 Service and support fees 30,352 27,466 22,336 15,060 12,775 Other revenue 6,076 4,708 3,676 2,798 3,060 --------- --------- --------- ---------- --------- Total revenue 85,630 72,649 59,947 36,776 32,616 Cost of revenue 29,423 27,041 20,844 11,672 9,646 --------- --------- --------- ---------- --------- Gross profit 56,207 45,608 39,103 25,104 22,970 Operating expenses 45,357 36,780 29,810 20,552 17,859 Acquired in-process research and development and other charges 2,661 -- 8,030 4,549 -- ========= ========= ========= ========== ========= Income from operations $ 8,189 $ 8,828 $ 1,263 $ 3 $ 5,111 ========= ========= ========= ========== ========= Net income $ 3,960 $ 4,680 $ 114 $ 323 $ 3,514 Preferred Stock dividend 95 95 97 97 97 --------- --------- --------- ---------- --------- Net income applicable to common shareholders $ 3,865 $ 4,585 $ 17 $ 226 $ 3,417 ========= ========= ========= ========== ========= Diluted net income per share $ 0.75 $ 0.90 $ -- $ 0.05 $ 0.71 ========= ========= ========= ========== ========= Shares used in diluted per share calculations 5,167 5,124 5,112 4,877 4,806 Basic net income per share $ 0.77 $ 0.93 $ -- $ 0.05 $ 0.87 ========= ========= ========= ========== ========= Shares used in basic per share calculations 5,012 4,919 4,763 4,369 3,922 CONSOLIDATED BALANCE SHEET DATA Cash, cash equivalents and short-term investments $ 3,795 $ 20 $ -- $ 7,670 $ 7,958 Working capital 16,972 7,187 2,792 8,759 10,336 Property and equipment, net 4,534 5,211 4,805 2,968 2,579 Total assets 56,781 57,542 46,845 36,587 27,487 Short-term debt 261 5,605 2,896 3,951 -- Long-term debt, less current portion 5,693 2,232 2,880 423 -- Mandatory Redeemable Class A Preferred Stock 738 746 754 761 764 Shareholders' equity $ 30,632 $ 25,943 $ 20,238 $ 18,169 $ 16,591 (1)Results for the year ended December 31, 1998 include pretax charges totaling $3.0 million for the value of in-process research and development efforts at the date of acquisition pertaining to the acquisition of the assets of Mortgage Dynamics, Inc. in October 1998 ($1.0 million), the remaining goodwill and associated severance charges related to the fisCAL products ($0.9 million), the present value of net future lease payments due with respect to certain office space in Atlanta that the Company ceased using ($0.8 million), and the initial investment of the Company in a joint venture ($0.3 million). Excluding the impact of these charges, net income and net income per share (diluted) would have been $5.7 million and $1.11, respectively. See Notes 1, 2 and 7 of Notes to Consolidated Financial Statements. (2)Results for the year ended December 31, 1996 include a pretax charge of $8.0 million for the value of in-process research and development efforts at the date of acquisition pertaining to five companies acquired in April 1996. Excluding the impact of the acquired in-process research and development charges, net income and net income per share (diluted) would have been $5.2 18 million and $1.02, respectively. The results of operations for the year ended December 31, 1996 include the results of these companies' operations since the date of acquisition in April 1996. See Note 2 of Notes to Consolidated Financial Statements. (3)Results for the year ended December 31, 1995 include a pretax charge of $4.5 million. The charge consists of $3.7 million for the value of Culverin Corporation's (Culverin) in-process research and development efforts at the date of acquisition and $0.8 million for restructuring. Excluding the impact of the acquired in-process research and development and restructuring charges, net income and net income per share (diluted) would have been $3.1 million and $0.64, respectively. The year ended December 31, 1995 statement of income includes the results of Culverin's operations since the date of acquisition in November 1995. See Note 2 of Notes to Consolidated Financial Statements.
19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO SHOULD BE READ IN CONJUNCTION WITH THE FOLLOWING DISCUSSION. THIS DISCUSSION CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THE CAUTIONARY STATEMENTS MADE IN THIS DISCUSSION SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS REPORT. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED HERE. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED ELSEWHERE IN THIS REPORT, AS WELL AS IN THE COMPANY'S OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION. OVERVIEW CFI is a leading provider of integrated, PC-based software for financial institutions, including solutions for branch automation, loan origination, new account opening, call centers, cross selling of products and electronic banking. Beginning in 1999 with the Company's acquisition of Modern Computer Systems, Inc. (MCS), the Company will also offer hardware and software solutions for the back office accounting needs of community banks and credit unions. The Company combines its technology, banking and legal expertise to deliver knowledge-based solutions that enable institutions to simplify key business processes such as sales and service, improve productivity, strengthen customer relationships, and maintain compliance with both internal business policies and external government regulations. More than 6,000 financial institutions have licensed one or more of the Company's products. During 1993 substantially all of the Company's revenue was derived from its Laser Pro and Deposit Pro products. Today, the Company licenses more than 20 products organized into four product groups: lending, retail delivery, connectivity software and, beginning in 1999, host processing. Due to its product diversification efforts, the Company is now less reliant on the Laser Pro and Deposit Pro products. In 1998 approximately 48% of the Company's revenue came from products other than Laser Pro and Deposit Pro. CFI generates recurring revenue from software maintenance agreements. In 1998 service and support fees, primarily for Laser Pro and Deposit Pro, accounted for approximately 35% of total revenue. Substantially all CFI customers subscribe to the Company's service and support programs, which provide ongoing product enhancements and, where applicable, updates to facilitate compliance with changing regulations. The Company's cost structure is relatively fixed and the cost of generating revenue, in aggregate, does not vary significantly with changes in revenue. As a result, the Company typically generates significantly greater profit margins from incremental sales once fixed costs are covered. In addition, any failure to achieve revenue targets in a particular period would adversely affect profit margins for that period. The Company believes that sales to larger financial institutions will constitute a higher percentage of total revenue in future periods. Transactions with these larger institutions are typically of greater scope, usually involve a greater sales effort over a longer period of time, and require more customization and prolonged acceptance testing. This project oriented business tends to cause growth in unbilled accounts receivable resulting from the use of percentage of completion 20 accounting and deferred payment terms, and also results in increased collection times for billed accounts receivable. These factors, in turn, result in higher days sales outstanding (DSOs) in accounts receivable. The Company's backlog as of December 31, 1998 was $18.3 million, compared to $15.2 million and $10.0 million at December 31, 1997 and 1996, respectively. CFI's backlog consists of firm signed orders taken and not yet converted to revenue, but expected to be converted to revenue within the next 12 months. Orders constituting the Company's backlog are subject to changes in delivery schedules or to cancellation at the option of the purchaser without significant penalty. The stated backlog is not necessarily indicative of the Company's revenue for any future period. ACQUISITIONS AND NEW BUSINESS VENTURES The Company has expanded its market presence by acquiring products, technologies and companies that complement the Company's product suite or increase its market share. The Company has completed the following 12 acquisitions since June 1994. See Note 2 of Notes to Consolidated Financial Statements.
COMPANY DATE ACQUIRED PRINCIPAL PRODUCTS/MARKETS ACQUIRED -------------------------- ------------- ----------------------------------- Assets of the Products June 1994 Access to customers in certain Division of Professional Midwestern states for the Company's Bank Systems, Inc. compliance products The Genesys Solutions September 1994 Call center software Group, Inc. Texas/Southwest Technology April 1995 StarGate connectivity products and Group, Inc. ACH products Culverin Corporation November 1995 Encore! Platform and Encore! Teller branch automation products OnLine Financial April 1996 Over 1,000 branch automation Communications customers employing DOS-based Systems, Inc. technology COIN Banking Systems, Inc. April 1996 Application Manager indirect lending product Assets of Input April 1996 LP Mortgage lending product Creations, Inc. Assets of Halcyon April 1996 fisCAL loan decision support product Group, Inc. Assets of Pathways April 1996 LoansPlus neural net loan decision Software, Inc. support and portfolio management product Vendor Payment Systems, Inc. April 1996 Bill payment services company Assets of Mortgage October 1998 Secondary mortgage loan processing Dynamics, Inc. products
21
COMPANY DATE ACQUIRED PRINCIPAL PRODUCTS/MARKETS ACQUIRED -------------------------- ------------- ----------------------------------- Assets of Modern Computer January 1999 Host processing software and Systems, Inc. hardware systems for community banks and credit unions
There can be no assurance that any of these or future acquisitions will have a favorable impact on the performance of the Company. The Company believes that it has achieved its objectives of growth and broadening its product offerings and customer base through this acquisition program and intends to continue to pursue acquisitions. However, the Company currently has no understandings, commitments or agreements with respect to any material acquisition of other businesses, products or technologies. The aggregate purchase price for the foregoing acquisitions was $28.9 million and 430,967 shares of Common Stock, plus contingent royalties. In connection with such acquisitions, the Company incurred non-cash charges primarily relating to the write-off of acquired in-process research and development efforts totaling approximately $1.0 million in 1998, $8.0 million in 1996 and $4.5 million in 1995. The terms of certain of the acquisitions provide that, based on various factors, including the passage of time or certain product revenue, the Company will be required to pay contingent royalties. Because amortization of certain intangible assets arising from the Company's acquisition activity is not deductible for federal income tax purposes, certain amortization expense incurred by the Company has the effect of increasing the Company's effective tax rate for financial reporting purposes. From time to time, the Company may also evaluate establishing new business operations or making investments in new business ventures, including joint ventures. In March 1997 CFI announced the creation of Lori Mae, L.L.C. (Lori Mae), a company that was designed to securitize small business loans originated by community banks. CFI owns 50% of Lori Mae and uses the equity method to account for this investment. In 1998 the Company wrote off its initial investment in Lori Mae due to lack of acceptable market demand for Lori Mae's initial product. See Note 1 of Notes to Consolidated Financial Statements. The Company believes that Lori Mae will in the future completely redesign its product offerings. 22 RESULTS OF OPERATIONS The following table sets forth statements of income data of the Company expressed as a percentage of total revenue for the periods indicated:
Year Ended December 31, ------------------------------------ 1998 1997 1996 ---------- ---------- ------- Revenue Software license fees 57.5 % 55.7 % 56.6 % Service and support 35.4 37.8 37.3 Other 7.1 6.5 6.1 ---------- ---------- ------ Total revenue 100.0 100.0 100.0 Gross profit 65.6 62.8 65.2 Operating expenses Sales and marketing 22.4 21.6 21.2 Product development 17.5 15.9 17.7 General and administrative 11.7 11.4 9.1 Amortization of intangibles 1.4 1.7 1.7 Acquired in-process research and development and other charges 3.1 -- 13.4 ---------- ---------- ------ Total operating expenses 56.1 50.6 63.1 ---------- ---------- ------ Income from operations 9.5 (1) 12.2 2.1 (1) Non-operating expense (0.9) (0.4) -- ---------- ---------- ------ Income before income taxes 8.6 11.8 2.1 Provision for income taxes 4.0 5.4 1.9 Preferred stock dividend 0.1 0.1 0.2 ========== ========== ====== Net income applicable to common 4.5 %(1) 6.3 % -- %(1) shareholders ========== ========== ====== (1)Excluding the impact of acquired in-process research and development and other charges, income from operations as a percentage of revenue in 1998 and 1996 would have been 12.7% and 15.5%, respectively, and net income applicable to common shareholders in 1998 and 1996 would have been 6.8% and 8.5%, respectively.
23 The following table sets forth percentage changes period over period in the statements of income data of the Company:
1998 Over 1997 Over 1997 1996 ----------- ----------- Revenue Software license fees 21.6 % 19.3 % Service and support 10.5 23.0 Other 29.0 28.1 ------- ------- Total revenue 17.9 21.2 Gross profit 23.2 16.6 Operating expenses Sales and marketing 22.2 23.4 Product development 29.1 8.8 General and administrative 21.2 52.3 In-process R&D and other charges 100.0 (100.0) ------- ------- Total operating expenses 30.6 (1) (2.8)(1) ------- ------- Income from operations (7.2)(1) 599.0 (1) Non-operating expense 211.6 (1,439.0) ------- ------- Income before income taxes (13.3) 570.0 Provision for income taxes (10.9) 235.0 ------- ------- Net income applicable to common shareholders (15.7)%(1) NM %(1)(2) ======= ======= (1)Excluding the impact of acquired in-process research and development and other charges, income from operations would have increased 22.9% in 1998 from 1997 and would have decreased 5.0% in 1997 from 1996, and net income applicable to common shareholders would have increased 27.5% in 1998 from 1997 and would have decreased 10.1% in 1997 from 1996. (2) Not meaningful.
REVENUE Total revenue increased $13.0 million, or 17.9%, to $85.6 million in 1998 from $72.6 million in 1997. Total revenue increased $12.7 million, or 21.2%, in 1997 from $59.9 million in 1996. SOFTWARE LICENSE FEES. Software license fees include sales of software to customers, fees for software customization and fees related to implementing software and systems at customer sites. Software license fees increased $8.7 million, or 21.6%, to $49.2 million in 1998 compared to $40.5 million in 1997. The increase was led by Laser Pro lending suite products, mortgage products, connectivity products and Deposit Pro, and was offset in part by declines in Encore! branch automation and home banking revenues. Revenues from 1997 also included results from the Company's RPxpress! remittance processing division, which was sold in September 1997. Software license fees increased $6.6 million, or 19.3%, in 1997 from $33.9 million in 1996. The increase was led by lending products and Encore! branch automation products, and was offset in part by declines in home banking and call center product revenues. No significant price changes for software products occurred during the periods presented. 24 PERCENTAGE OF SOFTWARE LICENSE FEES
Years Ended December 31, --------------------------------------- 1998 1997 1996 ----------- ----------- ---------- Lending Products 63 % 55 % 45 % Retail Delivery Products 32 42 50 Connectivity Products 5 3 5 =========== =========== ========== Total 100 % 100 % 100 % =========== =========== ==========
LENDING PRODUCTS. Lending products license revenue increased $8.8 million, or 39.9%, to $31.0 million in 1998 compared to $22.2 million in 1997. The increase resulted primarily from sales of Laser Pro Closing (particularly of the Company's Windows-based product), Laser Pro Mortgage and customization. Sales of fisCAL Analyzer and fisCAL Online declined substantially in 1998. The Company is not actively marketing the current fisCAL products and wrote off the remaining goodwill associated with the products in 1998. The Company simultaneously accrued for related severance costs calculated in accordance with pre-existing employment agreements. See Note 1 of Notes to Consolidated Financial Statements. The Company intends to completely redesign the fisCAL products in the future. Lending products license revenue increased $6.8 million, or 44.3%, in 1997 compared to $15.4 million in 1996. The increase resulted primarily from sales of Laser Pro Closing (particularly of the Company's Windows-based product to large banks), Laser Pro Mortgage and Laser Pro Application Manager. Lending products include Laser Pro Closing, Laser Pro Application, Laser Pro SBA, Laser Pro Credit Line, Laser Pro Application Manager, Laser Pro fisCAL Analyzer, Laser Pro fisCAL Online, Laser Pro Mortgage, Laser Pro SMarT and Laser Pro DocSMarT. RETAIL DELIVERY PRODUCTS. Retail delivery product license revenue decreased $1.3 million, or 7.7%, to $15.6 million in 1998 compared to $16.9 million in 1997. 1997 revenues included $0.7 million of RPxpress! sales that were not repeated in 1998. Increased revenues from Deposit Pro, Encore! Desktop and Flextran in 1998 were offset by decreased revenues from Encore! Teller, Encore! Platform, OnLine branch automation, Encore! Personal Branch and RPxpress! Retail delivery product license revenue decreased $0.2 million, or 1.2%, in 1997 compared to $17.1 million in 1996. Increased revenues from Encore! Teller and Encore! Platform products were offset by declines in revenues from OnLine branch automation products, Encore! Personal Branch, Deposit Pro, Encore! Call Center and Pro Active CRA. The declines in OnLine branch automation revenues in 1998 and 1997 reflect a decreased emphasis on the older DOS-based product and a transition to the Company's Windows-based Encore! branch automation products. Encore! Personal Branch revenues were adversely affected in 1997 as the Company transitioned the product from a UNIX to a Windows NT environment. The decrease in Deposit Pro revenues in 1997 reflects the one-time spike in demand when the Windows version of the product was released in mid-1996. Encore! Call Center revenues were adversely affected in 1997 when the product was substantially rewritten, and from the lack of an installed reference site. The decrease in retail delivery product license 25 revenues in 1997 was also caused by the sale of the Company's RPxpress! remittance processing division in September 1997. Retail delivery products include Encore! Teller, Encore! Platform, Flextran, OnLine branch automation, Deposit Pro, Encore! Desktop, Encore! Call Center, Encore! Personal Branch, Pro Active CRA and ACH. CONNECTIVITY PRODUCTS. Connectivity products license revenues increased $1.1 million, or 75.8%, to $2.5 million in 1998 from $1.4 million in each of 1997 and 1996. Revenues for these products are tied closely to the Company's sales of its various products to larger institutions and through third party host software providers. Connectivity products include StarGate middleware, Laser Pro interfaces and Deposit Pro interfaces. HOST PROCESSOR PRODUCTS. In January 1999 CFI acquired substantially all of the assets of Modern Computer Systems, Inc. and certain related corporations (collectively, MCS). MCS provides back office ("host") data processing and related services to community banks and credit unions. No revenues from host processor products are attributable to 1998, 1997 or 1996. SERVICE AND SUPPORT FEES. Service and support fees consist primarily of recurring software support charges and revenue from training customers in the use of the Company's products. Substantially all of the Company's customers subscribe to its support services, which require the payment of annual or quarterly maintenance fees. Service and support fees increased $2.9 million, or 10.5%, to $30.4 million in 1998 compared to $27.5 million in 1997. Service and support fees increased $5.1 million, or 22.8%, in 1997 compared to $22.4 million in 1996. These increases resulted primarily from increases in the installed base of the Company's products, by the Company's acquisition of new products and by an increase, effective in the fourth quarter of 1998, in service and support pricing for certain lending products. OTHER REVENUE. Other revenue includes Vendor Payment Systems (VPS) processing fees, sales of preprinted forms and supplies and certain consulting revenue. Other revenue increased $1.4 million, or 29.0%, to $6.1 million in 1998 compared to $4.7 million in 1997. Other revenue increased $1.0 million, or 27.8%, in 1997 compared to 1996. The acquisition of VPS in April 1996 was the primary cause for the increase in dollars in 1997. COST OF REVENUE Cost of revenue primarily consists of amortization of internally developed and purchased software, royalty payments, compliance warranty insurance premiums, software production costs, costs of product support, training and implementation, costs of software customization, materials costs for forms and supplies, and bill payment processing costs. Cost of revenue increased $2.4 million, or 8.9%, to $29.4 million in 1998 compared to 1997. Cost of revenue increased $6.2 million, or 29.8%, to $27.0 million for 1997 compared to $20.8 million in 1996. Of the 1997 increase, $2.6 million resulted from additional amortization of software development costs. The remainder of the increase in 1997 and the increase in 1998 are primarily attributable to higher implementation costs associated with the growing number of large financial institution projects, additional personnel required to support the increased installed base of customers and increased royalties and materials costs associated with 26 increased revenues. As the breadth of the Company's product line has expanded, the complexity and cost of providing high quality customer service and support has increased both in absolute dollars and as a percentage of revenue. Software amortization was $2.6 million in 1998, $4.5 million in 1997 and $1.9 million in 1996. During 1998, 1997 and 1996 several software development projects reached commercial feasibility. As a result, the Company began to amortize certain product development costs that had been capitalized in prior periods. In addition, the Company recorded amortization as a result of software acquired in connection with the MDI acquisition in October 1998 and the 1996 acquisitions. The increase in amortization costs in 1997 also resulted from accelerated amortization for certain products being replaced by new products or which management concluded were no longer technologically viable. As a result of acquisitions, costs associated with royalty payments will increase in future periods. The Company is obligated to pay royalties ranging from 3% to 18% of revenue related to certain products acquired in various acquisitions since June 1994. In addition, the Company is obligated to pay MicroBilt Corporation a fixed amount per OnLine customer converted to the Company's products. The royalty obligations generally extend three to five years from the acquisition date. The Company's gross margin was 65.6%, 62.8% and 65.2% in 1998, 1997 and 1996, respectively. The increase in 1998 is primarily attributable to lower software amortization than in 1997 and from improved implementation efficiencies. The decline in gross margin from 1996 to 1997 is primarily attributable to three factors: increased software amortization, a shift in product mix to more projects and increased royalty expenses for products acquired through acquisitions. The Company expects all three factors to continue in future periods, which may continue to adversely affect gross margin. In particular, software amortization is expected to increase in 1999 compared to 1998. OPERATING EXPENSES SALES AND MARKETING. Sales and marketing expenses increased to $19.2 million, or 22.4% of revenue, in 1998 compared to 1997. Sales and marketing expenses increased to $15.7 million, or 21.6% of revenue, in 1997 compared to $12.7 million, or 21.2% of revenue, in 1996. The increases in dollar amount in 1998 and 1997 resulted from increased commissions associated with increased revenues, salary increases, additional personnel and higher advertising costs. PRODUCT DEVELOPMENT. Product development expenses include costs of enhancing existing products and developing new products. Product development expenses were $14.9 million, or 17.4% of revenue, in 1998, $11.5 million, or 15.9% of revenue, in 1997 and $10.6 million, or 17.7% of revenue, in 1996. Increases in dollar amount of product development expenses were largely the result of increased staffing in the development areas of the Company, additional costs for integrating acquired products and accelerating development of the Company's home banking products. Product development expenses in each of 1998, 1997 and 1996 were offset in part by capitalization of software development efforts. The company capitalized $1.0 million of software development costs in 1998, $5.0 million in 1997 and $5.2 million in 1996. Capitalized software development costs, net of accumulated amortization, were $8.3 million as of 27 December 31, 1998 compared to $9.9 million as of December 31, 1997. The Company believes that the current development cycle for its compliance-related products, which typically have relatively long lives, was completed in the second quarter of 1998 and, accordingly, there should be a significant reduction in the capitalization of software development costs in future periods. No software development costs were capitalized in the third or fourth quarters of 1998. The Company anticipates that its capitalized software development costs existing as of December 31, 1998 will be fully amortized over the next four years. The Company will continue to commit significant resources to product development efforts. The Company anticipates that with the completion of the current development cycle of its compliance-related products, and the consequent reduction in capitalization of costs, product development cost will have a material adverse effect in future periods on operating margin and net income. GENERAL AND ADMINISTRATIVE. General and administrative expenses were $10.0 million, or 11.7% of revenue in 1998, $8.3 million, or 11.4% of revenue in 1997, and $5.4 million, or 9.0% of revenue, in 1996. The increases in dollar amounts in 1998 and 1997 are due principally to additional systems and infrastructure costs necessary to accommodate revenue growth. The increase in dollar amount in 1997 was also due to increased bad debt expense. Consolidation of the general and administrative functions of the companies acquired in April 1996 was the principal reason for the relatively low level of these expenses as a percentage of revenue in 1996. AMORTIZATION OF INTANGIBLES Intangibles include acquisition payments assigned to goodwill, noncompetition agreements and customer lists. These costs are amortized over periods ranging from five to seven years. Amortization of intangibles was $1.2 million, $1.3 million and $1.0 million in 1998, 1997 and 1996, respectively. ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT AND OTHER CHARGES In connection with its acquisition of the assets of Mortgage Dynamics, Inc. in October 1998, the Company recorded a pretax charge of $1.0 million for research and development efforts in process at the date of the acquisition. In the fourth quarter of 1998 the Company also recorded aggregate other pretax charges of $2.0 million consisting of the present value of the remaining liability for certain leased office space the Company ceased using, the remaining goodwill associated with the fisCAL credit analysis products and related severance costs, and the Company's initial investment in Lori Mae. See Notes 1, 2 and 7 of Notes to Consolidated Financial Statements. In connection with its acquisitions of six companies in April 1996, the Company recorded pretax charges of $8.0 million in the second quarter of 1996 for research and development efforts in process at the date of acquisition. The values assigned to the in-process research and development efforts were determined by independent appraisals and represent those efforts in process at the dates of acquisition that had not reached the point where technological feasibility had been established and that had no alternative future uses. Accounting rules require that these costs be expensed as incurred. At 28 December 31, 1998 the Company believes that acquired in-process research and development efforts related to the acquisitions will result in commercially viable products during 1999 at an additional cost of approximately $350,000. INCOME FROM OPERATIONS Income from operations in 1998 was $8.2 million, or 9.6% of revenue, compared to $8.8 million, or 12.2% of revenue, in 1997 and $1.3 million, or 2.1% of revenue, in 1996. Excluding the impact of the $2.6 million charge in the fourth quarter of 1998 and of the $8.0 million charge in the second quarter of 1996, operating income would have been $10.8 million, or 12.7% of revenue, in 1998 and $9.3 million, or 15.5% of revenue, in 1996. NON-OPERATING INCOME (EXPENSE) Non-operating income (expense), which consists primarily of interest income and expense, was a net expense of $0.7 million in 1998 compared to a net expense of $0.3 million in 1997 and net non-operating income of $18,000 in 1996. Non-operating expense in 1998 included a $0.4 million charge representing CFI's initial investment in Lori Mae. See Note 1 of Notes to Consolidated Financial Statements. Interest paid on outstanding balances under the Company's bank line of credit was the principal cause of the net expense in 1997. In September 1997 the Company completed the sale of its RPxpress! remittance processing division. On an annual basis, the remittance processing revenues and expenses were both approximately $1.0 million. The Company received 10% of the sales price in cash with the remainder to be paid in yearly installments with interest at 8.5% per annum over four years. In connection with the sale, the Company recorded a non-operating gain of $0.6 million. In February 1997 the Company's Board of Directors elected not to proceed with a planned follow-on stock offering of the Company's common stock. The Company took a $0.5 million non-operating charge in the first quarter as a result of the cancellation. The Company's Board of Directors determined that the stock price at which the Company would be required to offer the shares was too low and would unfairly dilute the investment of existing shareholders. PROVISION FOR INCOME TAXES The effective tax rate for 1998 was 44.3% compared to 45.5% in 1997 and 43.0% in 1996, excluding the effect of $3.0 million in pretax charges in 1998 and $8.0 million in pretax charges resulting from the April 1996 acquisitions. The difference between federal and state statutory tax rates and the Company's effective tax rates in 1998, 1997 and 1996 results primarily from increased amortization of nondeductible intangibles related to acquisitions. QUARTERLY RESULTS The Company has experienced, and expects in the future to experience, significant quarterly fluctuations in its results of operations. These fluctuations may be caused by various factors, including, among others: the size and timing of product orders and shipments; the timing and market acceptance of new products and product enhancements introduced by the Company and its competitors; the Company's product mix, including expenses of implementation and royalties related to certain products; the timing of the Company's completion of work under contracts 29 accounted for under the percentage of completion method; customer order deferrals in anticipation of new products; aspects of the customers' purchasing process, including the evaluation, decision-making and acceptance of products within the customers' organizations; the sales process for the Company's products, including the complexity of customer implementation of the Company's products; the number of working days in a quarter; federal and state regulatory events, including regulatory requirements for financial institutions with respect to the Year 2000; competitive pricing pressures; technological changes in hardware platform, networking or communication technology; changes in Company personnel; the timing of the Company's operating expenditures; specific economic conditions in the financial services industry and general economic conditions. The Company's business has experienced, and is expected to continue to experience, some degree of seasonality due to its customers' budgeting and buying cycles. The Company's strongest revenue quarter in any year is typically its fourth quarter and its weakest revenue quarter is typically its first quarter. Customers' purchases are tied closely to their internal budget processes. For some of the Company's customers, budgets are approved at the beginning of the year and budgeted amounts often must be utilized by the end of the year. In addition, the Company's incentive sales compensation plan provides for increases in commission percentages as sales people approach or exceed their annual sales quotas. As a result of these two factors, the Company usually experiences increased sales orders in the last quarter. YEAR 2000 The Year 2000 issue identifies problems that may arise in computer equipment and software, as well as embedded electronic systems, because of the way these systems are programmed to interpret certain dates that will occur around the change in century. In the computer industry this is primarily the result of computer programs being designed and developed using or reserving only two digits in date fields (rather than four digits) to identify the century, without considering the ability of the program to properly distinguish the upcoming century change in the Year 2000. In addition, the Year 2000 is a special-case leap year, and some programs may drop February 29th from their internal calendars. Likewise, other dates may present problems because of the way the digits are interpreted. Because the Company's business is based on the licensing of applications software, the Company's business would be impacted if its products or its internal systems experience problems associated with the century change. This issue also potentially affects the internal software systems used by the Company in its operations. The Company has completed its survey of internal computer systems, as well as critical third party software and systems used by the Company, regarding Year 2000 compliance status. The scope of the Year 2000 readiness effort included addressing (i) information technology such as software and hardware, (ii) non-information systems or embedded technology contained in various equipment, safety systems, facilities and utilities and (iii) readiness of mission critical third-party suppliers. The Company has communicated with its significant suppliers and vendors to understand their ability to continue providing services and products through the millenium change and to determine the extent to which the Company may be vulnerable in the event of a failure by them or their services and products. With respect to mission critical systems, the Company sought statements of compliance from each vendor either through direct response or by reference to information posted on an electronic bulletin board or in a government database. 30 INTERNAL SYSTEMS. Some of the computer programs and systems used by the Company require date-sensitive information to accurately and adequately process information critical to the Company's business. Inaccuracies or other errors in this information could have a material, adverse effect on the Company's business. Furthermore, non-compliance in these programs could cause a system failure or interruption, either of which could also materially adversely affect the Company. In addition to computer software, some machines and devices used by the Company and others may contain embedded technology that is not Year 2000 compliant, which could result in a malfunction or failure of such devices. The review and assessment of the Company's internal systems is complete. The Company's internal accounting system, including those components used for the Company's invoicing and bill payment, has been evaluated by the vendor and has been represented to be Year 2000 compliant. Nevertheless, the Company will conduct its own tests in the first half of 1999. Furthermore, the Company plans to routinely backup its financial data through the end of 1999 and will develop a contingency plan with respect to the accounting system in the second half of 1999. The Company anticipates that its customer support and call tracking system will be Year 2000 compliant after installation of an update scheduled to occur in the second quarter of 1999. The cost of the update is estimated to be immaterial. The Company completed the survey of its software vendors in the fourth quarter of 1998. The bulk of the Company's vendors have already provided compliant versions of their software. The Company continues to monitor all material third party software not indicated to be Year 2000 compliant and believes that few vendors, if any, will not provide compliant versions by the middle of 1999. The Company has received representations that its phone and voice mail systems became Year 2000 compliant through upgrades completed during the first quarter of 1999. As to its phone service providers, the Company has offices located at 10 disparate geographical locations all served by different local phone service providers and the Company contracts with two long distance carriers. Consequently, the Company can shift telecommunications through any of these locations should any other location be down. Further, neither the Company's base software nor updates are provided exclusively via downloading. Virtually all of the Company's base software and updates are provided to customers through magnetic media. Based on information gathered to date, the Company is not presently aware of any Year 2000 issue that could materially affect the Company's operations, either self-originated or caused by third-party service vendors or providers. Management believes that all mission critical systems will be compliant by the Year 2000. Nevertheless, there can be no assurance that the Company will not experience some operating difficulties as a result of Year 2000 issues. If they occur, these difficulties could require the Company to incur unanticipated costs to remedy the problems and, either individually or collectively, have a material adverse effect on the Company's business operations and financial results. The Company has not yet determined the cost of completing its investigation or the cost of any modification or remediation that may be required to correct Year 2000 issues. Costs incurred to date to assess Year 2000 issues have not been significant and have been funded through operating cash flows. The Company intends to develop contingency plans for its significant systems that can be implemented on or after January 1, 2000 in the event of a system failure resulting from the century change. 31 COMPANY DEVELOPED SOFTWARE. The Company develops software programs for use by financial institutions to automate various transactions and processes. These programs often are highly dependent upon historical or dynamic financial and other data that, if the programs are not able to distinguish between the Year 2000 and other century-end years, could be misreported or misinterpreted and cause significant resulting calculation errors. This data is often acquired from other systems that may or may not be Year 2000 compliant, further exacerbating the problem. The Company's financial institution customers are subject to regulatory scrutiny; any such errors could subject them to civil or regulatory action, or both, resulting in large fines, penalties or other costs. Additional consequences of the Year 2000 issue for the Company's financial institution customers may include systems failures and business process interruption, including, among other things, a temporary inability to process transactions, satisfy regulatory obligations, or engage in similar normal business activities. In addition, the impact of Year 2000 issues may severely impair the ability of the Company's customers to purchase the Company's products, or to make payments on software or services previously purchased. Concern over Year 2000 issues is permeating the financial services industry, and management expects that the resolution of these concerns will likely absorb a substantial portion of financial institution information technology budgets and attention in the near term (with an associated decreased focus on other business initiatives, including purchase decisions with respect to the Company's software). Year 2000 issues faced by its customers could materially and adversely affect the Company's operations and financial results through the Year 2000. The Federal Financial Institutions Examination Council (the "FFIEC") has issued a series of Statements beginning in June 1996 requiring that the various financial institutions regulated by FFIEC member agencies provide assurance that they will be capable of conducting business as usual in 2000 and into the 21st century. To this end, and among other obligations, each institution is required to survey its systems and operations (including software and vendor supplied services), determine any deficiencies, remediate to correct deficiencies, test mission critical third party software and services to confirm their Year 2000 readiness after remediation, and develop contingency plans against the event that a mission critical item, service or process fails to be Year 2000 compliant. Further information on the FFIEC mandate and related matters can be found at the FFIEC's website, www.ffiec.gov/y2k. In support of its customers' obligations resulting from the FFEIC's Statements, the Company has made the Year 2000 issue a significant priority and assigned a task force with responsibility for an ongoing effort to minimize Year 2000-related risks relative to the Company's products. The Company has completed its review of all of its software products for Year 2000 compliance, and has determined that most of the Company's standard software products are Year 2000 compliant. The Company has not undertaken, and does not intend to undertake, a review of the many customized versions of software products that it has provided customers. The Company has developed a plan to discontinue some of its standard products prior to December 31, 1999, and the Year 2000 issue has been one of the factors considered in those decisions. For those products that will not continue to be offered, generally a Year 2000 compliant replacement product currently exists. For standard products that will continue to be offered, but are not currently Year 2000 compliant, the Company has developed and executed a plan for resolving such compliance-related issues. 32 Remediation was substantially completed during 1998. A matrix describing the Company's product compliance (including a comprehensive definition to determine such compliance) has been communicated to the Company's customers and is available for review on the Company's website. The financial impact of making the required changes to the software programs is not expected to be material to the Company's consolidated financial position, results of operations or cash flows. The Company acquired substantially all of the assets of MCS in January 1999. Although MCS's BankServ product has been certified as Year 2000 compliant, none of the products of MCS are included in the foregoing discussion. The Company intends to complete its Year 2000 review of the MCS products during the first quarter of 1999 consistent with the standards established for the Company's other products. Information on the Company's website is provided to customers for the sole purpose of assisting them in planning for the transition to the Year 2000 and includes the Company's definition of Year 2000 compliance, product compliance status, and, in the case of the Laser Pro Closing/Lending product, includes test guides. This information is updated at least quarterly so that the Company's customers can access current information on the Year 2000 compliance status of the Company's products. The matrix does not provide certification of Year 2000 compliance and customers are cautioned that they should independently confirm Year 2000 compliance of the Company's products. The Company has developed a standard Year 2000 compliance warranty and is offering it to customers with respect to those products that will continue to be offered into the next century. This warranty is consistent with the Company's standard product warranties, extends no indeminities, and maintains the liability cap applying otherwise in its licenses. Financial institutions, financial institution regulators, and the many vendors supplying the financial services industry have not developed a consistent and comprehensive definition of what constitutes "compliance" with the Year 2000. This, coupled with the different combinations of software, firmware, and hardware used by customers may lead to disputes against the Company regarding the operation of its software. The outcome of such disputes and the impact on the Company are not estimable at this time. MARKET RISK The Company has not entered into derivative financial instruments. The Company may be exposed to future interest rate changes on its debt. The Company does not believe that a hypothetical 10 percent change in interest rates would have a material effect on the Company's cashflow. LIQUIDITY AND CAPITAL RESOURCES Working capital increased $9.8 million to $17.0 million at December 31, 1998 from $7.2 million at December 31, 1997. The increase resulted principally from enhanced efforts by the Company to improve cash collections, and from a net reduction in short-term debt of $5.3 million and an increase in long-term debt of $4.0 million in connection with a renegotiation of the Company's bank line of credit facility. Net cash provided by operations was $11.0 million in 1998 compared to $5.4 million in 1997. The increase was principally due to a charge for acquired research and development efforts 33 and other charges taken in 1998, decreased net accounts receivable and prepaid expenses, and increased customer deposits. These changes were offset in part by decreases in deferred revenues, depreciation and amortization, deferred income taxes and income taxes payable. Net cash used in investing activities in 1998 was $6.1 million compared to $7.9 million in 1997, due primarily to the reduction in capitalization of software development costs in 1998 and offset in part by cash paid for the MDI acquisition. Expenditures for property and equipment of $1.7 million in 1998 were primarily attributable to investments in infrastructure necessary to accommodate the Company's growth. Net cash used in financing activities of $1.3 million in 1998 resulted principally from a total of $2.0 million of repayment on the Company's bank line of credit facility and on acquisition-related debt. These payments were offset in part by $0.8 million in proceeds from issuance of common stock, primarily upon exercise of stock options. The Company's project-oriented business often requires unbilled accounts receivable and milestone billings, both of which often have longer collection cycles. Unbilled accounts receivable at December 31, 1998 were $7.6 million, or 25.8% of total accounts receivable, compared to $3.8 million, or 11.9% of total accounts receivable, at December 31, 1997. Days sales outstanding (DSOs) in accounts receivable, including both billed and unbilled accounts receivable, decreased to 108 days at December 31, 1998, from 136 days at December 31, 1997, primarily because the Company issued certain annual maintenance invoices in January 1999 instead of December 1998. Historically, the Company had issued such invoices in late December each year. DSOs at December 31, 1997, excluding the distorting impact of annual maintenance invoices, were 106 days. The shift in the timing of issuing annual maintenance invoices is also primarily responsible for the decreases in accounts receivable and deferred revenues at December 31, 1998 compared to December 31, 1997. Future cash requirements could include, among other things, purchases of companies, products or technologies, expenditures for internal software development, capital expenditures necessary to the expansion of the business, and installment payments on debt related to acquisitions. Available cash resources include cash generated by the Company's operations and a revolving bank line of credit of up to the lesser of $10.0 million or 50% of accounts receivable, of which $6.0 million was available at December 31, 1998. The line of credit expires May 1, 2000. From time to time, the Company receives contract claims from its customers. In the second quarter of 1997, one of the Company's customers canceled a $0.8 million project with the Company and requested a partial refund of moneys paid and cancellation of unpaid invoices. The Company believes that it has met all of its contractual obligations to this customer and intends to enforce the terms of the agreement. The Company believes that funds expected to be generated from existing operations and borrowings under its revolving line of credit will provide the Company with sufficient funds to finance its current operations for at least the next 12 months. The Company may require additional funds to support its working capital requirements, future acquisitions or for other purposes and may seek to raise such additional funds through one or more public or private financings of debt or equity, or from other sources. No assurance can be given that additional 34 financing will be available or, that, if available, such financing will be obtainable on terms favorable to the Company or its shareholders. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK SEE MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - MARKET RISK. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements, notes thereto and supplementary data required by this item begin on page F-1 as listed in Item 14 of Part IV of this document. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information required by this item is included under the captions Proposal 1. Election of Directors, Members of the Board of Directors Continuing in Office, Non-Director Executive Officers, and Section 16(a) Beneficial Ownership Reporting Compliance, respectively, in the Company's Proxy Statement for its 1999 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION Information required by this item is included under the captions Board Compensation, Executive Compensation, Employment Contracts, Termination of Employment and Change-in-Control Arrangements and Report of the Compensation Committee in the Company's Proxy Statement for its 1999 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is included under the caption Security Ownership of Certain Beneficial Owners and Management in the Company's Proxy Statement for its 1999 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is included under the caption Certain Relationships and Related Transactions in the Company's Proxy Statement for its 1999 Annual Meeting of Shareholders and is incorporated herein by reference. 35 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K FINANCIAL STATEMENTS AND SCHEDULES The Consolidated Financial Statements, together with the report thereon of Arthur Andersen LLP, are included on the pages indicated below: Page Report of Independent Public Accountants F-1 Consolidated Balance Sheets - December 31, 1998 and 1997 F-2 Consolidated Statements of Income for the years ended December 31, 1998, 1997 and 1996 F-3 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996 F-4 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 F-5 Notes to Consolidated Financial Statements F-6 The following schedule and report thereon is filed herewith: Report of Independent Public Accountants on Financial Statement Schedule F-23 Schedule II Valuation and Qualifying Accounts F-24 REPORTS ON FORM 8-K No reports on Form 8-K were filed during the quarter ended December 31, 1998. 36 EXHIBITS The following exhibits are filed herewith and this list is intended to constitute the exhibit index: Number Description - ---------- ------------------------------------------------------------------- 2.1 Stock Purchase and Sale Agreement dated November 21, 1995, among CFI ProServices, Inc., Culverin Corporation, Eric T. Wagner, John M. Loveless, David Steffens and Douglas Teets previously filed as Exhibit 2.1 to the Current Report on Form 8-K dated November 21, 1995 and as filed with the Securities and Exchange Commission on December 6, 1995 and incorporated herein by reference. 2.2 Stock Purchase and Sale Agreement effective April 1, 1996, by and among MicroBilt Corporation, First Financial Management Corporation and CFI ProServices, Inc. - previously filed as Exhibit 2.1 with the Company's Form 8-K dated April 1, 1996 and as filed with the Securities and Exchange Commission on April 16, 1996 and incorporated herein by reference. 2.3 Asset Purchase and Sale Agreement, effective April 1, 1996, by and among Input Creations, Inc., its shareholders and CFI ProServices, Inc. - previously filed as Exhibit 2.1 with the Company's Form 8-K dated April 17, 1996 and as filed with the Securities and Exchange Commission on May 2, 1996 and incorporated herein by reference. 2.4 Asset Purchase and Sale Agreement, effective January 1, 1999, by and among Modern Computer Systems, Inc., other affiliated corporations, their shareholder and CFI ProServices, Inc. previously filed as Exhibit 2.1 with the Company's Form 8-K dated February 10, 1999 and as filed with the Securities and Exchange Commission on February 10, 1999 and incorporated herein by reference. 3.1 Registrant's Amended and Restated Articles of Incorporation previously filed as Exhibit 3(i)(a) to the Registration Statement on Form S-1, Registration Statement No. 33-64894, as filed with the Securities and Exchange Commission on June 23, 1993 and incorporated herein by reference. 3.2 Amendments to Registrant's Amended and Restated Articles of Incorporation (effective June 28, 1993) - previously filed as Exhibit 3(i)(b) to the Registration Statement on Form S-1, Registration Statement No. 33-64894, as filed with the Securities and Exchange Commission on July 26, 1993 and incorporated herein by reference. 3.3 Amendments to Registrant's Amended and Restated Articles of Incorporation (effective July 26, 1993) - previously filed as Exhibit 3(i)(c) to the Registration Statement on Form S-1, Registration Statement No. 33-64894, as filed with the Securities and Exchange Commission on August 10, 1993 and incorporated herein by reference. 3.4 Registrant's Amended and Restated Bylaws - previously filed as Exhibit 3(ii) to the Registration Statement on Form S-1, Registration Statement No. 33-64894, as filed with the Securities and Exchange Commission on August 10, 1993 and incorporated herein by reference. 37 Number Description - ---------- ------------------------------------------------------------------- 10.1* Nonqualified Stock Option Plan dated October 15, 1993 previously filed as Exhibit 99.10 to the Registration Statement on Form S-8 (Registration No. 33-70506), as filed with the Securities and Exchange Commission on October 19, 1993 and incorporated herein by reference. 10.2* Registrant's Outside Director Compensation and Stock Option Plan previously filed as Exhibit 10.3 to the Company's Form 10-Q for the quarter ended March 31, 1994 and incorporated herein by reference. 10.3* Registrant's Standardized Regional Prototype 401(k) Cash or Deferred Savings Plan and Trust, adopted December 1, 1994 previously filed as Exhibit 10.12 to the Company's Form 10-K for the year ended December 31, 1995 and as filed with the Securities and Exchange Commission on April 1, 1996 and incorporated herein by reference. 10.4 Legal Services Agreement for the State of Louisiana effective March 13, 1986 between the Company and McGlinchey, Stafford, Mintz, Cellini & Lang, a Louisiana professional law corporation (confidential treatment requested) - previously filed as Exhibit 10.25 to the Registration Statement on Form S-1 (Registration No. 33-64894) filed with the Securities and Exchange Commission on July 26, 1993 and incorporated herein by reference. 10.5 1994 Employee Stock Purchase Plan - previously filed as Exhibit 10.2 to the Company's Form 10-Q for the quarter ended June 30, 1994 and incorporated herein by reference. 10.6* 1995 Consolidated and Restated Stock Option Plan - previously filed as Exhibit 99.13 to the Registration Statement on Form S-8 filed with the Securities and Exchange Commission on March 1, 1995 and incorporated herein by reference. 10.7* First Amendment to 1995 Consolidated and Restated Stock Option Plan - previously filed as Exhibit 9.2 to the Company's Registration Statement on Form S-8 filed with the Securities and Exchange Commission on or about September 4, 1996 and incorporated herein by reference. 10.8 Office Lease dated March 18, 1994 between the Company and John Hancock Mutual Life Insurance Company - previously filed as Exhibit 10.1 to the Company's Form 10-Q for the quarter ended March 31, 1994 and incorporated herein by reference. 10.9 First amendment, dated July 8, 1996, to office lease dated March 18, 1994 between the Company and John Hancock Mutual Life Insurance Company - previously filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996 as filed with the Securities and Exchange Commission on March 27, 1997 and is incorporated herein by reference. 10.10 Second amendment, dated January 11, 1999, to office lease dated March 18, 1994 between the Company and John Hancock Mutual Life Insurance Company. 38 Number Description - ---------- --------------------------------------------------------------- 10.11* Employment and Noncompetition Agreement dated November 21, 1995 between CFI ProServices, Inc. and Eric T. Wagner previously filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on December 6, 1995 and incorporated herein by reference. 10.12 Business Loan Agreement (Revolving Line of Credit) dated November 8, 1995 between CFI ProServices, Inc. and Bank of America, Oregon previously filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 as filed with the Securities and Exchange Commission on April 1, 1996 and incorporated herein by reference. 10.13 Amendment No. 1, dated May 17, 1996, to Business Loan Agreement dated November 8, 1995 - previously filed as Exhibit 10.7 to the Company's quarterly report of Form 10-Q for the quarter ended June 30, 1996 as filed with the Securities and Exchange Commission on August 13, 1996 and incorporated herein by reference. 10.14 Amendment No. 2, dated July 1, 1996, to Business Loan Agreement dated November 8, 1995 - previously filed as Exhibit 10.8 to the Company's quarterly report of Form 10-Q for the quarter ended June 30, 1996 as filed with the Securities and Exchange Commission on August 13, 1996 and incorporated herein by reference. 10.15 Amendment No. 3, dated September 24, 1996, to Business Loan Agreement dated November 8, 1995 - previously filed as Exhibit 10 to the Company's quarterly report of Form 10-Q for the quarter ended September 30, 1996 as filed with the Securities and Exchange Commission on November 14, 1996 and incorporated herein by reference. 10.16 Amendment No. 4, dated November 21, 1996, to Business Loan Agreement dated November 8, 1995 - previously filed as Exhibit 10.1 to the Company's Registration Statement No. 333-15505 on Form S-3 as filed with the Securities and Exchange Commission on January 27, 1997 and incorporated herein by reference. 10.17 Amendment No. 5, dated December 31, 1996, to Business Loan Agreement dated November 8, 1995 - previously filed as Exhibit 10.2 to the Company's Registration Statement No. 333-15505 on Form S-3 as filed with the Securities and Exchange Commission on January 27, 1997 and incorporated herein by reference. 10.18 Amendment No. 6, dated March 1, 1997, to Business Loan Agreement dated November 8, 1995 - previously filed as exhibit 10.41 with the Company's Form 10-K for the year ended December 31, 1996 and as filed with the Securities and Exchange Commission on March 21, 1997 and incorporated herein by reference. 10.19 Amendment No. 7 dated June 1, 1997, to business loan agreement dated November 8, 1995 - previously filed with the Company's Form 10-Q for the quarter ended June 30, 1997, as filed with the Securities and Exchange Commission on August 13, 1997, and is incorporated herein by reference. 39 Number Description - ---------- --------------------------------------------------------------- 10.20 Amendment No. 8 dated March 31, 1998, to business loan agreement dated November 8, 1995 - previously filed with the Company's Form 10-Q for the quarter ended March 31, 1998, as filed with the Securities and Exchange Commission on May 5, 1998, and is incorporated herein by reference. 10.21 Amendment No. 9 dated April 30, 1998, to business loan agreement dated November 8, 1995 - previously filed with the Company's Form 10-Q for the quarter ended March 31, 1998, as filed with the Securities and Exchange Commission on May 5,1998, and is incorporated herein by reference. 10.22* Form of Executive Retention Agreement - previously filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on August 22, 1994 and incorporated herein by reference. 21 Subsidiaries of the Registrant 23 Consent of Arthur Andersen LLP 27 Financial Data Schedule - ------------------ *Mangement contract or compensatory plan or arrangement. 40 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. Date: March 30, 1999 CFI PROSERVICES, INC. By: /s/ MATTHEW W. CHAPMAN ---------------------- Matthew W. Chapman Chairman and Chief 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 indicated on March 30, 1999. Signature Title - --------- ----- /s/ MATTHEW W. CHAPMAN Chairman and Chief Executive Officer - ---------------------- (Principal Executive Officer) Matthew W. Chapman /s/ ROBERT P. CHAMNESS Director, President and Chief - ---------------------- Operating Officer Robert P. Chamness /s/ KURT W. RUTTUM Vice President and Chief Financial Officer - ---------------------- (Principal Financial and Accounting Officer) Kurt W. Ruttum /s/ ROBERT T. JETT Director, Executive Vice President and - ---------------------- Secretary Robert T. Jett /s/ J. KENNETH BRODY Director - ---------------------- J. Kenneth Brody /s/ LORRAINE O. LEGG Director - ---------------------- Lorraine O. Legg /s/ ERAN S. ASHANY Director - ---------------------- Eran S. Ashany /s/ FRANK E. BRAWNER Director - ---------------------- Frank E. Brawner /s/ L. B. DAY Director - ---------------------- L. B. Day 41 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of CFI ProServices, Inc. We have audited the accompanying consolidated balance sheets of CFI ProServices, Inc. (an Oregon corporation) and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CFI ProServices, Inc. and subsidiaries as of December 31, 1998 and 1997 and the 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. ARTHUR ANDERSEN LLP Portland, Oregon January 22, 1999 F-1 CFI PROSERVICES, INC. CONSOLIDATED BALANCE SHEETS (Dollars in thousands)
December 31, ---------------------- 1998 1997 --------- --------- ASSETS Current Assets: Cash and cash equivalents $ 3,589 $ 20 Investments 206 - Receivables, net of allowances of $2,600 and $2,880 29,701 32,059 Inventory 249 297 Deferred tax asset 1,341 1,307 Prepaid expenses and other current assets 1,604 1,928 -------- -------- Total Current Assets 36,690 35,611 Property and Equipment, net of accumulated depreciation of $9,947 and $7,855 4,534 5,211 Software Development Costs, net of accumulated amortization of $3,368 and $735 8,277 9,856 Purchased Software Costs, net of accumulated amortization of $19 211 - Other Intangibles, net of accumulated amortization of $4,763 and $3,227 6,190 5,689 Other Assets, including deferred taxes 879 1,175 -------- -------- Total Assets $ 56,781 $ 57,542 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 1,986 $ 2,119 Accrued expenses 8,017 5,362 Deferred revenues 5,300 12,498 Customer deposits 3,681 1,715 Bank line of credit - 5,310 Current portion of long-term debt 261 295 Income taxes payable 473 1,125 -------- -------- Total Current Liabilities 19,718 28,424 Deferred Tax Liability - 197 Commitments and Contingencies Long-Term Debt, less current portion 5,693 2,232 -------- -------- Total Liabilities 25,411 30,853 Mandatory Redeemable Class A Preferred Stock 738 746 Shareholders' Equity: Series preferred stock, 5,000,000 shares authorized, none issued and outstanding - - Common stock, no par value, 10,000,000 shares authorized and 5,032,977 and 4,925,423 shares issued and outstanding 19,689 18,865 Retained earnings 10,943 7,078 -------- -------- Total Shareholders' Equity 30,632 25,943 -------- -------- Total Liabilities and Shareholders' Equity $ 56,781 $ 57,542 ======== ========
The accompanying notes are an integral part of these consolidated balance sheets. F-2 CFI PROSERVICES, INC. CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share data)
Years Ended December 31, --------------------------- 1998 1997 1996 ------ ------ ------ REVENUE Software license fees $ 49,202 $ 40,475 $ 33,935 Service and Support 30,352 27,466 22,336 Other 6,076 4,708 3,676 ------ ------ ------ Total Revenue 85,630 72,649 59,947 COST OF REVENUE 29,423 27,041 20,844 ------ ------ ------ Gross Profit 56,207 45,608 39,103 OPERATING EXPENSES Sales and marketing 19,204 15,709 12,725 Product development 14,913 11,549 10,615 General and administrative 10,012 8,263 5,425 Amortization of intangibles 1,228 1,259 1,045 Acquired in-process research and development and other charges 2,661 - 8,030 ------ ------ ------ Total Operating Expenses 48,018 36,780 37,840 ------ ------ ------ Income From Operations 8,189 8,828 1,263 NON-OPERATING INCOME (EXPENSE) Interest expense (454) (456) (251) Interest income 295 170 271 Canceled stock offering costs - (487) - Gain on sale of operating division - 628 - Equity in losses attributable to joint venture (670) (148) - Other, net 83 52 (2) ------ ------ ------ Total Non-operating Income (Expense) (746) (241) 18 ------ ------ ------ INCOME BEFORE PROVISION FOR INCOME TAXES 7,443 8,587 1,281 PROVISION FOR INCOME TAXES 3,483 3,907 1,167 ------ ------ ------ NET INCOME 3,960 4,680 114 PREFERRED STOCK DIVIDEND 95 95 97 ------ ------ ------ NET INCOME APPLICABLE TO COMMON SHAREHOLDERS $ 3,865 $ 4,585 $ 17 ====== ====== ====== BASIC NET INCOME PER SHARE $ 0.77 $ 0.93 $ - ====== ====== ====== DILUTED NET INCOME PER SHARE $ 0.75 $ 0.90 $ - ====== ====== ======
The accompanying notes are an integral part of these consolidated statements. F-3 CFI PROSERVICES, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS'S EQUITY (Dollars in thousands)
Common Stock ------------------- Retained Shares Amount Earnings Total --------- -------- -------- ------- BALANCES, DECEMBER 31, 1995 $ 4,496,136 $ 15,693 $ 2,476 $ 18,169 Issuance of Common Stock 328,837 1,420 - 1,420 Tax benefits from stock transactions - 632 - 632 Net income applicable to common shareholders - - 17 17 --------- -------- -------- ------- BALANCES, DECEMBER 31, 1996 4,824,973 17,745 2,493 20,238 Issuance of Common Stock 100,450 724 - 724 Tax benefits from stock transactions - 396 - 396 Net income applicable to common shareholders - - 4,585 4,585 --------- -------- -------- ------- BALANCES, DECEMBER 31, 1997 4,925,423 18,865 7,078 25,943 Issuance of Common Stock 107,554 768 - 768 Tax benefits from stock transactions - 56 - 56 Net income applicable to common shareholders - - 3,865 3,865 --------- -------- -------- ------- BALANCES, DECEMBER 31, 1998 $ 5,032,977 $ 19,689 $ 10,943 $ 30,632 ========= ======= ======= ======
The accompanying notes are an integral part of these consolidated statements. F-4 CFI PROSERVICES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Years Ended December 31, ------------------------- 1998 1997 1996 ------ ------ ------ Cash flows from operating activities: Net income applicable to common shareholders $ 3,865 $ 4,585 $ 17 Adjustments to reconcile net income applicable to common shareholders to cash provided by operating activities: Depreciation and amortization 6,805 8,540 4,731 Write-off of in-process research and development and other charges 2,661 - 8,030 Gain on sale of property and equipment - - (10) Gain on sale of operating division - (628) - Deferred income taxes (586) 87 (1,328) Interest accreted on mandatory redeemable preferred stock 95 95 97 Interest accreted on note payable 93 93 - Gain on sale of equity/debt investments - - (156) Equity in losses attributable to joint venture 670 148 - (Increase) decrease in assets, net of effects from purchase of businesses: Receivables, net 2,749 (9,135) ( 6,580) Income taxes receivable - - 229 Inventories, net 48 (141) 59 Prepaid expenses and other assets 612 (269) (325) Increase(decrease) in liabilities, net of effects from purchase of businesses: Drafts payable - (425) 425 Accounts payable (133) (765) 1,167 Accrued expenses 52 (1,186) 2,079 Deferred revenues (7,307) 2,053 2,069 Customer deposits 1,966 846 (609) Other current liabilities - - (338) Income taxes payable (596) 1,475 678 ------ ------ ------ Net cash provided by operating activities 10,994 5,373 10,235 Cash flows from investing activities: Expenditures for property and equipment (1,680) (2,713) (2,721) Software development costs capitalized (1,054) (4,994 (5,204) Investment in joint venture (304) (322) - Purchase of investments (206) - - Proceeds from sale/maturity of investments - - 2,982 Issuance of note receivable (391) - - Proceeds from long-term note receivable 189 - - Proceeds from sale of operating division - 87 - Proceeds from sale of property and equipment - - 19 Cash paid for acquisition of Mortgage Dynamics, Inc. (2,668) - - Cash paid for acquisition of OnLine and COIN Division, net of cash received - - (2,277) Cash paid for acquisition of Input Creations, Inc. - - (2,107) Cash paid for other acquisitions - - (812) Other assets - - 8 ------ ------ ------ Net cash used in investing activities (6,114) (7,942) (10,112) Cash flows from financing activities: Net proceeds from (payments on) line of credit (1,310) 3,719 1,591 Payments on notes payable - - (7,280) Payments on long-term debt (666) (1,751) (328) Payments on mandatory redeemable preferred stock (103) (103) (104) Proceeds from issuance of common stock 768 724 1,154 ------ ------ ------ Net cash provided by (used in) financing activities (1,311) 2,589 (4,967) ------ ------ ------ Increase (decrease) in cash and cash equivalents 3,569 20 (4,844) Cash and cash equivalents: Beginning of period 20 - 4,844 ------ ------ ------ End of period $ 3,589 $ 20 $ - ====== ====== ======
The accompanying notes are an integral part of these consolidated statements. F-5 CFI PROSERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF BUSINESS CFI ProServices, Inc. and its subsidiaries (the Company) develops, sells, and services customer service software used by financial institutions. The Company combines its technology, banking and legal expertise to deliver knowledge-based software solutions that enable institutions to simplify key sales and service business processes, improve productivity, strengthen customer relationships, and maintain compliance with both internal business policies and external government regulations. Although most sales historically have been to commercial banks within the United States, today the Company actively markets its products to most types of financial institutions domestically and, for the non-compliance oriented software, internationally. The Company has been in business since 1978. BASIS OF CONSOLIDATION Effective December 31, 1997, the Company's wholly owned subsidiaries (other than The Genesys Solutions Group, Inc. (Genesys) and Vendor Payment Systems, Inc. (VPS)) were dissolved and their assets were distributed to the Company. Genesys is an inactive subsidiary and its assets were distributed to the Company effective December 31, 1997. Genesys was dissolved in 1998. The consolidated financial statements include the accounts of the Company's wholly owned subsidiaries: Genesys, Texas/Southwest Technology Group, Inc., Culverin Corporation, OnLine Financial Systems, Inc., COIN Banking Systems, Inc., and VPS. All intercompany transactions and balances have been eliminated. A cash investment in VPS was included in other assets and was accounted for using the equity method until April 1996 when the Company purchased the remaining outstanding VPS common stock. The Company made certain acquisitions in April 1996 and October 1998 (see Note 2). These acquisitions have been included in the consolidated financial statements since the date of acquisition. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash and short-term investments with maturity dates of three months or less at the time of acquisition. INVESTMENTS Statement of Financial Accounting Standards (SFAS) No. 115 "Accounting for Certain Investments in Debt and Equity Securities" requires the Company to classify and account for its security investments as trading securities, securities available for sale or securities held to maturity depending on the Company's intent to hold or trade the securities at time of purchase. Securities available for sale are stated on the balance sheet at their fair market value, which approximates cost. Securities held to maturity are stated at amortized cost. There were no unrealized holding gains or losses at December 31, 1998 and 1997. The Company uses the specific identification method for determining the cost to use in computing realized gains and losses. F-6 Years Ended December 31, -------------------------------- 1998 1997 1996 -------- --------- --------- (In thousands) Proceeds from sale of debt securities $ -- $ -- $ 2,982 Realized gains on sales of debt securities -- -- 156 INVENTORY Inventory consists primarily of printed bank forms and supplies, and is stated at the lower of cost or market, with cost determined on the first-in, first-out (FIFO) method. PROPERTY AND EQUIPMENT Property and equipment is stated at cost. Depreciation is computed on a straight-line basis over the estimated useful lives of the individual assets, which are three years for computer equipment and software, and five to seven years for furniture, fixtures and other equipment. Expenditures for repairs and maintenance are charged to current operations, and costs related to renewals and improvements that add significantly to the useful life of an asset are capitalized. When depreciable properties are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in income. SOFTWARE The costs of internally developed software which meet the criteria in SFAS No. 86, "Accounting for the Costs of Computer Software To Be Sold, Leased or Otherwise Marketed," are capitalized. These costs are amortized on a straight-line basis over estimated economic lives ranging from three to five years. Purchased software is capitalized at cost and amortized on a straight-line basis over the estimated economic life of three years. Generally, contracts for purchased software require royalties to be paid based on revenues generated by the related software. Years Ended December 31, --------------------------------- 1998 1997 1996 --------- --------- --------- (In thousands) Amortization of internally developed software $ 2,633 $ 3,465 $ 1,194 Amortization of purchased software 19 1,079 693 During 1998, 1997 and 1996 several software development projects reached commercial feasibility. As a result, the Company began to amortize certain product development costs which had been capitalized in prior periods. In addition, the Company recorded amortization as a result of software acquired in connection with the 1998 and 1996 acquisitions. The increase in amortization costs in 1997 also resulted from accelerated amortization for certain products being replaced by new products or which management concluded were no longer technologically viable. F-7 INTANGIBLES The Company's intangibles consist primarily of amounts paid for goodwill, noncompetition agreements and customer lists. These costs are amortized on a straight-line basis over estimated economic lives of five to seven years. The Company believes these useful lives are appropriate based on the factors influencing acquisition decisions. These factors include product life, profitability and general industry outlook. The Company reviews its intangible assets for asset impairment at the end of each quarter, or more frequently when events or changes in circumstances indicate that the carrying amount of intangibles may not be recoverable. To perform that review, the Company estimates the sum of expected future undiscounted cash flows from operating activities. If the estimated net cash flows are less than the carrying amount of intangibles, the Company recognizes an impairment loss in an amount necessary to write the intangibles down to fair value as determined by the expected discounted future cash flows. In 1998 the Company wrote off $877,000, reflecting the remaining goodwill associated with its fisCAL credit analysis products and related severance costs calculated in accordance with pre-existing employment contracts. These charges are included in the acquired in-process research and development and other charges in the Company's Statement of Income for 1998. INVESTMENT IN JOINT VENTURE In November 1997 the Company made a 50% investment in Lori Mae, L.L.C. (Lori Mae), a company designed to securitize small business loans originated by community banks. The Company uses the equity method to account for its investment in this joint venture. In 1998 the Company wrote off its initial investment in Lori Mae in the amount of $352,000 due to lack of acceptable market demand for Lori Mae's initial product. This charge, in addition to losses attributable to the joint venture, are included in equity in losses attributable to joint venture in the Company's Statement of Income for 1998. At December 31, 1998, the net investment in Lori Mae was $0. REVENUE RECOGNITION License revenues are derived from three kinds of transactions: o Licenses with no follow-on obligations on the part of the Company are recognized upon shipment. o Licenses which require installation and training by the Company prior to use are recognized upon completion of the installation and training. o Licenses which include significant amounts of tailoring and, occasionally, customization are recognized on a percentage of completion basis as the tailoring and customization are performed. Estimates of efforts to complete a project are used in the percentage of completion calculation. Due to the uncertainties inherent in these estimates, actual results could differ from those estimates. If the license agreement obligates the Company to provide post-contract support at no additional cost to the customer, the revenue related to the post-contract support is recognized ratably over the support period. Returns and exchanges are infrequent and are recorded as reductions in license revenue when the obligation to accept the return or conduct the exchange becomes known. F-8 Revenues for consulting, custom programming and training, where separately contracted for, are recognized as the related services are performed. Other revenues include sales of preprinted forms and font cartridges, which are recognized upon shipment. Amounts received in advance for service and support contracts are deferred and recognized ratably over the support period. Amounts in excess of invoiced minimums for service and support charges based on usage are estimated and recognized in the period in which usage occurs. Included in receivables at December 31, 1998 and 1997 are unbilled receivables of $7,697,000 and $3,824,000, respectively. These primarily relate to percentage of completion contracts and contracts with deferred payment terms. During 1997 and 1998 Statements of Position (SOP) 97-2 and 98-9, "Software Revenue Recognition," were released and became effective for the Company for the year ended December 31, 1998. SOP 97-2 and SOP 98-9 did not have a material impact on the Company's financial statements. INCOME TAXES The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting For Income Taxes." This pronouncement requires deferred tax assets and liabilities to be valued using the enacted tax rates expected to be in effect when the temporary differences are recovered or settled. ADVERTISING COST Advertising costs are expensed as incurred. These costs were $1,406,000, $1,241,000 and $950,000 for the years ended December 31, 1998, 1997 and 1996, respectively. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. EARNINGS PER SHARE Basic earnings per share (EPS) and diluted EPS are computed using the methods prescribed by SFAS No. 128, "Earnings per Share." Basic EPS is calculated using the weighted average number of common shares outstanding for the period and diluted EPS is computed using the weighted average number of common shares and dilutive common equivalent shares outstanding. Following is a reconciliation of basic EPS and diluted EPS: F-9
Year Ended December 31, 1998 1997 1996 - ----------------------- -------------------- -------------------- -------------------- (In thousands, except per share data) Per Per Per Share Share Share Basic EPS Income Shares Amount Income Shares Amount Income Shares Amount - --------- -------------------- -------------------- -------------------- Income available to common shareholders $3,865 5,012 $ 0.77 $4,585 4,919 $ 0.93 $ 17 4,763 $ 0.00 ===== ===== ===== Effect of Dilutive Securities Stock Options - 155 - 205 - 349 -------------- ------------- ------------- Diluted EPS - ----------- Income available to common shareholders $3,865 5,167 $ 0.75 $4,585 5,124 $ 0.90 $ 17 5,112 $ 0.00 ===== ===== =====
The number of options to purchase shares of common stock that were excluded from the table above (as the effect would have been anti-dilutive) were 787,184, 94,500 and 10,000 for the years ended December 31, 1998, 1997 and 1996, respectively. SUPPLEMENTARY CASH FLOW INFORMATION The Company made the following cash payments: Years Ended December 31, ------------------------ 1998 1997 1996 ------ ------- ------ (In thousands) Interest and preferred dividends $ 554 $ 517 $ 148 Income taxes 4,751 2,294 1,597 Noncash investing and financing activities were as follows: Years Ended December 31, ------------------------ 1998 1997 1996 ------ ------ ------ (In thousands) Tax benefit from exercise of nonqualified stock options $ 56 $ 396 $ 632 MicroBilt Financial Services Division acquisition (Note 2): Issuance of note payable -- -- 3,500 Input Creations, Inc. acquisition (Note 2): Issuance of long term debt -- -- 1,533 Other acquisitions (Note 2): Issuance of long term debt -- -- 1,182 Issuance of notes payable -- -- 1,170 Issuance of Common Stock -- -- 266 Note receivable received in connection with the sale of of remittance processing division -- 788 -- Increase in goodwill for accrued acquisition related contingent royalties 1,085 1,140 -- Decrease in goodwill and increase in deferred tax asset -- 389 -- related to acquired net operating losses Reclassification of bank line of credit to long 4,000 -- -- term debt F-10 RECLASSIFICATIONS Certain reclassifications in the financial statements and notes have been made to prior year financial statements to conform with the current presentation. COMPREHENSIVE INCOME SFAS No. 130, "Reporting Comprehensive Income," establishes standards for reporting and display of comprehensive income. Comprehensive income includes charges or credits to equity that did not result from transactions with shareholders. SFAS No. 130 became effective during 1998. As net income and comprehensive income were identical in 1998, 1997 and 1996 SFAS No. 130 did not have an impact on the Company's financial statements. SEGMENT REPORTING SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," requires the Company to report certain information about operating segments. SFAS No. 131 became effective for the Company's year ended December 31, 1998. The Company provides integrated PC-based software to financial institutions for, among other things, use in branch automation, loan origination, new account opening and electronic banking. The Company classifies its products primarily as lending, retail delivery and connectivity. These products constitute the Company's suite of products and are sold to the same types of customer through similar distribution channels. Accordingly, the Company believes it operates in one segment. License revenues from lending, retail delivery and connectivity products were $31.0 million, $15.6 million and $2.5 million, respectively, in 1998, $22.2 million, $16.9 million and $1.4 million, respectively, in 1997, and $15.4 million, $17.1 million and $1.4 million, respectively, in 1996. Virtually all of the Company's sales are made in the United States. The remaining sales are made to customers located in Latin America. RECENT PRONOUNCEMENT SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," becomes effective for the Company's year ending December 31, 2000. The Company does not believe that SFAS No. 133 will have a material impact on its financial statements. 2. ACQUISITIONS In October 1998 the Company acquired substantially all of the assets of Mortgage Dynamics, Inc. (MDI). The acquisition was accounted for as a purchase. The purchase price was $2,668,000 in cash plus certain contingent royalties tied to future revenue production. In conjunction with this acquisition, the Company recorded approximately $1,518,000 of goodwill, which is being amortized ratably over a seven year period; $230,000 of purchased software, which is being amortized ratably over a three year period; and $991,000 of acquired in-process research and development, determined by independent appraisal, all of which was expensed in 1998. The technological feasibility of the acquired technology, which has no alternative future use, had not been established prior to the purchase. Pro forma results for 1998 and 1997 reflecting the MDI acquisition are not materially different from the Company's reported results for such years. In April 1996 the Company acquired all of the capital stock of OnLine Financial Communication Systems, Inc. (OnLine) and COIN Banking Systems, Inc. (COIN) (formerly F-11 subsidiaries of MicroBilt Corporation), and substantially all of the assets of Input Creations, Inc. (Input), Pathways Software, Inc. (Pathways) and The Halcyon Group, Inc. (Halcyon). All of these acquisitions were accounted for as purchases. The combined purchase prices totaled approximately $13,600,000 plus certain contingent royalties tied to future revenue production or to software conversions. The $13,600,000 included $5,196,000 of cash, $7,385,000 in notes payable and other long-term liabilities, $266,000 of common stock and approximately $700,000 of other assumed liabilities. In conjunction with these acquisitions, the Company recorded approximately $4,300,000 of goodwill which is being amortized ratably over a seven year period and $8,030,000 of acquired in-process research and development, determined by independent appraisal, all of which was expensed in 1996. The technological feasibility of the acquired technology, which has no alternative future use, had not been established prior to the purchase. In November 1995 the Company acquired all of the outstanding common stock of Culverin Corporation (Culverin), a software company with headquarters in Dayton, Ohio. The initial purchase price consisted of $3,888,000 in cash paid in installments through November 1996; cash of $50,000 and 33,341 shares of the Company's common stock, valued at $13.50 per share and discounted 40% for restrictions on trading, which were delivered on January 1, 1998; and expenses of $531,000. In addition, the Company will make annual contingent royalty payments through 2000 of between 2% and 14% of revenues generated by Culverin products, depending on the amount of such revenues in each year. The transaction has been accounted for as a purchase and the excess of the initial purchase price over the value of the identifiable assets, $1,969,000, has been recorded as an intangible asset, amortized on a straight-line basis over seven years. Annual contingent royalty payments earned are recorded as an addition to intangible assets and amortized on a straight line basis over the remaining life of the original seven-year period. 3. PROPERTY AND EQUIPMENT The major categories of property and equipment are summarized as follows: Years Ended December 31, ----------------------------- 1998 1997 ------------ ------------ (In thousands) Computer hardware and software $ 10,630 $ 9,546 Furniture and fixtures 3,293 3,008 Leasehold improvements 558 512 ------------ ------------ 14,481 13,066 Less- accumulated depreciation 9,947 7,855 ============ ============ $ 4,534 $ 5,211 ============ ============ F-12 Depreciation expense was as follows: Years Ended December 31, ----------------------------------- 1998 1997 1996 ---------- ---------- ---------- (In thousands) Depreciation expense $ 2,381 $ 2,230 $ 1,799 ========== ========== ========== 4. ACCRUED EXPENSES Accrued expenses consist of the following: Years Ended December 31, ------------------------- 1998 1997 ---------- ----------- (In thousands) Accrued royalties $ 1,766 $ 1,958 Accrued commissions 960 1,080 Accrued bonuses and profit sharing 2,095 392 Other 3,196 1,932 ========== =========== $ 8,017 $ 5,362 ========== =========== 5. EMPLOYEE BENEFIT PLANS The Company created a profit sharing plan (the Plan) on February 1, 1989 under the provisions of Section 401(k) of the Internal Revenue Code. Employer contributions to the Plan are made at the discretion of the Board of Directors and were as follows: Years Ended December 31, ------------------------------------ 1998 1997 1996 ---------- ---------- ----------- (In thousands) Employer contributions $ 856 $ 468 $ 327 ========== ========== =========== The Board of Directors has approved an officers' bonus plan and employee profit sharing plan. The amount and timing of the bonus and profit sharing payments are at the Board's discretion. The expense associated with these plans was as follows: Years Ended December 31, ------------------------------------ 1998 1997 1996 ---------- ---------- ----------- (In thousands) Bonus and profit sharing expense $ 2,735 $ 850 $ 2,298 ========== ========== =========== Through December 31, 1998 the Company had a qualified employee stock purchase plan (ESPP) which allowed qualified employees to direct up to seven percent of monthly base pay for purchases of stock. The purchase price for shares purchased under the plan was 85 F-13 percent of the lesser of the fair market value at the beginning or end of the plan year. The ESPP will terminate in accordance with its terms during 1999. 6. LINE OF CREDIT AND LONG-TERM DEBT Line of Credit The Company may borrow up to the lesser of $10,000,000 or 50 percent of accounts receivable, as defined under the terms of a committed, unsecured, revolving bank line of credit agreement. At the Company's option, interest on outstanding borrowings may be at the bank's published reference rate or alternative rates specified in the agreement. The interest rate in effect at December 31, 1998 was 6.7 percent. The line of credit expires on May 1, 2000. The agreement contains covenants which require the Company to maintain certain financial ratios and prohibits the Company from incurring other debts or liens outside the ordinary course of business. The Company is in compliance with the covenants at December 31, 1998. The Company pays an annual commitment fee of 0.2 percent on the average unused balance. Borrowings under the line totaled $4,000,000 at December 31, 1998 and $5,310,000 at December 31, 1997. Long-Term Debt At December 31, 1998 and 1997, long-term debt consisted of the following: 1998 1997 ------- ------- (In thousands) Note payable, in relation to Culverin acquisition, payment of $3,690 in 1996 with the balance due $ -- $ 50 January 1998 Note payable, in relation to Halcyon acquisition, with imputed interest at 8 percent, due in quarterly installments of $50, including interest, payable 449 605 through 2001 Note payable, assumed in the Halcyon acquisition, in monthly installments of $6, including interest imputed at 8.5 percent, with final payment due October 307 346 2004 Guaranteed royalties to be paid in relation to Input acquisition, with imputed interest at 6 percent, 1,148 1,426 payable through March 2001 TSTG non-compete payments through April 1999 50 100 Long-term portion of line of credit 4,000 -- ------- ------- 5,954 2,527 Less current portion of long-term debt (261) (295) ------- ------- Long-term debt $ 5,693 $ 2,232 ======= ======= F-14 Payouts under long-term debt are as follows (in thousands): Years Ending December 31, - ------------------------- 1999 $ 261 2000 4,230 2001 1,295 2002 55 2003 59 Thereafter 54 ---------- $ 5,954 ========== 7. COMMITMENTS AND CONTINGENCIES OPERATING LEASES The Company leases facilities and equipment under operating leases, with terms from one to 10 years, payable in monthly installments. Total lease expense was as follows: Years Ended December 31, ------------------------------------------- 1998 1997 1996 ------------ ----------- ------------ (In thousands) Lease expense $ 2,980 $ 2,786 $ 2,131 ============ =========== ============ Future minimum lease payments are as follows (in thousands): Years Ending December 31, - ------------------------- 1999 $ 2,833 2000 2,863 2001 1,838 2002 1,749 2003 1,293 Thereafter 506 ---------- $ 11,082 ========== In 1998 the Company recorded a loss of $793,000 for the present value of net future lease payments due with respect to certain office space in Atlanta that the Company ceased using. The loss was included in other charges on the Statement of Income for 1998. F-15 CONTINGENCIES The Company is involved in routine legal matters incidental to its business. The Company believes that the resolution of any such matters that are currently outstanding will not have a material effect on its financial condition or results of operations. However, no assurance can be given that the concurrent resolution of several of such matters in manners adverse to the Company would not have a material adverse effect on the Company's financial condition or results of operations. 8. INCOME TAXES The provision (benefit) for income taxes is as follows: Years Ended December 31, ------------------------------------------- 1998 1997 1996 ------------ ----------- ------------ (In thousands) Current tax provision: Federal $ 3,667 $ 3,443 $ 2,223 State 402 377 272 ------------ ----------- ------------ 4,069 3,820 2,495 Deferred tax provision (benefit) (586) 87 (1,328) ------------ ----------- ------------ Total provision $ 3,483 $ 3,907 $ 1,167 ============ =========== ============ The reconciliation of the statutory Federal income tax rate to the Company's effective income tax rate is as follows: Years Ended December 31, ------------------------------- 1998 1997 1996 --------- -------- -------- Federal statutory rate 34.0 % 34.0 % 34.0 % State income taxes net of Federal 4.8 4.2 6.8 benefit Disallowance of meals and entertainment expenses 1.4 1.1 6.0 Purchase accounting adjustments, including amortization of intangibles 5.5 5.7 47.6 Change in valuation allowance (0.1) (0.2) 10.9 Other 1.2 0.7 (14.1) --------- -------- -------- 46.8 % 45.5 % 91.2 % ========= ======== ======== F-16 Deferred tax assets and (liabilities) are comprised of the following components: December 31, ------------------------ 1998 1997 ---------- --------- (In thousands) Current deferred tax asset: Allowance for doubtful accounts $ 844 $ 950 Current portion of net operating loss carryforwards 164 177 Severance and other accruals 281 20 Other 52 160 ---------- --------- Total current deferred tax asset $ 1,341 $ 1,307 ========== ========= Long-term deferred tax asset (liability): In-process technology acquired $ 2,660 $ 2,477 Depreciation (160) (154) Intangibles amortization 702 651 Capitalized software (3,145) (3,746) Net operating loss and credit carryforwards 475 714 Other (77) 33 ---------- --------- Gross long-term deferred tax asset (liability) 455 (25) Valuation allowance (100) (172) ---------- --------- Total long-term deferred tax asset (liability) $ 355 $ (197) ========== ========= The increase (decrease) in the valuation allowance was as follows: Years Ended December 31, --------------------------------- 1998 1997 1996 --------- --------- --------- (In thousands) Increase (decrease) in valuation allowance $ (72) $ (17) $ 140 ========= ========= ========= At December 31, 1998, for Federal tax return reporting purposes, the Company had approximately $1,272,000 of regular and alternative minimum tax loss carryovers that expire at various dates through 2010. In addition, at December 31, 1998, the Company had $152,000 of general business credit carryovers that expire at various dates through 2007. The general business credit carryovers may not be used to offset taxes payable until the tax loss carryovers are fully utilized. In 1997, based on management's estimate of realization, the Company recorded an increase in deferred tax assets and a corresponding decrease in goodwill of $389,000 relating to net operating losses acquired in connection with a prior acquisition. Current Federal tax law limits the net operating loss and tax credit carryovers available to be used in any given year in the event of certain circumstances including significant changes in ownership interests. The Company is limited to using approximately $430,000 of net operating loss carryovers in any one year. F-17 9. PREFERRED STOCK The Company is redeeming the 10,300 outstanding shares of mandatory redeemable Class A preferred stock at $262.14 per share over a 28-year period ending in the year 2018. The present value of the remaining payments, which are due quarterly, has been recorded as the carrying value at December 31, 1998 and 1997. The carrying value is adjusted as payments are made and dividends are accrued on the shares yet to be redeemed. The rate used to calculate the present value was 13 percent per annum, which approximated the Company's borrowing rate at the time redemption commenced. At December 31, 1998 there were 7,410 outstanding shares remaining to be redeemed. The repayment schedule for the mandatory redeemable Class A preferred stock at December 31, 1998 is as follows (in thousands): Years Ending December 31, - ------------------------- 1999 $ 103 2000 103 2001 103 2002 103 2003 103 Thereafter 1,428 --------- Total future payments 1,943 Less- Amount representing dividends 1,205 --------- Present value of future payments 738 Less- Current portion -- --------- Long-term mandatory redeemable preferred stock $ 738 ========= 10. STOCK OPTIONS AND DIRECTOR COMPENSATION At December 31, 1998, the Company had five stock option plans: a Consolidated Plan, a nonqualified stock option plan, two plans for outside directors and the ESPP. Under the Consolidated Plan, options, which consist of incentive stock options and nonqualified stock options, generally vest ratably over five years and generally expire ten years from the date of grant. The exercise price for incentive stock options granted under the plan is set at the fair market value at the grant date. The exercise price for nonqualified options may be set below the fair market value at the grant date, but, to this date, no options have been granted with an exercise price less than fair market value at the grant date. Under the nonqualified stock option plan, available to officers and key employees, the vesting period and exercise price, which may be set below the fair market value at the date of grant, are determined by the Compensation Committee of the Board of Directors. No options have been granted with an exercise price less than fair market value at the date of grant. The Company has two stock option plans for outside directors: the Restated Outside Director Restricted Stock Plan (the Restricted Plan) and the Restated Outside Director Compensation F-18 and Stock Option Plan (the Compensation Plan). The Compensation Plan was approved by the shareholders of the Company in May 1994 and provides for outside directors to be paid $5,000 per year and allows for the issuance of stock options. A total of 50,000 shares of Common Stock were reserved for issuance under the Restricted Plan and the Compensation Plan, of which 15,400 shares were reserved under the Restricted Plan and 34,600 were reserved under the Consolidated Plan. As of December 31, 1998, 28,600 shares had been issued under the Restricted Plan and are no longer restricted. Under the ESPP 67,000 shares of Common Stock were reserved, of which 64,354 shares had been issued as of December 31, 1998. Below is a table showing the activity for the aforementioned stock option plans for the past three years: Weighted Total Shares Average Exercise Subject to Exercise Price Options Price Per (in Share thousands) ------------ ------------ -------------- Balances, December 31, 1995 824,682 $ 7.23 $ 5,962 Options granted 290,500 14.52 4,219 Options exercised (273,183) 3.63 (991) Options lapsed (10,179) 9.92 (101) ------------ ------------ -------------- Balances, December 31, 1996 831,820 10.93 9,089 Options granted 118,000 18.40 2,172 Options exercised (79,804) 5.52 (441) Options lapsed (86,713) 13.45 (1,167) ------------ ------------ -------------- Balances, December 31, 1997 783,303 12.32 9,653 Options granted 214,293 12.39 2,655 Options exercised (51,680) 10.43 (539) Options lapsed (30,490) 13.74 (419) ------------ ------------ -------------- Balances, December 31, 1998 915,426 $ 12.40 $ 11,350 ============ ============ ============== For all five plans at December 31, 1998, there were 987,591 shares of unissued stock reserved for issuance under the plans, of which 2,655 shares are reserved under the ESPP and options for the purchase of 69,510 shares remained available for future grants. Options to purchase 437,026, 361,873 and 250,990 shares of common stock were exercisable at December 31, 1998, 1997 and 1996, respectively. These exercisable options had weighted average exercise prices of $10.71, $9.91 and $8.27 at December 31, 1998, 1997 and 1996, respectively. The Financial Accounting Standards Board issued SFAS No.123 which defines a fair value based method of accounting for an employee stock option and similar equity instrument and encourages all entities to adopt that method of accounting for all of their employee stock compensation plans. However, it also allows an entity to continue to measure compensation cost for those plans using the method of accounting prescribed by APB 25. Entities electing to remain with the accounting in APB 25 must make pro forma disclosures of net income and earnings per share, as if the fair value based method of accounting defined in SFAS 123 had been adopted. F-19 The Company has elected to account for its stock-based compensation plans under APB 25; however, the Company has computed, for pro forma disclosure purposes, the value of all options granted during 1998, 1997 and 1996 using the Black-Scholes options pricing model as prescribed by SFAS 123 using the following weighted average assumptions for grants: For the Years Ended December 31, ----------------------------------------- 1998 1997 1996 ---------- ------------ ------------ Risk-free interest rate 6.0% 6.3% 6.0% Expected dividend yield 0.0% 0.0% 0.0% Expected lives (years) 7.5 6.9 4.7 Expected volatility 59.4% 60.7% 62.8% Using the Black-Scholes methodology, the total value of options granted during 1998, 1997 and 1996 was $1,215,000, $1,286,000 and $1,854,000, respectively, which would be amortized on a pro forma basis over the vesting period of the options (typically five years). The weighted average fair value of options granted during 1998, 1997 and 1996 was $8.36 per share, $11.51 per share and $7.39 per share, respectively. The number of shares issued under the ESPP was 22,383, 20,646 and 11,338 for the years ended December 31, 1998, 1997 and 1996, respectively, and the related weighted average purchase price and weighted average fair value of shares issued were $10.20 and $5.83, respectively, for 1998, $13.71 and $6.55, respectively, for 1997, and $13.71 and $6.61, respectively, for 1996. If the Company had accounted for its stock-based compensation plans in accordance with SFAS 123, the Company's net income and net income per share would approximate the pro forma disclosures below:
For the Years Ended December 31, (in thousands, except per share data) ------------------------------------------------------------------ 1998 1997 1996 -------------------- --------------------- --------------------- As Pro As Pro As Pro Reported Forma Reported Forma Reported Forma ---------- -------- ---------- --------- ---------- --------- Net income (loss) $3,865 $3,363 $4,585 $3,563 $ 17 $ (979) Net income (loss) per share - $ 0.77 $ 0.68 $ 0.93 $ 0.72 $ 0.00 $ (0.21) basic Net income(loss) per share - $ 0.75 $ 0.66 $ 0.90 $ 0.71 $ 0.00 $ (0.21) diluted
The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. Additional awards are anticipated in future years. F-20 The following table summarizes information about stock options outstanding at December 31, 1998:
Options Outstanding Options Exercisable - -------------------------------------------------------- -------------------------- Number Weighted Out- Average Weighted Number of Weighted Range of standing Remaining Average Shares Average Exercise Prices at Contractual Exercise Exercisable Exercise Per Share 12/31/98 Life (years) Price at 12/31/98 Price - ---------------- ---------- ------------ ---------- ------------ ------------ $1.00 - 4.99 118,449 3.0 $ 1.63 118,449 $ 1.63 10.00 - 14.99 499,877 7.1 $ 12.44 199,877 $ 12.61 15.00 - 15.00 200,000 7.1 $ 15.00 80,000 $ 15.00 16.13 - 20.00 87,100 8.1 $ 19.49 28,700 $ 18.46 24.25 - 24.25 10,000 2.3 $ 24.25 10,000 $ 24.25
11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
QUARTER ENDED (1) March 31, June 30, September December (In thousands, except per 1998 1998 30, 1998 31, 1998 share data) - ------------------------------- ---------- ----------- ------------- ------------- Revenue $ 19,051 $ 19,002 $ 23,186 $ 24,391 Gross profit 12,303 11,835 15,413 16,656 Net income applicable to common shareholders 1,000 927 1,593 345 Net income per share - basic $ 0.20 $ 0.19 $ 0.32 $ 0.07 Net income per share - diluted $ 0.19 $ 0.18 $ 0.31 $ 0.07 QUARTER ENDED March 31, June 30, September December (In thousands, except per 1997 1997 30, 1997 31, 1997 share data) - ------------------------------- ---------- ----------- ------------- ------------- Revenue $ 16,002 $ 17,880 $ 17,894 $ 20,873 Gross profit 10,374 11,870 10,907 12,457 Net income applicable to common shareholders 768 1,424 912 1,481 Net income per share - basic $ 0.16 $ 0.29 $ 0.19 $ 0.30 Net income per share - diluted $ 0.15 $ 0.28 $ 0.18 $ 0.29 (1) The results in the fourth quarter of 1998 reflect pretax charges totaling $3,013,000 for the value of in-process research and development efforts at the date of acquisition pertaining to MDI (see Note 2) and other charges (see Note 1 and Note 7).
F-21 12. SUBSEQUENT EVENT Effective January 1, 1999 the Company acquired substantially all of the assets of Modern Computer Systems, Inc. and certain related corporations (collectively, MCS). MCS offers hardware and software solutions for the back office accounting needs of community banks and credit unions. The acquisition was accounted for as a purchase. The purchase price was $6.0 million in cash and $650,000 of common stock. The Company believes it will likely write off in the first quarter of 1999 that portion of the purchase price allocated to acquired in-process research and development, as determined by independent appraisal. F-22 Report of Independent Public Accountants on Financial Statement Schedule To the Board of Directors and Shareholders of CFI ProServices, Inc. We have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in CFI ProServices, Inc.'s 1998 Annual Report on Form 10-K, and have issued our report thereon dated January 22, 1999. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The Valuation and Qualifying Accounts schedule is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, fairly states, in all material respects, the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP Portland, Oregon January 22, 1999 F-23 CFI PROSERVICES, INC. VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
Additions Balance At Charged To Balance Beginning Costs And Deductions At End Of Year Expenses (a) Other(b) Of Year --------- ---------- ---------- -------- ------- Year ended December 31, 1996 Allowance for doubtful accounts and sales returns $ 290 $ 2,147 $ (1,514) $ 380 $ 1,303 ===================================================== FASB 109 Valuation $ 49 $ 140 $ - $ - $ 189 ===================================================== Amortization Of Intangibles: Purchased software $ 1,176 $ 693 $ (640) $ - $ 1,229 Software development costs 2,514 1,194 (1,123) - 2,585 Intangibles 410 1,045 - - 1,455 ===================================================== $ 4,100 $ 2,932 $(1,763) $ - $ 5,269 ===================================================== Year ended December 31, 1997 Allowance for doubtful accounts and sales returns $ 1,303 $ 4,808 $ (3,231) $ - $ 2,880 ===================================================== FASB 109 Valuation $ 189 $ - $ (17) $ - $ 172 ===================================================== Amortization Of Intangibles: Purchased software $ 1,229 $ 1,079 $ (2,308) $ - $ - Software development costs 2,585 3,465 (5,315) - 735 Intangibles 1,455 1,772 - - 3,227 ===================================================== $ 5,269 $ 6,316 $ (7,623) $ - $ 3,962 ===================================================== Year ended December 31, 1998 Allowance for doubtful accounts and sales returns $ 2,880 $ 2,005 $ (2,285) $ - $ 2,600 ===================================================== FASB 109 Valuation $ 172 $ - $ (72) $ - $ 100 ===================================================== Lease Loss Accrual $ - $ 793 $ - $ - $ 793 ===================================================== Amortization Of Intangibles: Purchased software $ - $ 19 $ - $ - $ 19 Software development costs 735 2,633 - - 3,368 Intangibles 3,227 2,102 (566) - 4,763 ===================================================== $ 3,962 $ 4,754 $ (566) $ - $ 8,150 ===================================================== (a) Represents write-off of receivables, fully amortized intangibles, and, in 1998, goodwill associated with a 1996 acquisition. Also includes reduction in FASB 109 valuation account credited to income tax expense. (b) Includes allowance for doubtful accounts recorded as part of the acquisition of Microbilt Financial Products Division in April 1996.
F-24 EX-10.10 2 EXHIBIT 10.10 Exhibit 10.10 400 SIXTH AVENUE BUILDING SECOND AMENDMENT TO LEASE By and Between John Hancock Mutual Life Insurance Company ("Landlord") and CFI ProServices, Inc., an Oregon Corporation ("Tenant") Dated January 11, 1999 Recitals 1. Landlord and Tenant are parties to a lease Amendment dated March 18, 1994, and to a First Amendment to Lease, dated July 8, 1996 (collectively, the "Agreement"). 2. Pursuant to the Agreement, Tenant leases from Landlord approximately 72,111 rentable square feet ("rsf") on the second, third, fourth and tenth floors of the 400 Sixth Avenue Building known as Suites 200, 300, 400 and 1000. 3. The term of the Agreement is through September 30, 2003. 4. Tenant desires to lease an additional 7,721 rentable square feet as shown on the plan attached hereto as Exhibit A, known as the ninth floor, Suite 905 and 906 ("Expansion Area"). 5. The terms used in this Second Amendment, which are defined in the Agreement, shall have the meanings given to them in the Agreement, except as otherwise expressly provided in this Second Amendment. Agreement NOW, THEREFORE, the parties agree as follows: 1. Premises: The demised Premises shall be increased to a total square footage as follows: CFI Existing Area: 72,111 rsf CFI Expansion Area: 7,721 rsf Total CFI Premises: 79,832 rsf 2. Commencement and Expiration Date: The commencement date of the term of the agreement for the expansion area (Expansion Area Commencement Date) shall be in two stages. April 1, 1999, Tenant will occupy approximately 2,909 rsf known as Suite 905. August 1, 1999, Tenant will occupy 4,812 rsf known as Suite 906. The Agreement will expire as to the entirety of the Premises on September 30, 2003. 3. Upon Tenant's occupancy of Suite 906 on August 1, 1999, Suites 905 and 906 will be known collectively hereafter as Suite 905. 4. Rent: The monthly base rent for the Expansion Area shall be as follows: Months SF Rate ($/SF) Monthly Rent -------- ---- ----------- ------------ April 1, 1999 - July 31, 1999 2,909 $20.00 $4,848.33 August 1, 1999 - March 31, 2000 7,721 $20.00 $12,868.33 April 1, 2000 - March 31, 2002 7,721 $21.00 $13,511.75 April 1, 2002 - March 31, 2003 7,721 $22.00 $14,155.17 April 1, 2003 - September 30, 7,721 $23.00 $14,798.58 2003 5. Base Rent Schedule: Original Tenth Suites Total Lease Term Lease Floor 905 & 906 Base Rent ---------------- ---------- ---------- ---------- ----------- 4/1/99 - 6/30/99 $72,729.00 $26,124.00 $4,848.33 $103,701.33 7/1/99 - 7/31/99 $78,261.50 $26,124.00 $4,848.33 $109,233.83 8/1/99 - 3/31/00 $78,261.50 $27,707.00 $12,868.33 $118,836.83 4/1/00 - 7/31/01 $78,261.50 $27,707.00 $13,511.75 $119,480.25 8/1/01 - 3/31/02 $87,113.00 $30,478.00 $13,511.75 $131,102.75 4/1/02 - 3/31/03 $87,113.00 $30,478.00 $14,155.17 $131,746.17 4/1/03 - 9/30/03 $87,113.00 $30,478.00 $14,798.58 $132,389.58 6. Tenant's Percentage: Under section 24.2 of the Lease Agreement, Tenant's percentage of the Building will be based upon two calculations: (a) Tenant's existing square footage divided by the total building square footage as determined by old BOMA measurements 72,111 divided by 183,0501 equals 39.3% pro rata share). (b) Tenant's percentage for expansion area will be determined by dividing expansion square footage by building square footage determined by new BOMA measurements (7,721 divided by 188,917 equals 4.09% expansion space pro rate share). 7. Base Year: Under Section 19.4, Additional Rent: Operating Expense Adjustment, Tenant's Base Year for floors two, three, four and ten will be 1996; Tenant's Base Year for the Expansion Area (ninth floor) will be 1999. Under Section 19.1, Tenant's Base Year for real property taxes shall be 1994-1995 for floors two, three and four; 1996-1997 for the tenth floor; and 1998-1999 for the Expansion Area (Suites 905 and 906). 8. Tenant Improvements: Landlord shall provide Tenant a tenant improvement allowance up to and not to exceed $108,094.00 (the "TI Allowance"). The TI Allowance shall be used to pay for all costs and expenses incurred in connection with remodeling the Expansion Area, including, without limitation, all costs for heating, ventilation and air conditioning modifications made to the existing condition as of the signature date of the Second Amendment to Lease, electrical distribution, plumbing, partitions, working drawings, construction documents, design services, supervision and permits, but not furniture and furnishings. It is agreed and understood that Tenant will be responsible for payment of the entire cost of other improvements in excess of the TI Allowance. If Tenant exceeds the TI Allowance, any such excess costs shall promptly be paid by Tenant in a single lump sum within 15 days after receipt of invoice from the Landlord. Tenant shall not be entitled to a credit for any unused portion of the TI Allowance. Landlord will act as construction manager and administer a contract on the Tenant's behalf for the entire scope of the work outlined above and Landlord shall have no liability to tenant whatsoever for any claims or damages arising in connection with Landlord's services as construction manger or its administration of the construction contract, except as may be caused by Landlord's gross negligence, willful misconduct or delay, except for causes beyond the Landlord's control. Landlord shall not charge Tenant or the TI Allowance for any construction supervisory fee of landlord or its building manager. The plans for the remodeling work itself, and all contractors and subcontractors used in the remodeling work, shall be subject to Landlord's prior written approval, which approval shall not unreasonably be withheld. All remodeling work shall be in compliance with all applicable laws and regulations as of the date of this Amendment, including, without limitation, the Americans with Disabilities Act. 9. Parking: Section 26.1 of the Lease Agreement shall be amended to provide three additional parking spaces for a total of 30 parking spaces in the building parking garage at prevailing market rates which change form time to time. In the event Tenant chooses not to use its entire parking allocation, Tenant shall give Landlord at least 60 days' prior written notice of the number of parking spaces it will give up, and Landlord may use such given up spaces for its own account. Tenant can reinstate stalls up to its allowance with at least 60 days' prior written notice to Landlord. All other provisions stated in Section 26.1 of the Agreement shall remain in effect. Tenant acknowledges that this Section 9 complies with Landlord's obligations under the last sentence of Section 26.1 of the Agreement. 10. Option to Expand: The option to expand provision contained in the First Amendment to Agreement as paragraph 7, page 3, is hereby deleted in its entirety. 11. Early Possession: Landlord shall provide Tenant with early access to the Premises at least 21 days prior to the April 1, 1999 (Suite 905) and August 1, 1999 (Suite 906). Expansion Space Commencement Date in order for Tenant to ready the Premises for occupancy. Within this period, Tenant shall have access for its vendors to complete the necessary cabling for Tenant's equipment, and to install equipment and office furnishings. Tenant shall coordinate its activities with those of Landlord's contractor to avoid any delay in completion of the work. Tenant's access during such period shall be on all the terms and conditions of the Agreement, other than payment of rent. Except as amended by this Second Amendment, all other terms and conditions of the Lease Agreement shall remain in full force and effect. IN WITNESS WHEREOF, the parties have executed this Second Amendment as of the date first set forth above. AGREED AND ACCEPTED AGREED AND ACCEPTED John Hancock Mutual Life Insurance CFI ProServices, Inc. Company, Landlord By: /s/ Maryrose Sykes By: /s/ Kurt W. Ruttum Title: Associate Investment Officer Title: Vice President & CFO Date: 1/20/99 Date: 1/15/99 EX-23 3 EXHIBIT 23 Exhibit 23 Consent of Independent Public Accountants As independent public accountants, we hereby consent to the incorporation of our reports dated January 22, 1999 included in this Form 10-K into the Company's previously filed Registration Statements File No. 33-70506, No. 33-89872 and No. 333-11351 on Form S-8. ARTHUR ANDERSEN LLP Portland, Oregon March 26, 1999 EX-27 4 EXHIBIT 27
5 1,000 Jan-01-1998 12-MOS Dec-31-1998 Dec-31-1998 3,589 206 32,301 2,600 249 36,690 14,481 9,947 56,781 19,718 5,954 738 0 19,689 10,943 56,781 6,076 85,630 2,132 29,423 48,018 1,980 454 7,443 3,483 3,865 0 0 0 3,865 0.77 0.75
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