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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________.
Commission file number 0-28152
Affinity Technology Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
57-0991269
(I.R.S. Employer Identification No.)
1201 Main Street, Suite 2080
Columbia, SC 29201-3201
(Address of principal executive offices)
(Zip code)
(803) 758-2511
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of
the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.0001 per share
(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. [ ]
The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant was approximately $62,924,299 as of March 16,
2000. For purposes of such calculation, shares of Common Stock held by persons
who hold more than 10% of the outstanding shares of Common Stock and shares held
by directors and officers of the Registrant and certain of their immediate
family members have been included because such persons may be deemed to be
affiliates. This determination is not necessarily conclusive.
There were 31,870,311 shares of the Registrant's Common Stock
outstanding as of March 16, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Registrant's proxy statement with respect to
the 2000 Annual Meeting of Stockholders of the Registrant have been incorporated
by reference herein.
Item 1 of this Form 10-K entitled "Business" and Item 7 of this Form
10-K entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Forward-looking statements are inherently uncertain and
actual results could differ materially from those expressed or implied by the
forward-looking statements. These forward-looking statements should be
considered in the context of the business risks set forth below in Item 1 of
this report under the caption "Business Risks."
Part I
Item 1 Business
General
Affinity Technology Group, Inc. (the "Company") was formed to develop
and market technologies that enable financial institutions and other businesses
to provide consumer financial services electronically with reduced or no human
intervention. From the period of inception (January 12, 1994) through December
31, 1994, the Company was a development stage company, and its activities
principally related to developing its DeciSys/RT technology (formerly known as
the "DSS System") and the Affinity Automated Loan Machine ("ALM"), raising
capital and recruiting personnel.
To date, the Company has generated substantial operating losses, has
experienced an extremely lengthy sales cycle for its products and services and
has been required to use a substantial amount of existing cash resources to fund
its operations. If the Company continues to use cash at the rate used during
1999, the Company would deplete its existing cash reserves in the second quarter
of 2000. Although the Company has taken steps to reduce its operating expenses
and believes that existing cash, cash equivalents and internally generated funds
will be sufficient to fund operations during 2000, such resources, together with
projected revenues that may be received under existing contracts, will be
insufficient to fund the Company's operations in 2001 and beyond. To remain
viable after 2000, the Company must substantially increase revenues, raise
additional capital and/or substantially reduce its operations. No assurances can
be given that the Company will be able to increase its revenues, raise
additional capital or reduce its operations in a manner that would allow it to
continue operations in 2001 and beyond.
During 1995, 1996 and early 1997, the Company's primary products and
services consisted of the ALM, which captures origination information for
unsecured consumer loan applications and then routes this information to the
Company's proprietary DeciSys/RT for an automated decision, and a call center
decisioning system that provided financial institutions with the ability to
originate unsecured consumer loans with reduced or no human intervention. During
this period, the Company's primary product offering to its customers was the
ALM. Also during this period the Company developed additional financial products
which could be originated at an ALM and processed through DeciSys/RT. These
products included loans secured by cash collateral and the ability to open
checking accounts, renew existing loans, cross sell other products and make
counter offers to applicants who qualify for a loan amount higher or lower than
the loan amount originally requested.
During 1997, the Company developed e-xpertLender, which establishes
connectivity among a financial institution's delivery channels, Affinity's
automated decisioning system, and its risk management group. e-xpertLender also,
upon approval, gives the consumer the choice of closing or fulfillment methods
that include branches, ALMs, mail, and third party closing agents. The system
enables call center agents and branch personnel to inquire as to the status of
applications at any time and electronically notifies loan officers with respect
to exceptions and the reason for referral. e-xpertLender replaced the Company's
previously developed call center decisioning system.
During 1998, the Company's principal activities were directed toward
enhancing its e-xpertLender product delivery capabilities and designing and
developing a system to process automobile loans pursuant to a development
contract with Citibank. In 1999 Citibank sold its indirect automobile loan
business to Dime Savings Bank. To date, Dime has not deployed the Company's
indirect automobile loan processing system. Moreover, the Company is unsure as
to Dime's ultimate intention of deploying the Company's indirect automobile loan
processing system due to Dime's proposed merger with Hudson United Bancorp. The
Company believes that it is due significant amounts related to its development
contract and certain other amounts related to the Dime Citibank transaction and
the proposed Dime/Hudson United transaction. In the event the Company is unable
to deploy its indirect automobile loan processing system with Dime and is unable
to collect amounts it is due for its development activities, the Company's
future results of operations and financial position may be adversely affected.
During 1999, the Company completed the development of a general release version
of an automobile loan processing system, which is being offered under the brand
name of iDEAL.
In the latter part of 1998 and continuing throughout 1999, the Company
renewed its efforts to design additional products available through
point-of-sale devices similar to the ALM. The primary product developed during
this period was software to capture consumer application information to
originate a mortgage loan ("Mortgage ALM"). The Company believes that continued
development efforts will be necessary during 2000 to refine the Mortgage ALM for
sale to potential customers. The Company formed a wholly owned subsidiary,
Surety Mortgage, Inc. ("Surety"), to deploy Mortgage ALMs for the purpose of
originating mortgage loans and to gain an understanding of the market and
consumer response to the Mortgage ALM prior to marketing Mortgage ALMs to the
financial services industry. The Company does not anticipate that any
significant sales of Mortgage ALMs to third parties will occur before the latter
part of 2000.
In 1999, the U.S. Patent and Trademark Office (the "PTO") issued to the
Company two patents covering certain fully automated lending processes and
methods and the Company is currently in a reexamination proceeding on one of the
patents and has received a preliminary rejection of the previously issued
claims. In February 2000, the Company received a notice of allowance from the
PTO pertaining to a system for real-time establishment of a financial account,
including credit accounts, over a computer network without any human
intervention other than by the applicant. The Company believes its patents
provide it with proprietary rights covering fully automated loan processing
which is initiated by a consumer through a remote computer interface, which the
Company believes includes the Internet, wide area networks, local area networks,
and any other communications network. Kiosk lending systems, including ALMs, are
also included within the scope of the patent. During 1999, the Company entered
into one significant patent license agreement and other less significant patent
license agreements.
During February 1999, the Company formed a wholly owned subsidiary,
decisioning.com, Inc., which holds certain rights to the Company's patents and
is developing strategies to commercialize and license the Company's rights under
the patents. rtDS, which is based on the Company's previously developed
e-xpertLender technology, will deliver credit decisions to loan applicants using
the Internet. rtDS has been completed for a single lender, single product
implementation and is in the early stage of development for a multi lender,
multi product capability.
Products and Services
The Company's DeciSys/RT System automates the processing and
consummation of financial products and services. Based on the Company's
proprietary object-oriented software, DeciSys/RT uses a multi-tiered
client/server architecture to provide a stable, scalable platform capable of
processing large numbers of transactions in a reliable, efficient and timely
fashion. DeciSys/RT can simultaneously accept and capture consumer personal
information through remote input devices (such as through touch-screen terminals
or through desktop browsers) and through automated interaction with third
parties (such as credit bureaus) that supply additional information necessary to
process the transaction efficiently. A central server located at the Company's
Network Operations Center ("NOC") coordinates the flow and analysis of
information and evaluates, based on each customer's underwriting model, whether
and on what terms the transaction can be consummated.
The Company has focused its product development efforts on exploiting
its DeciSys/RT technology to enhance transaction origination, processing and
fulfillment systems. The Company believes its DeciSys/RT technology is useful to
businesses, such as consumer lending institutions, engaged in transactions that
require collecting information from consumers and third parties, analyzing such
information to reach a credit decision and providing transaction fulfillment.
For such transactions, the channel integration in conjunction with the speed and
efficiency of DeciSys/RT-based systems have the potential to offer significant
advantages when compared to more labor intensive and less technically advanced
origination, processing and fulfillment systems.
The Affinity ALM
General. The ALM and DeciSys/RT (together, the "ALM System") fully
automate the consumer lending process, enabling consumers to apply for and, if
approved, receive a personal loan (including loan documentation and proceeds) in
as little as 10 minutes without involving loan officers, customer service
representatives or other lending personnel. Similar in appearance to an
automated teller machine ("ATM"), the ALM is a fully automated system that
utilizes the Company's proprietary DeciSys/RT technology to process certain
financial service transactions, generate the underlying documentation and
distribute proceeds from loan transactions.
Design and Features. The ALM looks and interacts with consumers much
like an ATM and can be operated as a free standing kiosk. The ALM System
contains a magnetic strip card reader used to identify loan applicants by credit
card, charge card, or debit card, a personal identification number ("PIN") pad
which can be used in conjunction with the magnetic strip card reader to capture
PIN codes used by debit and ATM cards as an alternative or additional method to
identify loan applicants, a touch-screen monitor used to elicit information from
applicants, a magnetic pen and signature capture unit used to electronically
execute loan documents, a magnetic ink character reference ("MICR") reader used
to verify savings and checking account information, a digital camera system used
to photograph applicants as they sign loan documents, video cameras used to take
pictures at intervals during all hours of ALM operations, a laser printer used
to print loan documents and checks and a modem connecting the ALM to the
Company's NOC. The software supporting each ALM System is modified by the
Company to meet the marketing and underwriting requirements of each financial
institution customer.
The products and services currently available through an ALM System
include auto loan vouchers, the ability to open checking accounts, overdraft
protection, the ability to apply for lines of credit and credit cards and
unsecured personal loans. The ALM System can also make counter offers to
applicants who qualify for a loan amount higher or lower than the loan amount
originally requested. The ALM System also has the ability to cross-sell other
products and services offered by the institution during the time the applicant
is waiting for a decision on a loan application.
Other ALM Products. The Company has also developed a Mortgage ALM.
Similar to the ALM, the Mortgage ALM is a kiosk designed to allow consumers to
pre-qualify for a mortgage loan, determine the payments for specified loan
amounts and apply for a mortgage loan.
The Company is also considering the further development of an insurance
kiosk that will allow a consumer to consummate an insurance transaction without
human intervention. The insurance kiosk would provide consumers with the ability
to compare rates and coverages available from several insurance carriers and
select the carrier and coverage appropriate for the consumer's situation. Once
the consumer selects a carrier and the desired coverage, the kiosk would allow
the consumer to bind the insurance coverage at the kiosk, in real-time and
without human intervention. To date, the Company has not had sufficient
resources to more fully develop the insurance kiosk system.
The Company's developmental activities are subject to the risks inherent in
the development of new products and applications, including the development of
unforeseen design or engineering problems. See "Business Risks - Early Stage
Products and Services."
Fraud Detection. The ALM System employs a number of methods intended to
detect and prevent fraudulent applications, some of which are standard for all
ALMs and some of which are customized to fit each customer's underwriting model
and specifications. Certain information, such as credit card data, is verified
by contacting third party verification services. In addition, the DeciSys/RT
system contains fraud analysis software that evaluates consumer-supplied data,
such as social security numbers and addresses, against a number of format and
consistency tests. Moreover, additional fraud analysis is performed through the
use of on-line fraud detection service providers. As a further deterrent, each
ALM has the ability to imprint a digital photograph of the loan applicant on all
checks and other loan documents generated in a transaction. The Company
periodically refines its fraud detection programs to include other forms of data
verification to aid in the identification of fraud. Although the Company is
unaware of any significant instances of fraud in connection with loans
consummated through the use of ALMs, the rate of fraudulent activity could
increase. See "Business Risks - Risk of Fraud in Electronic Commerce
Transactions."
Deployment. The Company currently is able to design, assemble and
install an ALM or Mortgage ALM System for a new deployment in 45 to 90 days from
the time an order is accepted.
The Company has established relationships with vendors of the hardware
components of the ALM and Mortgage ALM. The Company purchases ALM and Mortgage
ALM components as needed to meet firm and expected orders. The Company believes
that all ALM and Mortgage ALM components are available from a wide variety of
sources.
e-xpertLender
During 1997, the Company developed its e-xpertLender System, which
enables automated decisioning and processing of certain financial products by
DeciSys/RT through ALMs and other non-ALM channels, including call centers,
branches, and other locations. e-xpertLender establishes connectivity between
the Company's automated decisioning system and all of a financial institution's
delivery channels and its risk management group. The System enables call center
agents and branch personnel to inquire as to the status of any transaction any
time and for loan transactions electronically notifies loan officers with
respect to any exceptions and the reason for referral. e-xpertLender supports
the ability to open, process and track checking accounts, overdraft protection,
applications for lines of credit and credit cards, unsecured personal loans and
direct and indirect auto loans. Using the e-xpertLender inquiry capabilities, a
lender can review online the status of a transaction and, when appropriate, make
counter offers to applicants who qualify for a loan amount higher or lower than
the loan amount originally requested. e-xpertLender also, upon approval, gives
the consumer a choice of closing methods that includes branches, ALMs, mail and
third party closing agents.
The Company currently has only one customer utilizing the e-xpertLender
System. Such System has been deployed in phases as the functionality of the
System has been developed and completed. The Company believes an e-xpertLender
System for a new customer can be installed in 60 to 90 days from the time an
order is accepted. However, due to the single e-xpertLender installation and the
nature of the initial installation process, no assurance can be given that the
Company will be able to meet such installation estimates.
iDEAL
The Company has developed an Indirect Electronic Automobile Lending
system ("iDEAL"), which enables automated decisioning and processing of
automobile loan applications originating at an automobile dealer. iDEAL is an
expansion of the core technology of e-xpertLender, enhanced specifically for
supporting lending activities associated with obtaining automobile loan
applications through an automobile dealer. Upon receipt of the loan application,
loan processing personnel input the loan applicant's information into the iDEAL
System through a standard set of input screens. The applicant's information is
immediately transmitted to the Company's proprietary DeciSys/RT System and an
automated lending decision is transmitted to the dealer. The iDEAL System
enables financial institution personnel to inquire as to the status of any
transaction anytime and notifies the financial institution with respect to
exceptions. In situations where an exception exists or an automated decision
cannot be rendered due to credit attributes of the loan applicant or collateral
values, iDEAL enables the financial institution to electronically refer the loan
application to a credit analyst so additional evaluations can be made. The iDEAL
system allows the credit analyst to input additional information received from
the loan applicant or the dealer and render a new decision and transmit that
decision to the dealer. In addition, iDEAL provides support for auditing and
dealer funding of approved loans when the loan package is completed.
Mortgage Brokerage Business
In January 1998, the Company formed Surety Mortgage, Inc. to engage in
the mortgage brokerage business, including marketing, originating, closing and
selling mortgage loans to permanent investors. The Company formed Surety for the
primary purpose of directly deploying Mortgage ALMs in a manner in which the
Company believes will facilitate future marketing and deployment of its mortgage
loan processing products. Surety's mission is to locate viable deployment
locations and develop deployment and business strategies which provide actual
market data that can be used to market the Company's mortgage loan processing
products to prospective customers. As of March 20, 2000, Surety has deployed 11
Mortgage ALMs in real estate agencies and community bank branches.
Surety offers first mortgage loans directly to consumers and
immediately sells such loans to wholesale mortgage bankers ("wholesalers") that
sponsor the loan programs offered by Surety. Surety only offers loans that will
be acquired by wholesalers under such programs. Moreover, upon making loan
commitments to consumers, Surety immediately receives a commitment from a
wholesaler to acquire the loan upon closing, thereby reducing the risk of loss
due to changes in interest rates. Prior to the time a loan is closed, the loan
is usually submitted to a wholesaler for underwriting. Accordingly, when the
loans are closed they are immediately transferred to a wholesaler, thereby
minimizing any credit risk associated with lending activities.
Sales and Marketing
The Company currently does not maintain a dedicated sales force. The
Company consults with existing and prospective customers to identify instances
where the Company's technologies are a suitable solution to core business issues
confronting such customers. Using market and process research, the Company also
consults with existing and potential customers to identify suitable applications
of the Company's technologies and refines underwriting models to achieve desired
rates of return and risk tolerance. The Company can also provide after-sale
support to its customers with respect to improving the performance of its
products and services.
Competition
The market for products and services that enable electronic commerce is
highly competitive and is subject to rapid innovation and technological change,
shifting consumer preferences, frequent new product introductions and
competition from traditional products and services having all or some of the
same features as products and services enabling electronic commerce. Competitors
in this market have frequently taken different strategic approaches and have
launched substantially different products or services in order to exploit the
same perceived market opportunity. Until the market actually validates a
strategy through widespread acceptance of a product or service, it is difficult
to identify all current or potential market participants or gauge their relative
competitive position. There can be no assurance that the Company's products and
services will be competitive technologically or otherwise. The ability of the
Company to compete in the market will depend upon, among other things, broad
acceptance of the Company's products and services and on the Company's ability
to continually improve and expand such products and services to meet changing
customer requirements.
Electronic commerce technologies in general, including the ALM, the
Mortgage ALM, e-xpertLender and iDEAL, compete with traditional consumer lending
methods, including in-person applications at branch offices of financial
institutions and cash advances on credit cards, home equity lines of credit and
other revolving credit facilities, some or all of which are employed by the
Company's existing and potential customers. The ability of the Company's
products and services to compete with traditional lending methods will be
dependent in part on consumer acceptance of electronic commerce in general and
industry acceptance of the Company's products and services in particular.
The Company also faces competition from companies engaged in the
business of producing automated lending and processing systems and other
alternatives to conventional consumer transactions, including software and data
processing companies and technology and service companies. In particular,
several companies, including Dyad Corporation ("Dyad"), Alltell Corporation
("Alltell"), FiData, Inc. ("FiData") and AnyTime Access, Inc. ("Anytime
Access"), have developed video and other kiosk technology for the delivery of
financial services. In addition, certain companies have designed and are
marketing software that enables loan applications to be taken over the
telephone. The Company also is aware that many banks have begun using on-line
services and Internet service providers to provide certain financial services
electronically, and is aware of several companies that have already made
substantial investments in software products that enable various other home
banking services. Additionally, a number of companies have developed certain
on-line processing systems to automate the mortgage application and underwriting
processes. Further, the Company understands that ULTRADATA Corporation
("ULTRADATA"), Anytime Access, and FiData have developed certain on-line
processing systems for the credit union market that may be in direct competition
with the Company's products and services. The Company will also compete with
Credit Management Solutions, Inc. ("CMSI"), Corporate Solutions International,
Inc. ("CSI"), APPRO Systems, Inc. (APPRO) and American Management Systems
("AMS") in connection with the Company's automobile loan system. See "Business
Risks - Competition; Future Price Erosion".
The Company expects competition to increase in the future from existing
and new competitors that produce automated loan systems and other alternatives
to traditional consumer lending methods. Such competitors may include actual or
potential customers of the Company that may develop competitive technology
internally. All of the Company's current and potential competitors have
substantially greater financial, marketing and technical resources than the
Company. Accordingly, the Company may not be able to compete successfully
against new or existing competitors. Furthermore, competition may reduce the
prices the Company is able to charge for its products and services, thereby
potentially lowering revenues and margins, which would have a material adverse
effect on the Company's business, operating results and financial condition. See
"Business Risks - Rapid Technological Changes" and "- Competition; Future Price
Erosion".
Technology
The DeciSys/RT System employs a multi-tiered client/server architecture
that integrates the consumer interface, application analysis function and
multiple data sources together in a seamless operating environment. The
DeciSys/RT architecture enables true multi-tasking, which permits an expedited
loan decision. DeciSys/RT uses standard C++ code and object-oriented programming
which permits the decoupling of functional development from system deployment,
greatly reducing the time and cost of maintenance. The Company anticipates easy
platform portability by using standards such as the TCP/IP communications
protocol and C++ programming language, while maintaining compatibility with
widely accepted third-party database programs and operating systems.
The Company's NOC, located in Columbia, South Carolina, connects
through a private network to the various ALMs and e-xpertLender workstations in
service. The NOC is connected to the network via dedicated 56.6 Kbps lines
(upgradable to T-1), while the ALMs use dial-up connections and the
e-xpertLender System utilizes T-1 or dial-up connections. The Company also
maintains leased line connections to TRW Inc., Trans Union Corporation, Equifax
Inc., and other providers of information for validation of a consumer's identity
and loan underwriting. The combination of data-encryption techniques and the
closed loop nature of the system provide for a secure environment.
The Company's operations are dependent on its ability to protect its
NOC against damage from fire, earthquake, power loss, telecommunications failure
or similar events. All of the Company's computer equipment constituting its
central computer system, including its processing operations, is located at the
Company's NOC in Columbia, South Carolina. The Company has adopted a formal
disaster recovery plan and has contracted with a disaster recovery company for
back-up and off-site processing systems capable of supporting its DeciSys/RT
operations in the event of system and other failure.
Intellectual Property
The Company was issued two patents in 1999 covering systems and methods
for real-time loan processing over a computer network without human
intervention. The Company is in a reexamination proceeding with the U.S. Patent
and Trademark Office ("PTO") on one of the previously issued loan processing
patents ("System and Method for real-time loan approval", U.S. Patent No.
5,870,721) due to a third party's request to invalidate or otherwise limit the
patent. In addition, the Company has received a preliminary rejection of the
previously issued claims. The reexamination is expected to conclude in 2000 and
could result in a loss or limitation of some or all of the previously issued
claims under the 5,870,721 patent.
In addition, the Company also holds a patent covering the issuance of
insurance products automatically through a kiosk ("Method and Apparatus for
Issuing Insurance from a Kiosk", U.S. Patent No. 5,537,315). The Company has
recently been notified by the PTO that its fourth patent covering an automated
system for establishing a financial account, including credit accounts, over a
computer network has been allowed. The Company has also applied with the PTO for
additional patent protection for certain features of the Company's technology,
including additional aspects of its closed loop lending system, its automated
insurance product, and its Internet related products and services. Certain of
such applications and amendments thereto have been rejected by the PTO and
others are at a preliminary stage. There can be no assurance that any of the
Company's patent applications or amendments thereto will be allowed by the PTO.
"Affinity", "ALM" and "e-xpertLender" are registered trademarks of the
corporation, and "Affinity Technologies", "Affinity enabled", and "Decisys/RT"
are registered servicemarks of the Corporation.
The Company's success and ability to compete is heavily dependent upon
its proprietary technology. The Company also relies on trade secret and
copyright law and employee, customer and business partner confidentiality
agreements to protect its technology. However, the Company believes that factors
such as technological and creative skills of its personnel, new product
developments, frequent product enhancements, name recognition and reliable
product maintenance are essential to establishing and maintaining a
state-of-the-art technological system. There can be no assurance that the
Company will be able to protect its technology from disclosure or that others
will not develop technologies that are similar or superior to the Company's
technology. See "Business Risks - Limited Protection of Technology".
Research and Development
The Company's ability to attract and retain highly skilled research and
development personnel is important to the Company's success. During 1999, 1998
and 1997, the Company spent approximately $1,871,000, $2,560,000 and $3,526,000,
respectively, on research and development activities which represented
approximately 65.1%, 96.4% and 85.0% of 1999, 1998 and 1997 revenues,
respectively. During 1999, the Company capitalized approximately $138,000 of
software development costs.
In January 2000, the Company substantially reduced the number of
employees on its research and development staff. While the Company believes that
its current research and development staff is sufficient to support ongoing
developmental projects, the Company does not currently have the capacity to
initiate numerous new projects.
Government Regulation
The financial services industry is subject to extensive and complex
federal and state regulation. The Company's current and prospective customers,
which consist of state and federally chartered banks, savings and loans, credit
unions, consumer finance companies and other consumer lenders, as well as
customers in real estate development, real estate sales and insurance industries
that the Company may target in the future, operate in markets that are subject
to extensive and complex federal and state banking and insurance regulation. The
Company's products and services must be designed to work within the regulatory
environment in which its customers operate.
Federal and state laws and regulations also regulate the lending
practices of financial institutions. These laws include federal and state
truth-in-lending disclosure rules, state usury laws, the Equal Credit
Opportunity Act, which prohibits discrimination in lending practices, the
Electronic Funds Transfer Act, which regulates electronic funds transfers, the
Fair Credit Reporting Act, which regulates access to and use of credit records
maintained by credit bureaus, and the Community Reinvestment Act, which requires
financial institutions to serve the credit needs of the entire community in
which they operate, including low and middle income neighborhoods. While these
regulations must be taken into account in the design of the Company's products
and services, the Company itself (with the exception of its mortgage subsidiary)
is not directly subject to these regulations, and the Company's standard
agreement with its customers provides that the customer will be responsible for
compliance with these laws.
Employees
At December 31, 1999, the Company employed approximately 77 full-time
employees and 1 part-time employee, compared to 87 full-time and 1 part-time
employee at December 31, 1998. Effective January 21, 2000, the Company reduced
its work force significantly and the Company currently has 40 full-time
employees and 1 part-time employee. The Company has no collective bargaining
agreements.
Business Risks
In addition to the other information in this report, readers should
carefully consider the following important factors, among others, that in some
cases have affected, and in the future could affect, the Company's actual
results and could cause the Company's actual consolidated results of operations
to differ materially from those expressed in any forward looking statements made
by, or on behalf of, the Company.
Limited Capital Resources; Operating Losses
The Company has generated net losses of $55,073,000 since its inception
and has financed its operations primarily through net proceeds from its initial
public offering in May 1996. Net proceeds from the Company's initial public
offering were $60,088,516. At December 31, 1999, cash and liquid investments
were $3,591,000. Net cash used during the year ended December 31, 1999 to fund
operations was approximately $6,101,000. Proceeds from the offering and other
sources of cash were used to fund current period operations, research and
development of approximately $1,871,000, software development of approximately
$138,000, and capital expenditures of approximately $195,000.
The Company continues to use a substantial amount of existing cash
resources to fund its operations. If the Company continued to use cash resources
at the rate used in 1999, the Company would deplete its existing cash resources
in the second quarter of 2000. The Company has taken certain measures to reduce
its cash depletion rate, including decreasing its employee base. Currently, the
Company's employee base is approximately 49% less than it was at December 31,
1999 and 53% less than it was at December 31, 1998. The Company believes
existing cash, cash equivalents and internally generated funds will be
sufficient to meet the Company's currently anticipated cash requirements during
2000. However, no assurances can be given that the Company's existing cash
resources will be sufficient to fund the Company's cash requirements for 2000.
Moreover, existing cash resources and projected revenues that may be received
under existing contracts will be insufficient to fund the Company's operations
for 2001 and thereafter. Accordingly, to remain viable after 2000, the Company
must substantially increase revenues, raise additional capital and/or
substantially reduce its operations. No assurance can be given that the Company
will be able to increase its revenues, raise additional capital or reduce its
operations in a manner that would allow it to continue operations after 2000. In
order to fund operations, the Company may need to raise additional funds through
the issuance of equity securities, in which case the percentage ownership of the
stockholders of the Company will be reduced, stockholders may experience
additional dilution, or such equity securities may have rights, preferences or
privileges senior to common stock. There can be no assurance that additional
financing will be available on terms acceptable to the Company or at all. If
adequate funds are not available or not available on acceptable terms, the
Company may be unable to continue operations, develop, enhance and market
products, retain qualified personnel, take advantage of future opportunities, or
respond to competitive pressures, any of which could have a material adverse
effect on the Company's business, operating results and financial condition.
Significant Losses; Accumulated Deficit; Future Losses
To date, the Company has incurred significant losses and has
experienced substantial negative cash flow from operations. The Company had an
accumulated deficit as of December 31, 1999 of $55,073,000 with net losses of
$706,000 for the period from inception (January 12, 1994) through December 31,
1994, and $2,308,000, $9,692,000, $15,399,000, $14,873,000 and $12,095,000 for
the years ended December 31, 1995, 1996, 1997, 1998, and 1999, respectively. The
Company expects to incur substantial additional costs to finance its operations.
There can be no assurance that the Company will ever achieve profitability or,
if achieved, sustain such profitability.
The Company's prospects must be considered in light of the risks,
expenses, and difficulties frequently encountered by companies in their early
stage of development, particularly technology based companies operating in
unproven markets with unproven products. To address these risks, the Company
must, among other things, respond to competitive developments, attract, motivate
and retain qualified personnel, establish effective distribution channels,
effectively manage any growth that may occur and continue to upgrade its
technologies and successfully commercialize products and services incorporating
such technologies.
Potential for Fluctuation in Quarterly Results
The Company's revenues are affected by many factors, including demand
for the Company's technology and demand for any additional products or services
developed by the Company, introduction and enhancement of products and services
by the Company and its competitors, market acceptance of such technology in
existence or developed in the future, types of distribution channels through
which products are sold and general economic conditions (particularly those
conditions affecting financial products and services supply and demand).
Further, the Company's customer base historically has been highly concentrated
and such concentration has had a significant effect on quarterly revenues.
Shortfalls in revenues in relation to the Company's expectations have had and
may continue to have an adverse effect on the Company's business, operating
results and financial condition.
The uncertainty regarding the extent and timing of revenues coupled
with the Company's substantial operating expenses (many of which the Company is
unable to adjust in a timely manner) means that the Company may likely continue
to experience substantial quarterly fluctuations in its operating results. In
addition, the Company will continue to commit significant resources to fund its
operations, develop new products and broaden its customer support capabilities.
To the extent these expenses are not preceded or followed by substantially
increased revenues, the Company's business, operating results and financial
condition will be materially adversely affected.
In accordance with Statement of Financial Accounting Standards No. 13
"Accounting for Leases," the Company treats certain of its ALM leases for which
the present value of future minimum lease payments exceeds 90% of the cost of
the related ALM as sales-type leases. All other leases are treated as operating
leases. For sales-type leases, the Company recognizes as revenue, generally upon
ALM installation and acceptance, the present value of the aggregate future
minimum lease payments to be received during the term of the related rental
agreement using the Company's incremental borrowing rate for lease-secured
transactions as the discount rate. For operating leases, the Company recognizes
lease payments as revenue ratably over the term of the applicable agreement. A
default by any significant customer of its obligation to make lease payments or
a termination of an ALM agreement could have an adverse effect on the Company's
quarterly operating results, particularly with regard to ALMs that are leased
under agreements treated as sales-type leases.
As a result of all the foregoing factors and other factors discussed
under "Business Risks," the Company believes that period-to-period comparisons
of its results of operations are not necessarily meaningful and should not be
relied upon as an indication of future performance. Moreover, it is likely that
in some future quarter the Company's operating results will be below the
expectation of public market analysts and investors. In such event, the price of
the Company's Common Stock could be materially adversely affected.
Unproven Market; Unproven Acceptance of the Company's Products and Services
The market for products and services that enable electronic commerce is
new, developing and uncertain. As is typical in the case of a new and rapidly
evolving industry, demand and market acceptance for recently introduced products
and services are subject to a high level of uncertainty. The Company's future
growth and financial performance will depend upon consumer acceptance of
electronic commerce as an attractive means of conducting certain consumer
financial transactions and also upon institutional acceptance of the Company's
products as a preferred means for serving consumers. Such institutional
acceptance will in part depend on continued and growing use of relatively new
quantitative credit scoring methodologies that are amenable to automation. If
the electronic commerce market fails to grow or grows more slowly than
anticipated, or if lenders reduce their use of quantitative credit scoring
tools, the Company's business, operating results and financial condition would
be materially adversely affected. Furthermore, even if this market does
experience substantial growth, there can be no assurance that the Company's
products and services will be commercially successful or benefit from such
growth. Failure of either the providers of consumer financial services or the
consumers of such services to quickly accept electronic commerce distribution
channels in general, and the Company's electronic commerce enabling technologies
in particular, or the inability of the Company's products and services to
satisfy its customers' or consumers' expectations, have had and may continue to
have a material effect on the Company's business, operating results and
financial condition.
Because the market for the Company's products and services is new,
evolving and uncertain, it is difficult to determine the size and predict the
future growth rate, if any, of this market. The market for the Company's
products may never be developed, or may develop at a slower pace than expected,
or such products and services may not be adopted by participants in this market
or may be adopted by only a limited number of participants. If the market fails
to develop or develops more slowly than expected, or if the Company's products
and services do not achieve significant market acceptance, the Company's
business, operating results and financial condition would be materially
adversely affected.
Lengthy Sales Cycle
The Company has to date experienced a lengthy sales cycle for its
products and services. In most cases, the time between initial customer contact
and the execution of a final contract has exceeded six months. While the Company
believes that the length of the sales cycle may compress over time, if the
Company's technologies gain acceptance in the marketplace, there can be no
assurance such compression will take place in the future.
Early Stage Products and Services
The Company's products and services are in the early stages of
development and are subject to the risks inherent in the development and
marketing of new products, including the development of unforeseen design or
engineering problems with the Company's products and applications. There can be
no assurance that these or other risks associated with new product development
will not occur. The occurrence of one or more of these risks could have a
material adverse effect on the Company's business, operating results and
financial condition.
Rapid Technological Changes
The market for products and services that enable electronic commerce is
highly competitive and subject to rapid innovation and technological change,
shifting consumer preferences, frequent new product introductions and
competition from traditional products and services having all or some of the
same features as products and services enabling electronic commerce. Competitors
in this market have frequently taken different strategic approaches and have
launched substantially different products or services in order to exploit the
same perceived market opportunity. Until the market validates a strategy through
widespread acceptance of a product or service, it is difficult to identify all
current or potential market participants or gauge their relative competitive
position. There can be no assurance that the Company's products and services
will be competitive technologically or otherwise. The ability of the Company to
compete in this market will depend upon, among other things, broad acceptance of
the Company's products and services and on the Company's ability to continually
improve its products and services to meet changing customer requirements. There
can be no assurance that the Company will successfully identify new product and
service opportunities and develop and bring to the market new and enhanced
services and products in a timely manner; that such products, services and
technologies will be commercially successful; that the Company will benefit from
such development; or that products, services and technologies developed by
others will not render the Company's products, services and technologies
noncompetitive or obsolete. If the Company is unable to penetrate new markets in
a timely manner in response to changing market conditions or customer
requirements or if new or enhanced products do not achieve a significant degree
of market acceptance, the Company's business, operating results and financial
condition would be materially and adversely affected.
Competition; Future Price Erosion
Electronic commerce technologies in general, including the Company's
products and services, compete with traditional consumer lending methods,
including in-person applications at branch offices of financial institutions or
at automobile dealerships and cash advances on credit cards and other revolving
credit facilities, some or all of which are employed by the Company's existing
and potential customers. The ability of the Company's products and services to
compete with traditional lending methods will be dependent in part on consumer
acceptance of electronic commerce in general and industry acceptance of the
Company's products and services in particular.
The Company also faces competition from companies engaged in the
business of producing automated lending systems and other alternatives to
conventional consumer lending, including software and data processing companies
and technology and service companies. In particular, several companies,
including Dyad, Alltell, FiData, and AnyTime Access, have developed video and
other kiosk technology for the delivery of financial services. In addition,
certain companies have designed and are marketing software that enables loan
applications to be taken over the telephone. The Company also is aware that many
banks have begun using on-line services and Internet service providers to
provide certain financial services electronically, and is aware of several
companies that have already made substantial investments in software products
that enable various other home banking services. Numerous companies have
developed certain on-line processing systems to automate the mortgage
application and underwriting processes. Further, the Company understands that
ULTRADATA, Anytime Access, and FiData have developed certain on-line processing
systems for the credit union market that may be in direct competition with the
Company's products and services. The Company will also compete with CMSI, CSI,
APPRO and AMS in connection with the Company's automobile loan system.
The Company expects competition to increase in the future from existing
and new competitors that produce automated loan systems and other alternatives
to traditional consumer lending methods. Such competitors may include actual or
potential customers of the Company that may develop competitive technology
internally. Most of the Company's current and potential competitors have
substantially greater financial, marketing and technical resources than the
Company. Accordingly, the Company may not be able to compete successfully
against new or existing competitors. Furthermore, competition may reduce the
prices that the Company is able to charge for its products and services, thereby
potentially lowering revenues and margins, which would have a material adverse
effect on the Company's business, operating results and financial condition.
Dependence on Consumer Retail Lending Industry; Cyclical Nature of
Consumer Lending
The Company's business is currently concentrated in the consumer
lending industry and is expected to be so concentrated for the foreseeable
future, thereby making the Company susceptible to a downturn in that industry.
For example, a decrease in consumer lending could result in a smaller overall
market for the Company's products and services. Furthermore, U.S. banks are
continuing to consolidate, decreasing the overall potential number of buyers for
the Company's products and services. Moreover, two customers accounted for
approximately 48.9% of the Company's revenue in 1999. The Company expects that
its operating revenues will continue to be attributable to a relatively small
number of customers. These factors as well as others affecting the consumer
lending industry could have a material adverse effect on the Company's business,
operating results and financial condition.
The Company's business currently depends upon the volume of consumer
loans made through its products and services. Historically, demand for consumer
loans has been cyclical, in large part based on general economic conditions and
cycles in overall consumer indebtedness levels. Changes in general economic
conditions that adversely affect the demand for consumer loans or the
willingness of financial institutions to provide such loans, such as changes in
interest rates and the overall consumer indebtedness level, could have a
material adverse effect on the Company's business, operating results and
financial condition.
Limited Protection of Technology
The Company regards certain of its technology as critical to its
business and attempts to protect such technology under patent, copyright and
trade secret laws and through the use of employee, customer and business partner
confidentiality agreements. Such measures, however, afford only limited
protection, and the Company may not be able to maintain the confidentiality of
its technology. As a result, existing and potential competitors may be able to
develop products and services that are competitive with, or superior to, the
Company's products and services, and such competition could have a material
adverse effect on the Company's business, operating results and financial
condition.
Risk of Fraud in Electronic Consumer Transactions
Electronic consumer transactions involve the risk of consumer fraud.
The customer using the Company's products is responsible for the selection and
use of the origination and underwriting parameters incorporated in the software
supporting the Company's products and services. The Company is unaware of any
significant instances of fraud in connection with the funding of loans through
the use of the Company's products and services. However, the rate of fraudulent
activity could increase, especially if the number of transactions processed by
the Company's products and services increased. Moreover, in light of the limited
operating experience of the Company, there can be no assurance that the
Company's experience with respect to fraud to date is indicative of future
performance for the Company's products and services. While the Company believes
the risk of collection in any given transaction belongs to its customers, the
Company may nevertheless be held responsible for losses associated with
fraudulent transactions if such transactions are attributable to the Company's
malfeasance. Furthermore, even if the Company is not directly liable or
contractually liable for fraudulent transactions processed by the Company's
products and services, an increase in fraud to levels greater than those
experienced in traditional and other emerging consumer credit processing systems
would likely have a material and adverse impact on the ability of the Company to
attract and retain financial institution customers and thus on the Company's
business, operating results and financial condition. In addition, the Company
may not be able to control adequately the occurrence of fraud in the future or
may only be able to do so at considerable cost, either of which would materially
and adversely affect the Company's business, operating results and financial
condition.
Risk of Third-Party Network Failure
The Company relies on third parties for certain fraud detection systems
and for obtaining credit information about loan applicants. Additionally, the
Company uses a dedicated private data network provided by a third party to gain
access to the networks maintained by such third parties and to customers.
Prolonged or repeated failure of (i) a network that provides access to
information necessary to complete a transaction through the Company's system or
(ii) the Company's network access provider to provide access to such networks or
customers would materially and adversely affect the Company's business,
operating results and financial condition.
Dependence on Third Parties
The expected rapid growth of the market for products that enable
electronic commerce, together with the number and resources of competitors
seeking to serve that market and the limited resources of the Company, make the
success of the Company and its business dependent on, among other things, its
ability to identify and reach agreements and work successfully with third
parties. In particular, the Company relies or may rely on third parties in
connection with its customer relationships, strategic alliance arrangements,
assembly of products and other areas. There can be no assurance that the Company
will be successful in identifying such third parties, that it will be able to
reach suitable agreements with such third parties or that it will be able to
successfully implement any such agreements that are or have been reached.
Failure by the Company to accomplish any of the above could have a material
adverse effect on the Company's business, operating results and financial
condition.
The Company's success depends particularly on the ability of customers
and third parties to successfully market the Company's products and services.
For example, the ability of the Company to realize recurring revenues from
transactions is dependent on the success of its customers in generating consumer
demand for transactions using the Company's products and services. Failure of
customers to generate and sustain consumer demand for the Company's products and
services has had and may continue to have an adverse effect on the Company's
business, operating results and financial condition. Although the Company views
its strategic and other alliances with third parties as an important factor in
the development and commercialization of its products and services, there can be
no assurance that such third parties view their alliances with the Company as
significant for their own businesses or that they will not reassess their
commitment to the Company in the future. Currently, the Company's agreements
with customers generally do not require them to meet minimum performance
requirements. Instead, the Company relies on the voluntary efforts of such
customers to promote consumer acceptance and use of the Company's products and
services. The Company's ability to maintain relationships with its customers and
third parties will depend, in part, on its ability to successfully enhance
products and services and develop new products and services. The Company's
inability to meet such requirements could result in its customers and third
parties seeking alternative providers of the Company's products and services,
which would have an adverse effect on the Company's business, operating results
and financial condition.
Undeveloped Distribution Channels
The Company currently sells its products and services directly. To
date, the Company has been unable to enter into strategic partnerships and
distribution agreements that have resulted in substantial sales of the Company's
products and services. For the Company to ever achieve broad distribution of its
products or services, it will have to implement effective marketing and
distribution programs. The inability of the Company to develop and implement
effective marketing programs could have a material adverse effect on the
Company's business, operating results and financial condition. To the extent
broad distribution of the Company's products and services is not achieved, there
would be a material adverse effect on the Company's business, operating results
and financial condition.
Dependence on Key Employees
The Company is highly dependent on certain key executive officers and
technical employees. The Company is also dependent on its ability to recruit,
retain and motivate high quality personnel. Competition for such personnel is
intense, and the inability to attract and retain qualified employees or the loss
of current key employees could materially and adversely affect the Company's
business, operating results and financial condition. Additionally, the Company
does not maintain "key man" insurance policies on any of its key employees nor
does the Company intend to secure such insurance. The loss of the services of
any of the Company's executive officers could have a material adverse effect
upon the Company's business, operating results and financial condition.
Shares Eligible for Future Sale; Possible Adverse Effect on Market Price
Sales of substantial amounts of Common Stock in the public market or
the prospect of such sales could adversely affect the market price for the
Company's Common Stock and the ability of the Company to raise equity capital in
the future. As of March 16, 2000, the Company had outstanding an aggregate of
31,870,311 shares of Common Stock. Of such shares, the Company believes that an
aggregate of approximately 20,760,244 shares of Common Stock are freely
tradeable without restriction or further registration under the Securities Act
of 1933 (the "Securities Act"), except for any of such shares acquired by
"affiliates" of the Company, as that term is defined in Rule 144 under the
Securities Act ("Affiliates"). The Company believes that the holders of the
remaining 11,110,067 shares are Affiliates of the Company and, accordingly, that
such shares may be sold without registration only in compliance with the
Securities Act (including Rule 144). In this regard, since April 28, 1999, Jeff
A. Norris, the Company's founder, has sold approximately 5,664,725 shares
beneficially owned by him and has filed notice to sell the remaining 2,942,667
shares beneficially owned by him. At December 31, 1999, approximately 308,000
and 200,000 options are exercisable under the 1996 and 1995 Option Plans,
respectively, at weighted average exercise prices of $2.15 and $0.44,
respectively, with a weighted average remaining contractual life of 8.5 years
and 6.8 years, respectively. There also were warrants exercisable into an
aggregate of 3,471,340 shares of common stock at a weighted average exercise
price of approximately $0.0001 per share. The issuance of shares of capital
stock to address liquidity needs of the Company or for other business purposes
could also adversely affect the market price of the Company's Common Stock.
Volatility of Stock Price and Risk of Litigation; Possible Delisting
of Securities from NASDAQ Stock Market
The Company's Common Stock price has been extremely volatile and has
experienced substantial and sudden fluctuations. In addition, the stock market
has experienced significant price and volume fluctuations that have especially
affected the market prices of equity securities of many high technology
companies, and that often have been unrelated to the operating performance of
such companies. These broad market fluctuations have adversely affected and may
continue to adversely affect the market price of the Company's Common Stock. In
the past, following periods of volatility in the market price of a company's
securities, securities class action litigation has often been instituted against
such a company. Such litigation could result in substantial costs and a
diversion of management's attention and resources, which would have a material
adverse effect on the Company's business, operating results and financial
condition.
On two separate occasions (once in 1998 and again on October 18, 1999),
the Company was notified by the Nasdaq Stock Market, Inc. ("Nasdaq") that the
Company was not in compliance with Nasdaq listing standards that require the
Company's stock to maintain a minimum bid price of $1.00 or more. In each case,
the Company was provided approximately 90 days to regain compliance with such
standards (which would require the Common Stock to have a closing bid price of
$1.00 or more for at least ten consecutive business days). In each case, the
Company's Common Stock did not regain compliance during such 90-day period, and
the Company requested a review by Nasdaq, which stayed delisting temporarily.
During the period in which the delisting was stayed, the Company's Common Stock
closed at or above $1.00 for the necessary 10 consecutive trading days. In the
case of the first delisting notice received by the Company in 1998, the Nasdaq
thereafter notified the Company that it had evidenced compliance with Nasdaq's
requirement for continued listing. In the case of the second delisting notice
received by the Company in October 1999, on March 13, 2000, Nasdaq notified the
Company of an additional concern with respect to the ability of the Company to
sustain compliance with the $4 million net tangible assets requirement for
continued listing on the Nasdaq National Market. On March 21, 2000, the Company
submitted a response to the Nasdaq's March 13, 2000 letter. On March 22, 2000,
the Company was notified of a decision by the Nasdaq Stock Market to transfer
the Company from the Nasdaq National Market to the Nasdaq SmallCap Market. The
Company's continued listing on the Nasdaq SmallCap Market is contingent upon
successful completion of an application and review process. There can be no
assurances the Company's Common Stock will not be delisted from the Nasdaq
SmallCap Market or that the Company will be able to maintain compliance with
Nasdaq listing standards in the future.
Government Regulation and Uncertainties of Future Regulation
The financial services industry is subject to extensive and complex
federal and state regulation. The Company's current and prospective customers,
which consist of state and federally chartered banks, savings and loans, credit
unions, consumer finance companies and other consumer lenders, as well as
customers in the real estate development, real estate sales and insurance
industries that the Company may target in the future, operate in markets that
are subject to extensive and complex federal and state banking and insurance
regulation. The Company's products and services must be designed to work within
the extensive and evolving regulatory constraints in which its customers
operate. These constraints include federal and state truth-in-lending disclosure
rules, state usury laws, the Equal Credit Opportunity Act, the Electronic Funds
Transfer Act, the Fair Credit Reporting Act, the Community Reinvestment Act, and
restrictions on the establishment, number and location of branch offices and
remote electronic banking facilities such as automated teller machines. Because
many of these regulations were promulgated before the development of products
that enable electronic commerce, the application of such regulations to any
products and services developed by the Company must be determined on a
case-by-case basis. The Company has not attempted to review the laws of each
state that might be applicable to the deployment of its products and services.
It is possible that other states may have or will in the future adopt specific
regulations applicable to the deployment and operation of the Company's products
and services. Regulations currently existing or promulgated in the future that
significantly restrict the ability of a financial institution to install ALMs at
multiple locations outside branch offices or otherwise adversely affect the use
of ALMs or any other products or services the Company has or may develop could
have a material adverse effect on the Company's business, operating results and
financial condition.
Anti-Takeover Provisions
Certain provisions of Delaware law and the Company's Certificate of
Incorporation and bylaws could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from attempting to
acquire, control of the Company. Such provisions could limit the price that
certain investors might be willing to pay in the future for shares of the
Company's Common Stock. These provisions of Delaware law and the Company's
Certificate of Incorporation and bylaws may also have the effect of discouraging
or preventing certain types of transactions involving an actual or threatened
change of control of the Company (including unsolicited takeover attempts), even
though such a transaction may offer the Company's stockholders the opportunity
to sell their stock at a price above the prevailing market price. Certain of
these provisions allow the Company to issue Preferred Stock with rights senior
to those of the Common Stock and other rights that could adversely affect the
interest of holders of Common Stock without any further vote or action by the
stockholders. The issuance of Preferred Stock, for example, could decrease the
amount of earnings or assets available for distribution to the holders of Common
Stock or could adversely affect the rights and powers, including voting rights,
of the holders of the Common Stock. In certain circumstances, such issuance
could have the effect of decreasing the market price of the Common Stock, as
well as having the anti-takeover effects discussed above.
Item 2. Properties
The Company's principal executive offices are located at 1201 Main
Street in Columbia, South Carolina. Such office space encompasses approximately
33,000 square feet and is currently under lease which expires in 2001. The
Company also leases approximately 2,800 square feet of office space at 1500
Hampton Street, Suite 130 in Columbia, South Carolina, under a lease that is due
to expire in 2001. The Company's primary assembly and quality assurance
facilities are located at 2500 Leaphart Road in West Columbia, South Carolina,
which encompasses approximately 19,000 square feet and is currently under lease
which expires in 2001. During 1999, the Company also sub-leased approximately
1,000 square feet of sales office space in New York, New York from Columbia
Financial Partners, L.P., an affiliate of Alan H. Fishman, who is Chairman of
the Board and a director of the Company. Such lease was terminated in January
2000.
Item 3. Legal Proceedings
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Executive Officers of the Registrant
Name Age Position with the Company
Joseph A. Boyle 46 President, Chief Executive Officer,
Chief Financial Officer
Terrence J. Sabol, Sr. 54 Senior Vice President of Technology
John D. Rogers 56 Senior Vice President
Joseph A. Boyle became President and Chief Executive Officer of the Company
in January 2000. Mr. Boyle has also served as Chief Financial Officer of the
Company since September 1996. Mr. Boyle also held the title of Senior Vice
President from September 1996 to January 2000 and Treasurer from May 1997. From
May 1997 to July 1998, Mr. Boyle also served as Secretary of the Company. Prior
to joining the Company, Mr. Boyle served as Price Waterhouse, LLP's engagement
partner for most of its Kansas City, Missouri financial services clients and as
a member of the firm's Mortgage Banking Group. Mr. Boyle was employed by Price
Waterhouse, LLP from June 1982 to August 1996.
Terrence J. Sabol, Sr., Senior Vice President of Technology, joined the
Company in October 1995. From July 1990 to October 1995, he served as Products
Manager for Policy Management Systems Corporation, a Columbia, South Carolina
company that provides and supports computer systems for insurance companies.
John D. Rogers became Senior Vice President of the Company in January 1997.
Mr. Rogers served as President of Affinity Processing Corporation, a subsidiary
of the Company, from May 1996 until May 1997. Prior to joining the Company, Mr.
Rogers served as Executive Vice President of the Information Services Group of
BISYS Group, Inc., from 1989 to 1996.
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
(a) Until March 27, 2000 the Company's Common Stock was traded on the
Nasdaq National Market under the symbol "AFFI." Effective as of
the opening of business on March 27, 2000, the Company's Common
Stock began trading on the Nasdaq SmallCap Market under the symbol
"AFFI." The following table presents the high and low sales prices
of the Company's Common Stock for the periods indicated during
1999 and 2000, as reported by the Nasdaq National Market. As of
March 16, 2000, there were 289 stockholders of record of the
Common Stock.
Sales Price Per Share
High Low
1998:
First Quarter 3.03 2.25
Second Quarter 2.25 0.69
Third Quarter 1.09 0.50
Fourth Quarter 0.97 0.22
1999
First Quarter 2.50 0.63
Second Quarter 3.81 1.19
Third Quarter 1.78 0.69
Fourth Quarter 1.31 0.41
The Company has never paid dividends on its capital stock. The
Company intends to retain earnings, if any, for use in its business and
does not anticipate paying any cash dividends in the foreseeable
future.
On two separate occasions, the Company has been notified by the
Nasdaq Stock Market, Inc. ("Nasdaq") that the Company was not in
compliance with Nasdaq's listing standards that require the Company's
stock to maintain a minimum bid price of $1.00 or more. On March 22,
2000 the Company was notified of a decision by Nasdaq to transfer the
Company from the Nasdaq National Market to the Nasdaq SmallCap Market.
The Company's continued listing on the Nasdaq SmallCap Market is
contingent upon successful completion of an application and review
process. SmallCap issuers must maintain a $1.00 minimum bid price and
have net tangible assets of $2 million, a $35 million market
capitalization or $500,000 in net income, among other requirements.
There can be no assurances that the Company's Common Stock will not be
delisted from the Nasdaq SmallCap Market or that the Company will be
able to maintain compliance with Nasdaq listing standards in the
future. See Item I "Business--Business Risks."
(b) The Company's registration statement on Form S-1 (File No.
333-1170) with regard to an initial public offering of 5,060,000
shares of common stock, par value $.0001 per share, of the Company
was declared effective by the Securities and Exchange Commission
on April 24, 1996. As set forth in the Company's Form SR, Report
of Sales of Securities and Use of Proceeds Therefrom, Montgomery
Securities and Donaldson, Lufkin & Jenrette Securities Corporation
acted as the managing underwriters for the offering, which
commenced April 25, 1996. As of December 31, 1999, the Company has
used net proceeds of $60,078,000 from the offering as follows:
Direct or indirect payments to
directors, officers, general
partners of the issuer or
their associates; to persons
owning ten percent or more of
any class of equity securities
of the issuer; and to Direct or indirect
affiliates of the issuer. payments to others
-------------------------------- ----------------------
Construction of plant, building and facilities $ -
Purchase and installation of machinery and equipment 5,668,000
Purchase of real estate -
Acquisition of other business(es) 300,000
Repayment of indebtedness $ 771,000 1 1,000,000
Working capital 31,530,000
Temporary investments:
US Treasury obligations 1,475,000
Commercial paper 0
Money market /cash 2,116,000
Other purposes:
Marketing 4,531,000
Research & development 10,446,000
Purchase of software 2,241,000
[FN]
1 Reflects the repayment of debt owed to Carolina First Corporation, as
described under the caption "Use of Proceeds" in the Company's Prospectus, dated
April 25, 1996.
Item 6. Selected Financial Data
The following table presents selected financial data of the Company for
the periods indicated. The following financial data should be read in
conjunction with the information set forth under "Management's Discussion and
Analysis of Financial Condition and Results of Operations," the Company's
Consolidated Financial Statements and Notes thereto and other information
included elsewhere in this report.
Year ended
December 31,
1999 1998 1997 1996 1995
------------------ --------------- ---------------- --------------- ---------------
Statements of Operations Data:
Revenues $ 2,874,901 $ 2,656,259 $ 4,146,899 $ 5,081,818 $ 1,524,911
Costs and expenses:
Cost of revenues 2,262,468 1,644,653 2,125,646 3,088,321 1,101,330
Research and development 1,870,509 2,559,600 3,526,257 2,905,232 368,452
Selling, general and
administrative expenses 11,208,310 14,358,335 15,892,560 10,819,381 2,305,653
------------------ --------------- ---------------- --------------- ---------------
Total costs and expenses 15,341,287 18,562,588 21,544,463 16,812,934 3,775,435
------------------ --------------- ---------------- --------------- ---------------
Operating loss ( 12,466,386) (15,906,329) (17,397,564) (11,731,116) (2,250,524)
Interest income 375,514 1,044,251 2,033,571 2,099,004 48,476
Interest expense (3,764) (10,923) (35,359) (60,083) (105,981)
------------------ --------------- ---------------- --------------- ---------------
Net loss (12,094,636) $ (14,873,001) $ (15,399,352) $ (9,692,195) $ (2,308,029)
=============== ================ =============== ===============
================== =============== ================ =============== ===============
Net loss per share -
basic and diluted $ (0.41) $ (0.50) $ (0.54) $ (0.40) $ (0.15)
================== =============== ================ =============== ===============
=============== ================ =============== ===============
Shares used in computing
net loss per share 29,738,459 29,755,034 28,477,880 24,136,480 15,044,286
================== =============== ================ =============== ===============
December 31,
1999 1998 1997 1996 1995
---------------- ---------------- --------------- ---------------- ---------------
Balance Sheet Data:
Cash and cash equivalents $ 2,116,016 $ 2,026,932 $ 4,470,185 $ 31,563,950 $ 1,235,983
Short-term investments 1,474,949 8,068,310 19,135,415 10,583,997 -
Working capital (deficit) 4,637,238 13,543,782 28,599,560 43,672,679 (1,134,465)
Net investment in sales-type
leases, less current portion 249,830 574,347 1,328,741 2,386,010 860,295
Total assets 13,129,528 24,196,875 42,209,570 56,098,857 4,591,168
Notes payable, less
current portion - - - - 222,399
Capital lease obligations to related
party, less current portion - - - 66,245 148,119
Capital stock of subsidiary held
by minority investor - - - 200,000 137,500
Stockholders' equity 10,670,980 22,556,201 39,230,570 52,134,639 617,412
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The Company was formed in 1994 to develop and market technologies that
enable financial institutions and other businesses to provide consumer financial
services electronically with reduced or no human intervention. From the period
of inception (January 12, 1994) through December 31, 1994, the Company was a
development stage company, and its activities principally related to developing
its DeciSys/RT technology (formerly known as the "DSS System") and the Affinity
ALM, raising capital and recruiting personnel.
Until early 1997 the Company's primary products and services consisted
of the ALM, which captures origination information for unsecured consumer loan
applications and then routes this information to the Company's proprietary
DeciSys/RT for an automated decision, and a call center decisioning system that
provided financial institutions with the ability to originate unsecured consumer
loans with reduced or no human intervention. During 1997, the Company developed
e-xpertLender, which connects all of a financial institution's delivery
channels, its automated decisioning system, and its risk management group and
gives the consumer a choice of closing methods that include branches, ALMs,
mail, and third party closing agents. During 1998, the Company began developing
a system to process automobile loans pursuant to a development contract with
Citibank. In 1999 Citibank sold its indirect automobile loan business to Dime
Savings Bank. In 1998 and 1999, the Company also renewed its efforts to design
additional products available through point-of-sale devices similar to the ALM.
The primary product developed during this time period is the Mortgage ALM, which
captures information necessary to originate a mortgage loan. During 1999, the
Company completed the development of its general release version of an
automobile loan processing system, which is being offered under the brand name
of iDEAL.
During 1999, the Company committed significant development and other
internal resources to enhancing its e-xpertLender product, fulfilling its
obligations under its Dime contracts and completing iDEAL for general release.
As a result, the Company was unable to, and did not, devote significant
resources to the development, sales and marketing of any of its other products
and services. The Company deployed no ALMs during 1999. Average consumer use of
ALMs and average rates of loan approvals have been lower than most customer
expectations. The Company believes that the ALM has not proven to be a viable
channel for the delivery of consumer loans and other products in a
fully-automated manner. Accordingly, the Company did not devote significant
resources to the development of the ALM product during 1999, nor does it
contemplate the allocation of significant resources to the ALM product in the
future. Most of the Company's ALM customers have terminated their relationship
with the Company and at December 31, 1999, there were 68 ALMs in operation.
To date, the Company has generated substantial operating losses, has
experienced an extremely lengthy sales cycle for its products and services and
has been required to use a substantial amount of existing cash resources to fund
its operations. Although the Company believes that existing cash, cash
equivalents and internally generated funds will be sufficient to fund operations
during 2000, such resources, together with projected revenues that may be
received under existing contracts, may be insufficient to fund the Company's
operations in 2001 and beyond. To remain viable after 2000, the Company must
substantially increase revenues, raise additional capital and/or substantially
reduce its operations. No assurances can be given that the Company will be able
to increase its revenues, raise additional capital or reduce its operations in a
manner that will allow it to continue operations in 2001 and beyond.
To date, the Company has generated minimal operating revenues, has
incurred significant losses and has experienced substantial negative cash flow
from operations. The Company's prospects must be considered in light of the
risks, expenses and difficulties frequently encountered by companies in their
early stage of development, particularly technology-based companies operating in
unproven markets with unproven products. The Company had an accumulated deficit
as of December 31, 1999 of $55,073,184 with net losses of $12,094,636,
$14,873,001 and $15,399,352 for the years ended December 31, 1999, 1998 and
1997, respectively. The Company expects to incur substantial additional costs to
develop its financial product origination capabilities, to enhance and market
iDEAL, e-xpertLender, and Decisys/RT and to complete any new products and
services that may be developed. Accordingly, there can be no assurance that the
Company will ever be able to achieve profitability or, if achieved, sustain such
profitability.
The market for the Company's products and services is new, evolving and
uncertain, and it is difficult to determine the size and predict the future
growth rate, if any, of this market. In addition, the market for products and
services that enable electronic commerce is highly competitive and is subject to
rapid innovation and competition from traditional products and services having
all or some of the same features as products and services enabling electronic
commerce. Competitors in this market have frequently taken different strategic
approaches and have launched substantially different products or services in
order to exploit the same perceived market opportunity. Until the market has
validated a strategy through widespread acceptance of a product or service, it
is difficult to identify all current or potential market participants or gauge
their relative competitive position.
Results of Operations
Revenues. The Company's revenues were $2,874,901, $2,656,259 and
$4,146,899 for the years ended December 31, 1999, 1998 and 1997, respectively.
The types of revenue recognized by the Company in the years ended December 31,
1999, 1998 and 1997 are as follows:
Years ended December 31,
1999 1998 1997
----- ------------------ --- --- ------------------- --- -- ------------------- ---
% of % of % of
Amount Total Amount Total Amount Total
--------------- -------- -------------- -------- -------------- --------
Transaction fees $ 538,073 18.7 $ 750,936 28.3 $ 545,551 13.2
Mortgage processing fees 397,024 13.8 453,657 17.1 - -
Initial set-up fees - - 91,000 3.4 638,687 15.4
Sales and rental fees 48,962 1.7 66,369 2.5 1,590,620 38.4
Professional services fees 850,497 29.6 797,301 30.0 792,734 19.1
Patent license revenue 645,000 22.4 - - - -
Other income 395,345 13.8 496,996 18.7 579,307 13.9
--------------- -------- -------------- -------- -------------- --------
$ 2,874,901 100.0 $ 2,656,259 100.0 $ 4,146,899 100.0
=============== ======== ============== ======== ============== ========
The nature and types of revenues earned by the Company has changed
significantly in the three-year period ended December 31, 1999. During 1997,
53.8% of the Company's revenues were derived from initial set-up fees and sales
and rental fees, most of which was associated with the deployment of ALMs under
sales-type leases. Revenue associated with ALM deployments was significantly
diminished in 1998 and 1999. In 1997 the Company entered into two contracts to
customize its core technology to accommodate specific customer requests. The
Company entered into a contract to provide professional services to a specific
customer to customize its core technology to accommodate an enterprise-wide loan
processing system, which became the basis for the Company's e-xpertLender
System. Additionally, in 1997 the Company entered into a contract to provide
professional services to a specific customer to customize an indirect automobile
loan processing system, which became the basis for the Company's iDEAL product.
The delivery of professional services under both contracts continued into 1998
and 1999. In addition, the Company began processing mortgage loans through
Surety in 1998. In 1999, the Company was granted a patent covering its
consumer-directed fully-automated lending system, and recognized $645,000 in
patent license revenue in 1999.
Transaction fees. The decrease in transaction fees in 1999 compared to
1998 is attributable primarily to the sale of the Company's former Transaction
Processing Division ("TPS") in December 1998. Transaction fees associated with
processing credit and debit card transactions through the Company's TPS division
were approximately $218,000 in 1998. The increase in transaction fees in 1998
compared to 1997 is attributable primarily to the deployment in mid-1997 of the
Company's first e-xpertLender System. Transaction fees processed through such
system were generated during the entire year of 1998. Transaction fees
associated with processing credit and debit card transactions through the
Company's TPS division decreased slightly from approximately $245,000 in 1997 to
approximately $218,000 in 1998.
Mortgage processing fees. Surety Mortgage, Inc. ("Surety"), a wholly
owned subsidiary of the Company, engages in mortgage brokerage activities which
involve originating, processing and selling mortgage loan products to outside
investors. Surety originates and processes mortgage loans directly with
consumers or on behalf of correspondents, and immediately sells such loans to
institutions that sponsor the loan programs offered by Surety. Surety only
offers loans that will be acquired by such institutions under such programs.
Upon making the loan commitment to the borrower, Surety immediately receives a
commitment from an institution to acquire the loan upon closing. Mortgage
processing fees include gains on sales of mortgage loans to institutions and
loan fees received for originating and processing the loan. Loan origination
fees and all other direct costs associated with originating loans are recognized
at the time the loans are sold. The decrease in mortgage processing fees in 1999
compared to 1998 is attributable to the processing of fewer loans in 1999
compared to 1998. In 1999 Surety processed and closed an aggregate principal
balance of loans of approximately $17,408,000 compared with approximately
$21,745,000 in 1998. The Company did not generate revenues from mortgage
processing services prior to 1998.
Initial set-up fees. The Company did not deploy any ALMs in 1999 and,
accordingly, recognized no set-up fees. Set-up fees recognized in 1998 relate to
the deployment of one ALM and the recognition of previously deferred set-up fees
associated with a customer's decision not to deploy ALMs. Set-up fees in 1997
relate to the deployment of 53 ALMs.
Sales and rental fees. The decrease in sales and rental revenue in 1999
compared to 1998 is due to a decrease in the number of ALMs deployed under
operating leases in 1999 compared to 1998 for which there were scheduled rental
payments. The decrease in sales and rental revenue in 1998 compared to 1997 is
attributable to a substantial decrease in ALM deployments in 1998 compared to
1997. Amounts recognized in 1998 also consisted of rental payments received on
ALMs deployed under operating leases in prior years. In 1997, the Company
recognized sales revenue associated with the deployment of 28 ALMs under
sales-type leases as well as rental revenue associated with ALMs deployed under
operating leases.
Professional services fees. When the Company agrees to provide
professional services to customize its core technology to conform to a specific
customer request, the Company generally enters into a contract with the customer
for the performance of these services which typically defines deliverables,
specific delivery and acceptance dates and specified fees for such services.
Upon completion and acceptance of the specific deliverables by the customer, the
Company recognizes the corresponding revenue as professional services revenue.
The level of professional services revenue remained relatively consistent for
the years 1999, 1998 and 1997. In 1999, 64% and 36% of professional services
fees were associated with the customization of the Company's e-xpertLender and
iDEAL systems, respectively. This customization was performed during the year to
meet the specific requirements of two of the Company's customers. These two
customers represent 100% of the amounts recognized in 1999 for customization of
the e-xpertLender and iDEAL systems. In 1998 and 1997, professional services
revenue related primarily to the customization of the Company's e-xpertLender
System to meet a specific customer's requirements. Such customer represented 97%
and 91% of professional services revenue in 1998 and 1997, respectively.
Patent license revenue. The Company was granted two patents in 1999
covering automated loan processing. Patent license revenue recognized in 1999
relates to certain patent licenses granted by the Company. Licensing agreements
with one customer and an affiliate of that customer constituted 93% of the
patent license revenue recognized in 1999.
As indicated above, two customers accounted for 100% of professional
services fees recognized in 1999. Moreover, in 1999 the development contract
under which the Company recognized 36% of its professional services revenue was
assigned to the Company's other customer which accounted for 64% of its 1999
professional services revenue. When combined, one current customer, therefore,
accounted for 100% of professional services revenue in 1999. Additionally, when
combined with other revenue associated with services provided to this customer,
the customer accounted for 49% of total revenue recognized by the Company in
1999. This same customer accounted for 99.1% of professional services revenue
for 1998 and 60.2% and 91.3% of ALM sales and rental and professional services
revenue, respectively, during 1997. This same customer accounted for 49.1% and
48.0% of total revenue for 1998 and 1997, respectively. One other customer
accounted for 13% of total revenue during 1997. For information relating to
customer revenue concentrations, see Note 12 of "Notes to Consolidated Financial
Statements - Segment Information." The loss of this customer or any other
significant customer may have a material adverse effect on the Company's
financial condition or results of operations due to the developing nature of the
Company's customer base and revenue streams. Additionally, revenue associated
with the Company's patent licensing program was 22% of total revenue in 1999.
One of the Company's patents is currently being reexamined by the PTO and has
resulted in a preliminary rejection of the patent claims. Such reexamination
could result in a loss or otherwise limit the previously issued claims which
could negatively affect the Company's ability to maintain or expand its patent
licensing program. The Company expects that a substantial portion of the
Company's operating revenues in the future may continue to be attributable to
relatively few customers. Such customer concentration may cause significant
fluctuations in the Company's quarterly and annual revenues due to the
uncertainty of the timing of new and additional orders for the Company's
products and services.
Costs and Expenses
Costs of Revenues. Costs of revenues for the years ended December 31,
1999, 1998 and 1997 were $2,262,468, $1,644,653, and $2,125,646, respectively.
Cost of revenues includes the direct costs associated with the generation of
specific types of revenue and the allocation of certain indirect costs when such
costs are specifically identifiable and allocable to revenue producing
activities. During the three years ended December 31, 1999, the nature and
amounts of costs, as well as gross profit margins, associated with certain
revenue producing activities varied significantly due to changes in the nature
of the services offered by the Company and due to different pricing structures
offered to certain customers.
Costs of revenues and the percentage of the costs of revenues to total
costs of revenues for the years ended December 31, 1999, 1998 and 1997 are as
follows:
Year ended December 31,
1999 1998 1997
--- ------------------- --- -- -------------------- -- --- ------------------- --------
% of % of % of
Amount Total Amount Total Amount Total
--------------- -------- -------------- ------- -------------- -------------
Transaction fees $ 209,424 9.2 $ 388,734 23.6 $ 328,067 15.4
Mortgage processing fees 194,239 8.6 192,726 11.7 - -
Initial set-up fees - - - - 232,077 10.9
Sales and rental fees 445,581 19.7 379,775 23.1 1,041,455 49.0
Professional services fees 573,381 25.3 204,058 12.4 524,047 24.7
Patent license 64,500 3.0 - - - -
revenue
Contract loss provision 775,343 34.2 479,360 29.2
--------------- -------- -------------- ------- -------------- -------------
--------------- -------- -------------- ------- -------------- -------------
$ 2,262,468 100.0 $ 1,644,653 100.0 $ 2,125,646 100.0
=============== ======== ============== ======= ============== =============
Costs of transaction fees. The cost of transaction fees consists
primarily of the direct costs incurred by the Company to process loan
applications and debit and credit card transactions through its systems. Such
direct costs are associated with services provided by third parties and includes
the cost of credit reports, fraud reports and communications networks used by
the Company. The cost of transaction fees decreased in 1999 compared to 1998 and
increased in 1998 compared to 1997 in direct correlation to a decrease in 1999
from 1998, and an increase in 1998 from 1997, of the volume of transactions the
Company processed through its systems compared with the previous period.
Costs of mortgage processing fees. The costs of mortgage processing
fees consist of the direct cost incurred by Surety associated with the
underwriting, processing and closing of mortgage loans. Such costs include
credit reports, appraisal reports, flood certifications, administration fees
charged by the purchasers of loans and fees paid to other lenders that provide
certain processing services associated with loans originated by Surety. The
costs of mortgage processing fees remained consistent in 1999 compared to 1998
even though Surety originated fewer loans. Accordingly, costs of mortgage
processing fees increased on a loan-for-loan basis in 1999 compared to 1998.
This increase was due to Surety's increased use of other lenders to provide
certain processing services in 1999 compared to 1998.
Costs of initial set-up fees. The costs of initial set-up fees are
related to the initial costs incurred to deploy and install ALMs. Such costs
include the allocation of direct and indirect labor and certain other indirect
costs associated with the initial preparation and deployment of ALMs for the
Company's customers. Additionally, the costs include direct costs incurred by
the Company, including shipping costs and amounts paid to third parties.
The Company deployed no ALMs in 1999 and no costs associated with
set-up fees were incurred during 1998. In 1997 the Company deployed 53 ALMs
under both sales-type and operating leases.
Costs of sales and rental fees. Costs of sales and rental fees are
related to the cost of ALM hardware components associated with ALMs deployed
under sales-type leases, maintenance of installed ALMs, amortization associated
with capitalized ALM and related systems development costs, and depreciation
associated with ALMs deployed under operating leases. Costs associated with
sales and rental fees remained consistent in 1999 compared to 1998 and reflected
an increase in amortization and depreciation related to ALMs deployed under
operating leases and related systems. Such increase was offset by lower ALM
maintenance costs in 1999 compared to 1998. In 1998 the costs of sales and
rental fees consisted primarily of depreciation related to ALMs deployed under
operating leases and the costs associated with maintaining the Company's
installed base of ALMs. Costs of sales and rental revenues were significantly
lower in 1998 compared to 1997 primarily as a result of the deployment in 1997
of 28 ALMs under sales-type leases compared to only 1 ALM deployed under a
sales-type lease in 1998.
Under the terms of an agreement with one customer covering 30 ALMs, the
customer's payment obligation to the Company is based on ALM performance, which
has resulted in revenues insufficient to cover the depreciation expense
recognized by the Company. Accordingly, the cost of sales and rental revenues
exceeded the sales and rental revenues recognized by the Company for such
contract. This contract will expire in early 2000 at which time the related ALMs
will be fully depreciated.
Costs of professional services fees. The costs of professional services
fees consist of the costs of the direct labor and the allocation of certain
indirect costs associated with performing software and system customization
services for customers. The costs of providing professional services will vary
depending upon the nature of professional services rendered, the level of
developers assigned to specific projects and the duration of the project.
Accordingly, the margins recognized by the Company may vary significantly
depending upon the nature of the project. The costs of providing professional
services increased in 1999 compared to 1998 primarily as a result of the greater
amount of time to conclude certain projects in 1999 compared to 1998. Similarly,
costs of professional services decreased in 1998 compared to 1997 as a result of
the shorter average duration of projects in 1998 compared to 1997.
Costs of patent license revenue. Costs of patent license revenue
recognized in 1999 consists of commissions paid to the Company's patent
licensing agent and is associated with such agent's commissions for patent
licenses granted by the Company. The Company commenced its patent licensing
program in 1999.
Contract loss provision. The Company periodically enters long-term
development contracts to design, develop and install loan processing systems for
its customers. In conjunction with such contracts the Company periodically
evaluates whether costs incurred and estimated future costs exceed revenues
under the contract. To the extent such costs exceed contracted revenues, the
Company records a charge to costs of revenues. In 1999 and 1998, the Company
recorded contract loss provisions of $775,343 and $479,360, respectively.
Research and Development. The Company accounts for research and
development costs as operating costs and expenses such costs in the period
incurred. In accordance with Statement of Financial Accounting Standards No. 86
("SFAS 86"), "Computer Software to be Sold, Leased or Otherwise Marketed," the
Company capitalizes software costs incurred in the development of a software
application after the technological feasibility of the application has been
established. Technological feasibility is established when an application design
and a working model of the application have been completed and the completeness
of the working model and its consistency with the application design have been
confirmed by testing. From the time technological feasibility is established
until the time the relevant application is available for general release to
customers, software development costs incurred are capitalized at the lower of
cost or net realizable value. Thereafter, costs related to the application are
again expensed as incurred. Capitalized software development costs are amortized
using the greater of the revenue curve or straight-line method over the
estimated economic life of the application. Software costs capitalized include
direct labor, other costs directly associated with the development of the
related application and an allocation of indirect costs, primarily facility
costs and other costs associated with the Company's software development staff.
The Company bases such allocation on the percentage of the Company's total labor
costs represented by the software development labor costs.
Research and development expenses for the year ended December 31, 1999
were approximately $1,871,000, compared to $2,560,000 and $3,526,000 for 1998
and 1997, respectively. The decrease in research and development expense in 1999
compared to 1998 is due to an overall decrease in the number of employees
involved in development activities in 1999 compared to 1998. The decrease in
research and development expenses in 1998 compared to 1997 is also due to an
overall decrease in the number of employees involved in developmental activities
in 1998 compared to 1997 as well as the progression of certain development
activities in 1998 to a point where the costs of such activities were
capitalized pursuant to applicable accounting guidelines.
During 1999, 1998 and 1997, the Company capitalized approximately
$138,000, $1,041,000, and $568,744, respectively, of software development costs
related primarily to the development of certain financial service applications
processed using DeciSys/RT. When a product is available for general release to
customers, capitalization of such costs is discontinued and amounts capitalized
are generally amortized over a 48 month period. The Company anticipates that it
will continue to commit substantial resources to research and development
activities for the foreseeable future.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses for the year ended December 31, 1999 were
$11,208,310, compared to $14,358,335 and $15,892,560 for the years ended
December 31, 1998 and 1997, respectively.
SG&A expenses during 1999 consisted primarily of personnel expense of
approximately $4,283,000; professional fees of approximately $969,000;
depreciation and amortization expense of approximately $1,695,000; rent expense
of approximately $903,000; provision for excess rental capacity of approximately
$449,000; writedown of deferred software development costs of approximately
$370,000; and, travel costs of approximately $270,000. SG&A expenses during 1998
consisted primarily of personnel costs of approximately $6,283,000; professional
fees of approximately $1,722,000; depreciation and amortization of approximately
$1,693,000; rent expense of approximately $915,000; advertising and marketing
costs of approximately $193,000; deferred compensation expense amortization of
approximately $599,000; and, travel costs of approximately $437,000. SG&A
expenses during 1997 consisted primarily of personnel costs of approximately
$7,207,000; professional fees of approximately $1,892,000; advertising and
marketing costs of approximately $1,488,000; deferred compensation expense
amortization of approximately $481,000; and, travel costs of approximately
$935,000.
The decrease in SG&A expense in 1999 compared to 1998 is due to a
substantial reduction in the Company's work force in the fourth quarter of 1998.
Other than certain increases associated with contract services, the provision
for excess rental capacity, and certain amounts the Company wrote off related to
capitalized software development costs, SG&A expenses were lower in all material
categories in 1999 compared with 1998. The decrease in SG&A expense in 1998, as
compared to 1997 is primarily attributable to a decrease in: (i.) employment
costs, primarily wage and recruiting costs associated with an overall reduction
in the Company's employee base; (ii.) advertising and marketing costs; (iii.)
professional fees consisting primarily of legal, accounting, recruiting and
relocation fees; and, (iv.) travel costs. The decrease in SG&A expenses was in
1998 compared to 1997 was partially offset by an increase in: (i.) depreciation
and amortization expense associated with an overall increase in the Company's
depreciable assets; (ii.) an increase in inventory valuation allowances
associated with potentially obsolete ALM shells due to planned design
improvements; and, (iii.) costs associated with benefits including severance
benefits for certain employees terminated during 1998.
Interest Income
Interest income of $375,514, $1,044,251, and $2,033,571 during 1999,
1998 and 1997, respectively, primarily reflects interest income attributable to
the short-term investment of the proceeds from the Company's initial public
offering in May 1996. Interest income also reflects the amortization of deferred
interest income attributable to ALM sales-type leases. The decrease in interest
income in 1999 compared to 1998 is attributable to a decrease in the average
cash and cash equivalents and investment balances in 1999 compared to 1998. The
decrease in interest income in 1999 and 1998 compared to the previous periods is
due to a lesser extent to a decrease in the amount of amortization of deferred
interest income associated with ALMs under sales-type lease agreements.
Similarly, the decrease in inte