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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Year Ended June 30, 1997
Commission File Number: 0-26802
CHECKFREE CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 31-1013521
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4411 EAST JONES BRIDGE ROAD
NORCROSS, GEORGIA 30092
(Address of principal executive offices,
including zip code)
(770) 441-3387
(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, $.01 par value
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 the
filing requirements for at least 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 $579,069,107 on September 12,
1997.
There were 54,686,159 shares of the Registrant's Common Stock outstanding
on September 12, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the 1997 Annual Meeting of
Stockholders are incorporated by reference in Part III.
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TABLE OF CONTENTS
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Page
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PART I
Item 1. Business 3
Item 2. Properties 26
Item 3. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 27
Item 6. Selected Financial Data 27
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations 29
Item 8. Financial Statements and Supplementary Data 37
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure 37
PART III
Item 10. Directors and Executive Officers of the Registrant 38
Item 11. Executive Compensation 38
Item 12. Security Ownership of Certain Beneficial Owners and Management 38
Item 13. Certain Relationships and Related Transactions 38
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 39
Signatures 44
Consolidated Financial Statements F-1
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PART I
ITEM 1. BUSINESS.
GENERAL
As used in this report, "CheckFree" is generally used to indicate
CheckFree Corporation prior to its acquisition of Servantis Systems Holdings,
Inc. on February 21, 1996 (the "Servantis Acquisition"), prior to its
acquisition of Security APL, Inc. on May 9, 1996 (the "Security APL
Acquisition"), and prior to its acquisition of Intuit Services Corporation on
January 27, 1997 (the "ISC Acquisition") (the Servantis Acquisition, the
Security APL Acquisition, and the ISC Acquisition are collectively referred to
as the "Acquisitions"). "Servantis" is generally used to indicate Servantis
Systems Holdings, Inc. prior to its acquisition by CheckFree, "Security APL" is
generally used to indicate Security APL, Inc. prior to its acquisition by
CheckFree, "ISC" is generally used to indicate Intuit Services Corporation prior
to its acquisition by CheckFree, and the term the "Company" is used to indicate
the combined company following the Acquisitions.
CheckFree Corporation (the "Company") is a leading provider of
electronic commerce services, institutional portfolio management services, and
financial application software for financial institutions and businesses and
their customers. The Company services approximately 1.8 million consumers, 1,000
businesses, and 850 financial institutions (including the 500 largest banks in
the United States). The Company has also signed agreements with over 276
financial institutions to provide electronic home banking services for the
customers of those financial institutions.
This report contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ materially from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those discussed in "Business
- -- Business Risks."
The business of the Company is pursued through three independent but
inter-related divisions: Electronic Commerce, Institutional Investment Services,
and Software. All three divisions market their services and products to
financial institutions, the investment industry, and to their customers, both
consumer and business. The Company's current business has been developed through
expansion of its core electronic commerce business and the acquisition of
companies operating businesses similar to, or complementary with, that business.
EVOLUTION OF CURRENT BUSINESS
The Company was incorporated in Ohio in 1981 and reincorporated in
Delaware in 1986. The Company has nine direct and indirect wholly owned
subsidiaries: Servantis Systems Holdings, Inc., a Delaware corporation;
Servantis Systems, Inc., a Georgia corporation; Servantis Services, Inc., a
Georgia corporation; CheckFree Software Solutions, Inc., a Delaware corporation;
Security APL, Inc., an Illinois corporation; Bow Tie Systems, Inc., an Illinois
corporation; CheckFree Services Corporation, a Delaware corporation; CheckFree
Investment Corporation, a Delaware corporation; and RCM Systems, Inc., a
Wisconsin corporation. The Company's principal executive offices are located at
4411 East Jones Bridge Road, Norcross, Georgia 30092 and its telephone number is
(770) 441-3387. The Company's Internet address is http://www.checkfree.com.
5B CAPABILITY
Prior to the Acquisitions, the Company operated its business in one
business segment, electronic bill payment. Through the Acquisitions the Company
obtained the customer relationships, technology, skilled personnel, and other
resources required to fulfill its strategy of diversifying its offerings in
electronic commerce to embrace each of the 5Bs: electronic bill payment, bill
presentment, banking, brokerage, and business payments ("5Bs"). These
acquisitions also helped to enable the Company to extend the application of its
expertise and relationships in electronic commerce to two related areas,
institutional investment services and software.
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THE SERVANTIS ACQUISITION
On February 21, 1996, CheckFree acquired Servantis for approximately
$165.1 million, consisting of the issuance of 5.7 million shares of the
Company's Common Stock valued at $20.00 per share and $42.5 million in cash to
repay Servantis' long-term debt. Founded in 1971, Servantis was a leading
provider of electronic commerce and financial applications software and services
for businesses and financial institutions. Servantis designed, marketed,
licensed, and supported software products for electronic corporate banking, home
banking, financial lending, regulatory compliance, and document imaging. In
addition, Servantis offered software consulting and remote processing services.
The Company accounted for the Servantis Acquisition using the purchase method of
accounting.
THE SECURITY APL ACQUISITION
On May 9, 1996, CheckFree acquired Security APL for approximately $53.3
million, consisting of the issuance of 2.8 million shares of the Company's
Common Stock valued at $18.50 per share. Security APL was a leading vendor of
portfolio management and software services for institutional investment
managers. Security APL had been developing and providing advanced investment
analysis systems since it was founded in 1978. Security APL's clients included
money management firms, bank trust departments, insurance companies, and
brokerage houses. Security APL had added an additional investment information
service by establishing a world-wide web site offering individuals some of the
same tools professional money managers employed to make investment decisions, to
enter trades, and to monitor the status of their investments. The Company
accounted for the Security APL Acquisition using the purchase method of
accounting.
THE ISC ACQUISITION
On January 27, 1997, CheckFree acquired ISC for approximately $199.0
million, consisting of the issuance of 12.6 million shares of the Company's
Common Stock and $20.0 million payable in two equal cash payments to the seller,
Intuit Inc. ("Intuit"). ISC was incorporated in Delaware on December 2, 1989,
under the name "National Payment Clearinghouse, Inc." ISC was acquired by Intuit
in July 1994 and later renamed Intuit Services Corporation. ISC's principal
business was to provide online electronic banking and bill payment processing
services (including Intuit's online banking and online bill payment services) to
approximately 40 financial institutions (including six of the ten largest
domestic banks and American Express), their customers, and a variety of
merchants. ISC also supported BankNow, an Intuit home banking service provided
through America Online, and banking, bill payment, and stock quote services
accessible through Microsoft Money. The Company accounted for the ISC
Acquisition using the purchase method of accounting.
INTEGRATION OF ACQUISITIONS
The Acquisitions further CheckFree's strategy of providing an expanding
range of convenient, secure, and cost-effective electronic commerce services and
related products to financial institutions and businesses and their customers.
Servantis' experience and relationships developed as a provider of electronic
commerce and financial applications software and services to financial
institutions substantially enhances the Company's presence in the financial
institutions market of the electronic commerce industry. Security APL's
experience as a vendor of portfolio management and software services to
institutional investment managers and consumers permits the Company to continue
to enhance these service offerings to institutional investment managers and for
consumers through the Company's financial institution distribution channels.
ISC's base of financial institution banking customers expanded the Company's
home banking and bill payment offering, and made the Company's services more
readily available to a wider base of financial institutions and their customers.
The integration of each of the Acquisitions with the original core business has
created a single vendor of electronic commerce services and related products to
an expanded customer base of financial institutions and businesses and their
customers.
POST-ACQUISITIONS STRATEGY
The Acquisitions support CheckFree's attainment of its overall goal of
providing an expanding range of convenient, secure, and cost-effective
electronic commerce services and related products to financial institutions,
businesses and their customers. The Company has designed its services and
products to take advantage of opportunities
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it perceives in light of current trends and the Company's fundamental strategy.
The components of the Company's strategy are to:
Offer an Expanding Range of Convenient, Easily Accessible, Secure and
Cost-Effective Services Through Multiple Delivery Channels. By integrating
CheckFree's ability to pay any bill from any checking account at any financial
institution in the United States with Servantis' capability as an electronic
commerce software provider and bank service organization, Security APL's
institutional investment services capabilities, and ISC's bill payment and home
banking capabilities, the Company intends to continue to enhance and expand its
range of financial institution and business electronic commerce services. These
services enable customers to execute electronic commerce transactions through
multiple delivery channels including personal computers, telephones, and the
Internet.
Offer Services to Consumers and Businesses Through Financial
Institutions. The Company believes that the public will most readily adopt
electronic methods for financial transactions when they are offered with the
imprimatur of a trusted financial institution. The Company, therefore, except
for prototype or legacy offerings, does not seek to serve consumers or
businesses except through financial institutions or investment houses. The
Company believes that this strategy enhances user confidence in the underlying
technology and encourages financial institutions to promote use of the Company's
services.
Expand Sales Efforts Through Multiple Distribution Channels. The
Company maximizes its distribution efforts through a direct sales force which
targets the largest financial institutions and other customers, and through
distribution alliances with market-leading companies to achieve deeper market
penetration. Additionally, by making its services available to users of personal
financial management software, such as Quicken, and of business management
software, such as QuickBooks, the Company expands public access to, and
awareness of, its services. Similarly, the Company offers web-based products to
both bank and non-bank financial institutions for their own and for their
customers' use.
Leverage Customers and Alliances Across Markets. The Company's efforts
in each target market are designed to increase its successor opportunities in
its other markets. The products and customer bases of the acquired companies
substantially increase the Company's offerings to financial institutions, which
the Company expects will enhance its opportunity to expand its electronic
commerce services through them to businesses and ultimately to the end users.
Expand Customer Care and Technical Support. The Company supports and
services its customers through numerous activities, including annual user group
meetings and customer satisfaction surveys, technical and non-technical support
(provided by help desk, e-mail, facsimile, and bulletin board), service
implementation, and training. The Company is enhancing its ability to provide
first and second-tier support of its services through advanced communications
technologies which enable the Company to efficiently respond to end-user
inquiries. The Company believes that providing superior quality and accessible
and reliable customer care is essential to establishing and maintaining
successful relationships with its customers.
ELECTRONIC COMMERCE
INTRODUCTION
Over the last decade, electronic execution of financial transactions
has increased substantially. Increased use of credit cards, automated teller
machines ("ATMs"), electronic funds transfer and direct payroll deposit have
automated, simplified and reduced the costs of financial transactions for
financial institutions and businesses and their customers. The Company believes
that increasing public awareness and acceptance of electronically-effected
transactions create an expanding market for its services. Electronic commerce
offers the potential to complete financial transactions more quickly, with
greater accuracy, and at a lower cost than traditional paper-based methods.
OPPORTUNITIES
The Company considers activities traditionally conducted on paper or in
person as offering it opportunities to sell its services. The Company believes
that the greater the volume of such activities, and the higher chance for error,
or the imposition of inconvenience, the greater will be the Company's
opportunity.
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Continued Use of Paper Checks. A substantial portion of financial
transactions in the U.S. are still executed by paper check. According to the
Bank for International Settlement, in 1995, approximately 77.4% of the total
U.S. dollar volume of payments was made using checks with a total dollar volume
over $73 trillion. According to the Federal Reserve Bank of Boston, the
printing, mailing, and delivery of more than 64 billion checks each year costs
the equivalent of approximately 0.5% of the U.S. Gross Domestic Product. Checks
impose significant costs on financial institutions and businesses and their
customers. Time costs include the writing, mailing, recording, and processing of
checks. Financial costs include postage, processing costs and costs associated
with the "float" created between the time checks are written and cleared.
Paper Billing. Many financial transactions are initiated by the
rendering of a paper bill or invoice which is delivered to the payer by U.S.
mail. It is estimated that 15 billion paper bills are produced each year, and
that the cost of submitting a printed bill, including printing, postage, and
advertisements, ranges between $0.65 and $1.25. Additional costs inherent in the
system include delays, opportunity for losses in the mail, misplaced bills,
printing errors, and accessibility limited to a single physical mail-drop.
Conventional Banking. Many financial transactions are currently
conducted in person at bank branches. For many bank customers, conducting
banking requires a physical visit to a branch in order to check balances,
transfer sums from one account to another, inquire on the status of an item, to
make deposits, or to obtain assistance in reconciling accounts. Banks incur
substantial expenses in providing personnel and physical plants to service these
requirements. Bank customers incur transportation costs and personal
inconvenience and delay by traveling to a branch location to complete these
transactions.
Conventional Brokerage. Traditional investment brokerage houses render
statements of account to customers on paper conveyed to their clients through
the U.S. mail. For active account-holders, or in rapidly-changing markets, by
the time the paper statement is received and reviewed, the information may be
seriously out-of-date. Tax lot accounting, and comparison to historical balances
is often unavailable through the paper statement. There are considerable costs
involved in preparing and mailing paper statements, and in providing personnel
at the brokerage to respond to inquiries regarding the status of accounts.
Business Payments. In addition to the costs and inconvenience borne by
consumers in receiving and paying paper bills, businesses often receive multiple
invoices from the same vendor comprising periodic statements. Issues such as
discounts for prompt payment, returns, allowances, disputed charges, and other
adjustments, as well as reconciliation to the business's own records, increase
the costs of payment. It is estimated that businesses issue 28 billion checks
annually.
TRENDS
Notwithstanding the current predominant usage of conventional methods
of conducting financial transactions, there are a number of current trends that
are driving increasing acceptance of electronic commerce in the U.S.:
- Increase in Electronic Financial Transactions. Over the last
decade, electronic execution of financial transactions has
increased substantially. Increased use of credit cards, ATMs,
electronic funds transfer, and direct payroll deposit have
automated, simplified, and reduced the costs of financial
transactions for consumers, businesses, and financial
institutions. In 1996, it is estimated that $8.3 billion worth
of electronic transactions were processed in the U.S. and a
Piper Jaffray study estimates that electronic transactions
will grow to $21.2 billion by 2001.
- Continuing Penetration of Personal Computers and Modems into
U.S. Households. According to Dataquest, more than a third of
U.S. households will have personal computers by the end of
1997, and virtually all home PCs are sold with internal
modems.
- Rapid Growth in On-line Interactive Services, Particularly in
the Internet. The number of Internet users, according to
International Data Corporation, was 34.6 million as of 1996,
and is projected to reach 163 million by 2000. By January
1997, 161.1 million Internet hosts were available to serve
them, according to Network Wizards. Booz, Allen & Hamilton
notes that while it took cable
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television 25 years to reach ten million households, and took
nine years for VCRs to reach the same penetration, the
Internet achieved that milestone in only four years. According
to Forrester, ten million U.S. households subscribed to
on-line interactive services as of 1997 and America On-line,
prior to its acquisition of CompuServe's customers, claimed
approximately 6.44 million of them.
- Growth in Small Business Use of Personal Computers. According
to a recent survey by McKinsey & Company/BAI, there are over
5.5 million small businesses in the United States. These small
businesses, which have less than $10 million in annual
revenues, represent over 95% of all the businesses in the
United States along with 40% of the United States gross
national product. The small business owner represents an
attractive market for electronic commerce since 85% of all
small businesses own one or more PCs, and 79% of those PCs are
equipped with modems. In addition, over 45% of those
businesses have Internet access today, and 1.6 million of
these small business use either Quicken or QuickBooks to do
their bookkeeping.
- Continuing Automation of Financial Institutions' Operations.
Financial institutions are facing increasing competition as a
result of banking deregulation and technological innovation.
The competition is not only from within the financial
institution industry, but also from new competitors in related
industries, such as insurance companies and mutual funds. The
Company believes that in an increasingly competitive
environment, financial institutions will seek opportunities to
automate their operations by providing electronic banking,
electronic bill payment and automated portfolio services to
their customers, and by investing in cost-saving software.
These services, the Company believes, will enable financial
institutions to reduce costs, generate fee-based income and
strengthen their customer relationships. In terms of
transaction costs, Booz, Allen & Hamilton cites the following
relative costs of banking transactions: Branch--$1.07;
Telephone--$0.54; ATM--$0.27; PC Banking--$0.02;
Internet--$0.01.
THE COMPANY'S RESPONSE
The Company believes there is a significant opportunity to expand the
market for electronic commerce among financial institutions, businesses, and
their customers. Paper transactions impose significant costs that can be reduced
through electronic execution. The continuing penetration of personal computers
and modems into U.S. households, along with the rapid growth in on-line
interactive services, are providing the technical infrastructure required to
accelerate the acceptance of electronic commerce. In addition, the Company
believes the key requirements that must be addressed to increase acceptance of
electronic commerce applications include: (i) maintenance of industry-wide
quality levels for security, accuracy, reliability and convenience; (ii)
reduction in transaction processing costs; (iii) application of easy-to-use
interfaces; and (iv) development of seamless integration with the existing
financial infrastructure and existing relationships among all parties to a
financial transaction. As a result, the Company believes that the opportunity
exists to provide an integrated set of electronic services that further automate
financial transactions for financial institutions and businesses and their
customers.
PRODUCTS, SERVICES, AND COMPETITION
ELECTRONIC COMMERCE SERVICES
The Company has adopted a "5B" response to the electronic commerce
market, comprising Bill Payment, Bill Presentment, Banking, Brokerage, and
Business Payment services. The Company's electronic commerce services and
related products are targeted to financial institutions, businesses, and their
customers. To ensure the security of all the electronic commerce transactions
that the Company processes, the Company utilizes a combination of measures,
including various proprietary security technologies and existing industry
security standards such as RSA encryption and multiple authorization and
authentication technologies. The Company is currently developing new electronic
commerce services and enhancing its existing services for each of its target
markets.
(1) Bill Payment. The Company's origins were in offering electronic
bill payment to consumers. In keeping with the Company's strategy of offering
electronic commerce alternatives through financial institutions, the Company
accommodates several alternative means for consumers to pay bills. The Company
designs and develops
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private label services for financial institutions, which in turn offer
electronic payment as one component of home banking services available to their
customers. Interfaces with personal financial management software, such as
Quicken, Managing Your Money and Microsoft Money are available to users of most
versions. Under the ISC Acquisition agreement, the Company is the exclusive
provider of bill payment and home banking services for all versions of Quicken
released through October 1997, including Quicken version eight. Since subsequent
releases will no longer support only the current proprietary protocol, the
Company will then compete for upgraded Quicken customers with other bill payment
and home banking service providers which, like the Company, can accommodate the
Open Financial Exchange protocol now being developed by the Company, Microsoft,
and Intuit.
The Company also offers, on a prototype basis, bill payment services in
conjunction with bill presentment through the Internet to consumers whose
financial institutions are not yet able to offer such services. The Company does
not intend to develop or market business or personal financial management
software, or PFMs, but instead to position itself as the provider of the bill
payment services required to effectuate the transactions initiated through a
wide variety of means. The Company believes that its services offer significant
benefits to financial institutions, including lower transaction processing
costs, additional fee income, potential new customers, and attractive additional
services to offer existing customers. By providing access to its services
through widely-sold PFMs, through proprietary financial institution software,
and through the Internet, the Company intends to encourage the greatest use of
its services.
Revenues are generated through contracts that the Company signs with
individual financial institutions. The Company typically negotiates with the
institution an implementation fee, a monthly base fee per customer account on
the service provided by the Company, plus a variable per transaction fee which
decreases based on the volume of transactions. Contracts typically have
three-to-five year terms and generally provide for minimum fees if certain
transaction volumes are not met. The Company utilizes direct sales and
distribution alliances to market to financial institutions and has the ability
to customize services for each institution.
The Company has contracts with more than 276 financial institutions
through which electronic payment services are provided to customers of the
financial institutions. Some of the financial institutions served by the Company
include: Bank of America, Bank One, Chase Manhattan, KeyCorp, NationsBank, Wells
Fargo, Charles Schwab, and Merrill Lynch.
The Company's bill payment services enable financial institution
customers and direct consumer subscribers to pay bills electronically using a
variety of devices such as personal computers and touch-tone telephones. Bills
paid by consumers using the Company's bill payment services typically include
payments such as credit card statements, monthly mortgage payments, and utility
bills, but a cornerstone of the Company's offering is that it can facilitate
payment to anyone. Consumers can use the Company to make any payments from any
checking account at any financial institution in the United States. Recurring
bills such as mortgages can be paid automatically and scheduled in advance for
an indefinite period of time, as specified by the user. As of July 5, 1997, the
Company had approximately 1.8 million consumers using bill payment and/or home
banking services.
(2) Bill Presentment. In March 1997, the Company announced the market
release of its electronic bill presentment and payment product, CheckFree
E-Bill. Offered originally as a world-wide web based service, it permits billing
companies to deliver full-color electronic bills to their customers personal
computers, together with detailed information and the electronic equivalent of
promotional inserts. The recipients can use the service to electronically make
payment. Pursuant to its strategy of offering services through financial
institutions, the Company is marketing the service to banks to be incorporated
into their electronic banking and bill payment services. As of September 15,
1997, the Company had entered into agreements with sixteen billing companies to
provide bill presentment services. The Company enters into a variety of
arrangements with banks and billing companies to provide such services and, in
some cases, will share revenue derived from billing companies with banks. The
Company believes that billing companies can achieve net savings in the range of
30% to 60% by utilizing the Company's bill presentment service.
(3) Banking. The Company supports home electronic banking services for
financial institutions and their customers. Using a variety of PFMs, institution
proprietary software, and other front ends, customers can access their accounts
through personal computers, the Internet, or telephone-based voice recognition
unit (VRU) systems, to effect a wide variety of banking transactions. Among
these are balance inquiries, fund transfers, customer service, customer billing,
and marketing. The service facilitates on-line reconciliation to PC-based
account registers, matching cleared
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items with previously-entered transactions. Revenues are generated through
contracts that the Company signs with individual financial institutions. The
Company typically negotiates with the institution an implementation fee, a base
monthly fee per customer account on the service provided by the Company, plus a
variable per transaction fee which decreases based on the volume of
transactions. Contracts typically have three-to-five-year terms and generally
provide for minimum fees if certain transaction volumes are not met. The Company
utilizes direct sales and distribution alliances to market to financial
institutions and has the ability to customize services for each institution.
The Company believes that banks that offer electronic banking increase
customer retention, have a superior marketing channel, and experience fewer
time-consuming customer service problems.
(4) Brokerage. The Company provides customized solutions for financial
service providers either for internal use, or to support offerings to their
customers. The Company's services provide fully integrated, on-line trading,
portfolio accounting, quotes, news services, research, and fundamental data. The
Company believes the service offers significant benefits to financial
institutions, including lower costs, additional fee income, potential new
customers, and attractive additional services to offer to existing customers.
A web-based product enables financial institutions to add to their own
web sites services which include a cost basis tax lot accounting tool that
allows financial institution customers to keep track of the investments they
own, and provides the customers with enough information to make informed
decisions about generating gains or losses from their portfolios when required.
It also provides a seamless connection to electronic brokerage via various order
entry screens. The system also allows for integration of third party information
(e.g,. research reports, financial news, fundamental data, etc.). These products
and services permit banks to offer many of the services required for them to
compete effectively with non-bank financial institutions.
(5) Business Payments. The Company facilitates electronic payments for
businesses through its offerings of business bill payment and banking, ACH
processing, and automatic accounts receivable processing services. As it does
for consumers, the Company enables businesses to make payments to anyone. The
Company's Electronic Cash Disbursement (ECD) system accommodates the special
requirements of businesses which can obtain the service through their financial
institution. The Company employs a direct sales force to market the ECD service
to banks, and, under an agreement with ADP, provides the service to their
customers. The Company's ACH processing offering affords financial institutions
the opportunity to outsource their ACH processing which has traditionally been
handled in-house. The Company's service provides a more cost efficient solution
to financial institutions and allows the institutions to focus on their higher
profitability core competencies. The Company provides automatic accounts
receivable collections for businesses in the on-line interactive services,
Internet access, health and fitness and various other industries, enabling these
businesses to collect monthly membership or access fees through links to the
customer's credit card or bank account. Services are typically provided under
exclusive contracts for three years with automatic renewals. For providing
collection services, businesses pay the Company implementation fees, transaction
fees and credit card discount fees.
The Company sold all of the assets and contracts related to the
automatic accounts receivable collection business, except for health and fitness
and certain other industries, to First USA, Inc. on March 26, 1997. The sale
allows the Company to concentrate on the development and sale of electronic bill
payment and on-line banking capabilities for businesses.
Competition. Portions of the electronic commerce market are becoming
increasingly competitive. The Company faces significant competition in all of
its customer markets. A number of banks have developed, and others may in the
future develop, home banking services in-house. A number of relatively small
companies, such as Travelers Express (a division of Viad), compete with the
Company in electronic bill payment. In the business market, the Company competes
with ACH processors. The Federal Reserve's ACH is the national payment clearance
system through which any bank can effect debit transactions to any authorized
consumer checking account. The Company also faces competition in ACH processing
from numerous banks. Microsoft Corporation and First Data Corporation have
announced the formation of a joint venture, MSFDC which they intend to compete
aggressively with the Company in the area of bill payment and bill presentment.
MSFDC has announced its intention to have a market-ready offering by early 1998.
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In the brokerage segment, the Company's primary competitor is Shaw
Data, and the Company competes for business bill payment customers with ACI and
Deluxe Data, which provide ACH processing.
Because the electronic commerce industry is expected to grow
substantially in the coming years, the Company anticipates strong competition,
but it believes that the increased attention and credibility such competition
will bring to the industry may broaden the market and increase the percentage of
financial transactions which are effected by electronic means.
INVESTMENT SERVICES
Generally. The Company offers portfolio accounting and performance
measurement to investment advisors, brokerage firms, banks, and insurance
companies. Clients are able to leverage their systems and streamline their
operations. The Company designs custom solutions with clients, allowing
investment managers the kind of functionality that dramatically increases
productivity. The full-range of portfolio management system solutions, include
data conversion, personnel training, trading system, graphical client reporting,
performance measurement, technical network support, interface setup, and DTC
processing.
Competition. Competition for portfolio services includes two main
segments. The Company competes with providers of portfolio accounting software,
including Advent Software, PORTIA (a division of Thomson Financial), and Shaw
Data (a SunGard Company). The Company also competes with service bureau
providers such as Shaw Data and FMC Service Bureau.
SOFTWARE
Generally. The Company is a leading provider of electronic commerce and
financial applications software and services for businesses and financial
institutions. The Company designs, markets, licenses, and supports software
products for electronic corporate banking, financial lending, regulatory
compliance, and document imaging. In addition, the Company offers software
consulting and remote processing services.
The Company's financial application software revenues are derived
primarily from the sale of software licenses and software maintenance fees. The
Company's software is sold under perpetual licenses, and maintenance fees are
received through renewable agreements. The Company also derives revenues from
project consulting services and from remote transaction processing fees.
Software products licensed by the Company provide systems that range
from back office operations to front-end interface with the clients of the
Company's customers. Applications include electronic funds transfer, electronic
wholesale banking, reconciliation, mortgage loan automation, imaging
technologies, item processing, regulatory compliance, and others.
The Company's software products are sold under individual brand names.
Its most significant products include:
BRAND NAME FUNCTION CUSTOMERS
---------- -------- ---------
PEP+ Automated Clearing House processing Businesses and financial institutions
LSAMS Mortgage loan servicing Mortgage lenders
TMO Mortgage originations Mortgage lenders
ACCESS/INFOVUE Corporate remote banking software Businesses and financial institutions
RECON-PLUS Corporate account reconciliation Businesses and financial institutions
ARP/SMS Financial account reconciliation Financial institutions
Electronic Funds Transfer. The ACH network was developed in the 1970s
to permit the electronic transfer of funds and thus curtail the growth in the
number of paper checks in circulation. The ACH network acts as the clearing
facility for routing electronic funds transfer entries between financial
institutions. All ACH transfers are handled in a standard format established
through the National Automated Clearing House Association ("NACHA"). More than
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15,000 financial institutions participate in the ACH system. There are 31 ACH's,
which geographically coincide with the 12 Federal Reserve Banks, their branches
and processing centers. The Company's electronic funds transfer products are
inter-related and may be used by either businesses or financial institutions
depending on the services they offer their customers and employees.
The Company developed the most widely used, comprehensive ACH
processing system in the United States, the Paperless Entry Processing System
Plus ("PEP+"). PEP+ is an on-line, real-time system providing an operational
interface for originating and receiving electronic payments through the ACH. The
Company continues to support the Paperless Entry Processing System ("PEP"),
which was the predecessor to PEP+.
Other products of the Company, the InfoVue ACH and MicroACH Systems,
allow financial institutions to provide their corporate customers more direct
access to the ACH network. The Company licenses this software to financial
institutions who then distribute it to their corporate customers. The financial
institution's corporate customer's component automatically initiates and
electronically sends ACH transactions, allowing such customer greater
flexibility in cash flow management and funds transfer. The bank's component
collects transactions from InfoVue ACH or MicroACH and then uploads these
transactions to a host ACH system, such as PEP+. Both operate on a PC platform
and together have approximately 100 bank users.
The Company also offers Financial Electronic Data Interchange ("FEDI")
in response to the growing need for banks and corporations to be able to handle
electronic data interchange ("EDI") data for financial transactions. The purpose
of FEDI is to allow corporations and banks already using EDI translators to
electronically process business documents and make payment transfers
electronically. The FEDI system can run as a stand-alone product as well as in
conjunction with the Company's PEP+ systems.
The Company entered the wire transfer business in 1990 with WireNet, a
PC/LAN-based wire transfer system. The Company now offers WireNext, a wire
transfer system built to take advantage of client-server architecture.
Electronic Wholesale Banking. The Company's wholesale banking software
systems electronically link banks and their corporate customers, permitting
banks to reduce transaction costs. The centerpieces of this product line are the
Company's ACCESS and InfoVue products, which provide an electronic link and
graphical user interface through which a bank's corporate customers can receive
bank account information and can initiate banking transactions. ACCESS operates
on the bank's premises while InfoVue is a Microsoft Windows-based system located
at the offices of the bank's corporate customers and is used by its customers to
interface with the ACCESS system. Banks can also use the systems as a global
gateway linking their branches and providing international cash management
services to their customers worldwide. Through the Company's electronic banking
systems, corporate customers can obtain previous and intraday account
information; initiate stop payments, account transfers and wire transfers;
create payroll and tax payments; receive lockbox, controlled disbursements, and
statement reports; and communicate with the bank via E-mail messages.
Reconciliation. The Company's reconciliation products provide U.S.
banks, international banks and corporate treasury operations with automated
check and non-check reconciliations in high volume, multi-location environments.
These systems are often tailored so that banks and multi-bank holding companies
may deliver reconciliation services meeting the specific needs of corporate
customers. Those reconciliation products are also designed for non-banking
corporations that perform account reconciliation in-house as well as companies
with many branch locations. Some of the services the Company's reconciliation
products provide are automated deposit verification, consolidated bank account
reconciliations and cash mobilization, immediate and accurate funds availability
data, and improved cash control.
In 1995, the Company introduced RECON-Plus for Windows a client/server
based "horizontal" reconciliation system. RECON-Plus for Windows is most
frequently used for internal reconciliation by large businesses, financial
service firms, and utilities, including the reconciliation of debit and credit
card transactions, checks, ATM transactions, ACH transfers, and securities
transactions.
The Company's Account Reconciliation Package ("ARP"), is one of the
most widely used account reconciliation systems in the U.S. banking industry.
The ARP/Service Management System ("ARP/SMS"), developed
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in 1995 to replace and augment the existing ARP package, is a fully integrated
on-line and real time system that enables banks to immediately processes their
customer transactions to produce accurate, timely reconciliations while
streamlining back-office processes. ARP/SMS also groups accounts across banks
within bank holding companies and allows banks to streamline their operations by
reconciling their intra-bank transactions.
Mortgage Loan Automation. The Company offers a number of products for
originators and servicers of mortgage loans, as well as products designed to
help secondary-market investors manage mortgage loan portfolios. In 1987, the
Company entered the mortgage industry as a software and services provider with a
loan origination product acquired from Software Concepts, Inc. The Company built
upon those products through the acquisition of a group of mortgage origination
and mortgage portfolio management products from Fannie Mae Software Systems, a
division of the Federal National Mortgage Corporation, in 1989. Subsequent
acquisitions of Traeger and Associates, and MLN Enterprises, as well as the
mortgage software division of Dyatron, Inc., have continued to provide
additional products for the Company in this area.
The Company's primary product for mortgage loan originators is The
Mortgage Originator, which provides mortgage lenders and originators
pre-qualification information, access to the most recent product pricing,
immediate interest rate lock-ins, imaging capabilities, laser printing, and
comprehensive reporting at every phase of the loan origination process. The
Mortgage Originator runs on mainframe, mid-range, and PC platforms.
The Company offers mortgage originators and lenders FORUM to manage
portfolios of originated loans for secondary market sales. This
client/server-based system is designed to either stand alone or to complement
The Mortgage Originator, and helps manage mortgage loan pipelines and
commitments to buy and sell loans.
The Company also offers a range of products designed for efficient
servicing of mortgage loans. The Loan Servicing, Accounting and Management
System ("LSAMS") offers loan setups and file maintenance, complete payment
processing capabilities, escrow disbursement and management features,
delinquency management, escrow analysis, and customer service for mid-range and
mainframe platforms. The Problem Loan Series, a series of four software systems
designed to run on PCs, is designed to automate all functions and
responsibilities associated with bankruptcy and foreclosure proceedings. The
Problem Loan Series interfaces with the other servicing products offered by the
Company as well as other industry products.
In addition, the Company offers mortgage lenders The Construction
Lender, a project management software application which provides complete loan
portfolio control and offers capabilities particular to construction loans that
standard loan systems do not offer. The Construction Lender runs on a PC
platform. The system was recently enhanced to provide project inspectors with
the capability of reporting their inspections through a portable hand-held unit.
The inspection information is then electronically transmitted into the base
system, allowing the lender faster turnaround and greatly reducing the chance of
error.
Other. The Company also offers software products and services in the
following areas: document management, lease accounting, check processing, safe
box accounting, and compliance with certain IRS regulations.
Licenses. The Company generally grants non-exclusive, non-transferable
perpetual licenses to use its application software at a single site. The
Company's standard license agreements contain provisions designed to prevent
disclosure and unauthorized use of its software. License fees vary according to
a number of factors, including the services to be provided by the Company.
Multiple site licenses are available for an additional fee. In its license
agreements, the Company generally warrants that its products will function in
accordance with the specifications set forth in its product documentation. A
significant portion of the license fee payable under the Company's standard
license agreement is payable upon the delivery of the product documentation and
software to the customer, with the balance of the license fee due upon
installation. The standard license fee for most products covers the installation
of the Company's software and maintenance for the first three to twelve months.
Installation, Maintenance, and Support. Maintenance includes certain
enhancements to the software. Customers who obtain maintenance generally retain
maintenance service from year to year. To complement customer support, the
Company and many of its customers frequently participate in user groups. These
groups exchange ideas
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and techniques for using the Company's products and provide a forum for
customers to make suggestions for product acquisition, development, and
enhancement.
Competition. The computer application software industry is highly
competitive. In the financial applications software market, the Company competes
directly or indirectly with a number of firms, including large diversified
computer software service companies and independent suppliers of software
products. Management believes there is at least one direct competitor for most
of its software products. Nonetheless, no competitor of the Company competes
with it in all software product areas.
The Company's product lines also face competition from competitors
which include TSAI, Fiserv, FiTech, EDS, Alltel Financial Information Services,
Inc. ("Alltel"), Computer Power, Inc. ("CPI"), Associated Software Consultants,
Inc. ("ASC"), and Gallagher Financial Systems, Inc. ("GFS") in products offered
to the mortgage services industry; the Company's Imaging/COLD product lines
compete with the products of several companies, including IBM, IIC, and
Computron, and its RECON-Plus product competes with Chesapeake and Driscoll.
Competitors for mortgage- related products include CPI (an Alltel Company).
Management believes that the major factors affecting customer
decisions in its market, in addition to price, are product availability,
flexibility, the comprehensiveness of offered products, and the availability and
quality of product maintenance, customer support and training. The Company's
ability to compete successfully also requires that it continue to develop and
maintain software products and respond to regulatory change and technological
advances. Management believes that it currently competes favorably in the
marketplace with respect to these criteria. See "Business -- Risk Factors
(Intense Competition)."
DISTRIBUTION ALLIANCES
A principal element of the Company's strategy is the creation and
maintenance of distribution alliances that maximize access to potential
customers for the Company's electronic commerce services and related products.
The Company believes that these partnerships enable the Company to offer its
services and related products to a larger customer base than can be reached
through stand-alone marketing efforts. The Company seeks distribution alliance
partners which have maximum penetration and leading reputations for quality with
the Company's target customers. To date, the Company has entered into or is
negotiating distribution alliances with several companies, including Automatic
Data Processing, Inc. ("ADP"), AT&T Corporation ("AT&T"), Alltel, EDS, Fiserv,
Inc. ("Fiserv"), FiTech, Inc. ("FiTech"), Five Paces, Inc. ("Five Paces"), and
Home Financial Network. The Company also has arrangements with Optika in
connection with its imaging offerings, and with MicroBank for RECON-Plus for
Windows.
RESEARCH AND DEVELOPMENT
The Company maintains a research and development group with a
long-term perspective of planning and developing new services and related
products for the electronic commerce, financial application software, and
investment services markets. The Company has established the following
guidelines for pursuing the development of new services:
- Distinctive benefits to customers
- Ability to establish a leadership position in the market
served
- Sustainable technological advantages
- First to market
The Company believes that in the emerging electronic commerce market
it will be critical to rapidly develop, test and offer new services and
enhancements. To that end, the Company's goal for the time period from
conceptualization to commercial availability of new services is less than one
year. As of June 30, 1997, the research and development group consisted of
approximately 375 employees. Additionally, the Company uses independent third
party software development contractors as needed. During fiscal 1994, 1995,
transition fiscal 1996, and fiscal 1997,
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the Company spent 12.3%, 14.2%, 19.9%, and 18.6% of revenues, respectively, on
research and development. The Company anticipates that it will continue to
commit substantial resources to research and development activities for the
foreseeable future.
TECHNOLOGY
The Company's historical approach to technology has been to utilize a
combination of hardware, networks, proprietary software and databases to solve
customer needs and to meet the varying requirements of the electronic commerce
market.
Electronic Commerce. The Company's original core technology
capabilities were developed to handle settlement services, merchant database
services, and on-line inquiry services on a traditional mainframe system with
direct bi-synchronous communications to businesses. As business
telecommunication requirements increased, the Company utilized links to an X.25
Value-Added Network.
Today, the Company has implemented a logical, nationwide client-server
system. Consumer, business, and financial institution customers all act as
clients communicating across dial-up telephone lines, private leased lines, a
private X.25 network, a frame relay network, or the Internet to the Company's
computing complex. Within this complex, there is a wide variety of application
servers seamlessly connected via TCP/IP across switched Ethernet. The Company
currently is able to support virtually any communication method required in a
secure manner.
Proprietary applications have been developed for the client-server
system on a variety of platforms with each platform selected and optimized for
specific electronic commerce needs. Applications to effect settlement services,
merchant database services, financial institution database services, and
heuristic risk management services have been implemented on an IBM mainframe,
optimized for high volume batch processing. Applications to confirm payment
instructions, enhance data integrity and security, and reduce fraud have been
implemented on Digital Equipment Alpha servers, optimized for high volume,
device independent, real-time data communication across a private X.25 network.
To handle financial transactions across the Internet, applications have been
implemented on Sun Microsystems servers designed for premium data security and
integrity. Applications to effect electronic bill presentment have been
implemented on Hewlett-Packard Unix servers, designed for efficient real-time
processing and data integrity and applications to effect real-time connections
to banks, ATM networks, and credit card networks have been implemented on a
Tandem Himalaya server. Other special purpose application servers are deployed
to handle unique electronic commerce requirements such as electronic payments
direct to merchant institutions, VRUs to telephone customers, and electronic
mail with customers and real-time connections to ATM networks.
The Company has implemented appropriate backup and recovery procedures
to ensure against any loss of data on any platform. Archival storage is kept on
site as well as off site in fireproof facilities. To maximize availability, the
Company has redundant computer systems to ensure that financial transaction
requests can always be honored. Diesel generators provide power to the computing
facilities in the event of a power disruption.
The Company's operations are dependent on its ability to protect its
computer equipment against damage from fire, earthquake, power loss,
telecommunications failure or similar event. Although the Company has contracted
for the emergency provision of an alternate site to aid in disaster recovery,
this measure will not eliminate the significant risk to the Company's operations
from a natural disaster or system failure. Any damage or failure that causes
interruptions in the Company's operations could have a material adverse effect
on the Company's business, operating results and financial condition. The
Company's property and business interruption insurance may not be adequate to
compensate the Company for all losses that may occur. See "Business -- Business
Risks (Risk of System Failure)."
With the growth anticipated for electronic commerce, the Company's
architecture has been designed to address incremental capacity requirements as
needed. The entire infrastructure and set of product technologies allow the
Company to efficiently service and support its three customer markets. Although
the Company's principal business is to provide electronic commerce services
rather than sell or license software products, the consumer financial software
products offered by the Company to access such services could contain errors or
"bugs" that could adversely affect the performance of the service or damage a
user's data. In addition, as the Company increases its share of the electronic
commerce services market, software reliability and security demands will
increase. The Company attempts to limit
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its potential liability for warranty claims through disclaimers in its software
documentation and limitation of liability provisions in its shrinkwrap license
and customer agreements. There can be no assurance that the measures taken by
the Company will prove effective in limiting the Company's exposure to warranty
claims. Additionally, despite the existence of various security precautions, the
Company's computer infrastructure may be also vulnerable to viruses or similar
disruptive problems caused by its customers or third parties gaining access to
the Company's processing system. See "Business -- Business Risks (Risk of
Product Defects)."
The Company has developed proprietary databases within the
client-server system, including a financial institution file that allows
accurate editing and origination of ACH and paper transactions to financial
institutions. The Company has also developed a merchant information file
consisting of over one million companies that allows accurate editing and
initiation of payments to merchants. These databases have been constructed over
the past 15 years as a result of the Company's transaction processing
experience.
Platform Integration: The Genesis Project. The Company intends to
integrate the existing data processing sites and platforms currently being
operated at Columbus, Ohio, Aurora, Illinois, and Austin, Texas, into a central
processing site at the Company's headquarters in Norcross, Georgia, and has
designated this integration the Genesis Project. The integration requires the
acquisition of, and investment in, extensive hardware and in operating and
system software, as well as extensive communications links and systems. The
Genesis Project requires substantial engineering and development of proprietary
software. Redundancy, anomaly monitoring, and off-site backup and recovery
systems are planned as a part of the project. Communications, in addition to the
technology described above, will be aided by the installation of a SONET network
provided through BellSouth.
Significant numbers of high-level employees have and will be hired to
facilitate the accomplishment of the project, and to manage the integrated site.
Management intends to operate the existing sites without substantial disruption
until the central site is completed and tested, and only then will a staged
migration be effected. The integrated site is scheduled to begin accepting
operations processing by September 1998, and the expected cost expended during
the fiscal year ending June 30, 1998 is approximately $15 million. As of
September 15, 1997, the project had met its interim deadlines and targets and
management expects the project to be completed on time and within budget.
Nonetheless, because of the magnitude of the project, and an aggressive
schedule, no assurance can be given that the project will be completed on time
or successfully. See "Business -- Business Risks (Rapid Technological Change;
Risk of Delays)."
Financial Application Software. Financial application suite of
software products offers a wide range of software addressing both end user
access and back room operational systems located in the customer data centers.
Every effort is taken to insure that each system is targeted for the appropriate
platform to optimize the characteristics of available technology with the
business requirements of each application and its market. This strategy utilizes
large IBM mainframes as the platform for high volume batch oriented systems,
IBM's RS/6000 UNIX Servers and Hewlett-Packard UNIX Servers for high volume OLTP
systems, Microsoft Windows NT for medium volume OLTP systems and Windows for
client connectivity.
Investment Services. Investment Services employs advanced technology
for its portfolio management services and utilizes IBM RS/6000's to process the
portfolio management software. Services are provided primarily as a service
bureau offering with the data center residing at the Company's Chicago office.
This data center functions seven days a week, twenty-four hours a day. Clients
can obtain access across a private TCP/IP Wide Area Network (WAN) either via
dedicated circuit or via dial-up methodologies. The Chicago data center is the
communication center for more than 70 dedicated links together with four
concentration hub sites located in New Jersey, New York, Boston, and San Diego.
Each of these hub sites support the concentration of local dedicated links plus
dial-up access. In addition to the dedicated private network, clients use frame
relay services from LDDS, MFS, MCI, and AT&T to access services. These services
are also available through AT&T Frame Relay national network with local numbers
in major cities across the U.S.
The system has been exclusively UNIX since 1991 and consists of 26 IBM
RS/6000 running AIX. In addition, there are another 11 IBM RS/6000 machines in
various client sites. The Company's investment advisory clients receive hardcopy
reporting for either internal usage or for quarterly reports. Hardcopy, either
ASCII or graphical PostScript, is produced on four Xerox DocuPrints 90 page per
minute duplexed laser printers.
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SALES, MARKETING, AND DISTRIBUTION
The Company's sales, marketing, and distribution efforts are designed
to maximize access to potential customers. The Company markets its services both
directly and indirectly through a direct sales and technical sales support force
of over 100 employees and, to achieve deeper market penetration, through select
distribution alliances with companies who are involved in the Company's target
customer markets. In addition to its direct sales force, the Company has an
extensive marketing department.
In the electronic commerce segment, the Company offers its services
and related products to the nations largest financial institutions directly
through its sales force, and markets to smaller institutions through its
strategic alliances with companies such as EDS, Fiserv, FiTech, Alltel, and Gold
Leaf. The Company offers its services and related products to the business
market directly through its sales force, through an arrangement with ADP, and
through the integration of the Company's services and related products into
major commercial accounting software programs. The Company currently offers
substantially all of its services and related products only to the domestic
marketplace.
Additionally, the Company's distribution of its home banking and
electronic consumer and business bill payment services is widened though
inclusion or access through front ends, such as Quicken, QuickBooks, Managing
Your Money, and Microsoft Money.
The Company markets its financial application software products
through its direct sales force and indirect sales through Alltel banking
services. Salespersons have specific product responsibility and receive support
from technical personnel as needed. The Company generates new customers through
direct solicitations, user groups, responses to advertisements, direct mail
campaigns and strategic alliances. The Company also participates in trade shows
and sponsors industry technology seminars for prospective customers. Existing
customers are often candidates for sales of additional products or for
enhancements to products they have already purchased.
The Company markets its investment services through its direct sales
force. The Company generates new customers through direct solicitation user
groups and responses to advertisements. The Company also participates in trade
shows and sponsors industry seminars for distribution alliances.
CUSTOMER CARE AND TECHNICAL SUPPORT
The provision of high quality customer care, technical support and
operations is an integral component of the Company's strategy in each of its
customer markets. To meet the needs of the Company's customers most efficiently,
the customer care staff is organized into vertical teams that support each
customer market. However, these teams share common resources, training and
orientation to ensure cost efficiency and consistency of quality standards and
measures. From an accessibility standpoint, all customer care teams provide
service by phone, e-mail, and facsimile. The Company has provided, through
advanced communications technology, a virtual call center enabling incoming
calls to be transparently routed to various physical support sites as volume
demands dictate. An important driver of profit margins for the Company is the
percentage of transactions completed through electronic means. Experience has
shown that the demand on customer care resources reduces substantially as the
percentage of electronic remittances grows. The Company has long been a leader
in electronic remittance, and its merchant systems group continually establishes
and maintains electronic links directly to the internal systems of payees.
The level and types of services provided vary by customer market. The
customer care group, consisting of more than 350 employees, supports payment
inquiry, customer service and technical support and interfaces with the merchant
systems group to improve posting efficiencies. Representatives in the business
customer care group are individually assigned to business customers in order to
provide high level customer service and technical support. The retail services
customer care group provides various levels of support that depend upon the
individual institution's requirements. This includes providing direct customer
care on a private label basis as well as research and support.
To maintain its customer care standards, the Company employs extensive
internal monitoring systems and conducts ongoing customer surveys. The feedback
from these sources is used to identify areas of strength and opportunities for
improvement in customer care and to aid in adjusting resources to a level
commensurate with efficient response.
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GOVERNMENT REGULATION
Management believes that the Company is not required to be licensed by
the Office of the Comptroller of the Currency, the Federal Reserve Board, or
other federal or state agencies that regulate or monitor banks or other types of
providers of electronic commerce services. The Company, however, is periodically
audited by the Office of the Comptroller of the Currency since it is a supplier
of products and services to financial institutions. There can be no assurance
that a federal or state agency will not attempt to regulate providers of
electronic commerce services such as the Company which could impede the
Company's ability to do business in the regulator's jurisdiction. A number of
states have legislation regulating or licensing check sellers or money
transmitters, and the Company has, from time to time, received demands that it
register under such legislation, but as of September 15, 1997, the Company has
not been required to obtain a license or to submit to jurisdiction. Management
does not believe that any state or federal legislation of this type currently
affects the Company. In addition, through its processing agreements, the Company
agrees to comply with the data, recordkeeping, processing, and other
requirements of applicable federal and state laws and regulations, Federal
Reserve Bank operating letters, and the National Automated Clearing House
Association Operating Rules imposed on the Company's processing banks. The
Company may be subject to audit or examination under any of these requirements.
Violations by the Company of these requirements could limit or further restrict
the Company's access to the payment clearance systems or the Company's ability
to obtain access to such systems from banks. Further, the Federal Reserve rules
provide that the Company can only access the Federal Reserve's ACH through a
bank. If the Federal Reserve rules were to change to further restrict access to
the ACH or limit the Company's ability to provide ACH transaction processing
services, the Company's business could be materially adversely affected. See
"Business -- Business Risks" and "-- Payment Clearance Systems."
In conducting various aspects of its business, the Company is subject
to laws and regulations relating to commercial transactions generally, such as
the Uniform Commercial Code, and is also subject to the electronic funds
transfer rules embodied in Regulation E, promulgated by the Federal Reserve
Board. The Federal Reserve's Regulation E implements the Electronic Fund
Transfer Act, which was enacted in 1978. Regulation E protects consumers
engaging in electronic transfers, and sets forth basic rights, liabilities, and
responsibilities of consumers who use electronic money transfer services and of
financial institutions that offer these services. For the Company, Regulation E
sets forth disclosure and investigative procedures. For consumers, Regulation E
establishes procedures and time periods for reporting unauthorized use of
electronic money transfer services and limitations on the consumer's liability
if the notification procedures are followed within prescribed periods. Such
limitations on the consumer's liability may result in liability to the Company.
Given the expansion of the electronic commerce market, it is possible
that the Federal Reserve might revise Regulation E or adopt new rules for
electronic funds transfer affecting users other than consumers. Because of
growth in the electronic commerce market, Congress has held hearings on whether
to regulate providers of services and transactions in the electronic commerce
market, and it is possible that Congress or individual states could enact laws
regulating the electronic commerce market. If enacted, such laws, rules, and
regulations could be imposed on the Company's business and industry and could
have a material adverse effect on the Company's business, operating results and
financial condition. See "Business -- Business Risks (Government Regulation)."
PAYMENT CLEARANCE SYSTEMS
Payment Systems. Across the Company's various electronic commerce
service offerings, the Company utilizes the Federal Reserve's ACH for electronic
funds transfers, and the conventional paper check clearing systems for
settlement of payments by check or draft. Like other users of these payment
clearance systems, the Company accesses these systems through contractual
arrangements with processing banks. For access to conventional paper check
clearing systems, the Company does not need a special contractual relationship,
except for its contractual relationships with its processing bank and its
customers. Such users are subject to applicable federal and state laws and
regulations, Federal Reserve Bank operating letters, and the National Automated
Clearing House Association Operating Rules. There are certain risks typically
faced by companies utilizing each of these payment clearance systems, and the
Company has its own set of operating procedures and proprietary risk management
systems and practices to mitigate credit-related risks. See "Business --
Business Risks (Risk of Loss from Returned Transactions, Merchant Fraud or
Erroneous Transmissions)," " -- Business Risks (ACH Access)," and " -- Business
Risks (Government Regulation)."
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ACH. The ACH is used by banks, corporations and governmental entities
for electronic settlement of transactions, direct deposits of payroll and
government benefits, and payment of bills such as mortgages, utility payments,
and loans. The Company uses the ACH to execute certain of its customers' payment
instructions. Like other users of the ACH, the Company bears credit risk
resulting from returned transactions caused by insufficient funds, stop payment
orders, closed accounts, frozen accounts, unauthorized use, disputes, theft or
fraud.
Paper Drafts. The Company uses conventional check clearance methods
for paper drafts to execute certain of its customers' payment instructions using
its bank and its customers' banks. The Company bears no credit risk with paper
drafts written on a customer's checking account returned for insufficient funds,
stop payment orders, closed accounts or frozen accounts. Nonetheless, the
Company may bear other risks for theft or fraud associated with paper drafts due
to unauthorized use of the Company's services. When a customer instructs the
Company to pay a bill, the Company has the ability to process the payment either
by electronic funds transfer or by paper draft, drawn on the customer's checking
account, on which the customer's pre-authorized signature is laser imprinted.
The Company manages the risk it assumes by adjusting the mix of electronic and
paper draft transactions in individual cases and overall. Regardless whether the
Company uses paper drafts or electronic funds transfers, the Company retains all
risks associated with transmission errors when it is unable to have erroneously
transmitted funds returned by an unintended recipient.
Other Clearance Systems. While the Company presently primarily
utilizes the two principal payment clearance systems, the Company intends to use
other clearance systems such as ATM networks to provide balance inquiry and fund
transfers functions, and such other clearance systems that may develop in the
future.
Risk Mitigation. The Company's patented bill payment processing system
determines the preferred method of payment to balance processing costs,
operational efficiencies, and risk of loss. The Company manages its risks
associated with its use of the various payment clearance systems through its
risk management systems, internal controls, and system security. The Company
also maintains a reserve for such risks, which reserve was $1,224,028 as of June
30, 1997, and the Company has not incurred losses in excess of 0.76% of its
revenues in any of the past five years. As further protection against losses due
to transmission errors, the Company maintains errors and omissions insurance.
See "Business -- Risk Factors (Risk of Loss from Returned Transactions, Merchant
Fraud or Erroneous Transactions)."
PROPRIETARY RIGHTS
The Company owns the following federally registered trademarks and
service marks: ACCESS BANKING(R), ALAS(R), BFCS(R), BANK STREET(R),
CHECKFREE(R), CHECKFREE and Design(R), CHECKFREE (Stylized Letters)(R),
CHECKFREE EASY(R), CHECKFREE EXTRA(R), CHECKFREE MANAGER(R), DISC CHECKBOOK
PLUS(R), CHECKFREE WALLET(R), CLAS(R), CLRS(R), CLUB HOOCH(R), CPIM(R), CSS(R),
CSSII(R), DASH(R), DECISION MANAGER(R), DISC and Design(R), DISC CHECKBOOK
PLUS(R), DISC WORLD$NET(R), ECP(R), EPOCH(R), FMS(R), FASTOCK PC(R), INTEGRATED
DECISION MGR.(R), LSAMS(R), LANPATH(R), LEASTRAC2000(R), MAX(R), MICROACH(R),
MOBILEPAY(R), NETWORK BANKER(R), ORBS(R), PAWWS(R), PAWTRACKS(R), PEP+(R), PEP
PAPERLESS ENTRY PROCESSING(R), PTT(R), PODIUM(R), QUICKKILL(R), RS/REACT(R),
SBA(R), SERVANTIS SYSTEMS(R), SERVANTIS SYSTEMS(R), SERVANTIS SYSTEMS(R),
SUPRRB(R), TCM THE CONTROL MACHINE(R), TMS-THE MORTGAGE SERVICER(R), TRS(R),
TST(R), VAULT(R), WIRENET(R), and WORLD$NET(R). Additionally, the Company has
applied to federally register the following service marks: CHARITY NET(SM),
CHECKFREE BILL(SM), CHECKFREE CONNECT(SM), CHECKFREE E-BILL(SM), CHECKFREE
ELECTRIC MONEY(SM), CHECKFREE FREES YOU FROM CHECKS(SM), ECX(SM), RCM 2001...THE
NEXT GENERATION(SM), and THE WAY MONEY MOVES and Design(SM), CAPS CORPORATE
AUTOMATED PAYMENTS SYSTEM(TM), OMNI(TM), SSI(TM), SSI LOGO and Design(TM), THE
SECONDARY MARKETER(TM), and WIRENEXT(TM). The Company is awaiting further
information to file applications for the following marks: ALLIANCE, APECS, APECS
PLUS, ARP, ARP - PC, ARP/QMS, ARP/SMS, BPS, BANKVUE, CHECKBOOK PLUS, CPCS, EASY
ACCESS TO TOTAL ELECTRONIC BANKING, SERVANTIS IRS, IRS/SRS, LCR, CHECKFREE
RECON-PLUS FOR WINDOWS, RECON-PLUS, RPS, RPS-PC, RPS/400, RRS, RS/REACT,
SERVANTIS, SERVANTIS with Design, SERVANTIS SYSTEMS, INC., SERVANTIS FORUM,
SERVANTIS QUIK, SIG FILER, SMS, and SERVANTIS WORLD$NET.
The Company regards its financial transaction services and related
products such as its software as proprietary and relies on a combination of
patent, copyright, trademark and trade secret laws, employee and third party
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nondisclosure agreements, and other intellectual property protection methods to
protect its services and related products. Although the Company believes its
consumer financial software to be proprietary, it does not depend on its
software to compete, but rather on its services to which the software provides
access.
The Company also copyrights certain of its programs and software
documentation and trademarks certain product names. Management believes that
these actions provide appropriate legal protection for the Company's
intellectual property rights in its software products. Furthermore, management
believes that the competitive position for some of the Company's products
depends primarily on the technical competence and creative ability of its
personnel and that its business is not materially dependent on copyright
protection or trademarks. See "Business -- Business Risks (Limited Protection of
Proprietary Technology; Risk of Third Party Infringement Claims)."
The Company's United States Letters Patent No. 5,383,113, issued on
January 17, 1995, relates to its system and method for electronically providing
services including payment of bills and financial analysis. Incorporating the
system described in the patent, the Company can pay any bill from any checking
account at any financial institution in the United States on the consumer's
behalf by selecting a preferred means of payment from various options described
above. See "Business -- Payment Clearance Systems." The Company's patent expires
on January 17, 2012. See "Business -- Competition," "-- Business Risks (Intense
Competition)," and "-- Business Risks (Limited Protection of Proprietary
Technology; Risk of Third Party Infringement Claims)."
Existing intellectual property laws afford only limited protection,
and it may be possible for unauthorized third parties to copy the Company's
services and related products or to reverse engineer or obtain and use
information that the Company regards as proprietary. There can be no assurance
that the Company's competitors will not independently develop services and
related products that are substantially equivalent or superior to those of the
Company. As the technology used by the Company evolves, however, its dependence
upon the patented technology continues to decrease.
EMPLOYEES
As of June 30, 1997, the Company employed 1,444 full-time employees,
including 373 in systems and development (including software development), 351
in customer care, and 128 in administration, financial control, corporate
services, and human resources. The Company is not a party to any collective
bargaining agreement and is not aware of any efforts to unionize its employees.
The Company believes its relations with its employees are good. The Company
believes its future success and growth will depend in large measure upon its
ability to attract and retain qualified technical, management, marketing,
business development, and sales personnel.
BUSINESS RISKS
The Company desires to take advantage of the "safe harbor" provisions
of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Many
of the following important factors discussed below have been discussed in the
Company's prior filings with the Securities and Exchange Commission. In addition
to the other information in this report, readers should carefully consider that
the following important factors, among others, 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 for the fiscal year ended
June 30, 1997, and beyond, to differ materially from those expressed in any
forward-looking statements made by, or on behalf of, the Company.
Emerging Electronic Commerce Market; Security and Privacy Concerns.
The electronic commerce market is a relatively new and growing service industry.
If the electronic commerce market fails to grow or grows more slowly than
anticipated, or if the Company, despite an investment of significant resources,
is unable to adapt to meet changing customer requirements or technological
changes in this emerging market or if the Company's services and related
products do not maintain a proportionate degree of acceptance in this growing
market, the Company's business, operating results, and financial condition could
be materially adversely affected. Additionally, the security and privacy
concerns of existing and potential customers may inhibit the growth of the
electronic commerce market in general and the Company's customer base and
revenues in particular. Similar to the emergence of the credit card and ATM
industries, the Company and other organizations serving the electronic commerce
market must educate users that electronic transactions use encryption technology
and other electronic security measures that make electronic transactions more
secure than paper-based transactions. While the Company believes that it is
utilizing proven
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applications designed for premium data security and integrity to process
electronic transactions, there can be no assurance that the Company's use of
such applications will be sufficient to address the changing market conditions
or the security and privacy concerns of existing and potential customers.
Adverse publicity raising concerns about the safety or privacy of electronic
transactions, or widely reported breaches of the Company's or another providers
security have the potential to undermine consumer confidence in the technology
and thereby have a materially adverse effect on the Company's business. See
"Business -- General" and "-- Services and Related Products."
Additionally, the Company's growth and acceptance in the electronic
commerce market is dependent on its continued growth in its target markets. See
"Business -- Services and Related Products." Although demand for the Company's
services and related products continues to grow, there can be no assurance that
the Company will be successful in each of its target markets. Accordingly, the
Company's inability to grow in any one of these markets could have a material
adverse effect on the Company's business, operating results, and financial
condition.
Because the Company's strategy is focused on relationships with
financial institutions, mergers, acquisitions, and personnel changes within key
financial institutions have the potential to adversely affect the Company's
business. Moreover, an important source of growth in demand for the Company's
services is generated by financial institutions marketing to their customer
base. Were these financial institutions to abandon or to curtail their marketing
efforts, a material adverse effect on the Company's business, operating results,
and financial condition would likely result.
Integration of Servantis, Security APL, and ISC. On February 21, 1996,
the Company acquired Servantis for approximately $165.1 million, consisting of
the issuance of 5.7 million shares of the Company's Common Stock valued at
$20.00 per share (approximately 16% of the Company's total shares outstanding
following the Servantis Acquisition) and $42.5 million in cash to repay
Servantis' long-term debt. In addition, on May 9, 1996, the Company acquired
Security APL for approximately $53.3 million, consisting of the issuance of 2.8
million shares of the Company's Common Stock valued at $18.50 per share
(approximately 7% of the Company's total shares outstanding following the
Security APL Acquisition). Finally, on January 27, 1997, the Company acquired
ISC for approximately $199.0 million, consisting of the issuance of 12.6 million
shares of the Company's Common Stock and $20.0 million payable in cash to
Intuit. In addition, in fiscal 1997, the Company wrote-off $140.0 million of the
purchase price for ISC as in process research and development, which had a
material adverse impact on the Company's results in 1997.
Intense Competition. Portions of the electronic commerce market are
becoming increasingly competitive. The Company faces significant competition in
all of its customer markets. A number of banks have developed, and others in the
future may develop, home banking services in-house. Additionally, Microsoft has
individually, and as part of a joint venture with First Data, announced its own
alliances with financial institutions to offer on-line home banking and
financial services as well as bill presentment and bill payment services to
consumers. In the business market, the Company competes with other ACH
processors. The Federal Reserve's ACH is the national payment clearance system
through which any bank can effect debit or credit transactions to any authorized
consumer checking account. The Company also faces competition in ACH processing
from numerous banks. The financial application software segment also faces
significant competition.
The Company's product lines also face competition from competitors
which include TSAI, Fiserv, FiTech, EDS, Alltel, Computer Power, Inc. ("CPI"),
Associated Software Consultants, Inc. ("ASC"), and Gallagher Financial Systems,
Inc. ("GFS") in products offered to the mortgage services industry; the
Company's Imaging/COLD product lines compete with the products of several
companies, including IBM, IIC, and Computron, and its RECON-Plus product
competes with Chesapeake and Driscoll. Competitors for mortgage-related products
include CPI (an Alltell Company). Competition for portfolio services includes
two main segments. The Company competes with providers of portfolio accounting
software, including Advent Software, PORTIA (a division of Thomson Financial),
and Shaw Data (a SunGard Company) . The Company also competes with service
bureau providers such as Shaw Data and FMC Service Bureau. In the brokerage
segment the Company's primary competitor is Shaw Data, and the Company competes
for business bill payment customers with ACI and Deluxe Data, which provide ACH
processing.
The Company expects competition to increase from both established and
emerging companies and that such increased competition will result in price
reductions and may result in a reduction of the Company's market share, either
or both of which could materially adversely affect the Company's business,
operating results, and financial condition. Moreover, the Company's current and
potential competitors, many of whom have significantly greater financial,
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technical, marketing, and other resources than the Company, may respond more
quickly than the Company to new or emerging technologies or could expand to
compete directly against the Company in any or all of its target markets.
Accordingly, it is possible that current or potential competitors could rapidly
acquire significant market share. There can be no assurance that the Company
will be able to compete against current or future competitors successfully or
that competitive pressures faced by the Company will not have a material adverse
effect on its business, operating results, and financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business -- General," and "-- Products, Services, and
Competition."
Today, the Company is the leading provider of electronic payment
services to users of personal finance software. The Company believes that as
consumer-based on-line interactive and telecommunications services continue to
grow, and as financial institutions offer their own proprietary or licensed
front-ends, retail-marketed personal financial software will become a less
important channel for the Company in acquiring new customers.
Management of Growth. The Company is currently experiencing a period
of rapid growth which has placed, and could continue to place, a significant
strain on its resources. The Company's ability to manage growth successfully
will require the Company to continue to improve its operational, management and
financial systems and controls as well as to expand its work force. A
significant increase in the Company's customer base would necessitate the hiring
of a significant number of additional customer care and technical support
personnel as well as computer software developers and technicians, qualified
candidates for which, at the present time, are in short supply. In addition, the
expansion and adaptation of the Company's computer and administrative
infrastructure will require substantial operational, management, and financial
resources. Although the Company believes that its current infrastructure is
adequate to meet the needs of its customers in the foreseeable future, there can
be no assurance that the Company will be able to expand and adapt its
infrastructure to meet additional demand on a timely basis, at a commercially
reasonable cost, or at all. If the Company's management is unable to manage
growth effectively, hire needed personnel, expand and adapt its computer
infrastructure or improve its operational, management, and financial systems and
controls, the Company's business, operating results, and financial condition
could be materially adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Acquisition-Related Risks. In the future, the Company may pursue
additional acquisitions of complementary service or product lines, technologies,
or businesses. Future acquisitions by the Company could result in potentially
dilutive issuances of equity securities, the incurrence of debt and contingent
liabilities, and amortization expenses related to goodwill and other intangible
assets, any of which could materially adversely affect the Company's business,
operating results, and financial condition. In addition, acquisitions involve
numerous risks, including difficulties in the assimilation of the operations,
technologies, services, and products of the acquired companies, the diversion of
management's attention from other business concerns, risks of entering markets
in which the Company has no or limited direct prior experience, and the
potential loss of key employees of the acquired company. From time to time, the
Company evaluates potential acquisitions of businesses, services, products, or
technologies. The Company has no present commitments or agreements with respect
to any material acquisition of other businesses, services, products, or
technologies. In the event that such an acquisition were to occur, however,
there can be no assurance that the Company's business, operating results, and
financial condition would not be materially adversely affected.
Potential Fluctuations in Quarterly Results; Seasonality. The
Company's quarterly results of operations may fluctuate significantly as a
result of a number of factors, including changes in the Company's pricing
policies or those of its competitors, relative rates of acquisition of new
customers, delays in the introduction of new or enhanced services, software, and
related products by the Company or by its competitors or market acceptance of
such services and products, other changes in operating expenses, personnel
changes, and general economic conditions. In addition, the Company's growth in
new consumer customers is impacted by certain seasonal factors such as
holiday-based personal computer sales. These seasonal factors may impact
operating results by concentrating customer acquisition and set-up costs, which
may not be immediately offset by revenue increases primarily due to introductory
service price discounts. Additionally, on-line interactive service customers
generally tend to be more active users during the non-summer seasons,
potentially causing revenue fluctuations during the summer months. Software
sales have historically displayed seasonal variation, with sales and earnings
generally stronger in the quarters ended December 31 and June 30 of each year
and generally weaker in the quarters ended September 30 and March 31 of each
year. The seasonality is due, in part, to calendar year-end buying patterns of
financial institution customers and software sales compensation structure, which
is based on fiscal year (June 30) sales performance. Moreover, the Company's
intention to aggressively promote
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the acceptance of its electronic commerce services and rapidly expand its
customer base may adversely impact the Company's short-term profitability. These
factors will impact the Company's operating results. Fluctuations in operating
results could result in volatility in the price of the Company's Common Stock.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Risk of Product Defects. The software products offered by the Company
could contain errors or "bugs" that could adversely affect the performance of
the Company's software or services or damage a user's data. In addition, as the
Company increases its share of the electronic commerce services market, software
reliability and security demands will increase. Additionally, the Company
attempts to limit its potential liability for warranty claims through
disclaimers in its software documentation and limitation-of-liability provisions
in its license and customer agreements. There can be no assurance that the
measures taken by the Company will prove effective in limiting the Company's
exposure to warranty claims. Additionally, despite the existence of various
security precautions, the Company's computer infrastructure may be also
vulnerable to viruses or similar disruptive problems caused by its customers or
third parties gaining access to the Company's processing system. See "Business
- -- Technology."
Erosion of Maintenance Base; License Revenue. The profitability of the
Software segment of the Company's business depends, to a substantial degree,
upon users of products electing to continue to periodically renew contracts for
maintenance. In the event that a substantial number of these customers were to
decline to renew these contracts, because use of the software product has been
abandoned, or for any other reason, the Company's revenues and profits would be
adversely affected. Sales of software licenses are dependent upon customer
demand for the product, which is affected by pricing decisions, the competition
of similar products, and reputation of the products for performance. Most of the
Company's software products are sold within the financial services industry, and
poor performance by one product has the potential to undermine the Company's
reputation and affect future sales of other products. A substantial decrease in
software license revenue would have a material adverse effect upon the Company's
business, operating results, and financial condition.
Proportion of Electronic Remittances. The Company's future financial
performance will be materially affected by the percentage of bill payments which
can be cleared electronically. As compared with making payment by paper check or
by draft, electronic payments: (i) cost much less to complete; (ii) give rise to
far fewer errors, which are costly to resolve; (iii) generate far fewer customer
inquiries and therefore consume far fewer customer care resources. Accordingly,
the Company's inability to continue to decrease the percentage of remittances
effected by paper documents will result in flat or decreased margins, and a
reversal of the current trend toward a smaller proportion of paper-based
payments would have a material adverse effect upon the Company's business,
operating results, and financial condition.
Rapid Technological Change; Risk of Delays. The Company's success is
highly dependent on its ability to develop new and enhanced software, services,
and related products that meet changing customer requirements. The market for
the Company's software, services, and related products is characterized by
rapidly changing technology, evolving industry standards, emerging competition
and frequent new and enhanced software, service and related product
introductions. In addition, the software market is subject to rapid and
substantial technological change. The Company, to remain successful, must be
responsive to new developments in hardware and semiconductor technology,
operating systems, programming technology, and computer capabilities. In many
instances, the new and enhanced services, products, and technologies are in the
emerging stages of development and marketing, and are subject to the risks
inherent in the development and marketing of new software, services, and
products. There can be no assurance that the Company can successfully identify
new service opportunities and develop and bring new and enhanced software,
services, and related products to market in a timely manner, that such software,
services, products or technologies will develop or will be commercially
successful, that the Company will benefit from such developments or that
services, products, or technologies developed by others will not render the
Company's software, services, and related products noncompetitive or obsolete.
If the Company is unable, for technological or other reasons, to develop and
introduce new services and products in a timely manner in response to changing
market conditions or customer requirements, or if new or enhanced software,
services, and related products do not achieve a significant degree of market
acceptance, the Company's business, operating results, and financial condition
would be materially adversely affected.
The Company's program to integrate its various processing sites and
platforms into a central site carries with it the risk of delays and performance
failures that have the potential to substantially interfere with the Company's
ability to provide acceptable service levels to its customers. Although
management believes that it has taken all reasonable
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steps to plan and monitor this integration, there can be no assurance that its
efforts will be successful or timely, and a failure to provide adequate service
levels could result in a material adverse effect upon the Company's business,
operating results, and financial condition. See "Business -- General," "--
Products, Services, and Competition," and "-- Research and Development."
Risk of Loss From Returned Transactions, Merchant Fraud or Erroneous
Transmissions. The Company utilizes the Federal Reserve's ACH for electronic
fund transfers and conventional paper check and draft clearing systems for
settlement of payments by check or drafts. In its use of these established
payment clearance systems, the Company generally bears the same credit risks
normally assumed by other users of these systems arising from returned
transactions caused by insufficient funds, stop payment orders, closed accounts,
frozen accounts, unauthorized use, disputes, theft, or fraud. In addition, the
Company also assumes the risk of merchant fraud and transmission errors when it
is unable to have erroneously transmitted funds returned by an unintended
recipient. Merchant fraud includes such actions as inputting false sales
transactions or false credits. The Company manages all of these risks through
its risk management systems, internal controls, and system security. The Company
also maintains a reserve for such credit risks and has not historically incurred
losses in excess of its reserve nor greater than 0.76% of its revenues in any of
the past five years. Past reserving experience cannot predict the adequacy of
reserves in the future. The Company believes that its risk management and
reserving practices are adequate. Nonetheless, there can be no assurance that
the Company's risk management practices or reserves will be sufficient to
protect the Company from returned transactions, merchant fraud, or erroneous
transmissions which could have a material adverse effect on the Company's
business, operating results, and financial condition. See "Business -- Payment
Clearance Systems."
Risk of System Failure. The Company's operations are dependent on its
ability to protect its computer equipment against damage from fire, earthquake,
power loss, telecommunications failure or similar event. All of the Company's
computer equipment, including its processing operations, is located at its
facilities in Columbus, Ohio, Norcross, Georgia, Chicago, Illinois, Aurora,
Illinois, Downers' Grove, Illinois, and Austin, Texas. A disproportionate amount
of the Company's computer equipment, including its primary processing
operations, is located in Columbus, Ohio. Although the Company is planing to
move most of its computer processing equipment to its headquarters site in
Norcross, Georgia, this measure will not eliminate the significant risk to the
Company's operations from a natural disaster or system failure. As a
precautionary measure, the Company has entered into disaster recovery agreements
for the processing systems at all sites, and conducts business resumption tests
on a scheduled basis. Any damage or failure that causes interruptions in the
Company's operations could have a material adverse effect on the Company's
business, operating results, and financial condition. The Company's property and
business interruption insurance may not be adequate to compensate the Company
for all losses that may occur. See "Business -- Technology."
Limited Protection of Proprietary Technology; Risk of Third Party
Infringement Claims. The Company regards its financial transaction services and
related products such as its software as proprietary and relies primarily on a
combination of patent, copyright, trademark and trade secret laws, employee and
third party nondisclosure agreements, and other intellectual property protection
methods to protect its services and related products.
The Company has been granted a patent for certain features of its
electronic bill payment processing system. See "Business -- Proprietary Rights."
While the Company believes that the ownership of the patent is a significant
factor in its business, its success does not depend on the ownership of the
patent or future patents, but on the innovative skills, technical competence,
quality of service and marketing abilities of its personnel. The Company
believes its patent provides some measure of security against competition, and
the Company intends to enforce its patent against infringement by third parties.
If the Company's patent is found to be invalid, to the extent it has or would in
the future serve as a barrier to entry in this marketplace, there may be
increased competition in the market. See "Business -- Competition" and "--
Business Risks (Intense Competition)."
Existing intellectual property laws afford only limited protection,
and it may be possible for unauthorized third parties to copy the Company's
services and related products or to reverse engineer or obtain and use
information that the Company regards as proprietary. There can be no assurance
that the Company's competitors will not independently develop services and
related products that are substantially equivalent or superior to those of the
Company.
Dependence on Key Personnel. The Company's success depends to a
significant degree upon the continued contributions of its key management,
marketing, service and related product development and operational personnel,
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including its Chairman, President, and Chief Executive Officer, Peter J. Kight,
its Chief Operating Officer, Peter F. Sinisgalli, its Vice Chairman for
Corporate Development and Marketing, Mark A. Johnson, and its Chief Technology
Officer, Ravi Ganesan. The Company's operations could be affected adversely if,
for any reason, any of these officers ceased to be active in the Company's
management. The Company maintains proprietary nondisclosure and noncompete
agreements with all of its key employees. The Company maintains key person life
insurance policies on Mr. Kight. The success of the Company depends to a large
extent upon its ability to retain and continue to attract highly skilled
personnel. Competition for employees in the electronic commerce industry is
intense, and there can be no assurance that the Company will be able to attract
and retain enough qualified employees. If the business of the Company grows, it
may become increasingly difficult to hire, train and assimilate the new
employees needed. The Company's inability to retain and attract key employees
could have a material adverse effect on the Company's business, operating
results, and financial condition. See "Business -- Employees."
ACH Access. The Federal Reserve rules provide that the Company can
only access the Federal Reserve's ACH through a bank. If the Federal Reserve
rules were to change to further restrict access to the ACH or limit the
Company's ability to provide ACH transaction processing services, the Company's
business could be materially adversely affected.
See "Business -- Government Regulation" and "-- Payment Clearance Systems."
Limited Prior Market; Volatility of Stock Price. Prior to September
28, 1995, there was no public market for the Company's Common Stock. Although
the Company is listed on the Nasdaq National Market, there can be no assurance
that an active or liquid trading market in the Company's Common Stock will
continue. The market price of the Company's Common Stock is subject to
significant fluctuations in response to variations in quarterly operating
results, the failure of the Company to achieve operating results consistent with
securities analysts' projections of the Company's performance, and other
factors. The stock market has experienced extreme price and volume fluctuations
and volatility that has particularly affected the market prices of many
technology, emerging growth, and developmental stage companies. Such
fluctuations and volatility have often been unrelated or disproportionate to the
operating performance of such companies. Factors such as announcements of the
introduction of new or enhanced services or related products by the Company or
its competitors, announcements of joint development efforts or corporate
partnerships in the electronic commerce market, market conditions in the
technology, banking, telecommunications and other emerging growth sectors, and
rumors relating to the Company or its competitors may have a significant impact
on the market price of the Company's Common Stock.
Control by Principal Stockholders. At September 12, 1997, the
directors, executive officers, and principal stockholders of the Company and
their affiliates collectively owned approximately 44.9% of the outstanding the
Company's Common Stock. As a result, these stockholders will be able to exercise
significant influence over matters requiring stockholder approval, including the
election of directors and approval of significant corporate transactions. Such
concentration of ownership may have the effect of delaying or preventing a
change in control of the Company.
Shares Eligible for Future Sale; Possible Adverse Effect on Market
Price. At September 12, 1997, the Company had 54,689,156 shares of the Company's
Common Stock outstanding. Of these shares, 30,679,158 shares are held by
nonaffiliates of the Company. The holders of the remaining 24,010,001 shares are
entitled to resell them only pursuant to a registration statement under the
Securities Act or an applicable exemption from registration thereunder such as
an exemption provided by Rule 144, Rule 145, or Rule 701 under the Securities
Act of 1933, as amended (the "Securities Act"). Additionally, as of June 30,
1997, the Company had outstanding options to purchase 4,441,461 shares of the
Company's Common Stock at a weighted average exercise price of $9.59, of which
options for 1,218,341 shares of the Company's Common Stock were exercisable as
of June 30, 1997 at a weighted average exercise price of $1.17.
The Company issued 5,692,734, 2,805,652, and 12,600,000 shares of the
Company's Common Stock in connection with the Servantis Acquisition, the
Security APL Acquisition, and ISC Acquisition, respectively. A portion of these
shares have been sold by the respective stockholders and the remainder are
available for resale subject to Rule 144 and Rule 145 under the Securities Act
or certain registration rights agreements.
Sales of substantial amounts of these shares in the public market or
the prospect of such sales could adversely affect the market price of the
Company's Common Stock.
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Anti-Takeover Provisions; Certain Provisions of Delaware Law;
Certificate of Incorporation, By-Laws, and Stockholder Rights Plan. Certain
provisions of Delaware law the Company's Certificate of Incorporation, By-Laws,
and Stockholder Rights Plan 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. The Company's Certificate of Incorporation
provides for the Board of Directors to be divided into three classes of
directors serving staggered three-year terms. Such classification of the Board
of Directors expands the time required to change the composition of a majority
of directors and may tend to discourage a proxy contest or other takeover bid
for the Company. Certain provisions of Delaware law, the Company's Certificate
of Incorporation, and the Stockholder Rights Plan allow the Company to issue
preferred stock with rights senior to those of the Company's Common Stock
without any further vote or action by the stockholders. The issuance of the
Company's Preferred Stock under the Stockholder Rights Plan could decrease the
amount of earnings and assets available for distribution to the holders of the
Company's Common Stock or could adversely affect the rights and powers,
including voting rights, of the holders of the Company's Common Stock. In
certain circumstances, such issuance could have the effect of decreasing the
market price of the Company's Common Stock. See Note 14 to Notes to the
Consolidated Financial Statements.
Government Regulation. Management believes that the Company is not
required to be licensed by the Office of the Comptroller of the Currency, the
Federal Reserve Board, or other federal or state agencies that regulate or
monitor banks or other types of providers of electronic commerce services. There
can be no assurance that a federal or state agency will not attempt to regulate
providers of electronic commerce services such as the Company which could impede
the Company's ability to do business in the regulator's jurisdiction. In
addition, through its processing agreements, the Company agrees to comply with
the data, recordkeeping, processing and other requirements of applicable federal
and state laws and regulations, Federal Reserve Bank operating letters, and the
National Automated Clearing House Association Operating Rules imposed on the
Company's processing banks. In conducting various aspects of its business, the
Company is subject to various laws and regulations relating to commercial
transactions generally, such as the Uniform Commercial Code, and is also subject
to the electronic funds transfer rules embodied in Regulation E, promulgated by
the Federal Reserve Board. Given the expansion of the electronic commerce
market, it is possible that the Federal Reserve might revise Regulation E or
adopt new rules for electronic funds transfer affecting users other than
consumers. Because of growth in the electronic commerce market, Congress has
held hearings on whether to regulate providers of services and transactions in
the electronic commerce market, and it is possible that Congress or individual
states could enact laws regulating the electronic commerce market. If enacted,
such laws, rules and regulations could be imposed on the Company's business and
industry and could have a material adverse effect on the Company's business,
operating results, and financial condition. See "Business -- Government
Regulation."
Future Capital Needs; Uncertainty of Additional Financing. The Company
currently anticipates that its available cash resources and funds from
operations will be sufficient to meet its presently anticipated working capital
and capital expenditure requirements both for the short-term and through at
least December 31, 1998. The Company has a $20 million line of credit available
for unanticipated needs. However, the Company may need to raise additional funds
through public or private debt or equity financings in order to take advantage
of unanticipated opportunities, including more rapid expansion or acquisitions
of complementary businesses or technologies, or to develop new or enhanced
services and related products, or otherwise respond to unanticipated competitive
pressures. If additional funds are raised through the issuance of equity
securities, the percentage ownership of the then current stockholders of the
Company may be reduced and such equity securities may have rights, preferences
or privileges senior to those of the holders of the Company's Common Stock.
There can be no assurance that additional financing will be available on terms
favorable to the Company, or at all. If adequate funds are not available or are
not available on acceptable terms, the Company may not be able to take advantage
of unanticipated opportunities, develop new or enhanced services and related
products or otherwise respond to unanticipated competitive pressures and the
Company's business, operating results, and financial condition could be
materially adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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ITEM 2. PROPERTIES.
The Company leases office facilities in Norcross, Georgia, Columbus,
Ohio, Aurora, Illinois, Downers' Grove, Illinois, Owings Mills, Maryland,
Austin, Texas, Jersey City, New Jersey, Chicago, Illinois, San Diego,
California, Boston, Massachusetts, Houston, Texas, and Ashburn, Virginia with
square footage of approximately 229,000, 107,000, 51,000, 14,000, 30,000,
32,000, 17,100, 10,000, 3,000, 2,000, 1,000, and 3,000, respectively. The
Company owns approximately eight acres of real property adjacent to the
Company's facility in Columbus, Ohio. The Company owns a 51,000 square foot
conference center in Norcross, Georgia which includes lodging, training, and
fitness facilities for the Company's customers and employees. Although the
Company owns the building, it is on land which is leased through June 30, 2021.
The Company believes that its facilities are adequate for current and near-term
growth and that additional space is available to provide for anticipated growth.
The Company leases its Columbus, Ohio facility from the Director of
Development, State of Ohio, pursuant to the terms of a capitalized lease entered
into as part of the issuance by the State of Ohio of State Economic Development
Revenue Bonds (the "Bonds") in the aggregate principal amount of $7.5 million.
Pursuant to the terms of the lease, the Company pays monthly lease payments
equal to the amount of the debt service on the Bonds. Upon full payment of the
amount due on the Bonds, the Company has a right to purchase the real property
from the Director of Development, State of Ohio, for the sum of one dollar.
Under the terms of the lease, the Company has the right to prepay all amounts
owed thereunder without significant prepayment penalty. See "Item 13. Certain
Relationships and Related Transactions."
ITEM 3. LEGAL PROCEEDINGS.
There are no material legal proceedings pending against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's Common Stock is traded in the over-the-counter market on
the Nasdaq National Market under the symbol "CKFR." The following table sets
forth, for the periods indicated, the high and low sales prices for the
Company's Common Stock, as reported on the Nasdaq National Market. Information
with respect to the Company commences on September 28, 1995, when the Company's
Common Stock was first offered to the public.
CALENDAR PERIOD COMPANY COMMON STOCK
- ---------------------------------------------- ----------------------------
Fiscal 1995: HIGH LOW
Third Quarter (September 28 to September 30) $22.875 $19.75
Fourth Quarter $29.375 $16.00
Transitional Fiscal 1996:
First Quarter $26.375 $16.50
Second Quarter $23.50 $16.875
Fiscal 1997:
First Quarter $22.125 $10.75
Second Quarter $25.00 $14.125
Third Quarter $17.375 $11.125
Fourth Quarter $19.625 $ 9.50
Fiscal 1998:
First Quarter (through September 12, 1997) $20.375 $16.50
The number of record holders of the Company's Common Stock, as of
September 12, 1997, was 530. The closing sales price of the common stock on
September 12, 1997, was $18.875.
The Company has paid no cash dividends since 1986. The Company
presently anticipates that all of its future earnings will be retained for the
development of its business and does not anticipate paying cash dividends on the
Company's Common Stock in the foreseeable future. The payment of any future
dividends will be at the discretion of the Company's Board of Directors and will
be based on the Company's future earnings, financial condition, capital
requirements and other relevant factors. Presently, the Company's line of credit
restricts the payment of dividends on the Company's Common Stock.
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial data for the year ended June 30,
1997, the six months ended June 30, 1996 and the years ended December 31, 1995
and 1994 and as of June 30, 1997 and 1996 have been derived from the Company's
financial statements included elsewhere in this Form 10-K which have been
audited by Deloitte and Touche LLP, independent certified public accountants,
whose report thereon is also included elsewhere in this Form 10-K. The selected
consolidated financial data for the years ended December 31, 1992 and 1993 and
as of December 31, 1992, 1993, 1994 and 1995 have been derived from audited
financial statements of the Company which are not included in this Form 10-K. To
assist the reader in the analysis of results of operations for the year ended
June 30, 1997, unaudited results of operations from the twelve months ended June
30, 1996 are also provided. The selected consolidated financial data set forth
below should be read in conjunction with Managements Discussion and Analysis of
Financial Condition and Results of Operations and the Consolidated Financial
Statements and Notes thereto included elsewhere in this Form 10-K.
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(Amounts and shares shown in thousands, except per share amounts)
Twelve
Six Months Months Year
Year Ended December 31, Ended Ended Ended
--------------------------------------------- June 30, June 30, June 30,
1992 1993 1994 1995 1996 1996 1997
-------- -------- -------- --------- --------- --------- ---------
STATEMENT OF OPERATIONS: (unaudited)
Revenues:
Processing, servicing and merchant discount $ 22,201 $ 28,986 $ 38,282 $ 49,330 $ 33,305 $ 59,053 $ 104,522
License fees -- -- -- -- 10,970 10,970 33,087
Maintenance fees -- -- -- -- 1,978 1,978 22,567
Other -- 1,906 984 -- 4,787 4,788 16,268
-------- -------- -------- --------- --------- --------- ---------
Total revenues 22,201 30,892 39,266 49,330 51,040 76,789 176,444
Expenses:
Cost of processing, servicing and support 13,873 18,387 24,212 30,258 35,439 51,236 102,721
Research and development 2,360 3,605 4,724 6,877 9,907 13,765 32,869
Sales and marketing 3,394 3,640 4,427 7,242 17,167 21,349 32,670
General and administrative 1,657 2,381 2,598 4,134 7,338 9,598 18,707
Depreciation and amortization 1,097 1,377 1,922 2,484 6,997 8,246 24,919
Exclusivity amortization and other -- -- -- -- -- -- 5,957
In process research and development -- -- -- -- 122,358 122,358 140,000
-------- -------- -------- --------- --------- --------- ---------
Total Expenses 22,381 29,390 37,883 50,995 199,206 226,552 357,843
Gain on sale of assets -- -- -- -- -- -- 6,250
-------- -------- -------- --------- --------- --------- ---------
Income (loss) from operations (180) 1,502 1,383 (1,665) (148,166) (149,763) (175,149)
Interest:
Income 171 165 298 2,135 1,659 3,104 2,153
Expense (230) (279) (795) (645) (325) 484 (834)
-------- -------- -------- --------- --------- --------- ---------
Income (loss) before income taxes (239) 1,388 886 (175) (146,832) (147,143) (173,830)
Income tax expense (benefit) (159) 368 400 40 (8,629) (8,650) (12,017)
-------- -------- -------- --------- --------- --------- ---------
Income (loss) before extraordinary item (80) 1,020 486 (215) (138,203) (138,493) (161,813)
Extraordinary item -- -- -- -- (364) (364) --
-------- -------- -------- --------- --------- --------- ---------
Net income (loss) $ (80) $ 1,020 $ 486 $ (215) $(138,567) $(138,857) $(161,813)
======== ======== ======== ========= ========= ========= =========
Income (loss) per common and equivalent share
before extraordinary item -- $ 0.04 $ 0.02 $ (0.01) $ (3.69) $ (4.14) $ (3.44)
Net income (loss) per common and equivalent
share -- $ 0.04 $ 0.02 $ (0.01) $ (3.70) $ (4.15) $ (3.44)
Weighted-average common and equivalent
shares outstanding 27,127 26,886 27,103 28,219 37,420 33,435 46,988
BALANCE SHEET DATA:
Working capital $ 304 $ 623 $ 11,399 $ 81,792 $ 45,496 $ 45,496 $ 20,002
Total assets 8,059 17,669 30,512 115,642 196,230 196,230 223,836
Long-term obligations, less current portion 1,275 8,968 8,213 7,282 8,324 8,324 8,401
Total stockholder's equity 1,915 2,985 16,372 99,325 137,675 137,675 148,643
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
The Company was founded in 1981 to provide electronic collection
services to businesses. This expertise was expanded in the late 1980s through
the introduction of electronic bill payment services for consumers. As a result
of significant acquisitions in 1996 and 1997, the Company now operates in three
business segments -- Electronic Commerce, Software, and Institutional Investment
Services. The Company's electronic transaction processing services, software,
and related products are targeted to financial institutions, businesses,
institutional investment portfolio managers, and their customers.
Electronic Commerce. Electronic Commerce services offered to financial
institutions and their customers include electronic bill payment, electronic
home banking, and business payments. The Company generates bill payment and home
banking revenues through contracts with financial institutions which typically
include an implementation fee, a base fee per customer account on services
provided by the Company, plus a variable per transaction fee which decreases
based on the volume of transactions. Contracts typically have three-to-five year
terms and generally provide for minimum fees if certain transaction volumes are
not met.
For businesses, the Company provides business payment processing
services, including business electronic bill payment, ACH processing, and
automatic payment collection services to companies in the health and fitness and
various other service industries. The Company generates revenues from
transaction fees and implementation fees. The Company also generated revenues
from credit card discount fees, until March 1997, when the automatic accounts
receivable collection business was sold, generating a gain on the sale of
$6,250,000. The sale allows the Company to concentrate on the development and
sale of electronic bill payment and on-line banking capabilities for business.
On January 27, 1997, the Company acquired ISC for a total of $199.0
million, including 12.6 million shares of the Company's Common Stock valued at
$177.2 million and the present value of cash payments due to Intuit under the
Services and License Agreement of $19.6 million. In addition to strengthening
the Company's leading share of the bill payment and home banking market, under
the merger agreement, the Company is the exclusive provider of bill payment and
home-banking services for Intuit's personal financial software product, Quicken,
until October 1, 1997.
The Company believes there is a significant opportunity to expand the
market for electronic commerce among financial institutions, businesses, and
their customers. Paper transactions impose significant costs that can be reduced
through electronic execution. The continuing penetration of personal computers
and modems into U.S. households, along with the growth in on-line interactive
services, are providing the technical infrastructure required to accelerate the
acceptance of electronic commerce. In addition, the Company believes the key
requirements that must be addressed to increase acceptance of electronic
commerce applications include: (i) maintenance of industry-wide quality levels
for security, accuracy, reliability, and convenience; (ii) reduction in
transaction processing costs; (iii) application of easy-to-use interfaces; and
(iv) development of seamless integration with the existing financial
infrastructure and existing relationships among all parties to a financial
transaction. As a result, the Company believes that the opportunity exists to
provide an integrated set of electronic services that further automate financial
transactions for financial institutions, businesses, and their customers.
Software. The Company started operating in the Software segment with
the Servantis Acquisition. Servantis was acquired for $165.1 primarily through
the issuance of 5.7 million shares of the Company's Common Stock valued at
$20.00 per share and $42.5 million paid to retire Servantis' long-term debt.
The Company is a leading provider of electronic commerce and financial
applications software and services for businesses and financial institutions.
The Company designs, markets, licenses, and supports software products for
electronic corporate banking, financial lending, regulatory compliance, and
document imaging. In addition, the Company offers software consulting and remote
processing services.
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The Company's financial application software revenues are derived
primarily from the sale of software licenses and software maintenance fees.
Software is sold under perpetual licenses, and maintenance fees are received
through renewable agreements. Software products licensed by the Company provide
systems that range from back office operations to front-end interface with the
clients of the Company's customers. Applications include electronic funds
transfer, electronic wholesale banking, reconciliation, mortgage loan
automation, and imaging technologies, among others.
Management believes that the major factors affecting customer decisions
in this market, in addition to price, are product availability, flexibility, the
comprehensiveness of offered products, and the availability and quality of
product maintenance, customer support, and training. The Company's ability to
compete successfully also requires that it continues to develop and maintain
software products and respond to regulatory change and technological advances.
Institutional Investment Services. On May 9, 1996, the Company entered
this business segment with the Security APL Acquisition for $53 million through
the issuance of 2.8 million shares of the Company's Common Stock. The Company
offers portfolio accounting and performance measurement to investment advisors,
brokerage firms, banks, and insurance companies. Clients are able to leverage
their systems and streamline their operations. The Company designs custom
solutions with clients, allowing investment managers the kind of functionality
that dramatically increases productivity. The full range of portfolio management
systems solutions include data conversion, personnel training, trading systems,
graphical client reporting, performance measurement, technical network support,
interface setup, and DTC processing.
The Company generates revenues based on the number of portfolios
managed, transaction fees, and implementation fees. Services are provided under
contracts with institutional investors through contracts with terms of
three-to-five years which generally provide for minimum fees if certain
transaction volumes are not met.
RESULTS OF OPERATIONS
On April 19, 1996, the Company elected to change its fiscal year end
from December 31 to June 30. To assist in the analysis of the results of
operations for the six months ended June 30, 1996, results from the unaudited
period for the six months ended June 30, 1995 are also provided. The following
table sets forth percentages of revenue represented by certain consolidated
statements of operations data:
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Six Twelve
Year Ended Months Transition Months Year
December 31, Ended Period Ended Ended
--------------- June 30, June 30, June 30, June 30,
1994 1995 1995 1996 1996 1997
----- ----- ----- ----- ----- -----
Total revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Expenses:
Cost of processing, servicing and support 61.7 61.3 61.2 69.4 66.7 58.2
Research and development 12.0 13.9 12.8 19.4 17.9 18.6
Sales and marketing 11.3 14.7 13.1 33.6 27.8 18.5
General and administrative 6.6 8.4 8.0 14.4 12.5 10.6
Depreciation and amortization 4.9 5.0 5.3 13.7 10.7 14.1
Exclusivity amortization and other -- -- -- -- -- 3.4
In process research and development -- -- -- 239.7 159.3 79.3
----- ----- ----- ----- ----- -----
Total expenses 96.5 103.4 100.3 390.3 295.0 202.8
Gain on sale of business -- -- -- -- -- 3.5
----- ----- ----- ----- ----- -----
Income (loss) from operations 3.5 (3.4) (0.3) (290.3) (195.0) (99.3)
Interest:
Income 0.8 4.3 2.3 3.3 4.0 1.2
Expense (2.0) (1.3) (1.4) (0.6) (0.6) (0.4)
----- ----- ----- ----- ----- -----
Income (loss) before income taxes 2.3 (0.4) 0.6 (287.7) (191.6) (98.5)
Income tax expense (benefit) 1.1 0.1 0.3 (16.9) (11.3) (6.8)
----- ----- ----- ----- ----- -----
Income (loss) before extraordinary item 1.2% (0.4)% 0.3% (270.8)% (180.4)% (91.7)%
===== ===== ===== ===== ===== =====
TWELVE MONTHS ENDED JUNE 30, 1996 AND 1997
Revenues. Total revenue increased by $99.6 million, or 129.8%, from
$76.8 million to $176.4 million for the twelve months ended June 30, 1996 and
1997, respectively. Estimated purchased profits in deferred revenues at the
Servantis Acquisition date in February 1996 have been eliminated as a purchase
accounting adjustment reducing revenues by approximately $12.7 million for the
twelve months ended June 30, 1996 and by approximately $7.8 million for the
twelve months ended June 30, 1997. Without the impact of these purchase
accounting adjustments, total revenues would have increased by $94.8 million, or
105.9%, from $89.5 million to $184.3 million for the twelve months ended June
30, 1996 and 1997, respectively.
Processing, servicing, and merchant discount revenue increased by
76.8% from $59.1 million to $104.5 million for the twelve months ended June 30,
1996 and 1997, respectively. The increase of $45.4 million was due to several
key factors including: (i) the purchase of ISC in January 1997 which added $18.1
million of new revenue in 1997; (ii) Security APL contributed twelve full months
of revenue in 1997 totaling $23.8 million versus $3.0 million during two months
in 1996 for an increase of $20.8 million; and (iii) an increase in processing
and servicing revenue from internal growth in the core electronic processing
business of 51% on a full year pro forma basis.
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License fee revenue excluding purchased profits adjustments of $3.0
million and $1.3 million in 1996 and 1997, respectively, increased by $20.4
million from $14.0 million in 1996 to $34.4 million in 1997. Software sales from
the Servantis Acquisition of only four months during the twelve months ended
June 30, 1996, took place in the seasonally high fourth quarter of the fiscal
year. Results from the twelve months ended June 30, 1997 represent growth of 27%
versus the same period in 1996 on a full year pro forma basis.
Maintenance fee revenue, excluding purchased profits adjustments of
$7.6 million in 1996 and $5.4 million in 1997, increased by $18.5 million from
$9.5 million to $28.0 million during the twelve months ended June 30, 1996 and
1997, respectively. Considering only four months of Servantis operations
included in 1996 revenue, maintenance has stabilized on a year over year basis.
The increase is the net result of the following: (i) an average price increase
of 7%; (ii) customer retention on renewal maintenance in the high 80% range; and
(iii) added first year maintenance on new software sales.
Other revenue, excluding purchased profits adjustments of $2.2 million
in 1996 and $1.1 million in 1997, increased by $10.4 million from $6.9 million
to $17.3 million for the twelve months ended June 30, 1996 and 1997,
respectively. The increase was due primarily to the Servantis Acquisition.
Cost of Processing, Servicing, and Support. Processing, servicing, and
support expenses consist primarily of data processing costs, customer care, and
technical support, and third party transaction fees, which consist principally
of credit card interchange fees, ACH transaction fees and the amortization of
software costs. The cost of processing, servicing, and support was $51.2 million
and $102.7 million, or 66.7% and 58.2% of revenue for the twelve months ended
June 30, 1996 and 1997, respectively. Adjusting service only revenues (all
revenue except license fees) for purchased profits charges of $9.7 million in
1996 and $6.5 million in 1997, the resulting processing, servicing, and support
costs as a percentage of adjusted service revenue were 67.8% and 68.5% for the
twelve months ended June 30, 1996 and 1997, respectively. Processing, servicing,
and support costs increased as a percentage of service revenue due primarily to
two factors: (i) a decrease of approximately 15% in the average revenue per
customer for the Company's home banking and bill payment services (excluding ISC
operations) as a result of the Company changing from a retail to a wholesale
distribution model late in calendar year 1995; and (ii) higher processing costs
in the ISC operations versus those achieved in the core electronic processing
operations.
The Company realizes greater operational efficiency in the remittance
and customer care operations as electronic payment to merchants displace
paper-based transactions. In June 1997, the Company processed 45% of payments
electronically in the core processing business, an increase from 37% in June
1996. Electronic transactions for ISC operations have increased from 2% at the
date of acquisition to 10% by June 1997.
Research and Development. Research and development expenses consist
primarily of salaries and consulting fees paid to software engineers and
business development personnel. Research and development expenses were $13.8
million and $32.9 million, or 17.9% and 18.6% of revenue during the twelve
months ended June 30, 1996 and 1997, respectively. Excluding purchased profits
adjustments, research and development expenses were 15.4% and 17.8% of adjusted
revenue for the twelve months ended June 30, 1996 and 1997, respectively. The
increase as a percentage of revenue for the twelve month period was due to
increased product and business development for new and existing services and
related products, including electronic bill presentment and expanded business
and home banking and bill payment offerings, such as web-based bill payment.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and commissions of sales associates, public relations and advertising
costs, customer acquisition fees, and royalties paid to distribution partners.
Sales and marketing costs were $21.3 million and $32.7 million, or 27.8% and
18.5% of revenue for the twelve months ended June 30, 1996 and 1997,
respectively. Excluding purchased profits, sales and marketing expenses were
23.9% and 17.7% of adjusted revenue for the twelve months ended June 30, 1996
and 1997, respectively. The 1996 costs exceeded 1997 due primarily to a direct
consumer marketing campaign in the amount of $6.5 million. Excluding such cost,
net sales and marketing for 1996 would have increased from 15.5% in 1996 to
16.6% in 1997 primarily due to sales and marketing efforts to financial
institutions in the Company's electronic commerce business.
General and Administrative. General and administrative expenses
consist principally of salaries for administrative, executive, finance, and
human resource employees. General and administrative expenses were $9.6
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million and $18.7 million, or 12.5% and 10.6% of revenue for the twelve months
ended June 30, 1996 and 1997, respectively. Excluding purchased profits, general
and administrative expenses were 10.7% and 10.2% of adjusted revenue for the
twelve months ended June 30, 1996 and 1997, respectively. The improved
productivity is due to increasing revenues and efficiencies gained in
administrative functions upon combining the various entities.
Depreciation and Amortization. Depreciation and amortization expenses
increased by $16.7 million from $8.2 million to $24.9 million for the twelve
months ended June 30, 1996 to 1997, respectively. Amortization of intangible
assets resulting from the purchases of Servantis and Security APL in 1996 and
ISC in 1997 have increased from $3.1 million in the twelve months ended June 30,
1996 to $17.7 million for the same period in 1997 representing $14.6 million of
the increase. The remaining $2.1 million increase is the result of depreciable
assets added as a result of the acquisitions and capital expenditures necessary
to support growth in the business.
Exclusivity Amortization and Other. Exclusivity amortization primarily
includes amortization for the value assigned to the exclusivity arrangement with
Intuit that is amortized ratably over the contractual exclusivity term, which
expires October 1, 1997.
In Process Research and Development. In process research and
development was $122.4 million and $140.0 million for the twelve months ended
June 30, 1996 and 1997, respectively. The 1996 costs related to the purchases of
Servantis, Security APL, and Interactive Solutions Corporation and the 1997 cost
relates to the purchase of ISC. The amounts allocated to in process research and
development for each of the acquisitions were based on independent appraisals
and were expensed at the time of the related acquisition.
Gain on Sale of Assets. On March 26, 1997, the Company sold certain
assets and certain contracts and licensed certain proprietary software for
processing automatic accounts receivable through credit cards or the Automated
Clearing House. The gain on the sale was $6.25 million.
Interest. Interest income decreased from $3.1 million for the twelve
month period ended June 30, 1996 to $2.2 million for the twelve month period
ended June 30, 1997 due to lower average cash, cash equivalent and investment
balances in 1997 compared to 1996. Such cash was used to fund acquisitions late
in 1996 and 1997 as well as to fund operations in 1997.
Interest expense increased from $484,254 for the twelve month period
ended June 30, 1996 to $834,247 for the twelve month period ended June 30, 1997.
The increase is primarily the result of higher average outstanding notes payable
and capital lease obligations in 1997 versus 1996.
Income Taxes. The effective income tax benefit was 6.6% for the twelve
months ended June 30, 1996 and 6.9% for the twelve months ended June 30, 1997.
For both periods, the difference from the statutory rate of 35% was due to
non-deductible in process research and development charges and non-deductible
intangible amortization offset by state and local tax benefits.
SIX MONTHS ENDED JUNE 30, 1995 AND 1996
Revenues. Processing, servicing, and merchant discount revenues
increased $9.7 million, or 41.2%, from $23.6 million for the six month period in
1995 to $33.3 million for the same period in 1996. The increase was due
primarily to $5.7 million of processing and servicing revenue recognized from
the acquisitions of Servantis, Security APL and Interactive Solutions
Corporation, a 20% increase in the number of bill payment and home banking
consumers (prior to consumers acquired from Servantis), and a 17% increase in
the number of transactions processed. In June 1995, the Company reduced its per
transaction prices to a major customer based on increased volume of transactions
attributable to such customer as part of the Company's on-going monitoring of
its pricing structure in each of the markets in which it competes. In addition,
license fees, maintenance fees, and other revenue all increased as a result of
the business acquisitions.
Cost of Processing, Servicing, and Support. Processing, servicing, and
support expenses, as a percentage of servicing revenues (all revenues except
license fees) were 61.2% and 88.4% for the six months ended June 30, 1995 and
1996, respectively. Excluding purchased profits of $12.7 million in 1996,
processing, servicing, and support costs
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34
would have been 67.2% of servicing revenue for the six months ended June 30,
1996 versus 61.2% in 1995. Processing, servicing, and supports costs increased
as a percentage of servicing due primarily to two pricing changes: (i) in June
1995, the Company reduced its per transaction pricing to a major business
services customer based on increased volume of transactions attributable to such
customer as part of the Company's monitoring of its pricing structure; and (ii)
in September 1995, the Company changed from a retail to a wholesale distribution
model which resulted in decrease of approximately 15% in the average revenue per
customer for the home banking and bill payment services (excluding ISC).
Research and Development. Research and development expenses were $3.0
million and $9.9 million, or 12.8% and 19.4% of revenue during the six months
ended June 30, 1995 and 1996, respectively. The increase of $6.9 million was due
to $2.7 million of research and development incurred by the acquired companies,
plus development efforts on new and existing services and related products,
including Electronic Cash Disbursement for business, expanded home banking
offerings, greater capability payment processing systems, and bill presentment.
Sales and Marketing. Sales and marketing costs were $3.1 million and
$17.2 million, or 13.1% and 33.6% of revenue for the six months ended June 30,
1995 and 1996, respectively. The significant increase of $14.1 million is due to
a $6.5 million direct consumer marketing campaign and $7.7 million of increased
sales and marketing expenses incurred by the acquired companies during the six
months period in 1996.
General and Administrative. General and administrative expenses were
$1.9 million and $7.3 million, or 8.0% and 14.4% of revenue for the six months
ended June 30, 1995 and 1996, respectively. This increase of $5.4 million was
due to $3.9 million of increased general and administrative expenses related to
the acquired companies, increased expenses related to becoming and being a
public company (such as legal fees and investor relations), and additional
management, finance, and human resource associates.
Depreciation and Amortization. Depreciation and amortization expenses
were $1.2 million and $7.0 million, or 5.3% and 13.7% of revenue for the six
months ended June 30, 1995 and 1996, respectively. The increase of $5.8 million
was due primarily to $5.5 million of increased depreciation and amortization
expenses related to the acquired companies and the resulting increase in
depreciation from $7.1 million of property additions (primarily computer
related) for the six months ended June 30, 1996 to support continued product
development and the growth of the Company.
In Process Research and Development. The Company incurred $122.4
million of in process research and development costs for the six months ended
June 30, 1996, in conjunction with the acquisitions of Servantis, Security APL,
and Interactive Solutions Corporation. The amounts allocated to in process
research and development for each acquisition were based on independent
appraisals.
Interest. Interest income increased from $0.5 million for the six
months ended June 30, 1995 to $1.7 million for the six months ended June 30,
1996. The increase was due to the income from the investment proceeds of the
initial public offering in September 1995.
Interest expense of $330,000 for the six months ended June 30, 1995
was comparable to the interest expense of $324,000 for the six months ended June
30, 1996.
Income Taxes. The effective income tax rate (credit) was 45.1% and
(5.9%) for the six months ended June 30, 1995 and 1996, respectively. For the
six months ended June 30, 1995, the effective tax rate was more than the
statutory federal rate of 35% due to state and local taxes and non-deductible
intangible asset amortization. For the six months ended June 30, 1996, the
effective tax benefit was less than the statutory rate due primarily to
non-deductible in process research and development and intangible asset
amortization.
YEARS ENDED DECEMBER 31, 1994, AND 1995
Revenues. Processing, servicing, and merchant discount revenues
increased by $11.0 million, or 28.9%, from $38.3 million in 1994 to $49.3
million in 1995. The increase was due primarily to a 20% increase in the number
of consumer subscribers which resulted in $6.6 million of added revenue and a
36.3% or $2.6 million increase in merchant
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35
discounts. In June 1995, the Company reduced it per transaction prices to a
major business customer based on increased transaction volume attributable to
that customer as part of the Company's on-going monitoring of its pricing
structure in each of the markets in which it competes.
Other revenues during this time period include reimbursement of
services and related product development expenses from distribution partners Due
to the termination of a joint development project with a distribution partner in
1994, other revenue decreased from $1.0 million in 1994 to $0 in 1995.
Cost of Processing, Servicing, and Support. Processing, servicing, and
support expenses as a percent of revenue were 61.7% and 61.3% in 1994 and 1995,
respectively. Excluding other revenues, processing, servicing, and support costs
were 63.2% in 1994 and 61.4% in 1995. The 1.8% decrease in costs as a percentage
of net revenue was due primarily to more efficient customer care operations
resulting in slower growth in the number of customer care associates compared to
growth in revenue and an increase in lower cost electronic payments to
merchants.
Research and Development. Research and development expenses were $4.7
million in 1994 and $6.9 million in 1995 or 12.0% and 13.9% of revenue,
respectively. The increase of $2.2 million was due to developmental efforts on
new and existing services and related products, including Electronic Cash
Disbursement, expanded home banking offerings, greater capability payment
processing systems and an Electronic Exchange Network.
Sales and Marketing. Sales and marketing costs increased by $2.8
million, or 64%, from 1994 to 1995 and as a percentage of revenue they increased
from 11.3% to 14.7%, respectively. The increase was due to increased sales
staffing levels in anticipation of new services and business opportunities in
addition to increased public relations activities related to new products and
services.
General and Administrative. General and administrative expenses were
$2.6 million, or 6.6% of revenue in 1994, and $4.1 million, or 8.4% of revenue
in 1995. 1994 expenses were positively impacted by a one time gain of $223,000
related to real estate lease. Without this gain, general and administrative
costs would have increased from $2.8 million, or 7.2% of revenue in 1994, to
$4.1 million or 8.4% of revenue in 1995. This increase was due to the hiring of
additional operating, administrative, and finance associates to manage current
and expected future growth.
Depreciation and Amortization. As a percent of revenue, depreciation
and amortization remained consistent from 4.9% in 1994 to 5.0% in 1995. The
increase was due primarily to property additions in 1994 and 1995 to support
increased research and development activities and increasing staffing levels.
Interest. Interest income increased from $298,000 in 1994 to $2.1
million in 1995 due to income from the private placement of the Company's Common
Stock in December of 1994 and income from the proceeds of the initial public
offering in September 1995.
Interest expense decreased from $795,000 to $645,000 due to the
redemption and conversion of $1.0 million of convertible subordinated debentures
outstanding in September 1994 offset by increased interest related to new
capital lease obligations in 1994 and 1995.
Income Taxes. Income tax expense was $400,000 in 1994. The effective
rate of 45.1% in 1994 was greater than the statutory federal rate of 35% due
primarily to state and local taxes and non-deductible intangible asset
amortization. In 1995, the Company recognized a $40,000 tax expense while
incurring a pre-tax loss of $175,000 also due primarily to state and local taxes
and non-deductible intangible asset amortization.
LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth a summary of cash flow activity and
should be read in conjunction with comments regarding the Company's liquidity
and capital resources:
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36
SUMMARY OF CASH FLOWS
-------------------------------------------------------
(IN THOUSANDS)
-------------------------------------------------------
SIX MONTHS
YEAR ENDED YEAR ENDED ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, JUNE 30, DECEMBER 31,
1994 1995 1996 1997
-------- -------- -------- --------
Cash provided by (used in)
operating activities $ 2,654 $ 2,361 $ (6,645) $ (7,832)
Cash flow from investing
activities (12,839) (22,785) (37,132) 24,912
Cash flow from financing
activities 10,939 82,055 925 (5,982)
-------- -------- -------- --------
Net increase (decrease) in
cash and cash equivalents $ 754 $ 61,631 $(42,852) $ 11,098
======== ======== ======== ========
The Company has historically funded its business primarily through
cash flows generated from operations, the sale of equity and debt securities and
capital lease financing. During the six month period ending June 30, 1996 and
the year ended June 30, 1997 several acquisitions and dispositions have taken
place that have had a significant impact on cash flow.
During the year ended December 31, 1994, the Company received proceeds
of $12.1 million from a private placement of its Common Stock and $11.8 million
of these funds were invested in short term U.S. government securities. Cash
provided from operations of $2.7 million was used to invest in property
additions of $1.0 million and to pay capital lease obligations of $0.7 million.
The Company redeemed $250,000 of subordinated debentures and paid $250,000
toward outstanding notes payable. Cash and cash equivalents increased by $0.8
million for the period.
For the year ended December 31, 1995, the Company received proceeds of
$82.7 from the issuance of 4,975,310 shares of its Common Stock in the initial
public offering. An additional $2.3 million of cash was generated from operating
activities and $0.4 million was received from the combination of stock options
exercised and payments on stockholder notes receivable, $16.4 million of funds
were invested in a net increase in short term U.S. Government securities, $3.4
million was invested in property additions, $3.0 million was invested in a
trademark license, and $1.0 million was applied to principal payments on capital
lease obligations. Cash and cash equivalents increased by $61.6 million for the
period.
During the six month period ended June 30, 1996, the Company used $6.6
million in operating activities. The Company invested $39.4 million, net of cash
acquired, for the acquisitions of Servantis and Security APL. These acquisitions
were partially funded through $10.6 million of maturities and sales of
investments, $7.1 million of funds were invested in property additions, $1.3
million on capitalization of software development costs, $0.6 million on the
repayment of notes payable, and $0.6 million was applied to principal payments
on capital lease obligations. The Company borrowed $1.1 million under an
unsecured loan and received $0.9 million from the exercise of stock options.
Cash and cash equivalents decreased by $42.9 million for the period.
For the year ended June 30, 1997, the Company used $7.8 million in
operating activities. The sale of certain businesses generated proceeds of $28.9
million while $0.6 million was received from stock options exercised during the
year. The Company invested $11.4 million, net of cash acquired, for the
acquisition of ISC and an additional payment of $10.0 million is due on October
1, 1997. Certain stockholders exercised options to sell back to the Company
276,469 shares of Common Stock at a price of $19 per share. The Company received
proceeds of $16.5 million on net
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maturities and sales of investments, $9.8 million was invested in property and
software additions, while $0.6 million was received on the sale of property and
equipment. Principal payments on capital leased totaled $1.1 million, $50,000
was applied to the repayment of stockholder notes payable and an additional
$68,750 was expended on repayment of outstanding notes payable balances. Cash
and cash equivalents increased by $11.1 million for the year. The Company also
has available a $20 million working capital line of credit which was executed in
May 1997. No funds have been drawn against the line at June 30, 1997.
In August 1997, the Company sold a software product line for cash of
$33.5 million. See Note 17 to Notes to the Consolidated Financial Statements.
The Company believes that the proceeds of this sale combined with cash
equivalents and investments on hand at June 30, 1997 will be sufficient to meet
the Company's presently anticipated working capital and capital expenditure
requirements through at least June 1998.
INFLATION
The Company believes the effects of inflation have not had a
significant impact on the Company's results of operations.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This annual report contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), which are
intended to be covered by the safe harbors created thereby. Those statements
include, but may not be limited to, all statements regarding the intent, belief
and expectations of the Company and its management, such as statements
concerning the Company's future profitability and its operating and growth
strategy. Investors are cautioned that all forward-looking statements involve
risks and uncertainties including, without limitation, the factors set forth
under the caption "Business -- Business Risks" in this report and other factors
detailed from time to time in the Company's filings with the Securities and
Exchange Commission. Although the Company believes that the assumptions
underlying the forward-looking statements contained herein are reasonable, any
of the assumptions could be inaccurate. Therefore, there can be no assurance
that the forward-looking statements included in this annual report will prove to
be accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as a representation by the Company or any other person
that the objectives and plans of the Company will be achieved.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's consolidated balance sheets as of as of June 30, 1997
and 1996 and the related consolidated statements of operations, stockholders'
equity and cash flows for the year ended June 30, 1997, the six months ended
June 30, 1996, and the years ended December 31, 1995 and 1994, and the notes to
the financial statements, together with the independent auditors' report thereon
appear in the Company's Annual Report and are incorporated herein by reference.
The Company's Financial Statement Schedule and Independent Auditors'
Report on Financial Statement Schedule are included in response to Item 14
hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item is included under the captions
"ELECTION OF DIRECTORS," "EXECUTIVE OFFICERS" and "SECTION 16(A) BENEFICIAL
OWNERSHIP REPORTING COMPLIANCE" in the Company's Proxy Statement (the "Proxy
Statement") relating to the Company's 1997 Annual Meeting of Stockholders to be
held on October 30, 1997, and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is included under the captions
"INFORMATION CONCERNING THE BOARD OF DIRECTORS" and "EXECUTIVE COMPENSATION" in
the Proxy Statement and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is included under the captions
"OWNERSHIP OF COMMON STOCK BY DIRECTORS AND EXECUTIVE OFFICERS" and "OWNERSHIP
OF COMMON STOCK BY PRINCIPAL STOCKHOLDERS" in the Proxy Statement and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is included under the captions
"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" and "COMPENSATION COMMITTEE
INTERLOCKS AND INSIDER PARTICIPATION" in the Proxy Statement and is incorporated
herein by reference.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
(1) The following financial statements appearing in the
Company's Annual Report are incorporated herein by reference:
Independent Auditors' Report.
Consolidated Balance Sheets as of June 30, 1997 and 1996.
Consolidated Statements of Operations for the year ended June
30, 1997, the six months ended June 30, 1996, and for each of
the two years in the period ended December 31, 1995.
Consolidated Statements of Stockholders' Equity for the year
ended June 30, 1997, the six months ended June 30, 1996, and
for each of the three years in the period ended December 31,
1995.
Consolidated Statements of Cash Flows for the year ended June
30, 1997, the six months ended June 30, 1996, and for the each
of the two years in the period ended December 31, 1995.
Notes to the Consolidated Financial Statements.
(2) The following financial statement schedule is included in
this Annual Report on Form 10-K and should be read in conjunction with the
Consolidated Financial Statements contained in the Annual Report.
Schedule II -- Valuation and Qualifying Accounts.
Independent Auditors' Report on Financial Statement Schedule.
Schedules not listed above are omitted because of the absence of the conditions
under which they are required or because the required information is included in
the financial statements or the notes thereto.
(3) Exhibits:
EXHIBIT EXHIBIT
NUMBER DESCRIPTION
------ -----------
2(a) Agreement and Plan of Merger, dated as of January 15,
1996, among the Company, CheckFree Acquisition
Corporation, and Servantis Systems Holdings, Inc.
(Reference is made to Exhibit 2 to the Current Report
on Form 8-K, dated January 15, 1996, filed with the
Securities and Exchange Commission on January 16,
1996, and incorporated herein by reference.)
2(b) Agreement and Plan of Merger, dated as of March 21,
1996, among the Company, ISC Acquisition Corporation,
and Security APL, Inc. (Reference is made to Exhibit
2 to the Current Report on Form 8-K, dated March 21,
1996, as amended, filed with the Securities and
Exchange Commission, and incorporated herein by
reference.)
2(c) Amendment to Agreement and Plan of Merger, dated as
of April 30, 1996, among the Company, ISC Acquisition
Corporation, and Security APL, Inc. (Reference is
made to Exhibit 2(c) to the Form 10-Q for the quarter
ended March 31, 1996, filed with the Securities and
Exchange Commission, and incorporated herein by
reference.)
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40
2(d) Agreement and Plan of Merger, dated as of September
15, 1996, among the Company, CheckFree Acquisition
Corporation II, Intuit Inc. and Intuit Services
Corporation. (Reference is made to Exhibit 2 to the
Current Report on Form 8-K, dated September 15, 1996,
filed with the Securities and Exchange Commission,
and incorporated herein by reference.)
3(a) Restated Certificate of Incorporation of the Company.
(Reference is made to Exhibit 3(a) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
3(b) Amended and Restated By-Laws of the Company.
(Reference is made to Exhibit 3(b) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
3(c) Form of Specimen Stock Certificate. (Reference is
made to Exhibit 3(c) to Registration Statement on
Form S-1, as amended (Registration No. 33-95738),
filed with the Securities and Exchange Commission on
August 14, 1995, and incorporated herein by
reference.)
4 Articles FOURTH, FIFTH, SEVENTH, EIGHTH, TENTH AND
ELEVENTH of the Company's Restated Certificate of
Incorporation (contained in the Company's Restated
Certificate of Incorporation filed as Exhibit 3(a)
hereto) and Articles II, III, IV, VI and VIII of the
Company's Amended and Restated By-Laws (contained in
the Company's Amended and Restated By-Laws filed as
Exhibit 3(b) hereto).
10(a) CheckFree Corporation 1995 Stock Option Plan.
(Reference is made to Exhibit 10(a) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(b) * CheckFree Corporation Amended and Restated 1995 Stock
Option Plan.
10(c) CheckFree Corporation Amended and Restated 1993 Stock
Option Plan. (Reference is made to Exhibit 10(b) to
Registration Statement on Form S-1, as amended
(Registration No. 33- 95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
10(d) CheckFree Corporation Second Amended and Restated
1983 Non-Statutory Stock Option Plan. (Reference is
made to Exhibit 10(c) to Registration Statement on
Form S-1, as amended (Registration No. 33-95738),
filed with the Securities and Exchange Commission on
August 14, 1995, and incorporated herein by
reference.)
10(e) CheckFree Corporation Second Amended and Restated
1983 Incentive Stock Option Plan. (Reference is made
to Exhibit 10(d) to Registration Statement on Form
S-1, as amended (Registration No. 33-95738), filed
with the Securities and Exchange Commission on August
14, 1995, and incorporated herein by reference.)
10(f) Form of Indemnification Agreement. (Reference is made
to Exhibit 10(a) to Registration Statement on Form
S-1, as amended (Registration No. 33-95738), filed
with the Securities and Exchange Commission on August
14, 1995, and incorporated herein by reference.)
10(g) * Schedule identifying material details of
Indemnification Agreements substantially identical
to Exhibit 10(f).
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41
10(h) Noncompete, Nondisclosure, and Assignment Agreement,
dated February 1, 1990, between Peter J. Kight and
the Company. (Reference is made to Exhibit 10(i) to
Registration Statement on Form S-1, as amended
(Registration No. 33-95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
10(i) Noncompete, Nondisclosure, and Assignment Agreement,
dated February 1, 1990, between Mark A. Johnson and
the Company. (Reference is made to Exhibit 10(j) to
Registration Statement on Form S-1, as amended
(Registration No. 33-95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
10(j) Electronic Bill Payment Services Agreement, dated
March 10, 1995, between the Company and FiTech, Inc.
(Reference is made to Exhibit 10(gg) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)**
10(k) Amendment to Bill Payment and Remote Banking Services
Agreement, dated July 1, 1995, between the Company
and FiTech, Inc. (Reference is made to Exhibit 10(hh)
to Registration Statement on Form S-1, as amended
(Registration No. 33-95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)**
10(l) ACH Operations Agreement, dated April 1, 1994,
between the Company and Society National Bank.
(Reference is made to Exhibit 10(ii) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(m) Merchant Processing Agreement, dated March 13, 1995,
between the Company and Society National Bank.
(Reference is made to Exhibit 10(jj) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(n) Lease, dated August 1, 1993, between the Company and
The Director of Development of the State of Ohio.
(Reference is made to Exhibit 10(rr) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(o) Guaranty Agreement, dated August 1, 1993, between the
Company and The Provident Bank. (Reference is made to
Exhibit 10(ss) to Registration Statement on Form S-1,
as amended (Registration No. 33-95738), filed with
the Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
10(p) Demand Mortgage Note, dated August 25, 1993, of the
Company. (Reference is made to Exhibit 10(tt) to
Registration Statement on Form S-1, as amended
(Registration No. 33- 95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
10(q) Irrevocable Letter of Credit from Society National
Bank for the Company, dated August 25, 1993
(including second renewal thereof). (Reference is
made to Exhibit 10(uu) to Registration Statement on
Form S-1, as amended (Registration No. 33-95738),
filed with the Securities and Exchange Commission on
August 14, 1995, and incorporated herein by
reference.)
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10(r) Open-End Mortgage, Assignment of Rents and Security
Agreement, dated August 25, 1993, with the Company as
mortgagor and Society National Bank as mortgagee.
(Reference is made to Exhibit 10(vv) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(s) Loan and Security Agreement, dated August 25, 1993,
between the Company and Society National Bank.
(Reference is made to Exhibit 10(ww) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(t) Commercial Note Variable Rate, dated January 3, 1995,
of the Company. (Reference is made to Exhibit 10(xx)
to Registration Statement on Form S-1, as amended
(Registration No. 33-95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
10(u) Reimbursement Agreement, dated August 25, 1993,
between the Company and Peter J. Kight. (Reference is
made to Exhibit 10(yy) to Registration Statement on
Form S-1, as amended (Registration No. 33-95738),
filed with the Securities and Exchange Commission on
August 14, 1995, and incorporated herein by
reference.)
10(v) License Agreement, dated October 27, 1995, between
the Company and Block Financial Corporation.
(Reference is made to Exhibit 10(ddd) to the
Company's Annual Report on Form 10-K for the year
ended December 31, 1995, filed with the Securities
and Exchange Commission, and incorporated herein by
reference.)**
10(w) Joint Marketing and Trademark License Agreement,
dated December 28, 1995, between the Company and
Electronic Data Systems Corporation. (Reference is
made to Exhibit 10(eee) to the Company's Annual
Report on Form 10-K for the year ended December 31,
1995, filed with the Securities and Exchange
Commission, and incorporated herein by reference.)**
10(x) Joint Marketing Agreement, dated November 3, 1995,
between the Company and Fiserv, Inc. (Reference is
made to Exhibit 10(fff) to the Company's Annual
Report on Form 10-K for the year ended December 31,
1995, filed with the Securities and Exchange
Commission, and incorporated herein by reference.)**
10(y) Payment Services, Software Development and Marketing
Agreement, dated as of February 27, 1996, between the
Company and CyberCash. (Reference is made to Exhibit
10(a) to the Form 10-Q for the quarter ended March
31, 1996, filed with the Securities and Exchange
Commission, and incorporated herein by reference.) **
10(z) * Executive Employment Agreement between the Company
and Peter J. Kight.
10(aa) Executive Employment Agreement between the Company
and Kenneth J. Benvenuto. (Reference is made to
Exhibit 10(d) to the Form 10-Q for the quarter ended
March 31, 1996, filed with the Securities and
Exchange Commission, and incorporated herein by
reference.)
10(bb) Executive Employment Agreement between the Company
and Lynn D. Busing. (Reference is made to Exhibit
10(f) to the Form 10-Q for the quarter ended March
31, 1996, filed with the Securities and Exchange
Commission, and incorporated herein by reference.)
10(cc) Executive Employment Agreement between the Company
and Jay N. Whipple, III. (Reference is made to
Exhibit 10(i) to the Form 10-Q for the quarter ended
March 31, 1996, filed with the Securities and
Exchange Commission, and incorporated herein by
reference.)
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43
10(dd) Agreement for ACH Services between the Company and
The Chase Manhattan Bank, N.A., dated as of July 1,
1996. (Reference is made to Exhibit 10(qqq) to the
Form 10-K for the transition period ended June 30,
1996, filed with the Securities and Exchange
Commission, and incorporated herein by reference.)
10(ee) * Loan and Security Agreement, dated as of May 13,
1997, among KeyBank National Association, the
Company, CheckFree Software Solutions, Inc.,
CheckFree Services Corporation, Security APL, Inc.,
Servantis Systems, Inc., and Servantis Services, Inc.
10(ff) * CheckFree Corporation Incentive Compensation Plan.
21 * Subsidiaries of the Company.
23 * Consent of Deloitte & Touche LLP.
24 * Power of Attorney.
27 * Financial Data Schedule.
- ----------
* Filed with this report.
** Portions of this Exhibit have been given confidential treatment by the
Securities and Exchange Commission.
(b) REPORTS ON FORM 8-K
The Company filed the following Current Reports on Form 8-K
since March 31, 1997:
(i) Current Report on Form 8-K, dated July 1, 1997, filed
with the Securities and Exchange Commission on July
3, 1997 (Items 5 and 7).
(ii) Current Report on Form 8-K, dated July 17, 1997,
filed with the Securities and Exchange Commission on
July 18, 1997 (Items 5 and 7).
(iii) Current Report on Form 8-K, dated August 30, 1997,
filed with the Securities and Exchange Commission on
September 5, 1997 (Items 2 and 7).
(c) EXHIBITS
The exhibits to this report follow the Consolidated Financial
Statements.
(d) FINANCIAL STATEMENT SCHEDULES
The financial statement schedule and the independent auditors'
report thereon are included on the pages following the Notes to the Consolidated
Financial Statements.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CHECKFREE CORPORATION
Date: September 25, 1997 By: /s/ James S. Douglass
-------------------------------
James S. Douglass, Executive Vice President -
Finance and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Company and in the capacities indicated on the 25th day of September, 1997.
Signature Title
*Peter J. Kight Chairman of the Board, President,
- -------------------------------- and Chief Executive Officer
Peter J. Kight (Principal Executive Officer)
*Mark A. Johnson Vice Chairman - Corporate Development
- -------------------------------- Director
Mark A. Johnson
/s/ James S. Douglass Executive Vice President - Finance and
- -------------------------------- Chief Financial Officer
James S. Douglass (Principal Financial Officer)
*Gary A. Luoma, Jr. Vice President and Chief Accounting
- -------------------------------- Officer
Gary A. Luoma, Jr. (Principal Accounting Officer)
*William P. Boardman Director
- --------------------------------
William P. Boardman
*George R. Manser Director
- --------------------------------
George R. Manser
*Eugene F. Quinn Director
- --------------------------------
Eugene F. Quinn
*Jeffrey M. Wilkins Director
- --------------------------------
Jeffrey M. Wilkins
*By: /s/ Curtis A. Loveland
--------------------------------------
Curtis A. Loveland, Attorney-in-Fact
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45
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Independent Auditors........................................................ F-2
Consolidated Balance Sheets........................................................... F-3
Consolidated Statements of Operations................................................. F-4
Consolidated Statements of Stockholders' Equity....................................... F-5
Consolidated Statements of Cash Flows................................................. F-6
Notes to Consolidated Financial Statements............................................ F-7
Independent Auditor's Report On Financial Statement Schedule.......................... F-22
Schedule II -- Valuation and Qualifying Accounts...................................... F-23
F-1
46
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
CheckFree Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of CheckFree
Corporation and its subsidiaries as of June 30, 1997 and 1996 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year ended June 30, 1997, the six months ended June 30, 1996, and the years
ended December 31, 1995 and 1994. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of CheckFree Corporation and its
subsidiaries at June 30, 1997 and 1996 and the results of their operations and
their cash flows for the year ended June 30, 1997, the six months ended June 30,
1996, and the years ended December 31, 1995 and 1994, in conformity with
generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Atlanta, Georgia
August 8, 1997, except for Note 17 as to which
the date is September 25, 1997
F-2
47
CHECKFREE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1997 AND 1996
1997 1996
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................................... $ 32,085,872 $ 20,987,355
Investments............................................................. 4,430,558 18,089,029
Accounts receivable..................................................... 44,506,852 29,516,548
Assets held for sale.................................................... -- 20,000,000
Prepaid expenses and other.............................................. 2,197,477 2,205,800
Deferred income taxes................................................... 3,002,341 --
------------- -------------
Total current assets............................................. 86,223,100 90,798,732
PROPERTY AND EQUIPMENT -- Net............................................. 44,027,188 36,567,141
OTHER ASSETS:
Capitalized software, net............................................... 26,644,084 34,407,680
Intangible assets, net.................................................. 56,895,587 27,507,677
Investments............................................................. 14,770 2,898,065
Deferred income taxes................................................... 3,063,250 --
Other noncurrent assets................................................. 6,968,287 4,050,249
------------- -------------
Total other assets............................................... 93,585,978 68,863,671
------------- -------------
$ 223,836,266 $ 196,229,544
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable........................................................ $ 7,050,860 $ 5,434,468
Accrued liabilities..................................................... 31,055,726 14,876,861
Customer deposits....................................................... 434,399 575,595
Current portion of long-term obligations................................ 953,220 1,112,184
Deferred revenue........................................................ 26,497,863 15,438,798
Income taxes payable.................................................... 228,709 45,608
Deferred income taxes................................................... -- 7,819,505
------------- -------------
Total current liabilities........................................ 66,220,777 45,303,019
ACCRUED RENT AND OTHER.................................................... 570,189 195,169
DEFERRED INCOME TAXES..................................................... -- 4,732,324
LONG-TERM OBLIGATIONS -- Less current portion:
Obligations under capital leases........................................ 7,301,027 7,136,817
Stockholder's note...................................................... -- 50,000
Notes payable to banks.................................................. 1,100,000 1,137,500
------------- -------------
Total long-term obligations...................................... 8,401,027 8,324,317
COMMITMENTS (Notes 10, 11, 12 and 13)
STOCKHOLDERS' EQUITY:
Preferred stock -- 15,000,000 authorized shares, $.01 par value; no
amounts issued or outstanding......................................... -- --
Common stock -- 150,000,000 authorized shares, $.01 par value; issued
55,546,321 shares, 42,274,800 shares.................................. 555,464 422,748
Additional paid-in capital.............................................. 454,850,522 276,823,109
Less:
Treasury stock -- at cost, 1,041,552 shares, 757,536 shares........... (6,007,391) (629,481)
Accumulated deficit................................................... (300,754,322) (138,941,661)
------------- -------------
Total stockholders' equity....................................... 148,644,273 137,674,715
------------- -------------
$ 223,836,266 $ 196,229,544
============== ==============
See notes to consolidated financial statements.
F-3
48
CHECKFREE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
SIX MONTHS
YEAR ENDED ENDED YEAR ENDED DECEMBER 31,
JUNE 30, JUNE 30, -------------------------
1997 1996 1995 1994
------------- ------------- ----------- -----------
REVENUES:
Processing and servicing.............. $ 94,527,853 $ 27,141,624 $39,535,737 $31,097,631
Merchant discount..................... 9,994,189 6,162,914 9,794,280 7,184,729
License fees.......................... 33,087,369 10,970,034 -- --
Maintenance fees...................... 22,567,001 1,978,287 -- --
Other................................. 16,268,292 4,787,003 -- 984,275
------------- ------------- ----------- -----------
Total revenues................ 176,444,704 51,039,862 49,330,017 39,266,635
EXPENSES:
Cost of processing, servicing and
support............................ 102,721,210 35,438,504 30,257,787 24,212,164
Research and development.............. 32,869,249 9,907,312 6,876,625 4,723,910
Sales and marketing................... 32,669,930 17,167,157 7,242,341 4,427,408
General and administrative............ 18,706,944 7,337,675 4,134,019 2,598,175
Depreciation and amortization......... 24,918,903 6,997,101 2,484,677 1,921,665
Exclusivity amortization and other.... 5,957,300 -- -- --
In process research and development... 140,000,000 122,357,586 -- --
------------- ------------- ----------- -----------
Total expenses................ 357,843,536 199,205,335 50,995,449 37,883,322
Gain on sale of assets.................. 6,250,000 -- -- --
------------- ------------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS........... (175,148,832) (148,165,473) (1,665,432) 1,383,313
OTHER:
Interest income....................... 2,153,418 1,658,749 2,135,085 298,186
Interest expense...................... (834,247) (324,726) (644,837) (795,204)
------------- ------------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES....... (173,829,661) (146,831,450) (175,184) 886,295
INCOME TAX EXPENSE (BENEFIT)............ (12,017,000) (8,628,615) 40,000 400,000
------------- ------------- ----------- -----------
INCOME (LOSS) BEFORE EXTRAORDINARY
ITEM.................................. (161,812,661) (138,202,835) (215,184) 486,295
EXTRAORDINARY ITEM, EXTINGUISHMENT OF
DEBT -- Net of tax.................... -- (364,374) -- --
------------- ------------- ----------- -----------
NET INCOME (LOSS)....................... $(161,812,661) $(138,567,209) $ (215,184) $ 486,295
============ ============ ========== ==========
PER SHARE AMOUNTS:
Income (loss) before extraordinary
item............................... $ (3.44) $ (3.69) $ (0.01) $ 0.02
Extraordinary item.................... -- (0.01) -- --
------------- ------------- ----------- -----------
Net income (loss)............. $ (3.44) $ (3.70) $ (0.01) $ 0.02
============ ============ ========== ==========
WEIGHTED AVERAGE COMMON AND EQUIVALENT
SHARES OUTSTANDING.................... 46,988,225 37,419,580 28,218,521 27,103,287
============ ============ ========== ==========
See notes to consolidated financial statements.
F-4
49
CHECKFREE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NUMBER OF COMMON ADDITIONAL NUMBER OF TREASURY STOCKHOLDERS'
SHARES OF STOCK AT PAID-IN SHARES OF STOCK AT NOTES
COMMON STOCK PAR CAPITAL TREASURY STOCK COST RECEIVABLE
------------ -------- ------------ -------------- ----------- -------------
BALANCE, DECEMBER 31, 1993................... 24,021,579 $240,216 $ 4,344,979 (667,014) $ (554,260) $(401,153)
Net income................................... -- -- -- -- -- --
Stock options exercised...................... 52,614 526 29,474 -- -- --
Treasury stock acquired...................... -- -- -- (90,522) (75,221) 75,221
Conversion of subordinated debentures........ 1,127,439 11,274 738,726 -- -- --
Sale of common stock......................... 2,417,561 24,176 12,096,853 -- -- --
------------ -------- ------------ -------------- ----------- -------------
BALANCE, DECEMBER 31, 1994................... 27,619,193 276,192 17,210,032 (757,536) (629,481) (325,932)
Net loss..................................... -- -- -- -- -- --
Stock options exercised...................... 270,262 2,703 172,082 -- -- --
Tax benefit associated with exercise of stock
options.................................... -- -- 57,586 -- -- --
Sale of common stock, net of expenses related
to public offering......................... 4,975,310 49,753 82,694,100 -- -- --
Repayment of loans to stockholders........... -- -- -- -- -- 192,139
Cash payments in lieu of fractional shares... -- -- -- -- -- --
------------ -------- ------------ -------------- ----------- -------------
BALANCE -- December 31, 1995................. 32,864,765 328,648 100,133,800 (757,536) (629,481) (133,793)
Net loss................................... -- -- -- -- -- --
Stock options exercised.................... 874,195 8,742 862,088 -- -- --
Tax benefit associated with exercise of
stock options............................ -- -- 1,100,141 -- -- --
Issuance of common stock and stock options
pursuant to acquisitions................. 8,535,840 85,358 174,727,080 -- -- --
Repayment of loans to stockholders......... -- -- -- -- -- 133,793
Cash payments in lieu of fractional
shares................................... -- -- -- -- -- --
------------ -------- ------------ -------------- ----------- -------------
BALANCE -- June 30, 1996..................... 42,274,800 422,748 276,823,109 (757,536) (629,481) --
Net loss................................... -- -- -- -- -- --
Stock options exercised.................... 636,309 6,364 591,063 -- -- --
Tax benefit associated with exercise of
stock options............................ -- -- 886,503 -- -- --
Issuance of common stock and stock options
pursuant to acquisitions................. 12,635,212 126,352 176,549,847 -- -- --
Treasury stock acquired.................... -- -- -- (284,016) (5,377,910) --
------------ -------- ------------ -------------- ----------- -------------
BALANCE -- June 30, 1997..................... 55,546,321 $555,464 $454,850,522 (1,041,552) $(6,007,391) $ --
============== ========= ============= ============= ============ ============
TOTAL
ACCUMULATED STOCKHOLDERS'
DEFICIT EQUITY
------------- -------------
BALANCE, DECEMBER 31, 1993................... $ (645,020) $ 2,984,762
Net income................................... 486,295 486,295
Stock options exercised...................... -- 30,000
Treasury stock acquired...................... -- --
Conversion of subordinated debentures........ -- 750,000
Sale of common stock......................... -- 12,121,029
------------- -------------
BALANCE, DECEMBER 31, 1994................... (158,725) 16,372,086
Net loss..................................... (215,184) (215,184)
Stock options exercised...................... -- 174,785
Tax benefit associated with exercise of stock
options.................................... -- 57,586
Sale of common stock, net of expenses related
to public offering......................... -- 82,743,853
Repayment of loans to stockholders........... -- 192,139
Cash payments in lieu of fractional shares... (398) (398)
------------- -------------
BALANCE -- December 31, 1995................. (374,307) 99,324,867
Net loss................................... (138,567,209) (138,567,209)
Stock options exercised.................... -- 870,830
Tax benefit associated with exercise of
stock options............................ -- 1,100,141
Issuance of common stock and stock options
pursuant to acquisitions................. -- 174,812,438
Repayment of loans to stockholders......... -- 133,793
Cash payments in lieu of fractional
shares................................... (145) (145)
------------- -------------
BALANCE -- June 30, 1996..................... (138,941,661) 137,674,715
Net loss................................... (161,812,661) (161,812,661)
Stock options exercised.................... -- 597,427
Tax benefit associated with exercise of
stock options............................ -- 886,503
Issuance of common stock and stock options
pursuant to acquisitions................. -- 176,676,199
Treasury stock acquired.................... -- (5,377,910)
------------- -------------
BALANCE -- June 30, 1997..................... $(300,754,322) $ 148,644,273
============== ==============
See notes to consolidated financial statements.
F-5
50
CHECKFREE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS
YEAR ENDED ENDED YEAR ENDED DECEMBER 31,
JUNE 30, JUNE 30, ---------------------------
1997 1996 1995 1994
------------- ------------- ------------ ------------
OPERATING ACTIVITIES:
Net income (loss)....................................... $(161,812,661) $(138,567,209) $ (215,184) $ 486,295
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Extraordinary item, extinguishment of debt, net of
tax................................................. -- 364,374 -- --
Write-off of in process research and development...... 140,000,000 122,357,586 -- --
Write-off of capitalized software..................... 3,618,570 -- -- --
Exclusivity amortization.............................. 4,937,500 -- -- --
Depreciation and amortization......................... 24,918,903 6,997,102 2,484,677 1,921,665
Deferred income taxes................................. (13,101,264) (8,653,323) 78,628 64,540
Gain on sale of assets................................ (6,250,000) -- -- --
Loss on disposal of property and equipment............ 640,540 99,819 12,650 33,996
Accretion of investment discount -- net............... -- -- (337,221) --
Change in certain assets and liabilities (net of
acquisitions):
Accounts receivable................................. (10,951,954) (1,109,875) (1,499,502) 543,052
Prepaid expenses and other.......................... (2,975,501) 820,701 (915,259) (269,276)
Refundable income taxes............................. -- -- (144,119) --
Accounts payable.................................... 1,248,697 2,605,707 223,407 723
Accrued liabilities................................. 3,837,001 3,428,406 2,623,425 (87,607)
Customer deposits................................... 366,195 272,647 (25,495) (113,237)
Deferred revenue.................................... 7,509,066 4,585,841 228,017 153,093
Income taxes payable................................ 183,101 152,903 (153,032) (79,409)
------------- ------------- ------------ ------------
Net cash provided by (used in) operating
activities..................................... (7,831,807) (6,645,321) 2,360,992 2,653,835
------------- ------------- ------------ ------------
INVESTING ACTIVITIES:
Property additions...................................... (9,754,858) (7,089,391) (3,431,016) (1,042,892)
Proceeds from the sale of property and equipment........ 588,509 29,016 270 23,548
Proceeds from the sale of assets........................ 28,900,000 -- --
Capitalization of software development costs............ -- (1,312,327) -- --
Purchase of businesses, net of cash acquired............ (11,363,140) (39,404,209) -- --
Purchase of investments................................. (3,000,000) -- (54,078,818) (11,819,937)
Proceeds from maturities and sales of investments....... 19,541,766 10,644,945 37,725,000 --
Purchase of trademark license........................... -- -- (3,000,000) --
------------- ------------- ------------ ------------
Net cash provided by (used in) investing
activities..................................... 24,912,277 (37,131,966) (22,784,564) (12,839,281)
------------- ------------- ------------ ------------
FINANCING ACTIVITIES:
Proceeds from sale of common stock...................... -- -- 82,743,853 12,121,029
Repayment of notes payable and other debt
extinguishment........................................ (68,750) (608,874) (75,000) (250,000)
Proceeds from notes payable............................. -- 1,100,000 225,000 --
Principal payments under capital lease obligations...... (1,076,356) (570,816) (1,038,264) (711,435)
Proceeds from stock options exercised................... 591,063 870,830 232,371 30,000
Purchase of treasury stock.............................. (5,377,910) -- -- --
Receipts (payments) on stockholder notes................ (50,000) 133,648 (33,259) --
------------- ------------- ------------ ------------
Net cash provided by (used in) financing
activities..................................... (5,981,953) 924,788 82,054,701 10,939,594
------------- ------------- ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS...... 11,098,517 (42,852,499) 61,631,129 754,148
CASH AND CASH EQUIVALENTS:
Beginning of period..................................... 20,987,355 63,839,854 2,208,725 1,454,577
------------- ------------- ------------ ------------
End of period........................................... $ 32,085,872 $ 20,987,355 $ 63,839,854 $ 2,208,725
============== ============== ============= =============
See notes to consolidated financial statements.
F-6
51
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF JUNE 30, 1997 AND 1996 AND FOR THE YEAR ENDED
JUNE 30, 1997, THE SIX MONTHS ENDED JUNE 30, 1996
AND THE YEARS ENDED DECEMBER 31, 1995 AND 1994
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization. CheckFree Corporation (the "Company") was organized in 1981
and is a leading provider of transaction processing services, software and
related products to financial institutions and businesses and their customers
throughout the United States. See Note 16 for a description of the Company's
business segments.
Principles of Consolidation and Change in Fiscal Year. The accompanying
consolidated financial statements include the results of operations of the
Company and its wholly owned subsidiaries. All significant intercompany
transactions have been eliminated.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles ("GAAP"). The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Effective January 1, 1996, the Company changed its fiscal year-end from
December 31 to June 30. The following presents unaudited summarized consolidated
financial information for the six months ended June 30, 1995:
Total revenues.......................................................... $23,581,343
Loss from operations.................................................... (67,792)
Income taxes............................................................ 61,592
Net income.............................................................. 75,288
Net income per share.................................................... Nil
Processing Agreements. The Company has agreements with transaction
processors to provide origination and settlement services for the Company. Under
the agreements, the Company must fund service fees and returned transactions
when presented. These agreements expire at various times through June 1999.
Transaction Processing. In connection with the timing of the Company's
financial transactions processing, the Company is exposed to credit risk in the
event of nonperformance by other parties, such as returns and chargebacks. The
Company utilizes credit analysis and other controls to manage its credit risk
exposure. The Company also maintains a reserve for future returns and
chargebacks.
Cash and Cash Equivalents. The Company considers all highly liquid debt
instruments (primarily United States government agency obligations and
commercial paper) purchased with maturities of one month or less to be cash
equivalents. Substantially all cash and cash equivalents are on deposit with
seven financial institutions.
Investments. The Company's investments consist primarily of United States
government or government agency obligations and certificates of deposit. The
Company classifies these investments as available-for-sale securities in
accordance with Statement of Financial Accounting Standards ("SFAS") 115,
"Accounting for Certain Investments in Debt and Equity Securities." Such
investments are carried at amortized cost, which approximates market value.
Property and Equipment. Property and equipment are stated at cost.
Property and equipment are depreciated using the straight-line and accelerated
methods over the estimated useful lives as follows: land improvements, building
and building improvements, 15 to 30 years; computer equipment, software, and
F-7
52
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
furniture, 3 to 5 years. Equipment under capital leases is amortized using the
straight-line method over the terms of the leases. Leasehold improvements are
amortized over the lesser of the estimated useful lives or remaining lease
terms.
Capitalized Software Costs. Software development costs incurred prior to
the establishment of technological feasibility are expensed as incurred.
Software development costs incurred after the technological feasibility of the
subject software product has been established are capitalized in accordance with
SFAS 86. Capital software development costs are amortized on a
product-by-product basis using either the estimated economic life of the product
on a straight-line method or the ratio of current year gross product revenue to
current and anticipated future gross product revenue, whichever is greater.
Unamortized software development costs in excess of estimated future net
revenues from a particular product are written down to estimated net realizable
value.
Amortization of software costs totaled $7,687,390, $2,520,802, $207,500 and
$267,624 for the year ended June 30, 1997, the six months ended June 30, 1996,
and the years ended December 31, 1995 and 1994, respectively.
Intangible Assets. The cost of identified intangible assets are generally
amortized on a straight-line basis over periods from 8 months-15 years. Goodwill
is amortized on a straight-line basis over 10 years. At each balance sheet date,
a determination is made by management to ascertain whether the intangible assets
have been impaired based on several criteria, including, but not limited to,
sales trends, undiscounted operating cash flows, and other operating factors.
Capital Stock. On April 21, 1995, the Company's stockholders increased the
authorized number of shares of $.01 par value Common Stock to 25,000,000 and on
August 8, 1995 increased the number of authorized shares of $.01 par value
Common Stock to 150,000,000. In addition, on August 8, 1995, the Company's
stockholders authorized the Board of Directors to issue up to 15,000,000 shares
of $.01 par value preferred stock in one or more series and to establish such
relative voting, dividend, redemption, liquidation, conversion and other powers,
preferences, rights, qualifications, limitations and restrictions as the Board
may determine without further stockholder approval. No preferred shares have
been issued.
Advertising. The Company expenses advertising costs as incurred.
Advertising expenses were $2,110,489, $7,159,234, $1,757,601 and $613,158 for
the year ended June 30, 1997, the six months ended June 30, 1996, and the years
ended December 31, 1995 and 1994, respectively.
Net Income (Loss) per Common and Equivalent Share. Net income (loss) per
common and equivalent share is based on the weighted average number of shares
and dilutive common stock equivalents (stock options) outstanding during the
periods presented. All share and per share information has been retroactively
adjusted for the five-for-one stock split on May 1, 1995 and the 5.2614-for-one
split on the effective date of the initial public offering (September 28, 1995).
Pursuant to the Securities and Exchange Commission Staff Accounting Bulletin 83,
all common shares and stock options issued during the twelve months immediately
preceding the initial public offering were treated as if they had been
outstanding for all periods, using the treasury stock method. The assumed
conversion of the convertible debentures had an insignificant impact on net
income (loss) per common and equivalent share. In February 1997, Statement of
Financial Accounting Standards No. 128 "Earnings Per Share" was issued. The
Statement is not effective until periods ending after December 15, 1997.
However, had the Company adopted the Statement in the current year, basic and
dilutive loss per share, as defined in the Statement, would be the same as the
loss per share currently reported in the accompanying financial statements.
Recent Accounting Pronouncements. In February 1997, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
(SFAS) No. 129, "Disclosure of Information about Capital Structure", which is
effective for periods ending after December 15, 1997. The Statement establishes
F-8
53
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
standards for disclosing information about an entity's capital structure. The
adoption of SFAS 129 is not expected to have a material impact on the Company's
disclosures.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income", which
is effective for periods beginning after December 15, 1997. The Statement
requires businesses to disclose comprehensive income and its components in their
general-purpose financial statements, with reclassification of comparative
(earlier period) financial statements. The adoption of SFAS 130 is not expected
to have a material impact on the Company's disclosures.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information", which is effective for periods beginning
after December 15, 1997. SFAS No. 131 redefines how operating segments are
determined and requires disclosure of certain financial and descriptive
information about a company's operating segments. The adoption of SFAS 131 is
not expected to have a material impact on the Company's disclosures.
Reclassifications. Certain amounts in the prior years' financial
statements have been reclassified to conform to the 1997 presentation.
REVENUE RECOGNITION
- Processing and Servicing. Processing and servicing revenues include
revenues from transaction processing, electronic funds transfer and
monthly service fees on consumer funds transfer services. The Company
recognizes revenue when the services are performed.
As part of processing certain types of transactions, the Company earns
interest from the time money is collected from its customers until the
time payment is made to the applicable merchants. These revenues are
included in processing and servicing and totaled $3,227,904, $1,019,288,
$1,622,963 and $740,290 for the year ended June 30, 1997, the six months
ended June 30, 1996 and the years ended December 31, 1995 and 1994,
respectively.
- Merchant Discount. Merchant discount revenues are recognized when the
services are performed. Interchange fees incurred in the settlement of
merchant credit card transactions are included in processing and servicing
expenses.
- License Fees. Revenue from software license agreements is recognized
upon delivery of the software if there are no significant postdelivery
obligations. The revenue related to significant postdelivery obligations
is deferred and recognized using the percentage-of-completion method.
- Maintenance Fees. Maintenance fee revenue is recognized ratably over the
term of the related contractual support period, generally 12 months.
EXPENSE CLASSIFICATION
- Processing, Servicing and Support. Processing, servicing and support
costs consist primarily of data processing costs, customer care and
technical support, and third party transaction fees, which consist
primarily of credit card interchange fees, ACH transaction fees and the
amortization of software costs.
- Research and Development. Research and development expenses consist
primarily of salaries and consulting fees paid to software engineers and
business development personnel.
- Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and commissions of sales employees, public relations and
advertising costs, customer acquisition fees and royalties paid to
distribution partners.
F-9
54
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- General and Administrative. General and administrative expenses consist
primarily of salaries for administrative, executive, finance, and human
resource employees.
2. ACQUISITIONS AND DISPOSITIONS
On January 27, 1997, the Company acquired Intuit Services Corporation
("ISC") for a total of $199.0 million, including 12.6 million shares of common
stock valued at $177.2 million, the present value of cash payments due to
Intuit, Inc. under the Services and License Agreement of $19.6 million and
acquisition costs of $2.2 million. The acquisition was treated as a purchase for
accounting purposes, and, accordingly, the assets and liabilities were recorded
based on their fair values at the date of the acquisition. Of the total purchase
price, $28.9 million was allocated to goodwill. In addition, $140.0 million was
allocated to in-process research and development, which was charged to
operations at the time of the acquisition. $7.9 million was allocated to an
exclusivity agreement with Intuit, Inc. and is being amortized on a
straight-line basis over the contractual life of eight months. Further, $3.5
million was allocated to other identifiable intangible assets and $20.3 million
allocated to tangible assets. ISC's operations are included in the consolidated
results of operations from the date of the acquisition.
On February 21, 1996, the Company acquired Servantis Systems Holdings, Inc.
("Servantis") for $165.1 million, including 5.7 million shares of common stock,
valued at $20.00 per share, the issuance of stock options valued at $8.2 million
and the retirement of certain debt of $42.5 million. The acquisition was treated
as a purchase for accounting purposes, and accordingly, the assets and
liabilities were recorded based on their fair values at the date of the
acquisition. Of the total purchase price, $11.2 million was allocated to
goodwill, $46.5 million to other identifiable intangible assets and $55.2
million to tangible assets. In addition, $90.6 million was allocated to
in-process research and development, which was charged to operations at the time
of the acquisition. Servantis' operations are included in the consolidated
results of operations from the date of the acquisition.
On May 9, 1996, the Company acquired Security APL, Inc. ("Security APL")
for $53 million, including 2.8 million shares of common stock, valued at $18.50
per share. The acquisition was treated as a purchase for accounting purposes,
and, accordingly, the assets and liabilities were recorded based on their fair
values at the date of the acquisition. Of the total purchase price, $10.9
million was allocated to goodwill, $9.0 million to other identifiable intangible
assets and $9.8 million to tangible assets. Additionally, $28.8 million was
allocated to in-process research and development, which was charged to
operations at the time of the acquisition. Security APL's operations are
included in the consolidated results of operations from the date of the
acquisition.
In March 1996, the Company acquired Interactive Solutions Corp. ("IS") for
$3.0 million, including 85,000 shares of common stock valued at $21.25 per
share. The acquisition was treated as a purchase for accounting purposes, and,
accordingly, the assets and liabilities were recorded based on their fair values
at the date of the acquisition. Of the total purchase price, $3.0 million was
allocated to in-process research and development, which was charged to
operations at the time of the acquisition. IS's operations are included in the
consolidated results of operations from the date of acquisition.
Consistent with the Company's policy for internally developed software, the
Company determined the amounts to be allocated to in-process research and
development based on whether technological feasibility had been achieved and
whether there was any alternative future use for the technology. As of the date
of the acquisitions, the Company concluded that the in-process research and
development had no alternative future use after taking into consideration the
potential for usage of the software in different products, resale of the
software and internal usage.
F-10
55
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The unaudited pro forma results of operations of the Company for the year
ended June 30, 1997, the six months ended June 30, 1996 and the twelve months
ended June 30, 1996, assuming the acquisitions occurred at the beginning of each
period are as follows (in thousands, except per share data):
YEAR ENDED SIX MONTHS ENDED 12 MONTHS ENDED
JUNE 30, 1997 JUNE 30, 1996 JUNE 30, 1996
------------- ---------------- ---------------
Total revenues............................. $ 194,354 $ 69,607 $ 131,815
Loss before extraordinary item............. (28,567) (34,290) (43,872)
Net loss................................... (28,567) (34,655) (44,236)
Net loss per share......................... (0.53) (0.65) (0.81)
Weighted average shares outstanding........ 54,272 53,630 54,529
This information is presented to facilitate meaningful comparisons to
on-going operations and to other companies. The unaudited pro forma amounts
above do not include a charge for in-process research and development of $122.4
million and $140.0 million arising from the Servantis, Security APL and IS
acquisitions in 1996 and the ISC acquisition in 1997, respectively. The
unaudited pro forma information is not necessarily indicative of the actual
results of operations had the transactions occurred at the beginning of the
periods presented, nor should it be used to project the Company's results of
operations for any future periods.
On March 26, 1997, the Company sold certain assets and certain contracts
and licensed certain proprietary software for processing automatic accounts
receivable through credit cards or the Automated Clearing House resulting in a
net gain on the sale of $6,250,000.
3. INVESTMENTS
The carrying amounts, which approximate market value, of investments in
debt securities are as follows:
JUNE 30,
------------------------
1997 1996
---------- -----------
U.S. Government and Government Agency Obligations............ $4,445,328 $20,762,950
Certificates of Deposit...................................... -- 224,144
---------- -----------
Total.............................................. $4,445,328 $20,987,094
========= ==========
Gross unrealized gains and losses at each date were insignificant. In
addition, sales of securities and related realized gains/losses, based on the
specific identification cost method, were insignificant for each of the periods.
Contractual maturities of debt securities at June 30, 1997 are shown below.
Expected maturities will differ from contractual maturities because debt issuers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
Due in one year or less.................................................. $4,430,558
Due after one year through five years.................................... 14,770
----------
Total.......................................................... $4,445,328
=========
F-11
56
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
JUNE 30,
-------------------------
1997 1996
----------- -----------
Trade accounts receivable................................... $22,049,201 $14,858,364
Unbilled trade accounts receivable.......................... 20,957,992 16,203,055
Other receivables........................................... 5,716,724 734,851
----------- -----------
48,723,917 31,796,270
Less allowance for doubtful accounts........................ 4,217,065 2,279,722
----------- -----------
Total............................................. $44,506,852 $29,516,548
========== ==========
5. INCOME TAXES
The Company accounts for income taxes in accordance with SFAS 109,
"Accounting for Income Taxes," which requires an asset and liability approach to
financial accounting and reporting for income taxes. In accordance with SFAS
109, deferred income tax assets and liabilities are computed annually for
differences between the financial statement and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Income tax expense (benefit)
is the tax payable or refundable for the period plus or minus the change during
the period in deferred tax assets and liabilities.
Income tax expense (benefit) consists of the following:
YEAR ENDED
YEAR ENDED SIX MONTHS ENDED DECEMBER 31,
JUNE 30, JUNE 30, --------------------
1997 1996 1995 1994
------------ ---------------- --------- --------
Current:
Federal........................... $ -- $ -- $(123,406) $250,929
State and local................... 1,084,264 24,708 84,778 84,531
------------ ---------------- --------- --------
Total current............. 1,084,264 24,708 (38,628) 335,460
Deferred Federal and state taxes.... (13,101,264) (8,653,323) 78,628 64,540
------------ ---------------- --------- --------
Total income tax expense
(benefit)............... $(12,017,000) $ (8,628,615) $ 40,000 $400,000
=========== ============= ========= ========
F-12
57
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Income tax expense differs from the amounts computed by applying the U.S.
federal statutory income tax rate of 35 percent to income before income taxes as
a result of the following:
YEAR ENDED
YEAR ENDED SIX MONTHS ENDED DECEMBER 31,
JUNE 30, JUNE 30, -------------------
1997 1996 1995 1994
------------ ---------------- -------- --------
Computed "expected" tax expense
(benefit).......................... $(60,843,807) $(49,922,693) $(59,563) $301,340
Non-deductible in-process research
and development of acquired
businesses......................... 49,000,000 41,601,579 -- --
Nondeductible intangible
amortization....................... 838,651 218,918 64,767 64,767
State and local taxes, net of Federal
income tax benefit................. (552,903) (626,334) 55,953 55,790
Other -- net......................... (458,941) 99,915 (21,157) (21,897)
------------ ---------------- -------- --------
Total income tax expense
(benefit)................ $(12,017,000) $ (8,628,615) $ 40,000 $400,000
=========== ============= ======== ========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at June 30,
1997 and June 30, 1996 are:
JUNE 30,
--------------------------
1997 1996
----------- ------------
Deferred tax assets:
Net operating loss carryforwards......................... $ 9,149,769 $ 9,295,934
Intangible assets........................................ 5,117,698 --
Allowance for bad debts and returns...................... 1,812,560 1,254,497
Accrued compensation and related items................... 338,807 1,001,332
State income tax accrued................................. -- 89,328
Reserve accruals......................................... 910,974 --
Property and equipment................................... 55,238 --
Valuation allowance...................................... (6,000,000) (6,000,000)
----------- ------------
Total deferred tax assets........................ 11,385,046 5,641,091
Deferred tax liabilities:
Assets held for sale..................................... -- (8,000,000)
Property and equipment................................... -- (1,434,982)
Capitalized software..................................... (5,259,455) (5,953,098)
Intangible assets........................................ -- (640,176)
Deferred revenue......................................... -- (1,936,171)
Prepaid expenses......................................... (60,000) (169,711)
Other, net............................................... -- (58,782)
----------- ------------
Total deferred tax liabilities................... (5,319,455) (18,192,920)
----------- ------------
Net deferred tax asset (liability)............... $ 6,065,591 $(12,551,829)
========== ===========
At June 30, 1997, the Company has approximately $24,000,000 of net
operating loss carryforwards available, expiring in 2009 to 2011, including
approximately $9,000,000 related to a purchased subsidiary which can only be
used to offset income earned by the subsidiary up to specified annual amounts.
The valuation allowance reduces deferred tax assets to the amount the Company
believes more likely than not will be realized. Any future realization of tax
benefits for which the valuation allowance has been recorded would result in a
reduction of intangible assets, based on unamortized recorded balances as of
June 30, 1997.
F-13
58
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. PROPERTY AND EQUIPMENT
The components of property and equipment are as follows:
JUNE 30,
-------------------------
1997 1996
----------- -----------
Land and land improvements.................................. $ 3,145,746 $ 3,145,746
Building and building improvements.......................... 14,441,906 13,531,873
Computer equipment and software licenses.................... 41,263,964 22,655,049
Furniture and equipment..................................... 7,107,480 7,055,892
----------- -----------
Total............................................. 65,959,096 46,388,560
Less accumulated depreciation and amortization.............. 21,931,908 9,821,419
----------- -----------
Property -- net............................................. $44,027,188 $36,567,141
========== ==========
7. INTANGIBLE ASSETS
The components of intangible assets are as follows:
JUNE 30,
-------------------------
1997 1996
----------- -----------
Workforce................................................... $ 8,370,477 $ 7,195,200
Tradenames.................................................. 4,150,000 4,164,444
Customer base............................................... 3,440,000 3,459,111
Goodwill.................................................... 41,125,528 13,647,058
Exclusivity................................................. 7,900,000 --
----------- -----------
Total............................................. 64,986,005 28,465,813
Less accumulated amortization............................... 8,090,418 958,136
----------- -----------
Intangible assets, net...................................... $56,895,587 $27,507,677
========== ==========
8. ACCRUED LIABILITIES
The components of accrued liabilities are as follows:
JUNE 30,
-------------------------
1997 1996
----------- -----------
Salaries and related costs.................................. $10,715,876 $ 5,467,592
Services and license agreement accrual...................... 9,886,762 --
Processing fees............................................. 2,657,887 3,662,257
Reserve for returns and chargebacks......................... 1,224,028 542,387
Other....................................................... 6,571,173 5,204,625
----------- -----------
Total............................................. $31,055,726 $14,876,861
========== ==========
9. LONG-TERM DEBT AND NOTES PAYABLE
Stockholders' and Bank Notes Payable The Company had unsecured loans
payable to certain stockholders totaling $50,000 at June 30, 1996 which were due
in December 1998 but paid in full in July 1996. In January 1995, $225,000 was
refinanced with a bank into a 36 month unsecured term loan payable in monthly
installments of $6,250 at the prime rate, due in February 1998, however the note
was fully paid in December, 1996.
F-14
59
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In March 1996, the Company executed an unsecured note payable with a bank
for $1.1 million. The principal amount is due in July 1998, with interest
payable quarterly based on the LIBOR rate (total of 5.8% at June 30, 1997).
The estimated fair value of the Company's notes payable approximates their
carrying amounts based on currently available debt with similar interest rates
and remaining maturities.
During the six months ended June 30, 1996, the Company retired certain debt
in connection with a business acquisition, resulting in an extraordinary loss of
$364,374, net of income taxes of $204,961.
In May 1997, the Company obtained a working capital line of credit which
enables the Company to borrow up to $20 million, based on the collateral of
eligible accounts receivable. The line expires in October 1999, and contains
certain restrictive covenants, including defined quarterly operating results,
minimum tangible net worth requirements, and the prohibition of dividend
payments. No funds have been drawn against the line through June 30, 1997.
10. OBLIGATIONS UNDER CAPITAL LEASES
During 1993, the Company entered into a 20 year lease with the Department
of Development of the State of Ohio for land and an office building located in
Columbus, Ohio. The Company has the option to purchase the land and building for
$1 at the termination of the lease and thus, the Company has recorded the
transaction as a capital lease. The lease payments are secured by a $751,500
standby letter of credit agreement with a bank and are partially guaranteed by
an officer and principal stockholder of the Company. The standby letter of
credit is collateralized by a savings account totaling $562,046 at June 30, 1997
and certain real estate adjacent to the leased property. The lease contains
certain covenants, the most restrictive of which require the Company to maintain
certain debt to equity ratios and tangible net worth and working capital levels.
The Company also leases certain computer equipment, furniture and telephone
equipment under capital leases. The Company is required to pay certain taxes,
insurance and other expenses related to the leased property.
The following is a summary of property under capital leases included in the
accompanying balance sheets:
JUNE 30,
-------------------------
1997 1996
----------- -----------
Land........................................................ $ 3,145,746 $ 3,145,746
Building.................................................... 4,525,860 4,369,254
Computer equipment.......................................... 4,318,244 3,204,468
----------- -----------
Total............................................. 11,989,850 10,719,468
Less accumulated amortization............................... 3,081,443 2,425,823
----------- -----------
Property held under capital leases.......................... $ 8,908,407 $ 8,293,645
========== ==========
F-15
60
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum lease payments required by the capital leases and the net
future minimum lease payments are as follows:
Fiscal year ending June 30:
1998.................................................................. $ 1,420,928
1999.................................................................. 1,358,412
2000.................................................................. 1,239,813
2001.................................................................. 1,044,945
2002.................................................................. 976,196
Thereafter............................................................ 6,288,701
-----------
Total future minimum lease payments........................... 12,328,995
Less amount representing interest..................................... 4,092,743
-----------
Net future minimum lease payments............................. $ 8,236,252
==========
11. OPERATING LEASES
The Company leases certain office space and equipment under operating
leases. Certain leases contain renewal options and generally provide that the
Company shall pay for insurance, taxes and maintenance. In addition, certain
leases include rent escalations throughout the terms of the leases. Total
expense under all operating lease agreements for the year ended June 30, 1997,
the six months ended June 30, 1996, and the years ended December 31, 1995 and
1994 was $5,881,575, $1,935,880, $664,948 and $671,528, respectively. Minimum
future rental payments under these leases are as follows:
Fiscal year ending June 30:
1998.................................................................. $ 5,150,650
1999.................................................................. 5,117,939
2000.................................................................. 5,065,752
2001.................................................................. 4,495,355
2002.................................................................. 4,503,477
Thereafter............................................................ 7,683,209
-----------
Total......................................................... $32,016,382
==========
12. EMPLOYEE BENEFIT PLANS
Retirement Plans. The Company has a defined contribution 401(k) retirement
plan covering substantially all of its employees. Under the plan eligible
employees may contribute a portion of their salary until retirement and the
Company, at its discretion, may match a portion of the employee's contribution.
Total expense under these plans amounted to $1,862,310, $366,670, $96,913 and
$70,880 for the year ended June 30, 1997, the six months ended June 30, 1996,
and the years ended December 31, 1995 and 1994, respectively.
Group Medical Plan. The Company has a group medical self-insurance plan
covering certain of its employees. The Company has employed an administrator to
manage this plan. Under terms of this plan, both the Company and eligible
employees are required to make contributions to this plan. The administrator
reviews all claims filed and authorizes the payment of benefits. The Company has
stop-loss insurance coverage on all individual claims exceeding $100,000. Total
expense under this plan amounted to $3,458,272, $1,139,960, $626,000 and
$397,000 for the year ended June 30, 1997, the six months ended June 30, 1996,
and the years ended December 31, 1995 and 1994, respectively. The Company
expenses amounts as claims are incurred and recognizes a liability for incurred
but not reported claims. At June 30, 1997, and June 30, 1996, the Company has
accrued $378,000 and $120,000, respectively, as a liability for costs incurred
under this plan.
F-16
61
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. COMMON STOCK
During 1995, the Company adopted the 1995 Stock Option Plan (the "1995
Plan"). The 1995 Plan replaces in its entirety the 1993 Stock Option Plan (the
"1993 Plan"). The options granted under the 1995 and 1993 Plans may be either
incentive stock options or non-statutory stock options. The terms of the options
granted under the 1995 and 1993 Plans are at the sole discretion of a committee
of members of the Company's Board of Directors, not to exceed ten years.
Generally, options vest at 20% per year from the date of grant. The 1995 Plan
provides that the Company may grant options for not more than 5,000,000 shares
of common stock to certain key employees, officers and directors. Options
granted under the 1995 and 1993 Plans are exercisable according to the terms of
each option, however, in the event of a change in control or merger as defined,
the options shall become immediately exercisable. At June 30, 1997, 2,013,730
additional shares are available for grant in the aggregate for all Plans.
Previously, the Company had adopted the 1983 Incentive Stock Option Plan
and the 1983 Non-Statutory Stock Option Plan (collectively, the "1983 Plans"),
which provided that the Board of Directors may grant options for shares of
common stock to certain employees and directors. Under the terms of the 1983
Plans, options are exercisable over a period up to ten years from the grant
date. In the event the Company is sold, options outstanding under the 1983 Plans
must be repurchased at a price calculated as if the options had been fully
exercised.
All options granted under the 1983 Plans, the 1993 Plan, and the 1995 Plan
were granted at exercise prices not less than the fair market value of the
underlying common stock at the date of grant. In the event that shares purchased
through the exercise of incentive stock options are sold within one year of
exercise, the Company is entitled to a tax deduction. The tax benefit of the
deduction is not reflected in the consolidated statements of operations but is
reflected as an increase in additional paid-in capital.
The following summarizes the stock option activity from January 1, 1994 to
June 30, 1997:
NUMBER
OF SHARES PRICE
--------- ----------
Balance at December 31, 1993................................. 2,848,206 $.57-$ .91
Granted...................................................... 927,322 $.83-$3.04
Exercised.................................................... (52,614) $.57
Cancelled.................................................... (648,178) $.57-$ .91
---------
Balance at December 31, 1994................................. 3,074,736 $.57-$3.04
========
YEAR ENDED SIX MONTHS ENDED YEAR ENDED
JUNE 30, 1997 JUNE 30, 1996 DECEMBER 31, 1995
--------------------------- --------------------------- ---------------------------
NUMBER WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
OF SHARES EXERCISE PRICE OF SHARES EXERCISE PRICE OF SHARES EXERCISE PRICE
--------- ---------------- --------- ---------------- --------- ----------------
Outstanding -- Beginning of period.... 2,908,218 $ 4.58 2,901,782 $ 1.19 3,074,736 $ 0.82
Granted............................... 2,282,056 14.32 459,289 21.79 160,746 7.12
Exercised............................. (636,309) 1.01 (874,195) 0.99 (270,262) 0.65
Cancelled............................. (112,504) 14.88 (22,020) 1.06 (63,438) 0.73
Issued in conjunction with Servantis
Acquisition......................... -- 443,362 1.52 --
--------- --------- ---------
Outstanding -- End of period.......... 4,441,461 9.59 2,908,218 4.58 2,901,782 1.19
========= ========= =========
Weighted average fair value of options
granted during the year............. $ 6.68 $ 8.45 $ 2.92
================ ================ ================
F-17
62
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about options outstanding at
June 30, 1997:
OPTIONS OUTSTANDING
----------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED AVERAGE ----------------------------
RANGE OF REMAINING WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICES NUMBER CONTRACTUAL LIFE EXERCISE PRICE NUMBER EXERCISE PRICE
---------------------------------- --------- ---------------- ---------------- --------- ----------------
$ 0.57-$ 1.00..................... 1,550,814 5.5 $ 0.83 1,047,378 $ 0.82
$ 1.00-$10.00..................... 206,649 8.3 2.76 93,474 2.00
$10.00-$15.00..................... 1,724,609 9.6 13.39 2,500 13.07
$15.00-$20.00..................... 760,300 9.3 17.39 16,900 19.08
$20.00-$25.00..................... 199,089 8.7 22.18 58,089 22.61
--------- ---------
4,441,461 $ 9.59 1,218,341 $ 1.17
======== ========
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in the year ended June 30, 1997, the six months
ended June 30, 1996, and the year ended December 31, 1995, respectively:
dividend yield of 0% in all periods; expected volatility of 47, 40 and 40
percent; risk-free interest rates of 6.41%, 6.68% and 5.25%; and expected lives
of 3-5 years.
Under the 1997 Associate Stock Purchase Plan, the Company is authorized to
issue up to one million shares of common stock to its full-time employees,
nearly all of whom are eligible to participate. Under the terms of the Plan,
employees can choose, every six months, to have up to 15% of their salary over
the six month period withheld to purchase the Company's common stock. The
purchase price of the stock is 85 percent of the lower of its
beginning-of-period or end-of-period market price. Approximately 39 percent of
eligible employees participated in the first six month period beginning January
1, 1997. Under the Plan, the Company sold no shares in the year ended June 30,
1997; however, 53,013 shares were sold in July 1997 from salary withholding
accumulated in the year ended June 30, 1997. The weighted average fair market
value of this look-back option of $3.93 is estimated on the grant date using the
Black-Scholes option-pricing model with the following assumptions for the grant
for the year ended June 30, 1997: dividend yield of 0%, expected volatility of
47 percent, risk free interest rate of 5.1% and an expected life of three
months.
The Company applies APB Opinion 25 and related Interpretations in
accounting for its stock option plans and employee stock purchase plan. Had
compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of SFAS 123, the Company's net loss and loss
per share, net of related income tax effects, would have been as follows:
YEAR ENDED SIX MONTHS ENDED 12 MONTHS ENDED
JUNE 30, 1997 JUNE 30, 1996 JUNE 30, 1995
------------- ---------------- ---------------
Pro forma net loss................... $ 164,088,799 $138,797,202 $ 244,759
Pro forma net loss per share......... $ 3.49 $ 3.71 $ 0.01
The pro forma amounts are not representative of the effects on reported net
income (loss) for future years.
In January 1997 the Board of Directors approved an amendment to the
Company's 401(k) plan which authorized up to 1,000,000 shares of Common Stock
for the Company's matching contribution.
In accordance with the terms of a joint marketing agreement, a strategic
partner has warrants to purchase up to 650,000 shares of common stock at $20 per
share should the partner attain certain customer acquisition targets.
As of June 30, 1996, certain stockholders had an option to sell up to
280,565 shares of common stock to the Company at $19 per share which expired on
September 30, 1996. Of the eligible shares, 276,469 were sold to the Company and
were recorded as treasury stock.
F-18
63
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. PREFERRED STOCK
In January 1997, the Company's Board of Directors declared a dividend
distribution of Preferred Share Purchase Rights to protect its stockholders in
the event of an unsolicited attempt to acquire the Company. On February 14,
1997, the Rights were issued to the Company's stockholders of record, with an
expiration date of 10 years. Until a person or group acquires 15% or more of the
Company's Common Stock, the Rights will automatically trade with the shares of
Common Stock. Only when a person or group has acquired 15% or more of the
Company's Common Stock, will the Rights become exercisable and separate
certificates issued. Prior to the acquisition by a person or group of beneficial
ownership of 15% or more of the Company's Common Stock, the Rights are
redeemable for $.001 per Right at the option of the Board of Directors.
15. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
YEAR ENDED
YEAR ENDED SIX MONTHS DECEMBER 31,
JUNE 30, ENDED JUNE 30, ---------------------
1997 1996 1995 1994
------------- -------------- -------- ----------
Interest paid.............................. $ 584,663 $ 321,477 $645,443 $ 838,153
============ ============ ======== =========
Income taxes paid.......................... $ 1,147,152 $ 468,077 $211,150 $ 414,869
============ ============ ======== =========
SUPPLEMENTAL DISCLOSURE OF NON-CASH
INVESTING AND FINANCING ACTIVITIES:
Capital lease additions.................. $ 1,914,000 $ 501,160 $261,981 $1,594,492
============ ============ ======== =========
Loans to stockholders repaid with common
stock.................................... $ 75,221
=========
Conversions of subordinated debentures..... $ 750,000
=========
Computer equipment received in exchange for
accounts receivable...................... $ 395,000
=========
Tax benefit associated with the exercise of
stock options............................ $ 886,503 $ 1,100,141 $ 57,586
============ ============ ========
Purchase price of business acquisitions.... $ 200,996,642 $ 265,238,845
Less: Issuance of common stock and stock
options pursuant to acquisitions.... (177,187,500) (174,812,438)
Liabilities assumed................. (1,618,816) (44,064,523)
Net present value of future payment
due................................. (9,609,815) --
Cash acquired in acquisitions....... (1,217,371) (6,957,675)
------------- --------------
Net cash paid.................... $ 11,363,140 $ 39,404,209
============ ============
16. BUSINESS SEGMENTS
Prior to 1996, the Company operated in one segment -- Electronic Commerce.
With the acquisition of Servantis in February 1996 and Security APL in May 1996,
the Company now also operates in the Software and Institutional Investment
Services segments. The net revenues of each segment are principally domestic,
and no single customer accounted for 10% or more of consolidated revenues for
the year ended June 30, 1997 or the six months ended June 30, 1996.
Approximately 13% and 11% of the Company's revenues for the years ended December
31, 1995 and 1994, respectively, were from a single customer.
F-19
64
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A further description of each business segment follows:
- Electronic Commerce. Electronic commerce includes electronic home
banking, electronic bill payment and business payments. These services are
primarily directed to financial institutions and businesses and their
customers.
- Software. Business services includes end-to-end software products for
ACH processing, account reconciliation, wire transfer, mortgage loan
origination and servicing, lease accounting and debt recovery. These
products and services are primarily directed to financial institutions and
large corporations.
- Institutional Investment Services. Institutional investment services
includes investment portfolio management services and investment trading
and reporting services. These products and services are primarily directed
to institutional investment managers.
The following sets forth certain financial information attributable to the
Company's business segments for the year ended June 30, 1997 and the six months
ended June 30, 1996 (in thousands):
SIX MONTHS
YEAR ENDED ENDED
JUNE 30, 1997 JUNE 30, 1996
------------- -------------
Revenues:
Electronic Commerce................................................ $ 56,932 $ 29,783
Software........................................................... 95,737 18,271
Institutional Investment Services.................................. 23,775 2,986
------------- -------------
Total...................................................... $ 176,444 $ 51,040
========== ==========
Operating income (loss):
Electronic commerce, including charge for acquired in-process
research and development of $140,000 in 1997 and $77,250 in
1996............................................................ $(155,573) $ (92,160)
Software, including charge for acquired in-process research and
development of $16,308 in 1996.................................. (1,328) (24,675)
Institutional investment services, including charge for acquired
in-process research and development of $28,800 in 1996.......... 949 (28,629)
Corporate.......................................................... (19,197) (2,701)
------------- -------------
Total...................................................... $(175,149) (148,165)
========== ==========
Identifiable assets:
Electronic Commerce................................................ $ 59,851 $ 29,425
Software........................................................... 66,909 96,844
Institutional Investment Services.................................. 24,076 25,099
Corporate.......................................................... 73,000 44,862
------------- -------------
Total...................................................... $ 223,836 $ 196,230
========== ==========
Capital expenditures:
Electronic Commerce................................................ $ 3,182 $ 4,651
Software........................................................... 1,171 1,087
Institutional Investment Services.................................. 1,973 686
Corporate.......................................................... 3,429 665
------------- -------------
Total...................................................... $ 9,755 $ 7,089
========== ==========
F-20
65
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SIX MONTHS
YEAR ENDED ENDED
JUNE 30, 1997 JUNE 30, 1996
------------- -------------
Depreciation and amortization:
Electronic Commerce................................................ $ 2,094 $ 1,698
Software........................................................... 10,501 4,345
Institutional Investment Services.................................. 4,379 632
Corporate.......................................................... 7,945 322
------------- -------------
Total...................................................... $ 24,919 $ 6,997
========== ==========
17. SUBSEQUENT EVENT
On August 29, 1997 the Company sold certain software for $33,500,000. The
projected gain from the sale will enable the Company to eliminate a deferred tax
benefit valuation allowance of $6,000,000 in the first quarter of fiscal 1998.
This deferred tax benefit valuation allowance reduction will first be applied
against the balance of goodwill and any remaining amounts will be ratably
applied against remaining intangible asset balances resulting from the Servantis
acquisition.
F-21
66
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
CheckFree Corporation and Subsidiaries:
We have audited the consolidated financial statements of CheckFree
Corporation and subsidiaries as of June 30, 1997 and 1996, and for the year
ended June 30, 1997 and for the six months ended June 30, 1996 and for the years
ended December 31, 1995 and 1994, and have issued our report thereon dated
August 8, 1997, except for Note 17 as to which the date is August 29, 1997; such
financial statements and report are included elsewhere in this Form 10-K. Our
audits also included the financial statement schedule of CheckFree Corporation
and subsidiaries, listed in Item 14. This financial statement schedule is the
responsibility of the Corporation's management. Our responsibility is to express
an opinion based on our audits. In our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
DELOITTE & TOUCHE LLP
Atlanta, Georgia
August 8, 1997
F-22
67
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1995,
THE SIX MONTHS ENDED JUNE 30, 1996, AND FISCAL YEAR
ENDED JUNE 30, 1997
BALANCE AMOUNT
AS OF ASSUMED IN CHARGES TO CHARGES TO BALANCE
BEGINNING BUSINESS COSTS AND OTHER AS OF END
OF PERIOD COMBINATION EXPENSES DEDUCTIONS DEDUCTIONS OF PERIOD
--------- ----------- ---------- ---------- ---------- ---------
Allowance for Doubtful Accounts
1994................. 45,531 -- 11,769 -- 30,565 26,735
1995................. 26,735 -- 18,068 -- 12,142 32,661
1996................. 32,661 1,861,039 915,472 -- 529,450 2,279,722
1997................. 2,279,722 1,000,000 9,195,754 -- 8,258,411 4,217,065
Reserve for Returns and
Chargebacks
1994................. 100,000 -- 299,389 -- 124,740 274,649
1995................. 274,649 -- 370,229 -- 254,715 390,163
1996................. 390,163 -- 250,655 -- 98,431 542,387
1997................. 542,387 -- 1,920,377 -- 1,236,736 1,226,028
F-23
68
CHECKFREE CORPORATION
FORM 10-K FOR THE
YEAR ENDED
JUNE 30, 1997
EXHIBIT INDEX
69
EXHIBIT EXHIBIT
NUMBER DESCRIPTION
------ -----------
2(a) Agreement and Plan of Merger, dated as of January 15,
1996, among the Company, CheckFree Acquisition
Corporation, and Servantis Systems Holdings, Inc.
(Reference is made to Exhibit 2 to the Current Report
on Form 8-K, dated January 15, 1996, filed with the
Securities and Exchange Commission on January 16,
1996, and incorporated herein by reference.)
2(b) Agreement and Plan of Merger, dated as of March 21,
1996, among the Company, ISC Acquisition Corporation,
and Security APL, Inc. (Reference is made to Exhibit
2 to the Current Report on Form 8-K, dated March 21,
1996, as amended, filed with the Securities and
Exchange Commission, and incorporated herein by
reference.)
2(c) Amendment to Agreement and Plan of Merger, dated as
of April 30, 1996, among the Company, ISC Acquisition
Corporation, and Security APL, Inc. (Reference is
made to Exhibit 2(c) to the Form 10-Q for the quarter
ended March 31, 1996, filed with the Securities and
Exchange Commission, and incorporated herein by
reference.)
2(d) Agreement and Plan of Merger, dated as of September
15, 1996, among the Company, CheckFree Acquisition
Corporation II, Intuit Inc. and Intuit Services
Corporation. (Reference is made to Exhibit 2 to the
Current Report on Form 8-K, dated September 15, 1996,
filed with the Securities and Exchange Commission,
and incorporated herein by reference.)
3(a) Restated Certificate of Incorporation of the Company.
(Reference is made to Exhibit 3(a) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
3(b) Amended and Restated By-Laws of the Company.
(Reference is made to Exhibit 3(b) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
3(c) Form of Specimen Stock Certificate. (Reference is
made to Exhibit 3(c) to Registration Statement on
Form S-1, as amended (Registration No. 33-95738),
filed with the Securities and Exchange Commission on
August 14, 1995, and incorporated herein by
reference.)
4 Articles FOURTH, FIFTH, SEVENTH, EIGHTH, TENTH AND
ELEVENTH of the Company's Restated Certificate of
Incorporation (contained in the Company's Restated
Certificate of Incorporation filed as Exhibit 3(a)
hereto) and Articles II, III, IV, VI and VIII of the
Company's Amended and Restated By-Laws (contained in
the Company's Amended and Restated By-Laws filed as
Exhibit 3(b) hereto).
10(a) CheckFree Corporation 1995 Stock Option Plan.
(Reference is made to Exhibit 10(a) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(b) * CheckFree Corporation Amended and Restated 1995 Stock
Option Plan.
10(c) CheckFree Corporation Amended and Restated 1993 Stock
Option Plan. (Reference is made to Exhibit 10(b) to
Registration Statement on Form S-1, as amended
(Registration No. 33- 95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
70
10(d) CheckFree Corporation Second Amended and Restated
1983 Non-Statutory Stock Option Plan. (Reference is
made to Exhibit 10(c) to Registration Statement on
Form S-1, as amended (Registration No. 33-95738),
filed with the Securities and Exchange Commission on
August 14, 1995, and incorporated herein by
reference.)
10(e) CheckFree Corporation Second Amended and Restated
1983 Incentive Stock Option Plan. (Reference is made
to Exhibit 10(d) to Registration Statement on Form
S-1, as amended (Registration No. 33-95738), filed
with the Securities and Exchange Commission on August
14, 1995, and incorporated herein by reference.)
10(f) Form of Indemnification Agreement. (Reference is made
to Exhibit 10(a) to Registration Statement on Form
S-1, as amended (Registration No. 33-95738), filed
with the Securities and Exchange Commission on August
14, 1995, and incorporated herein by reference.)
10(g) * Schedule identifying material details of
Indemnification Agreements substantially identical
to Exhibit 10(f).
10(h) Noncompete, Nondisclosure, and Assignment Agreement,
dated February 1, 1990, between Peter J. Kight and
the Company. (Reference is made to Exhibit 10(i) to
Registration Statement on Form S-1, as amended
(Registration No. 33-95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
10(i) Noncompete, Nondisclosure, and Assignment Agreement,
dated February 1, 1990, between Mark A. Johnson and
the Company. (Reference is made to Exhibit 10(j) to
Registration Statement on Form S-1, as amended
(Registration No. 33-95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
10(j) Electronic Bill Payment Services Agreement, dated
March 10, 1995, between the Company and FiTech, Inc.
(Reference is made to Exhibit 10(gg) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)**
10(k) Amendment to Bill Payment and Remote Banking Services
Agreement, dated July 1, 1995, between the Company
and FiTech, Inc. (Reference is made to Exhibit 10(hh)
to Registration Statement on Form S-1, as amended
(Registration No. 33-95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)**
10(l) ACH Operations Agreement, dated April 1, 1994,
between the Company and Society National Bank.
(Reference is made to Exhibit 10(ii) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(m) Merchant Processing Agreement, dated March 13, 1995,
between the Company and Society National Bank.
(Reference is made to Exhibit 10(jj) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(n) Lease, dated August 1, 1993, between the Company and
The Director of Development of the State of Ohio.
(Reference is made to Exhibit 10(rr) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(o) Guaranty Agreement, dated August 1, 1993, between the
Company and The Provident Bank. (Reference is made to
Exhibit 10(ss) to Registration Statement on Form S-1,
as amended (Registration No. 33-95738), filed with
the Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
71
10(p) Demand Mortgage Note, dated August 25, 1993, of the
Company. (Reference is made to Exhibit 10(tt) to
Registration Statement on Form S-1, as amended
(Registration No. 33- 95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
10(q) Irrevocable Letter of Credit from Society National
Bank for the Company, dated August 25, 1993
(including second renewal thereof). (Reference is
made to Exhibit 10(uu) to Registration Statement on
Form S-1, as amended (Registration No. 33-95738),
filed with the Securities and Exchange Commission on
August 14, 1995, and incorporated herein by
reference.)
10(r) Open-End Mortgage, Assignment of Rents and Security
Agreement, dated August 25, 1993, with the Company as
mortgagor and Society National Bank as mortgagee.
(Reference is made to Exhibit 10(vv) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(s) Loan and Security Agreement, dated August 25, 1993,
between the Company and Society National Bank.
(Reference is made to Exhibit 10(ww) to Registration
Statement on Form S-1, as amended (Registration No.
33-95738), filed with the Securities and Exchange
Commission on August 14, 1995, and incorporated
herein by reference.)
10(t) Commercial Note Variable Rate, dated January 3, 1995,
of the Company. (Reference is made to Exhibit 10(xx)
to Registration Statement on Form S-1, as amended
(Registration No. 33-95738), filed with the
Securities and Exchange Commission on August 14,
1995, and incorporated herein by reference.)
10(u) Reimbursement Agreement, dated August 25, 1993,
between the Company and Peter J. Kight. (Reference is
made to Exhibit 10(yy) to Registration Statement on
Form S-1, as amended (Registration No. 33-95738),
filed with the Securities and Exchange Commission on
August 14, 1995, and incorporated herein by
reference.)
10(v) License Agreement, dated October 27, 1995, between
the Company and Block Financial Corporation.
(Reference is made to Exhibit 10(ddd) to the
Company's Annual Report on Form 10-K for the year
ended December 31, 1995, filed with the Securities
and Exchange Commission, and incorporated herein by
reference.)**
10(w) Joint Marketing and Trademark License Agreement,
dated December 28, 1995, between the Company and
Electronic Data Systems Corporation. (Reference is
made to Exhibit 10(eee) to the Company's Annual
Report on Form 10-K for the year ended December 31,
1995, filed with the Securities and Exchange
Commission, and incorporated herein by reference.)**
10(x) Joint Marketing Agreement, dated November 3, 1995,
between the Company and Fiserv, Inc. (Reference is
made to Exhibit 10(fff) to the Company's Annual
Report on Form 10-K for the year ended December 31,
1995, filed with the Securities and Exchange
Commission, and incorporated herein by reference.)**
10(y) Payment Services, Software Development and Marketing
Agreement, dated as of February 27, 1996, between the
Company and CyberCash. (Reference is made to Exhibit
10(a) to the Form 10-Q for the quarter ended March
31, 1996, filed with the Securities and Exchange
Commission, and incorporated herein by reference.) **
10(z) * Executive Employment Agreement between the Company
and Peter J. Kight.
10(aa) Executive Employment Agreement between the Company
and Kenneth J. Benvenuto. (Reference is made to
Exhibit 10(d) to the Form 10-Q for the quarter ended
March 31, 1996, filed with the Securities and
Exchange Commission, and incorporated herein by
reference.)
72
10(bb) Executive Employment Agreement between the Company
and Lynn D. Busing. (Reference is made to Exhibit
10(f) to the Form 10-Q for the quarter ended March
31, 1996, filed with the Securities and Exchange
Commission, and incorporated herein by reference.)
10(cc) Executive Employment Agreement between the Company
and Jay N. Whipple, III. (Reference is made to
Exhibit 10(i) to the Form 10-Q for the quarter ended
March 31, 1996, filed with the Securities and
Exchange Commission, and incorporated herein by
reference.)
10(dd) Agreement for ACH Services between the Company and
The Chase Manhattan Bank, N.A., dated as of July 1,
1996. (Reference is made to Exhibit 10(qqq) to the
Form 10-K for the transition period ended June 30,
1996, filed with the Securities and Exchange
Commission, and incorporated herein by reference.)
10(ee) * Loan and Security Agreement, dated as of May 13,
1997, among KeyBank National Association, the
Company, CheckFree Software Solutions, Inc.,
CheckFree Services Corporation, Security APL, Inc.,
Servantis Systems, Inc., and Servantis Services, Inc.
10(ff) * CheckFree Corporation Incentive Compensation Plan.
21 * Subsidiaries of the Company.
23 * Consent of Deloitte & Touche LLP.
24 * Power of Attorney.
27 * Financial Data Schedule.
- ----------
* Filed with this report.
** Portions of this Exhibit have been given confidential treatment by the
Securities and Exchange Commission.