SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2004

Commission file number           000-25959          

Private Business, Inc.

(615) 221-8400
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [x]       No [  ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes [ ]       No [x]

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

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PRIVATE BUSINESS, INC.

Form 10-Q

For Quarter Ended September 30, 2004

INDEX

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Part 1
Financial Information

Item 1.      Financial Statements

PRIVATE BUSINESS, INC. AND SUBSIDIARIES

The accompanying notes are an integral part of these consolidated financial statements.

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PRIVATE BUSINESS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME — UNAUDITED

The accompanying notes are an integral part of these consolidated financial statements.

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PRIVATE BUSINESS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME — UNAUDITED

The accompanying notes are an integral part of these consolidated financial statements.

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PRIVATE BUSINESS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS — UNAUDITED

The accompanying notes are an integral part of these consolidated financial statements.

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PRIVATE BUSINESS, INC.

Notes to Consolidated Financial Statements — Unaudited

A.

Basis of Presentation

     The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and in accordance with Rule 10-01 of Regulation S-X.

     In the opinion of management, the unaudited interim financial statements contained in this report reflect all adjustments, consisting of only normal recurring accruals, which are necessary for a fair presentation of the financial position, and the results of operations for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year.

     These consolidated financial statements, footnote disclosures and other information should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003.

B.

Summary of Significant Accounting Policies

Principles of Consolidation

     The accompanying financial statements include the accounts of Private Business, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

     Our significant accounting policies include revenue recognition and software development costs. Please refer to our Annual Report on Form 10-K for the year ended December 31, 2003 for a more detailed description of these accounting policies.

Stock-Based Compensation

     The Company has elected to account for its stock-based compensation plans under the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and does not utilize the fair value method.

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     The following table illustrates the effect on net income (loss) available to common shareholders and earnings (loss) per share if the fair value based method had been applied to all outstanding and unvested awards for the three and nine month periods ended September 30, 2004 and 2003, respectively.

C.

Income Taxes

     During September 2004, the Company recorded a $972,000 tax benefit relating to an income tax contingent liability for which the statute of limitations expired in September 2004. This resulted in an overall tax benefit for the third quarter of 2004 totaling $531,000.

D.

Reclassifications

     Certain prior year amounts have been reclassified to conform with current year presentation.

E.

Capital Event

     On January 20, 2004, the Company completed the sale of 20,000 shares of Series A non-convertible preferred stock and a warrant to purchase 16,000,000 shares of our common stock ($1.25 per share exercise price) for a total of $20 million (the “Lightyear Transaction”) to Lightyear Fund, L.P. (together with its affiliates, “Lightyear”). The Series A preferred shares carry a cash dividend rate of 10% per annum of an amount equal to the liquidation preference, payable quarterly in arrears, when and as declared by the Board of Directors. The Series A preferred stock has a liquidation preference superior to the common stock and to the extent required by the terms of the Series B preferred stock, in parity with the currently outstanding Series B preferred stock. The liquidation preference is equal to the original $20 million purchase price, plus all accrued but unpaid dividends. In addition, the Securityholders agreement between the Company and Lightyear PBI Holdings, LLC, executed in conjunction with the sale of the preferred stock and warrant, entitles Lightyear to an additional equity purchase right. The equity purchase right allows Lightyear, so long as Lightyear continues to hold any shares of Series A Preferred Stock, all or any portion of its rights under the warrant or any shares of common stock issued pursuant to an exercise of the warrant, the right to purchase its pro rata portion of all or any part of any new securities which the Company may, from time to time, propose to sell or issue. However, in the case of new security issuances resulting from the exercise of employee stock options which have an

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exercise price less than $1.25 per share, Lightyear must still pay $1.25 per share under this equity purchase right. To the extent that new security issuances resulting from the exercise of employee stock options occur which have an exercise price in excess of $1.25 per share, then Lightyear will be required, if it chooses to exercise their equity purchase right, to pay the same price per share as the employee stock options being exercised.

The net proceeds from the Lightyear Transaction are shown below (in thousands):

     The net proceeds above were allocated among the preferred stock, the common stock warrant and the additional common stock equity right based upon the estimated fair values of each instrument, resulting in $6.2 million allocated to the preferred shares and $10.7 million allocated to the common stock warrant and additional common stock equity right. The estimated fair value of the preferred stock was determined based on valuing the expected preferred stock dividend stream using expected yields ranging from 20.2% to 30.2%. These yield ranges were derived by comparison to other similar preferred issuances at companies with similar equity ratings. The estimated fair value of the common stock warrant and additional common stock equity right were determined by using the Black-Scholes model. The assumptions used in this valuation for the warrant included the exercise price of $1.25, the expected life of the warrant of ten years, an interest rate of 4.41% and volatility factors of between 51.9% and 64.3% based on selected comparable companies. The assumptions used in this valuation for the additional common stock equity right included exercise prices ranging from $1.25 to $42.64, expected lives between two and seven years, an interest rate of 4.0% and a volatility factor of 75%.

     Simultaneous with the closing of the Lightyear Transaction, the Company entered into a new credit facility (the “Bank of America Credit Facility”). The Bank of America Credit Facility is an $11.0 million facility that includes a term loan in the amount of $5.0 million and a revolving line of credit of up to $6.0 million. The revolving line of credit includes a $1.0 million letter of credit sub-limit.

     The Bank of America Credit Facility expires on January 19, 2007. The revolving credit commitment reduces by $1.0 million on each of the first two anniversary dates of the credit facility.

     The term loan is repayable in twelve equal quarterly installments of $416,667, along with interest at the applicable margin. Interest is also due on the outstanding revolving line of credit quarterly at the applicable margin. The interest rates of the term loan and revolving loan are based on a pricing grid using the Company’s Funded Debt to EBITDA Ratio, as follows (The Company has the option of choosing the Libor or Base Rate):

     The Bank of America Credit Facility includes certain restrictive financial covenants relating to minimum net worth, maximum annual capital expenditures, funded debt to EBITDA ratio and fixed charge coverage ratio.

     The Bank of America Credit Facility prohibits the Company from declaring and paying any cash dividends on any class of stock except for the Series A and Series B preferred shares outstanding, provided that no default,

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as defined in the Bank of America Credit Facility, exists as of the date of the dividend payment and such dividend payment will not cause a default.

     The total net proceeds of both the Lightyear Transaction and the Bank of America Credit Facility were used to extinguish the Company’s 1998 credit facility.

     As a result of the 1998 credit facility extinguishment, the Company recorded a charge of $780,000 to write-off the unamortized portion of debt issuance costs as of January 20, 2004. Also, the Lightyear Transaction required that the Company obtain directors and officers tail insurance coverage for periods prior to January 20, 2004. The premium for the tail directors and officers liability insurance coverage totaled approximately $900,000. The Company expensed the entire premium in January 2004. Therefore, first quarter 2004 other operating expense includes two unusual expense items totaling approximately $1.7 million.

F.

Sale of Bank Insurance Business

     On June 30, 2003, the Company entered into an agreement to sell certain operating assets of its Bank Insurance business for cash of $325,000 and a note receivable for $175,000. The note is secured by all assets of the business sold, is due in equal quarterly installments of principal and interest through June 2006 and bears interest at 3%. The result of this transaction is a gain on sale of approximately $427,000, which is included in maintenance and other revenues in the accompanying 2003 statement of operations.

G.

Stock Option Grants

     On May 30, 2003, the Company’s Board of Directors approved grants of incentive stock options totaling 745,700 shares to certain employees of the Company. All of the grants have an exercise price equal to the market value of a share of stock as of the date of grant. As such, no compensation expense was recorded in accordance with Accounting Principles Board Opinion No. 25.

H.

Net Income (Loss) Per Share

     Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common and common equivalent shares outstanding during the period, which includes the additional dilution related to exercise of stock options and warrant as computed under the treasury stock method and the conversion of the preferred stock under the if-converted method.

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     The following table represents information necessary to calculate earnings per share for the three and nine month periods ended September 30, 2004 and 2003:

     For the nine months ended September 30, 2004 and 2003, approximately 17.1 million and 2.1 million employee stock options, warrant and the Series B preferred shares were excluded from diluted earnings per share calculations, as their effects were anti-dilutive.

I.

Bank Covenants

     The Company’s Bank of America Credit Facility is secured by a pledge of all Company assets and imposes financial covenants and requirements and contains limitations on the Company’s ability to sell material assets, redeem capital stock and pay dividends, among other actions. As of September 30, 2004, the Company was in compliance with all such covenants.

J.

Comprehensive Income

     Comprehensive income (loss) for the three and nine months ended September 30, 2004 and 2003 was comprised solely of net income (loss).

K.

Legal Proceedings

     The Company is subject to various legal proceedings, tax matters and other claims which arise in the ordinary course of business. In the opinion of management, the amount of any ultimate liability with respect to these actions will not materially affect the financial position or results of operations of the Company.

L.

Segment Information

     The Company accounts for segment reporting under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. No corporate overhead costs or interest have been allocated to income (loss) before taxes of the retail inventory forecasting segment, but are included in the accounts receivable financing segment costs. Additionally, $1.5 million of goodwill associated with the Towne merger has been allocated to the retail inventory forecasting segment and is therefore included in the segment’s total assets.

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     The following tables summarize the financial information concerning the Company’s reportable segments for the three and nine months ended September 30, 2004 and 2003.