UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________.
Commission file number 0-28152
Affinity Technology Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
57-0991269
(I.R.S. Employer Identification No.)
1053-B Sparkleberry Lane Extension
Columbia, SC 29223
(Address of principal executive offices)
(Zip code)
(803) 758-2511
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.0001 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
1
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. [ ]
Indicate by check mark whether the registrant is an accelerated filer.
[ ]
The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant was approximately $5,660,000 as of June 30,
2003. For purposes of such calculation, persons who hold more than 10% of the
outstanding shares of Common Stock, directors and officers of the Registrant and
certain of their immediate family members have been treated as affiliates. This
determination is not conclusive.
There were 41,864,485 shares of the Registrant's Common Stock
outstanding as of March 15, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Registrant's proxy statement with respect to
the 2004 Annual Meeting of Stockholders of the Registrant have been incorporated
by reference herein.
2
Item 1 of this Form 10-K entitled "Business" and Item 7 of this Form
10-K entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Forward-looking statements are inherently uncertain and
actual results could differ materially from those expressed or implied by the
forward-looking statements. These forward-looking statements should be
considered in the context of the business risks set forth below in Item 1 of
this report under the caption "Business Risks."
3
Part I
Item 1. Business
Affinity Technology Group, Inc. (the "Company") was formed to develop
and market technologies that enable financial institutions and other businesses
to provide consumer financial services electronically with reduced or no human
intervention. Products and services previously offered by the Company include
its DeciSys/RT(R) loan processing system, which automated the processing and
consummation of consumer financial services transactions; the Affinity Automated
Loan Machine (the ALM(R)), which allowed an applicant to apply for and, if
approved, obtain a loan in as little as ten minutes; the Mortgage ALM, which
allowed an applicant to apply for a mortgage loan; e-xpertLender(R), which
permitted a financial institution to make automated lending decisions through
its call centers and branches; iDEAL, which permitted automobile lenders to make
automobile lending decisions for loan applications originated at automobile
dealers; and rtDS, which permitted lenders to deliver credit decisions to
applicants over the Internet. Due to capital constraints, the Company has
suspended all efforts to further develop, market and operate these products and
services. The Company's last processing contract terminated in late 2002, and
the Company has no plans in the near term to engage in further sales or other
activities related to its products or services, other than to license the
patents that it owns. Currently, the Company's business activities consist
exclusively of attempting to enter into license agreements with third parties to
license the Company's rights under certain of its patents.
In conjunction with its product development activities, the Company
applied for and obtained three patents. The Company has been granted two patents
covering its fully-automated loan processing systems (U. S. Patents No.
5,870,721 and 5,940,811). In August 2000, the U.S. Patent and Trademark Office
issued to the Company a patent covering the fully-automated establishment of a
financial account, including credit accounts (U.S. Patent No. 6,105,007). In
addition, in 1997 the Company acquired a patent that covers the automated
processing of an insurance binder through a kiosk (U. S. Patent No. 5,537,315).
Both of the Company's patents covering fully automated loan processing
systems have been subject to reexamination by the U.S. Patent and Trademark
Office (the "PTO") due to challenges to such patents by third parties. On
January 28, 2003, the Company received a Reexamination Certificate (U. S. Patent
No. 5,870,721 C1) from the PTO which formally concluded the reexamination of U.
S. Patent No. 5,870,721. The reexamination of the Company's other loan
processing patent (U. S. Patent No. 5,940,811) is still ongoing. In March 2004,
the Company received notification from the PTO that it had rejected the claims
of U.S. Patent No. 5,940,811. The Company intends to contest the PTO's rejection
and to continue to prosecute the reexamination of this patent.
On March 26, 2004, the Company was notified by Federated Department
Stores, Inc. ("Federated") and Ameritrade Holding Corporation ("Ameritrade")
that they had jointly filed a request with the PTO to reexamine U. S. Patent No.
6,105,007. The Company has lawsuits pending against Federated and Ameritrade in
the Columbia Division of the United States District Court for the State of South
Carolina (the "Court") in which it claims that both Federated and Ameritrade
infringe U. S. Patent No. 6,105,007. The Company has jointly, with Federated and
Ameritrade, requested the Court to stay the lawsuits against Federated and
Ameritrade pending the PTO's determination as to whether it will grant the
reexamination request. The procedural rules of the PTO require the PTO to make a
determination as to whether it will initiate a reexamination within three months
from the date it receives the request. If the PTO grants the reexamination
request, it is likely that it will take an extended period of time to complete
the reexamination proceedings and the related litigation with Federated and
Ameritrade. Moreover, if the PTO grants the reexamination request, it is likely
such decision will have a material adverse effect on the Company's patent
licensing program and its ability to attract additional capital resources in
order to continue its operations.
It is possible that third parties may bring additional actions to
contest all or some of the Company's patents. The Company can make no assurances
that it will not lose all or some of the claims covered by its existing patents.
To date, the Company has generated substantial operating losses and has
been required to use a substantial amount of cash resources to fund its
operations. At December 31, 2003, the Company had cash and cash equivalents of
$578,398. The Company believes that its existing cash resources are sufficient
to fund its ordinary course operating expenses through the remainder of 2004.
However, the Company's ability to continue its operations for the remainder of
2004 is contingent upon the final outcome of the Company's litigation with
Temple Ligon, which is discussed below, and the ability of the Company to extend
the maturity date of all or substantially all of its convertible notes that are
due in June 2004. If the Company becomes obligated to pay more than an amount of
damages in connection with the Temple Ligon litigation or is unable to extend
the maturity date of all or substantially all of the convertible notes that are
due in June 2004, the Company will be forced to consider alternatives for
winding down its business, which may include filing for bankruptcy protection.
4
To remain viable, the Company must generate working capital through the
sale of patent licenses or by raising additional capital. To date, the Company
generally has been unable to enter into licensing agreements with potential
licensees upon terms that are acceptable to the Company. As a result, the
Company has been forced to become involved in litigation with alleged
infringers. Currently, the Company is involved in three patent litigation
actions. The Company believes that these lawsuits may take an extended period of
time to complete, and no assurance can be given that the Company will have the
resources necessary to complete these lawsuits or that it will be successful in
obtaining a favorable outcome. As discussed previously, two of the alleged
infringers (Federated and Ameritrade) have notified the Company that they have
filed a request with the PTO to reexamine the Company's patent covering the
fully automated establishment of a financial account (U. S. Patent No.
6,105,007). If the PTO grants the reexamination request, it is likely that it
will take an extended period of time to complete the reexamination proceeding
and the related litigation with Federated and Ameritrade. Moreover, the
uncertainties of these litigation matters and other factors affecting the
Company's short and long-term liquidity discussed in the preceding paragraph
will likely impede the Company's ability to raise additional capital. To
maintain the minimal resources necessary to support its current operations and
execute a patent licensing strategy, the Company does not believe that
substantial additional reductions in its operating expenses are feasible. No
assurances can be given that the Company will be able to raise additional
capital or generate working capital from its patent licensing business.
The Company is a defendant in a lawsuit brought by Temple Ligon, who
claims that the Company breached an agreement to give him a 1% equity interest
in the Company in consideration of services he claims to have performed in 1993
and 1994 in conjunction with the formation of the Company. In January 2004, this
litigation resulted in a jury verdict against the Company of $386,148. The
Company is seeking to have the verdict overturned by the trial judge. If it is
unsuccessful in doing so, the Company intends to appeal any adverse decision. No
assurances can be given that the Company will be successful in overturning the
verdict or, if it appeals the decision, in obtaining a favorable outcome on
appeal. If the Company becomes obligated to pay more than an insignificant
amount of damages in connection with this litigation, it will be forced to
consider alternatives for winding down its business, which may include filing
for bankruptcy protection.
As of March 30, 2004, the Company had outstanding $1,206,336 in
aggregate principal amount of convertible secured notes (the "notes"). Under the
terms of these notes, principal and accrued interest is due and payable on the
second anniversary of the date on which the notes were issued. The maturity
dates for the notes outstanding as of March 30, 2004 is as follows:
Accrued Interest Total Principal and
Maturity Date Principal at Maturity Accrued Interest
June 2, 2004 $756,336 $121,014 $877,350
March 13, 2005 200,000 32,000 232,000
August 28, 2005 25,000 4,000 29,000
November 3, 2005 100,000 16,000 116,000
November 12, 2005 50,000 8,000 58,000
December 18, 2005 50,000 8,000 58,000
January 8, 2006 25,000 4,000 29,000
5
The notes bear interest at 8% and are collateralized by the stock of
the Company's wholly owned subsidiary, decisioning.com, Inc. decisioning.com is
the Company's patent licensing subsidiary and owns the Company's patent
portfolio. The notes are convertible into the Company's common stock at a
conversion rate of $.20 per share. The outstanding notes include a note in the
current principal amount of $131,336 issued to AMRO International, S.A.
("AMRO"). In June 2002, the Company issued to AMRO a convertible note in the
principal amount of $205,336 in satisfaction of the principal and accrued
interest outstanding under a convertible debenture previously issued by the
Company to AMRO. In October 2003, AMRO converted $74,000 of principal and $7,959
of accrued interest related to its convertible note into 409,796 shares of the
Company's common stock. The outstanding notes also include a note in the
principal amount of $100,000 note acquired on November 5, 2003 by a subsidiary
of The South Financial Group, which owns approximately 12% of the Company's
outstanding capital stock. The Company's ability to continue operations for the
remainder of 2004 is subject to its ability to extend the maturity date of all
or substantially all of the notes that are due in June 2004. The Company intends
to initiate discussions with certain holders of the notes that are due in June
2004 to extend the maturity date of these notes. However, no assurances can be
given that the Company will be able to extend the maturity date of these notes.
Under the terms of the notes, principal and accrued interest under all of the
notes will become immediately due and payable in certain events, including
bankruptcy or similar proceedings involving the Company, a default in the
payment of principal and interest under any note, or a change in control of the
Company. If the Company is not able to extend the maturity date of substantially
all of these notes that are due in June 2004, it will be forced to consider
alternatives for winding down its business, which may include filing for
bankruptcy protection.
The Company formerly deployed its Mortgage ALM through a wholly owned
subsidiary, Surety Mortgage, Inc., ("Surety"). Surety deployed Mortgage ALMs,
processed mortgage loan applications obtained through its Mortgage ALM network,
and processed mortgage loan applications under contracts with third parties. In
the second quarter of 2001, the Company issued a $1 million note to HomeGold
Financial, Inc., which was secured by the stock of Surety. The note matured on
December 31, 2001, at which time the Company tendered the stock of Surety in
full satisfaction of outstanding principal and accrued interest under the note
in accordance with the terms of the note. The Company had previously entered
into a contract with HomeGold under which it processed certain mortgage loan
applications originated by HomeGold. Such contract expired on December 31, 2001.
The Company maintains an Internet site at http://www.affi.net, although
the contents of such web site are not incorporated into this report. In August
2003, the Company began making its annual reports on Form 10-K, quarterly
reports on Form 10-Q, and current reports on Form 8-K and any amendments to
these reports available through its web site free of charge through a link to
the SEC's web site.
The Company was incorporated as a Delaware corporation in 1994. Its
principal executive offices are located at 1053-B Sparkleberry Lane Extension,
Columbia, South Carolina 29223, and its telephone number is (803) 758-2511.
Patent Licensing Agent
On May 27, 2003, decisioning.com entered into a legal representation
agreement with Withrow & Terranova, PLLC, pursuant to which decisioning.com
appointed Withrow & Terranova, PLLC as its exclusive representative for the
solicitation and negotiation of agreements to license decisioning.com's patents.
(This arrangement replaced the former patent licensing agent agreement between
decisioning.com and Information Ventures LLC d/b/a LPS Group, which was
terminated on April 30, 2003.) Under the agreement, Withrow & Terranova, PLCC
has agreed to promote, market, solicit, and negotiate the licensing of patents
with third parties and to represent decisioning.com as legal counsel in
connection with any patent litigation associated with the enforcement of the
patents. As compensation for its services under the agreement, Withrow &
Terranova will receive 25% of all revenues received by decisioning.com under any
patent agreements and 25% of all amounts paid in settlement of any patent
litigation commenced by the Company. The term of the agreement is for the life
of the patents, subject to either party's right to terminate the agreement for
"cause," as specified in the agreement, and without cause following the third
anniversary of the agreement. If the agreement is terminated by decisioning.com,
Withrow & Terranova, PLLC will be entitled to continue to receive compensation
attributable to patent agreements negotiated prior to termination and, if such
termination is without cause, compensation for certain future patent agreements.
Competition
The market for technologies that enable electronic commerce is highly
competitive and is subject to rapid innovation and technological change,
shifting consumer preferences, frequent new product introductions and
competition from traditional methods having all or some of the same features as
technologies enabling electronic commerce. Competitors in this market have
frequently taken different strategic approaches and have launched substantially
different products or services in order to exploit the same perceived market
opportunity. Until the market actually validates a strategy through widespread
acceptance of a product or service, it is difficult to identify all current or
potential market participants. There can be no assurance that the technologies
covered by the Company's patents will be competitive technologically or
otherwise.
6
Electronic commerce technologies in general, including the methods
covered by the Company's patents, compete with traditional methods for
processing financial transactions. The success of the Company's patent licensing
efforts will depend in part on consumer acceptance of electronic commerce and
industry use of systems that are covered by the Company's patents.
Intellectual Property
The Company was issued two patents in 1999 covering systems and methods
for real-time loan processing over a computer network without human intervention
("System and Method for Real-time Loan Approval", U.S. Patent No. 5,870,721, and
"Closed-loop Financial Transaction Method and Apparatus," U.S. Patent No.
5,940,811). Both of the Company's patents covering fully automated loan
processing systems expire in 2013 and have been subject to reexamination by the
PTO due to requests by third parties who have challenged the validity of the
patents. On January 28, 2003, the Company received a Reexamination Certificate
relating to the completion of the PTO's reexamination of U. S. Patent No.
5,870,721. The reexamination of the Company's other loan processing patent (U.S.
Patent No. 5,940,811) is still ongoing. In March 2004 the Company received
notification from the PTO that it had rejected the claims of U.S. Patent No.
5,940,811. The Company intends to contest the PTO's rejection and to continue to
prosecute the reexamination of this patent. It is possible that third parties
may bring additional actions to contest all or some of the Company's patents.
The Company can make no assurances that it will not lose all or some of the
claims covered by its existing patents.
In August 2000, the Company was issued a patent covering the automated
establishment of a financial account without human intervention ("Automatic
Financial Account Processing System", U.S. Patent No. 6,105,007). The patent
expires in 2013. On March 26, 2004, the Company was notified by Federated
Department Stores, Inc. ("Federated") and Ameritrade Holding Corporation
("Ameritrade") that they had jointly filed a request with the PTO to reexamine
U. S. Patent No. 6,105,007. The Company has lawsuits pending against Federated
and Ameritrade in the Columbia Division of the United States District Court for
the State of South Carolina (the "Court") in which it claims that both Federated
and Ameritrade infringe U. S. Patent No. 6,105,007. The Company has jointly,
with Federated and Ameritrade, requested the Court to stay the lawsuits against
Federated and Ameritrade pending the PTO's determination as to whether it will
grant the reexamination request. The procedural rules of the PTO require the PTO
to make a determination as to whether it will initiate a reexamination within
three months from the date it receives the request. If the PTO grants the
reexamination request, it is likely that it will take an extended period of time
to complete the reexamination proceedings and the related litigation with
Federated and Ameritrade. Moreover, if the PTO grants the reexamination request,
it is likely such decision will have a material adverse effect on the Company's
patent licensing program and its ability to attract additional capital resources
in order to continue its operations.
The Company also holds a patent, which expires in 2014, covering the
issuance of insurance products automatically through a kiosk ("Method and
Apparatus for Issuing Insurance from a Kiosk", U.S. Patent No. 5,537,315).
"Affinity", "ALM" "DeciSys/RT", and "e-xpertLender" are registered
trademarks of the Company and "Affinity Technologies," "iDEAL," "rtDS," and
"Affinity enabled" are registered service marks of the Company.
The Company's success is completely dependent upon its ability to
defend and license its patents. There can be no assurance that the Company will
be able to protect its intellectual property. Moreover, there can be no
assurance that new technological innovations will not be developed and widely
accepted by the market which will render obsolete the types of systems and
methods over which the Company believes it has proprietary intellectual property
rights.
7
Research and Development
During 2001, the Company spent approximately $496,000 on research and
development activities, which represented approximately 38.6% of 2001 revenues
from continuing operations. The Company has eliminated its research and
development staff due to capital constraints.
Employees
At December 31, 2003, the Company employed 2 full-time employees and 2
part-time employees, compared to 3 full-time employees and 1 part-time employee
at December 31, 2002. Effective April 1, 2003, Joseph A. Boyle, President and
Chief Executive Officer of the Company, became employed by the Company on a
part-time basis. The Company has no collective bargaining agreements.
Business Risks
In addition to the other information in this report, readers should
carefully consider the following important factors, among others, that in some
cases have affected, and in the future could affect, the Company's actual
results and could cause the Company's future results to differ materially from
those expressed in any forward looking statements made by, or on behalf of, the
Company.
Limited Capital Resources; Operating Losses
The Company has generated net losses of $68,460,905 since its inception
and has financed its operations primarily through net proceeds from its initial
public offering in May 1996 and cash generated from operations and other
financing transactions. Net proceeds from the Company's initial public offering
were $60,088,516.
To date, the Company has generated substantial operating losses and has
been required to use a substantial amount of cash resources to fund its
operations. At December 31, 2003, the Company had cash and cash equivalents of
$578,398. The Company believes that its existing cash resources are sufficient
to fund its ordinary course operating expenses through the remainder of 2004.
However, the Company's ability to continue its operations for the remainder of
2004 is contingent upon the final outcome of the Company's litigation with
Temple Ligon, which is discussed below, and the ability of the Company to extend
the maturity date of all or substantially all of its convertible notes that are
due in June 2004. If the Company becomes obligated to pay more than an
insignificant amount of damages in connection with the Temple Ligon litigation
or is unable to extend the maturity date of all or substantially all of the
convertible notes that are due in June 2004, the Company will be forced to
consider alternatives for winding down its business, which may include filing
for bankruptcy protection.
To remain viable, the Company must generate working capital through the
sale of patent licenses or by raising additional capital. To date, the Company
generally has been unable to enter into licensing agreements with potential
licensees upon terms that are acceptable to the Company. As a result, the
Company has been forced to become involved in litigation with alleged
infringers. Currently, the Company is involved in three patent litigation
actions. The Company believes that these lawsuits may take an extended period of
time to complete, and no assurance can be given that the Company will have the
resources necessary to complete these lawsuits or that it will be successful in
obtaining a favorable outcome. As discussed previously, two of the alleged
infringers (Federated and Ameritrade) have notified the Company that they have
filed a request with the PTO to reexamine the Company's patent covering the
fully automated establishment of a financial account (U. S. Patent No.
6,105,007). If the PTO grants the reexamination request, it is likely that it
will take an extended period of time to complete the reexamination proceeding
and the related litigation with Federated and Ameritrade. Moreover, the
uncertainties of these litigation matters and other factors affecting the
Company's short and long-term liquidity discussed in the preceding paragraph
will likely impede the Company's ability to raise additional capital. To
maintain the minimal resources necessary to support its current operations and
execute a patent licensing strategy, the Company does not believe that
substantial additional reductions in its operating expenses are feasible. No
assurances can be given that the Company will be able to raise additional
capital or generate working capital from its patent licensing business.
8
The Company is a defendant in a lawsuit brought by Temple Ligon, who
claims that the Company breached an agreement to give him a 1% equity interest
in the Company in consideration of services he claims to have performed in 1993
and 1994 in conjunction with the formation of the Company. In January 2004, this
litigation resulted in a jury verdict against the Company of $386,148. The
Company is seeking to have the verdict overturned by the trial judge. If it is
unsuccessful in doing so, the Company intends to appeal any adverse decision. No
assurances can be given that the Company will be successful in overturning the
verdict or, if it appeals the decision, in obtaining a favorable outcome on
appeal. If the Company becomes obligated to pay more than an insignificant
amount of damages in connection with this litigation, it will be forced to
consider alternatives for winding down its business, which may include filing
for bankruptcy protection.
As of March 30, 2004, the Company had outstanding $1,206,336 in
aggregate principal amount of convertible secured notes (the "notes"). Under the
terms of these notes, principal and accrued interest is due and payable on the
second anniversary of the date on which the notes were issued. The maturity
dates for the notes outstanding as of March 30, 2004 is as follows:
Accrued Interest Total Principal and
Maturity Date Principal at Maturity Accrued Interest
June 2, 2004 $756,336 $121,014 $877,350
March 13, 2005 200,000 32,000 232,000
August 28, 2005 25,000 4,000 29,000
November 3, 2005 100,000 16,000 116,000
November 12, 2005 50,000 8,000 58,000
December 18, 2005 50,000 8,000 58,000
January 8, 2006 25,000 4,000 29,000
The notes bear interest at 8% and are collateralized by the stock of
the Company's wholly owned subsidiary, decisioning.com, Inc. decisioning.com is
the Company's patent licensing subsidiary and owns the Company's patent
portfolio. The notes are convertible into the Company's common stock at a
conversion rate of $.20 per share. The outstanding notes include a note in the
current principal amount of $131,336 issued to AMRO International, S.A.
("AMRO"). In June 2002, the Company issued to AMRO a convertible note in the
principal amount of $205,336 in satisfaction of the principal and accrued
interest outstanding under a convertible debenture previously issued by the
Company to AMRO. In October 2003, AMRO converted $74,000 of principal and $7,959
of accrued interest related to its convertible note into 409,796 shares of the
Company's common stock. The outstanding notes also include a note in the
principal amount of $100,000 note acquired November 5, 2003, by a subsidiary of
The South Financial Group, which owns approximately 12% of the Company's
outstanding capital stock. The Company's ability to continue operations for the
remainder of 2004 is subject to its ability to extend the maturity date of all
or substantially all of the notes that are due in June 2004. The Company intends
to initiate discussions with certain holders of the notes that are due in June
2004 to extend the maturity date of these notes. However, no assurances can be
given that the Company will be able to extend the maturity date of these notes.
Under the terms of the convertible notes, principal and accrued interest under
all of the notes will become immediately due and payable in certain events,
including bankruptcy or similar proceedings involving the Company, a default in
the payment of principal and interest under any note, or a change in control of
the Company. If the Company is not able to extend the maturity date of
substantially all of these notes, it will be forced to consider alternatives for
winding down its business, which may include filing for bankruptcy protection.
In order to fund its operations, the Company may need to raise
additional funds through the issuance of additional equity securities, in which
case the percentage ownership of the stockholders of the Company will be
reduced, stockholders may experience additional dilution, or such equity
securities may have rights, preferences or privileges senior to common stock.
There can be no assurance that additional financing will be available on terms
acceptable to the Company or at all. If adequate funds are not available or not
available on acceptable terms, the Company may be unable to continue operations.
9
Dependence on Patent Licensing Program
Due to capital constraints, the Company has suspended efforts to deploy
its loan processing products and services. The Company's business activities
currently consist exclusively of attempting to license certain of its patents.
The Company's prospects are dependent on its ability to finance and execute a
sustainable patent licensing program. Even though the Company believes there are
companies that may be using systems, processes and methods covered by the
Company's patents, it is not known whether the Company will be able to enter
into any new licensing agreements. Moreover, the Company may not have the
resources to sustain its patent licensing program, enforce its patent rights,
finance any related litigation, or successfully negotiate patent licenses on
terms that will generate meaningful future revenues.
The Company is further subject to the risk that negotiations to license
its patents may be lengthy and that it may be necessary for the Company to
become involved in litigation to assert and protect its intellectual property
rights. To date, the Company generally has been unable to enter into licensing
agreements with alleged licensees upon terms that are acceptable to the Company.
As a result, the Company has been forced to become involved in litigation with
alleged infringers. Currently, the Company is involved in three patent
litigation actions. The Company believes that these lawsuits may take an
extended period of time to complete. Moreover, two of the alleged infringers
(Federated and Ameritrade) have notified the Company that they have filed a
request to reexamine the Company's patent covering the fully automated
establishment of a financial account (U.S. Patent No. 6,105,007). If the PTO
grants the reexamination request, it is likely that it will take an extended
period of time to complete the reexamination proceeding and the related
litigation with Federated and Ameritrade. No assurance can be given that the
Company will have the resources necessary to complete these lawsuits or that it
will be successful in obtaining a favorable outcome. Prolonged patent litigation
or reexaminations conducted by the PTO could have a material adverse effect on
the Company's business, operating results and financial position.
Challenges to Patents
Both of the Company's patents covering fully-automated loan processing
systems have been subject to reexamination by the PTO due to requests by third
parties who have challenged the validity of the patents. On January 28, 2003,
the Company received a Reexamination Certificate relating to the completion of
the PTO's reexamination of U. S. Patent No. 5,870,721. The reexamination of the
Company's other loan processing patent (U.S. Patent No. 5,940,811) is still
ongoing. In March 2004 the Company received notification from the PTO that it
had rejected the claims of U.S. Patent No. 5,940,811. The Company intends to
contest the PTO's rejection and to continue to prosecute the reexamination of
this patent.
On March 26, 2004, the Company was notified by Federated and Ameritrade
that they had jointly filed a request with the PTO to reexamine U. S. Patent No.
6,105,007. The Company has lawsuits pending against Federated and Ameritrade in
the Columbia Division of the United States District Court for the State of South
Carolina (the "Court") in which it claims that both Federated and Ameritrade
infringe U. S. Patent No. 6,105,007. The Company has jointly, with Federated and
Ameritrade, requested the Court to stay the lawsuits against Federated and
Ameritrade pending the PTO's determination as to whether it will grant the
reexamination request. The procedural rules of the PTO require the PTO to make a
determination as to whether it will initiate a reexamination within three months
from the date it receives the request. If the PTO grants the reexamination
request, it is likely that it will take an extended period of time to complete
the reexamination proceedings and the related litigation with Federated and
Ameritrade. Moreover, if the PTO grants the reexamination request, it is likely
such decision will have a material adverse effect on the Company's patent
licensing program and its ability to attract additional capital resources in
order to continue its operations.
It is possible that third parties may bring additional actions to
contest all or some of the Company's patents. The Company can make no assurances
that it will not lose all or some of the claims covered by its existing patents.
The loss of all or some of its claims or a significant limitation of such claims
could have a material adverse effect on the Company's ability to execute a
successful patent licensing program. Moreover, if other parties request
reexaminations of or otherwise challenge the Company's patents in the future,
the Company is subject to the risk that such proceeding may not be resolved to
the Company's satisfaction on a timely basis, if at all. Any such proceeding may
have a material adverse effect on the Company's business, operating results and
financial position. Moreover, in the event a challenge to the Company's patents
results in a significant loss of all or some of its claims, the Company's only
remedy may be to contest the decision, which would likely be a lengthy process.
Due to the Company's limited capital resources, it is unlikely that the Company
could successfully contest the decision without additional cash resources.
Accordingly, a decision by the PTO to limit all or some of the Company's patent
claims could have a material adverse effect on the Company's business, operating
results and financial position.
10
Dependence on E-Commerce Technologies
The Company's patents are specific to the e-commerce businesses of the
financial services industry and generally cover the automated establishment of
loans, financial accounts and credit accounts using specific e-commerce related
systems, processes and methods. The market for products and services that enable
e-commerce is subject to change and technological development, shifting consumer
preferences, new product introductions and competition from traditional products
and services having all or some of the same features as products and services
which enable e-commerce. It is possible that new products or technologies may be
developed that may render obsolete the systems, processes and methods over which
the Company believes it has intellectual property rights. Moreover, the delivery
of products and services through e-commerce channels is not fully developed, and
competition from traditional channels to deliver these same products and
services is intense. Any wide-scale rejection of e-commerce channels by
consumers will have a material adverse effect on the Company's business,
operating results and financial position.
Dependence on Third Parties
Patent licensing is a highly technical and specialized business which
requires the Company to rely on the services of third parties. In May 2003, the
Company appointed Withrow & Terranova, PLLC as its exclusive patent licensing
agent. Under the terms of the agreement, Withrow & Terranova, PLLC has agreed,
among other things, to perform market research, initiate the sales of patent
license agreements, negotiate patent licensing arrangements with third parties,
and represent the Company as legal counsel in connection with the enforcement of
its patents. Accordingly, the Company is dependent on Withrow & Terranova, PLLC
to successfully execute its patent licensing program. Additionally, the
agreement requires Withrow & Terranova, PLLC to coordinate the engagement of
experts, on terms satisfactory to the Company, if litigation becomes necessary
to enforce the Company's patent rights. The success of the Company's patent
licensing program and enforcement of its patents may depend on the satisfactory
retention of and efforts of experts. Moreover, experts frequently request and
charge significant fees.
Potential for Fluctuation in Quarterly Results
Since its inception, the Company's quarterly results have fluctuated
and have not been susceptible to meaningful period-to-period comparisons. The
Company believes that it may continue to experience significant fluctuations in
its quarterly operating results in the foreseeable future. The Company
anticipates that its period-to-period revenue and operating results will depend
on numerous factors including the ability of the Company to successfully
negotiate and enter into patent licensing agreements and the timing, terms and
the pricing attributes of any such agreements.
The Company believes that period-to-period comparisons of its operating
results are not meaningful and should not be relied upon as an indication of
future performance. The uncertainty regarding the extent and timing of revenues
coupled with the risk of substantial fluctuations in its quarterly operating
results may have a material adverse effect on the price of the Company's Common
Stock in the future.
Dependence on Key Employees
The Company is highly dependent on the services of its Chairman,
President and Chief Executive Officer, Joseph A. Boyle, notwithstanding the fact
that he has significantly reduced his time commitment to the Company effective
April 1, 2003. The Company does not have an employment agreement with Mr. Boyle
or "key man" insurance on his life. The complete loss of the services of Mr.
Boyle could have a material adverse effect upon the Company's business,
operating results and financial condition. In addition, the Company's financial
condition would likely adversely affect the Company's ability to retain or
recruit employees and executives.
11
Risk of Substantial Dilution
The Company has issued convertible notes that are convertible into
common stock at $0.20 per share, which could be substantially less than the
market price of the common stock at the time of conversion. The issuance of
stock at a price that is less than the market price could have an immediate
adverse effect on the market price of the Company's common stock. In addition,
the Company has issued options and warrants to acquire shares of its common
stock, and the Company may issue additional warrants in connection with
financing arrangements and may grant additional stock options under its stock
option plan that may further dilute the Company's common stock. The exercise of
such warrants and options would have a dilutive effect on the Company's common
stock. Also, to the extent that persons who acquire shares under all the
foregoing agreements sell those shares in the market, the price of the Company's
shares may decrease due to additional shares in the market.
Volatility of Stock Price and Risk of Litigation
The Company's common stock price has been volatile and has experienced
substantial and sudden fluctuations in response to a number of events and
factors. In addition, the stock market has experienced significant price and
volume fluctuations that have especially affected the market prices of equity
securities of many companies directly and indirectly involved in the high
technology industry, and that often have been unrelated to the operating
performance of such companies. These broad market fluctuations have adversely
affected and may continue to adversely affect the market price of the Company's
common stock. In the past, following periods of volatility in the market price
of a company's securities, securities class action litigation has often been
instituted against such a company. Such litigation could result in substantial
costs and a diversion of management's attention and resources, which would have
a material adverse effect on the Company's business, operating results and
financial condition.
Anti-Takeover Provisions
Certain provisions of Delaware law and the Company's Certificate of
Incorporation and bylaws could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from attempting to
acquire, control of the Company. Such provisions could limit the price that
certain investors might be willing to pay in the future for shares of the
Company's common stock. These provisions of Delaware law and the Company's
Certificate of Incorporation and bylaws may also have the effect of discouraging
or preventing certain types of transactions involving an actual or threatened
change of control of the Company (including unsolicited takeover attempts), even
though such a transaction may offer the Company's stockholders the opportunity
to sell their stock at a price above the prevailing market price. Certain of
these provisions allow the Company to issue preferred stock with rights senior
to those of the common stock and other rights that could adversely affect the
interests of holders of common stock without any further vote or action by the
stockholders. The issuance of preferred stock, for example, could decrease the
amount of earnings or assets available for distribution to the holders of common
stock or could adversely affect the rights and powers, including voting rights,
of the holders of the common stock. In certain circumstances, such issuance
could have the effect of decreasing the market price of the common stock, as
well as having the anti-takeover effects discussed above.
Item 2. Properties
The Company's principal executive offices are located at 1053 B
Sparkleberry Lane Extension in Columbia, South Carolina. Such office space
encompasses approximately 1200 square feet and is currently under a
month-to-month lease. The Company also leases warehouse space located in
Columbia, South Carolina, which encompasses approximately 4000 square feet. Such
space is under a month-to-month lease.
12
Item 3. Legal Proceedings
The Company and its founder, Jeff Norris, are defendants in a lawsuit
filed by Temple Ligon on November 30, 1996 in the Court of Common Pleas for the
County of Richland in Columbia, South Carolina. Mr. Ligon claims, among other
things, that the Company and Mr. Norris breached an agreement to give him a 1%
equity interest in the Company in consideration of services Mr. Ligon claims to
have performed in 1993 and 1994 in conjunction with the formation of the
Company, and seeks monetary damages of $5,463,000. This lawsuit initially
resulted in a jury verdict against the Company of $68,000. However, Mr. Ligon
subsequently requested and was granted a new trial. In January 2004, this
lawsuit resulted in another jury verdict against the Company of $386,148. The
Company has filed a motion to have the verdict overturned by the trial judge. If
it is unsuccessful in doing so, the Company intends to appeal any adverse
decision. The Company believes that it has meritorious defenses to the claims
made by Mr. Ligon and intends to vigorously defend itself. However, no
assurances can be given that the Company will be successful in overturning the
verdict or, if it appeals the decision, in obtaining a favorable outcome on
appeal. If the Company becomes obligated to pay more than an insignificant
amount of damages in connection with this litigation, it will be forced to
consider alternatives for winding down its business, which may include filing
for bankruptcy protection.
In June 2003, the Company filed a lawsuit against Federated Department
Stores, Inc., and certain of its subsidiaries alleging that Federated has
infringed one of the Company's patents (U. S. Patent No. 6,105,007). In
September 2003, the Company filed a similar lawsuit against Ameritrade Holding
Corporation and its subsidiary, Ameritrade, Inc., alleging infringement of the
same patent. Both lawsuits were filed in the United States District Court in
Columbia, South Carolina, and both seek unspecified damages. On March 26, 2004,
the Company was notified by Federated and Ameritrade that they had jointly filed
a request with the PTO to reexamine U. S. Patent No. 6,105,007. The Company has
jointly, with Federated and Ameritrade, requested the Court to stay the lawsuits
against Federated and Ameritrade pending the PTO's determination as to whether
it will grant the reexamination request. The procedural rules of the PTO require
the PTO to make a determination as to whether it will initiate a reexamination
within three months from the date it receives the request. If the PTO grants the
reexamination request, it is likely that it will take an extended period of time
to complete the reexamination proceedings, and it is likely that the pending
lawsuits against Federated and Ameritrade will be stayed until the reexamination
proceedings are completed.
In November 2003, Household International, Inc. filed a declaratory
judgment action against the Company in United States District Court in
Wilmington, Delaware. In its complaint Household requested the court to rule
that Household was not infringing any of the claims of the Company's patents
(U.S. Patent No. 5,870,721 C1, No. 5,940,811, and No. 6,105,007) and that the
patents were not valid. The company filed counterclaims against Household
claiming that Household infringes U.S. Patent Nos. 5,870,721 C1, 5,940,811 and
6,105,007.
On December 13, 2003, The Company resolved its pending litigation
against Citibank, N.A. The lawsuit arose out of a contract between Affinity and
Citibank with regard to the development of an automobile loan processing system.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Executive Officers of the Registrant
Name Age Position with the Company
Joseph A. Boyle 50 Chairman, President, Chief Executive Officer,
and Chief Financial Officer
S. Sean Douglas 35 Executive Vice President and Chief Operating
Officer
13
Joseph A. Boyle became President and Chief Executive Officer of the
Company in January 2000 and Chairman in March 2001. Mr. Boyle has also served as
Chief Financial Officer of the Company since September 1996. Mr. Boyle also held
the title of Senior Vice President from September 1996 to January 2000. Mr.
Boyle has previously served as Secretary and Treasurer of the Company. Effective
April 1, 2003, Mr. Boyle significantly reduced his time commitment to the
Company and was admitted as a partner with Elliott Davis, LLC, a South Carolina
public accounting firm. Prior to joining the Company, Mr. Boyle served as Price
Waterhouse, LLP's engagement partner for most of its Kansas City, Missouri,
financial services clients and was a member of the firm's Mortgage Banking
Group. Mr. Boyle was employed by Price Waterhouse, LLP from June 1982 to August
1996.
S. Sean Douglas became Executive Vice President and Chief Operating Officer of
the Company in March 2003. Mr. Douglas also held the title of Senior Vice
President of Finance, Operations and Administration of the Company from March
2002 to March 2003. From January 2000 to March 2002, Mr. Douglas held the title
of Vice President and Controller of the Company. From November 1995 to January
2000 Mr. Douglas was the Company's accounting manager.
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and
Issuer Purchases of Equity Securities
(a) Since February 12, 2001, the Company's common stock has traded on the
OTC Bulletin Board under the symbol "AFFI." The Company's common stock
traded on the Nasdaq SmallCap Market from March 27, 2000 to February
12, 2001. Prior to March 27, 2000, the Company's common stock was
traded on the Nasdaq National Market. The following table presents the
high and low sales prices of the Company's Common Stock for the
periods indicated during 2003 and 2002 as reported by the OTC Bulletin
Board. As of March 10, 2004, there were 435 stockholders of record of
the Common Stock.
Sales Price Per Share
High Low
2003
First Quarter 0.27 0.09
Second Quarter 0.23 0.15
Third Quarter 0.19 0.12
Fourth Quarter 0.17 0.09
2002
First Quarter 0.13 0.06
Second Quarter 0.11 0.06
Third Quarter 0.10 0.06
Fourth Quarter 0.23 0.05
The Company has never paid dividends on its capital stock. The Company
intends to retain earnings, if any, for use in its business and does
not anticipate paying any cash dividends in the foreseeable future.
(b) On October 7, 2003, AMRO International, S.A. converted $74,000
principal amount and $7,959 of accrued interest under an 8%
convertible note issued by the Company to AMRO into an aggregate of
409,796 shares of the Company's common stock. Under the terms of the
note, principal and interest converted into shares of common stock at
$.20 per share. Such shares were issued by the Company in reliance on
an exemption from registration set forth in Section 3(a)(9)of the
Securities Act of 1933.
14
Item 6. Selected Financial Data
The following table presents selected financial data of the Company for
the periods indicated. The following financial data should be read in
conjunction with the information set forth under "Management's Discussion and
Analysis of Financial Condition and Results of Operations," the Company's
Consolidated Financial Statements and Notes thereto and other information
included elsewhere in this report.
Year Ended December 31,
2003 2002 2001 2000 1999
----------------------------------------------------------------
Statement of Operations Data:
Revenues $517,647 $185,960 $1,285,944 $1,723,075 $2,477,877
Cost and expenses:
Cost of revenues 1,765 16,846 63,751 344,931 2,068,229
Research and development - - 496,441 683,600 1,870,509
Impairment loss - - 448,945 2,608,773 -
Selling, general and
administrative expenses 996,711 1,406,841 3,847,807 6,791,767 10,548,539
----------------------------------------------------------------
Total costs and expenses 998,476 1,423,687 4,856,944 10,429,071 14,487,277
----------------------------------------------------------------
Operating loss (480,829) (1,237,727) (3,571,000) (8,705,996) (12,009,400)
Interest income 694 1,643 10,101 64,155 305,362
Interest expense (80,373) (70,334) (115,557) (26,277) -
----------------------------------------------------------------
Loss from continuing
operations (560,508) (1,306,418) (3,676,456) (8,668,118) (11,704,038)
Income (loss) from operations
of discontinued subsidiary - - 467,188 (534,978) (390,598)
Gain on disposal of subsidiary - - 891,569 - -
----------------------------------------------------------------
Net loss $(560,508) $(1,306,418) $(2,317,699) $(9,203,096)$(12,094,636)
================================================================
Loss per share - basic and
diluted
Continuing operations $(0.01) $(0.03) $(0.10) $(0.29) $(0.39)
================================================================
Net loss per share $(0.01) $(0.03) $(0.06) $(0.30) $(0.41)
================================================================
Shares used in computing
net loss per share 41,512,897 40,707,108 38,004,089 30,242,054 29,738,459
================================================================
15
December 31,
2003 2002 2001 2000 1999
--------------------------------------------------------------------
Balance Sheet Data:
Cash and cash equivalents $578,398 $156,780 $27,720 $646,198 $2,116,016
Short-term investments - - - - 1,474,949
Working capital (909,356) (82,512) 117,477 2,216,854 4,637,238
Net investment in sales-type
leases, less current portion - - - - 249,830
Total assets 618,002 234,848 927,657 5,638,453 13,129,528
Convertible debenture - - 225,090 (1) 951,456 951,456
Convertible notes 1,181,336 (2) 830,336 - - -
Capital stock of subsidiary
held by minority investor - - - 22,668 -
Stockholder's equity
(deficiency) (1,329,579) (908,230) 343,438 2,326,314 10,670,980
- ----------------------------
(1) Amounts outstanding under the convertible debeture as of December 31, 2001
were classified as a current liability and, accordingly are included in the
working capital of the Company at December 31, 2001, set forth above.
(2) $756,336 of the amount outstanding under the convertible notes as of
December 31, 2003 was classified as a current liability and, accordingly
is included in the working capital of the Company at December 31, 2003,
set forth above.
16
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The Company was formed in 1994 to develop and market technologies that
enable financial institutions and other businesses to provide consumer financial
services electronically with reduced or no human intervention. Due to capital
constraints, the Company has suspended efforts to deploy products and services
that use its loan processing system, DeciSys/RT, in order to focus its efforts
exclusively on licensing certain of its patents.
In conjunction with its product development activities, the Company
applied for and obtained three patents. The Company has been granted two patents
covering its fully-automated loan processing systems (U. S. Patents No.
5,870,721 and 5,940,811). In August 2000, the U.S. Patent and Trademark Office
issued to the Company a patent covering the fully-automated establishment of a
financial account, including credit accounts (U.S. Patent No. 6,105,007). In
addition, in 1997 the Company acquired a patent that covers the automated
processing of an insurance binder through a kiosk (U. S. Patent No. 5,537,315).
Both of the Company's patents covering fully automated loan
processing systems have been subject to reexamination by the U.S. Patent and
Trademark Office (the "PTO") due to challenges to such patents by third parties.
On January 28, 2003, the Company received a Reexamination Certificate (U. S.
Patent No. 5,870,721 C1) from the PTO which formally concluded the reexamination
of U. S. Patent No. 5,870,721. The reexamination of the Company's other loan
processing patent (U. S. Patent No. 5,940,811) is still ongoing. In March 2004
the Company received notification from the PTO that it had rejected the claims
of U.S. Patent No. 5,940,811. The Company intends to contest the PTO's rejection
and to continue to prosecute the reexamination of this patent.
On March 26, 2004, the Company was notified by Federated Department
Stores, Inc. ("Federated") and Ameritrade Holding Corporation ("Ameritrade")
that they had jointly filed a request with the PTO to reexamine U. S. Patent No.
6,105,007. The Company has lawsuits pending against Federated and Ameritrade in
the Columbia Division of the United States District Court for the State of South
Carolina (the "Court") in which it claims that both Federated and Ameritrade
infringe U. S. Patent No. 6,105,007. The Company has jointly, with Federated and
Ameritrade, requested the Court to stay the lawsuits against Federated and
Ameritrade pending the PTO's determination as to whether it will grant the
reexamination request. The procedural rules of the PTO require the PTO to make a
determination as to whether it will initiate a reexamination within three months
from the date it receives the request. If the PTO grants the reexamination
request, it is likely that it will take an extended period of time to complete
the reexamination proceedings and the related litigation with Federated and
Ameritrade. Moreover, if the PTO grants the reexamination request, it is likely
such decision will have a material adverse effect on the Company's patent
licensing program and its ability to attract additional capital resources in
order to continue its operations.
It is possible that third parties may bring additional actions to
contest all or some of the Company's patents. The Company can make no assurances
that it will not lose all or some of the claims covered by its existing patents.
To date, the Company has generated substantial operating losses and has
been required to use a substantial amount of cash resources to fund its
operations. At December 31, 2003, the Company had cash and cash equivalents of
$578,398. The Company believes that its existing cash resources are sufficient
to fund its ordinary course operating expenses through the remainder of 2004.
However, the Company's ability to continue its operations for the remainder of
2004 is contingent upon the final outcome of the Company's litigation with
Temple Ligon, which is discussed below, and the ability of the Company to extend
the maturity date of all or substantially all of its convertible notes that are
due in June 2004. If the Company becomes obligated to pay more than an
insignificant amount of damages in connection with the Temple Ligon litigation
or is unable to extend the maturity date of all or substantially all of the
convertible notes that are due in June 2004, the Company will be forced to
consider alternatives for winding down its business, which may include filing
for bankruptcy protection.
To remain viable, the Company must generate working capital through the
sale of patent licenses or by raising additional capital. To date, the Company
generally has been unable to enter into licensing agreements with potential
licensees upon terms that are acceptable to the Company. As a result, the
Company has been forced to become involved in litigation with alleged
infringers. Currently, the Company is involved in three patent litigation
actions. The Company believes that these lawsuits may take an extended period of
time to complete, and no assurance can be given that the Company will have the
resources necessary to complete these lawsuits or that it will be successful in
obtaining a favorable outcome. As discussed previously, two of the alleged
infringers (Federated and Ameritrade) have notified the Company that they have
filed a request with the PTO to reexamine the Company's patent covering the
fully automated establishment of a financial account (U. S. Patent No.
6,105,007). If the PTO grants the reexamination request, it is likely that it
will take an extended period of time to complete the reexamination proceedings
and the related litigation with Federated and Ameritrade. Moreover, the
uncertainties of these litigation matters and other factors affecting the
Company's short and long-term liquidity discussed in the preceding paragraph
will likely impede the Company's ability to raise additional capital. To
maintain the minimal resources necessary to support its current operations and
execute a patent licensing strategy, the Company does not believe that
substantial additional reductions in its operating expenses are feasible. No
assurances can be given that the Company will be able to raise additional
capital or generate working capital from its patent licensing business.
17
The Company is a defendant in a lawsuit brought by Temple Ligon, who
claims that the Company breached an agreement to give him a 1% equity interest
in the Company in consideration of services he claims to have performed in 1993
and 1994 in conjunction with the formation of the Company. In January 2004, this
litigation resulted in a jury verdict against the Company of $386,148. The
Company is seeking to have the verdict overturned by the trial judge. If it is
unsuccessful in doing so, the Company intends to appeal any adverse decision. No
assurances can be given that the Company will be successful in overturning the
verdict or, if it appeals the decision, in obtaining a favorable outcome on
appeal. If the Company becomes obligated to pay more than an insignificant
amount of damages in connection with this litigation, it will be forced to
consider alternatives for winding down its business, which may include filing
for bankruptcy protection.
As of March 30, 2004, the Company had outstanding $1,206,336 in
aggregate principal amount of convertible secured notes (the "notes"). Under the
terms of these notes, principal and accrued interest is due and payable on the
second anniversary of the date on which the notes were issued. The maturity
dates for the notes outstanding as of March 30, 2004 is as follows:
Accrued Interest Total Principal and
Maturity Date Principal at Maturity Accrued Interest
June 2, 2004 $756,336 $121,014 $877,350
March 13, 2005 200,000 32,000 232,000
August 28, 2005 25,000 4,000 29,000
November 3, 2005 100,000 16,000 116,000
November 12, 2005 50,000 8,000 58,000
December 18, 2005 50,000 8,000 58,000
January 8, 2006 25,000 4,000 29,000
The notes bear interest at 8% and are collateralized by the stock of
the Company's wholly owned subsidiary, decisioning.com, Inc. decisioning.com is
the Company's patent licensing subsidiary and owns the Company's patent
portfolio. The notes are convertible into the Company's common stock at a
conversion rate of $.20 per share. The outstanding notes include a note in the
current principal amount of $131,336 issued to AMRO International, S.A.
("AMRO"). In June 2002, the Company issued to AMRO a convertible note in the
principal amount of $205,336 in satisfaction of the principal and accrued
interest outstanding under a convertible debenture previously issued by the
Company to AMRO. In October 2003, AMRO converted $74,000 of principal and $7,959
in accrued interest related to its convertible note into 409,796 shares of the
Company's common stock. The outstanding notes also include a note in the
principal amount of $100,000 note acquired on November 5, 2003 by a subsidiary
of The South Financial Group, which owns approximately 12% of the Company's
outstanding capital stock. The Company's ability to continue operations for the
remainder of 2004 is subject to its ability to extend the maturity date of all
or substantially all of the notes that are due in June 2004. The Company intends
to initiate discussions with certain holders of the notes that are due in June
2004 to extend the maturity date of these notes. However, no assurances can be
given that the Company will be able to extend the maturity date of these notes.
Under the terms of the notes, principal and accrued interest under
all of the notes will become immediately due and payable in certain events,
including bankruptcy or similar proceedings involving the Company, a default in
the payment of principal and interest under any note, or a change in control of
the Company. If the Company is not able to extend the maturity date of
substantially all of these notes, it will be forced to consider alternatives for
winding down its business which may include filing for bankruptcy protection.
18
Critical Accounting Policies
The Company applies certain accounting policies which are critical in
understanding the Company's results of operations and the information presented
in the consolidated financial statements. We consider critical accounting
policies to be those that require more significant judgments and estimates in
the preparation of our financial statements and include the following: (1)
valuation of long-lived assets; and, (2) valuation reserve on net deferred tax
assets.
Valuation of Long-Lived Assets
The Company annually evaluates the carrying value of long-lived assets,
including property and equipment and goodwill. Goodwill results from business
acquisitions and is initially recorded at the excess of the purchase price over
the fair value of net identifiable assets acquired. Prior to 2001, the Company
amortized goodwill over ten years. Management must make certain judgments when
estimating and recording impairment charges. Such judgments are typically based
on their plans to utilize or sell long-lived assets, the current market value of
such assets, and in the case of goodwill, management's plans and strategies to
continue business lines the Company previously acquired. To the extent that the
carrying value of long-lived assets is greater than the Company's estimates of
the undiscounted cash flows associated with the asset, the Company records an
impairment charge equal to the excess of carrying value over the asset's fair
value. The Company recognized an impairment loss of $448,945 in 2001 associated
with the remaining balance of goodwill previously recorded by the Company and
certain other long-lived assets.
Valuation Reserve on Net Deferred Tax Assets
The Company records a valuation allowance to reduce its deferred tax
assets to the amount that it estimates is more likely than not to be realized.
As of December 31, 2003, the Company recorded a valuation allowance that reduced
its deferred tax assets to equal its deferred tax liability.
Results of Operations
Revenues. The Company's revenues from continuing operations were
$517,647, $185,960, and $1,285,944 for the years ended December 31, 2003, 2002,
and 2001, respectively. The types of revenue recognized by the Company in the
years ended December 31, 2003, 2002, and 2001, are as follows:
Years ended December 31,
2003 2002 2001
---------------------------- --------------------------- ---------------------------
% of % of % of
Amount Total Amount Total Amount Total
--------------- -------- -------------- -------- --------------- --------
Transaction fees $ - - $ 104,878 56.4 $ 265,666 20.7
Professional services fees - - - - 249,871 19.4
Patent license revenue 17,647 3.4 25,000 13.4 20,000 1.6
Other income 500,000 96.6 56,082 30.2 750,407 58.3
--------------- -------- -------------- -------- --------------- --------
$ 517,647 100.0 $ 185,960 100.0 $ 1,285,944 100.0
=============== ======== ============== ======== =============== ========
Transaction fees. The Company recognized no transaction fee revenue in
2003. During 2002 and 2001 the Company provided transaction processing services
to one customer that used the Company's e-xpertLender system. The contract with
the customer terminated in October 2002. The decrease in transaction fees in
2002 compared to 2001 is attributable to the customer's migration to another
system during 2002 and the termination of the contract in October 2002.
19
Professional services fees. Previously, when the Company agreed to
provide professional services to customize its core technology to conform to a
specific customer request, the Company generally entered into a contract with
the customer for the performance of these services which typically defined
deliverables, specific delivery and acceptance dates and specified fees for such
services. Upon completion and acceptance of the specific deliverables by the
customer, the Company recognized the corresponding revenue as professional
services revenue. Because the Company has suspended efforts to deploy its loan
processing systems, it performed no professional services in 2003 or 2002, and
accordingly, recognized no revenue associated with such activities. Moreover, it
does not anticipate that it will earn professional service fees in the future.
In 2001, the Company recognized $249,871 of professional services fees, which
were primarily associated with services rendered under one contract. Most of the
services were performed during 2000 and the associated revenue was deferred
until 2001 and recognized upon termination of the contract.
Patent license revenue. In 2003, 2002 and 2001, the Company recognized
patent licensing revenue associated with the annual fee from one patent license
agreement executed in 1999.
Other income. In 2003, other income related exclusively to amounts
received by the Company as a result of the settlement of a lawsuit. In 2002 and
2001, other income consisted primarily of non-recurring miscellaneous income
items and certain insignificant recurring income items such as fees charged for
the routine maintenance of products in service. In 2001, other income also
included $640,000 related to the settlement of a lawsuit. The decrease in other
income in 2002 compared to 2001 is primarily attributable to an overall
reduction in the Company's business activities in 2002 compared with 2001 and
the settlement of a lawsuit in 2001.
Costs and Expenses
Costs of Revenues. Costs of revenues from continuing operations for the
years ended December 31, 2003, 2002, and 2001 were $1,765, $16,846, and $63,751,
respectively. Cost of revenues includes the direct costs associated with the
generation of specific types of revenue and the allocation of certain indirect
costs when such costs are specifically identifiable and allocable to revenue
producing activities. During the three years ended December 31, 2003, the nature
and amounts of costs, as well as gross profit margins, associated with certain
revenue producing activities varied significantly due to changes in the nature
of the services offered by the Company and due to different pricing structures
offered to certain customers.
Costs of revenues and the percentage of the costs of revenues to total
costs of revenues for the years ended December 31, 2003, 2002, and 2001 are as
follows:
Year ended December 31,
2003 2002 2001
--------------------------- -------------------------- --------------------------------
% of % of % of
Amount Total Amount Total Amount Total
--------------- -------- -------------- ------- -------------- -------------
Transaction fees $ - - $ 14,346 85.2 $ 46,347 72.7
Professional services fees - - - - 15,404 24.2
Patent license revenue 1,765 100.0 2,500 14.8 2,000 3.1
--------------- -------- -------------- ------- -------------- -------------
$ 1,765 100.0 $ 16,846 100.0 $ 63,751 100.0
=============== ======== ============== ======= ============== =============
Costs of transaction fees. The Company had no cost of transaction fees
in 2003. In 2002 and 2001, the cost of transaction fees consisted primarily of
the direct costs incurred by the Company to process loan applications through
its systems. Such direct costs were associated with services provided by third
parties and included the cost of credit reports, fraud reports and
communications networks used by the Company. During 2002 and 2001, the Company
provided transaction processing services to one customer that used the Company's
e-xpertLender system. The contract with the customer terminated in October 2002.
The decrease in the cost of transaction fees in 2002 compared to 2001 is
attributable to the customer's migration to another system during 2002 and the
termination of the contract in October 2002.
20
Costs of professional services fees. The Company had no cost of
professional services fees in 2003 or 2002. In 2001, the costs of professional
services fees consisted of the costs of the direct labor and the allocation of
certain indirect costs associated with performing software and system
customization services under one contract. In 2003 and 2002, the Company
provided no professional services.
Costs of patent license revenue. Costs of patent license revenue
recognized in 2003, 2002, and 2001 consist of the patent licensing agent's
commissions.
Research and Development. The Company accounts for research and
development costs as operating costs and expenses such costs in the period
incurred. In accordance with Statement of Financial Accounting Standards No. 86
("SFAS 86"), "Computer Software to be Sold, Leased or Otherwise Marketed," the
Company capitalizes software costs incurred in the development of a software
application after the technological feasibility of the application has been
established. Technological feasibility is established when an application design
and a working model of the application have been completed and the completeness
of the working model and its consistency with the application design have been
confirmed by testing. From the time technological feasibility is established
until the time the relevant application is available for general release to
customers, software development costs incurred are capitalized at the lower of
cost or net realizable value. Thereafter, costs related to the application are
again expensed as incurred. Capitalized software development costs are amortized
using the greater of the revenue curve or straight-line method over the
estimated economic life of the application. Software costs capitalized include
direct labor, other costs directly associated with the development of the
related application and an allocation of indirect costs, primarily facility
costs and other costs associated with the Company's software development staff.
The Company bases such allocation on the percentage of the Company's total labor
costs represented by the software development labor costs.
In conjunction with the Company's suspension of its efforts to further
develop and market its software products and services, the Company suspended all
research and development activities. Accordingly, the Company recognized no
expenses associated with research and development activities in 2003 and 2002.
Research and development expenses for the year ended December 31, 2001, were
$496,441. The Company capitalized no costs associated with software development
in 2003, 2002, and 2001.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses related to continuing operations for the year
ended December 31, 2003, were $996,711, compared to $1,406,841 and $3,847,807
for the years ended December 31, 2002 and 2001, respectively.
SG&A expenses during 2003 consisted primarily of personnel expense of
approximately $266,000; professional fees of approximately $269,000;
depreciation and amortization expense of approximately $15,000; rent expense of
approximately $54,000; insurance and taxes of approximately $72,000; and
litigation accruals of approximately $318,000.
SG&A expenses during 2002 consisted primarily of personnel expense of
approximately $434,000; professional fees of approximately $303,000;
depreciation and amortization expense of approximately $138,000; rent expense of
approximately $101,000; and insurance and taxes of approximately $159,000.
SG&A expenses during 2001 consisted primarily of personnel expense of
approximately $787,000; professional fees of approximately $470,000;
depreciation and amortization expense of approximately $570,000; and rent
expense of approximately $312,000.
The decrease in SG&A in 2003 compared to 2002 and 2002 compared to 2001
is due the continued reduction of the Company's workforce over the past three
years and curtailment of other expenses. SG&A expenses were lower in all
material categories in 2003 compared to 2002, except for litigation accruals,
and in 2002 compared to 2001.
Impairment Loss. The Company periodically evaluates the carrying value
of long-lived assets to be held and used, including property and equipment and
goodwill. In accordance with its evaluation, the Company recorded an impairment
loss of $448,945 in 2001. In 2001, the impairment loss was primarily associated
with goodwill the Company had previously recorded in conjunction with the
acquisition of an insurance-related business which included rights to a patent.
In 2001, the Company was unsuccessful in obtaining expanded rights associated
with its insurance patent and accordingly wrote off all amounts previously
recorded as goodwill. Impairment losses included charges taken by the Company to
reduce the carrying value of property and equipment and goodwill. The Company
did not record any impairment losses in 2002 or 2003.
21
Interest Income
Interest income associated with continuing operations was $694, $1,643,
and $10,101 during 2003, 2002, and 2001, respectively, and primarily reflects
interest income attributable to short-term investments. The decrease in interest
income in 2003 compared to 2002 and in 2002 compared to 2001 is primarily
attributed to the decrease in average cash balances maintained during the year.
Interest Expense
Interest expense associated with continuing operations was $80,373,
$70,334, and $115,557 in 2003, 2002, and 2001, respectively. Interest expense is
primarily associated with the issuance of a $1 million convertible debenture in
November 2000 that was satisfied on June 3, 2002, the issuance of a $1 million
note in July 2001 that was satisfied in December 2001, and the issuance of
$1,255,336 aggregate principal amount of convertible notes in installments in
June 2002 ($830,336), March 2003 ($200,000), August 2003 ($25,000), November
2003 ($150,000), and December 2003 ($50,000), which notes are currently
outstanding. The increase in interest expense in 2003 compared to 2002 is
attributable to the recognition of a full year of interest on the convertible
notes issued in June 2002 and interest associated with the issuance of
additional convertible notes in 2003 in the aggregate principal amount of
$425,000. The decrease in interest expense in 2002 compared with 2001 is
attributable to the liquidation in December 2001 of the $1 million note issued
in July 2001 and a reduction of amounts outstanding under the $1 million
convertible debenture. The decrease was offset by interest expense associated
with the issuance of $830,336 principal amount of convertible notes in June
2002.
Income (Loss) from Operations of Discontinued Subsidiary and Gain on Disposal of
Subsidiary
In July 2001, the Company issued a $1 million note to HomeGold
Financial, Inc., which note was collateralized by the stock of Surety Mortgage,
Inc., the Company's wholly-owned mortgage banking subsidiary. On December 31,
2001, in accordance with the terms of the note, the Company tendered the stock
of Surety to HomeGold in full satisfaction of the $1 million note and accrued
interest of $25,511. The Company accounted for the transaction as the disposal
of a segment of a business and has reported the operations of Surety as a
separate component of loss for 2001. Similarly, the gain of $891,569 which the
Company recognized is also reported as a separate component of net loss in 2001.
The components of Surety's operations for 2001 are as follows:
Year Ended December 31,
2001
------------------------
Mortgage revenue $2,851,720
Cost of revenue (1,008,266)
S G & A (1,378,366)
------------------------
Total cost and expenses (2,386,632)
------------------------
465,088
Net interest income 2,100
------------------------
Net income $467,188
========================
22
Surety was formed to deploy and test the Company's automated mortgage loan
application system ("Mortgage ALM"), and engaged in mortgage brokerage
activities which involved originating, processing and selling mortgage loans to
outside investors. Surety originated and processed mortgage loans directly with
consumers or on behalf of correspondents, and immediately sold such loans to
institutions that sponsor the loan programs offered by Surety. Surety only
offered loans that would be acquired by such institutions under such programs.
Upon making the loan commitment to the borrower, Surety immediately received a
commitment from an institution to acquire the loan upon closing. Mortgage
revenue included gains on sales of mortgage loans to institutions, loan fees
received for originating and processing the loan and fees charged to third
parties for processing services pursuant to certain contracts Surety entered
into during 2000 and 2001. Loan origination fees and all other direct costs
associated with originating loans were recognized at the time the loans were
sold.
Income Taxes
The Company has recorded a valuation allowance for the full amount of
its net deferred income tax assets as of December 31, 2003, 2002, and 2001,
based on management's evaluation of the recognition criteria as set forth in
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes."
Liquidity and Capital Resources
The Company has generated net losses of $68,460,905 since its inception
and has financed its operations primarily through net proceeds from its initial
public offering in May 1996 and cash generated from operations and other
financing transactions. Net proceeds from the Company's initial public offering
were $60,088,516.
To date, the Company has generated substantial operating losses and has
been required to use a substantial amount of cash resources to fund its
operations. At December 31, 2003, the Company had cash and cash equivalents of
$578,398. The Company believes that its existing cash resources are sufficient
to fund its ordinary course operating expenses through the remainder of 2004.
However, the Company's ability to continue its operations for the remainder of
2004 is contingent upon the final outcome of the Company's litigation with
Temple Ligon, which is discussed below, and the ability of the Company to extend
the maturity date of all or substantially all of its convertible notes that are
due in June 2004. If the Company becomes obligated to pay more than an
insignificant amount of damages in connection with the Temple Ligon litigation
or is unable to extend the maturity date of all or substantially all of the
convertible notes that are due in June 2004, the Company will be forced to
consider alternatives for winding down its business, which may include filing
for bankruptcy protection.
To remain viable, the Company must generate working capital through the
sale of patent licenses or by raising additional capital. To date, the Company
generally has been unable to enter into licensing agreements with potential
licensees upon terms that are acceptable to the Company. As a result, the
Company has been forced to become involved in litigation with alleged
infringers. Currently, the Company is involved in three patent litigation
actions. The Company believes that these lawsuits may take an extended period of
time to complete, and no assurance can be given that the Company will have the
resources necessary to complete these lawsuits or that it will be successful in
obtaining a favorable outcome. As discussed previously, two of the alleged
infringers (Federated and Ameritrade) have notified the Company that they have
filed a request with the PTO to reexamine the Company's patent covering the
fully automated establishment of a financial account (U. S. Patent No.
6,105,007). If the PTO grants the reexamination request, it is likely that it
will take an extended period of time to complete the reexamination proceeding
and the related litigation with Federated and Ameritrade. Moreover, the
uncertainties of these litigation matters and other factors affecting the
Company's short and long-term liquidity discussed in the preceding paragraph
will likely impede the Company's ability to raise additional capital. To
maintain the minimal resources necessary to support its current operations and
execute a patent licensing strategy, the Company does not believe that
substantial additional reductions in its operating expenses are feasible. No
assurances can be given that the Company will be able to raise additional
capital or generate working capital from its patent licensing business.
The Company is a defendant in a lawsuit brought by Temple Ligon, who
claims that the Company breached an agreement to give him a 1% equity interest
in the Company in consideration of services he claims to have performed in 1993
and 1994 in conjunction with the formation of the Company. In January 2004, this
litigation resulted in a jury verdict against the Company of $386,148. The
Company is seeking to have the verdict overturned by the trial judge. If it is
unsuccessful in doing so, the Company intends to appeal any adverse decision. No
assurances can be given that the Company will be successful in overturning the
verdict or, if it appeals the decision, in obtaining a favorable outcome on
appeal. If the Company becomes obligated to pay more than an insignificant
amount of damages in connection with this litigation, it will be forced to
consider alternatives for winding down its business which may include filing for
bankruptcy protection.
23
As of March 30, 2004, the Company had outstanding $1,206,336 in
aggregate principal amount of convertible secured notes (the "notes"). Under the
terms of these notes, principal and accrued interest is due and payable on the
second anniversary of the date on which the notes were issued. The maturity
dates for the notes outstanding as of March 30, 2004 is as follows:
Accrued Interest Total Principal and
Maturity Date Principal at Maturity Accrued Interest
June 2, 2004 $756,336 $121,014 $877,350
March 13, 2005 200,000 32,000 232,000
August 28, 2005 25,000 4,000 29,000
November 3, 2005 100,000 16,000 116,000
November 12, 2005 50,000 8,000 58,000
December 18, 2005 50,000 8,000 58,000
January 8, 2006 25,000 4,000 29,000
The notes bear interest at 8% and are collateralized by the stock of
the Company's wholly owned subsidiary, decisioning.com, Inc. decisioning.com is
the Company's patent licensing subsidiary and owns the Company's patent
portfolio. The notes are convertible into the Company's common stock at a
conversion rate of $.20 per share. The outstanding notes include a note in the
current principal amount of $131,336 issued to AMRO International, S.A.
("AMRO"). In June 2002, the Company issued to AMRO a convertible note in the
principal amount of $205,336 in satisfaction of the principal and accrued
interest outstanding under a convertible debenture previously issued by the
Company to AMRO. In October 2003, AMRO converted $74,000 of principal and $7,959
of accrued interest related to its convertible note into 409,796 shares of the
Company's common stock. The outstanding notes also include a note in the
principal amount of $100,000 note acquired on November 5, 2003 by a subsidiary
of The South Financial Group, which owns approximately 12% of the Company's
outstanding capital stock. The Company's ability to continue operations for the
remainder of 2004 is subject to its ability to extend the maturity date of all
or substantially all of the notes that are due in June 2004. The Company intends
to initiate discussions with certain holders of the notes that are due in June
2004 to extend the maturity date of these notes. However, no assurances can be
given that the Company will be able to extend the maturity date of these notes.
Under the terms of the notes, principal and accrued interest will become
immediately due and payable in certain events, including bankruptcy or similar
proceedings involving the Company, a default in the payment of principal and
interest under any note, or a change in control of the Company. If the Company
is not able to extend the maturity date of substantially all of these notes, it
will be forced to consider alternatives for winding down its business, which may
include filing for bankruptcy protection.
In the second quarter of 2001, the Company issued a $1 million note to
HomeGold Financial, Inc., which was secured by the stock of its wholly owned
mortgage subsidiary, Surety Mortgage, Inc. The note matured on December 31,
2001, at which time the Company tendered the stock of Surety in full
satisfaction of outstanding principal and accrued interest under the note in
accordance with the terms of the note. The Company had previously entered into a
contract with HomeGold under which it processed certain mortgage loan
applications originated by HomeGold. Such contract expired on December 31, 2001.
On September 22, 2000, the Company entered into a convertible debenture
and warrants purchase agreement with AMRO International, S.A. ("AMRO"). Under
the agreement on November 22, 2000, the Company issued to AMRO an 8% convertible
debenture in the principal amount of $1,000,000. The debenture was convertible,
at the option of AMRO, into shares of the Company's common stock at a price
equal to the lesser of $1.00 per share or 65% of the average of the three lowest
closing prices of the Company's stock during the month prior to conversion. AMRO
exercised a portion of the debenture into an aggregate of 6,214,665 shares of
the Company's stock. In June 2002, the Company issued to AMRO an 8% convertible
secured note in the principal amount of $205,336 in full satisfaction of amounts
outstanding under its convertible debenture. The terms of the 8% convertible
secured notes are discussed above.
24
Net cash used during the year ended December 31, 2003, to fund
operations was approximately $44,000, which included non-recurring cash receipts
of $500,000 related to the settlement of a lawsuit, compared to approximately
$457,000 and $2,062,000 for 2002 and 2001, respectively. At December 31, 2003,
2002, and 2001, cash and liquid investments were $578,000, $156,780, and
$27,720, respectively, and working capital was ($909,356), ($82,512), and
$117,477, respectively. For purposes of determining working capital at December
31, 2003, $765,336 of principal and accrued interest under the Company's
convertible notes that mature in June 2004 are included as current liabilities.
Contractual Obligations
The following table sets forth the Company's long-term debt and other
obligations at December 31, 2003.
Payment Due By Period
----------------------------------------------
Total Less than 1 1-3 years 3-5 years More than
year 5 years
-------------------------------------------------------------
Long-Term Debt Obligations (1) $1,399,350 $877,350 $522,000 $- $-
Operating Lease Obligations 14,880 11,624 3,256 - -
Purchase Obligations 11,700 7,440 4,260 - -
-------------------------------------------------------------
Total $1,425,930 $896,414 $529,516 $- $-
=============================================================
(1) Long-term debt obligations consist of the Company's convertible notes,
including accrued interest, which become immediately due and payable in
certain events such as the filing of bankruptcy proceedings and similar
events involving the Company, a payment default under any of the
outstanding notes, or a change in control of the Company.
Item 7(a). Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
Item 8. Financial Statements and Supplemental Data
The report of independent auditors and consolidated financial
statements are set forth below (see item 15(a) for list of financial statements
and financial statement schedules):
25
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Affinity Technology Group, Inc.
Columbia, South Carolina
We have audited the accompanying consolidated balance sheets of
Affinity Technology Group, Inc. and subsidiaries (collectively, the "Company"),
as of December 31, 2003 and 2002, and the related consolidated statements of
operations, changes in stockholders' equity (deficiency), and cash flows for
each of the years in the three-year period ended December 31, 2003. The
Company's audit also included the financial statement schedule listed in the
Index at Item 15(a)(2). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company as of December 31, 2003 and 2002, and the consolidated results of
its operations and its cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion, the related
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.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has incurred recurring operating losses, has
an accumulated deficit, has certain convertible notes maturing in June 2004 and
is a defendant to a lawsuit in which an unfavorable jury verdict was rendered in
January 2004. These matters raise substantial doubt about the ability of the
Company to continue as a going concern. Management's plans in regard to these
matters are also discussed in Note 1. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ SCOTT McELVEEN LLP
Columbia, South Carolina
March 15, 2004, except for Note 1
which is as of March 29, 2004
26
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31,
2003 2002
-------------------------------
Assets
Current assets:
Cash and cash equivalents $578,398 $156,780
Receivables - 5,666
Prepaid expenses 20,121 42,784
-------------------------------
Total current assets 598,519 205,230
Property and equipment, net 18,336 27,600
Other assets 1,147 2,018
-------------------------------
Total assets $618,002 $234,848
===============================
Liabilities and stockholders' deficiency
Current liabilities:
Accounts payable $76,056 $20,741
Accrued expenses 565,136 194,631
Accrued compensation and related benefits 92,700 47,370
Convertible notes 756,336 -
Current portion of deferred revenue 17,647 25,000
-------------------------------
Total current liabilities 1,507,875 287,742
Convertible notes 425,000 830,336
Deferred revenue 14,706 25,000
Commitments and contingent liabilities
Stockholders' deficiency:
Common stock, par value $0.0001; authorized
60,000,000 shares, issued 44,032,493 shares
in 2003 and 43,049,363 shares in 2002 4,403 4,305
Additional paid-in capital 70,632,210 70,441,149
Common stock warrants - 52,000
Treasury stock, at cost (2,168,008 shares at
December 31, 2003 and 2002) (3,505,287) (3,505,287)
Accumulated deficit (68,460,905) (67,900,397)
-------------------------------
Total stockholders' deficiency (1,329,579) (908,230)
-------------------------------
Total liabilities and stockholders' deficiency $618,002 $234,848
===============================
See accompanying notes.
27
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Statements of Operations
Years ended December 31,
2003 2002 2001
-----------------------------------------------
Revenues:
Transactions $ - $104,878 $265,666
Professional services - - 249,871
Patent license revenue 17,647 25,000 20,000
Other income 500,000 56,082 750,407
-----------------------------------------------
517,647 185,960 1,285,944
-----------------------------------------------
Costs and expenses:
Cost of revenues 1,765 16,846 63,751
Research and development - - 496,441
Selling, general and administrative
expenses 996,711 1,406,841 3,847,807
Impairment loss - - 448,945
-----------------------------------------------
998,476 1,423,687 4,856,944
-----------------------------------------------
Operating loss from continuing operations (480,829) (1,237,727) (3,571,000)
Interest income 694 1,643 10,101
Interest expense (80,373) (70,334) (115,557)
-----------------------------------------------
Loss from continuing operations $(560,508) $(1,306,418) $(3,676,456)
Income from operations of discontinued
subsidiary - - 467,188
Gain on disposal of subsidiary - - 891,569
-----------------------------------------------
Net loss $ 560,508) $(1,306,418) $(2,317,699)
===============================================
Loss per share - basic and diluted:
Continuing operations $(0.01) $(0.03) $(0.10)
===============================================
Net loss per share $(0.01) $(0.03) $(0.06)
===============================================
Shares used in computing net loss per
share 41,512,897 40,707,108 38,004,089
===============================================
See accompanying notes.
28
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity (Deficiency)
Common Stock
-------------------- Total
Shares Amount Additional Common Deferred Treasury Accumulated Stockholder's
Paid-in Stock Compensation Stock Deficit Equity
Capital Warrants (Deficiency)
---------------------------------------------------------------------------------------------
Balance at
December 31, 2000 32,713,368 $3,271 $70,084,414 $52,000 $(31,804)$(3,505,287)$(64,276,280) $2,326,314
Exercise of warrant 3,471,340 347 - - - - - 347
Debenture conversion to
common stock 6,214,655 622 302,050 - - - - 302,672
Amortization of deferred
compensation - - - - 31,804 - - 31,804
Net loss - - - - - - (2,317,699) (2,317,699)
---------------------------------------------------------------------------------------------
Balance at
December 31, 2001 42,399,363 4,240 70,386,464 52,000 - (3,505,287) (66,593,979) 343,438
Issuance of common
stock as executive
compensaton 500,000 50 44,950 - - - - 45,000
Issuance of common
stock as finder's
fees 150,000 15 9,735 - - - - 9,750
Net loss - - - - - - (1,306,418) (1,306,418)
---------------------------------------------------------------------------------------------
Balance at
December 31, 2002 43,049,363 4,305 70,441,149 52,000 - (3,505,287) (67,900,397) (908,230)
Expiration of warrants - - 52,000 (52,000) - - - -
Note payable conversion
to common stock 409,796 41 81,918 - - - - 81,959
Issuance of common stock
as board service
compensation 283,334 28 25,472 - - - - 25,500
Issuance of common stock
for consulting services 250,000 25 22,475 - - - - 22,500
Issuance of common stock
as finder's fees 40,000 4 9,196 - - - - 9,200
Net loss - - - - - - (560,508) (560,508)
---------------------------------------------------------------------------------------------
Balance at
December 31, 2003 44,032,493 $4,403 $70,632,210 $ - $ - $(3,505,287)$(68,460,905) $(1,329,579)
=============================================================================================
See accompanying notes.
29
Affinity Technology Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended December 31,
2003 2002 2001
---------------------------------------------------
Operating activities
Net loss $(560,508) $(1,306,418) $(2,317,699)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 14,859 137,557 841,258
Amortization of deferred compensation - - 31,804
Gain on disposal of subsidiary - - (891,569)
Impairment loss - - 448,945
Writedown of software development costs - 656 -
Provision for doubtful accounts - 7,519 22,909
Inventory valuation allowance - 100,379 865,000
Deferred revenue (17,647) 50,000 (568,942)
Other 12,311 127,830 114,254
Changes in current assets and
liabilities:
Accounts receivable 5,666 445,921 (668,569)
Net investment in sales-type leases - - 157,139
Inventories - - 11,895
Other assets 22,663 71,707 179,429
Accounts payable 55,315 (119,017) (16,898)
Accrued expenses 378,463 72,867 (248,184)
Accrued compensation and related
benefits 45,331 (45,730) (22,705)
---------------------------------------------------
Net cash used in operating activities (43,547) (456,729) (2,061,933)
Investing activities
Purchases of property and equipment (4,724) (9,2