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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 0-30152
PAYMENT DATA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
NEVADA 98-0190072
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
12500 SAN PEDRO, SUITE 120, SAN ANTONIO, TEXAS 78216
(Address of principal executive offices, including Zip Code)
(210) 249-4100
(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 $.001 per share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer. Yes [ ]
No [X]
The aggregate market value of common stock held by non-affiliates of the
registrant as of June 30, 2003, was $2,383,105. As of March 15, 2004 21,415,181
shares of the registrant's common stock were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement for the Registrant's 2004 Annual
Meeting of Stockholders to be filed within 120 days after the end of the fiscal
year covered by this Report are incorporated by reference in Part III of this
Report.
PAYMENT DATA SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2003
INDEX
Page
PART I ----
Item 1. Business...........................................................................................3
Item 2. Properties.........................................................................................8
Item 3. Legal Proceedings..................................................................................8
Item 4. Submission of Matters to a Vote of Security Holders................................................8
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..............................9
Item 6. Selected Financial Data...........................................................................10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............11
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................................23
Item 8. Financial Statements and Supplementary Data.......................................................24
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..............42
Item 9A. Controls and Procedures...........................................................................43
PART III
Item 10. Directors and Executive Officers of the Registrant................................................44
Item 11. Executive Compensation............................................................................44
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters....44
Item 13. Certain Relationships and Related Transactions....................................................44
Item 14. Principal Accountant Fees and Services............................................................44
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................45
Signatures........................................................................................47
FACTORS THAT MAY AFFECT FUTURE RESULTS
This Annual Report on Form 10-K and the documents incorporated herein by
reference contain certain forward-looking statements within the meaning of the
Federal Securities Laws. Specifically, all statements other than statements of
historical facts included in this Annual Report on Form 10-K regarding our
financial performance, business strategy and plans and objectives of management
for future operations are forward-looking statements and based on our beliefs
and assumptions. If used in this report, the words "anticipate," "believe,"
"estimate", "expect," "intend," and words or phrases of similar import are
intended to identify forward-looking statements. Such statements reflect the
current view of the Company with respect to future events and are subject to
certain risks, uncertainties, and assumptions, including, but without
limitation, those risks and uncertainties contained in the Risk Factors section
of Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations, of this Annual Report on Form 10-K. Although we believe
that our expectations are reasonable, we can give no assurance that such
expectations will prove to be correct. Based upon changing conditions, any one
or more of these events described herein as anticipated, believed, estimated,
expected or intended may not occur. All prior and subsequent written and oral
forward-looking statements attributable to the Company or persons acting on its
behalf are expressly qualified in their entirety by this cautionary statement.
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PART I
ITEM 1. BUSINESS
INTRODUCTION
All references to "we," "us," "our," "PDS" or the "Company" in this Annual
Report on Form 10-K mean Payment Data Systems, Inc., formerly Billserv, Inc.,
and its consolidated subsidiaries. All references to "merchants," "billers,"
"billing customers" or "customers" in this Annual Report on Form 10-K mean the
companies that have contracted with us to receive services from us. All
references to "consumers" in this Annual Report on Form 10-K mean the persons
that are receiving bills or services from companies, including the companies
that are customers of PDS.
The Company was founded in July 1998 and is incorporated in the State of Nevada.
On July 25, 2003 (the "Closing") the Company sold substantially all of its
assets (the "Business") to Saro, Inc., a Delaware corporation (the "Purchaser"),
which is a wholly owned subsidiary of CyberStarts, Inc., a Delaware corporation
(the "Sale.") CyberStarts, Inc. has subsequently changed its name to Harbor
Payments, Inc. The aggregate selling price for the Business was $4,800,000 (the
"Purchase Price"), including $700,000 subject to certain earnout provisions,
plus the Purchaser's assumption of certain liabilities of the Company. The
assets sold represented the Company's proprietary technology infrastructure
along with certain third party software and hardware platforms and certain
furniture and fixtures that supported its Electronic Bill Presentment and
Payment ("EBPP") service offerings, including its eServ and eConsulting
products. The assets sold represented virtually all of the Company's assets,
which it used to produce nearly all of its revenue; therefore, the Company
discontinued its primary EBPP operations and began to concentrate on building
its electronic payments business. The Company also continued to operate its
bills.com consumer bill payment portal that it retained subsequent to the Sale.
OUR PROSPECTS TO CONTINUE AS A GOING CONCERN MUST BE CONSIDERED IN LIGHT OF THE
RISKS, EXPENSES AND DIFFICULTIES FREQUENTLY ENCOUNTERED BY COMPANIES IN THEIR
EARLY STAGES OF GROWTH, PARTICULARLY COMPANIES IN NEW AND RAPIDLY EVOLVING
MARKETS SUCH AS ELECTRONIC COMMERCE. Such risks include, but are not limited to,
an evolving and unpredictable business model and our ability to continue as a
going concern. To address these risks, we must, among other things, grow and
maintain our customer base, implement a successful marketing strategy, continue
to maintain and upgrade our technology and transaction-processing systems,
provide superior customer service, respond to competitive developments, attract,
retain and motivate qualified personnel, and respond to unforeseen industry
developments and other factors. We cannot assure you that we will be successful
in addressing such risks, and the failure to do so could have a material adverse
effect on our business, prospects, financial condition and results of
operations.
CONTINUING OPERATIONS
General
PDS provides integrated electronic payment processing services to merchants and
businesses, including all types of Automated Clearinghouse ("ACH") processing
and credit and debit card-based processing services. This processing takes place
in a variety of forms and channels. For example, our capabilities allow for
point of sale check truncation/conversion or card authorization, customer
service representatives to take e-check or card payments from consumers by
telephone, and consumers to make e-check or card payments directly through the
use of an Interactive Voice Response ("IVR") system or Web site. The Company
also operates an Internet electronic bill payment processing service for
consumers under the domain name www.bills.com. PDS generates revenues by
charging fees for the electronic processing of payment transactions and related
services. Merchants may be charged for these processing services at a bundled
rate based on a percentage of the dollar amount of each transaction and, in some
instances, additional fees are charged for each transaction. Certain merchant
customers are charged a flat fee per transaction, while others may also be
charged miscellaneous fees, including fees for chargebacks or returns, monthly
minimums, and other miscellaneous services. PDS operates solely in the United
States as a single operating segment, and does not currently have any foreign
operations.
Industry Background
The use of non-paper based forms of payment by consumers in the United States,
such as credit and debit cards, has steadily increased over the past several
years. According to the Federal Reserve, paper check use as a percentage of
retail non-cash payments declined from 77.1% in 1995 to 59.5% in 2000. The
proliferation of electronic commerce has made the acceptance of card-based and
other electronic forms of payment a necessity for businesses, both large and
small, in order to remain competitive. Consumer expenditures using electronic or
card-based payment methods are expected to grow to $5.2 trillion by 2010, or 62%
of all U.S. payments, from $1.8 trillion in 2000, or 35% of all U.S. payments,
according to The Nilson Report, a newsletter covering the consumer payment
systems industry.
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We believe that the electronic payment processing industry will continue to
benefit from the following trends:
FAVORABLE DEMOGRAPHICS
As consumers age, we expect that they will continue to use the payment
technology to which they have grown accustomed. More consumers are beginning to
use card-based and other electronic payment methods for purchases at an earlier
age. According to the Federal Reserve Survey of Consumer Finances, the
percentage of households with consumers under the age of 30 years using debit
cards increased from 24.5% in 1995 to 60.6% in 2001. As these consumers who have
witnessed the wide adoption of card products, technology and the Internet
comprise a greater percentage of the population and increasingly enter the work
force, we expect that purchases using electronic payment methods will comprise
an increasing percentage of total consumer spending. Because of the Internet's
increasing adoption rate, businesses have a growing opportunity to conduct
commerce with their consumers and business partners over the Internet.
INCREASED ELECTRONIC PAYMENT ACCEPTANCE BY SMALL BUSINESSES
Small businesses are a vital component of the U.S. economy and are expected to
contribute to the increased use of electronic payments methods. The U.S. Census
Bureau estimates that approximately 20 million businesses, with an average of
less than $1.0 million in annual sales in the United States, generate an
aggregate of $1.7 trillion in annual sales. The lower costs associated with
electronic payment methods are making these services more affordable to a larger
segment of the small business market. In addition, we believe these businesses
are experiencing increased pressure to accept electronic payment methods in
order to remain competitive and to meet consumer expectations. As a result, many
of these small businesses are seeking, and we expect many new small businesses
will seek, to provide customers with the ability to pay for merchandise and
services using electronic payment methods, including those in industries that
have historically accepted cash and checks as the only forms of payment for
their merchandise and services.
GROWTH IN ONLINE TRANSACTIONS
Market researchers expect dramatic growth in card-not-present transactions due
to the rapid growth of the Internet and electronic commerce. According to the
U.S. Census Bureau, retail e-commerce sales for 2003 were $54.9 billion, an
increase of 26% from $43.5 billion in 2002. The prevalence of the Internet makes
having an online presence a basic consideration for those operating a business
today. To remain competitive, many companies are seeking to leverage the
Internet to provide operational efficiencies, create new revenue opportunities
and maximize the longevity and profitability of their customer relationships.
STRATEGY
Our goal is to be a leading provider of electronic payment processing services.
In order to achieve this goal, we are implementing a strategy consisting of the
following key elements:
GROW AND MAINTAIN A RECURRING REVENUE BASE
We believe that establishing a large customer base that processes a significant
number of electronic payments is critical to the long-term success of our
business. We believe that by providing our merchants a consistently high level
of service and support at a competitive price, we will build merchant loyalty
and limit merchant attrition. Through merchant retention and the benefits of
increased use of our electronic payment processes and services, we will strive
to build and maintain a stable and recurring revenue base. In addition, we
believe the integrated nature of our service offerings makes individual
merchants less likely to change providers due to the inconvenience associated
with transferring multiple services to another provider or providers. By
limiting merchant attrition, we believe that the increasing use of electronic
payment systems will allow us to maintain a stable and recurring revenue base.
EXPAND AND LEVERAGE STRATEGIC RELATIONSHIPS
We intend to continue expanding our customer base, targeting those companies
with a high likelihood of generating significant revenue. We are actively
building relationships with organizations that resell our services to their
clients and prospects. Our partners leverage relationships with existing and
prospective clients, using our payment processing capabilities as a means to
retain or obtain new accounts, as well as enhance profit margins. This strategy
allows us to take advantage of opportunities that arise from the sales
activities of our resellers while expending limited resources on our direct
sales efforts.
We qualify potential resellers based on their market orientation, geographic
presence, account base, and sales capabilities. To date, we have signed
multi-year agreements with several companies to resell our services on either a
direct or referral basis. The reseller agreements generally provide for
commissions based on referred and qualified sales. If our services are resold on
a direct basis, the reseller receives wholesale pricing from us for our services
and negotiates terms with the biller directly. If our services are resold on a
referral basis, we negotiate terms with the biller directly and the reseller
earns a specified commission. Our
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reselling partners are generally leaders in their industries, with a strategic
commitment to electronic commerce. We will continue to add select partners when
advantageous to us to expand our sales coverage. Our direct sales efforts are
coordinated with resellers to achieve efficient coverage of targeted markets.
PURSUE STRATEGIC ACQUISITIONS
We intend to expand our merchant base by acquiring other providers of payment
processing services as well as portfolios of merchant accounts. The payment
processing market is serviced by many independent providers of payment
processing services that lack the resources to generate sufficient scale in this
market. We believe opportunities will exist for us to purchase these businesses
when their resources begin to limit their ability to continue to grow
independently.
PRODUCTS AND SERVICES
Our service offerings are supported by our systems infrastructure that
integrates certain proprietary components with processing systems outsourced to
third party providers to offer our customers a flexible and secure payment
process. Our systems infrastructure allows us to work with our customers to
build a customized electronic payment service offering tailored to their
specific needs. The components of our service offering include all forms of ACH
transaction processing, such as Returned Check Processing (RCK) and Accounts
Receivable Conversion (ARC), one-time and recurring Web payments via e-checks or
credit cards, Interactive Voice Response (IVR) telephone payments utilizing
e-checks or credit cards, and merchant account services (VISA and MasterCard),
including virtual or retail terminal services.
PDS also operates a consumer Web site, or portal, focused on providing bill
payment services under the domain name www.bills.com. The bills.com strategy is
to provide the consumer with an efficient and secure interface for viewing,
paying and managing bills via the Internet. We also market this portal service
to online financial services providers looking to provide EBPP capabilities as
part of their service offering.
RELATIONSHIPS WITH SPONSORS AND PROCESSORS
In order to provide payment processing services for Automated Clearinghouse
("ACH") transactions, we must maintain a relationship with an Originating
Depository Financial Institution ("ODFI") in the ACH Network. Similarly, in
order to provide payment processing services for Visa and MasterCard
transactions, we must be sponsored by a financial institution that is a
principal member of the Visa and MasterCard card associations. We have
agreements with several processors to provide to us, on a non-exclusive basis,
transaction processing and transmittal, transaction authorization and data
capture, and access to various reporting tools. We have an agreement with
Network 1 Financial, Inc. through which its member bank sponsors us for
membership in the Visa and MasterCard card associations and settles card
transactions for our merchants. This agreement may be terminated by the
processor if we materially breach the agreement and we do not cure the breach
within 30 days, or if we enter bankruptcy or file for bankruptcy.
SALES AND MARKETING
We market and sell our products and services through direct contact by our sales
personnel, as well as through non-exclusive resellers which act as an external
sales force, with minimal direct investment in sales infrastructure and
management. The Company's direct sales effort is coordinated by a sales
executive and supported by other employees who function in sales capacities. We
will continue to analyze our sales and marketing efforts in order to control
costs, increase the effectiveness of our sales force, and broaden our reach
through reseller initiatives and advantageous alliances.
Our primary market focus is on companies generating high volumes of electronic
payment transactions. Most of our customers have signed long-term contracts,
with generally three-year terms, that provide for volume-based transaction fees.
We processed our first ACH transactions during the third quarter of 2003 and
processed our first card-based transactions during the fourth quarter of 2003.
COMPETITION
The payment processing industry is highly competitive. Many small and large
companies compete with us in providing payment processing services and related
services to a wide range of merchants. There are a number of large transaction
processors, including First Data Merchant Services Corporation, Concord EFS,
Inc., National Processing, Inc., and Global Payments, Inc., that serve a broad
market spectrum from large to small merchants and provide banking, ATM and other
payment-related services and systems in addition to card-based payment
processing. There are also a large number of smaller transaction processors that
provide various services to small and medium-sized merchants. Many of our
competitors have substantially greater capital resources than we have and
operate as subsidiaries of financial or bank holding companies, which may allow
them on a consolidated basis to own and conduct depository and other banking
activities that we do not have the regulatory authority to own or conduct. We
believe that the principal competitive factors in our market include:
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o quality of service
o reliability of service
o ability to evaluate, undertake and manage risk
o speed in implementing payment processes
o price and other financial terms
o multi-channel payment capability
We believe that our specific focus on providing integrated payment processing
solutions to merchants, in addition to our understanding of the needs and risks
associated with providing payment processing services electronically, gives us a
competitive advantage over other competitors, which have a narrower market
perspective, and over competitors of a similar or smaller size that may lack our
experience in the electronic payments industry. Furthermore, we believe we
present a competitive distinction through the use of our internal technology to
provide a single integrated payment storage or warehouse that consolidates,
processes, tracks and reports all payments regardless of payment source or
channel.
Trademarks
We own federally registered trademarks on the marks Bills.com, and Bills.com and
design, and have applied for trademarks on Payment Data Systems, Inc., and
Payment Data Systems, Inc. and design with the United States Patent and
Trademark Office. We have also secured domain name registrations for bills.com,
paymentdatasystems.com, paymentdata.org and paymentdata.com. We rely on a
combination of copyright, trademark and trade secret laws, employee and third
party nondisclosure agreements and other intellectual property protection
methods to protect our services and related products.
DISCONTINUED OPERATIONS
General
Prior to the Sale of the Business in July 2003, the Company provided Electronic
Bill Presentment and Payment ("EBPP") and related services to companies that
generate recurring paper-based bills. During the years ended December 31, 2003,
2002 and 2001, the discontinued operations of the Business provided revenue of
$2,155,000, $4,129,000 and $2,925,000, respectively. EBPP is the process of
sending bills to consumers securely through the Internet and processing Internet
payment of bills utilizing an electronic transfer of funds. This service
offering allowed companies to outsource their electronic billing process,
providing them a single point of contact for designing, developing, implementing
and managing their EBPP process. The Company offered services to consolidate
billing information and then securely deliver an electronic bill to the biller's
own Company-hosted payment Web site, the consumer's e-mail inbox and numerous
Internet bill consolidation Web sites, such as those sponsored by financial
institutions. Our EBPP services allowed billers to establish an interactive,
online relationship with their consumers by integrating Internet customer care
and direct marketing with the electronic bill. We also provided professional
services to assist with the implementation and maintenance of an electronic bill
offering. In addition, we offered consumer marketing support to assist billers
in encouraging their consumers to switch from paper to electronic billing.
The Company generated EBPP revenue by charging volume-based fees fixed under
long-term contracts for transactions processed through its system, such as
loading, delivering, viewing and paying bills, customer care interactions,
handling payment returns and consolidating remittances. In certain instances,
the Company received a fixed amount per e-bill delivered and made available to
consumers regardless of whether they paid the e-bill using our services. The
Company also typically received an up-front fee from a customer to cover the
initial basic implementation of the contracted services. The Company charged
customers that contracted for professional consulting services on a time and
materials basis and charged license fees for the use of its proprietary gateway
services technology and the CheckFree iSolutions software that was resold by the
Company as an authorized reseller of CheckFree iSolutions software in Australia
only.
Industry Background
As a paper-based process, bill presentment and payment is a critical function in
which most businesses engage. For many companies, particularly those generating
recurring bills, the bill represents a critical touch point for communicating
with customers. However, the paper-based bill delivery and payment process is
limited in its functionality and potential for personalization, and there are
few opportunities for companies to engage in interactive communication with
their consumers through the paper-based bill payment experience. The majority of
paper-based bills are recurring monthly or quarterly invoices prepared either by
the biller itself or by an outsourced bill fulfillment vendor. Creating and
distributing a paper bill is a costly, multiple-step process that includes
extracting relevant data from the internal accounts receivable system of the
biller, organizing the data into a billing format, printing and separating the
bills, inserting the bills into envelopes, applying postage and mailing the bill
to the consumer. Payments mailed by the consumer must then be received and
processed manually by the biller or its lockbox provider in order to provide
remittance information. This paper bill and payment process is less efficient
than electronic bill delivery and payment, which eliminates or accelerates many
of these steps.
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Products and Services
The components of our EBPP service offering, all of which were available to
customers and generated revenue, included:
eServ
eServ was our flagship product and the foundation for our comprehensive EBPP
services. eServ provided our customers with a single offering for developing and
managing their entire EBPP capabilities. Our eServ product provided outsourced
creation and management of presentment and payment processes for a biller direct
site and all aggregator sites, as well as payment processing and full reporting
and reconciliation capabilities. Our offering also supported the EBPP process
with Internet-enabled customer care services, available as either a Web-based
tool for our clients to deliver customer support in-house or on an outsourced
basis using our employees to perform customer service.
eConsulting
eConsulting was the Company's professional services group that offered
electronic billing, customer care, project management, and IT consulting
services to both existing billing customers and the EBPP industry in general.
The Company's eConsulting group offered services ranging from project monitoring
to complete turnkey project development and implementation.
eServ Gateway
The Company's eServ Gateway offered billers who were already participating in
EBPP a single distribution point to virtually all bill presentment and payment
locations across the World Wide Web. The Gateway was designed to improve a
biller's existing EBPP system, whether an in-house offering, biller direct site
or limited distribution channel, by expanding the range of distribution
partners. The Company's unique Gateway specifications could also be embedded as
an OEM (Original Equipment Manufacturer) component within companies' software or
service offerings, affording such vendors a cost-effective, proven method to
give their clients and consumers the ability to make online payments, and view
and pay bills through bank and internet payment portals.
Product Development
Our total research and development expenses were $82,055, $461,065, and $760,082
for 2003, 2002, and 2001, respectively. We created a proprietary technology
infrastructure to support all of the components of our service offering. Our
systems consisted primarily of proprietary software applications that we
integrated with third party hardware and software platforms.
Sales and Marketing
We sold our EBPP services through direct sales efforts that included marketing
to existing customers led by our Account Management team. We also sold our
services through organizations that had exclusive reseller agreements with us to
sell our EBPP services. Our marketing efforts were primarily EBPP
adoption-focused. Our professional staff of Account Managers actively assisted
our customers in creating programs to encourage their consumers to utilize EBPP.
Customers
Our primary market focus was on top-tier and middle-market companies generating
high volumes of recurring (usually monthly) paper-based bills. The Company
serviced billers in select vertical markets, such as utilities, telecom, cable,
media and financial services industries, as well as the higher education market.
All of our billing customers signed long-term contracts, with generally three to
five-year terms, that provided for set-up fees, in certain cases, and
volume-based transaction fees. The number of customers served by the Company for
the three years ended December 31, 2003, including additions and attrition, was
as follows:
Number at beginning of period Additions Attrition Number at end of period
----------------------------- --------- --------- -----------------------
Year ended December 31, 2001 49 53 1 101
Year ended December 31, 2002 101 34 16 119
Year ended December 31, 2003 119 0 119 0
The attrition in 2003 was due primarily to the assignment of the customer
contracts to the Purchaser in conjunction with the Sale of the Business in July
2003. The attrition in 2002 is primarily attributable to the loss of certain
customers serviced via resellers as a normal part of the resellers' account
turnover and the migration of certain customers to in-house EBPP offerings after
their billing agreements expired. EBPP services provided to a certain customer
accounted for approximately 12%, 16% and 23% of total revenues for the years
ended December 31, 2003, 2002 and 2001, respectively.
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EMPLOYEES
As of December 31, 2003, we had 7 employees. We are not a party to any
collective bargaining agreements. We believe that our relations with our
employees are good.
ITEM 2. PROPERTIES
As of December 31, 2003, our headquarters and operations were housed in
approximately 4,500 square feet of leased office space in San Antonio, Texas.
The office lease has a three-year term that expires in October 2006 and has a
renewal option for an additional three-year term. The Company believes its
existing facilities will be adequate to meet its anticipated needs for the
foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
Beginning in December 2000, the Company pledged certain funds held as money
market funds and certificates of deposit to collateralize certain margin loans
of four officers of the Company (only two of which are currently employed by the
Company). These funds were classified as Cash pledged as collateral for related
party obligations on the Company's balance sheet at December 31, 2002. The
margin loans were from institutional lenders and were secured by shares of the
Company's common stock held by these officers. The Company's purpose in
collateralizing the margin loans was to prevent the sale of the Company's common
stock held by these officers while the Company was pursuing efforts to raise
additional capital through private equity placements. The sale of the Company's
common stock could have hindered the Company's ability to raise capital in such
a manner and compromised the Company's continuing efforts to secure additional
financing. The total balance of the margin loans guaranteed by the Company was
approximately $1.3 million at December 31, 2002. The Company believed it had the
unrestricted legal right to use the pledged funds for its operations, if
necessary, based on (i) its interpretation of the loan guarantee agreements,
(ii) the market price of the Company's stock at the time of the pledge, and
(iii) assurances the Company received from one of the institutional lenders that
funds would be made available if needed. During the fourth quarter of 2002, the
Company sought partial release of the funds for operating purposes, which was
denied by the institutional lender, based upon their interpretation of the loan
guarantee agreements. In light of this action, the Company recognized a loss on
the guarantees of $1,278,138 in the fourth quarter of 2002 and recorded a
corresponding payable under related party guarantees on the Company's balance
sheet at December 31, 2002. During the quarter ended March 31, 2003, the lenders
applied the pledged funds to satisfy the outstanding balances of the loans. The
total balance of the margin loans guaranteed by the Company was zero at December
31, 2003. The Company may institute litigation or arbitration concerning these
matters, which may result in the assertion of claims by these officers under
their employee agreements. The ultimate outcome of this matter cannot presently
be determined.
On July 25, 2003, certain stockholders of the Company (such stockholders being
Mike Procacci, Jr., Mark and Stefanie McMahon, Anthony and Lois Tedeschi, Donna
and James Knoll, John E. Hamilton, III, William T. Hagan, Samuel A. Fruscione,
Dana Fruscione-Penzone, Gia Fruscione, Alicia Fruscione, Joseph Fruscione,
Robert Evans, John Arangio, Gary and JoAnne Gardner, Lee and Margaret Getson, G.
Harry Bonham, Jr., Gary Brewer, Bob Lastowski, Robert Filipe, Mitchell D.
Hovendick, Dr. John Diephold, Joseph Maressa, Jr., and Charles Brennan
(collectively, the "Plaintiffs")) commenced legal action against the Company,
Ernst & Young, LLP and certain of the Company's current and former directors
(such directors being Louis A. Hoch, Michael R. Long, David S. Jones, Roger
Hemminghaus, E. Scott Crist, Peter Kirby, Richard Bergman, and Terri A. Hunter
(the "Defendant Directors")) in the District Court of the 45th Judicial
District, Bexar County, Texas (the "Suit"). The Plaintiffs allege, as the Suit
pertains to the Company, that the Company, acting through the Defendant
Directors, misstated in the Company's 2000 and 2001 Form 10-Ks the Company's
ability to use for operational purposes the funds pledged as security for margin
loans of certain officers of the Company, as discussed above. The Plaintiffs
seek economic and exemplary damages, rescission, interest, attorneys' fees and
costs of court.
The Company believes the Suit to be without merit, and intends to vigorously
defend itself and the Defendant Directors.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the Company's stockholders during
the fourth quarter of fiscal year 2003.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
Our common stock was traded on the National Association of Securities Dealers
("NASD") Over the Counter Bulletin Board ("OTCBB") through March 13, 2000 at
which time our common stock was approved for trading on the NASDAQ Small Cap
Market. Subsequently, our stock was approved for trading on the NASDAQ National
Market on July 31, 2000 under the symbol "BLLS." On February 4, 2003, the NASDAQ
National Market delisted our common stock because the Company did not meet the
requirements for continued listing on the NASDAQ National Market. The Company's
common shares were immediately eligible for quotation on the OTCBB effective at
opening of business on February 4, 2003. The Company began trading under a new
ticker symbol, PYDS, on the OTC BB on August 20, 2003.
The following table sets forth for the quarterly periods indicated the range of
high and low closing prices of the common stock as reported on the OTCBB:
High Low
---------- ----------
2003
--------------------
First Quarter $ 0.23 $ 0.07
Second Quarter $ 0.14 $ 0.08
Third Quarter $ 0.35 $ 0.09
Fourth Quarter $ 0.32 $ 0.14
2002
--------------------
First Quarter $ 1.25 $ 0.90
Second Quarter $ 1.70 $ 1.02
Third Quarter $ 1.25 $ 0.52
Fourth Quarter $ 0.70 $ 0.17
HOLDERS
As of March 15, 2004, 21,415,181 shares of the Company's common stock are issued
and outstanding. As of March 15, 2004, there were approximately 5,088
stockholders of record of the Company's common stock.
DIVIDEND POLICY
We have never declared or paid cash or stock dividends and have no present plan
to pay any such dividends in the foreseeable future, intending instead to
reinvest our earnings, if any.
- --------------------------------------------------------------------------------
9
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction
with the Consolidated Financial Statements and Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere in this Form 10-K.
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Year Ended Year Ended Year Ended Year Ended Year Ended
December 31, December 31, December 31, December 31, December 31,
2003 2002 2001 2000 1999 (1)
----------------------------------------------------------------------------
Revenues $ 119,297 $ 77,070 $ 43,835 $ 4,074 $ -
Operating expenses:
Cost of services 138,009 58,739 38,004 55,182 32,975
Selling, general and
administrative 1,726,028 2,431,566 3,077,783 4,428,189 2,002,252
Depreciation and
amortization 130,671 183,594 199,384 109,687 28,037
Non-cash expense related
to the issuance of warrants - - - 7,488,000 491,428
Total operating expenses 1,994,708 2,673,899 3,315,171 12,081,058 2,554,692
Other income (expense), net 101,112 (2,665,631) 352,124 546,173 5,749
Loss from continuing
operations (1,774,299) (5,262,460) (2,919,212) (11,530,811) (2,548,943)
Income (loss) from
discontinued operations 2,259,195 (5,692,217) (7,486,494) (8,425,239) $ (2,924,005)
Cumulative effect of a
change in accounting
principle - - - (52,273) -
Net income (loss) $ 484,896 $(10,954,677) $(10,405,706) $(20,008,323) $ (5,472,948)
Per share data- basic and
diluted:
Loss from continuing
operations $ (0.09) $ (0.25) $ (0.16) $ (0.78) $ (0.23)
Income (loss) from
discontinued operations 0.11 (0.28) (0.42) (0.57) (0.27)
----------------------------------------------------------------------------
Net income (loss) $ 0.02 $ (0.53) $ (0.58) $ (1.35) $ (0.50)
============================================================================
Weighted average common 20,883,218 20,591,304 18,017,051 14,793,622 10,876,096
shares outstanding
CONSOLIDATED BALANCE SHEET DATA
----------------------------------------------------------------------------
2003 2002 2001 2000 1999 (1)
----------------------------------------------------------------------------
Working capital (deficit) $ (40,206) $ (2,539,560) $ 5,750,354 $ 5,291,006 $ 6,293,217
Current assets 685,462 2,514,973 7,255,124 8,848,543 7,490,648
Total assets 938,400 4,709,263 11,415,136 15,290,542 9,398,168
Long-term obligations, net of
current portion - - - 148,428 259,694
Accumulated deficit (46,651,164) (47,136,060) (36,181,383) (25,775,677) (5,767,354)
Total stockholders' equity
(deficit) 212,732 (345,270) 9,748,566 11,011,410 7,936,043
(1) The accounting change related to SAB 101 has not been reflected in the financials prior to its adoption on
January 1, 2000.
- --------------------------------------------------------------------------------
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and Notes thereto, and other financial
information included elsewhere in this Form 10-K. This report contains
forward-looking statements that involve risks and uncertainties. Actual results
in future periods may differ materially from those expressed or implied in such
forward-looking statements as a result of a number of factors, including, but
not limited to, the risks discussed under the heading "Risk Factors" and
elsewhere in this Form 10-K.
OVERVIEW
On July 25, 2003 (the "Closing") the Company sold substantially all of its
assets (the "Business") to Saro, Inc., a Delaware corporation (the "Purchaser"),
which is a wholly owned subsidiary of CyberStarts, Inc., a Delaware corporation
(the "Sale"). The aggregate selling price for the Business was $4,800,000 (the
"Purchase Price"), including $700,000 subject to certain earnout provisions,
plus the Purchaser's assumption of certain liabilities of the Company. The
Purchase Price was determined through extensive negotiations between the
Purchaser and the Company. The Board of Directors of the Company, in its
reasonable business judgment, approved the Purchase Price based upon the
following factors: 1) the extensive search for a purchaser of the Business; 2)
the number of offers made by potential purchasers for the Business; 3) the
Company's ability to raise other sources of capital to operate the Business; and
4) the future trends in the industry of the Business. The sale of the Business
was approved by a majority of the shareholders of PDS at a Special Meeting of
Shareholders held on July 14, 2003. The assets sold represented the Company's
proprietary technology infrastructure along with certain third party software
and hardware platforms and certain furniture and fixtures that supported its
EBPP service offerings, including its eServ and eConsulting products. The
carrying value of these non-current assets was approximately $1,068,000 at July
25, 2003. The Purchaser also assumed certain current and non-current liabilities
of the Company with carrying values of $83,000 and $30,000, respectively, at
July 25, 2003. The assets sold represented virtually all of the Company's
assets, which it used to produce nearly all of its revenue; therefore, the
Company has ceased its primary EBPP operations and will continue to operate its
bills.com consumer bill payment portal and concentrate on building its
electronic payments business. The results of operations for the asset group
disposed of have been reported as discontinued operations in the accompanying
statements of operations. The Company retained its accounts receivable and
related deferred revenue associated with the customers of the Business, as well
as certain accounts payable and accrued liabilities related to the Business. At
December 31, 2003, the Company's balance sheet included approximately $38,000 of
net accounts receivable and approximately $277,000 of current liabilities that
related to the operations of the Business.
Prior to the Sale, the Company provided EBPP and related services to companies
that generate recurring bills, primarily in the United States. EBPP is the
process of sending bills to consumers securely through the Internet and
processing Internet payment of bills utilizing an electronic transfer of funds.
Our service offering allowed companies to outsource their electronic billing
process, providing them a single point of contact for developing, implementing
and managing their EBPP process. The Company offered services to consolidate
customer billing information and then securely deliver an electronic bill to the
biller's own payment Web site hosted by the Company, the consumer's e-mail inbox
and numerous Internet bill consolidation Web sites, such as those sponsored by
financial institutions. Our EBPP services allowed billers to establish an
interactive, online relationship with their consumers by integrating Internet
customer care and direct marketing with the electronic bill. The Company also
provided Internet-based customer care interaction services and professional
services to assist with the implementation and maintenance of an electronic bill
offering. As a condition of the Sale to Saro, Inc., the Company and certain
principal employees of the Company agreed, for a period of two years, not to
compete in the business of providing electronic bill presentment services in
conjunction with bill payment solutions (the "Restricted Business"). Under such
non-compete provisions, the Company and the applicable officers are prohibited
from performing the Restricted Business 1) for former Restricted Business
customers of the Company; or 2) in geographic areas in which the Company
performed the Restricted Business prior to the Sale. The Company believes that
these non-compete provisions will not have a significant impact on the Company's
strategic plan to provide electronic payment processing and related services.
The Company continues to operate an Internet electronic payment processing
service for consumers under the domain name www.bills.com and provides
integrated electronic payment services, including credit and debit card-based
processing services and transaction processing via the ACH network. Since
inception, we have incurred operating losses each quarter, and as of December
31, 2003, we have an accumulated deficit of $46.7 million. OUR PROSPECTS TO
CONTINUE AS A GOING CONCERN MUST BE CONSIDERED IN LIGHT OF THE RISKS, EXPENSES
AND DIFFICULTIES FREQUENTLY ENCOUNTERED BY COMPANIES IN THEIR EARLY STAGES OF
GROWTH, PARTICULARLY COMPANIES IN NEW AND RAPIDLY EVOLVING MARKETS SUCH AS
ELECTRONIC COMMERCE. Such risks include, but are not limited to, an evolving and
unpredictable business model and our ability to continue as a going concern. To
address these risks, we must, among other things, grow and maintain our customer
base, implement a successful marketing strategy, continue to maintain and
upgrade our technology and transaction-processing systems, provide superior
customer service, respond to competitive developments, attract, retain and
motivate qualified personnel, and respond to unforeseen industry developments
and other factors. We cannot assure you that we will be successful in addressing
such risks, and the failure to do so could have a material adverse effect on our
business, prospects, financial condition and results of operations.
- --------------------------------------------------------------------------------
11
We believe that our success will depend in large part on our ability to (a)
manage our operating expenses, (b) add quality customers to our client base, (c)
meet evolving customer requirements and (d) adapt to technological changes in an
emerging market. Accordingly, we intend to focus on customer acquisition
activities and outsource some of our processing services to third parties to
allow us to maintain an efficient operating infrastructure and expand our
operations without significantly increasing our fixed operating expenses.
As a result of our limited operating history and the emerging nature of the
markets in which we compete, we are unable to precisely forecast our revenues.
Our current and future expense levels are based largely on our investment plans
and estimates of future revenues. Revenue and operating results will depend on
the volume of payment transactions processed and related services rendered. The
timing of such services and transactions and our ability to fulfill a customer's
demands are difficult to forecast. Although we systematically budget for planned
outlays and maintain tight controls on our expenditures, we may be unable to
adjust spending in a timely manner to compensate for any unexpected revenue
shortfall. Accordingly, any significant shortfall in revenues in relation to our
planned expenditures could have a material adverse effect on our business,
prospects, financial condition and results of operations. Further, we may make
certain pricing, service, marketing or acquisition decisions that could have a
material adverse effect on each or all of these areas.
CRITICAL ACCOUNTING POLICIES
General
Management's discussion and analysis of its financial condition and results of
operations is based upon the Company's consolidated financial statements, which
have been prepared in accordance with U.S. generally accepted accounting
principles. The preparation of these financial statements requires the Company
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, the Company evaluates its estimates,
including those related to the reported amounts of revenues and expenses, bad
debt, investments, intangible assets, income taxes, and contingencies and
litigation. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results could differ from these estimates under different
assumptions or conditions.
Reserve for Losses on Card Processing
If, due to insolvency or bankruptcy of the merchant, or for another reason, we
are not able to collect amounts from our card processing merchant customers that
have been properly "charged back" by the cardholders, we must bear the credit
risk for the full amount of the cardholder transaction. We may require cash
deposits and other types of collateral from certain merchants to minimize any
such risk. In addition, we utilize a number of systems and procedures to manage
merchant risk. Card merchant processing loss reserves are primarily determined
by performing a historical analysis of our chargeback loss experience and
considering other factors that could affect that experience in the future. This
reserve amount is subject to risk that actual losses may be greater than our
estimates. At December 31, 2003, we did not have a significant card merchant
processing loss reserve due to the limited volume of transactions processed by
the Company since the inception of our card processing services during the
fourth quarter of 2003.
Bad Debt
The Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability or failure of its customers to make required
payments. The Company recorded bad debt expense of $10,700, $30,000 and $21,000
for 2003, 2002 and 2001, respectively, and recorded bad debt write-offs of
$54,742, $1,734 and $12,069 to its allowance for doubtful accounts in 2003, 2002
and 2001, respectively. At December 31, 2003 and 2002, the balance of the
allowance for doubtful accounts was $3,155 and $47,197, respectively. If the
financial condition of the Company's customers were to deteriorate, resulting in
an impairment of their ability to make contractual payments, additional
allowances may be required.
Valuation of Long-Lived and Intangible Assets
The Company assesses the impairment of long-lived and intangible assets at least
annually, and whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors considered important, which could
trigger an impairment review, include the following: significant
underperformance relative to historical or projected future cash flows;
significant changes in the manner of use of the assets or the strategy of the
overall business; and significant negative industry trends. When management
determines that the carrying value of long-lived and intangible assets may not
be recoverable, impairment is measured as the excess of the assets' carrying
value over the estimated fair value. Impairment losses of $217,000 and $855,000
were recorded in 2003 and 2002, respectively, and are included in discontinued
operations in the statements of operations except for $17,000 that is included
in continuing operations in 2003. No impairment losses were recorded in 2001.
- --------------------------------------------------------------------------------
12
Income Taxes
Deferred tax assets and liabilities are recorded based on the difference between
the tax bases of assets and liabilities and their carrying amount for financial
reporting purposes, as measured by the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. Deferred tax assets are
computed with the presumption that they will be realizable in future periods
when pre-taxable income is generated. Predicting the ability to realize these
assets in future periods requires a great deal of judgment by management. It is
our judgment that we cannot predict with reasonable certainty that the deferred
tax assets as of December 31, 2003 will be fully realized in future periods.
Accordingly, a valuation allowance has been provided to reduce the net deferred
tax assets to $0. At December 31, 2003, the Company has available net operating
loss carryforwards of approximately $34.6 million, which expire beginning in the
year 2020.
RESULTS OF CONTINUING OPERATIONS
Subsequent to the Sale, our only continuing revenues were derived from the
operation of an Internet electronic payment processing service for consumers
under the domain name www.bills.com. The Company also provides integrated
electronic payment services to merchants and businesses, including credit and
debit card-based processing services and transaction processing via the ACH
network. We processed our first ACH transactions during the third quarter of
2003 and processed our first card-based transactions during the fourth quarter
of 2003, but the related transaction volumes for 2003 were not significant so
the only component of our service offering that generated significant revenue
for 2003 was the bills.com payment service. Total revenues for 2003 increased
55% to $119,297 from $77,070 for 2002. Total revenues for 2002 increased 76%
from $43,835 for 2001. The increases from the prior years were primarily
attributable to an increase in the number of consumers subscribing to the
bills.com payment service.
Cost of services includes the cost of personnel dedicated to the creation and
maintenance of connections to third party payment processors and fees paid to
such third party providers for electronic payment processing services. Through
its contractual relationships with its payment processors, the Company is able
to process ACH and debit or credit card transactions on behalf of its customers
and their consumers. The Company pays volume-based fees for debit and credit
transactions initiated through these processors, and pays fees for other
transactions such as returns, notices of change to bank accounts and file
transmission. Cost of revenues was $138,009, $58,739 and $38,004 for 2003, 2002
and 2001, respectively. The increases from the prior years are due to the higher
subscriber volume of the bills.com payment service and implementation fees
charged in the last six months of 2003 by third party payment processors to
initiate electronic payment processing services.
Selling, general and administrative expenses decreased to $1,726,028 in 2003
from $2,431,566 for 2002 and $3,077,783 in 2001. The decrease in such expenses
from 2002 to 2003 was primarily due to lower salary and benefit costs resulting
from the personnel reductions made during 2002 and then again with the Sale of
the Business in 2003. The number of employees decreased from 35 immediately
preceding the Sale to 7 at December 31, 2003. The decrease from 2001 to 2002 is
attributable to cost reductions resulting from the restructuring and realignment
of our organization during the latter half of 2001 to better position the
Company for current economic and market conditions. During the third quarter of
2001, the Company downsized and realigned its organization to make more
efficient use of its resources and better match the Company's infrastructure to
market conditions and the current business environment since the overall growth
of the economy and rate of technology spending by businesses had slowed. This
realignment included the layoff of certain employees and reassignment of other
employees to different functions to reduce our cash outflows and allow us to
utilize our limited resources more prudently by eliminating functions that did
not directly contribute to our goal of profitability.
Depreciation and amortization was $130,671, $183,594 and $199,384 for 2003, 2002
and 2001, respectively. The decreases from year to year were due to lower
depreciation related to certain assets that became fully depreciated during 2002
and 2001, respectively. We purchased $66,000 of computer equipment and software
during 2003 and do not anticipate making significant capital expenditures in
2004.
Net other income was $101,112 in 2003 compared to net other expense of
$2,665,631 in 2002 and net other income of $352,124 in 2001. The improvement
from 2002 to 2003 is primarily attributable to $1.4 million of interest and
other expenses related to the convertible debt issuance in 2002 and a $1.3
million loss on related party loan guarantees in 2002. The improvement is also
due to $165,000 of consulting fees recognized in other income in the third
quarter of 2003 for transitional EBPP consulting services provided to the
Company's former equal partner in an EBPP joint venture in Australia. The joint
venture was dissolved as a result of the Sale of the Business during the third
quarter of 2003. In addition to the expenses related to the convertible debt and
related party guarantees in 2002, the decrease in net other income from 2001 to
2002 is attributable to lower interest income earned in 2002 as a result of
lower invested balances and market interest rates.
Loss from continuing operations improved to $1,774,299 in 2003 from $5,262,460
in 2002, primarily as a result of decreases in net other expenses and selling,
general and administrative expenses. The increase in loss from continuing
operations from $2,919,212 in 2001 to $5,262,460 in 2002 was primarily due to
the increase in net other expenses.
- --------------------------------------------------------------------------------
13
RESULTS OF DISCONTINUED OPERATIONS
The following table presents the operating results of the Company's Business for
the years ended December 31, 2003, 2002 and 2001, which are reflected as
discontinued operations in the Consolidated Statements of Operations. Results of
operations for 2003 are not comparable to results for prior years because 2003
only includes operating revenues and expenses for the period from January 1,
2003 through July 25, 2003, which was the date of the Sale of the Business.
2003 2002 2001
----------------- ------------------ ------------------
Service revenues:
Implementation revenues $ 256,564 $ 311,712 $ 502,753
Transaction revenues 1,273,931 1,875,561 1,119,379
Consulting revenues 624,787 1,704,211 1,302,711
----------------- ------------------ ------------------
Total service revenues 2,155,282 3,891,484 2,924,843
Software license revenues - 238,000 -
----------------- ------------------ ------------------
Total revenues 2,155,282 4,129,484 2,924,843
Cost of service revenues 1,436,449 4,403,605 4,957,157
Cost of software license revenues - 228,000 -
----------------- ------------------ ------------------
Total cost of revenues 1,436,449 4,631,605 4,957,157
Gross margin 718,833 (502,121) (2,032,314)
General and administrative 308,998 1,517,118 1,403,097
Selling and marketing 120,833 873,775 1,942,435
Research and development 82,555 461,065 760,082
Provision for impairment of assets 200,000 855,117 -
Depreciation and amortization 579,227 1,475,292 1,356,242
Other income (expense) 94,934 (7,729) 7,676
Gain on disposal of discontinued
operations 2,737,041 - -
----------------- ------------------ ------------------
Income (loss) from discontinued
operations 2,259,195 (5,692,217) (7,486,494)
================= ================== ==================
Prior to the Sale, our revenues were principally derived from fees for
implementing EBPP capabilities, processing EBPP transactions and providing
related customer care, and consulting services. The Company also became a
licensed reseller of CheckFree's e-billing software in Australia during 2002.
The components of our service offering that generated revenue through July 25,
2003, include:
o Internet billing services for EBPP through a Company -hosted
payment Web site, direct delivery to the consumer's email inbox,
or distribution via bill aggregators.
o Internet-enabled, interactive customer care services on an
in-house or outsourced basis.
o Professional consulting services for EBPP billers or software
vendors needing value-added resources to deliver customized EBPP
services, including payment gateway services that provide billers
who are already participating in EBPP using in-house software a
single distribution point to virtually any bill presentment and
payment location across the World Wide Web in addition to their
existing distribution points or biller direct site.
o Licensing of CheckFree e-billing software as an authorized
reseller in Australia only.
Total revenues decreased 48% to $2,155,282 in 2003 from $4,129,484 in 2002 due
to the Sale of the Business in July 2003. Implementation fee revenue for 2003
included the recognition of the remaining balance of deferred revenue upon the
sale of the Business. Total revenues increased 41% to $4,129,484 in 2002 from
$2,924,843 in 2001. Of the total increase from the prior year, 63% was
attributable to the growth in transaction fee revenue, while growth in
consulting revenues, which includes revenue from the licensing of the Company's
gateway technology, accounted for 33% of the increase. These increases were due
to an increase in the number of implemented billers and volume of transactions.
As of December 31, 2002, we had 119 billers under contract who were in various
stages of development, including 106 billers that were in full production or
pilot stages, as compared to 84 billers in full production or pilot stages at
December 31, 2001. The Company's first sale of a software license as a reseller
of CheckFree's e-billing software in Australia in 2002 also contributed $238,000
to the increase in revenue from the prior year. The sale was made to an
Australian billing service provider that was also an equal partner with the
Company in a joint venture formed to provide EBPP services to the Australian
market. One billing customer accounted for approximately 12%, 16% and 23% of
total revenues for the years ended December 31, 2003, 2002 and 2001,
respectively.
- --------------------------------------------------------------------------------
14
During 2002, the Company entered into two separate nonmonetary transactions
whereby the Company licensed the use of its gateway technology to certain third
party software vendors to be used as an original equipment manufacturer ("OEM")
component of their product offering in exchange for software products from those
vendors. The Company accounted for these transactions in accordance with APB
Opinion No. 29, "Accounting for Nonmonetary Transactions." These exchanges were
determined to culminate the earning process because the technology exchanged by
the Company was held for sale in the ordinary course of business and the
products received by the Company were expected to be deployed and utilized as
productive assets. The Company recognized revenue related to these transactions
at the fair value of the software received, which was determined by reference to
vendor-specific objective evidence, because it was more clearly evident than the
value of the assets transferred. The value of the software received was
estimated by comparison to third party evidence including vendor-specific
established pricing lists and historical sales information and was more readily
determinable because the Company did not have a history of comparable cash sales
of its payment gateway technology. The Company recognized $300,000 in a
transaction where the Company's technology was exchanged for customer
relationship management software and concurrent seat licenses to use in
providing customer care services via the Internet or telephone. The Company also
recognized $300,000 in a transaction where the Company's technology was
exchanged for document archival and retrieval software to use in the storage of
electronic billing statements. The carrying value of the gateway technology
exchanged in both transactions was zero. The Company capitalized the software
received at the time of acquisition and subsequently recognized a loss on
impairment of these assets which took the carrying amount of these assets to
zero.
Cost of revenues includes the cost of personnel dedicated to the design of
electronic bill templates, creation of connections to third party aggregators
and payment processors, testing and quality assurance processes related to
implementation and presentment, as well as professional staff dedicated to
providing contracted services to EBPP customers under consulting arrangements.
Cost of revenues also includes fees paid for presentation of consumer bills on
Web sites powered by aggregators and processing of payments for EBPP
transactions by third party providers. Cost of revenues decreased 69% to
$1,436,449 in 2003 from $4,631,605 for 2002. The decrease from 2002 was
partially attributable to the Sale of the Business in July 2003 as well as lower
salary and benefit costs due to the personnel reductions during 2002. Cost of
revenues decreased 7% to $4,631,605 in 2002 from $4,957,157 for 2001. The
decrease from 2001 to 2002 is primarily due to cost reductions that were
implemented in the second half of 2001, which included a decrease in the number
of personnel employed to provide revenue-producing services from an average of
79 such employees for 2001 to 63 in 2002. The cost savings from the prior year
period were partially offset by the cost of the CheckFree software license that
was resold in 2002, which was $228,000.
General and administrative expenses directly related to the Business consisted
of rent and costs of personnel providing direct support services for EBPP
operations. These expenses decreased to $308,998 in 2003 from $1,517,118 in 2002
and were $1,403,097 in 2001. The decrease from 2002 was partially attributable
to the Sale of the Business in July 2003 as well as lower salary and benefit
costs due to the personnel reductions during 2002, and lower rental expenses
under the Company's amended lease agreement. In May 2002, the Company
renegotiated the lease terms for its corporate headquarters to provide for a
reduction in future rent expense of approximately $1.6 million over the
remaining term of the lease. The lease amendment required the Company to expense
a portion of its prepaid rent, which resulted in a one-time charge of $312,000
for the second quarter of 2002. This charge offset the rent savings from the
amended lease agreement in 2002, which contributed to an overall increase in
general and administrative expenses from 2001.
Selling and marketing expenses directly related to the Business decreased to
$120,833 in 2003 from $873,775 for 2002 and $1,942,435 for 2001. The decrease
from 2002 was partially attributable to the Sale of the Business in July 2003
and was also due to reductions in our direct sales staff. The decrease in 2002
from 2001 was primarily the result of reductions in our direct sales staff,
which contributed 74% to the decrease from the prior year, as well as lower
related travel expenses and trade show participation, which contributed 23% to
the decrease from the prior year. As we increased our focus throughout 2002 on
using strategic reseller partners to provide sales opportunities related to the
deployment and use of our EBPP services, we experienced a decrease in the amount
of expenses related to our direct sales force.
Research and development expenses directly related to the Business consisted
primarily of the cost of personnel devoted to the design of new processes that
would improve our electronic presentment and payment abilities and capacities,
new customer care and direct marketing services, additional business-to-consumer
applications, and integration of third party applications. These expenses
decreased to $82,555 in 2003 from $461,065 in 2002 and $760,082 in 2001. The
decrease from 2002 was partially attributable to the Sale of the Business in
July 2003. The decreases from year to year were also due to a progressive focus
on our core competencies in order to implement and service existing products.
During the earlier stages of our Company, we applied additional resources to
design and develop our base technology infrastructure and operating systems. All
research and development costs were expensed as incurred.
Depreciation and amortization was $579,227, $1,475,292 and $1,356,242 for 2003,
2002 and 2001, respectively. The decrease from 2002 was partially attributable
to the Sale of the Business in July 2003 and was also due to lower depreciation
related to certain assets that became fully depreciated during 2002. The
increase from 2001 was the result of writing off $207,000 of leasehold
improvements in 2002 related to our corporate office facility due to the
cancellation of the related lease in March 2003.
- --------------------------------------------------------------------------------
15
During the fourth quarter of 2002, the Company performed an impairment review
because the uncertainty of the Company's ability to continue as a going concern
due to decreased liquidity indicated that the carrying value of certain
long-lived assets may not be recoverable. The Company determined that customer
relationship management software and document archival and retrieval software
with a carrying amount of $855,117 were no longer recoverable and recorded a
non-cash charge of $855,117, which is included as a component of discontinued
operations in the accompanying consolidated statement of operations. Fair value
was based on the expected future cash flows to be generated by these assets,
which was determined to be zero because of the Company's inability to deploy and
utilize the assets to provide revenue-generating services, due to the Company's
limited resources and lack of liquidity. During the second quarter of 2003, the
Company performed an impairment review because the Company expected to sell the
asset group comprising the Business. The Company determined that the asset group
to be sold was impaired and recorded a non-cash charge of $200,000, which is
included as a component of discontinued operations in the accompanying
consolidated statement of operations. Fair value was based on the expected
selling price of the asset group.
Other income was $94,934 in 2003 and represented the gain on the settlement of a
vendor payable directly related to the discontinued operations. Other income
(expense) for 2002 and 2001 represented the Company's equity in the loss and
earnings, respectively, of the Company's unconsolidated EBPP joint venture in
Australia. The joint venture was dissolved as a result of the Company's sale of
the Business during the third quarter of 2003.
Income from discontinued operations improved to $2,259,195 in 2003 and included
a gain on the disposal of the discontinued operations of $2,737,041. Loss from
discontinued operations of $5,692,217 in 2002 decreased from $7,486,494 in 2001
primarily as a result of the overall increase in gross profit from the prior
year.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2003, the Company's principal source of liquidity consisted of
$528,000 of cash and cash equivalents, compared to $286,000 of cash and cash
equivalents at December 31, 2002. The Company has incurred substantial losses
since inception, which has led to a significant decrease in its cash position
and a deficit in working capital. The Company defaulted under its convertible
debt agreement during the fourth quarter of 2002 and was unsuccessful in its
attempt to access its funds held as collateral to guarantee certain executive
margin loans after attempting to retrieve such funds during the fourth quarter
of 2002. Consequently, the Company sold substantially all of its assets in July
2003 and reduced expenditures for operating requirements. Despite these actions,
the Company believes that its current available cash and cash equivalents along
with anticipated revenues may be insufficient to meet its anticipated cash needs
for the foreseeable future. CONSEQUENTLY, THE COMPANY'S ABILITY TO CONTINUE AS A
GOING CONCERN MAY BE CONTINGENT ON THE COMPANY RECEIVING ADDITIONAL FUNDS IN THE
FORM OF EQUITY OR DEBT FINANCING. The Company is currently aggressively pursuing
strategic alternatives, including investment in the Company via an equity line
of credit. In February 2004, the Company executed an agreement for an equity
line of credit with Dutchess Private Equities Fund, LP ("Dutchess"). Under the
terms of the agreement, the Company may elect to receive as much as $10 million
from Dutchess in common stock purchases over the next three years at the option
of the Company. The Company agreed to file with the Securities and Exchange
Commission, and have declared effective before any funds may be received under
the agreement, a registration statement registering the resale of the shares of
the Company's common stock to be issued to Dutchess. The satisfactory completion
of an additional investment in the Company or growth of cash flow from
operations is essential or the Company has no other alternative that will
provide sufficient cash flows to meet current operating requirements. The sale
of additional equity or convertible debt securities would result in additional
dilution to the Company's stockholders, and debt financing, if available, may
involve restrictive covenants which could restrict operations or finances. There
can be no assurance that financing will be available in amounts or on terms
acceptable to the Company, if at all. If the Company cannot raise funds, on
acceptable terms, or achieve positive cash flow, it may not be able to continue
to exist, conduct operations, grow market share, take advantage of future
opportunities or respond to competitive pressures or unanticipated requirements,
any of which would negatively impact its business, operating results and
financial condition.
Beginning in December 2000, the Company pledged certain funds held as money
market funds and certificates of deposit to collateralize certain margin loans
of four officers of the Company (only two of which are currently employed by the
Company). These funds were classified as Cash pledged as collateral for related
party obligations on the Company's balance sheet at December 31, 2002. The
margin loans were from institutional lenders and were secured by shares of the
Company's common stock held by these officers. The Company's purpose in
collateralizing the margin loans was to prevent the sale of the Company's common
stock held by these officers while the Company was pursuing efforts to raise
additional capital through private equity placements. The sale of the Company's
common stock could have hindered the Company's ability to raise capital in such
a manner and compromised the Company's continuing efforts to secure additional
financing. The total balance of the margin loans guaranteed by the Company was
approximately $1.3 million at December 31, 2002. The Company believed it had the
unrestricted legal right to use the pledged funds for its operations, if
necessary, based on (i) its interpretation of the loan guarantee agreements,
(ii) the market price of the Company's stock at the time of the pledge, and
(iii) assurances the Company received from one of the institutional lenders that
funds would be made available if needed. During the fourth quarter of 2002, the
Company sought partial release of the funds for operating purposes, which was
denied by the institutional lender, based upon their interpretation of the loan
guarantee agreements. In light of this action, the Company recognized a loss on
the guarantees of $1,278,138 in the fourth quarter of 2002 and recorded a
corresponding payable under related party guarantees on the Company's
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16
balance sheet at December 31, 2002. During the quarter ended March 31, 2003, the
lenders applied the pledged funds to satisfy the outstanding balances of the
loans. The total balance of the margin loans guaranteed by the Company was zero
at December 31, 2003. The Company may institute litigation or arbitration
concerning these matters, which may result in the assertion of claims by these
officers under their employee agreements. The ultimate outcome of this matter
cannot presently be determined.
In June 2000, the Company executed a working capital line of credit agreement
with a bank in the amount of $1,500,000. Advances under the line of credit
accrued interest at the prime rate minus 0.25%, with repayment terms of monthly
interest-only payments and principal due in July 2001. The line of credit was
secured by certain investments of the Company. The Company borrowed $1,500,000
on this line of credit for the security deposit and leasehold improvements of
the Company's corporate headquarters and repaid the entire outstanding balance
plus accrued interest in January 2001. The line of credit expired in July 2001
and was not renewed. In March 2002, the Company executed a working capital line
of credit agreement with a bank in the amount of $700,000. The Company borrowed
$645,000 under this line of credit during the first six months of 2002. In
September 2002, the Company repaid the outstanding balance in full, including
accrued interest, and terminated the line of credit. Advances under the line of
credit accrued interest at the prime rate minus 0.25%, with repayment terms of
monthly interest-only payments and principal due in June 2003. As part of the
line of credit agreement, the Company had to maintain a minimum restricted cash
balance of $800,000 with the bank.
On July 24, 2002, the Company executed a financing agreement with Laurus Master
Fund, Ltd. ("Laurus") in exchange for a $1.5 million convertible note and a
four-year warrant to purchase 300,000 shares of the Company's common stock at
exercise prices of $0.936 for the first 150,000 shares, $0.975 for the next
50,000 shares, and $1.17 for the remaining 100,000 shares. Laurus could convert
the convertible note, which bore interest at 7% annually, at any time into
shares of the Company's common stock at a fixed conversion price of $0.78,
subject to certain restrictions in the purchase agreement. The Company could pay
the principal and interest on the convertible note, which had a one-year term,
in cash, shares of its common stock or a combination of cash and stock. If
common stock was used to pay the note, the conversion price was the lesser of
(i) $0.78 or (ii) 88% of the average of the 7 lowest closing prices during the
22 trading days prior to the date the Company gave notice of payment. Accrued
interest and one-ninth of the principal was due on the first business day of
each calendar month beginning on November 1, 2002 and continuing until the
maturity date of July 1, 2003. If the required principal payment was made in
cash, the principal amount paid was 105% of the amount due. The Company granted
Laurus a security interest in all of its assets. The Company defaulted under the
note during the fourth quarter of 2002 and a penalty of 120% of the outstanding
principal amount, or $300,000, was assessed to the Company for the default, and
was included in the balance of short-term borrowings on the Company's balance
sheet at December 31, 2002.
The Company recorded a debt discount as a result of the issuance of the warrant
to Laurus of approximately $259,000, which was being charged to interest expense
over the term of the convertible note using the effective yield method. Upon the
Company's default under the note, the remaining balance of the discount was
charged to interest expense. Furthermore, the Company recorded an additional
debt discount as a result of the beneficial conversion feature of approximately
$283,000, which was charged to interest expense at the date of issuance. The
amount related to the beneficial conversion feature was determined by dividing
the note proceeds allocated to the convertible security of approximately
$1,241,000 by the number of shares into which the note was convertible, or
1,923,077 shares based on the fixed conversion price of $0.78 per common share.
The resulting effective conversion price of $0.65 per common share was then
compared to the fair value of the Company's stock, which was $0.93 per common
share on the issuance date. The difference of $0.28 per common share between the
fair value of the stock and the effective conversion price was then multiplied
by 1,009,586, which was the number of shares the note was convertible into at
the date of issuance, taking into account the limitation on the number of shares
that Laurus could convert at that time. The agreement stipulated that Laurus
could not convert that amount of the note that would result in beneficial
ownership of more than 4.9% of the outstanding common shares of the Company on
the date of conversion. The conversion limitation was to become null and void
upon an event of default under the note and could have been raised if the
Company chose to redeem the outstanding principal amount of the note in cash and
Laurus elected to convert the note instead. The limitation could also have been
raised if the Company had issued additional common shares for any reason, thus
increasing the number of outstanding shares. Due to the Company's default under
the note during the fourth quarter of 2002, the 4.9% limitation became null and
void and additional interest expense of approximately $256,000 was recognized at
a rate of $0.28 per common share for the 913,491 additional shares that the note
became convertible into upon default. During 2002, the Company capitalized
$238,000 in financing costs related to the issuance of the Laurus debt that were
being charged to interest expense over the term of the convertible note using
the effective yield method. Upon default under the note in the fourth quarter of
2002, the remaining unamortized balance was charged to interest expense.
In connection with the Sale of the Business, the Company paid $1.8 million in
cash to Laurus during July 2003, in full settlement of the outstanding balance
of the convertible note, including accrued penalties and interest, and all
claims by Laurus. In addition, the four-year warrant to purchase 300,000 shares
of the Company's common stock initially granted to Laurus was canceled as part
of the settlement.
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Net cash used in operating activities was $2.0 million, $2.2 million and $2.8
million for 2003, 2002 and 2001, respectively. Net cash used in operating
activities was primarily attributable to operating net losses generated by early
growth stage activities and overhead costs. We plan to focus on expending our
resources prudently given our current state of liquidity and do not expect to
achieve positive cash flow from operations for 2004.
Net cash provided by investing activities was $4.1 million in 2003 and reflected
proceeds of approximately $4.2 million from the sale of the Business and other
assets offset by capital expenditures of approximately $66,000 for computer
equipment and software. Net cash provided by investing activities was $240,000
in 2002 and primarily reflected the return of $256,000 of deposits that had been
used to secure leases. Net cash provided by investing activities for 2001 was
$2.1 million and reflected sales and maturities of marketable securities of $2.0
million and the return of $219,000 of deposits that had been used to secure
leases. We do not anticipate making significant capital expenditures during
2004.
Net cash used in financing activities of $1.7 million for 2003 primarily
resulted from the payment of $1.8 million under the Company's convertible debt
agreement in July 2003. Net cash provided by financing activities of $1.9
million for 2002 resulted primarily from $1.5 million of borrowings under the
convertible debt agreement and the return of $707,000 that had been pledged as
collateral for margin loans of officers. Net cash provided by financing
activities of $6.5 million for 2001 resulted from proceeds, net of issuance
costs, of $9.2 million from the issuance of common stock private placement
offerings in March and November 2001. The $1.5 million repayment of the
outstanding line of credit in January 2001 and additional pledge of $1.0 million
as collateral for margin loans of officers reduced the amount of net cash
provided by financing activities in 2001.
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
On May 15, 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity" ("FAS
150"). FAS 150 establishes standards for classifying and measuring as
liabilities certain freestanding financial instruments that embody obligations
of the issuer and have characteristics of both liabilities and equity. The
statement defines an obligation as "a conditional or unconditional duty or
responsibility on the part of the issuer to transfer assets or to issue its
equity shares." FAS 150 is effective for all financial instruments created or
modified after May 31, 2003, and otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. The adoption of this
statement did not have a significant impact on the Company's results of
operations or financial position.
RISK FACTORS
There are many factors that affect the Company's business and the results of its
operations, some of which are beyond its control. The following is a description
of some of the important factors that may cause the actual results of the
Company's operations in future periods to differ materially from those currently
expected or desired.
ABILITY TO CONTINUE AS A GOING CONCERN; UNCERTAINTY OF ADDITIONAL FINANCING
Due to continuing operating losses, the Company believes that its current
available cash and cash equivalents along with anticipated revenues may be
insufficient to meet its anticipated cash needs for the foreseeable future.
Consequently, the Company's ability to continue as a going concern may be
contingent on the Company receiving additional funds in the form of equity or
debt financing. The Company currently plans to meet its capital requirements
primarily through issuance of equity securities or new borrowing arrangements,
and in the longer term, revenue from operations. Accordingly, the Company is
currently aggressively pursuing strategic alternatives, including investment in
the Company via an equity line of credit. The sale of additional equity or
convertible debt securities would result in additional dilution to our
shareholders, and debt financing, if available, may involve restrictive
covenants that could restrict our operations or finances. There can be no
assurance that financing will be available in amounts or on terms acceptable to
the Company, if at all. If the Company cannot raise funds on acceptable terms,
or achieve positive cash flow, it may not be able to continue to exist, conduct
operations, grow market share, take advantage of future opportunities or respond
to competitive pressures or unanticipated requirements, any of which would
negatively impact its business, operating results and financial condition.
LACK OF PROFITABILITY; UNCERTAINTY OF FUTURE PROFITABILITY
The Company was organized in 1998 and began operations as a public company in
1999 offering electronic billing services to other companies. Subsequent to the
sale of the Company's Business in July 2003, the Company has concentrated on
building its electronic payments services operations. The Company has not been
profitable since inception and may never achieve profitability. As of December
31, 2003, the Company's accumulated deficit was $46.6 million. Because we have a
relatively limited history in a rapidly evolving and dynamic market, it is
difficult to predict our future operating results. Therefore, all historical
information included herein may not necessarily be indicative of the results of
operations, financial position and cash flows of the Company in the future.
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UNCERTAIN RELIABILITY, GROWTH AND CONSUMER ACCEPTANCE OF THE INTERNET, INTERNET
TECHNOLOGY, AND ELECTRONIC COMMERCE
The electronic commerce market is a relatively new and growing service industry.
If the electronic commerce market fails to grow or grows slower than
anticipated, or if the Company, despite an investment of significant resources,
is unable to adapt to meet changing customer requirements or technological
changes in this emerging market, or if the Company's services and related
products do not maintain a proportionate degree of acceptance in this growing
market, the Company's business, operating results, and financial condition could
be materially adversely affected. Additionally, the security and privacy
concerns of existing and potential customers may inhibit the growth of the
electronic commerce market in general, and the Company's customer base and
revenues, in particular. Similar to the emergence of the credit card and
automatic teller machine ("ATM") industries, the Company and other organizations
serving the electronic commerce market must educate users that electronic
transactions use encryption technology and other electronic security measures
that make electronic transactions more secure than paper-based transactions.
While the Company believes that it is utilizing proven applications designed for
premium data security and integrity to process electronic transactions, there
can be no assurance that the Company's use of such applications will be
sufficient to address the changing market conditions or the security and privacy
concerns of existing and potential customers. Adverse publicity raising concerns
about the safety or privacy of electronic transactions, or widely reported
breaches of the Company's or another provider's security, have the potential to
undermine consumer confidence in the technology and thereby have a materially
adverse effect on the Company's business. In addition, there can be no guarantee
that the Internet will continue to grow in acceptance or maintain its
reliability, or that new technologies will not supplant the Internet in part or
in whole.
UNCERTAIN GROWTH OF PROPORTION OF ELECTRONIC REMITTANCES
The Company's future financial performance will be materially affected by the
percentage of payments that can be cleared electronically. As compared with
making payment by paper check or by draft, the Company believes that electronic
payments: (i) cost much less to complete; (ii) give rise to fewer errors, which
are costly to resolve; and (iii) generate far fewer customer inquiries and
therefore consume fewer customer care resources. Accordingly, a reversal of the
current trend toward a smaller proportion of paper-based payments would have a
material adverse effect upon the Company's business, operating results, and
financial condition.
RISK OF INABILITY TO ADAPT TO RAPID TECHNOLOGICAL CHANGE; RISK OF DELAYS
The Company's success is highly dependent on its ability to develop new and
enhanced services, and related products that meet changing customer
requirements. The market for the Company's services, however, is characterized
by rapidly changing technology, evolving industry standards, emerging
competition and frequent new and enhanced software, service and related product
introductions. In addition, the software market is subject to rapid and
substantial technological change. The Company, to remain successful, must be
responsive to new developments in hardware and semiconductor technology,
operating systems, programming technology and computer capabilities. In many
instances, the new and enhanced services, products, and technologies are in the
emerging stages of development and marketing, and are subject to the risks
inherent in the development and marketing of new software, services, and
products. The Company may not successfully identify new service opportunities,
and develop and bring new and enhanced services and related products to market
in a timely manner; there can be no assurance that any such services, products
or technologies will develop or will be commercially successful, that the
Company will benefit from such developments or that services, products or
technologies developed by others will not render the Company's services and
related products noncompetitive or obsolete. If the Company is unable, for
technological or other reasons, to develop and introduce new services and
products in a timely manner in response to changing market conditions or
customer requirements, or if new or enhanced software, services and related
products do not achieve a significant degree of market acceptance, the Company's
business, operating results and financial condition would be materially
adversely affected.
CHANGES IN REGULATION OF ELECTRONIC COMMERCE AND RELATED FINANCIAL SERVICES
Management believes that the Company is not required to be licensed by the
Office of the Comptroller of the Currency, the Federal Reserve Board, or other
federal or state agencies that regulate or monitor banks or other types of
providers of electronic commerce services. There can be no assurance that a
federal or state agency will not attempt to regulate providers of electronic
commerce services, such as the Company, which could impede the Company's ability
to do business in the regulator's jurisdiction. The Company is subject to
various laws and regulations relating to commercial transactions generally, such
as the Uniform Commercial Code, and may be subject to the electronic funds
transfer rules embodied in Regulation E, promulgated by the Federal Reserve
Board. Given the expansion of the electronic commerce market, the Federal
Reserve Board might revise Regulation E or adopt new rules for electronic funds
transfer affecting users other than consumers. Because of growth in the
electronic commerce market, Congress has held hearings on whether to regulate
providers of services and transactions in the electronic commerce market, and it
is possible that Congress or individual states could enact laws regulating the
electronic commerce market. If enacted, such laws, rules and regulations could
be imposed on the Company's business and industry and could have a material
adverse effect on the Company's business, operating results and financial
condition.
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UNCERTAINTY OF ACH ACCESS
The Company has a contractual relationship with a third party provider, which
maintains a relationship with multiple Originating Depository Financial
Institutions ("ODFI") in the Automated Clearinghouse ("ACH") Network. The ACH
Network is a nationwide batch-oriented electronic funds transfer system that
provides for the interbank clearing of electronic payments for participating
financial institutions. An ODFI is a participating financial institution that
must abide by the provisions of the ACH Operating Rules and Guidelines. Through
its relationship with this third party provider, the Company is able to process
payment transactions on behalf of its customers and their consumers by
submitting payment instructions in a prescribed ACH format. The Company pays
volume-based fees to the third party provider for debit and credit transactions
processed each month, and pays fees for other transactions such as returns and
notices of change to bank accounts. These fees are part of the Company's cost
structure. If the Federal Reserve rules were to change to introduce restrictions
or modify access to the ACH, the Company's business could be materially
adversely affected.
UNCERTAINTY OF ACCESS TO CARD-BASED PROCESSING.
Substantially all of the card-based transactions we process involve Visa or
MasterCard. If our third party processing provider or our bank sponsor fail to
comply with the applicable requirements of the Visa and MasterCard credit card
associations, Visa or MasterCard could suspend or terminate their registration.
The termination of their registration or any changes in the Visa or MasterCard
rules that would impair their registration could require us to stop providing
such payment processing services if we were unable to obtain another provider or
sponsor.
COMPETITION IN ELECTRONIC COMMERCE AND RELATED FINANCIAL SERVICES
Portions of the electronic commerce market are becoming increasingly
competitive. The Company expects to face growing competition in all areas of the
electronic payment processing market. New companies could emerge and compete for
merchants of all sizes. The Company expects competition to increase from both
established and emerging companies and that such increased competition could
materially adversely affect the Company's business, operating results and
financial condition. Moreover, the Company's current and potential competitors,
many of whom have greater financial, technical, marketing and other resources
than the Company, may respond more quickly than the Company to new or emerging
technologies or could expand to compete directly against the Company in any or
all of its target markets. Accordingly, it is possible that current or potential
competitors could rapidly acquire market share. There can be no assurance that
the Company will be able to compete against current or future competitors
successfully or that competitive pressures faced by the Company will not have a
material adverse effect on its business, operating results and financial
condition.
DEPENDENCE ON KEY PERSONNEL
The Company's success depends to a significant degree upon the continued
contributions of its key management, marketing, service and related product
development and operational personnel, including its Chairman, Chief Executive
Officer and Chief Financial Officer, Michael R. Long and its President and Chief
Operating Officer, Louis A. Hoch. The Company's operations could be affected
adversely if, for any reason, either of these officers ceased to be active in
the Company's management. The Company maintains proprietary nondisclosure and
non-compete agreements with all of its key employees. The success of the Company
depends to a large extent upon its ability to retain and continue to attract
highly skilled personnel. Competition for employees in the electronic commerce
industry is intense, and there can be no assurance that the Company will be able
to attract and retain enough qualified employees. If the Company experiences
significant growth, it may become increasingly difficult to hire, train and
assimilate the new employees needed. The Company's potential inability to retain
and attract key employees could have a material adverse effect on the Company's
business, operating results and financial condition.
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS
The Company's quarterly results of operations may fluctuate significantly as a
result of a number of factors, including changes in the Company's pricing
policies or those of its competitors, relative rates of acquisition of new
customers, delays in the introduction of new or enhanced services, software and
related products by the Company or by its competitors or market acceptance of
such services and products, other changes in operating expenses, personnel
changes and general economic conditions. These factors will impact the Company's
operating results. Fluctuations in operating results could result in volatility
in the price of the Company's common stock.
RISK OF PRODUCT DEFECTS
The software products utilized by the Company could contain errors or "bugs"
that could adversely affect the performance of services or damage a user's data.
In addition, as the Company increases its share of the electronic commerce
services market, software reliability and security demands will increase. The
Company attempts to limit its potential liability for warranty claims through
technical audits and limitation-of-liability provisions in its customer
agreements. There can be no assurance that the
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measures taken by the Company will prove effective in limiting the Company's
exposure to warranty claims. Despite the existence of various security
precautions, the Company's computer infrastructure may also be vulnerable to
viruses or similar disruptive problems caused by its customers or third parties
gaining access to the Company's processing system.
EROSION OF REVENUE FROM SERVICES
The profitability of the Company's business depends, to a substantial degree,
upon merchants electing to continue to periodically renew contracts and receive
services under existing contracts. In the event that a substantial number of
these customers were to decline to renew these contracts or choose to
discontinue receiving services for any reason, the Company's revenues and
profits would be adversely affected. Sales of the Company's services are
dependent upon customer demand for the services, which is affected by pricing
decisions, the competition of similar products and services, and reputation of
the products and services for performance. Poor performance by the Company in
performing its services would have the potential to undermine the Company's
reputation and affect future sales of other services. A substantial decrease in
revenue from services would have a material adverse effect upon the Company's
business, operating results and financial condition.
RISK OF LOSS FROM RETURNED TRANSACTIONS, MERCHANT FRAUD OR ERRONEOUS
TRANSMISSIONS
The Company relies upon the Federal Reserve's ACH for electronic fund transfers
and conventional paper check and draft clearing systems for settlement of
payments by check or drafts. In its use of these established payment clearance
systems, the Company generally bears the same credit risks normally assumed by
other users of these systems arising from returned transactions caused by
insufficient funds, stop payment orders, closed accounts, frozen accounts,
unauthorized use, disputes, theft or fraud. In addition, the Company also
assumes the risk of merchant fraud and transmission errors when it is unable to
have erroneously transmitted funds returned by an unintended recipient. Merchant
fraud includes such actions as inputting false sales transactions or false
credits.
RISK OF SYSTEM FAILURE
The Company's operations are dependent on its ability to protect its computer
equipment against damage from fire, earthquake, power loss, telecommunications
failure or similar event. Any damage or failure that causes interruptions in the
Company's operations could have a material adverse effect on the Company's
business, operating results and financial condition. The Company's property and
business interruption insurance may not be adequate to compensate the Company
for all losses that may occur.
LIMITED PROTECTION OF PROPRIETARY SERVICES
The Company regards some of its services as proprietary and relies primarily on
a combination of trademark and trade secret laws, employee and third party
non-disclosure agreements, and other intellectual property protection methods to
protect its products and services. Existing intellectual property laws afford
only limited protection, and it may be possible for unauthorized third parties
to copy the Company's services and related products or to reverse engineer or
obtain and use information that the Company regards as proprietary. There can be
no assurance that the Company's competitors will not independently develop
services and related products that are substantially equivalent or superior to
those of the Company.
VOLATILITY OF STOCK PRICE
The market price of the Company's common stock is subject to significant
fluctuations in response to variations in quarterly operating results, the
failure of the Company to achieve operating results consistent with securities
analysts' projections of the Company's performance, and other factors. The stock
market has experienced extreme price and volume fluctuations and volatility that
has particularly affected the market prices of many technology, emerging growth
and developmental stage companies. Such fluctuations and volatility have often
been unrelated or disproportionate to the operating performance of such
companies. Factors such as announcements of the introduction of new or enhanced
services or related products by the Company or its competitors, announcements of
joint development efforts or corporate partnerships in the electronic commerce
market, market conditions in the technology, banking, telecommunications and
other emerging growth sectors, and rumors relating to the Company or its
competitors may have a significant impact on the market price of the Company's
common stock.
CONTROL BY PRINCIPAL STOCKHOLDERS
As of December 31, 2003, the directors and officers of the Company and their
affiliates collectively own approximately 6% of the outstanding shares of the
Company's common stock. As a result, these stockholders are able to exercise
some degree of influence over matters requiring stockholder approval, including
the election of directors and approval of significant corporate transactions.
Such concentration of ownership may have the effect of delaying or preventing a
change in control of the Company.
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SHARES ELIGIBLE FOR FUTURE SALE; POSSIBLE ADVERSE EFFECT ON MARKET PRICE
As of December 31, 2003, the Company had 20,987,956 shares of common stock
issued and outstanding. The Company anticipates that it may need future equity
financing to meet certain operational and strategic requirements. Such future
equity financing may have a significant dilutive effect on the Company's stock
price.
ANTI-TAKEOVER PROVISIONS; CERTAIN PROVISIONS OF NEVADA LAW; CERTIFICATE OF
INCORPORATION, BYLAWS, AND STOCKHOLDER RIGHTS PLAN
On October 4, 2000, the Company approved a stockholder rights plan to protect
stockholders in the event of an unsolicited attempt to acquire the Company in a
manner that would not be in the best interests of its stockholders. This
stockholder rights plan could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from attempting to
acquire, control of the Company. The Company's Board of Directors is also
classified into three classes of directors serving staggered three-year terms.
Such classification of the Board of Directors expands the time required to
change the composition of a majority of directors and may tend to discourage a
proxy contest or other takeover bid for the Company. The issuance of common
stock under a stockholder rights plan could decrease the amount of earnings and
assets available for distribution to the holders of the Company's common stock
or could adversely affect the rights and powers, including voting rights, of the
holders of the Company's common stock. In certain circumstances, such issuance
could have the effect of decreasing the market price of the Company's common
stock.
DIFFICULTY IN MANAGEMENT OF GROWTH
The Company may experience a period of rapid growth that could place a
significant strain on its resources. The Company's ability to manage growth
successfully will require the Company to continue to improve its operational,
management and financial systems and controls as well as to expand its work
force. A significant increase in the Company's customer base may necessitate the
hiring of a significant number of additional personnel, qualified candidates for
which, at the time needed, may be in short supply. In addition, the expansion
and adaptation of the Company's computer and administrative infrastructure will
require substantial operational, management and financial resources. Although
the Company believes that its current infrastructure is adequate to meet the
needs of its customers in the foreseeable future, there can be no assurance that
the Company will be able to expand and adapt its infrastructure to meet
additional demand on a timely basis, at a commercially reasonable cost, or at
all. If the Company's management is unable to manage growth effectively, hire
needed personnel, expand and adapt its computer infrastructure or improve its
operational, management, and financial systems and controls, the Company's
business, operating results, and financial condition could be materially
adversely affected.
ACQUISITION-RELATED RISKS
In the future, the Company may pursue acquisitions of complementary service or
product lines, technologies or businesses. Future acquisitions by the Company
could result in potentially dilutive issuance of equity securities, the
incurrence of debt and contingent liabilities, and amortization expenses related
to goodwill and other intangible assets, any of which could materially adversely
affect the Company's business, operating results and financial condition. In
addition, acquisitions involve numerous risks, including difficulties in the
assimilation of the operations, technologies, services and products of the
acquired companies, the diversion of management's attention from other business
concerns, risks of entering markets in which the Company has no or limited
direct prior experience, and the potential loss of key employees of the acquired
company. From time to time, the Company evaluates potential acquisitions of
businesses, services, products or technologies. The Company has no present
commitments or agreements with respect to any material acquisition of other
businesses, services, products or technologies. In the event that such an
acquisition were to occur, however, there can be no assurance that the Company's
business, operating results and financial condition would not be materially
adversely affected.
PAYMENT OF DIVIDENDS
The Company has paid no cash dividends and has no present plan to pay cash
dividends, intending instead to reinvest its earnings, if any. However, payment
of future cash dividends will be determined from time to time by its Board of
Directors, based upon its future earnings, financial condition, capital
requirements and other factors. The Company is not presently subject to any
restriction on its present or future ability to pay such dividends.
DEPENDENCE UPON CONTRACTS WITH MERCHANTS
The Company's business is dependent upon performing under the terms of
agreements with merchants. Although the Company is unaware of any circumstance
that would prevent the operational ability to perform these agreements, there
can be no assurance that the Company will be able to fully perform under these
agreements or that other factors may prevent merchants from processing payments
through the Company.
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DEPENDENCE UPON CONTRACTS WITH PAYMENT PROCESSORS AND SERVICE PROVIDERS
The Company's business is dependent upon executing and maintaining agreements
with third party providers to provide dependable financial services to merchants
and their consumers. Such financial services include ACH processing and credit
and debit-card based processing. There can be no assurance that any of the
payment processors will be able to perform under these agreements in the future.
Typically, our contracts with these third parties are subject to cancellation
upon limited notice by either party. The termination by our service providers of
their arrangements with us or their failure to perform their services
efficiently and effectively