UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT
For the transition period from ____ to ____
Commission file number 000-30152
Payment Data Systems, Inc.
(Exact name of small business issuer as specified in its charter)
Nevada 98-0190072
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
12500 San Pedro, Suite 120
San Antonio, TX 78216
(Address of principal executive offices)
(210) 249-4100
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirement for the past 90 days. Yes X No ___
--
As of August 8, 2005, 31,110,577 shares of the issuer's common stock, $0.001 par
value, were outstanding.
Transitional Small Business Disclosure Format (Check one): Yes ___ No X
================================================================================
PAYMENT DATA SYSTEMS, INC.
INDEX
PART I - FINANCIAL INFORMATION . . . . . . . . . . . . . . . . . . Page
------------------------------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of June 30, 2005
and December 31, 2004 3
Consolidated Statements of Operations for the three and six months
ended June 30, 2005 and 2004 4
Consolidated Statements of Cash Flows for the six months
ended June 30, 2005 and 2004 5
Notes to Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis or Plan of Operation 10
Item 3 Controls and Procedures 15
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 16
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 17
Item 3 Defaults Upon Senior Securities 17
Item 4 Submission of Matters to a Vote of Security Holders 18
Item 5 Other Information 18
Item 6 Exhibits and Reports on Form 8-K 18
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
June 30, 2005 December 31, 2004
(Unaudited)
--------------- ---------------
Assets:
Current assets:
Cash and cash equivalents . . . . . . . . . . . $ 463,162 $ 153,966
Accounts receivable, net. . . . . . . . . . . . 74,207 57,788
Prepaid expenses and other. . . . . . . . . . . 159,930 47,833
--------------- --------------
Total current assets . . . . . . . . . . . . . . 697,299 259,587
Property and equipment, net. . . . . . . . . . . 175,700 132,064
Other assets . . . . . . . . . . . . . . . . . . 23,589 23,589
--------------- --------------
Total assets . . . . . . . . . . . . . . . . . . $ 896,588 $ 415,240
=============== ==============
Liabilities and stockholders' equity (deficit):
Current liabilities:
Accounts payable. . . . . . . . . . . . . . . . $ 562,367 $ 482,788
Accrued expenses. . . . . . . . . . . . . . . . 397,896 392,515
Note payable. . . . . . . . . . . . . . . . . . 579,376 264,165
--------------- --------------
Total current liabilities. . . . . . . . . . . . 1,539,639 1,139,468
Stockholders' equity (deficit):
Common stock, $0.001 par value, 200,000,000 shares
authorized; 30,600,078 and 23,569,180 issued and
outstanding . . . . . . . . . . . . . . . . . . 30,600 23,569
Additional paid-in capital . . . . . . . . . . . 48,986,664 47,417,898
Deferred compensation. . . . . . . . . . . . . . (542,109) -
Accumulated deficit. . . . . . . . . . . . . . . (49,118,206) (48,165,695)
--------------- --------------
Total stockholders' equity (deficit) . . . . . . (643,051) (724,228)
--------------- --------------
Total liabilities and stockholders' equity (deficit)$ 896,588 $ 415,240
=============== ==============
See notes to interim consolidated financial statements.
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30,
2005 2004 2005 2004
---------- ---------- ----------- ----------
Revenues. . . . . . . . . . . . . . . . . . . $ 314,926 $ 64,202 $ 557,888 $ 119,399
Operating expenses:
Cost of services. . . . . . . . . . . . . . . 271,211 65,719 495,840 129,359
Selling, general and administrative . . . . . 449,886 272,884 860,989 632,703
Depreciation and amortization . . . . . . . . 17,718 25,353 38,111 53,035
---------- ---------- ----------- ----------
Total operating expenses. . . . . . . . . . . 738,815 363,956 1,394,940 815,097
---------- ---------- ----------- ----------
Operating loss. . . . . . . . . . . . . . . . (423,889) (299,754) (837,052) (695,698)
Other income (expense), net:
Interest income . . . . . . . . . . . . . . . 264 245 266 643
Interest expense. . . . . . . . . . . . . . . (68,544) - (110,609) -
Other income (expense). . . . . . . . . . . . (4,362) (3,440) (5,116) (8,610)
---------- ---------- ----------- ----------
Total other income (expense), net . . . . . . (72,642) (3,195) (115,459) (7,967)
---------- ---------- ----------- ----------
Loss from operations before income taxes. . . (496,531) (302,949) (952,511) (703,665)
Income taxes. . . . . . . . . . . . . . . . . - - - -
---------- ---------- ----------- ----------
Net loss. . . . . . . . . . . . . . . . . . . $(496,531) $(302,949) $ (952,511) $(703,665)
========== ========== =========== ==========
Basic and diluted net loss per common share: $ (0.02) $ (0.01) $ (0.04) $ (0.03)
Weighted average common shares outstanding 28,596,016 21,491,884 26,523,006 21,340,681
See notes to interim consolidated financial statements.
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30,
2005 2004
---------- ----------
Operating activities:
Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(952,511) $(703,665)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . 38,111 53,035
Non-cash issuance of common stock. . . . . . . . . . . . . . . . . . . . . 353,667 69,200
Deferred compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . 49,281 -
Amortization of debt discount. . . . . . . . . . . . . . . . . . . . . . . 46,086 -
Changes in current assets and current liabilities:
Accounts receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . (16,419) 17,027
Prepaid expenses and other . . . . . . . . . . . . . . . . . . . . . . . . 64,903 54,372
Accounts payable and accrued expenses. . . . . . . . . . . . . . . . . . . 93,204 62,058
---------- ----------
Net cash used in operating activities . . . . . . . . . . . . . . . . . . . (323,678) (447,973)
Investing activities:
Purchases of property and equipment . . . . . . . . . . . . . . . . . . . . (71,747) (1,079)
---------- ----------
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . (71,747) (1,079)
Financing activities:
Proceeds from notes payable . . . . . . . . . . . . . . . . . . . . . . . . 600,000 -
Principal payments for notes payable. . . . . . . . . . . . . . . . . . . . (330,875) -
Financing costs, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . (20,000) -
Issuance of common stock, net of issuance costs . . . . . . . . . . . . . . 455,496 3,345
---------- ----------
Net cash provided by financing activities . . . . . . . . . . . . . . . . . 704,621 3,345
---------- ----------
Change in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . 309,196 (445,707)
Cash and cash equivalents, beginning of period. . . . . . . . . . . . . . . 153,966 528,119
---------- ----------
Cash and cash equivalents, end of period. . . . . . . . . . . . . . . . . . $ 463,162 $ 82,412
========== ==========
See notes to interim consolidated financial statements.
PAYMENT DATA SYSTEMS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Basis of Presentation
Payment Data Systems, Inc. and subsidiaries (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 believes that
its current available cash 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 is likely contingent on the
Company receiving additional funds in the form of equity or debt financing. The
Company is currently aggressively pursuing strategic alternatives (see Note 5).
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 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. The accompanying unaudited consolidated financial
statements of the Company do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.
The accompanying unaudited consolidated financial statements of the Company have
been prepared without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with U.S.
generally accepted accounting principles have been condensed or omitted pursuant
to such rules and regulations. In the opinion of management, the accompanying
consolidated financial statements reflect all adjustments of a normal recurring
nature considered necessary to present fairly the Company's financial position,
results of operations and cash flows for such periods. The accompanying interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-KSB for the year ended December 31, 2004.
Results of operations for interim periods are not necessarily indicative of
results that may be expected for any other interim periods or the full fiscal
year.
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Note 2. Stock-Based Compensation
The Company applies the intrinsic value method under the recognition and
measurement provisions of APB No. 25, "Accounting for Stock Issued to
Employees," in accounting for its stock option and stock purchase plans.
Accordingly, no stock-based employee compensation expense has been recognized
for options granted with an exercise price equal to the market value of the
underlying common stock on the date of grant or in connection with the employee
stock purchase plan. The following table illustrates the effect on net income
and earnings per share if the Company had applied the fair value recognition
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation," to stock-based employee compensation.
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
Net loss, as reported. . . . . . . . . $(496,531) $(302,949) $(952,511) $(703,665)
Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects (275) (67,755) (1,590) (135,510)
---------- ---------- ---------- ----------
Pro forma net loss . . . . . . . . . . $(496,806) $(370,074) $(954,101) $(839,175)
========== ========== ========== ==========
Net loss per common share
- basic and diluted, as reported . . . $ (0.02) $ (0.01) (0.04) $ (0.03)
Net loss per common share
- basic and diluted, pro forma . . . . $ (0.02) $ (0.02) $ (0.04) $ (0.04)
Note 3. Related Party Transactions
Beginning in December 2000, the Company pledged as loan guarantees certain funds
held as money market funds and certificates of deposit to collateralize margin
loans for the following executive officers of the Company: (1) Michael R. Long,
then Chairman of the Board of Directors and Chief Executive Officer; (2) Louis
A. Hoch, then President and Chief Operating Officer; (3) Marshall N. Millard,
then Secretary, Senior Vice President, and General Counsel; and (4) David S.
Jones, then Executive Vice President. Mr. Millard and Mr. Jones are no longer
employees of the Company. The margin loans were obtained in March 1999 from
institutional lenders and were secured by shares of the Company's common stock
owned by these officers. The pledged funds were held in the Company's name in
accounts with the lenders that held the margin loans of the officers. The
Company's purpose in collateralizing the margin loans was to prevent the sale of
its common stock owned by these officers while it was pursuing efforts to raise
additional capital through private equity placements. The sale of that common
stock could have hindered the Company's ability to raise capital in such a
manner and compromised its continuing efforts to secure additional financing.
The highest total amount of funds pledged for the margin loans guaranteed by the
Company was approximately $2.0 million. The total balance of the margin loans
guaranteed by the Company was approximately $1.3 million at December 31, 2002.
At the time the funds were pledged, the Company believed they would have access
to them because (a) their stock price was substantial and the stock pledged by
the officers, if liquidated, would produce funds in excess of the loans payable,
and (b) with respect to one of the institutional lenders (who was also assisting
the Company as a financial advisor at the time), even if the stock price fell,
they had received assurances from that institutional lender that the pledged
funds would be made available as needed. During the fourth quarter of 2002, the
Company requested partial release of the funds for operating purposes, which
request was denied by an institutional lender. At that time, their stock price
had fallen as well, and it became clear that both institutional lenders would
not release the pledged funds. In light of these circumstances, 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 their
balance sheet at December 31, 2002 because it became probable at that point that
they would be unable to recover their pledged funds. 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 June 30, 2005. The Company may institute litigation or
arbitration in collection of the outstanding repayment obligations of Mr. Long,
Mr. Hoch, Mr. Millard, and Mr. Jones, which currently total $1,278,138.
Presently, the Company has refrained from initiating action to recover these
funds from Mr. Long, Mr. Hoch, and Mr. Millard because they may have offsetting
claims that total $1,445,500 collectively by virtue of the change of control
clause in their respective employment agreements based on our preliminary
analysis. The Company understands that these individuals may assert such claims
based on the Company's sale of substantially all of its assets to Harbor
Payments, Inc. on July 25, 2003. The Company has not initiated any formal
settlement negotiations with these individuals because they have been under an
extended employment contract with us or have not been amenable to such an
action. On July 25, 2004, the Company's employment agreements with Michael Long,
Chief Executive Officer and Chief Financial Officer, and Louis Hoch, President
and Chief Operating Officer, expired. The Company intends to enter into new
employment agreements with both of these individuals and is currently
negotiating the terms of such agreements. The Company has not pursued the
outstanding repayment obligation of Mr. Jones because the Company does not
consider a recovery attempt to be cost beneficial. In order to attempt a
recovery from Mr. Jones, the Company estimates that it would incur a minimum of
$20,000 in estimated legal costs with no reasonable assurance of success in
recovering his outstanding obligation of approximately $38,000. Because of the
limited amount of the obligation, the Company also anticipates difficulty in
retaining counsel on a contingency basis to pursue collection of this
obligation. The ultimate outcome of this matter cannot presently be determined.
Note 4. Note Payable
On December 10, 2004, the Company entered into a zero-discount promissory note
with Dutchess Private Equities Fund, II, LP ("Dutchess"). Pursuant to terms of
the promissory note, the Company received $260,000 and promised to pay Dutchess
$284,000 with a maturity date of April 10, 2005, which represents an effective
annual interest rate of 28%. The Company also issued 75,000 shares of restricted
common stock to Dutchess as an incentive for the investment and agreed to
register the common stock issued pursuant to the promissory note on the next
registration statement filed by the Company. The Company defaulted on final
payment of this promissory note to Dutchess on its maturity date.
On May 12, 2005, the Company entered into a zero-discount promissory note with
Dutchess. Pursuant to terms of the promissory note, the Company received
$600,000 and promised to pay Dutchess $720,000 with a maturity date of December
22, 2005, which represents an effective annual interest rate of 33%. The Company
also issued 500,000 shares of restricted common stock to Dutchess as an
incentive for the investment and agreed to register the common stock issued
pursuant to the promissory note on the next registration statement filed by the
Company. The Company used a portion of the proceeds from this note to repay the
balance of the note due April 10, 2005 to Dutchess in full, including a penalty
of $5,116 for late payment.
Payments on the promissory note are to be made from the equity line of credit
that the Company previously entered into with Dutchess (see Note 5). The Company
will make payments to Dutchess in the amount of 50% of each put, until the face
amount of the promissory note is paid in full. The payments are due at the
closing of every put to Dutchess and the payment amount as a percentage of a put
escalates to 75% after the cumulative amount of financing we receive from any
source during the term of the note exceeds $250,000. The payment amount as a
percentage of a put increases to 80% after the cumulative amount of financing
exceeds $600,000 and reaches a maximum of 100% once the Company has raised over
$700,000 in financing. The Company issued as collateral twenty-five put notices
to Dutchess for the full amount applicable under the terms of the equity line of
credit and agreed to do so at the maximum frequency allowed under the equity
line agreement, until such time as the note is paid in full.
In the event that on the maturity date, there are any remaining amounts unpaid
on this note, Dutchess can exercise its right to increase the residual amount by
10% as an initial penalty and 2.5% per month paid as liquated damages. In the
event that the Company defaults, Dutchess has the right, but not the obligation,
to switch the residual amount to a five-year, 10% interest bearing convertible
debenture at a conversion rate at the lesser of (i) 75% of the average of the
lowest closing bid price during the fifteen trading immediately preceding the
convertible maturity date or (ii) 100% of the average of the lowest bid price
for the twenty trading days immediately preceding the convertible maturity date.
If Dutchess chooses to convert the residual amount to a convertible debenture,
the Company shall have twenty business days after notice of the same to file a
registration statement covering an amount of shares equal to 300% of the
residual amount. In the event the Company does not file such registration
statement within twenty business days of Dutchess' request, or such registration
statement is not declared by the Securities and Exchange Commission to be
effective within the time period described above, the residual amount shall
increase by $1,000 per day.
Note 5. 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. During the six months ended June 30, 2005, the Company sold 1,735,358
shares of its common stock pursuant to the equity line of credit and received
total proceeds, net of issuance costs, of $374,470. Pursuant to the terms of a
promissory note with Dutchess Private Equities Fund, II, LP, the Company is
obligated to use a portion of the proceeds from the equity line to pay back the
promissory note (see Note 4).
Note 6. Issuance of Capital Stock
In January 2005, the Company's Chief Executive Officer and Chief Financial
Officer; President and Chief Operating Officer, and all other employees owed
unpaid wages elected to receive common stock from the Company in lieu of a total
of $179,000 in accumulated unpaid salary. The Company's Board of Directors
granted a total of 859,743 shares of common stock in exchange for the unpaid
salaries. All shares were issued under the terms of the Company's Employee
Comprehensive Stock Plan.
On March 28, 2005, the Company's Board of Directors granted a total of 2,956,950
shares of common stock to employees as a long-term incentive and recorded
$591,390 of deferred compensation. The common stock is restricted and vests
equally over three years on the anniversary date of the grant. The Company's
Board of Directors also granted a total of 50,000 shares of unrestricted common
stock under the terms of the Company's Employee Comprehensive Stock Plan to
certain employees and recorded $10,000 of compensation expense.
In April 2005, the Company issued 250,000 shares of common stock and received
cash proceeds of $60,000 related to the exercise of stock warrants granted under
the terms of a warrant agreement with Kubra Data Transfer, Ltd.
During the six months ended June 30, 2005, the Company issued a total of 363,847
shares of common stock under the terms of its Comprehensive Employee Stock Plan
to independent contractors providing consulting services to the Company and
recorded $93,988 of related expense.
During the six months ended June 30, 2005, the Company issued 15,000 shares of
common stock and received cash proceeds of $1,275 related to the exercise of
stock options granted under the terms of its Comprehensive Employee Stock Plan.
Note 7. Shareholder Rights Plan
On April 22, 2005, the Company's Board of Directors declared a dividend of one
right for each outstanding share of common stock. The rights were issued to
shareholders of record on April 29, 2005 and will expire on April 29, 2009.
Until the rights become exercisable, the rights will trade automatically with
the common stock and separate rights certificates will not be issued. The rights
will be exercisable only if a person or group acquires 15% or more of the
Company's common stock, whether through open market or private purchases or
consummation of a tender or exchange offer, or announces an offer the
consummation of which would result in such person or group owning 15% or more of
the Company's common stock. When the rights first become exercisable, each right
will entitle the holder to purchase one share of common stock for $0.23, subject
to adjustment. If the Company is involved in a merger or other business
combination after a person or group has acquired 15% or more of its common
stock, each right will entitle its holder to purchase, at the right's
then-current exercise price, a number of the acquiring company's shares having a
market value of twice the exercise price of each right. If a person or group
acquires 15% or more of the Company's common stock, each right will entitle its
holder to purchase a number of additional shares of common stock having a market
value of twice the exercise price of each right.
Note 8. Subsequent Events
Subsequent to June 30, 2005 and through the date of this report, the Company
sold 534,503 shares of its common stock pursuant to the equity line of credit
(see Note 5) and received total proceeds, net of issuance costs, of $92,700.
Subsequent to June 30, 2005 and through the date of this report, the Company
issued a total of 52,019 shares of common stock under the terms of its
Comprehensive Employee Stock Plan to independent contractors providing
consulting services to the Company for which it recorded $10,240 of related
expense.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion and analysis of financial condition and results of
operations contains forward-looking statements that involve a number of risks
and uncertainties. Actual results in future periods may differ materially from
those expressed or implied in such forward-looking statements. This discussion
and analysis should be read in conjunction with the unaudited interim
consolidated financial statements and the notes thereto included in this report,
and our Annual Report on Form 10-KSB for the year ended December 31, 2004.
Overview
We provide integrated electronic payment processing services to merchants and
businesses, including credit and debit card-based processing services and
transaction processing via the Automated Clearinghouse Network. We also operate
an online payment processing service for consumers under the domain name
www.bills.com through which consumers can pay anyone. Since inception, we have
incurred operating losses each quarter, and as of June 30, 2005, we have an
accumulated deficit of $49.1 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. 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.
Critical Accounting Policies
General
Management's Discussion and Analysis of Our Financial Condition and Results of
Operations is based upon our consolidated financial statements, which have been
prepared in accordance with U.S. generally accepted accounting principles. The
preparation of these financial statements requires us 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, we evaluate our estimates, including those related to the
reported amounts of revenues and expenses, bad debt, investments, intangible
assets, income taxes, and contingencies and litigation. We base our 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. We consider the following
accounting policies to be critical because the nature of the estimates or
assumptions is material due to the levels of subjectivity and judgment necessary
to account for highly uncertain matters or the susceptibility of such matters to
change or because the impact of the estimates and assumptions on financial
condition or operating performance is material.
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, such
as the types of card transactions processed and nature of the merchant
relationship with their consumers. This reserve amount is subject to risk that
actual losses may be greater than our estimates. At June 30, 2005, our card
merchant processing loss reserve was $15,017. We have not incurred any
chargeback losses to date. Our estimate for chargeback losses is likely to
increase in the future as our volume of card-based transactions processed
increases.
Bad Debts
We maintain an allowance for doubtful accounts for estimated losses resulting
from the inability or failure of our customers to make required payments. We
determine the allowance for doubtful accounts based on an account-by-account
review, taking into consideration such factors as the age of the outstanding
balance, historical pattern of collections and financial condition of the
customer. Past losses incurred by us due to bad debts have been within our
expectations. We did not record any bad debt expense or bad debt write-offs in
2004. At June 30, 2005, the balance of the allowance for doubtful accounts was
$10,207. If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make contractual payments,
additional allowances may be required. Our estimate for bad debt losses is
likely to increase in the future as our volume of transactions processed
increases.
Valuation of Long-Lived and Intangible Assets
We assess 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. No
impairment losses were recorded in 2004 or during the six months ended June 30,
2005.
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 June 30, 2005 will be realized in future periods. Accordingly,
a valuation allowance has been provided to reduce the net deferred tax assets to
$0. At December 31, 2004, we had available net operating loss carryforwards of
approximately $36.1 million, which expire beginning in the year 2020.
Results of Operations
Our revenues are principally derived from providing integrated electronic
payment services to merchants and businesses, including credit and debit
card-based processing services and transaction processing via the Automated
Clearinghouse Network. We also operate an online payment processing service for
consumers under the domain name www.bills.com. Revenues for the quarter ended
June 30, 2005 increased 391% to $314,926 from $64,202 for the quarter ended June
30, 2004. Revenues for the six months ended June 30, 2005 increased 367% to
$557,888 from $119,399 for the six months ended June 30, 2004. The increases
from the prior year periods were primarily attributable to the increase in
revenues generated from card-based processing services due to increased
transaction volume. The increase in revenue was also due to an increase in the
average number of consumers subscribing to the bills.com payment service and an
increase in the monthly fee paid by certain consumers subscribing to the
bills.com payment service because these consumers were converted from a per
payment pricing plan to a flat monthly fee pricing plan during the second
quarter of 2004. The monthly average number of consumers using our online
payment service increased to 2,892 and 2,929 in the first quarter and six months
of 2005 from 1,986 and 2,039 in the first quarter and six months of 2004,
respectively.
The number of transactions generated by bills.com customers is not indicative of
revenue growth because the majority of these customers pay a flat monthly fee to
process up to a certain number of payments each month and do not exceed the
maximum number of payments allowed. We expect that revenues generated by our
bills.com payment service will decrease as we transition to processing the
online payments ourselves during the third quarter of 2005. We had previously
been using a third party provider to process the payments, but will now be able
to market the service as a private-label application to prospective resellers.
We expect our total revenues to increase as we anticipate continued growth in
the volume of card transactions and additional merchant customers. Revenue
generated by our merchant customers represented approximately 85% of our total
revenues in the three months ended June 30, 2005, and we believe that this
percentage will increase as we anticipate adding new merchant customers and
experiencing growth in transaction volumes as a result. We believe that our
merchant business provides us with the best opportunity for revenue growth and
that revenues from card-based processing services will continue to grow in
future periods.
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
our contractual relationships with our payment processors, we are able to
process Automated Clearinghouse and debit or credit card transactions on behalf
of our customers and their consumers. We pay volume-based fees for debit and
credit transactions initiated through these processors, and pay fees for other
transactions such as returns, notices of change to bank accounts and file
transmission. Cost of services was $271,211 and $65,719 for the quarters ended
June 30, 2005 and 2004, respectively, and $495,840 and $129,359 for the six
months ended June 30, 2005 and 2004, respectively. The increases from the prior
year periods were due primarily to the increases in fees related to processing
the increased card-based transaction volume.
Selling, general and administrative expenses increased to $449,886 for the
quarter ended June 30, 2005, from $272,884 for the second quarter of 2004. The
increase from the prior year quarter was principally due to an increase in
consulting expenses related to debt and equity financing efforts of
approximately $81,000 and non-cash amortization of deferred compensation of
$49,281 related to employee incentive stock grants. Selling, general and
administrative expenses for the six months ended June 30, 2005 increased to
$860,989 from $632,703 for the six months ended June 30, 2004. The increase from
the prior year period was primarily due to the higher consulting expenses and
the deferred compensation expense recorded in the second quarter of 2005. In
addition, higher contract labor costs in sales and legal fees also contributed
to the increase from the prior year period.
Depreciation and amortization decreased to $17,718 for the quarter ended June
30, 2005, as compared to $25,353 for the second quarter of 2004. Depreciation
and amortization for the six months ended June 30, 2005 decreased to $38,111
from $53,035 for the six months ended June 30, 2004. These decreases were due to
lower depreciation related to certain assets that became fully depreciated
during 2004. We capitalized $71,747 of computer hardware and software purchased
during the six months ended June 30, 2005 and anticipate making additional
capital expenditures of approximately $25,000 over the remaining six months of
2005.
Net other expense was $72,642 for the quarter ended June 30, 2005, compared to
$3,195 for the second quarter of 2004. Net other expense was $115,459 for the
six months ended June 30, 2005, compared to $7,967 for the six months ended June
30, 2004. The increases were attributable to $73,660 and $115,725 of interest
expense and penalties incurred in the quarter and six months ended June 30,
2005, respectively, related to our notes payable to Dutchess.
Net loss increased to $496,531 for the quarter ended June 30, 2005 from $302,949
for the prior year quarter and increased to $952,511 for the six months ended
June 30, 2005 from $703,665 for the prior year comparable period. Net loss
increased from both the prior year quarter and period primarily as a result of
the increases in selling, general and administrative expenses and interest
expense as discussed.
Liquidity and Capital Resources
At June 30, 2005, we had $463,162 of cash and cash equivalents, compared to
$153,966 of cash and cash equivalents at December 31, 2004. We have incurred
substantial losses since inception, which has led to a significant decrease in
our cash position and a deficit in working capital. We believe that our current
available cash and cash equivalents along with anticipated revenues may be
insufficient to meet our anticipated cash needs for the foreseeable future.
Consequently, our ability to continue as a going concern may be contingent on us
receiving additional funds in the form of equity or debt financing. We are
currently aggressively pursuing strategic alternatives.
On May 12, 2005, we entered into a promissory note with Dutchess Private
Equities Fund, II, LP. Pursuant to terms of the promissory note, we received
$600,000 and promised to pay Dutchess $720,000 with a maturity date of December
22, 2005. We also issued 500,000 shares of restricted common stock to Dutchess
as an incentive for the investment and agreed to register the common stock
issued pursuant to the promissory note on the next registration statement that
we file. We used a portion of the proceeds from this note to repay the balance
of the note due April 10, 2005 to Dutchess in full, including a penalty of
$5,116 for late payment. We had previously defaulted on final payment of this
promissory note to Dutchess on its maturity date.
Payments on the promissory note are to be made from the equity line of credit
that we previously entered into with Dutchess. We will make payments to Dutchess
in the amount of 50% of each put, until the face amount of the promissory note
is paid in full. The payments are due at the closing of every put to Dutchess
and the payment amount as a percentage of a put escalates to 75% after the
cumulative amount of financing we receive from any source during the term of the
note exceeds $250,000. The payment amount as a percentage of a put increases to
80% after the cumulative amount of financing exceeds $600,000 and reaches a
maximum of 100% once we have raised over $700,000 in financing. We will issue as
collateral twenty-five put notices to Dutchess for the full amount applicable
under the terms of the equity line of credit and shall do so at the maximum
frequency allowed under the equity line agreement, until such time as the note
is paid in full.
In the event that on the maturity date, there are any remaining amounts unpaid
on this note, Dutchess can exercise its right to increase the residual amount by
10% as an initial penalty and 2.5% per month paid as liquated damages. In the
event that we default, Dutchess has the right, but not the obligation, to switch
the residual amount to a five-year, 10% interest bearing convertible debenture
at a conversion rate at the lesser of (i) 75% of the average of the lowest
closing bid price during the fifteen trading immediately preceding the
convertible maturity date or (ii) 100% of the average of the lowest bid price
for the twenty trading days immediately preceding the convertible maturity date.
If Dutchess chooses to convert the residual amount to a convertible debenture,
we shall have twenty business days after notice of the same to file a
registration statement covering an amount of shares equal to 300% of the
residual amount. In the event we do not file such registration statement within
twenty business days of Dutchess' request, or such registration statement is not
declared by the Securities and Exchange Commission to be effective within the
time period described above, the residual amount shall increase by $1,000 per
day.
In June 2004, we executed an agreement for an equity line of credit with
Dutchess Private Equities Fund, LP. Under the terms of the agreement, we may
elect to receive as much as $10 million from Dutchess in common stock purchases
over three years at our option. Through June 30, 2005, we have sold a total of
3,194,793 shares of our common stock pursuant to the equity line of credit and
received total proceeds, net of issuance costs, of $695,956. Pursuant to the
terms of a promissory note with Dutchess, we are obligated to use a portion of
the proceeds from the equity line to pay back the promissory note.
The satisfactory completion of an additional investment, adequate sales of stock
under our equity line of credit, or growth of cash flow from operations is
essential or we have 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 our
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 us, if at
all. If we cannot raise funds, on acceptable terms, or achieve positive cash
flow, we 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
our business, operating results and financial condition.
Net cash used in operating activities was $323,678 and $447,973 for the six
months ended June 30, 2005 and 2004, respectively. Net cash used in operating
activities was primarily attributable to operating net losses generated by
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 2005.
Net cash used in investing activities was $71,747 and $1,079 for the six months
ended June 30, 2005 and 2004, respectively, and reflected capital expenditures
for computer hardware and software. We anticipate making capital expenditures of
approximately $25,000 during the remaining six months of 2005.
Net cash provided by financing activities of $704,621 for the six months ended
June 30, 2005 resulted from receiving $455,496 in net proceeds from the issuance
of common stock, primarily under our equity line of credit, and receiving
$269,125 in net proceeds under our notes payable. Net cash provided by financing
activities of $3,345 for the six months ended June 30, 2004 resulted from the
exercise of stock options.
Beginning in December 2000, we pledged as loan guarantees certain funds held as
money market funds and certificates of deposit to collateralize margin loans for
the following executive officers of the Company: (1) Michael R. Long, then
Chairman of the Board of Directors and Chief Executive Officer; (2) Louis A.
Hoch, then President and Chief Operating Officer; (3) Marshall N. Millard, then
Secretary, Senior Vice President, and General Counsel; and (4) David S. Jones,
then Executive Vice President. Mr. Millard and Mr. Jones no longer are employees
of the Company. The margin loans were obtained in March 1999 from institutional
lenders and were secured by shares of our common stock owned by these officers.
The pledged funds were held in our name in accounts with the lenders that held
the margin loans of the officers. Our purpose in collateralizing the margin
loans was to prevent the sale of our common stock owned by these officers while
we were pursuing efforts to raise additional capital through private equity
placements. The sale of that common stock could have hindered our ability to
raise capital in such a manner and compromised our continuing efforts to secure
additional financing. The highest total amount of funds pledged for the margin
loans guaranteed by us was approximately $2.0 million. The total balance of the
margin loans guaranteed by us was approximately $1.3 million at December 31,
2002. At the time the funds were pledged, we believed we would have access to
them because (a) our stock price was substantial and the stock pledged by the
officers, if liquidated, would produce funds in excess of the loans payable, and
(b) with respect to one of the institutional lenders (who was also assisting us
as a financial advisor at the time), even if the stock price fell, we had
received assurances from that institutional lender that the pledged funds would
be made available as needed. During the fourth quarter of 2002, we requested
partial release of the funds for operating purposes, which request was denied by
an institutional lender. At that time, our stock price had fallen as well, and
it became clear that both institutional lenders would not release the pledged
funds. In light of these circumstances, we 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 our balance sheet at December 31, 2002 because
it became probable at that point that we would be unable to recover our pledged
funds. 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 us was zero at June 30, 2005. We may institute
litigation or arbitration in collection of the outstanding repayment obligations
of Mr. Long, Mr. Hoch, Mr. Millard, and Mr. Jones, which currently total
$1,278,138. Presently, we have refrained from initiating action to recover these
funds from Mr. Long, Mr. Hoch, and Mr. Millard because they may have offsetting
claims that total $1,445,500 collectively by virtue of the change of control
clause in their respective employment agreements based on our preliminary
analysis. We understand that these individuals may assert such claims based on
our sale of substantially all of our assets to Harbor Payments, Inc. on July 25,
2003. We have not initiated any formal settlement negotiations with these
individuals because they have been under an extended employment contract with us
or have not been amenable to such an action. We have not pursued the outstanding
repayment obligation of Mr. Jones because we do not consider a recovery attempt
to be cost beneficial. In order to attempt a recovery from Mr. Jones, we
estimate that we would incur a minimum of $20,000 in estimated legal costs with
no reasonable assurance of success in recovering his outstanding obligation of
approximately $38,000. Because of the limited amount of the obligation, we also
anticipate difficulty in retaining counsel on a contingency basis to pursue
collection of this obligation. The ultimate outcome of this matter cannot
presently be determined.
Off-balance Sheet Arrangements
We currently have no off-balance sheet arrangements that have or are reasonably
likely to have a current or future material effect on our financial condition,
changes in financial condition, revenues or expenses, results of operations,
liquidity, capital expenditures or capital resources.
FORWARD-LOOKING STATEMENTS DISCLAIMER
Except for the historical information contained herein, the matters discussed in
our Form 10-QSB include certain forward-looking statements, which are intended
to be covered by safe harbors. Those statements include, but are not limited to,
all statements regarding our and management's intent, belief and expectations,
such as statements concerning our future and our operating and growth strategy.
Investors are cautioned that all forward-looking statements involve risks and
uncertainties including, without limitation, the factors set forth under the
Risk Factors section of Item 6, Management's Discussion and Analysis of
Financial Condition and Results of Operations, of the Annual Report on Form
10-KSB for the year ended December 31, 2004 and other factors detailed from time
to time in our filings with the Securities and Exchange Commission. One or more
of these factors have affected, and in the future could affect, our businesses
and financial results in the future and could cause actual results to differ
materially from plans and projections. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the inclusion of
such information should not be regarded as a representation by us or any other
person that our objectives and plans will be achieved. All forward-looking
statements made in this Form 10-QSB are based on information presently available
to our management. We assume no obligation to update any forward-looking
statements, except as required by law.
Item 3. CONTROLS AND PROCEDURES
Our management evaluated, with the participation of our Chief Executive
Officer/Chief Financial Officer, the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this Quarterly Report on
Form 10-QSB. Based on this evaluation, our Chief Executive Officer/Chief
Financial Officer has concluded that our disclosure controls and procedures are
effective to ensure that information we are required to disclose in reports that
we file or submit under the Securities Exchange Act of 1934 (i) is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms, and (ii) is accumulated and
communicated to our management, including our Chief Executive Officer/Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure. Our disclosure controls and procedures are designed to provide
reasonable assurance that such information is accumulated and communicated to
our management. Our disclosure controls and procedures include components of
our internal control over financial reporting. Management's assessment of the
effectiveness of our internal control over financial reporting is expressed at
the level of reasonable assurance that the control system, no matter how well
designed and operated, can provide only reasonable, but not absolute, assurance
that the control system's objectives will be met.
There was no change in our internal control over financial reporting that
occurred during the second quarter of the year covered by this report that
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
Part II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Beginning in December 2000, we pledged as loan guarantees certain funds held as
money market funds and certificates of deposit to collateralize margin loans for
the following executive officers of the Company: (1) Michael R. Long, then
Chairman of the Board of Directors and Chief Executive Officer; (2) Louis A.
Hoch, then President and Chief Operating Officer; (3) Marshall N. Millard, then
Secretary, Senior Vice President, and General Counsel; and (4) David S. Jones,
then Executive Vice President. Mr. Millard and Mr. Jones are no longer our
employees. The pledged funds were held in our name in accounts with the lenders
that held the margin loans of the officers. Our purpose in collateralizing the
margin loans was to prevent the sale of our common stock owned by these officers
while we were pursuing efforts to raise additional capital through private
equity placements. The sale of that common stock could have hindered our ability
to raise capital in such a manner and compromised our continuing efforts to
secure additional financing. We were also trying to accommodate the requests of
the named executive officers, who were seeking to preserve their financial
liquidity. We believe this action served our purpose of assuring stable
management and leadership for our future. The margin loans were obtained in
March 1999 from institutional lenders and were secured by shares of our common
stock owned by these officers. Each of the officers used the proceeds of their
respective margin loans for investment purposes and usual and customary living
expenses.
None of the margin loans were recourse with respect to the officers and none of
the loan guarantees were recourse with respect to us because at the times the
margin loans were made and the funds pledged, the value of the common stock
collateralizing the margin loans exceeded the loan amounts. Under the original
terms of the arrangement, we charged each of the officers, pro rata, the
difference between the rate of return earned by us before the collateralization
of the margin loans on the funds that were to be the pledged funds and the rate
of return earned on the pledged funds after the collateralization of the margin
loans. We offset such amounts due from Mr. Long, Mr. Hoch, and Mr. Millard
against their respective salaries from the date the funds were pledged until
November of 2002, when we underwent significant downsizing and Mr. Long, Mr.
Hoch, and Mr. Millard began deferring their salaries. We offset such amounts due
from Mr. Jones against his salary from the date the funds were pledged until the
date of his departure in August 2001.
The highest total amount of funds pledged for the margin loans guaranteed by us
was approximately $2.0 million. The total balance of the margin loans guaranteed
by us was approximately $1.3 million at December 31, 2002. At the time the funds
were pledged, we believed we would have access to them because (a) our stock
price was substantial and the stock pledged by the officers, if liquidated,
would produce funds in excess of the loans payable, and (b) with respect to one
of the institutional lenders (who was also assisting us as a financial advisor
at the time), even if the stock price fell, we had received assurances from that
institutional lender that the pledged funds would be made available as needed.
During the fourth quarter of 2002, we requested partial release of the funds for
operating purposes, which request was denied by an institutional lender. At that
time, our stock price had fallen as well, and it became clear that both
institutional lenders would not release the pledged funds. In light of these
circumstances, we 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 our balance sheet at December 31, 2002 because it became probable
at that point that we would be unable to recover our pledged funds. 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 us was zero at December 31, 2004.
The pledged funds were classified as cash and cash equivalents on our balance
sheet and disclosed in the accompanying footnotes in our Annual Report on Form
10-K for each of the years ended December 31, 2000 and 2001, respectively. The
pledged funds were classified as cash and cash equivalents on our balance sheet
and disclosed in the accompanying footnotes in our Quarterly Report on Form 10-Q
for the quarters ended March 31, 2002 and June 30, 2002, respectively. Under the
terms of the related guaranty agreements, we could, at any time, terminate our
obligations and the lenders' rights under the guaranty agreements, but we would
remain liable for any losses incurred by the lenders in liquidating the
guaranteed accounts by selling the common stock held as collateral in the margin
loan accounts in order to pay off the margin loan balances in full during a
reasonable time subsequent to the receipt of our termination notice. On June 30,
2003, we filed an amended Annual Report on Form 10-K for the year ended December
31, 2001 and amended Quarterly Reports on Form 10-Q for the quarters ended March
31, 2002 and June 30, 2002. These amended reports included restated balance
sheets that classified the pledged funds as cash pledged as collateral for
related party obligations beginning at December 31, 2000 as a result of comments
received from the Securities and Exchange Commission in connection with their
review of our registration statement on Form S-3 that we originally filed on
August 9, 2002.
We may institute litigation or arbitration in collection of the outstanding
repayment obligations of Mr. Long, Mr. Hoch, Mr. Millard, and Mr. Jones, which
currently total $1,278,138. Presently, we have refrained from initiating action
to recover these funds from Mr. Long, Mr. Hoch, and Mr. Millard because they may
have offsetting claims that total $1,445,500 collectively by virtue of the
change of control clause in their respective employment agreements based on our
preliminary analysis. We understand that these individuals may assert such
claims based on our sale of substantially all of our assets to Harbor Payments,
Inc. on July 25, 2003. We have not initiated any formal settlement negotiations
with these individuals because they were under an extended employment contract
with us or have not been amenable to such an action. We have not pursued the
outstanding repayment obligation of Mr. Jones because we do not consider a
recovery attempt to be cost beneficial. In order to attempt a recovery from Mr.
Jones, we estimate that we would incur a minimum of $20,000 in estimated legal
costs with no reasonable assurance of success in recovering his outstanding
obligation of approximately $38,000. Because of the limited amount of the
obligation, we also anticipate difficulty in retaining counsel on a contingency
basis to pursue collection of this obligation. The ultimate outcome of this
matter cannot presently be determined.
On July 25, 2003, certain of our stockholders (those 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) commenced legal
action against us, Ernst & Young, LLP, and certain of our current and former
directors (including the executive officers named above) in the District Court
of the 45th Judicial District, Bexar County, Texas. With respect to us and the
current and former directors named in the suit, the plaintiffs allege that we,
acting through such directors, misstated in our 2000 and 2001 Form 10-Ks our
ability to use for operational purposes the funds pledged as security for margin
loans of certain of our executive officers, as discussed above. The plaintiffs
allege and seek resulting economic and exemplary damages, rescission, interest,
attorneys' fees and costs of court. We believe this suit is without merit and
intend to vigorously defend the company and the directors named in the suit. As
of the date of this report, there have been no material developments in the suit
other than the case being set for trial in late 2005. The results of legal
proceedings cannot be predicted with certainty. If we fail to prevail in this
legal matter, our financial position, results of operations, and cash flows
could be materially adversely affected.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the six months ended June 30, 2005, we sold 1,735,358 shares of our
common stock to Dutchess Private Equities Fund pursuant to an equity line of
credit and received total proceeds, net of issuance costs, of $374,470.
Item 3. DEFAULTS UPON SENIOR SECURITIES
On April 10, 2005, we defaulted on payment of a note payable to Dutchess Private
Equities Fund, II, LP in the amount of $194,900, including principal and accrued
interest. As of the date of this report, there was no amount in arrearage
because we repaid the full balance of the note plus accrued interest and
penalties using a portion of the proceeds from a promissory note we entered into
with Dutchess dated May 12, 2005.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Stockholders held on June 21, 2005, the following
matters were adopted by the margins indicated:
1. To elect director Peter G. Kirby to serve until the 2008 Annual Meeting
of Stockholders.
For: 24,164,782
Withheld: 93,564
2. To ratify the appointment of Akin, Doherty, Klein & Fuege, P.C.,
certified public accountants, as the independent auditors of the Company for the
year ending December 31, 2005.
For: 24,204,183
Against: 29,203
Abstain: 24,960
The following directors continued their term of office subsequent to the Annual
Meeting: Michael R. Long, Louis A. Hoch and Peter G. Kirby.
Item 5. OTHER INFORMATION
Not Applicable.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit
Number Description
------ -----------
3.1 Articles of Incorporation, as amended (included as exhibit 3.1 to the
Form 10-Q filed November 14, 2003, and incorporated herein by reference).
3.2 By-laws, as amended (included as exhibit 3.2 to the Form SB-2 filed
December 29, 1999, and incorporated herein by reference).
4.1 Amended and Restated 1999 Employee Comprehensive Stock Plan (included as
exhibit 4.1 to the Form S-8 filed January 26, 2005, and incorporated herein by
reference).
4.2 Amended and Restated 1999 Non-Employee Director Plan (included as
exhibit 4.2 to the Form S-8 filed January 26, 2005, and incorporated herein by
reference).
4.3 Employee Stock Purchase Plan (included as exhibit 4.3 to the Form S-8
filed February 23, 2000, and incorporated herein by reference).
4.4 Registration Rights Agreement between the Company and Dutchess Private
Equities Fund, LP, dated June 6, 2004 (included as exhibit 10.9 to the Form SB-2
filed June 18, 2004, and incorporated herein by reference).
4.5 Rights Agreement between the Company and American Stock Transfer & Trust
Company, dated May 2, 2005 (included as exhibit 4.1 to the Form 8-A filed May 5,
2005, and incorporated herein by reference).
10.1 Asset Purchase Agreement between the Company and Saro, Inc., dated May
19, 2003 (included as Appendix A to the Definitive Proxy Statement on Form DEF
14A filed June 19, 2003, and incorporated herein by reference).
10.2 First Amendment to Asset Purchase Agreement between the Company and
Saro, Inc., dated July 25, 2003 (included as exhibit 10.2 to the Form 10-Q filed
November 14, 2003, and incorporated herein by reference).
10.3 Lease Agreement between the Company and Frost National Bank, Trustee
for a Designated Trust, dated August 2003 (included as exhibit 10.3 to the Form
10-Q filed November 14, 2003, and incorporated herein by reference).
10.4 Employment Agreement Form between the Company and Executive Officers,
dated May 31, 2001 (included as exhibit 10.4 to the Form 10-K filed April 1,
2002, and incorporated herein by reference).
10.5 Investment Agreement between the Company and Dutchess Private Equities
Fund, LP, dated June 4, 2004 (included as exhibit 10.8 to the Form SB-2 filed
June 18, 2004, and incorporated herein by reference).
10.6 Placement Agent Agreement between the Company, Charleston Capital
Corporation, and Dutchess Private Equities Fund, LP, dated June 4, 2004
(included as exhibit 10.10 to the Form SB-2 filed June 18, 2004, and
incorporated herein by reference).
10.7 Affiliate Office Agreement between the Company and Network 1 Financial,
Inc. (included as exhibit 10.11 to the Form SB-2 filed April 28, 2004, and
incorporated herein by reference).
10.8 Promissory Note between the Company and Dutchess Private Equities Fund,
II, LP, dated August 24, 2004 (included as exhibit 10.1 to the Form 8-K filed
September 2, 2004, and incorporated herein by reference).
10.9 Warrant Agreement between the Company and Kubra Data Transfer LTD,
dated as of September 30, 2004 (included as exhibit 10.1 to the Form 8-K filed
October 6, 2004, and incorporated herein by reference).
10.10 Promissory Note between the Company and Dutchess Private Equities
Fund, II, LP, dated December 10, 2004 (included as exhibit 10.1 to the Form 8-K
filed December 16, 2004, and incorporated herein by reference).
10.11 Promissory Note between the Company and Dutchess Private Equities
Fund, II, LP, dated May 12, 2005 (included as exhibit 10.11 to the Form 10-QSB
filed May 16, 2005, and incorporated herein by reference).
10.12 Corporate Consulting Agreement between the Company and Theodore Smith,
dated April 26, 2005 (included as exhibit 10.1 to the Form S-8 filed June 3,
2005, and incorporated herein by reference).
21.1 Subsidiaries of the Company (included as exhibit 21.1 to the Form 10-K
filed April 1, 2002, and incorporated herein by reference).
31.1 Certification of the Chief Executive Officer/Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Officers pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(a) Reports on Form 8-K:
On May 5, 2005, the Company filed a report on Form 8-K to disclose that the
Company entered into a Common Stock Rights Agreement between the Company and
American Stock Transfer & Trust Company, as Rights Agent.
SIGNATURE
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PAYMENT DATA SYSTEMS, INC.
Date: August 15, 2005 By: /s/ Michael R. Long
----------------------
Michael R. Long
Chairman of the Board,
Chief Executive Officer and
Chief Financial Officer
(principal executive officer and
principal financial and accounting officer)