UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005.
[ ] TRANSITION REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ________
COMMISSION FILE NO. 000-30152
PAYMENT DATA SYSTEMS, INC.
(Name of small business issuer in its charter)
NEVADA 98-0190072
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
12500 SAN PEDRO, STE. 120, SAN ANTONIO, TX 78216
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (210) 249-4100
Securities registered under Section 12(b) of the Exchange Act: NONE.
Securities registered under Section 12(g) of the Exchange Act: COMMON STOCK,
PAR VALUE
$0.001 PER
SHARE.
(Title of class)
Check whether the issuer is not required to file reports pursuant to Section 13
or 15(d) of the Exchange Act. [ ]
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 twelve months (or 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
State issuer's revenues for its most recent fiscal year: $1,180,753.
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, or the average bid and asked price of such common equity, as of
March 10, 2006: $5,124,221.
State the number of shares outstanding of each of the registrant's classes of
common stock as of March 10, 2006: 39,417,088 common shares.
Documents incorporated by reference: Portions of the Definitive Proxy Statement
for the 2006 Annual Meeting of Stockholders
Transitional Small Business Disclosure Format (Check One): [ ] Yes [X] No
1
PAYMENT DATA SYSTEMS, INC.
FORM 10-KSB
FOR THE YEAR ENDED DECEMBER 31, 2005
INDEX
Page
PART I
Item 1. Description of Business. 3
Item 2. Description of Property. 6
Item 3. Legal Proceedings. 7
Item 4. Submission of Matters to a Vote of Security Holders. 7
PART II
Item 5. Market for Common Equity and Related Stockholder Matters. 8
Item 6. Management's Discussion and Analysis or Plan of Operation. 9
Item 7. Financial Statements. 16
Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure. 31
Item 8A. Controls and Procedures. 31
Item 8B. Other Information. 31
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With
Section 16 (a) of the Exchange Act. 32
Item 10. Executive Compensation. 32
Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. 32
Item 12. Certain Relationships and Related Transactions. 32
Item 13. Exhibits. 32
Item 14. Principal Accountant Fees and Services. 33
FACTORS THAT MAY AFFECT FUTURE RESULTS
This Annual Report on Form 10-KSB 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-KSB regarding our
financial performance, business strategy and plans and objectives of management
for future operations and any other future events 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 our current view 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 6, Management's Discussion and Analysis, of this Annual Report on Form
10-KSB. 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.
2
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
General
Payment Data Systems, Inc. was founded in July 1998 and is incorporated in the
State of Nevada. Our primary operations consist of functioning as a processor of
electronic payments for other companies. We provide integrated electronic
payment processing services to merchants and businesses, including all types of
Automated Clearinghouse processing and credit and debit card-based processing
services. The Automated Clearinghouse Network is a nationwide electronic funds
transfer system that is regulated by the Federal Reserve and provides for the
clearing of electronic payments between participating financial institutions.
Our Automated Clearinghouse processing services enable merchants or businesses
to both disburse or collect funds electronically using e-checks to transfer
funds instead of traditional paper checks. An e-check is an electronic debit to
a bank checking account that is initiated at the point-of-sale, on the Internet,
over the telephone or via a bill payment sent through the mail and is processed
using the Automated Clearinghouse network. Our card-based processing services
enable merchants to process both traditional card-present, or "swipe,"
transactions, as well as card-not-present transactions. A traditional
card-present transaction occurs whenever a cardholder physically presents a
credit or debit card to a merchant at the point-of-sale. A card-not-present
transaction occurs whenever the customer does not physically present a payment
card at the point-of-sale and may occur over the Internet, mail, fax or
telephone. Our electronic payment processing may take place in a variety of
forms and situations. For example, our capabilities allow merchants to convert a
paper check to an e-check or receive card authorization at the point-of-sale,
have their customer service representatives take e-check or card payments from
their consumers by telephone, and enable their consumers to make e-check or card
payments directly through the use of a web site or by calling an Interactive
Voice Response telephone system. We also operate an online payment processing
service for consumers under the domain name www.billx.com, formerly
www.bills.com, through which consumers can pay anyone.
We generate revenues by charging fees for the electronic processing of payment
transactions and related services. We charge certain merchants 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. We charge other merchant customers a flat fee per transaction, and
may also charge miscellaneous fees to our customers, including fees for returns,
monthly minimums, and other miscellaneous services. We charge consumers that use
our billx.com online payment service a flat monthly fee that allows them to make
a certain number of payments in a month. We also charge these consumers an
additional fee for each payment that exceeds the allowed number of payments in a
given month. We operate solely in the United States as a single operating
segment.
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 2004 Federal Reserve Payments Study, the number of
electronic payment transactions totaled 44.5 billion in 2003 while the number of
checks paid totaled 36.7 billion. This marked the first time that electronic
payment transactions in the U.S. exceeded check payments. If current growth
rates are sustained, payments made by credit cards and debit cards will each
exceed the number of paid checks by 2010. The growth 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.
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 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 payment methods. According to the
U.S. Small Business Administration, small businesses generate more than 50% of
the nonfarm private gross domestic product in the United States. 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 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.
3
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 2005 were $86.3 billion, an
increase of 25% from $69.2 billion in 2004. 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.
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. We utilize a secure sockets layer so that connections and information
are secure from outside inspection. We also use 128-bit encryption for all
electronic transactions that we process to make information unreadable as it
passes over the Internet. Our systems infrastructure allows us to work with our
customers to build a customized electronic payment service offering tailored to
their specific needs. We have designed and implemented our integrated payment
systems to function as gateways between our customers and our third party
processing providers. Our systems provide for interfaces with our customers
through which payment data is captured electronically and transferred through
the connections we have with our processing providers. Our systems also provide
a data warehousing capability so that all of a customer's payment data can be
stored in one place to facilitate efficient data retrieval and analysis. We
outsource our Automated Clearinghouse transaction processing and card-based
transaction processing to third party providers. Our card-based processing
system is capable of connecting with all of the major card-based processors in
the United States.
The components of our service offering include all forms of Automated
Clearinghouse transaction processing, such as Re-presented Check, which is a
consumer non-sufficient funds check that is re-presented for payment
electronically rather than through the paper check collection system, and
Accounts Receivable Check Conversion, which is a consumer paper check payment
that is converted into an e-check. Our customers can initiate Automated
Clearinghouse transactions directly using an online terminal accessible through
a web site or we can initiate Automated Clearinghouse transactions on their
behalf. Our service offering also includes merchant account services for the
processing of card-based transactions through the VISA and MasterCard networks,
including online terminal services accessed through a web site or retail
services accessed via a physical terminal. We offer a proprietary web-based
customer service application that combines both Automated Clearinghouse and card
processing capabilities and allows companies to process one-time and recurring
payments via e-checks or credit cards at the request of their consumers. In
addition, we offer an Interactive Voice Response telephone system to companies
that accept payments directly from consumers over the telephone using e-checks
or credit cards.
In addition to these acquiring services, we are also aggressively developing and
marketing prepaid gift cards and personal spending debit cards. In December
2005, we signed an agreement with MetaPayments Systems, a division of MetaBank,
a federally chartered bank, to be our issuing bank for select prepaid debit card
programs running on the various card associations and debit networks. We also
entered into an agreement in February 2006 with Symmetrex, Inc. to provide us
with backend card processing services for our debit card processing platform. We
are working with MetaPayments to develop a series of competitive celebrity,
gift, and personal spending card programs. We have already announced our first
celebrity card program, which will involve Carmen Electra, and we also have a
private labeled ATM card program currently in development.
We also operate a consumer web site focused on providing bill payment services
under the domain name www.billx.com and manage all of the related back-end
processing through our own proprietary processing engine. Consumers subscribe to
the payment service and are allowed to make a certain number of payments each
month for a flat monthly fee and are assessed a separate fee for any additional
payments made over the limit. Our online payment processing service seeks to
provide consumers with an efficient and secure interface for paying and managing
bills via the Internet. We also sell this payment portal service as a private
label solution to online financial services providers looking to provide online
bill payment capabilities as part of their service offering to consumers. We
also offer this service to other debit card issuers, as we are able to utilize
the bill payment component of this service for payments made via debit cards, a
process for which we have applied for a patent.
4
Relationships with Sponsors and Processors
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. In order to provide payment
processing services for Automated Clearinghouse transactions, we must maintain a
relationship with an Originating Depository Financial Institution in the
Automated Clearinghouse Network because we are not a bank and therefore not
eligible to be an Originating Depository Financial Institution. The third party
provider that handles our Automated Clearinghouse processing maintains a
relationship with several Originating Depository Financial Institutions on our
behalf. 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 an
agreement with TriSource Solutions, LLC through which their 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.
Under our processing agreement with TriSource Solutions, we are financially
liable for all fees, chargebacks and losses related to our card processing
merchant customers. If, due to insolvency or bankruptcy of our merchant
customers, or for another reason, we are unable to collect from them amounts
that have been refunded to the cardholders because the cardholders properly
initiated a chargeback transaction to reverse the credit card charges, we must
bear the credit risk for the full amount of the cardholder transaction. We
utilize a number of systems and procedures to evaluate and manage merchant risk,
such as obtaining approval of prospective merchants from our processor and
sponsor bank, setting transaction limits and monitoring account activity. We may
also require cash deposits and other types of collateral from certain merchants
to mitigate any such risk. We maintain a reserve for losses resulting from card
processing and related chargebacks. We estimate our potential loss for
chargebacks by performing a historical analysis of our chargeback loss
experience with similar merchants 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.
We also maintain a separate allowance for doubtful accounts for estimated losses
resulting from the inability or failure of our merchant customers to make
required payments for fees charged by us. Amounts due from customers may be
deemed uncollectible because of merchant disputes, fraud, insolvency or
bankruptcy. 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 receivable, historical pattern of collections and financial
condition of the customer. We closely monitor extensions of credit and 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.
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 that act as an external
sales force, with minimal direct investment in sales infrastructure and
management. Our direct sales effort is coordinated by a sales executive and
supported by other employees who function in sales capacities. Our primary
market focus is on companies generating high volumes of electronic payment
transactions. We tailor our sales efforts to reach this market by pre-qualifying
prospective sales leads through direct contact or market research. Our sales
personnel typically initiate contact with prospective customers that we identify
as meeting our target profile. We also plan to market and sell our celebrity
card programs, such as the Carmen Electra card, directly to consumers, primarily
through the Internet. 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.
Customers
Nearly all of our customers are consumers geographically dispersed throughout
the United States utilizing our billx.com Internet bill payment service on a
recurring monthly basis to pay household bills. The service relationship between
our billx.com customers and us is not contractual and the fee we charge for the
service is not negotiable. We seek to retain customers by providing high service
levels. Customers are also more likely than not to continue using the service
once activated due to their investment of time in setting up the service with
their personal banking and payment information. The monthly average number of
billx.com customers using our online payment service increased to 2,419 in 2005
from 2,190 in 2004.
Our other customers are merchants and businesses that use our Automated
Clearinghouse and/or card-based processing services in order to provide their
consumers with the ability to pay for goods and services without having to use
cash or a paper check. These merchant customers operate in a variety of retail
industries and are under contract with us to exclusively use the services that
we provide to them. Most of our merchant customers have signed long-term
contracts, with generally three-year terms, that provide for volume-based
transaction fees. We provided services to 119 and 51 merchant customers at
December 31, 2005 and 2004, respectively. Services provided to Lexicon Marketing
and NII Communications accounted for approximately 33% and 7%, respectively, of
our total consolidated revenues for the year ended December 31, 2005. Services
provided to Credit Payment Services, Inc. accounted for approximately 11% and
13% of our total consolidated revenues for the years ended December 31, 2005 and
2004, respectively. Revenue generated by our merchant customers represented
approximately 86% of our total revenues in 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 our merchant
business provides us with the best opportunity for revenue growth and will
continue to comprise the majority of our business in the future.
5
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, automatic
teller machine, 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 us 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:
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; and
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 Payment Data Systems, Inc.
and Payment Data Systems, Inc. and design. We have also secured domain name
registrations for billx.com, billxpress.com, billhelp.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.
Patent
We have filed the final application for patent protection from the U.S. Patent
Office for the technology that will enable the industry's first bill payment
capability using a debit card. The debit card technology for which we have filed
for patent protection allows a cardholder to use their stored-value debit or ATM
card to pay local, national, or international bills with the card from their
electronic balance. Because it does not require linkage to a traditional
checking or savings account, this new debit technology is unique in that it
allows for use by "unbanked" consumers.
EMPLOYEES
As of December 31, 2005, we had 8 employees. We are not a party to any
collective bargaining agreements. We believe that our relations with our
employees are good.
ITEM 2. DESCRIPTION OF PROPERTY.
As of December 31, 2005, our headquarters and operations were housed in
approximately 4,500 square feet of leased office space in San Antonio, Texas. We
recently extended the term of our office lease, which calls for annual rent of
$81,126 through October 2009. We believe our existing facilities will be
adequate to meet our anticipated needs for the foreseeable future.
6
ITEM 3. 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: (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 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 December 31, 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. While
Mr. Long and Mr. Hoch agreed, in connection with such sale, to forego any
affirmative recovery of their compensation by virtue of a change of control,
they have maintained the right to claim an offset of that amount in the event we
seek recovery of the loan balances. 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.
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 alleged 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
alleged and sought resulting economic and exemplary damages, rescission,
interest, attorneys' fees and court costs.
On November 9, 2005, we entered into a settlement agreement with all the
plaintiffs named in the suit. Under the terms of the settlement, the plaintiffs
dismissed the pending litigation, with prejudice, and released all claims
against us, our current and former officers and directors, and our former
auditors, Ernst & Young, LLP. Additionally, we reset the exercise price of
1,912,400 warrants to purchase our common stock held by the plaintiffs from
$1.80 per share to a new exercise price of $0.20 per share. We also extended the
expiration date of the warrants from November 27, 2006, to November 27, 2007. We
recorded a non-cash expense of $151,309 in the third quarter of 2005 as a result
of the modification of the warrant terms. We are not paying any other economic
consideration to fund this settlement. On balance, we believe the terms of this
settlement to be fair and equitable to our shareholders and us. We will no
longer incur significant expenses associated with defense of the litigation and
the uncertainly inherent in any litigation is now resolved at a reasonable cost.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of our stockholders during the fourth
quarter of fiscal year 2005.
7
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION
Our common stock was traded on the National Association of Securities Dealers
Over the Counter Bulletin Board 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 we did not meet the requirements for continued listing
on the NASDAQ National Market. Our common shares were immediately eligible for
quotation on the Over the Counter Bulletin Board effective at opening of
business on February 4, 2003. Our common stock began trading under a new ticker
symbol, PYDS, on the Over the Counter Bulletin Board on August 20, 2003.
The following table sets forth for the quarterly periods indicated the range of
high and low closing prices of our common stock as reported on the Over the
Counter Bulletin Board:
High Low
----- -----
2005
--------------
First Quarter $0.34 $0.20
Second Quarter $0.25 $0.19
Third Quarter $0.22 $0.15
Fourth Quarter $0.15 $0.08
2004
--------------
First Quarter $0.46 $0.15
Second Quarter $0.43 $0.21
Third Quarter $0.26 $0.16
Fourth Quarter $0.34 $0.21
HOLDERS
As of March 10, 2006, 39,417,088 shares of our common stock are issued and
outstanding. As of March 10, 2006, there were approximately 4,473 stockholders
of record of our common stock.
DIVIDENDS
We have never declared or paid cash or stock dividends and have no plans to pay
any such dividends in the foreseeable future, instead, we intend to reinvest our
earnings, if any.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table provides information as of December 31, 2005 with respect to
compensation plans (including individual compensation arrangements) under which
equity securities of the registrant are authorized for issuance:
Weighted-average Number of securities
Number of securities to be exercise price remaining available for
issued upon exercise of of outstanding future issuance under
outstanding options options compensation plan
-------------------------- ---------------- -----------------------
Employee Comprehensive Stock
Plan approved by stockholders 4,658,167 $ 0.50 1,353,959
Non-Employee Director
Plan approved by stockholders 858,003 $ 1.20 1,160,000
UNREGISTERED SALES OF EQUITY SECURITIES
During the quarter ended December 31, 2005, we sold 160,000 shares of our common
stock to Dutchess Private Equities Fund, LP pursuant to an equity line of
credit and received total proceeds, net of issuance costs, of $21,367.
8
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
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-KSB. 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-KSB.
OVERVIEW
We provide integrated electronic payment services, including credit and debit
card-based processing services and transaction processing via the Automated
Clearinghouse Network, and continue to operate an Internet electronic payment
processing service for consumers under the domain name www.billx.com. Since
inception, we have incurred operating losses each quarter, and as of December
31, 2005, we have an accumulated deficit of $49.4 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.
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 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 we believe 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, 2005, the balance of our card merchant processing
loss reserve was $33,552.
9
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
charged bad debt expense of $10,000 and recorded bad debt write-offs of $936
against our allowance for doubtful accounts in 2005. We did not charge any bad
debt expense or bad debt write-offs in 2004. At December 31, 2005 and 2004, the
balance of the allowance for doubtful accounts was $12,219 and $3,155,
respectively. 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.
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 we determine that the carrying value of
long-lived and intangible assets may not be recoverable, we measure impairment
as the excess of the assets' carrying value over the estimated fair value. No
impairment losses were recorded in 2005 or 2004.
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 us. It is our
judgment that we cannot predict with reasonable certainty that the deferred tax
assets as of December 31, 2005 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, 2005, we have available net operating loss
carryforwards of approximately $37.0 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.billx.com. Total revenues for 2005 increased
230% to $1,180,753 from $357,566 for 2004. The increase from the prior year was
primarily attributable to the increase in revenues generated from card-based
processing services due to increased transaction volume. Revenues also increased
form the prior year due to an increase in the average number of consumers
subscribing to the billx.com payment service. The monthly average number of
consumers using our online payment service increased to 2,419 in 2005 from 2,190
in 2004. The number of transactions generated by billx.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 transitioned to processing the
online payments ourselves during the third quarter of 2005, and are now able to
market the service as a private-label application to prospective resellers.
We expect our 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 86% of our total revenues
for the year ended December 31, 2005, and we believe this percentage will
increase as we anticipate adding new merchant customers and experiencing growth
in transaction volumes as a result. We believe our merchant business provides us
with the best opportunity for revenue growth and 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 $1,038,346 and $327,474 for 2005 and 2004,
respectively. The increase from the prior year is due primarily to the increase
in fees related to processing the increased card-based transaction volume.
Selling, general and administrative expenses increased to $1,696,015 in 2005
from $1,374,779 for 2004. The increase from the prior year was primarily due to
non-cash deferred compensation expense of $140,193 recorded in 2005 and an
increase of approximately $94,000 in legal fees.
10
Depreciation and amortization was $86,374 and $95,190 for 2005 and 2004,
respectively. The decrease from the prior year was due to lower depreciation
expense related to certain assets that became fully depreciated during 2005. We
purchased $107,000 of computer equipment and software during 2005 and do not
anticipate making significant capital expenditures in 2006.
Net other income was $444,292 in 2005 compared to net other expense of $74,654
in 2004. The change from 2004 to 2005 is primarily attributable to a gain of
$911,350 on the sale of our bills.com domain name and trademark to Alivio
Holdings, LLC in December 2005. We retained our existing customer base that had
been using bills.com for online payment processing services and transitioned it
to a new domain name, www.billx.com, and continue to offer such services
directly to consumers as well as through resellers, including Alivio.
Net loss improved to $1,195,690 in 2005 from $1,514,531 in 2004, as a result of
the items discussed above.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2005, we had $378,098 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 and believe 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.
In February 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. We filed a registration statement registering
the resale of the shares of our common stock to be issued to Dutchess, which
became effective on August 13, 2004. During the years ended December 31, 2005
and 2004, we sold 3,179,844 and 1,459,435 shares of its common stock,
respectively, pursuant to the equity line of credit and received total proceeds,
net of issuance costs, of $597,162 and $321,485, respectively.
On August 24, 2004, we entered into a promissory note with Dutchess. Pursuant to
terms of the promissory note, we received $260,000 and promised to pay Dutchess
$284,000 with a maturity date of December 24, 2004. We repaid this note in full
on the maturity date. We 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
that we file.
On December 10, 2004, we entered into another promissory note with Dutchess.
Pursuant to terms of the promissory note, we received $260,000 and promised to
pay Dutchess $284,000 with a maturity date of April 10, 2005. We 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 that we file.
On May 12, 2005, we entered into another promissory with Dutchess. 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 repaid the
note due December 22, 2005 to Dutchess in full on the maturity date.
Net cash used in operating activities was $891,786 and $940,859 for 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 continue focusing on expending our resources
prudently given our current state of liquidity.
Net cash provided by investing activities was $849,986 for 2005 and primarily
reflected proceeds of $950,000 from the sale of our bills.com domain name in
December 2005 partially offset by $106,910 of capital expenditures for computer
hardware and software. Net cash provided by investing activities was $2,095 in
2004 and reflected the return of $6,693 of deposits that had been used to secure
the lease for our corporate office offset by capital expenditures of $4,598 for
computer equipment. We do not anticipate making significant capital expenditures
during 2006.
Net cash provided by financing activities of $265,932 for 2005 resulted
primarily from proceeds, net of issuance costs, of $689,932 from the issuance of
common stock offset by $404,000 of net repayments of borrowings under short-term
promissory notes. Net cash provided by financing activities of $564,611 for 2004
resulted primarily from proceeds, net of issuance costs, of $328,611 from the
issuance of common stock as well as $236,000 of net borrowings under short-term
notes.
The satisfactory completion of an additional investment or growth of cash flow
from operations is essential as 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 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.
11
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.
RISK FACTORS
There are many factors that affect our business and the results of its
operations, some of which are beyond our control. The following is a description
of some of the important factors that may cause the actual results of our
operations in future periods to differ materially from those currently expected
or desired.
RISKS RELATED TO OUR BUSINESS
Our independent accountants have issued a going concern opinion and if we cannot
obtain additional financing, we may have to curtail operations and may
ultimately cease to exist.
Our independent accountants have issued a going concern opinion. Due to
continuing operating losses, our current available cash and cash equivalents
along with anticipated revenues are likely to be insufficient to meet our
anticipated cash needs for the near future. Consequently, our ability to
continue as a going concern is likely contingent on us receiving additional
funds in the form of equity or debt financing. We currently plan to meet our
capital requirements primarily through the issuance of equity securities or new
borrowing arrangements. Accordingly, we are aggressively pursuing strategic
alternatives. However, financing may not 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 be forced to curtail operations or may
ultimately cease to exist.
We have generated significant losses and expect to generate operating losses for
the foreseeable future, therefore we may not become profitable.
We organized in 1998 and began operations as a public company in 1999 by
offering electronic billing services to other companies. After the sale of our
primary business in July 2003, we have concentrated on building our electronic
payments services operations. We have not been profitable since inception and we
may never become profitable. As of December 31, 2005, our accumulated deficit
was $49.4 million.
If our security applications are not sufficient to address changing market
conditions and customer concerns, we may not be able to sell our services.
Our use of applications designed for premium data security and integrity to
process electronic transactions may not be sufficient to address 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 our or another
provider's security, have the potential to undermine consumer confidence in the
technology and could have a materially adverse effect on our business.
If we do not adapt to rapid technological change, our business may fail.
Our success depends on our ability to develop new and enhanced services, and
related products that meet changing customer needs. The market for our 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. To remain successful, we must
respond to new developments in hardware and semiconductor technology, operating
systems, programming technology and computer capabilities. In many instances,
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. We may not
successfully identify new service opportunities, and develop and bring new and
enhanced services and related products to market in a timely manner. Even if we
do bring such services, products or technologies to market, they may not become
commercially successful. Additionally, services, products or technologies
developed by others may render our services and related products noncompetitive
or obsolete. If we are 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, our business may fail.
12
We rely on our relationship with the Automated Clearinghouse Network and if the
Federal Reserve rules were to change, our business could be adversely affected.
We have a contractual relationship with a third party provider, which maintains
a relationship with multiple Originating Depository Financial Institutions in
the Automated Clearinghouse Network. The Automated Clearinghouse Network is a
nationwide batch-oriented electronic funds transfer system that provides for the
interbank clearing of electronic payments for participating financial
institutions. An Originating Depository Financial Institution is a participating
financial institution that must abide by the provisions of the Automated
Clearinghouse Operating Rules and Guidelines. Through our relationship with this
third party provider, we are able to process payment transactions on behalf of
our customers and their consumers by submitting payment instructions in a
prescribed Automated Clearinghouse format. We pay volume-based fees to the third
party provider for debit and credit transactions processed each month, and pay
fees for other transactions such as returns and notices of change to bank
accounts. These fees are part of our cost structure. If the Federal Reserve
rules were to change to introduce restrictions or modify access to the Automated
Clearinghouse, our business could be materially adversely affected.
If our third party card processing providers or our bank sponsors fail to comply
with the applicable requirements of Visa and MasterCard credit card
associations, we may have to find a new third party processing provider, which
could increase our costs.
Substantially all of the card-based transactions we process involve Visa or
MasterCard. If our third party processing provider, TriSource Solutions, LLC, or
our bank sponsor, DuTrac Community Credit Union, fail to comply with the
applicable requirements of the Visa and MasterCard credit card associations,
Visa or MasterCard could suspend or terminate their registration. Also, our
contract with these third parties is subject to cancellation upon limited notice
by either party. The cancellation of our contract, 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 are unable to obtain another provider or sponsor at similar
costs. Additionally, changing our bank sponsor could adversely affect our
relationship with our merchants if the new sponsor provides inferior service or
charges higher costs.
We depend on Michael R. Long and Louis A. Hoch and if these officers ceased to
be active in our management, our business may not be successful.
Our success depends to a significant degree upon the continued contributions of
our key management, marketing, service and related product development and
operational personnel, including our Chairman, Chief Executive Officer and Chief
Financial Officer, Michael R. Long and our President and Chief Operating
Officer, Louis A. Hoch. We had employment agreements with Mr. Long and Mr. Hoch
that expired in July 2004 and prohibited them from competing with us for a
period of two years upon termination of their employment. We intend to enter
into similar new employment agreements with both of these individuals and are
currently negotiating the terms of such agreements. Our business may not be
successful if, for any reason, either of these officers ceased to be active in
our management.
If our software fails, and we need to repair or replace it, or we become subject
to warranty claims, our costs could increase.
Our software products could contain errors or "bugs" that could adversely affect
the performance of services or damage a user's data. We attempt to limit our
potential liability for warranty claims through technical audits and
limitation-of-liability provisions in our customer agreements. However, these
measures may not be effective in limiting our exposure to warranty claims. We
have not experienced a significant increase in software errors or warranty
claims. Despite the existence of various security precautions, our computer
infrastructure may also be vulnerable to viruses or similar disruptive problems
caused by our customers or third parties gaining access to our processing
system. If our software fails, and we need to replace or repair it, or we become
subject to warranty claims, our costs could increase.
Our business strategy includes identifying new businesses to acquire, and if we
cannot integrate acquisitions into our company successfully, we may not become
profitable.
Our success partially depends upon our ability to identify and acquire
undervalued businesses within our industry. Although we believe that there are
companies available for potential acquisition that are undervalued and might
offer attractive business opportunities, we may not be able to make any
acquisitions, and if we do make acquisitions, they may not be profitable. As a
result, our business may not grow and we may not achieve or sustain
profitability.
If we do not manage our growth, we may not achieve or sustain profitability.
We may experience a period of rapid growth that could place a significant strain
on our resources. In order to manage our growth successfully, we will have to
continue to improve our operational, management and financial systems and expand
our work force. A significant increase in our 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 our computer and administrative infrastructure will require
substantial operational, management and financial resources. Although we believe
that our current infrastructure is adequate to meet the needs of our customers
in the foreseeable future, we may not be able to expand and adapt our
infrastructure to meet additional demand on a timely basis, at a commercially
reasonable cost, or at all. If our management is unable to manage growth
effectively, hire needed personnel, expand and adapt our computer infrastructure
and improve our operational, management, and financial systems and controls, we
may not attain or sustain profitability.
13
If we do not manage our credit risks related to our merchant accounts, we may
incur significant losses.
We rely on the Federal Reserve's Automated Clearinghouse system for electronic
fund transfers and the Visa and MasterCard associations for settlement of
payments by credit or debit card on behalf of our merchant customers. In our use
of these established payment clearance systems, we generally bear the credit
risks arising from returned transactions caused by insufficient funds, stop
payment orders, closed accounts, frozen accounts, unauthorized use, disputes,
customer charge backs theft or fraud. Consequently, we assume the credit risk of
merchant disputes, fraud, insolvency or bankruptcy in the event we attempt to
recover funds related to such transactions from our customers. We have not
experienced a significant increase in the rate of returned transactions or
incurred any losses with respect to such transactions. We utilize a number of
systems and procedures to manage and limit credit risks, but if these actions
are not successful in managing such risks, we may incur significant losses.
RISKS RELATED TO OUR INDUSTRY
The electronic commerce market is relatively new and if it does not grow, we may
not be able to sell sufficient services to make our business viable.
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 we, despite an investment of significant resources, are
unable to adapt to meet changing customer requirements or technological changes
in this emerging market, or if our services and related products do not maintain
a proportionate degree of acceptance in this growing market, our business may
not grow and could even fail. Additionally, the security and privacy concerns of
existing and potential customers may inhibit the growth of the electronic
commerce market in general, and our customer base and revenues, in particular.
Similar to the emergence of the credit card and automatic teller machine
industries, we 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.
Changes in regulation of electronic commerce and related financial services
industries could increase our costs and limit our business opportunities.
We believe that we are 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. It is possible that a federal or state agency will
attempt to regulate providers of electronic commerce services, which could
impede our ability to do business in the regulator's jurisdiction. We are
subject to various laws and regulations relating to commercial transactions,
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. 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 our business and industry and could increase our costs or limit
our business opportunities.
If we cannot compete successfully in our industry, we could lose market share
and our costs could increase.
Portions of the electronic commerce market are becoming increasingly
competitive. We expect to face growing competition in all areas of the
electronic payment processing market. New companies could emerge and compete for
merchants of all sizes. We expect competition to increase from both established
and emerging companies and that such increased competition could lower our
market share and increase our costs. Moreover, our current and potential
competitors, many of whom have greater financial, technical, marketing and other
resources than us, may respond more quickly than us to new or emerging
technologies or could expand to compete directly against us in any or all of our
target markets. Accordingly, it is possible that current or potential
competitors could rapidly acquire market share. We may not be able to compete
against current or future competitors successfully. Additionally, competitive
pressures may increase our costs, which could lower our earnings, if any.
14
RISKS RELATED TO OUR COMMON STOCK
Our stock price is volatile and you may not be able to sell your shares at a
price higher than what you paid.
The market for our common stock is highly volatile. In 2005, our closing stock
price fluctuated between $0.08 and $0.34. The trading price of our common stock
could be subject to wide fluctuations in response to, among other things,
quarterly variations in operating and financial results, announcements of
technological innovations or new products by our competitors or us, changes in
prices of our products and services or our competitors' products and services,
changes in product mix, or changes in our revenue and revenue growth rates.
Existing stockholders may experience significant dilution from the sale of
securities pursuant to our investment agreement with Dutchess Private Equities
Fund.
The sale of shares pursuant to our Investment Agreement with Dutchess Private
Equities Fund may have a dilutive impact on our stockholders. As a result, our
net income per share could decrease in future periods and the market price of
our common stock could decline. In addition, the lower our stock price is at the
time we exercise our put option, the more shares we will have to issue to
Dutchess Private Equities Fund to draw down on the full equity line with
Dutchess Private Equities Fund. If our stock price decreases, then our existing
stockholders would experience greater dilution. As of December 31, 2005, we had
issued 4,639,279 shares to Dutchess under our Investment Agreement. At a stock
price of $0.25 or less, we would have to issue all of the remaining 35,360,721
shares currently registered in order to draw down on the full equity line.
Dutchess Private Equities Fund will pay less than the then-prevailing market
price of our common stock, which could cause the price of our common stock to
decline.
Our common stock to be issued under our agreement with Dutchess Private Equities
Fund will be purchased at a 5% discount to the lowest closing best bid price
during the five days immediately following our notice to Dutchess Private
Equities Fund of our election to exercise our put right. Dutchess Private
Equities Fund has a financial incentive to sell our common stock immediately
upon receiving the shares to realize the profit between the discounted price and
the market price. If Dutchess Private Equities Fund sells our shares, the price
of our stock could decrease. If our stock price decreases, Dutchess Private
Equities Fund may have a further incentive to sell the shares of our common
stock that it holds. The discounted sales under our agreement with Dutchess
Private Equities Fund could cause the price of our common stock to decline.
We must comply with penny stock regulations that could effect the liquidity and
price of our stock.
The SEC has adopted rules that regulate broker-dealer practices in connection
with transactions in "penny stocks." Penny stocks generally are equity
securities with a price of less than $5.00, other than securities registered on
certain national securities exchanges or quoted on NASDAQ, provided that current
price and volume information with respect to transactions in such securities is
provided by the exchange or system. Prior to a transaction in a penny stock, a
broker-dealer is required to:
- deliver a standardized risk disclosure document prepared by the SEC;
- provide the customer with current bid and offer quotations for the penny
stock;
- explain the compensation of the broker-dealer and its salesperson in the
transaction;
- provide monthly account statements showing the market value of each penny
stock held in the customer's account;
- make a special written determination that the penny stock is a suitable
investment for the purchaser and receive the purchaser's executed
acknowledgement of the same; and
- provide a written agreement to the transaction.
These requirements may have the effect of reducing the level of trading activity
in the secondary market for our stock. Because our shares are subject to the
penny stock rules, you may find it more difficult to sell your shares.
We have adopted certain measures that may make it more difficult for a third
party to acquire control of our company.
Our Board of Directors is 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 our
company. We have also instituted a shareholders rights plan that serves to help
prevent a hostile takeover of our company.
15
ITEM 7. FINANCIAL STATEMENTS.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm 17
Consolidated Balance Sheets as of December 31, 2005 and 2004 18
Consolidated Statements of Operations for the years ended
December 31, 2005 and 2004 19
Consolidated Statement of Changes in Stockholders' Equity (Deficit) for the years ended
December 31, 2005 and 2004 20
Consolidated Statements of Cash Flows for the years ended
December 31, 2005 and 2004 21
Notes to Consolidated Financial Statements 22
16
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Payment Data Systems, Inc. and Subsidiaries
San Antonio, Texas
We have audited the accompanying consolidated balance sheets of Payment Data
Systems, Inc. and Subsidiaries (collectively referred to as "the Company") as of
December 31, 2005 and 2004, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Company at
December 31, 2005 and 2004, and the consolidated results of their operations and
cash flows for the years then ended, in conformity with U.S. generally accepted
accounting principles.
The accompanying financial statements of Payment Data Systems, Inc. and
Subsidiaries have been prepared assuming that the Company will continue as a
going concern. As more fully described in Note 1, 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. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
The financial statements of Payment Data Systems, Inc. and Subsidiaries 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.
/s/ Akin, Doherty, Klein & Feuge, P.C.
AKIN, DOHERTY, KLEIN & FEUGE, P.C.
San Antonio, Texas
February 17, 2006, except for Note 15,
to which the date is March 10, 2006
17
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2005 2004
------------- -------------
Assets:
Cash and cash equivalents $ 378,098 $ 153,966
Accounts receivable, net 59,558 57,788
Prepaid expenses and other 51,962 47,833
------------- -------------
Total current assets 489,618 259,587
Property and equipment, net 162,600 132,064
Other assets 20,833 23,589
------------- -------------
Total assets $ 673,051 $ 415,240
============= =============
Liabilities and stockholders' equity (deficit):
Current liabilities:
Accounts payable $ 524,520 $ 482,788
Accrued expenses 776,595 364,953
Deferred revenue 44,038 27,562
Short-term borrowings - 264,165
------------- -------------
Total current liabilities 1,345,153 1,139,468
Stockholders' equity (deficit):
Common stock, $.001 par value, 200,000,000 shares authorized;
32,827,056 and 23,569,180 issued and outstanding 32,827 23,569
Additional paid-in capital 49,486,143 47,417,898
Deferred compensation (829,687) -
Accumulated deficit (49,361,385) (48,165,695)
------------- -------------
Total stockholders' equity (deficit) (672,102) (724,228)
------------- -------------
Total liabilities and stockholders' equity (deficit) $ 673,051 $ 415,240
============= =============
See notes to consolidated financial statements.
18
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended Year ended
December 31, December 31,
2005 2004
-------------- --------------
Revenues $ 1,180,753 $ 357,566
Operating expenses:
Cost of services 1,038,346 327,474
Selling, general and administrative 1,696,015 1,374,779
Depreciation and amortization 86,374 95,190
-------------- --------------
Total operating expenses 2,820,735 1,797,443
-------------- --------------
Operating loss (1,639,982) (1,439,877)
Other income (expense):
Interest income 950 712
Interest expense (171,330) (46,111)
Other income (expense) 614,672 (29,255)
-------------- --------------
Total other income (expense) 444,292 (74,654)
-------------- --------------
Loss from operations before income taxes (1,195,690) (1,514,531)
Income taxes - -
-------------- --------------
Net loss $ (1,195,690) $ (1,514,531)
============== ==============
Net loss per common share - basic and diluted $ (0.04) $ (0.07)
Weighted average common shares
outstanding - basic and diluted 29,254,629 21,813,979
See notes to consolidated financial statements.
19
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
Total
Common Stock Additional Stockholders'
-------------------------- Paid - In Deferred Accumulated Equity
Shares Amount Capital Compensation Deficit (Deficit)
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2003 20,987,956 $ 20,988 $46,842,908 $ - $(46,651,164) $ 212,732
Issuance of common stock-equity line of credit 1,459,435 1,459 320,026 - - 321,485
Issuance of common stock-other 1,070,789 1,071 218,215 - - 219,286
Exercise of stock options 51,000 51 7,074 - - 7,125
Issuance of common stock warrants - - 29,675 - - 29,675
Net loss for the year - - - - (1,514,531) (1,514,531)
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2004 23,569,180 23,569 47,417,898 - (48,165,695) (724,228)
Issuance of common stock-equity line of credit 3,179,844 3,181 625,476 - - 628,657
Issuance of common stock-other 5,813,032 5,812 1,230,450 - - 1,236,262
Exercise of stock options 15,000 15 1,260 - - 1,275
Exercise of stock warrants 250,000 250 59,750 - - 60,000
Modification of common stock warrants - - 151,309 - - 151,309
Deferred compensation - - - (829,687) - (829,687)
Net loss for the year - - - - (1,195,690) (1,195,690)
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2005 32,827,056 $ 32,827 $49,486,143 $ (829,687) $(49,361,385) $ (672,102)
============ ============ ============ ============ ============ ============
See notes to consolidated financial statements.
20
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
2005 2004
------------ ------------
Operating activities:
Net loss $(1,195,690) $(1,514,531)
Adjustments to reconcile net loss
to net cash used in operating activities:
Bad debts 10,000 -
Depreciation 86,374 87,690
Amortization - 7,500
Gain on disposition of assets (911,350) -
Deferred compensation 147,843 -
Non-cash issuance of common stock 484,548 215,710
Non-cash issuance of common stock warrants 151,309 29,675
Amortization of debt discount 139,835 28,165
Changes in current assets and current liabilities:
Accounts receivable (11,770) (14,095)
Prepaid expenses and other 168,731 65,817
Accounts payable and accrued expenses 21,908 125,648
Deferred revenue 16,476 27,562
------------ ------------
Net cash used in operating activities (891,786) (940,859)
Investing activities:
Purchases of property and equipment (106,910) (4,598)
Proceeds from sale of assets 950,000 -
Long-term deposits, net 6,896 6,693
------------ ------------
Net cash provided by investing activities 849,986 2,095
Financing activities:
Proceeds from notes payable 600,000 520,000
Principal payments for notes payable (1,004,000) (284,000)
Financing costs, net (20,000) -
Issuance of common stock, net of issuance costs 689,932 328,611
------------ ------------
Net cash provided by financing activities 265,932 564,611
------------ ------------
Change in cash and cash equivalents 224,132 (374,153)
Cash and cash equivalents, beginning of year 153,966 528,119
------------ ------------
Cash and cash equivalents, end of year $ 378,098 $ 153,966
============ ============
Supplemental information:
Cash paid for interest $ 144,000 $ 24,000
Cash paid for federal income taxes - -
See notes to consolidated financial statements.
21
PAYMENT DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Going Concern
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 its current available cash along with anticipated revenues may
be insufficient to meet its anticipated cash needs for the foreseeable future.
Accordingly, the Company is currently aggressively pursuing strategic
alternatives, including investment in the Company via an equity line of credit
(See Note 2). The satisfactory completion of an additional investment in the
Company or growth of cash flow from operations is essential as the Company has
no other alternative that will provide sufficient funds 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.
Description of Business
Payment Data Systems, Inc. and its subsidiaries (collectively referred to as
"the Company"), provide integrated electronic payment services, including credit
and debit card-based processing services and transaction processing via the
automated clearinghouse ("ACH") network to billers and retailers. In addition,
the Company operates an Internet electronic payment processing service for
consumers under the domain name www.billx.com.
Principles of Consolidation and Basis of Presentation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation.
The accompanying financial statements have been presented assuming the Company
will continue as a going concern.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year
presentation.
Use of Estimates
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.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents.
Accounts Receivable
Accounts receivable are reported at outstanding principal net of an allowance
for doubtful accounts of $12,219 and $3,155 at December 31, 2005 and 2004,
respectively. The allowance for doubtful accounts is generally determined based
on an account-by-account review. Accounts are charged off when collection
efforts have failed and the account is deemed uncollectible. The Company
normally does not charge interest on accounts receivable.
22
Concentration of Credit Risk
Financial instruments that potentially expose the Company to credit risk consist
of cash and cash equivalents, investments and accounts receivable. The Company
is exposed to credit risk on its cash, cash equivalents and investments in the
event of default by the financial institutions or the issuers of these
investments to the extent of the amounts recorded on the balance sheet in excess
of amounts that are insured by the FDIC. Trade receivables potentially subject
the Company to concentrations of credit risk. The Company's customer base
operates in a variety of industries and is geographically dispersed, however,
the relatively small number of customers increases the risk. The Company closely
monitors extensions of credit and credit losses have been provided for in the
consolidated financial statements and have been within management's
expectations. The Company recorded bad debt expense of $10,000 and recorded bad
debt write-offs of $936 to its allowance for doubtful accounts in 2005. No bad
debt expense or bad debt write-offs were recorded in 2004. For the year ended
December 31, 2005, 51% of total revenues were from sales to three customers. For
the year ended December 31, 2004, 13% of total revenues were from sales to a
single customer.
Fair Value of Financial Instruments
Cash and cash equivalents, accounts receivable, accounts payable, accrued
liabilities and short-term borrowings are reflected in the accompanying
consolidated financial statements at cost, which approximates fair value because
of the short-term maturity of these instruments.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are
computed on a straight-line method over the estimated useful lives of the
related assets, ranging from three to seven years. Leasehold improvements are
amortized over the lesser of the estimated useful lives or remaining lease
period. Expenditures for maintenance and repairs are charged to expense as
incurred.
Impairment of Long-Lived Assets
The Company periodically reviews, on at least an annual basis, the carrying
value of its long-lived assets, including property, plant and equipment,
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable. To the extent fair value of a long-lived asset, determined
based upon the estimated future cash inflows attributable to the asset, less
estimated future cash outflows, are less than the carrying amount, an impairment
loss is recognized.
Revenue Recognition
Revenue consists primarily of fees generated through the electronic processing
of payment transactions and related services, and are recognized as revenue in
the period the transactions are processed or when the related services are
performed. 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. Revenues derived from electronic
processing of credit and debit card transactions that are authorized and
captured through third party networks are reported gross of amounts paid to
sponsor banks as well as interchange and assessments paid to credit card
associations (MasterCard and Visa). Revenue also includes any up-front fees for
the work involved in implementing the basic functionality required to provide
electronic payment processing services to a customer. Revenue from such
implementation fees is recognized over the term of the related service contract.
Reserve for Losses on Merchant Accounts
Disputes between a cardholder and a merchant periodically arise as a result of,
among other things, cardholder dissatisfaction with merchandise quality or
merchant services. Such disputes may not be resolved in the merchant's favor. In
these cases, the transaction is "charged back" to the merchant and the purchase
price is refunded to the customer through the merchant's acquiring bank, and
charged to the merchant. If the merchant has inadequate funds, the Company must
bear the credit risk for the full amount of the transaction. The Company
evaluates its risk for such transactions and estimates its potential loss for
chargebacks based primarily on historical experience and other relevant factors.
Advertising Costs
The cost of advertising is expensed as incurred. The Company incurred $4,291 in
advertising costs in 2005 and did not incur any advertising costs in 2004.
23
Income Taxes
Deferred tax assets and liabilities are recorded based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.
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" ("FAS 123"), to stock-based employee compensation.
2005 2004
------------ ------------
Net loss, as reported $(1,195,690) $(1,514,531)
Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects (89,332) (141,751)
------------ ------------
Pro forma net loss $(1,285,022) $(1,656,282)
============ ============
Net loss per common share:
Basic and diluted, as reported $ (0.04) $ (0.07)
Basic and diluted, pro forma $ (0.04) $ (0.08)
Net Loss Per Share
Basic and diluted losses per common share are calculated by dividing net loss by
the weighted average number of common shares outstanding during the period.
Common stock equivalents, which consist of stock options and warrants and the
convertible debt, were excluded from the computation of the weighted average
number of common shares outstanding for purposes of calculating diluted loss per
common share because their effect was antidilutive. See Notes 10 and 11 for
disclosure of securities that could potentially dilute basic EPS in the future
that were not included in the computation of diluted EPS because to do so would
have been antidilutive for the periods presented.
Recent Accounting Pronouncements
In December 2004, the FASB issued Statement No. 123R, "Share-Based Payment,"
which requires all companies to measure compensation cost for all share-based
payments (including employee stock options) at fair value. We will adopt this
statement as of January 1, 2006, and do not expect it to have a material impact
on the Company's results of operations or financial position.
NOTE 2. ISSUANCE OF COMMON 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.
24
On December 29, 2005, the Company's Board of Directors granted a total of
4,439,024 shares of common stock to employees as a long-term incentive and
recorded $364,000 of deferred compensation. The common stock is restricted and
vests in ten years on the anniversary date of the grant. The Company's Board of
Directors also granted a total of 270,000 shares to independent contractors as a
long-term incentive and recorded $22,140 of deferred compensation. The common
stock is restricted and vests equally over three years on the anniversary date
of the grant.
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. On August 11, 2004, the Company filed an amended registration statement
on Form SB-2 with the Securities and Exchange Commission to register the resale
of the shares to be issued under the equity line of credit with Dutchess Private
Equities Fund, LP. The Securities and Exchange Commission declared this amended
registration statement to be effective on August 13, 2004. During the years
ended December 31, 2005 and 2004, the Company sold 3,179,844 and 1,459,435
shares of its common stock, respectively, pursuant to the equity line of credit
and received total proceeds, net of issuance costs, of $597,162 and $321,485,
respectively.
During the years ended December 31, 2005 and 2004, the Company issued a total of
1,146,339 and 943,564 shares of common stock, respectively, under the terms of
its Comprehensive Employee Stock Plan to independent contractors providing
consulting services to the Company and recorded $209,948 and $202,960 of related
expense, respectively. During the year ended December 31, 2005, the Company
issued 300,000 shares of common stock to an independent contractor performing
services for the Company. Such shares were issued pursuant to registration on
Form S-8 of the Securities and Exchange Act of 1933, as amended. The Company
recorded $64,500 of expense related to the issuance of this stock in 2005. In
February 2004, the Company also issued 55,000 shares of common stock under the
terms of its Comprehensive Employee Stock Plan to a former employee for services
provided while employed by the Company in 2003.
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 years
ended December 31, 2005 and 2004, the Company issued 15,000 and 51,000 shares of
common stock, respectively, and received cash proceeds of $1,275 and $7,125,
respectively, related to the exercise of stock options granted under the terms
of its Comprehensive Employee Stock Plan.
During the year ended December 31, 2004, the Company issued 72,225 shares of
common stock to certain independent contractors performing services for the
Company. Such shares were issued pursuant to Section 506 of Regulation D of the
Securities and Exchange Act of 1933, as amended. The Company recorded $11,375 of
expense related to the issuance of this stock in 2005 and 2004, respectively.
The average closing price was used to value the stock given as consideration
because the related independent contractor agreements called for the contractors
to earn a certain number of shares of common stock for each month (prorated for
any partial month) spent working on behalf of the Company with no specified
term. In effect, the contractors earned the same fixed number of shares for each
day that they worked for the Company so the performance commitment was met by
the contractors on a daily basis and valued as such in accordance with the
measurement date guidance provided by EITF 96-18.
NOTE 3. PROPERTY AND EQUIPMENT
The following is a summary of property and equipment at December 31:
2005 2004
---------- ----------
Furniture and fixtures $ 175,856 $ 175,856
Equipment 453,953 428,420
Software 265,780 175,819
Leasehold improvements 9,850 8,434
---------- ----------
905,439 788,529
Less: accumulated depreciation and amortization (742,839) (656,465)
---------- ----------
Total property and equipment, net $ 162,600 $ 132,064
========== ==========
25
NOTE 4. SALE OF INTANGIBLE ASSETS
In December 2005, the Company sold its bills.com domain name and related
trademark to Alivio Holdings, LLC for cash consideration of $950,000 and
realized a gain of $911,350 on the sale. The Company plans to continue offering
online payment processing services directly to consumers under a new domain
name, www.billx.com, as well as through resellers, including Alivio. The
Company's existing customer base using bills.com for online payment services was
retained and transitioned to the new billx.com domain name.
NOTE 5. ACCRUED EXPENSES
Accrued expenses consist of the following balances:
December 31, December 31,
2005 2004
------------- -------------
Accrued salaries $ 600,548 $ 289,709
Accrued taxes 26,773 12,266
Accrued professional fees 39,140 32,875
Other accrued expenses 110,134 30,103
------------- -------------
Total $ 776,595 $ 364,953
============= =============
NOTE 6. OPERATING LEASES
The Company has a lease expiring in October 2009 for approximately 4,500 square
feet that serves as the Company's headquarters. Additionally, the Company leases
office equipment under non-cancelable operating leases. Rental expense under
operating leases for the years ended December 31, 2005 and 2004 was $86,000 and
$85,000, respectively. Future minimum lease payments required under operating
leases are as follows.
Year ending December 31,
2006 $ 81,126
2007 81,126
2008 81,126
2009 67,605
--------
Total minimum lease payments $310,983
========
NOTE 7. DEBT
On August 24, 2004, the Company entered into a zero-discount promissory note
with Dutchess Private Equities Fund, II, LP. Pursuant to terms of the promissory
note, the Company received $260,000 and promised to pay Dutchess $284,000 with a
maturity date of December 24, 2004, which represents an effective annual
interest rate of 28%. The Company repaid this note in full on the maturity date.
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.
On December 10, 2004, the Company entered into another zero-discount promissory
note with Dutchess Private Equities Fund, II, LP. 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 balance of this note was
$264,165 at December 31, 2004, and the Company repaid this note in full in May
2005.
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 repaid this note in full on the maturity date.
26
NOTE 8. RELATED PARTY TRANSACTIONS AND GUARANTEES
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 December 31, 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. While Mr. Long and Mr. Hoch agreed, in
connection with such sale, to forego any affirmative recovery of their
compensation by virtue of a change of control, they have maintained the right to
claim an offset of that amount in the event the Company seeks recovery of the
loan balances. 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. 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 9. INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities as of December 31 are as
follows:
2005 2004
------------- -------------
Deferred Tax Assets:
----------------------------------
Warrant expense $ 3,228,527 $ 3,177,082
Loss on related party guarantees 434,567 434,567
Net operating loss carryforwards 12,586,135 12,266,021
Other items 94,720 77,419
------------- -------------
16,343,949 15,955,089
Valuation allowance (16,319,367) (15,914,425)
------------- -------------
Total Deferred Tax Asset 24,582 40,664
Deferred Tax Liabilities:
----------------------------------
Depreciation and other items 24,582 40,664
------------- -------------
Net Deferred Tax Asset (Liability) $ - $ -
============= =============
27
For the period from inception (July 30, 1998) through December 31, 2005, the
Company has net operating loss carryforwards for tax purposes of approximately
$37.0 million that begin to expire in the year 2020. In October 1999, the
Company issued common stock pursuant to a private placement offering. As a
result, an ownership change occurred under Section 382 that limits the
utilization of pre-change net operating loss carryforwards. Approximately $3.5
million of the total net operating loss is subject to the Section 382
limitations.
The reconciliation of income tax computed at the U.S. federal statutory tax
rates to income tax expense is as follows:
2005 2004
---------- ----------
Tax (benefit) at statutory rate -- 34% $(406,535) $(514,941)
Change in valuation allowance 404,942 514,356
Permanent and other differences 1,593 585
---------- ----------
Income tax expense $ - $ -
========== ==========
NOTE 10. EMPLOYMENT BENEFIT PLANS
Stock Option Plans
The Board of Directors and stockholders approved the 1999 Employee Comprehensive
Stock Plan ("Employee Plan") to provide qualified incentive stock options
("ISOs") and non-qualified stock options ("NQSOs") as well as restricted stock
grants to key employees. Under the terms of the Employee Plan, the exercise
price of ISOs must be equal to 100% of the fair market value on the date of
grant (or 110% of fair market value in the case of an ISO granted to a 10%
stockholder/grantee). There is no price requirement for NQSOs, other than that
the option price must exceed the par value of the common stock. The Company has
reserved 10,000,000 shares of its common stock for issuance pursuant to the
Employee Plan. On December 29, 2003, the Employee Plan was amended and restated
by the Board of Directors to add provisions 1) allowing for stock awards to be
made to consultants as provided in Rule 405 promulgated under the Securities Act
of 1933, as amended from time to time, and other applicable law, 2) increasing
the amount of shares of common stock of the Company exercisable per fiscal year
from stock options, whether ISOs or NQSOs, from 350,000 to 500,000, and 3)
removing minimum holding periods on "Restricted Stock" as such term is defined
in the Employee Plan.
The 1999 Non-Employee Director Plan ("Director Plan") was approved by the Board
of Directors and stockholders in 1999. Under the Director Plan, non-employee
directors may be granted options to purchase shares of common stock at 100% of
fair market value on the date of grant. The Company has reserved 1,500,000
shares of its common stock for issuance pursuant to the Director Plan.
Option activity under the Employee Plan and Director Plan is as follows:
Weighted Average
Number of Shares Exercise Price
----------------- -----------------
Outstanding, December 31, 2003 4,551,770 $ 0.78
Granted 30,000 0.20
Canceled (296,000) 0.86
Exercised (51,000) 0.14
-----------------
Outstanding, December 31, 2004 4,234,770 0.78
Granted 1,575,000 0.08
Canceled (278,600) 0.32
Exercised (15,000) 0.09
-----------------
Outstanding, December 31, 2005 5,516,170 $ 0.61
=================
There was an aggregate of 2,513,959 and 5,866,441 options to purchase the
Company's common stock available for future grants under the Employee and
Director Plans at December 31, 2005 and 2004, respectively. Exercisable stock
options amounted to 5,496,170 at a weighted average price of $0.61 and 4,079,770
at a weighted average price of $0.81 at December 31, 2005 and 2004,
respectively.
28
Summarized information about stock options outstanding at December 31, 2005 is
as follows:
Options Outstanding Options Exercisable
-------------------------------------------- ------------------------------------
Weighted Average Weighted Average Weighted Average
Range of Exercise Prices Options Outstanding Remaining Contractual Life Exercise Price Number of Options Exercise Price
------------------------ ------------------- -------------------------- ---------------- ----------------- -----------------
$0.08 - $0.14 3,230,000 8.9 years $ 0.11 3,230,000 $ 0.11
$0.18 - $0.26 874,500 7.1 years $ 0.18 854,500 $ 0.18
$0.86 - $0.88 662,668 5.8 years $ 0.86 662,668 $ 0.86
$1.88 - $2.07 334,001 5.0 years $ 2.06 334,001 $ 2.06
$2.81 - $11.25 415,001 3.2 years $ 3.85 415,001 $ 3.85
------------------------ ------------------- -----------------
5,516,170 7.6 years $ 0.61 5,496,170 $ 0.61
=================== =================
The weighted average fair value of stock options at date of grant was $0.06 and
$0.13 per option for options granted during fiscal years 2005 and 2004,
respectively. The fair value of each option granted was estimated using the
Black-Scholes option-pricing model, utilizing the following assumptions:
2005 2004
----- -----
Dividend yield None None
Expected volatility 135% 143%
Risk-free interest rate 4.38% 2.50%
Expected life 2.00 2.00
Employee Stock Purchase Plan
The Company established the 1999 Employee Stock Purchase Plan ("ESPP") under the
requirements of Section 423 of the Internal Revenue Code (the "Code") to allow
eligible employees to purchase the Company's common stock at regular intervals.
Participating employees may purchase common stock through voluntary payroll
deductions at the end of each participation period at a purchase price equal to
85% of the lower of the fair market value of the common stock at the beginning
or the end of the participation period. Common stock reserved for future
employee purchases under the plan aggregated 755,828 shares at December 31,
2005. There were no shares issued under the ESPP in 2005 or 2004.
401(k) Plan
The Company has a defined contribution plan (the "401(k) Plan") pursuant to
Section 401(k) of the Code. All eligible full and part-time employees of the
Company who meet certain age requirements may participate in the 401(k) Plan.
Participants may contribute between 1% and 15% of their pre-tax compensation,
but not in excess of the maximum allowable under the Code. The 401(k) Plan
allows for discretionary and matching contributions by the Company. The Company
made no contributions during 2005 or 2004.
NOTE 11. STOCK WARRANTS
On September 30, 2004, the Company signed a performance-based warrant agreement
with Kubra Data Transfer, Ltd., a provider of enterprise information solutions
servicing Electronic Bill Presentment and Payment customers, as consideration
for entering into a customer referral agreement with the Company for a
three-year term. Under the terms of the referral agreement, the Company will
become Kubra's preferred provider of credit and debit card payment processing.
The incentive warrant agreement provides for both an initial vested warrant for
250,000 shares of restricted common stock at $0.24 per share (see Note 2) and
contingent warrants to be earned based on the achievement of annual or quarterly
goals for delivery of gross revenue to the Company through the referral or
transfer of profitable payment processing customers. The contingent warrants
will also be for restricted common stock and will be priced at 120% of the
market price for the common stock when earned.
At December 31, 2005, the outstanding vested warrants to purchase common stock
were as follows:
Shares of Common Stock Exercise Price Expiration Date
---------------------- --------------- ---------------
2,179,121 $ 11.38 06/02/2010
87,600 1.80 11/27/2006
1,912,400 0.20 11/27/2007
------------
4,179,121
============
29
NOTE 12. 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 13. COMMON STOCK LISTING
The Company's common stock began trading on the Over the Counter Bulletin Board
("OTCBB") operated by the National Association of Securities Dealers ("NASD") on
December 3, 1998. The NASD adopted eligibility rules in 1999, which required
clearance of comments by the SEC on all SEC filings. The Company filed its
initial filing on Form 10 with the SEC on June 10, 1999 but, as of October 7,
1999, the SEC had not cleared its comment period. In accordance with the OTCBB's
phase-in schedule for the new eligibility rules, the listing on the OTCBB was
terminated. The Company's common stock was quoted in the National Quotation
Board's Electronic Pink Sheets until December 7, 1999, when the SEC cleared the
comment period and the stock was relisted and traded on the OTCBB through March
13, 2000 at which time the stock was approved for trading on the NASDAQ Small
Cap Market. Subsequently the stock was approved for trading on the NASDAQ
National Market ("NNM") on July 31, 2000, under the symbol "BLLS." On February
4, 2003, the NNM delisted the Company's common stock because the Company did not
meet the requirements for continued listing on the NNM. The Company's common
shares were immediately eligible for quotation on the OTCBB effective at opening
of business on February 4, 2003. On July 29, 2003, the Company amended its
Articles of Incorporation to change its name to Payment Data Systems, Inc. and
began trading on the OTCBB under a new symbol, PYDS, on August 20, 2003.
NOTE 14. LEGAL PROCEEDINGS
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 alleged 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 in Note 8. The
plaintiffs alleged and sought resulting economic and exemplary damages,
rescission, interest, attorneys' fees and costs of court.
On November 9, 2005, the Company entered into a settlement agreement with all
the plaintiffs named in the suit. Under the terms of the settlement, the
plaintiffs dismissed the pending litigation, with prejudice, and released all
claims against the Company, its current and former officers and directors, and
our former auditors, Ernst & Young, LLP. Additionally, the Company reset the
exercise price of 1,912,400 warrants to purchase our common stock held by the
plaintiffs from $1.80 per share to a new exercise price of $0.20 per share. The
Company also extended the expiration date of the warrants from November 27, 2006
to November 27, 2007. The Company recorded a non-cash expense of $151,309 in the
quarter ended September 30, 2005 as a result of the modification of the warrant
terms. The Company is not paying any other economic consideration to fund this
settlement.
NOTE 15. SUBSEQUENT EVENTS
Subsequent to December 31, 2005 and through March 10, 2006, the Company sold
1,298,460 shares of unregistered common stock to Dutchess Private Equities Fund,
LP pursuant to the equity line of credit (see Note 2) and received total
proceeds, net of issuance costs, of $171,735.
Subsequent to December 31, 2005 and through March 10, 2006, the Company issued a
total of 582,548 shares of common stock under the terms of its Employee
Comprehensive Stock Plan to independent contractors providing consulting
services to the Company for which it recorded $76,875 of related expense.
30
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 8A. CONTROLS AND PROCEDURES.
As of the end of the period covered by this Annual Report on Form 10-KSB, an
evaluation was performed under the supervision and with the participation of our
management, including the individual serving as both our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 of
the Securities Exchange Act of 1934). Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer 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 and 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 controls, which are included within
disclosure controls and procedures, during our most recently completed fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, our internal controls.
ITEM 8B. OTHER INFORMATION.
None.
31
PART III
We omitted certain information required by Part III from this Report because we
will file our definitive Proxy Statement for our 2006 Annual Meeting of
Stockholders pursuant to Regulation 14A of the Securities and Exchange Act of
1934 not later than 120 days after the end of the fiscal year covered by this
Report. Certain information included in the Proxy Statement is incorporated
herein by reference.
ITEM 9. DIRECTORS , EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
There is incorporated in this Item 9, by reference, that portion of our
definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, which
appears therein under the captions "Election of Director," "Committees of the
Board of Directors and Meetings" and "Section 16(a) Beneficial Ownership
Reporting Compliance."
We have adopted a Code of Ethics that applies to our principal executive
officer, principal financial officer, principal accounting officer or
controller, and persons performing similar functions. Our Code of Ethics is
filed as Exhibit 14.1 to our Annual Report on Form 10-K for the year ended
December 31, 2003. We will provide a copy of our code of ethics to any person
without charge, upon request. Requests should be addressed to: Payment Data
Systems, Inc., Attn: Investor Relations Department, 12500 San Pedro, Suite 120,
San Antonio, Texas 78216.
ITEM 10. EXECUTIVE COMPENSATION.
There is incorporated in this Item 10, by reference, that portion of our
definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, which
appears under the caption "Executive Compensation."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
There is incorporated in this Item 11, by reference, that portion of our
definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, which
appears under the caption "Security Ownership of Certain Beneficial Owners and
Management."
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
There are no reportable relationships or transactions.
ITEM 13. EXHIBITS.
The exhibits listed below are filed as part of or incorporated by reference in
this Report.
Exhibit Description
------- -----------
3.1 Amended and Restated Articles of Incorporation.
3.2 Amended and Restated By-laws.
4.1 Amended and Restated 1999 Employee Comprehensive Stock Plan (included as
exhibit 10.1 to the Form 8-K filed January 3, 2006, and incorporated herein
by reference).
4.2 Amended and Restated 1999 Non-Employee Director Plan (included as exhibit
10.2 to the Form 8-K filed January 3, 2006, 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).
32
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 22, 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).
10.13 Trademark and Domain Name Purchase Agreement between the Company and
Alivio Holdings, LLC, dated November 14, 2005 (included as exhibit 10.1 to
the Form 8-K filed November 17, 2005, and incorporated herein by
reference).
14.1 Code of Ethics (included as exhibit 14.1 to the Form 10-K filed March 30,
2004, and incorporated herein by reference).
16.1 Letter from Ernst and Young LLP to the Securities and Exchange Commission
dated February 10, 2004 (included as exhibit 16.1 to the Form 8-K filed
February 11, 2004, 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).
23.1 Consent of Akin Doherty Klein & Feuge, P.C., Independent Auditors.
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.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
There is incorporated in this Item 14, by reference, that portion of our
definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, which
appears under the caption "Fees Paid to the Independent Accountant."
33
SIGNATURES
In accordance with Section 13 or 15(d) 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.
By: /s/ Michael R. Long
----------------------
Michael R. Long
Chairman of the Board, Chief Executive Officer, and
Chief Financial Officer
Date: March 31, 2006
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities indicated on
March 31, 2006.
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)
By: /s/ Louis A. Hoch
--------------------
Louis A. Hoch
President, Chief Operating Officer, and
Director
By: /s/ Peter G. Kirby
---------------------
Peter G. Kirby
Director
34