UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT
For the transition period from ____ to ____
Commission file number 000-30152
PAYMENT DATA SYSTEMS, INC.
(Exact name of small business issuer as specified in its charter)
NEVADA 98-0190072
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
12500 SAN PEDRO, SUITE 120
SAN ANTONIO, TX 78216
(Address of principal executive offices)
(210) 249-4100
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirement for the past 90 days. Yes X No ___
--
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes ___ No X
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As of August 1, 2006, 42,883,365 shares of the issuer's common stock, $0.001 par
value, were outstanding.
Transitional Small Business Disclosure Format (Check one): Yes ___ No X
--
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PAYMENT DATA SYSTEMS, INC.
INDEX
PART I - FINANCIAL INFORMATION Page
----
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of June 30, 2006
and December 31, 2005 3
Consolidated Statements of Operations for the three and six months
ended June 30, 2006 and 2005 4
Consolidated Statements of Cash Flows for the six months
ended June 30, 2006 and 2005 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis or Plan of Operation 9
Item 3. Controls and Procedures 14
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 15
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
June 30, 2006 December 31, 2005
------------- -----------------
(Unaudited)
Assets:
Current assets:
Cash and cash equivalents $ 112,912 $ 378,098
Accounts receivable, net 132,548 59,558
Prepaid expenses and other 152,980 51,962
------------ ------------
Total current assets 398,440 489,618
Property and equipment, net 163,709 162,600
Other assets 179,385 20,833
------------ ------------
Total assets $ 741,534 $ 673,051
============ ============
Liabilities and stockholders' equity (deficit):
Current liabilities:
Accounts payable $ 550,493 $ 524,520
Accrued expenses 420,108 776,595
Deferred revenue 48,593 44,038
------------ ------------
Total current liabilities 1,019,194 1,345,153
Stockholders' equity (deficit):
Common stock, $0.001 par value, 200,000,000 shares authorized; 42,371,088 and
32,827,056 issued and outstanding 42,371 32,827
Additional paid-in capital 50,504,695 49,486,143
Deferred compensation (709,231) (829,687)
Accumulated deficit (50,115,495) (49,361,385)
------------ ------------
Total stockholders' equity (deficit) (277,660) (672,102)
------------ ------------
Total liabilities and stockholders' equity (deficit) $ 741,534 $ 673,051
============ ============
See notes to interim consolidated financial statements.
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PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30,
2006 2005 2006 2005
------------ ------------ ------------ ------------
Revenues $ 539,615 $ 314,926 $ 887,625 $ 557,888
Operating expenses:
Cost of services 404,956 271,211 703,338 495,840
Selling, general and administrative 433,611 449,886 877,441 860,989
Depreciation and amortization 20,891 17,718 42,358 38,111
------------ ------------ ------------ ------------
Total operating expenses 859,458 738,815 1,623,137 1,394,940
------------ ------------ ------------ ------------
Operating loss (319,843) (423,889) (735,512) (837,052)
Other income (expense):
Interest income 54 264 243 266
Interest expense (8,364) (68,544) (18,841) (110,609)
Other income (expense) - (4,362) - (5,116)
------------ ------------ ------------ ------------
Total other income (expense) (8,310) (72,642) (18,598) (115,459)
------------ ------------ ------------ ------------
Loss from operations before income taxes (328,153) (496,531) (754,110) (952,511)
Income taxes - - - -
------------ ------------ ------------ ------------
Net loss $ (328,153) $ (496,531) $ (754,110) $ (952,511)
============ ============ ============ ============
Basic and diluted net loss per common share: $ (0.01) $ (0.02) $ (0.02) $ (0.04)
Weighted average common shares
outstanding 41,695,994 28,596,016 38,938,161 26,523,006
See notes to interim consolidated financial statements.
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PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30,
--------------------------
2006 2005
------------ ------------
Operating activities:
Net loss $ (754,110) $ (952,511)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 42,358 38,111
Non-cash issuance of common stock 130,556 353,667
Deferred compensation 120,456 49,281
Amortization of debt discount - 46,086
Changes in current assets and current liabilities:
Accounts receivable (72,990) (16,419)
Prepaid expenses and other (144,570) 64,903
Deferred revenue 4,555 7,737
Accounts payable and accrued expenses 65,542 85,467
------------ ------------
Net cash used in operating activities (608,203) (323,678)
Investing activities:
Deposits, net 10,000 -
Purchases of property and equipment (43,467) (71,747)
------------ ------------
Net cash used in investing activities (33,467) (71,747)
Financing activities:
Proceeds from notes payable - 600,000
Principal payments for notes payable - (330,875)
Financing costs - (20,000)
Issuance of common stock, net of issuance costs 376,484 455,496
------------ ------------
Net cash provided by financing activities 376,484 704,621
------------ ------------
Change in cash and cash equivalents (265,186) 309,196
Cash and cash equivalents, beginning of period 378,098 153,966
------------ ------------
Cash and cash equivalents, end of period $ 112,912 $ 463,162
============ ============
See notes to interim consolidated financial statements.
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PAYMENT DATA SYSTEMS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
Payment Data Systems, Inc. and subsidiaries (the "Company"), has incurred
substantial losses since inception, which has led to a significant decrease in
its cash position and a deficit in working capital. The Company believes that
its current available cash along with anticipated revenues may be insufficient
to meet its anticipated cash needs for the foreseeable future. CONSEQUENTLY, THE
COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN IS LIKELY CONTINGENT ON THE
COMPANY RECEIVING ADDITIONAL FUNDS IN THE FORM OF EQUITY OR DEBT FINANCING. The
Company is currently aggressively pursuing strategic alternatives (see Note 4).
The sale of additional equity or convertible debt securities would result in
additional dilution to the Company's stockholders, and debt financing, if
available, may involve covenants which could restrict operations or finances.
There can be no assurance that financing will be available in amounts or on
terms acceptable to the Company, if at all. If the Company cannot raise funds on
acceptable terms, or achieve positive cash flow, it may not be able to continue
to exist, conduct operations, grow market share, take advantage of future
opportunities or respond to competitive pressures or unanticipated requirements,
any of which would negatively impact its business, operating results and
financial condition. The accompanying unaudited consolidated financial
statements of the Company do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.
The accompanying unaudited consolidated financial statements of the Company have
been prepared without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with U.S.
generally accepted accounting principles have been condensed or omitted pursuant
to such rules and regulations. In the opinion of management, the accompanying
consolidated financial statements reflect all adjustments of a normal recurring
nature considered necessary to present fairly the Company's financial position,
results of operations and cash flows for such periods. The accompanying interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-KSB for the year ended December 31, 2005.
Results of operations for interim periods are not necessarily indicative of
results that may be expected for any other interim periods or the full fiscal
year.
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
NOTE 2. STOCK-BASED COMPENSATION
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. Statement No. 123R
eliminates the ability to account for stock-based compensation using APB No. 25,
"Accounting for Stock Issued to Employees," and requires that these transactions
be recognized as compensation cost in the income statement based on their fair
values on the date of grant. The transition provisions require the "modified
prospective method" be applied to all new or modified awards and the remaining
expense for unvested options. The Company adopted Statement No. 123R as of
January 1, 2006, but the impact to the current period was immaterial, as
substantially all outstanding options completed their vesting during 2005, and
no new options have been granted in 2006.
The Company previously applied the intrinsic value method under the recognition
and measurement provisions of APB No. 25 in accounting for its stock option and
stock purchase plans. Accordingly, no stock-based employee compensation expense
has been recognized in prior periods 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
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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 No. 123R, "Accounting for Stock-Based Compensation," to stock-based
employee compensation in the prior period.
Three Months Ended June 30, 2005 Six Months Ended June 30, 2005
------------------------------------- ---------------------------------
Net loss, as reported $ (496,531) $ (952,511)
Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects (275) (1,590)
--------------- ---------------
Pro forma net loss $ (496,806) $ (954,101)
=============== ===============
Net loss per common share
- basic and diluted, as reported $ (0.02) $ (0.04)
Net loss per common share
- basic and diluted, pro forma $ (0.02) $ (0.04)
NOTE 3. RELATED PARTY TRANSACTIONS
Beginning in December 2000, the Company pledged as loan guarantees certain funds
held as money market funds and certificates of deposit to collateralize margin
loans for the following executive officers of the Company: (1) Michael R. Long,
then Chairman of the Board of Directors and Chief Executive Officer; (2) Louis
A. Hoch, then President and Chief Operating Officer; (3) Marshall N. Millard,
then Secretary, Senior Vice President, and General Counsel; and (4) David S.
Jones, then Executive Vice President. Mr. Millard and Mr. Jones are no longer
employees of the Company. The margin loans were obtained in March 1999 from
institutional lenders and were secured by shares of the Company's common stock
owned by these officers. The pledged funds were held in the Company's name in
accounts with the lenders that held the margin loans of the officers. The
Company's purpose in collateralizing the margin loans was to prevent the sale of
its common stock owned by these officers while it was pursuing efforts to raise
additional capital through private equity placements. The sale of that common
stock could have hindered the Company's ability to raise capital in such a
manner and compromised its continuing efforts to secure additional financing.
The highest total amount of funds pledged for the margin loans guaranteed by the
Company was approximately $2.0 million. The total balance of the margin loans
guaranteed by the Company was approximately $1.3 million at December 31, 2002.
At the time the funds were pledged, the Company believed they would have access
to them because (a) their stock price was substantial and the stock pledged by
the officers, if liquidated, would produce funds in excess of the loans payable,
and (b) with respect to one of the institutional lenders (who was also assisting
the Company as a financial advisor at the time), even if the stock price fell,
they had received assurances from that institutional lender that the pledged
funds would be made available as needed. During the fourth quarter of 2002, the
Company requested partial release of the funds for operating purposes, which
request was denied by an institutional lender. At that time, their stock price
had fallen as well, and it became clear that both institutional lenders would
not release the pledged funds. In light of these circumstances, the Company
recognized a loss on the guarantees of $1,278,138 in the fourth quarter of 2002
and recorded a corresponding payable under related party guarantees on their
balance sheet at December 31, 2002 because it became probable at that point that
they would be unable to recover their pledged funds. During the quarter ended
March 31, 2003, the lenders applied the pledged funds to satisfy the outstanding
balances of the loans. The total balance of the margin loans guaranteed by the
Company was zero at June 30, 2006. 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 a 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
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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. On July 25, 2004, the Company's employment
agreements with Michael Long, Chief Executive Officer and Chief Financial
Officer, and Louis Hoch, President and Chief Operating Officer, expired. The
Company intends to enter into new employment agreements with both of these
individuals and is currently negotiating the terms of such agreements. The
Company has not pursued the outstanding repayment obligation of Mr. Jones
because the Company does not consider a recovery attempt to be cost beneficial.
In order to attempt a recovery from Mr. Jones, the Company estimates that it
would incur a minimum of $20,000 in estimated legal costs with no reasonable
assurance of success in recovering his outstanding obligation of approximately
$38,000. Because of the limited amount of the obligation, the Company also
anticipates difficulty in retaining counsel on a contingency basis to pursue
collection of this obligation. The ultimate outcome of this matter cannot
presently be determined.
NOTE 4. EQUITY LINE OF CREDIT
In February 2004, the Company executed an agreement for an equity line of credit
with Dutchess Private Equities Fund, LP ("Dutchess"). Under the terms of the
agreement, the Company may elect to receive as much as $10 million from Dutchess
in common stock purchases over the next three years at the option of the
Company. During the six months ended June 30, 2006, the Company sold 2,993,885
shares of its common stock pursuant to the equity line of credit and received
total proceeds, net of issuance costs, of $357,642.
NOTE 5. ISSUANCE OF CAPITAL STOCK
During the quarter ended March 31, 2006, the Company issued a total of 4,439,024
shares of common stock granted to employees on December 29, 2005 as a long-term
incentive for which it 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 also issued a total of 270,000 shares granted to independent
contractors on December 29, 2005 as a long-term incentive for which it recorded
$22,140 of deferred compensation. The common stock is restricted and vests
one-third annually on the anniversary date of the grant.
During the quarter ended March 31, 2006, the Company issued 735,295 shares of
restricted common stock to Carmen Electra under the terms of a license agreement
with her and recorded $125,000 of prepaid expense, which will be amortized over
the remaining term of the license agreement.
During the six months ended June 30, 2006, the Company issued a total of
1,105,828 shares of common stock under the terms of its Comprehensive Employee
Stock Plan to independent contractors providing consulting services to the
Company for which it recorded $140,472 of related expense.
NOTE 6. SUBSEQUENT EVENTS
Subsequent to June 30, 2006 and through August 14, 2006, the Company sold
639,498 shares of its common stock pursuant to the equity line of credit (see
Note 4) and received total proceeds, net of issuance costs, of $52,479.
Subsequent to June 30, 2006 and through August 14, 2006, the Company issued a
total of 197,224 shares of common stock under the terms of its Comprehensive
Employee Stock Plan to independent contractors providing consulting services to
the Company for which it recorded $17,750 of related expense.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
FORWARD-LOOKING STATEMENTS DISCLAIMER
Except for the historical information contained herein, the matters discussed in
this Form 10-QSB include certain forward-looking statements that involve risks
and uncertainties, which are intended to be covered by safe harbors. Those
statements include, but are not limited to, all statements regarding our and
management's intent, belief and expectations, such as statements concerning our
future and our operating and growth strategy. We generally use words such as
"believe," "may," "could," "will," "intend," "expect," "anticipate," "plan," and
similar expressions to identify forward-looking statements. You should not place
undue reliance on these forward-looking statements. Our actual results could
differ materially from those anticipated in the forward-looking statements for
many reasons including our ability to implement our business plan, our ability
to raise additional funds and manage our substantial debts, consumer acceptance
of our products, our ability to broaden our customer base, our ability to
maintain a satisfactory relationship with our suppliers and other risks
described in our reports filed with the Securities and Exchange Commission.
Although we believe the expectations reflected in the forward-looking statements
are reasonable, they relate only to events as of the date on which the
statements are made, and our future results, levels of activity, performance or
achievements may not meet these expectations. Investors are cautioned that all
forward-looking statements involve risks and uncertainties including, without
limitation, the factors set forth under the Risk Factors section of Item 6,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, of the Annual Report on Form 10-KSB for the year ended December 31,
2005 and other factors detailed from time to time in our filings with the
Securities and Exchange Commission. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the inclusion of
such information should not be regarded as a representation by us or any other
person that our objectives and plans will be achieved. All forward-looking
statements made in this Form 10-QSB are based on information presently available
to our management. We do not intend to update any of the forward-looking
statements after the date of this document to conform these statements to actual
results or to changes in our expectations, except as required by law.
This discussion and analysis should be read in conjunction with the unaudited
interim consolidated financial statements and the notes thereto included in this
report, and our Annual Report on Form 10-KSB for the year ended December 31,
2005.
OVERVIEW
We provide integrated electronic payment processing services to merchants and
businesses, including credit and debit card-based processing services and
transaction processing via the Automated Clearinghouse Network. We also operate
an online payment processing service for consumers under the domain name
www.billx.com through which consumers can pay anyone. Since inception, we have
incurred operating losses each quarter, and as of June 30, 2006, we have an
accumulated deficit of $50.1 million. OUR PROSPECTS TO CONTINUE AS A GOING
CONCERN MUST BE CONSIDERED IN LIGHT OF THE RISKS, EXPENSES AND DIFFICULTIES
FREQUENTLY ENCOUNTERED BY COMPANIES IN THEIR EARLY STAGES OF GROWTH,
PARTICULARLY COMPANIES IN 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.
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CRITICAL ACCOUNTING POLICIES
General
Management's Discussion and Analysis or Plan of Operation is based upon our
consolidated financial statements, which have been prepared in accordance with
U.S. generally accepted accounting principles. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenue and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, we
evaluate our estimates, including those related to the reported amounts of
revenues and expenses, bad debt, investments, intangible assets, income taxes,
and contingencies and litigation. We base our estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results could differ from these estimates under different
assumptions or conditions. We consider the following accounting policies to be
critical because the nature of the estimates or assumptions is material due to
the levels of subjectivity and judgment necessary to account for highly
uncertain matters or the susceptibility of such matters to change or because the
impact of the estimates and assumptions on financial condition or operating
performance is material.
Reserve for Losses on Card Processing
If, due to insolvency or bankruptcy of the merchant, or for another reason, we
are not able to collect amounts from our card processing merchant customers that
have been properly "charged back" by the cardholders, we must bear the credit
risk for the full amount of the cardholder transaction. We may require cash
deposits and other types of collateral from certain merchants to minimize any
such risk. In addition, we utilize a number of systems and procedures to manage
merchant risk. Card merchant processing loss reserves are primarily determined
by performing a historical analysis of our chargeback loss experience and
considering other factors that could affect that experience in the future, such
as the types of card transactions processed and nature of the merchant
relationship with their consumers. This reserve amount is subject to risk that
actual losses may be greater than our estimates. At June 30, 2006, our card
merchant processing loss reserve was $56,236. We have not incurred any
chargeback losses to date. Our estimate for chargeback losses is likely to
increase in the future as our volume of card-based transactions processed
increases.
Bad Debts
We maintain an allowance for doubtful accounts for estimated losses resulting
from the inability or failure of our customers to make required payments. We
determine the allowance for doubtful accounts based on an account-by-account
review, taking into consideration such factors as the age of the outstanding
balance, historical pattern of collections and financial condition of the
customer. Past losses incurred by us due to bad debts have been within our
expectations. We charged bad debt expense of $10,000 and recorded bad debt
write-offs of $936 against our allowance for doubtful accounts in 2005. We
charged bad debt expense of $15,000 and did not record any bad debt write-offs
against our allowance for doubtful accounts in the six months ended June 30,
2006. At June 30, 2006, the balance of the allowance for doubtful accounts was
$27,219. If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make contractual payments,
additional allowances may be required. Our estimate for bad debt losses is
likely to increase in the future as our volume of transactions processed
increases.
Valuation of Long-Lived and Intangible Assets
We assess the impairment of long-lived and intangible assets at least annually,
and whenever events or changes in circumstances indicate that the carrying value
may not be recoverable. Factors considered important, which could trigger an
impairment review, include the following: significant underperformance relative
to historical or projected future cash flows; significant changes in the manner
of use of the assets or the strategy of the overall business; and significant
negative industry trends. When management determines that the carrying value of
long-lived and intangible assets may not be recoverable, impairment is measured
as the excess of the assets' carrying value over the estimated fair value. No
impairment losses were recorded in 2005 or during the quarter ended June 30,
2006.
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Income Taxes
Deferred tax assets and liabilities are recorded based on the difference between
the tax bases of assets and liabilities and their carrying amount for financial
reporting purposes, as measured by the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. Deferred tax assets are
computed with the presumption that they will be realizable in future periods
when pre-taxable income is generated. Predicting the ability to realize these
assets in future periods requires a great deal of judgment by management. It is
our judgment that we cannot predict with reasonable certainty that the deferred
tax assets as of June 30, 2006 will be realized in future periods. Accordingly,
a valuation allowance has been provided to reduce the net deferred tax assets to
$0. At December 31, 2005, we had available net operating loss carryforwards of
approximately $36.1 million, which expire beginning in the year 2020.
RESULTS OF OPERATIONS
Our revenues are principally derived from providing integrated electronic
payment services to merchants and businesses, including credit and debit
card-based processing services and transaction processing via the Automated
Clearinghouse Network. We also operate an online payment processing service for
consumers under the domain name www.billx.com and sell this service as a
private-label application to resellers. Revenues for the quarter ended June 30,
2006 increased 71% to $539,615 from $314,926 for the quarter ended June 30,
2005. Revenues for the six months ended June 30, 2006 increased 59% to $887,625
from $557,888 for the six months ended June 30, 2005. The increases from the
prior year periods were primarily attributable to the increase in revenues
generated from card-based processing services due to increased transaction
volume. The 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. Revenues generated by our
billx.com payment service for the second quarter and first six months of 2006
decreased from the prior year periods due to a decrease in the average number of
consumers subscribing to our online payment service. The monthly average number
of such consumers decreased to 1,441 in the first six months of 2006 from 2,929
in the first six months of 2005.
We expect our total revenues to increase as we anticipate continued growth in
the volume of card transactions and additional merchant customers. Revenue
generated by our merchant customers represented approximately 94% of our total
revenues in the six months ended June 30, 2006, and we believe that this
percentage will increase as we anticipate adding new merchant customers and
experiencing growth in transaction volumes as a result. We believe that our
merchant business provides us with the best opportunity for revenue growth and
that revenues from card-based processing services will continue to grow in
future periods.
Cost of services includes the cost of personnel dedicated to the creation and
maintenance of connections to third party payment processors and fees paid to
such third party providers for electronic payment processing services. Through
our contractual relationships with our payment processors, we are able to
process Automated Clearinghouse and debit or credit card transactions on behalf
of our customers and their consumers. We pay volume-based fees for debit and
credit transactions initiated through these processors, and pay fees for other
transactions such as returns, notices of change to bank accounts and file
transmission. Cost of services was $404,956 and $271,211 for the quarters ended
June 30, 2006 and 2005, respectively, and $703,338 and $495,840 for the six
months ended June 30, 2006 and 2005, respectively. The increase from the prior
year quarter was due primarily to the increase in fees related to processing the
increased card-based transaction volume.
Selling, general and administrative expenses decreased to $433,611 for the
quarter ended June 30, 2006, from $449,886 for the second quarter of 2005. The
decrease from the prior year quarter was primarily due to lower consulting
expenses. Selling, general and administrative expenses for the six months ended
June 30, 2006 increased to $877,441 from $860,989 for the six months ended June
30, 2005. The increase from the prior year period was principally due to higher
non-cash amortization of deferred compensation of $61,166 related to employee
incentive stock grants partially offset by lower consulting expenses. We expect
our selling, general and administrative expenses to increase in subsequent
quarters as we incur marketing costs related to the promotion of new debit card
products, such as the Carmen Electra Prepaid MasterCard.
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Depreciation and amortization increased to $20,891 for the quarter ended June
30, 2006 from $17,718 for the second quarter of 2005. Depreciation and
amortization for the six months ended June 30, 2006 increased to $42,358 from
$38,111 for the six months ended June 30, 2005. These increases were primarily
due to depreciation related to asset additions enabling our online payment
processing capabilities that were put into production during the latter half of
2005. We capitalized $43,467 of computer hardware and software purchased during
the six months ended June 30, 2006 and anticipate making additional capital
expenditures of approximately $75,000 over the remaining six months of 2006.
Net other expense decreased to $8,310 for the quarter ended June 30, 2006 from
$72,642 for the second quarter of 2005, and decreased to $18,598 for the six
months ended June 30, 2006 from $115,459 for the six months ended June 30, 2005.
The decreases from the prior year periods were attributable to $73,660 and
$115,725 of interest expense and financing costs incurred in the quarter and six
months ended June 30, 2005, respectively, related to our note payable to
Dutchess.
Net loss decreased to $328,153 for the quarter ended June 30, 2006 from $496,531
for the prior year quarter and decreased to $754,110 for the six months ended
June 30, 2006 from $952,511 for the prior year comparable period. Net loss
decreased from the prior year periods primarily as a result of the increase in
gross margin and decrease in interest expense as discussed.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2006, we had $112,912 of cash and cash equivalents, compared to
$378,098 of cash and cash equivalents at December 31, 2005. We have incurred
substantial losses since inception and have a deficit in net working capital. We
believe that our current available cash and cash equivalents along with
anticipated revenues may be insufficient to meet our anticipated cash needs for
the foreseeable future. CONSEQUENTLY, OUR ABILITY TO CONTINUE AS A GOING CONCERN
MAY BE CONTINGENT ON US RECEIVING ADDITIONAL FUNDS IN THE FORM OF EQUITY OR DEBT
FINANCING. We are currently aggressively pursuing strategic alternatives.
In June 2004, we executed an agreement for an equity line of credit with
Dutchess Private Equities Fund, LP. Under the terms of the agreement, at our
option we may elect to receive as much as $10 million from Dutchess in common
stock purchases over three years. Through June 30, 2006, we have sold a total of
7,633,164 shares of our common stock pursuant to the equity line of credit and
received total proceeds, net of issuance costs, of $1,276,289.
The satisfactory completion of an additional investment, adequate sales of stock
under our equity line of credit, or growth of cash flow from operations is
essential or we have no other alternative that will provide sufficient cash
flows to meet current operating requirements. The sale of additional equity or
convertible debt securities would result in additional dilution to our
stockholders, and debt financing, if available, may involve restrictive
covenants which could restrict operations or finances. There can be no assurance
that financing will be available in amounts or on terms acceptable to us, if at
all. If we cannot raise funds, on acceptable terms, or achieve positive cash
flow, we may not be able to continue to exist, conduct operations, grow market
share, take advantage of future opportunities or respond to competitive
pressures or unanticipated requirements, any of which would negatively impact
our business, operating results and financial condition.
Net cash used in operating activities was $608,203 and $323,678 for the six
months ended June 30, 2006 and 2005, respectively. Net cash used in operating
activities was primarily attributable to operating net losses generated by
growth stage activities and overhead costs. We plan to focus on expending our
resources prudently given our current state of liquidity.
Net cash used in investing activities was $33,467 and $71,747 for the six months
ended June 30, 2006 and 2005, respectively, and reflected capital expenditures
for computer hardware and software. We anticipate making capital expenditures of
approximately $75,000 during the remaining six months of 2006.
Net cash provided by financing activities of $376,484 for the six months ended
June 30, 2006 represented the net proceeds from the issuance of common stock
under our equity line of credit. Net cash provided by financing activities of
$704,621 for the six months ended June 30, 2005 resulted from receiving $455,496
in net proceeds from
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the issuance of common stock, primarily under our equity line of credit, and
receiving $269,125 in net proceeds under our notes payable.
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.
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ITEM 3. CONTROLS AND PROCEDURES
As of the end of the period covered by this Quarterly Report on Form 10-QSB, 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.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Beginning in December 2000, we pledged as loan guarantees certain funds held as
money market funds and certificates of deposit to collateralize margin loans for
the following executive officers: (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 June 30, 2006. 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 a 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.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended June 30, 2006, we sold 1,460,125 shares of our common
stock to Dutchess Private Equities Fund, LLP, an accredited investor, pursuant
to an equity line of credit and received total proceeds, net of issuance costs,
of $158,977.
The shares were sold in accordance with Rule 506 of Regulation D under the
Securities Act of 1933 (as amended) in that:
- the sales were made to a sophisticated or accredited investors, as defined
in Rule 502;
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- we gave each purchaser the opportunity to ask questions and receive answers
concerning the terms and conditions of the offering and to obtain any
additional information which we possessed or could acquire without
unreasonable effort or expense that is necessary to verify the accuracy of
information furnished;
- at a reasonable time prior to the sale of securities, we advised each
purchaser of the limitations on resale in the manner contained in Rule
502(d)2;
- neither we nor any person acting on our behalf sold the securities by any
form of general solicitation or general advertising; and
- we exercised reasonable care to assure that each purchaser of the
securities is not an underwriter within the meaning of Section 2(11) of the
Securities Act of 1933 in compliance with Rule 502(d).
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Stockholders held on June 22, 2006, the following
matters were adopted by the margins indicated:
1. To elect director Louis A. Hoch to serve until the 2009 Annual Meeting of
Stockholders.
For: 32,264,131
Withheld: 328,480
2. To ratify the appointment of Akin, Doherty, Klein & Fuege, P.C.,
certified public accountants, as the independent auditors of the Company for the
year ending December 31, 2006.
For: 32,451,403
Against: 124,723
Abstain: 16,485
The following directors continued their term of office subsequent to the Annual
Meeting: Michael R. Long, Louis A. Hoch and Peter G. Kirby.
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit
Number Description
------ -----------
3.1 Amended and Restated Articles of Incorporation (included as exhibit 3.1 to
the Form 10-KSB filed March 31, 2006, and incorporated herein by
reference).
3.2 Amended and Restated By-laws (included as exhibit 3.2 to the Form 10-KSB
filed March 31, 2006, and incorporated herein by reference).
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4.1 Amended and Restated 1999 Employee Comprehensive Stock Plan (included as
exhibit 4.1 to the Form S-8 filed May 25, 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).
10.2 First Amendment to Asset Purchase Agreement between the Company and Saro,
Inc., dated July 25, 2003 (included as exhibit 10.2 to the Form 10-Q filed
November 14, 2003, and incorporated herein by reference).
10.3 Lease Agreement between the Company and Frost National Bank, Trustee for a
Designated Trust, dated August 2003 (included as exhibit 10.3 to the Form
10-Q filed November 14, 2003, and incorporated herein by reference).
10.4 Employment Agreement Form between the Company and Executive Officers, dated
May 31, 2001 (included as exhibit 10.4 to the Form 10-K filed April 1,
2002, and incorporated herein by reference).
10.5 Investment Agreement between the Company and Dutchess Private Equities
Fund, LP, dated June 4, 2004 (included as exhibit 10.8 to the Form SB-2
filed June 18, 2004, and incorporated herein by reference).
10.6 Placement Agent Agreement between the Company, Charleston Capital
Corporation, and Dutchess Private Equities Fund, LP, dated June 4, 2004
(included as exhibit 10.10 to the Form SB-2 filed June 18, 2004, and
incorporated herein by reference).
10.7 Affiliate Office Agreement between the Company and Network 1 Financial,
Inc. (included as exhibit 10.11 to the Form SB-2 filed April 28, 2004, and
incorporated herein by reference).
10.8 Promissory Note between the Company and Dutchess Private Equities Fund, II,
LP, dated August 24, 2004 (included as exhibit 10.1 to the Form 8-K filed
September 2, 2004, and incorporated herein by reference).
10.9 Warrant Agreement between the Company and Kubra Data Transfer LTD, dated as
of September 30, 2004 (included as exhibit 10.1 to the Form 8-K filed
October 6, 2004, and incorporated herein by reference).
10.10 Promissory Note between the Company and Dutchess Private Equities Fund,
II, LP, dated December 10, 2004 (included as exhibit 10.1 to the Form 8-K
filed December 16, 2004, and incorporated herein by reference).
10.11 Promissory Note between the Company and Dutchess Private Equities Fund,
II, LP, dated May 12, 2005 (included as exhibit 10.11 to the Form 10-QSB
filed May 16, 2005, and incorporated herein by reference).
10.12 Corporate Consulting Agreement between the Company and Theodore Smith,
dated April 26, 2005 (included as exhibit 10.1 to the Form S-8 filed June
3, 2005, and incorporated herein by reference).
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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).
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.
(b) Reports on Form 8-K:
None.
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SIGNATURE
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PAYMENT DATA SYSTEMS, INC.
Date: August 14, 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)
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