The accompanying unaudited interim condensed consolidated financial statements of Payment Data Systems, Inc. and its subsidiaries (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 United States generally accepted accounting principles have been omitted pursuant to such rules and regulations. In the opinion of management, the accompanying interim condensed 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 unaudited interim condensed 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-K for the year ended December 31, 2016,2017, as filed with the Securities and Exchange Commission on April 6, 2017.March 30, 2018. 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.

 

 

 

On September 1, 2017, the Company entered into a membership interest purchase agreement with Singular Payments, LLC (“Singular”Singular Payments”), a Florida limited liability company in the business of credit card processing, pursuant to which the Company agreed to purchase all of the membership interest in Singular Payments, LLC. The aggregate purchase price was $5,000,000 and consisted of a cash payment of $1,500,000 at closing, minus the balance on the outstanding note receivable of $600,000 and subject to adjustment based on net working capital, and $3,500,000 in shares of common stock, or 1,515,152 shares of the Company's common stock, $0.001 par value per share, valued at $2.31 per share. Such shares are unregistered and subject to a lock-up agreement of 24 months.

The purchase price was allocated to the net assets acquired based upon their estimated fair values as follows:

 

On February 2, 2016, the Company entered intoUnder a loan and security agreement with C2Go,dated February 2, 2016, the Company's wholly-owned subsidiary FiCentive, Inc., a Nevada corporation, pursuant to which the Company agreed to loan loaned a principal amount of $200,000 to C2Go, Inc. with an interest rate of 10% per annum for a term of 18 months. C2Go’s obligations under theThe loan and security agreement arewas secured by a first lien on all assets of C2Go. The debt is senior, and any future debt incurredC2Go defaulted under the note by C2Go must be subordinatedfailing to the debt ofrepay the loan and security agreement. Upon maturity of the debt, C2Go was required to issue to the Company 5% of the issued and outstanding shares of common stock of C2Go as of the date of issuance,plus interest on a fully diluted basis, giving effect to any convertible securities, warrants, etc., such shares being validly issued, fully-paid and non-assessable shares for no additional consideration. C2Go defaulted on the Note, therefore the interest rate under the loan and security agreement rose to 18% per annum. The full principal of the note, plus accrued and unpaid interest, was due to be repaid on or before August 2, 2017. C2Go did not make any payment on that date.  Pursuant to the Note, C2Go had until August 16, 2017 to cure the payment default.  The default was not cured. On August 28, 2017, our wholly-owned subsidiary,A lawsuit filed by FiCentive Inc. filed a lawsuit against C2Go, Inc, alleging multiple defaults of our mutual loan and security agreement. The case is pending in Bexar County, San Antonio, TX. TheTexas. On December 7, 2017, the Company is in ongoingentered into a note purchase and settlement discussionsagreement with C2Go regardingand Mercury Investment Partners LLC. Pursuant to the note purchase and settlement agreement Mercury Investment Partners agreed to purchase the note and the rights secured by the security agreement with all rights and obligations and pay to FiCentive a sum of $200,000 in three installments. The first installment of $50,000 was paid on December 7, 2017. The second installment of $50,000 was due on April 30, 2018, and the remaining amount of $100,000 is due on October 31, 2018. In return, FiCentive agreed to waive all interest due and payable under the terms of the C2Go loan. Mercury Investment Partners has not paid the amount due on April 30, 2018. FiCentive has issued a letter of default. In principle, FiCentive has agreed to extend the due date of the $50,000 payment due on the note. C2Go has brought forward an investor interested in buying out the Note via extended payment termsApril 30, 2018 to cover the principal. However,May 16, 2018. There are no assurances that the Company haswill be able to recover the remaining $150,000 principal due and there are no assurances the Company will be able to recover any value from our lien on all the assets of C2Go, Inc. if payment in full of the obligation is not reached a final agreement with this investor.made. Due to the uncertainty of the situation and “more likely than not” recognition threshold as of September 30, 2017,March 31, 2018, the Company has not recorded a loss reserve on the note receivable. At September 30, 2017, the Company wrote off the accrued interest of $31,667 previously recognized on the C2Go note receivable.

On March 7, 2017, the Company agreed to provide $500,000 to Singular Payments, LLC, a Florida limited liability company, under a secured line of credit promissory note. Interest on the note did not accrue until the earlier of August 31, 2017, the date of closing and funding the Company’s proposed acquisition of Singular Payments or the termination of a non-binding letter of intent regarding the proposed acquisition,acquisition; or until such mutually agreed upon extended date. The loan was increased to $600,000 on August 2, 2017. The Singular Payments, LLC acquisition closed on September 1, 2017. The note receivable was applied to the cash purchase price as part of the Purchase Agreement.

Accrued expenses consisted of the following balances:

Basic earnings (loss) per share (EPS) were computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted EPS differs from basic EPS due to the assumed conversion of potentially dilutive awards and options that were outstanding during the period. The following is a reconciliation of the numerators and the denominators of the basic and diluted per share computations for net income (loss) for the three and nine months ended September 30, 2017March 31, 2018 and September 30, 2016.March 31, 2017.

Deferred tax assets and liabilities are recorded based on the difference between financial reporting and tax basis of assets and liabilities and are measured by the enacted tax rates and laws that are expected to 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 taxable income is generated. Predicting the ability to realize these assets in future periods requires a great deal of judgment by management. U.S. generally accepted accounting principles prescribe a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return. Income tax benefits that meet the “more likely than not” recognition threshold should be recognized. Goodwill is amortized over 15 years for tax purposes.

 

The Company has recognized a deferred tax asset of $1.6approximately $1.4 million and has recorded a valuation allowance of $12.7approximately $8.2 million to reduce the other deferred tax assets. The Company reviews the assessment of the deferred tax asset and valuation allowance on an annual basis or more often when events indicate a change to the valuation allowance may be warranted.

 

At December 31, 2016,2017, the Company had available net operating loss carryforwards of approximately $40.2$41.3 million, which expire beginning in the year 2020.2021. Approximately $0.1 million of the total net operating loss carryforward is subject to an IRS Section 382 limitation from 1999.

 

Management is not aware of any tax positions that would have a significant impact on the Company’s financial position.

During the ninethree months ended September 30, 2017March 31, 2018 and the year ended December 31, 2016,2017, the Company purchased a total of $1,826$0 and $2,250,$1,826, respectively, of corporate imprinted sportswear and caps from Angry Pug Sportswear. Nikole Killough and Louis Hoch, the Company’s President and Chief Executive Officer, are eachis a 50% ownersowner of Angry Pug Sportswear.

 

During the ninethree months ended September 30, 2017March 31, 2018 and the year ended December 31, 2016,2017, the Company received $21,907$7,709 and $51,500,$29,555, respectively, in revenue from Lush Rooftop. Miguel Chapa, a member of the Company’s Board of Directors, is a managing memberan owner of Lush Rooftop. Louis Hoch, the Company’s President and Chief Executive Officer, is also a minority owner in Lush Rooftop.

On April 26, 2016, Michael McFarland, derivatively on behalf the Company, re-filedUnder a class-action lawsuit in United States District Court, District of Nevada that had been previously filedloan and dismissed. The suit alleges breach of fiduciary duties and unjust enrichment by the Company’s Board of Directors and certain executive officers and directors in connection with excessive and unfair compensation paid or awarded during fiscal years 2013 and 2014. The lawsuit seeks disgorgement of excessive compensation as well as damages in an unspecified amount. In Julysecurity agreement dated February 2, 2016, the Company filed a motion to dismiss the case. In January 2017, the court granted a partial dismissal of the claims and suggested the plaintiffs re-file their petition. Subsequently, the Company re-filed a motion to dismiss the case. On October 7, 2017, the court granted a full dismissal of all claims.

Aside from the lawsuit described above, the Company may be involved in legal matters arising in the ordinary course of business from time to time. While the Company believes that such matters are currently not material, there can be no assurance that matters arising in the ordinary course of business for which the Company is or could become involved in litigation will not have a material adverse effect on the Company’sour business, financial condition or results of operations.

This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. If used in this report, the words "anticipate," "believe," "estimate," "intend," and words or phases of similar import are intended 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 the risks described in our annual report on Form 10-K and other reports we file 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. We do not intend to update any of the forward-looking statements after the date of this report to conform these statements to actual results or to changes in our expectations, except as required by law.

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 Clearing House, or ACH, network and the program management and processing of prepaid debit cards. 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 September 30, 2017March 31, 2018 increased 17%108% to $3,588,853,$5,843,665, as compared to $3,067,335$2,810,744 for the quarter ended September 30, 2016. Revenues for the nine months ended September 30, 2017 decreased 3% to $8,950,038, as compared to $9,186,027 for the nine months ended September 30, 2016.March 31, 2017. The increase for the quarter ended September 30, 2017March 31, 2018 versus the same period in 20162017 was primarily due to increased credit card revenues associated with one monthacquisition of revenues resulting from the acquisitionbusiness of Singular Payments, LLC on September 1, 2017. The decrease for the nine months ended September 30, 2017 as compared to the same periods in the prior year, was due to the decrease in the overall volume of ACH processing transactions, and return transactions.combined with organic growth.

Cost of services includes the cost of personnel dedicated to the creation and maintenance of connections to third-party payment processors and the fees paid to such third-party providers for electronic payment processing services. Through our contractual relationships with our payment processors and sponsoring banks, we are able to process ACH and debit, credit or prepaid card transactions on behalf of our customers and their consumers. We pay volume-based fees for debit, credit, ACH and prepaid transactions initiated through these processors or sponsoring banks, and pay fees for other transactions such as returns, notices of change to bank accounts and file transmission.

Stock-based compensation expenses were $230,206$374,378 and $264,154$207,920 for the quarters ended September 30,March 31, 2018 and 2017, and September 30, 2016, respectively. Stock-based compensation expenses were $655,885 and $835,590 for the nine months ended September 30, 2017 and September 30, 2016, respectively. The decreaseincrease in stock-based compensation expense iswas due to shares that vested or were canceledthe incremental expenses associated with the stock grants issued in December 2016 that are fully amortized.

Depreciation and amortization totaled $458,663 for the quarter. Interest income was $88,927quarter ended March 31, 2018, compared to depreciation and $72,739,amortization of $228,545 for the nine months ended September 30, 2017 and September 30, 2016, respectively. The increase in interest for the nine months, as compared to the same period in 2017. Increased amortization expense was as a result of the prior year, wasSingular Payments acquisition in September, 2017.

Other income (expense) netted income of $9,979 for the quarter ended and March 31, 2018 compared to income of $35,355 for the quarter ended March 31, 2017, respectively. The decrease in other income is primarily due to the increase in interest earned on higherlower interest-bearing cash balancesbalances.

Under a loan and $0 for the nine months ended September 30, 2016. The financing activities represented treasury stock purchases.

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.

Our management evaluated, with the participation of our Chief Executive and Chief Financial Officers, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report on Form 10-Q. Based on that evaluation, our Chief Executive and Chief Financial Officers concluded that our disclosure controls and procedures as of September 30, 2017March 31, 2018 were effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive and Chief Financial Officers, 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 evaluation of disclosure controls and procedures included an evaluation of certain components of our internal control over financial reporting. Management’s assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance that the control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system's objectives will be met.

There was no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2017March 31, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

On April 26,Under a loan and security agreement dated February 2, 2016, Michael McFarland, derivatively on behalf the Company, re-filed a class-action lawsuit in United States District Court, District of Nevada that had been previously filed and dismissed. The suit alleges breach of fiduciary duties and unjust enrichment by our Board of Directors and certain executive officers and directors in connection with excessive and unfair compensation paid or awarded during fiscal years 2013 and 2014. The lawsuit seeks disgorgement of excessive compensation as well as damages in an unspecified amount. In July 2016, we filed a motion to dismiss the case. In January 2017, the court granted a partial dismissal of the claims and suggested the plaintiffs re-file their petition. Subsequently, we re-filed a motion to dismiss the case. On October 7, 2017, the court granted a full dismissal of all claims.

Aside from the lawsuit described above, wethe Company may be involved in legal matters arising in the ordinary course of business from time to time. While we believethe Company believes that such matters are currently not material, there can be no assurance that matters arising in the ordinary course of business for which we arethe Company is or could become involved in litigation will not have a material adverse effect on our business,

There were no issuances of registered common stock valued at $2.31 per share associated withunregistered equity securities during the acquisition of Singular Payments to Vaden Landers. We relied on the Section 4(a)(2) exemption from securities registration under the federal securities laws for transactions not involving any public offering. No advertising or general solicitation was employed in offering the securities. The securities were issued to an accredited investor. The securities were offered for investment purposes only and not for the purpose of resale or distribution. The transfer thereof was appropriately restricted by us.quarter ended March 31, 2018.

On November 2, 2016, we announced that our Board of Directors authorized the repurchase of up to $1 million of our common stock from time to time on the open market, in block transactions, or in privately negotiated transactions. On January 9, 2018, the Board of Directors added an additional $2 million to the buyback plan. The funds available at December 31, 2017 were $455,030 and after the increase were $2,455,030. At March 31, 2018, $1,498,902 are available under the repurchase plan. The program began on November 16, 2016 and will be available until all funds are exhausted, or September 29, 2019, unless terminated earlier by us. The program may be used for purchases of stock from employees and directors; and for open-market purchases through a broker. During the ninethree months ended September 30, 2017,March 31, 2018, we made the following stock repurchases: