UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Amendment No. 1)
(Mark One)
x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended:March 31, 2013
¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from N/A to N/A
Commission file number: 000-27145
THE SPENDSMART PAYMENTS COMPANY
(Name of small business issuer in its charter)
Colorado | | | 33-0756798 |
(State or jurisdiction of incorporation or organization) | | | (I.R.S. Employer Identification No.) |
2680 Berkshire Parkway Suite 130 | | | |
Des Moines Iowa | | | 50325 |
(Address and of principal executive offices) | | | (Zip Code) |
(858) 677-0080
(Issuer’s telephone number, including area code)
Indicate by check mark whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 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 requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filero | Accelerated filero |
Non-accelerated filero(Do not check if a smaller reporting company) | Smaller reporting companyx |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
At October 18, 2013 there were 10,356,423 shares outstanding of the issuer’s common stock, par value $0.001 per share.
EXPLANATORY NOTE
This Amendment No. 1 hereby amends our Quarterly Report on Form 10-Q/A (the “Amended 10-Q”) for the three and six ended March 31, 2013 and 2012, which was originally filed with the Securities and Exchange Commission on May 17, 2013 (the “Original 10-Q”). This Amendment is being filed to include restated financial statements as described in Note 1, “Restatement of previously issued financial statements”, of the Notes to the Condensed Consolidated Statements. The condensed consolidated statements are being restated to correct accounting errors as follows:
On August 19, 2013, after consulting with the Company’s Audit Committee, management concluded it had incorrectly calculated its historical volatility for the fiscal years ended September 30, 2012 and 2011. The error also impacted the three and six months ended March 31, 2013 and 2012. The error specifically related to an excel spreadsheet calculation whereby it was calculating a volatility that was significantly higher than it should have been. The historical volatility is a key assumption and driver in determining the valuation of the company’s stock based compensation and derivative liabilities. The impact of the change affects the derivative liabilities, changes in fair value of derivative liabilities, and stock based compensation as of and for the three and six months ended March 31, 2013 and 2012.
As part of the restatement process, the Company also corrected its tables with respect to options and warrants outstanding. While the financial effects of correcting these tables were not significant, such tables were included as part of the restatement.
In addition, the Company had previously concluded that they did not maintain effective controls over financial reporting relating to the classification and reporting of financial instruments and consequently that deficiency represented a material weakness over financial reporting as of March 31, 2013. The aforementioned error constitutes an additional deficiency and therefore the Company’s assessment of internal control over financial reporting as of March 31, 2013 has not changed.
The following sections of this Amended 10-Q have been amended to reflect the restatement:
Part I – Item 1 – Financial Statements and Notes to the Consolidated Financial Statements
Part I - Item 2 - Management’s Discussion and Analysis of Financial Condition and Result of Operations
Part I - Item 4 - Controls and Procedures
Part II - Item 1-Legal Proceedings
For the convenience of the reader, this Amended 10-Q sets forth the Company’s Original 10-Q/A in its entirety, as amended by, and to reflect the restatement, as described above. Except as discussed above, the Company has not modified or updated disclosures presented in this Amendment. Accordingly, this Amendment does not reflect events occurring after the Original 10-Q or modify or update those disclosures affected by subsequent events, except as specifically referenced herein. Information not affected by the restatement is unchanged and reflects the disclosures made at the time of the Filing of the Original 10-Q.
This Amended 10-Q has been signed as of the date hereof and all certifications of the Company’s Chief Executive Officer/Principal Executive Officer and Chief Financial Officer/Chief Accounting Officer and Principal Financial Officer are given as of the date hereof. Accordingly, this Amended 10-Q should be read in conjunction with the Company’s filings with the Securities and Exchange Commission subsequent to the filing of the Original 10-Q, including any amendments to those filings.
TABLE OF CONTENTS
PART I: Financial Information | |
| | |
Item 1 – | Financial Statements | |
| Condensed Consolidated Balance Sheets as of March 31, 2013 (Restated) (unaudited) and September 30, 2012 | 1 |
| Condensed Consolidated Statements of Operations (unaudited) for the three and six months ended March 31, 2013 and 2012 (Restated) | 2 |
| Condensed Consolidated Statement of Stockholders’ Equity for the six months ended March 31, 2013 (Restated) | 3 |
| Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended March 31, 2013 and 2012 (Restated) | 4 |
| Notes to Condensed Consolidated Financial Statements (unaudited) | 5 |
Item 2 – | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 16 |
Item 3 – | Quantitative and Qualitative Disclosures about Market Risk | 20 |
Item 4 – | Controls and Procedures | 20 |
| | |
PART II: Other Information | |
| | |
Item 1 – | Legal Proceedings | 21 |
Item 1A – | Risk Factors | 21 |
Item 2 – | Unregistered Sales of Equity Securities and Use of Proceeds | 30 |
Item 3 – | Defaults upon Senior Securities | 30 |
Item 4 – | Mine Safety Disclosures | 30 |
Item 5 – | Other Information | 30 |
Item 6 – | Exhibits | 30 |
| | |
Signatures | 30 |
| |
Exhibits | 31 |
FORWARD LOOKING STATEMENTS
In addition to historical information, this Quarterly Report on Form 10-Q may contain statements relating to future results of The SpendSmart Payments Company. (including certain projections and business trends) that are “forward-looking statements.” Our actual results may differ materially from those projected as a result of certain risks and uncertainties. These risks and uncertainties include, but are not limited to, without limitation, statements that express or involve discussions with respect to predictions, expectations, beliefs, plans, projections, objectives, assumptions or future events or performance (often, but not always, using words or phrases such as “expects” or “does not expect”, “is expected”, “anticipates” or “does not anticipate”, “plans”, “estimates” or “intends”, or stating that certain actions, events or results “may”, “could”, “would”, “might” or “will” be taken, occur or be achieved) are not statements of historical fact and may be “forward-looking statements.” Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results or achievements of our Company to be materially different from any future results or achievements of our Company expressed or implied by such forward-looking statements. Such factors include, among others, those set forth herein and those detailed from time to time in our other Securities and Exchange Commission (“SEC”) filings including those contained in our most recent Form 10-K. These forward-looking statements are made only as of the date hereof, and we undertake no obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise, except as otherwise required by law. Our Company cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. Our Company disclaims any obligation subsequently to revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Also, there can be no assurance that our Company will be able to raise sufficient capital to continue as a going concern.
THE SPENDSMART PAYMENTS COMPANY
Condensed Consolidated Balance Sheets
| | March 31, | | | | |
| | 2013 | | | September 30, | |
| | (unaudited) | | | 2012* | |
| | (restated) | | | | |
Assets | | | | | | | | |
Current assets: | | | | | | | | |
Cash and cash equivalents | | $ | 2,454,245 | | | $ | 5,509,911 | |
Amounts on deposit with or due from merchant processors | | | 207,536 | | | | 203,479 | |
Prepaid insurance | | | 97,127 | | | | 56,010 | |
| | | | | | | | |
Total current assets | | | 2,758,908 | | | | 5,769,400 | |
| | | | | | | | |
Property and equipment, net of accumulated depreciation of $46,320 ($44,057 – September 30, 2012) | | | 6,450 | | | | 8,713 | |
Other assets | | | 5,700 | | | | 5,700 | |
| | | | | | | | |
| | $ | 2,771,058 | | | $ | 5,783,813 | |
| | | | | | | | |
Liabilities and Stockholders' Deficiency | | | | | | | | |
| | | | | | | | |
Current liabilities: | | | | | | | | |
Accounts payable and accrued liabilities | | $ | 1,014,947 | | | $ | 1,161,191 | |
Accrued and deferred personnel compensation | | | 374,621 | | | | 271,067 | |
Derivative liabilities | | | 317,929 | | | | 14,345,625 | |
| | | | | | | | |
Total current liabilities | | | 1,707,497 | | | | 15,777,883 | |
| | | | | | | | |
Redeemable Series B convertible preferred stock; $0.001 par value; 10,000,000 shares authorized; 0 shares issued and outstanding; liquidation preference of $0 converted to common stock at January 19, 2013 (10,165 shares issued and outstanding at September 30, 2012; liquidation preference of $10,165,000 at September 30, 2012) | | | - | | | | 8,656,892 | |
| | | | | | | | |
Redeemable common stock; $0.001 par value; 0 shares issued and outstanding, and not classified as equity at March 31, 2013 (784,750 shares issued and outstanding, and not classified as equity at September 30, 2012) | | | - | | | | 1,026,173 | |
| | | | | | | | |
Commitments and contingencies | | | | | | | | |
| | | | | | | | |
Stockholders’ equity (deficiency): | | | | | | | | |
Series A convertible preferred stock; $.001 par value; 10,000,000 shares authorized; 353 shares issued and outstanding | | | - | | | | - | |
Common stock; $0.001 par value; 300,000,000 shares authorized; 9,261,062 shares issued and outstanding (5,855,313 – September 30, 2012) | | | 138,917 | | | | 87,830 | |
Additional paid-in capital | | | 59,945,128 | | | | 34,252,571 | |
Accumulated deficit | | | (59,020,484 | ) | | | (54,017,536 | ) |
| | | | | | | | |
Total stockholders' equity (deficiency) | | | 1,063,561 | | | | (19,677,135 | ) |
| | | | | | | | |
| | $ | 2,771,058 | | | $ | 5,783,813 | |
See accompanying notes to condensed consolidated financial statements.
*Derived from audited financial information.
THE SPENDSMART PAYMENTS COMPANY
Unaudited Condensed Consolidated Statements of Operations
For the three and six months ended March 31, 2013 and 2012
| | For the three months ended March 31, | | | For the six months ended March 31, | |
| | 2013 | | | 2012 | | | 2013 | | | 2012 | |
| | (restated) | | | (restated) | | | (restated) | | | (restated) | |
Revenues | | $ | 298,686 | | | $ | 282,339 | | | $ | 546,182 | | | $ | 517,515 | |
| | | | | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | | | | |
Selling and marketing | | | 323,677 | | | | 303,884 | | | | 4,978,625 | | | | 1,796,362 | |
Personnel related | | | 3,372,126 | | | | 1,835,396 | | | | 7,265,308 | | | | 3,456,603 | |
Processing | | | 554,822 | | | | 577,940 | | | | 942,176 | | | | 1,489,067 | |
General and administrative | | | 459,102 | | | | 386,933 | | | | 773,748 | | | | 620,948 | |
| | | | | | | | | | | | | | | | |
Total operating expenses | | | 4,709,727 | | | | 3,104,153 | | | | 13,959,857 | | | | 7,362,980 | |
| | | | | | | | | | | | | | | | |
Loss from operations | | | (4,411,041 | ) | | | (2,821,814 | ) | | | (13,413,675 | ) | | | (6,845,465 | ) |
| | | | | | | | | | | | | | | | |
Non-operating income (expense): | | | | | | | | | | | | | | | | |
Interest income | | | 1,132 | | | | 1,161 | | | | 2,176 | | | | 2,611 | |
Change in fair value of derivative liabilities | | | (178,739 | ) | | | 934,872 | | | | 8,408,551 | | | | 1,454,343 | |
| | | | | | | | | | | | | | | | |
| | | (177,607 | ) | | | 936,033 | | | | 8,410,727 | | | | 1,456,954 | |
| | | | | | | | | | | | | | | | |
Net loss and comprehensive net loss | | $ | (4,588,648 | ) | | $ | (1,885,781 | ) | | $ | (5,002,948 | ) | | $ | (5,388,511 | ) |
| | | | | | | | | | | | | | | | |
Deemed dividend on preferred stock | | | - | | | | (137,802 | ) | | | - | | | | (137,802 | ) |
Net loss and comprehensive net loss applicable to common shareholders | | $ | (4,588,648 | ) | | $ | (2,023,583 | ) | | $ | (5,002,948 | ) | | $ | (5,526,313 | ) |
Basic and diluted net loss per share | | $ | (0.59 | ) | | $ | (0.31 | ) | | $ | (0.70 | ) | | $ | (0.93 | ) |
| | | | | | | | | | | | | | | | |
Basic and diluted weighted average number of common shares outstanding used in computing basic and diluted net loss per share | | | 7,768,072 | | | | 6,505,248 | | | | 7,116,097 | | | | 5,952,662 | |
See accompanying notes to condensed consolidated financial statements.
THE SPENDSMART PAYMENTS COMPANY
Consolidated Statements of Changes in Stockholders' Deficiency and Redeemable Preferred and Common Stock (not classified as equity)
For the six months ended March 31, 2013
| | Redeemable Series B Preferred Stock (not classified as equity) | | | Redeemable Common Stock (not classified as equity) | | | Series A Preferred Stock | | | Common Stock (classified as equity) | | | Additional Paid-In | | | Accumulated | | | Total Stockholders' | |
| | Shares | | | Amount | | | Shares | | | Amount | | | Shares | | | Par Value | | | Shares | | | Par Value | | | Capital | | | Deficit | | | Deficiency | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at September 30, 2012 | | | 10,165 | | | $ | 8,656,892 | | | | 784,750 | | | $ | 1,026,173 | | | | 353 | | | $ | - | | | | 5,855,313 | | | $ | 87,830 | | | $ | 34,252,571 | | | $ | (54,017,536 | ) | | $ | (19,677,135 | ) |
Issuance of common stock and warrants for cash, less issuance costs | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Issuance of redeemable common and preferred stock and warrants for cash, less issuance costs | | | - | | | | - | | | | 914,665 | | | | 4,866,192 | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Allocation of net proceeds to warrant derivative liability | | | - | | | | - | | | | - | | | | (3,114,932 | ) | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Conversions of preferred stock to common stock | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Issuance of common stock for services | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 11,167 | | | | 168 | | | | 66,834 | | | | - | | | | 67,002 | |
Common Shares (reclassify from convertible common stock) | | | - | | | | - | | | | (1,699,415 | ) | | | (2,777,433 | ) | | | - | | | | - | | | | 1,699,415 | | | | 25,491 | | | | 2,751,942 | | | | - | | | | 2,777,433 | |
Series B (reclassify from convertible preferred stock) | | | (10,165 | ) | | | (8,656,892 | ) | | | - | | | | - | | | | - | | | | - | | | | 1,694,167 | | | | 25,413 | | | | 8,631,479 | | | | - | | | | 8,656,892 | |
Stock based compensation from stock options and warrants | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 5,499,232 | | | | - | | | | 5,499,232 | |
Preferred stock deemed dividend | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Repurchase of common stock | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Exercise of warrants to purchase common stock | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 1,000 | | | | 15 | | | | 8,985 | | | | - | | | | 9,000 | |
Forfeiture of accrued compensation | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Reclassification of derivative liabilities | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 8,734,085 | | | | - | | | | 8,734,085 | |
Net loss | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | (5,002,948 | ) | | | (5,002,948 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at March 31, 2013 (restated) | | | - | | | | - | | | | - | | | | - | | | | 353 | | | $ | - | | | | 9,261,062 | | | $ | 138,917 | | | $ | 59,945,128 | | | $ | (59,020,484 | ) | | $ | 1,063,561 | |
See accompanying notes to condensed consolidated financial statements
THE SPENDSMART PAYMENTS COMPANY
Unaudited Condensed Consolidated Statements of Cash Flows
For the six months ended March 31, 2013 and 2012
| | 2013 | | | 2012 | |
| | (restated) | | | (restated) | |
Cash flows used in operating activities: | | | | | | | | |
Net loss | | $ | (5,002,948 | ) | | $ | (5,388,511 | ) |
Adjustments to reconcile net loss to cash flows from operating activities: | | | | | | | | |
Depreciation expense | | | 2,263 | | | | - | |
Stock based compensation | | | 5,499,232 | | | | 2,336,469 | |
Issuance of common stock for services | | | 67,002 | | | | 289,198 | |
Change in fair value of derivative liabilities | | | (8,408,551 | ) | | | (1,454,343 | ) |
Changes in operating assets and liabilities: | | | | | | | | |
Prepaid insurance | | | (41,117 | ) | | | 33,500 | |
Amounts on deposit with or due from merchant processors | | | (4,057 | ) | | | (183,484 | ) |
Accounts payable and accrued liabilities | | | (146,237 | ) | | | (963,210 | ) |
Accrued and deferred personnel compensation | | | 103,555 | | | | (187,301 | ) |
| | | | | | | | |
Cash flows used in operating activities | | | (7,930,858 | ) | | | (5,517,682 | ) |
| | | | | | | | |
Cash flows used in financing activities: | | | | | | | | |
Proceeds from issuance of common stock and warrants, net | | | 4,866,192 | | | | 4,814,923 | |
Exercise of warrants to purchase common stock | | | 9,000 | | | | - | |
| | | | | | | | |
Cash flows from financing activities | | | 4,875,192 | | | | 4,814,923 | |
| | | | | | | | |
Change in cash and cash equivalents | | | (3,055,666 | ) | | | (702,759 | ) |
| | | | | | | | |
Cash and cash equivalents, beginning of period | | | 5,509,911 | | | | 1,386,402 | |
| | | | | | | | |
Cash and cash equivalents, end of period | | $ | 2,454,245 | | | $ | 683,643 | |
See accompanying notes to condensed consolidated financial statements.
| 1. | Restatement of previously issued financial statements |
On August 19, 2013, after consulting with the Company’s Audit Committee, management concluded it had incorrectly calculated its historical volatility for the years ended September 30, 2012 and 2011. Those errors also impacted the March 31, 2013 and 2012 interim periods. The error specifically related to an excel spreadsheet calculation whereby it was calculating a volatility that was significantly higher than it should have been. The historical volatility is a key assumption and driver in determining the valuation of the company’s stock based compensation and derivative liabilities. The impact of the change affected the derivative liabilities, changes in fair value of derivative liabilities, and stock based compensation as of and for the three and six months ended March 31, 2013 and 2012.
As part of the restatement process, the Company also corrected its tables with respect to options and warrants outstanding. The financial effects of correcting these tables were not significant, however were included as part of the restatement.
The following tables summarize the effects of the restatements on the specific items presented in the Company’s historical consolidated financial statements previously included inthe Company’s annual report on Form 10-K for the fiscal year ended September 30, 2012, as amended:
Consolidated Statement of Operations
For the three and six months ended March 31, 2012
| | For the three months ended March 31, 2012 | | | For the six months ended March 31, 2012 | |
| | As Previously Reported | | | Adjustments | | | As Restated | | | As Previously Reported | | | Adjustments | | | As Restated | |
Personnel related | | $ | 2,249,495 | | | | (414,099 | ) | | | 1,835,396 | | | | 4,204,623 | | | | (748,020 | ) | | | 3,456,603 | |
Total operating expenses | | $ | 3,518,252 | | | | (414,099 | ) | | | 3,104,153 | | | | 8,111,000 | | | | (748,020 | ) | | | 7,362,980 | |
Loss from operations | | $ | (3,235,913 | ) | | | 414,099 | | | | (2,821,814 | ) | | | (7,593,485 | ) | | | 748,020 | | | | (6,845,465 | ) |
Change in fair value of derivative liabilities | | $ | 73,146 | | | | 861,726 | | | | 934,872 | | | | 178,813 | | | | 1,275,530 | | | | 1,454,343 | |
Net loss and comprehensive net loss | | $ | (3,161,606 | ) | | | 1,275,825 | | | | (1,885,781 | ) | | | (7,412,061 | ) | | | 2,023,550 | | | | (5,388,511 | ) |
Deemed dividend on preferred stock | | $ | - | | | | (137,802 | ) | | | (137,802 | ) | | | - | | | | (137,802 | ) | | | (137,802 | ) |
Net loss and comprehensive net loss applicable to common shareholders | | $ | (3,161,606 | ) | | | 1,138,023 | | | | (2,023,583 | ) | | | (7,412,061 | ) | | | 1,885,748 | | | | (5,526,313 | ) |
Basic and diluted net loss per share | | $ | (0.50 | ) | | | 0.19 | | | | (0.31 | ) | | | (1.25 | ) | | | 0.32 | | | | (0.93 | ) |
Consolidated Statement of Cash Flows
For the six months ended March 31, 2012
| | For the six months ended March 31, 2012 | |
| | As Previously Reported | | | Adjustments | | | As Restated | |
Net loss | | $ | (7,412,061 | ) | | | 2,023,550 | | | | (5,388,511 | ) |
Stock based compensation | | $ | 3,084,489 | | | | (748,020 | ) | | | 2,336,469 | |
Change in fair value of derivative liabilities | | $ | 178,813 | | | | 1,275,530 | | | | 1,454,343 | |
Consolidated Balance Sheet
For the six months ended March 31, 2013
| | For the six months ended March 31, 2013 | |
| | As Previously Reported | | | Adjustments | | | As Restated | |
Derivative liabilities | | $ | 433,727 | | | | (115,798 | ) | | | 317,929 | |
Total current liabilities | | $ | 1,823,295 | | | | (115,798 | ) | | | 1,707,497 | |
Additional paid-in capital | | $ | 66,579,624 | | | | (6,634,496 | ) | | | 59,945,128 | |
Accumulated deficit | | $ | (65,770,778 | ) | | | 6,750,294 | | | | (59,020,484 | ) |
Total stockholders’ equity (deficiency) | | $ | 947,763 | | | | 115,798 | | | | 1,063,561 | |
Consolidated Statement of Operations
For the three and six months ended March 31, 2013
| | For the three months ended March 31, 2013 | | | For the six months ended March 31, 2013 | |
| | As Previously Reported | | | Adjustments | | | As Restated | | | As Previously Reported on Form 10-Q | | | Adjustments | | | As Restated | |
Personnel related | | $ | 4,070,580 | | | | (698,454 | ) | | | 3,372,126 | | | | 9,482,937 | | | | (2,217,629 | ) | | | 7,265,308 | |
Total operating expenses | | $ | 5,408,181 | | | | (698,454 | ) | | | 4,709,727 | | | | 16,177,486 | | | | (2,217,629 | ) | | | 13,959,857 | |
Loss from operations | | $ | (5,109,495 | ) | | | 698,454 | | | | (4,411,041 | ) | | | (15,631,304 | ) | | | 2,217,629 | | | | (13,413,675 | ) |
Change in fair value of derivative liabilities | | $ | (319,044 | ) | | | 140,305 | | | | (178,739 | ) | | | 9,068,880 | | | | (660,329 | ) | | | 8,408,551 | |
Net loss and comprehensive net loss | | $ | (5,427,407 | ) | | | 838,759 | | | | (4,588,648 | ) | | | (6,560,248 | ) | | | 1,557,300 | | | | (5,002,948 | ) |
Basic and diluted net loss per share | | $ | (0.70 | ) | | | 0.11 | | | | (0.59 | ) | | | (0.92 | ) | | | 0.22 | | | | (0.70 | ) |
Consolidated Statement of Cash Flows
For the six months ended March 31, 2013
| | For the six months ended March 31, 2013 | |
| | As Previously Reported | | | Adjustments | | | As Restated | |
Net loss | | $ | (6,560,248 | ) | | | 1,557,300 | | | | (5,002,948 | ) |
Stock based compensation | | $ | 7,716,861 | | | | (2,217,629 | ) | | | 5,499,232 | |
Change in fair value of derivative liabilities | | $ | (9,068,880 | ) | | | 660,329 | | | | (8,408,551 | ) |
On February 13, 2013, the Shareholders of SpendSmart Payments Company (hereinafter referred to as “we” or “the/our Company”) authorized its Board of Directors to effect a reverse stock split of all outstanding shares of common stock, warrants and options. The Board of Directors subsequently approved the implementation of a reverse stock split at a ratio of fifteen to one shares, which became effective on April 25, 2013. All share and per share data in these condensed consolidated financial statements and related notes hereto have been retroactively adjusted to the account for the effect of the reverse stock split for the three and six month periods ended March 31, 2013 and 2012, respectively and the balance sheet at September 30, 2012.
The Company is a Colorado corporation. Through our subsidiary incorporated in the state of California, The SpendSmart Payments Company (“SpendSmart-CA”), we issue and service prepaid cards marketed to young people and their parents. We are a publicly traded company trading on the OTC Bulletin Board under the symbol “SSPC.” The accompanying unaudited condensed consolidated financial statements include the accounts of our Company and SpendSmart-CA as of and through March 31, 2013. All intercompany amounts have been eliminated in consolidation.
We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with rules and regulations of the United States Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of our management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Operating results for the three and six months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the entire year. For further information, see our consolidated financial statements and related disclosures thereto for the year ended September 30, 2012 in our Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on October 7, 2013.
For the year ended September 30, 2012, our audited consolidated financial statements included an opinion containing an explanatory paragraph as to the uncertainty of our Company’s ability to continue as a going concern. Additionally, we have incurred net losses through March 31, 2013 and have yet to establish profitable operations. These factors among others create a substantial doubt about our ability to continue as a going concern. Our unaudited condensed consolidated financial statements as of and for the three and six months ended March 31, 2013 do not contain any adjustments for this uncertainty. In response to our Company’s cash needs, in the first quarter of fiscal 2013 we raised additional cash through the sale of common stock and warrants as described in our footnotes that follow. All additional amounts raised will be used for our future investing and operating cash flow needs.
We also currently plan to attempt to raise additional required capital through the sale of unregistered shares of our Company’s preferred or common stock (accompanied by warrants to purchase our common stock). All additional amounts raised will be used for our future investing and operating cash flow needs. However there can be no assurance that we will be successful in consummating such financing. This description of our recent financing and future plans for financing does not constitute an offer to sell or the solicitation of an offer to buy our securities, nor shall such securities be offered or sold in the United States absent registration or an applicable exemption from the registration requirements and certificates evidencing such shares contain a legend stating the same.
| 4. | Summary of Significant Accounting Policies |
Our condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, fair value of financial instruments, at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates.
Revenue Recognition
We generally have two revenue sources: monthly account fees and usage fees. Monthly account fees are recognized in the month for which the cardholder has a balance on an active card. No fees are charged or recorded as revenue for cards for which there is no cardholder balance. Usage fees are recognized at the time of the transaction. We defer revenue for monthly fees paid in advance of the related month of service. Deferred revenues at March 31, 2013 and September 30, 2012 were insignificant. We recognize fee revenue gross of related processing costs and service fees. We do not collect sales taxes in connection with our products or services. During the six months ended March 31, 2013 we remitted cardholder funds to the issuing bank within two business days of card loading. As of March 31, 2013 and September 30, 2012 we had $207,536 and $203,479, respectively, of cardholder funds included in amounts on deposit with or due from merchant processor and also recorded an offsetting liability of the same amount in accounts payable.
Cash and cash equivalents
We consider all investments with an original maturity of three months or less to be cash equivalents. Cash equivalents primarily represent funds invested in money market funds, bank certificates of deposit and U.S. government debt securities whose cost equals fair market value.
Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances.
Property and Equipment
Property and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the related assets (generally three to five years). Costs incurred for maintenance and repairs are expensed as incurred and expenditures for major replacements and improvements are capitalized and depreciated over their estimated remaining useful lives. Depreciation expense for the three and six months ended March 31, 2013 totaled $1,131 and $2,263, respectively (for the three and six months ended March 31, 2012, there was no depreciation expense).
Valuation of Long-Lived Assets
We record impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amounts of the assets exceed the estimated fair value of the assets. No impairment expense was recorded for the three and six months ended March 31, 2013 or March 31, 2012.
Income Tax Expense Estimates and Policies
As part of the income tax provision process of preparing our financial statements, we are required to estimate our Company’s provision for income taxes. This process involves estimating our current tax liabilities together with assessing temporary differences resulting from differing treatments of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. Management then assesses the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent believed that recovery is not likely, a valuation allowance is established. Further, to the extent a valuation allowance is established and changes occur to this allowance in a financial accounting period, such changes are recognized in our tax provision in our consolidated statement of operations. We use our judgment in making estimates to determine our provision for income taxes, deferred tax assets and liabilities and any valuation allowance is recorded against our net deferred tax assets.
There are various factors that may cause these tax assumptions to change in the near term, requiring us to write down deferred tax assets or establish tax reserves. We recognize the benefit of an uncertain tax position taken or expected to be taken on our income tax returns if it is “more likely than not” that such tax position will be sustained based on its technical merits.
Stock Based Compensation
We have historically accounted for stock based compensation arrangements through the measurement and recognition of compensation expense for all stock based payment awards to employees and directors based on estimated fair values. We use the Black-Scholes option valuation model to estimate the fair value of our stock options and warrants at the date of grant. The Black-Scholes option valuation model requires the input of subjective assumptions to calculate the value of options and warrants. We use historical company data among other information to estimate the expected price volatility and the expected forfeiture rate.
Derivatives
We account for certain of our outstanding warrants issued in fiscal 2010, 2012 and 2013 (“2010 Warrants,” “2012 Warrants” and “2013 Warrants, respectively) as derivative liabilities. The 2010 Warrants were determined to be ineligible for equity classification due to provisions of the respective instruments that may result in an adjustment to their conversion or exercise prices. These derivative liabilities which arose from the issuance of the 2010 Warrants resulted in an ending balance of derivative liabilities of $317,929 and $1,015,284 as of March 31, 2013 and September 30, 2012, respectively. On March 20, 2013, the Company amended its warrant agreement for the 2012 and 2013 warrants whereby removing all terms that required net cash settlement, and as a result, the Company recorded its derivative liabilities relating to these warrants through March 20, 2013, at which time the balance of the derivative liability was reclassified into additional paid in capital. The value of the derivative liability that was reclassified to additional paid in capital at March 20, 2013 was $8,734,085.
Fair value of assets and liabilities
Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value for applicable assets and liabilities, we consider the principal or most advantageous market in which we would transact and we consider assumptions market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance. This guidance also establishes a fair value hierarchy to prioritize inputs used in measuring fair value as follows:
| · | Level 1: Observable inputs such as quoted prices in active markets; |
| · | Level 2: Inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and |
| · | Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. |
Our financial instruments are cash and cash equivalents, accounts payable, and derivative liabilities. The recorded values of cash equivalents and accounts payable approximate their fair values based on their short-term nature. The fair value of derivative liabilities is estimated using option pricing models that are based on the individual characteristics of our warrants, preferred and common stock, the derivative liability on the valuation date as well as assumptions for volatility, remaining expected life, risk-free interest rate and, in some cases, credit spread. The derivative liabilities are the only Level 3 fair value measures.
These derivative liabilities are remeasured to estimated fair value at March 31, 2013 and September 30, 2012, using the Black-Scholes option pricing model using the following assumptions: contractual life according to the remaining terms of the warrants, no dividend yield, weighed average risk-free interest rate of 0.69% and 0.29% at March 31, 2013 and September 30, 2012, respectively, and weighted average volatility of 75.5% and 72.7% at March 31, 2013 and September 30, 2012, respectively.
At March 31, 2013 and September 30, 2012, the estimated fair values of the liabilities measured on a recurring basis are as follows:
| | Fair Value Measurements at March 31, 2013 | |
| | Balance at March 31, 2013 | | | Quoted Prices in Active Markets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | |
Warrant derivative liabilities | | $ | 317,929 | | | $ | – | | | $ | – | | | $ | 317,929 | |
Total | | $ | 317,929 | | | $ | – | | | $ | – | | | $ | 317,929 | |
| | Fair Value Measurements at September 30, 2012 | |
| | Balance at September 30, 2012 | | | Quoted Prices in Active Markets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | |
Warrant derivative liabilities | | $ | 14,345,625 | | | $ | – | | | $ | – | | | $ | 14,345,625 | |
Total | | $ | 14,345,625 | | | $ | – | | | $ | – | | | $ | 14,345,625 | |
The following tables present the activity for liabilities measured at estimated fair value using unobservable inputs for the six months ended March 31, 2013:
| | Fair Value Measurements Using Significant Unobservable Inputs (Level 3) | |
| | Warrant Derivative Liabilities | | | | |
Beginning balance at October 1, 2012 | | $ | 14,345,625 | | | | | |
Issuance of warrants with derivative liabilities | | | 3,114,940 | | | | | |
Changes in estimated fair value | | | (8,408,551 | ) | | | | |
Reclassification of derivative liability to additional paid in capital | | | (8,734,085 | ) | | | | |
Ending balance at March 31, 2013 | | $ | 317,929 | | | | | |
Net Loss per Share
We calculate basic earnings per share (“EPS”) by dividing our net income or loss by the weighted average number of common shares outstanding for the period, without considering common stock equivalents. Diluted EPS is computed by dividing net income or net loss by the weighted average number of common shares outstanding for the period and the weighted average number of dilutive common stock equivalents, such as options and warrants. Options and warrants are only included in the calculation of diluted EPS when their effect is dilutive.
Advertising
We expense advertising costs as incurred. We have no existing arrangements under which we provide or receive advertising services from others for any consideration other than cash. On-air advertising expenses totaled $0 and $305,516 for the three and six months ended March 31, 2013, respectively ($106,029 and $1,244,405 during the three and six months ended March 31, 2012, respectively).
Litigation
From time to time, we may become involved in disputes, litigation and other legal actions. We estimate the range of liability related to any pending litigation where the amount and range of loss can be estimated. We record our best estimate of a loss when the loss is considered probable. Where a liability is probable and there is a range of estimated loss with no best estimate in the range, we record a charge equal to at least the minimum estimated liability for a loss contingency when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated. As of the date of this quarterly report we are currently not involved in any significant disputes, litigation and other legal actions.
Recently Issued Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board, “FASB” issued ASU 2011-05, “Presentation of Comprehensive Income”, an amendment to FASB ASC Topic 220, “Comprehensive Income”. The update gives companies the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments in the update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The ASU is effective for the Company for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU 2011-05 did not have any impact on the company as the company has no other comprehensive income or loss, and therefore the net income or loss equals to the total comprehensive income or loss. In December 2011, the FASB issued ASU 2011-12 “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” This update stated that the specific requirement to present items that are reclassified from other comprehensive income to net income alongside their respective components of net income and other comprehensive income will be deferred. In February 2013, the FASB issued ASU 2013-02 “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”. This update requires companies to present the effects on the line items of net income of significant reclassifications out of accumulated other comprehensive income if the amount being reclassified is required under U.S. generally accepted accounting principles to be reclassified in its entirety to net income in the same reporting period. ASU 2013-02 is effective prospectively for the Company for fiscal years, and interim periods within those years, beginning after December 15, 2012. The Company’s condensed consolidated financial statements were not significantly impacted by the adoption of this amended guidance.
| 5. | Issuances of common stock and warrants |
During the three and six months ended March 31, 2013, we issued 4,000 and 11,167 shares of our common stock (in each respective period) to a contractor and two vendors in exchange for programming services and other services performed. In connection with these issuances of shares, we recognized expenses of $24,000 and $67,000 during the respective periods.
During the three and six months ended March 31, 2013 and 2012, we entered into 0 and 63 subscription agreements with accredited investors for 914,665 shares.
The common stock and related warrants are subject to certain registration rights. Prior to amending the registration rights agreement in March 2013, the 2012 and 2013 Warrants contained a cashless exercise option (the “Penalty”). Despite the Penalty, the registration rights agreements did not include certain prescribed liquidating damage penalties in the event our Company failed to cause the related registration statement to be declared effective and consequently, the presumption under GAAP was that the common stock and related warrants may be settled in cash. Therefore the common stock was classified as redeemable common stock, outside of equity as of September 30, 2012. In addition, the 2012 and 2011 Warrants were also included in derivative liabilities as of September 30, 2012. On March 20, 2013, the Company amended its warrant and registration rights agreement whereby removing all terms that required net cash settlement. As of March 31, 2013, the 1,699,415 shares of common stock of $1,034,281 and related 2012 and 2013 warrants of $14,465,635 are classified as equity and are not reported as derivative liabilities.
During the six months ended March 31, 2012, the Company issued Series B preferred stock with warrants to purchase additional common stock. The fair value of the warrants issued was approximately $137,802 at the issue date, resulting in a beneficial conversion feature and an immediate deemed dividend of approximately $137,802.
| 6. | Convertible Preferred Stock |
Series A Preferred Stock
At March 31, 2013 and September 30, 2012 we had 353 shares of Series A Cumulative Convertible Preferred Stock (the “Series A Stock”) outstanding. The Series A Stock was originally issued to investors for $100 per share. The following summarizes the terms of the Series A preferred stock outstanding:
Face Value: Each share of Series A Stock has a face and par value of $100 and $.001 per share, respectively.
Voluntary Conversion: Each share of Series A Stock is convertible at the election of the holders at any time into approximately 20 shares of our common stock, subject to increase under the anti-dilution provisions under the Certificate of Designation and the Subscription Agreement upon the occurrence of events as defined therein.
Dividends: Except in the event of default under the terms of the Subscription Agreement, the Series A Stock pays no dividends. In the event of an uncured default by our Company, the Series A Stock pays dividends of 12% per annum during the period our Company is in default as described under the Certificate of Designation.
Redemption: The Series A Stock is not required to be redeemed by our Company.
Liquidation Rights: Upon the occurrence of a liquidation event (as defined in the Certificate of Designation), the holders of Series A Stock will be repaid their full face value and cumulative accrued dividends prior to the receipt of any other class of preferred or common stock.
Forced Conversion: We have the right to force conversion of each share of Series A Stock into approximately 20 shares of common stock at any time provided our common stock has maintained a closing price of $15.00 per share for three consecutive trading days prior to conversion.
Voting Rights: Our Series A Stock has no voting rights.
Covenants: The Subscription Agreement imposes certain covenants on us, including restrictions against incurring additional indebtedness, issuing any additional equity except certain permitted issuances, creating any liens on our property, amending our certificate of incorporation or bylaws in a manner which may adversely affect the Series A Stock holders, redeeming or paying dividends on shares of our outstanding common stock, and entering into certain related party transactions.
At March 31, 2013 and September 30, 2012, the Series A preferred stock was convertible into 7,121 shares of our common stock at an effective price of $4.95 per share.
Series B Preferred Stock
Our Series B Convertible Preferred Stock (“Series B Stock”) automatically converted to common stock on January 19, 2013 as in accordance with the registration statement which states that six months from the date of the final closing, as defined in the related subscription agreement, each share of Series B will automatically convert into common stock. 10,165 outstanding shares of Series B Stock automatically converted into 1,694,167 common shares at an effective price of $600 per share.
At September 30, 2012 we had 10,165 shares of Series B convertible preferred stock (“Series B Stock”) outstanding that were issued to investors for $1,000 per share. The following summarizes the terms of the Series B Stock outstanding:
Face Value: Each share of Series B Stock has a face and par value of $1,000 and $0.001 per share, respectively.
Voluntary Conversion: Each share of Series B Stock is convertible at the election of the holders at any time into 167 shares of our common stock.Dividends: None.
Redemption: The Series B Stock is not required to be redeemed by our Company.
Liquidation Rights: Upon the occurrence of a liquidation event and after any payments to the holders of Series A Stock, the holders of Series B Stock will be repaid their full face value prior to the receipt of any other class of preferred or common stock.
Forced Conversion: Each share of Series B Stock shall automatically convert into common stock at the earlier of: 1) the effective date of registration of common shares into which Series B Stock is convertible; or 2) six months from the date of the final closing as defined in the related subscription agreement. The Series B Stock automatically converted to common stock on January 19, 2013 due to (2) above (the final closing date was July 19, 2012).
Voting Rights: Equal to the largest number of full shares of common stock into which the shares can be converted.
| 7. | Agreements for services, officer and Board of Directors’ compensation |
In August 2012, we entered into one-year consulting agreements with Patrick Kolenik and Cary Sucoff (Messrs. Kolenik and Sucoff are members of our Company’s Board of Directors). The agreements call for the payment to Messrs. Kolenik and Sucoff of $5,000 each per month for their services to our Company. During the three and six months ended March 31, 2013, we recognized and paid expenses totaling $15,000 and $30,000, respectively, each in connection with these consulting agreements.
In November 2012 (the "Effective Date"), we entered into an Endorsement Agreement (the “Endorsement Agreement”) for the promotion of our products. The Endorsement Agreement has a term of fourteen months (the “Term”), unless extended as provided in the Endorsement Agreement. In connection with the Endorsement Agreement, we agreed to pay a nonrefundable advance totaling $3,750,000 (the “Advance”), of which $1,900,000 was paid in November 2012, with the remainder totaling $1,850,000 paid in January 2013. In addition to the Advance, we have agreed to pay monthly incentive compensation per active account (“Incentive Compensation”). The Advance is not recoupable from incentive compensation payments. We also agreed to pay a per month royalty per active account (“Royalty”). The Royalty payments are a single digit percentage of the revenue per card. The Advance is recoupable from Royalty payments made under the Endorsement Agreement. Upon the expiration of the Endorsement Agreement, the endorser will be entitled to receive the Royalty payments, subject to the recoupment of the Advance, and the Incentive Compensation, in perpetuity. The entire balance of the Advance totaling $3,750,000 was charged to operations during the three months ended December 31, 2012. The amount of the royalty payments were immaterial at the end of the six months ended March 31, 2013 due to the timing of the start of this program and the number of accounts earned to date as a result of this endorsement.
Pursuant to the terms of the Endorsement Agreement, we issued the endorser warrants to purchase up to 133,334 shares of our common stock, as follows: 1) warrants to purchase 66,667 shares of our common stock vested upon the Effective Date, and 2) warrants to purchase another 66,667 shares of our common stock shall vest in equal monthly installments during the Term, each exercisable at an exercise price $7.05 per share. We also issued the endorser warrants to purchase up to an additional 133,333 shares of our common stock (the “Additional Warrant”). The Additional Warrant is exercisable for the number of shares of our common stock equal to five times the number of active accounts in effect at the end of the Term, provided there are more than two hundred and fifty thousand active accounts as of the last day of the Term. The Additional Warrant will be exercisable no more rapidly than in equal monthly installments during the six month period immediately following the Term at an exercise price of $7.05 per share. In the event the product of five times the number of active accounts exceeds two million, we will issue the endorser an “End of Term Warrant” for the number of shares in excess of 133,333. The exercise price of the End of Term Warrant shall be the arithmetic mean of the high and low prices of our Company’s common stock on the last trading day before the date of the issuance of the End of Term Warrant. If the Endorsement Agreement is extended, which is at the sole discretion of the endorser, the endorser will receive additional warrants to purchase 133,333 shares of our Company’s common stock for any such Extension Period (each, an “Extension Warrant”). Extension Warrants will vest equally on a monthly basis and will have an exercise price equal to the mean of the high and low prices of our Company’s common stock on the last trading day before the date of issuance of each Extension Warrant. We recognized $150,674 and $454,723 in expense related to the warrants issued to the endorser during the three and six months ended March 31, 2013.
Payments made in connection with the Advance, Incentive Compensation and Royalty will be recorded as an expense when incurred. Compensation expense related to the warrants, additional warrants, end of term warrants and extension warrants will be recognized based upon actual and expected vesting, of which an insignificant amount has been expensed for the six months ended March 31, 2013.
In connection with the Endorsement Agreement as of March 31, 2013, we made payments to two entities associated with a member of our Board of Directors, Jesse Itzler. Expenses related to these payments totaled $604,406 during the period.
During January 2013 (the "Effective Date"), we entered into a Promotion/Endorsement Agreement (the “P/E Agreement”) with a term of eighteen (18) months (the “Term”). In connection with the P/E Agreement, we agreed to pay a nonrefundable fee of two hundred and fifty thousand dollars payable in four equal installments, on predetermined dates over the Term.
In addition to the fee, we have agreed to pay monthly incentive compensation per active account (“Incentive Compensation”) and have issued to the endorser additional warrants to purchase our common stock. Should the number of accounts reach a specified level, the endorser will have the opportunity to earn additional warrants equal to five times the number of active accounts at the end of the Term.The Additional Warrant (“Additional Warrant”) is exercisable for the number of shares of our common stock equal to five times the number of active accounts in effect at the end of the Term, provided there are more than two hundred and fifty thousand active accounts as of the last day of the Term. The Additional Warrant will be exercisable no more rapidly than in equal monthly installments during the six month period immediately following the Term at an exercise price of $5.70 per share. In the event the product of five times the number of active accounts exceeds two million, we will issue the endorser an “End of Term Warrant” for the number of shares in excess of 133,333. The exercise price of the End of Term Warrant shall be the arithmetic mean of the high and low prices of our Company’s common stock on the last trading day before the date of the issuance of the End of Term Warrant. Extension Warrants will vest equally on a monthly basis and will have an exercise price equal to the mean of the high and low prices of our Company’s common stock on the last trading day before the date of issuance of each Extension Warrant. The amount of the warrants were immaterial at the end of the six months ended March 31, 2013 due to the timing of the start of our program and the number of accounts earned to date as a result of this endorsement.
In October 2012, our Company granted a five-year warrant to purchase up to 133,333 shares of common stock to Chris Leong, a member of our Board of Directors. The warrant vests monthly over a period of twelve months; has an exercise price of $6.90 per share; and includes a cashless exercise option. In November 2012, our Company granted warrants to purchase up to 333,333 shares of common stock to William Hernandez, our Company’s President and a member of our Board of Directors (as of January 2013). The warrants vest over a period of three years; have an exercise price of $7.355 per share; include a cashless exercise option; and expire five years after the date of grant. The fair value of these warrants on the grant date was $1,210,150 of which $80,677 and $366,949 was recognized as a noncash charge to personnel related expense during the three and six months ended March 31, 2013, respectively.
In February 2013, our Company granted warrants to purchase up to 200,000 shares of common stock to Kim Petry, our Company’s CFO. The warrants vest over a period of three years; have an exercise price of $5.85 per share; include a cashless exercise option; and expire five years after the date of grant. The fair value of these warrants on the grant date was $587,802 of which $81,695 was recognized as a noncash charge to personnel related expense during the three months ended March 31, 2013.
As mentioned in Note 1 the Company effected a reverse stock split of all outstanding shares of common stock, warrants and options, which became effective on April 25, 2013. All share and per share data in these condensed consolidated financial statements and related notes hereto have been retroactively adjusted to the account for the effect of the reverse stock split for the three and six month periods ended March 31, 2013 and 2012, respectively and the balance sheet at September 30, 2012.
Stock options
On January 8, 2013, our Board of Directors approved the adoption of the SpendSmart Payments Company 2013 Equity Incentive Plan (the “2013 Plan”).The 2013 Plan was approved by the Company’s shareholders on February 15, 2013.The 2013 Plan provides forgranting of stock-based awards including: incentive stock options, non-statutory stock options, stock bonuses and rights to acquire restricted stock. The total number of shares of common stock that may be issued pursuant to stock awards under the 2013 Plan shall not exceed in the aggregate 3,000,000 shares of the common stock of our Company.On August 4, 2011, our Board of Directors approved the adoption of the SpendSmart Payments Company 2011 Equity Incentive Plan (the “2011 Plan”). The 2011 Plan provides forgranting of stock-based awards including: incentive stock options, non-statutory stock options, stock bonuses and rights to acquire restricted stock. The total number of shares of common stock that may be issued pursuant to stock awards under the Plan shall not exceed in the aggregate 1,666,667 shares of the common stock of our Company.We also have a stockholder-approved Plan (the IdeaEdge, Inc. 2007 Equity Incentive Plan - the “2007 Plan”, previously approved by our shareholders). The 2007 Plan has similar provisions and purposes as the 2011 Plan. The total number of shares of common stock that may be issued pursuant to stock awards under the 2007 Plan (as amended) shall not exceed in the aggregate 266,667 shares of the common stock of our Company. Upon shareholder approval of the 2013 Plan, our Board has expressed its intentions to issue no more shares under the 2011 and 2007 Plans.
Through March 31, 2013, we have outstanding and vested a total of 1,805,000 and1,160,555, respectively, of incentive and nonqualified stock options granted under the Plans, all of which we have estimated will eventually vest. All of the options have terms of five years with expiration dates ranging from April 2013 to November 2017.
Warrants
In recompense for services performed on our behalf, we issued warrants to purchase up to 200,000 and 486,667 shares of our common stock during the three and six months ended March 31, 2013, including a five-year warrant to purchase up to 133,333 shares (exercise price of $6.90 per share) to a member of our Board of Directors and a five-year warrant to purchase up to 200,000 shares at $5.85 to our CFO. Our Company issued warrants to purchase up to 1,003,000 shares of our common stock during the three and six months ended March 31, 2012, including five-year warrants to purchase up to 166,667 shares (exercise price of $7.65 per share) to Mr. Blech, five-year warrants to purchase up to 666,667 (exercise price $6.00 per share) to Mr. Desantis, and five year warrants to purchase up to 3,000,000 (exercise price $6.60 per share) to Mr. Proto. Through March 31, 2013, we have issued warrants to purchase up to a total of 20,000 shares of common stock to advisors, consultants and in connection with the purchase of intellectual property. Warrants to purchase up to 26,667 shares of common stock have expired. Warrants to purchase up to 3,905,992 shares of common stock remain outstanding at March 31, 2013, of which 2,351,970 have vested.
Through March 31, 2013, we have also issued warrants to purchase up to 4,717,276 shares of our common stock to investors (and as compensation to third parties in connection with investments) related to the sale of our common stock, 4,676,872 of which remain outstanding net of exercises, cancellations and expirations (all of which are fully vested).
The numbers and exercise prices of all options and warrants outstanding at March 31, 2013 are as follows:
| | | Weighted | | | |
| | | Average | | | |
Shares | | | Exercise | | | Expiration |
Outstanding | | | Price | | | Fiscal Period |
| 19,667 | | | | 9.30 | | | 3rd Qtr, 2013 |
| 124,000 | | | | 7.20 | | | 4th Qtr, 2013 |
| 134,445 | | | | 6.60 | | | 1st Qtr, 2014 |
| 42,044 | | | | 8.25 | | | 2nd Qtr, 2014 |
| 60,667 | | | | 9.60 | | | 3rd Qtr, 2014 |
| 35,000 | | | | 7.65 | | | 4th Qtr, 2014 |
| 106,973 | | | | 7.65 | | | 1st Qtr, 2015 |
| 78,100 | | | | 7.80 | | | 2nd Qtr, 2015 |
| 10,600 | | | | 10.05 | | | 3rd Qtr, 2015 |
| 103,918 | | | | 6.75 | | | 4th Qtr, 2015 |
| 695,572 | | | | 8.10 | | | 1st Qtr, 2016 |
| 882,800 | | | | 7.20 | | | 2nd Qtr, 2016 |
| 960,100 | | | | 6.45 | | | 3rd Qtr, 2016 |
| 1,239,958 | | | | 6.75 | | | 4th Qtr, 2016 |
| 697,996 | | | | 7.95 | | | 1st Qtr, 2017 |
| 859,750 | | | | 6.15 | | | 2nd Qtr, 2017 |
| 1,273,600 | | | | 7.80 | | | 3rd Qtr, 2017 |
| 1,992,958 | | | | 6.75 | | | 4th Qtr, 2017 |
| 736,383 | | | | 7.95 | | | 1st Qtr, 2018 |
| 200,000 | | | | 5.85 | | | 2nd Qtr, 2018 |
| 133,333 | | | | 7.05 | | | 1st Qtr, 2023 |
| 10,387,864 | | | | | | | |
Stock-based compensation
During the three and six months ended March 31, 2013, we recognized stock-based compensation expense totaling $2,501,729 and $5,499,232, respectively in connection with the issuance of stock options and warrants issued to employees, directors, advisors and consultants (not including shares of stock issued directly for services). For purposes of accounting for stock-based compensation, the fair value of each award is estimated on the date of grant (or performance of the contracted services as appropriate) using the Black-Scholes-Merton option pricing formula. The following weighted average assumptions were utilized for the calculations of newly issued options and warrants during the six months ended March 31, 2013:
Expected life (in years) | | | 4.33 years | |
Weighted average volatility | | | 93.89 | % |
Forfeiture rate | | | 0 | % |
Risk-free interest rate | | | .74 | % |
Expected dividend rate | | | 0 | % |
At March 31, 2013, the weighted average exercise price of vested options and warrants outstanding (issued in connection with stock-based compensation) is $6.98 per share while the corresponding weighted average remaining contractual period was approximately 42.9 months. As of March 31, 2013, $9,084,508 of total unrecognized compensation expense related tounvested stock-based compensation is expected to be recognized through February 2016.
We currently estimate our Company’s book net operating loss carryforwards (“NOL”) and deferred tax asset balance total approximately $56,027,000 and $22,579,000, as of March 31, 2013 ($31,000,000 and $12,885,000 as of September 30, 2012). We have recorded a valuation allowance against our entire deferred tax asset balance due to our lack of a history of earnings, the limitations on the use of our NOL as a result of the SpendSmart-CA acquisition and the future expiration of the NOL. These factors give rise to substantial uncertainty as to whether our net deferred tax assets will be realized. As a result of these factors, our utilization of the NOL will likely be severely limited and a substantial portion of the NOL will likely expire unused.
On June 10, 2013, the Company announced its intention to redeem certain classes of outstanding warrants that were initially issued to investors participating in private placement financings in 2010, 2011 and 2012 consisting of the following classes: (i) outstanding warrants to purchase an aggregate of 634,916 shares of the Company’s common stock issued to investors participating in the Company’s private placement financing completed on December 13, 2012 and November 30, 2012, of which 541,667 are exercisable at an exercise price of $7.50 per share (the “$7.50 December Warrants”) and 93,249 are exercisable at an exercise price of $9.00 per share (the “$9.00 December Warrants”); (ii) outstanding warrants to purchase an aggregate of 1,016,518 shares of the Company’s common stock issued to investors participating in the Company’s private placement financings closed on July 19, 2012, June 20, 2012, May 24, 2012 and March 31, 2012, of which 833,333 are exercisable at an exercise price of $7.50 per share (the “$7.50 Investor Warrants”) and 183,185 are exercisable at an exercise price of $9.00 per share (the “$9.00 Investor Warrants”); (iii) outstanding warrants to purchase an aggregate of 446,188 shares of the Company’s common stock issued to investors participating in the Company’s private placement financing completed on October 21, 2011 and November 21, 2011, of which 333,334 are exercisable at an exercise price of $7.50 per share (the “$7.50 2011 Warrants”) and 112,854 are exercisable at an exercise price of $9.00 per share (the “$9.00 2011 Warrants”); and (iv) outstanding warrants to purchase an aggregate of 431,950 shares of the Company’s common stock issued to investors participating in the Company’s private placement financings closed on November 16, 2010, of which 125,000 are exercisable at an exercise price of $6.00 per share (the “$6.00 2010 Warrants”) and 306,950 are exercisable at an exercise price of $9.00 per share (the “$9.00 2010 Warrants”).The warrant redemption was intended to raise non-dilutive capital.
A Notice of Election to Participate was provided to the affected warrant holders on June 10, 2013. These warrant holders had until 5:00 p.m. ET on July 15, 2013, to exercise their outstanding warrants at $2.25 per share. Pursuant to the Offer to Amend and Exercise, on July 15, 2013 an aggregate of 662,540 warrants were tendered by their holders and were amended and exercised in connection therewith for an aggregate exercise price of approximately $1,490,715, including the following warrants: 85,974 $9.00 December Warrants; 99,703 $9.00 Investor Warrants; 83,334 $7.50 Investor Warrants; 82,408 $9.00 2011 Warrants; 93,751 $7.50 2011 Warrants; 154,870 $9.00 2010 Warrants; and 62,500 $6.00 2010 Warrants.
On October 1, 2013, Jerold Rubinstein was elected as a new board of director and head of the Audit Committee. He received 133,333 warrants with an exercise price of 2.00 per share.
On October 1, 2013, Brian Thompson resigned as a member of the board and as head of the Audit Committee.
On October 15, 2013, the Company, through its wholly owned subsidiary The SpendSmart Payments Company, a California corporation, entered into an Asset Purchase Agreement (the “Agreement”) with Intellectual Capital Management, Inc., d/b/a SMS Masterminds (“SMS”) a Nevada corporation, whereby, upon the completion of certain closing conditions, the Company will purchase substantially all of the assets of SMS. In consideration for such assets, the Company has agreed to issue SMS an aggregate of five million two hundred and fifty thousand shares of common stock of the Company. The closing of the Agreement is subject to standard and customary closing deliverables and is contingent upon, among other things, the Company completing due diligence of the assets and business of SMS to its sole satisfaction.
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis is intended as a review of significant factors affecting our financial condition and results of operations for the periods indicated. The discussion should be read in conjunction with our consolidated financial statements and the notes presented herein. In addition to historical information, the following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these forward-looking statements as a result of certain factors discussed in this Quarterly Report and our other periodic reports filed with the Securities and Exchange Commission.
Overview and Financial Condition
Discussions with respect to our Company’s operations included herein refer to our operating subsidiary, The SpendSmart Payments Company, a California Corporation (“SpendSmart-CA”). Our Company purchased SpendSmart-CA on October 16, 2007. We have no other operations than those of SpendSmart-CA. We are a Colorado corporation and operate in one business segment.
Results of Operations
Revenues
Our Company had total revenues of $298,686 and $546,182 for the three and six months ended March 31, 2013 ($282,339 and $517,515, for the three and six months ended March 31, 2012, respectively). Revenues consist of fees charged to our customer prepaid cardholders for monthly maintenance fees, ATM fees, load fees and other insignificant revenues. We continue to not charge our cardholders for new card initiation fees. We charge maintenance fees on our issued cards (“ICs”) to cardholders on a monthly basis pursuant to the terms and conditions in our cardholder agreements. We charge ATM fees to cardholders when they withdraw money or conduct other transactions at certain ATMs in accordance with the terms and conditions in our cardholder agreements. Other revenues (currently insignificant) consist primarily of fees associated with optional products or services, which we may offer to consumers during the card activation process.
Our aggregate new card fee revenues vary based upon the number of ICs activated and the activities associated therewith. Our aggregate monthly maintenance fee revenues vary primarily based upon the number of active cards in our portfolio and the average fee assessed per account. Our average monthly maintenance fee per active account depends upon the extent to which fees are waived based on promotional considerations. Our aggregate ATM fee revenues vary based upon the number of cardholder ATM transactions and the average fee per ATM transaction.
Our prepaid card product offerings are marketed primarily to parents, enabling them to link and communicate with younger cardholders (generally their children or other young people in their care) in order to guide responsible spending. Our products have been designed with significant features that we hope consumers will find compelling. Going forward we plan to market our products (both online, in traditional retail settings and with strategic partners)to the public as a convenient and safe youth payment system.
While we are optimistic about the prospects for our prepaid card products, there can be no assurance about whether or when they will turn out to be a successful or if they will generate sufficient revenues to fund our operations over future periods.
Operating Expenses
In order to better represent our financial results and to make them comparable to leading companies in the prepaid card industry, we classify our operating expenses into four major categories: 1) selling and marketing; 2) personnel related; 3) processing; and 4) general and administrative expenses. We do not allocate common expenses to any of these expense categories.
Selling and marketing expenses
Selling and marketing expenses totaled $323,677 and $4,978,625 for the three and six months ended March 31, 2013 ($303,884, and $1,796,362 for the three and six months ended March 31, 2012). This amounted to an increase of $19,793 and $3,182,265, respectively, from fiscal 2012 to fiscal 2013 (6.5% and 171.6%, respectively). The following is a detail of the significant components of selling and marketing expenses for those periods.
Selling and marketing expense Detail
| | Fiscal 2013 | | | Fiscal 2012 | | | Absolute Change | | | Percentage Change | |
| | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Marketing consulting | | $ | 154,767 | | | $ | 261,257 | | | $ | 113,052 | | | $ | 332,434 | | | $ | 41,715 | | | $ | (71,177 | ) | | | 36.9 | % | | | (21.4 | )% |
Public relations | | | 58,425 | | | | 97,070 | | | | 28,795 | | | | 63,718 | | | | 29,630 | | | | 33,352 | | | | 102.9 | % | | | 52.3 | % |
Direct marketing | | | 15,351 | | | | 46,036 | | | | 106,029 | | | | 1,244,405 | | | | (90,678 | ) | | | (1,198,369 | | | | (85.5 | )% | | | (96.3 | )% |
Marketing programs | | | 72,358 | | | | 4,550,788 | | | | 49,869 | | | | 120,963 | | | | 22,489 | | | | 4,429,825 | | | | 45.1 | % | | | 3662.1 | % |
Market research | | | 22,776 | | | | 23,474 | | | | 6,139 | | | | 34,842 | | | | 16,637 | | | | (11,368 | ) | | | 271.0 | % | | | (32.6 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | $ | 323,677 | | | $ | 4,978,625 | | | $ | 303,884 | | | $ | 1,796,362 | | | $ | 19,793 | | | $ | 3,182,263 | | | | 6.5 | % | | | 177.2 | % |
Increases in marketing consulting in the most recent quarter over the prior year’s corresponding quarter’s totals were due to increased expenditures for marketing agencies in the current year. Our levels of direct marketing were substantially reduced in the current quarter while we focused more on our account engagement (e.g. revenue per card) and our shift in focus to an endorser-based marketing model. Marketing programs in the current year included the recognition of $62,500 in expense in connection with payment made and in connection with a new endorsement agreement signed in January 2013 with Scooter Braun Projects LLC. Marketing programs in the current year included the recognition of $3,750,000 in expense in connection with payment made in connection with a new endorsement agreement signed in November 2012.
Personnel related expenses
Personnel related expenses totaled $3,372,126 and $7,265,308 for the three and six months ended March 31, 2013, respectively. This amounted to an increase of $1,536,730 and $3,808,705, respectively, from fiscal 2012 to fiscal 2013 (83.7% and 110.2%, respectively). More significant components of these expenses for the three and six months ended March 31, 2013 and 2012 were as follows.
| | Fiscal 2013 | | | Fiscal 2012 | | | Absolute Change | | | Percentage Change | |
| | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Salaries and wages | | $ | 459,161 | | | $ | 880,060 | | | $ | 376,626 | | | $ | 870,306 | | | $ | 82,535 | | | $ | 9,754 | | | | 21.9 | % | | | 1.1 | % |
Stock based compensation | | | 2,501,729 | | | | 5,499,232 | | | | 1,314,459 | | | | 2,336,469 | | | | 1,187,270 | | | | 3,162,763 | | | | 90.3 | % | | | 135,4 | % |
Consulting and outside services | | | 118,301 | | | | 228,165 | | | | 68,911 | | | | 103,111 | | | | 49,390 | | | | 125,054 | | | | 71.7 | % | | | 121.3 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other | | | 292,935 | | | | 657,851 | | | | 75,400 | | | | 146,717 | | | | 217,535 | | | | 511,134 | | | | 288.5 | % | | | 348.4 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | $ | 3,372,126 | | | $ | 7,265,308 | | | $ | 1,835,396 | | | $ | 3,456,603 | | | $ | 1,536,730 | | | $ | 3,808,705 | | | | 83.7 | % | | | 110.2 | % |
Overall increases in personnel related expenses reflected the addition of employees and consultants over the prior fiscal year, including a new President and Controller as well as provisions for bonuses accrued during the quarter. Stock based compensation was significantly higher due to option and warrant grants made to directors, executive officers and endorsers in the most recently completed quarter (and in prior periods that vested in the current quarter). Other personnel related expenses include employer taxes, employee benefits and other employee related costs.
Processing Expenses Detail
| | Fiscal 2013 | | | Fiscal 2012 | | | Absolute Change | | | Percentage Change | |
| | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Card processing | | $ | 106,662 | | | $ | 136,044 | | | $ | 102,213 | | | $ | 192,533 | | | $ | 4,449 | | | $ | (56,484 | ) | | | 4.4 | % | | | (29.3 | )% |
Fraud losses | | | 1,233 | | | | 5,402 | | | | 11,285 | | | | 43,475 | | | | (10,052 | ) | | | (38,073 | ) | | | (89.1 | )% | | | (87.6 | )% |
Account initiation | | | 2 | | | | 384 | | | | 3,897 | | | | 106,481 | | | | (3,895 | ) | | | (106,097 | ) | | | (99.9 | )% | | | (99.6 | )% |
Card creation | | | 16,120 | | | | 29,996 | | | | 11,481 | | | | 148,203 | | | | 4,639 | | | | (118,207 | ) | | | 40.4 | % | | | (79.8 | )% |
Account holder communications | | | 12,361 | | | | 24,027 | | | | 13,551 | | | | 31,207 | | | | (1,190 | ) | | | (7,180 | ) | | | (8.8 | )% | | | (23.0 | )% |
Merchant credit card fees | | | 67,851 | | | | 145,925 | | | | 91,605 | | | | 178,498 | | | | (23,754 | ) | | | (32,573 | ) | | | (25.9 | )% | | | (18.2 | )% |
Contracted software development | | | 302,547 | | | | 488,545 | | | | 264,344 | | | | 528,458 | | | | 38,203 | | | | (39,913 | ) | | | 14.5 | % | | | (7.6 | )% |
Customer service | | | 34,867 | | | | 82,699 | | | | 70,938 | | | | 180,356 | | | | (36,071 | ) | | | (97,657 | ) | | | (50.8 | )% | | | (54.1 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other | | | 13,179 | | | | 29,149 | | | | 8,626 | | | | 79,856 | | | | 4,553 | | | | (50,707 | ) | | | (52.8 | )% | | | (63.5 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | $ | 554,822 | | | $ | 942,171 | | | $ | 577,940 | | | $ | 1,489,067 | | | $ | (23,118 | ) | | $ | (546,896 | ) | | | (4.0 | )% | | | (36.7 | )% |
Decreases in processing expenses were the result of a decrease in our account holder base compared to the comparable quarter in fiscal 2012 as well as more favorable rates with our new processor. Our plan is to continue to reduce such costs on a per account basis over time. Contracted software development expenses decreased compared to the prior fiscal year due to expenses incurred in fiscal 2012 in connection with the completed transition to our new card processor. Card creation and account initiation expenses were down significantly year to date due to our change in processors and the related cost structure negotiated. Customer service costs were reduced due to our bringing much of the customer service function in house (with the related personnel expense included in salaries and wages above).
General and administrative expenses
General and administrative expenses totaled $459,102 and $773,748 for the three and six months ended March 31, 2013, respectively ($386,933 and $620,948 for the three and six months, respectively, ended March 31, 2012). This resulted in an increase of $72,169 and $152,800, respectively and corresponding percentage increase of 18.7% and 24.6% for corresponding periods from fiscal 2012 to 2013. The following is a detail of the significant components of processing expenses for the respective periods.
General and Administrative Expenses Detail
| | Fiscal 2013 | | | Fiscal 2012 | | | Absolute Change | | | Percentage Change | |
| | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | | | Quarter 2 | | | Year to Date | |
| | | | | | | | | | | | | | | | | | | | | |
Accounting | | $ | 13,821 | | | $ | 69,245 | | | $ | 10,250 | | | $ | 54,993 | | | $ | 3,571 | | | $ | 14,252 | | | | 34.8 | % | | | 25.9 | % |
Insurance | | | 46,475 | | | | 64,356 | | | | 16,836 | | | | 33,832 | | | | 29,639 | | | | 30,524 | | | | 176.0 | % | | | 90.2 | % |
Investor relations | | | 70,372 | | | | 103,523 | | | | 26,419 | | | | 54,590 | | | | 43,953 | | | | 48,933 | | | | 166.4 | % | | | 89.6 | % |
Investor relations consulting | | | 18,000 | | | | 18,000 | | | | 183,198 | | | | 233,196 | | | | (165,198 | ) | | | (215,196 | ) | | | (90.2 | )% | | | (92.3 | )% |
Legal fees - general counsel | | | 117,581 | | | | 216,350 | | | | 68,270 | | | | 94,839 | | | | 49,311 | | | | 121,511 | | | | 72.2 | % | | | 128.1 | % |
Rent | | | 14,517 | | | | 35,111 | | | | 8,325 | | | | 16,650 | | | | 6,192 | | | | 18,461 | | | | 74.4 | % | | | 110.9 | % |
Travel and lodging | | | 38,016 | | | | 74,975 | | | | 25,803 | | | | 43,336 | | | | 12,213 | | | | 31,639 | | | | 47.3 | % | | | 73.0 | % |
Seminars | | | 1,796 | | | | 7,088 | | | | 18,420 | | | | 21,842 | | | | (16,624 | ) | | | (14,754 | ) | | | (90.2 | )% | | | (67.5 | )% |
Telecommunications | | | 20,166 | | | | 41,484 | | | | 13,191 | | | | 24,903 | | | | 6,975 | | | | 16,581 | | | | 52.9 | % | | | 66.6 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other | | | 118,358 | | | | 143,616 | | | | 16,221 | | | | 42,767 | | | | 102,137 | | | | 100,849 | | | | (629.7 | )% | | | 235.8 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | $ | 459,102 | | | $ | 773,748 | | | $ | 386,933 | | | $ | 620,948 | | | $ | 72,169 | | | $ | 152,800 | | | | 18.7 | % | | | 24.6 | % |
Total operating expenses
Total operating expenses for the three and six months ended March 31, 2013 were $4,709,727 and $13,959,857, respectively ($3,104,153 and $7,362,980 for the three and six months ended March 31, 2012). The increase in operating expenses of $1,605,574 and $6,596,877, respectively (51.7% and 89.6%, respectively, in percentage terms) over the previous comparable period’s level was noted previously throughout above. Included in the total operating expenses were noncash expenses (primarily for stock based compensation) totaling $5,499,232 and $2,336,469 for the six months ended March 31, 2013 and 2012, respectively.
Non-operating Income and Expense
We recognized a loss from the change in the fair value of derivative liabilities of $178,739 and a gain of $8,408,551 for the three and six months ended March 31, 2013, respectively, compared to gains of $934,872 and $1,454,343 for the comparable periods in fiscal 2012.
For the three and six months ended March 31, 2013, interest income totaled $1,131 and $2,176, respectively ($1,161 and $2,611, respectively for fiscal 2012), while we incurred no interest expense in either period (both 2013 and 2012).
Net Loss and Net Loss per Share
For the three and six months ended March 31, 2013, our net loss totaled $4,588,648 and $5,002,948, respectively ($1,885,781 and $5,388,511 for the three and six months ended March 31, 2012, respectively). Our basic and diluted net loss per share was $0.59 and $.70 for the three and six months ended March 31, 2013 (a loss of $.31 and $.93 per share for the three and six months ended March 31, 2012, respectively). Common stock equivalents and outstanding options and warrants were not included in the calculations due to their anti-dilutive effects.
Liquidity and Capital Resources
We have primarily financed our operations to date through the sale of unregistered equity (accompanied by warrants to purchase shares of our common stock) and in prior years with the issuance of notes payable. At March 31, 2013, our total assets were $2,758,908, while we had working capital of $1,051,411. Total liabilities were $1,707,497 (all of which were current) and our stockholders’ equity totaled $1,063,561.
We may raise additional funding through the sale of unregistered common stock and warrants although there can be no assurance that we will be successful in raising such funds. This description of our recent financing and our future plans does not constitute an offer to sell or the solicitation of an offer to buy our securities, nor shall such securities be offered or sold in the United States absent registration or an applicable exemption from the registration requirements and certificates evidencing such shares contain a legend stating the same.
Our cash and cash equivalents balance at March 31, 2013 totaled $2,454,245. During the six months ended March 31, 2013, positive cash flows resulted from the sale of unregistered common stock and warrants to purchase common stock described above, offset by negative cash flows from operating activities totaling $7,930,858.
Plan of Operations
We do not currently expect to purchase any significant property or equipment, or to have substantial changes in the number of our employees for the next twelve months. We expect however to continue to incur costs in improving, maintaining and marketing our prepaid card products during fiscal 2013. We expect that our greatest cost to be incurred during fiscal 2013 will be in the area of customer account acquisition.
Going Concern
As noted above (and by our independent registered public accounting firm in its report on our consolidated financial statements as of and for the year ended September 30, 2012), there exists substantial doubt about our ability to continue as a going concern for twelve months after the date of these financial statements. Our unaudited condensed consolidated financial statements do not contain any adjustments related to the outcome of this uncertainty.
Critical Accounting Policies
Management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which are prepared in accordance with accounting principles that are generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, related 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. We continually evaluate our estimates and judgments and we base our estimates and judgments on historical experience and other factors that we believe to be reasonable under the circumstances. Materially different results can occur as circumstances change and additional information becomes known. There were no changes in our critical accounting policies during fiscal 2013.
Item 3—Quantitative and Qualitative Disclosures about Market Risk
Intentionally omitted pursuant to Item 305(e) of Regulation S-K.
Item 4 – Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures and internal controls that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information 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. In designing and evaluating the disclosure controls and procedures and internal controls, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable, and not absolute, assurance of achieving the desired control objectives. In reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures and internal controls.
As required by the Securities and Exchange Commission Rule 13a-15(e) and Rule 15d-15(e), we carried out an evaluation, under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. On August 19, 2013, after consulting with the Company’s Audit Committee, management concluded it had incorrectly calculated its historical volatility for the fiscal years ended September 30, 2012 and 2011.Those errors also impacted the March 31, 2013 and 2012 interim periods. The error specifically related to an excel spreadsheet calculation whereby it was calculating a volatility that was significantly higher than it should have been. The historical volatility is a key assumption and driver in determining the valuation of the company’s stock based compensation and derivative liabilities. The aforementioned error constitute a material weakness over financial reporting and therefore the Company did not maintain effective internal control over financial reporting as of March 31, 2013.
Changes in Internal Controls over Financial Reporting
During the period ended March 31, 2013, we concluded that we did not maintain effective control overfinancial reporting related to the classification and reporting of certain financial instruments.In order to remediate such condition, we undertook and put in place the following actions.
| · | In October 2012, we hired a Controller to assist our Chief Financial Officer with our Company’s accounting and financial tasks. |
| · | We consult with experts in the area of accounting for financial instruments in the event that any transactions related to the classification and reporting of financial instruments take place. Although no such transactions that were materially different from previously reported transactions took place in the most recently completed quarter, our newly established internal control procedures require that we obtain opinion of such experts prior to entering into such transactions. |
| · | In December of 2012, we hired a President and Chief Operating Officer with extensive industry experience. |
| · | In July of 2013, we started using an industry leading software tool to calculate our share based compensation expense. |
Part II: Other Information
Item 1 – Legal Proceedings
From time to time and in the course of business, we may become involved in various legal proceedings seeking monetary damages and other relief. The amount of the ultimate liability, if any, from such claims cannot be determined. However, in the opinion of our management, there are no legal claims currently pending or threatened against us that would be likely to have a material adverse effect on our financial position, results of operations or cash flows.Our Company is involved in a disagreement with our incumbent processor. We are currently involved in an arbitration proceeding with our former transaction processor and our arbitration hearing date is currently set for December 3, 2013. In connection with the services provided under a processing agreement, the processor asserted that we are liable for previously unbilled services. We are vigorously asserting our position and we currently estimate that we will prevail in the arbitration. We have adequate reserves allocated in the event that we would be required to make any payments in connection with this matter. If we are judged liable for either a portion or all of the charges, or should we enter into amonetary settlement with the processor, such liability or settlement could materially affect our ability to execute our customer acquisition strategy by reducing the amount available for such activities by any amounts due to the processor or needed for related expenses.
Item 1A – Risk Factors
Investment in our common stock involves a high degree of risk. You should carefully consider the risks described below together with all of the other information included in this herein before making an investment decision. If any of the following risks actually occur, our business, financial condition or results of operations could suffer. In that case, the market price of our common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Business
WE HAVE A LIMITED OPERATING HISTORY OVERALL AND HAVE ONLY RECENTLY EMBARKED ON OUR CURRENT CORPORATE FOCUS OF PROVIDING ONLINE PAYMENT SOLUTIONS.
We completed our acquisition of BillMyParents, Inc. a California corporation (“BillMyParents-CA”) on October 16, 2007. BillMyParents-CA was formed in April 2007 to pursue opportunities in the gift card industry. We subsequently refocused our efforts on providing prepaid cards for young people and their parents. In March 2013, the Company changed its name to SpendSmart Payments Company, Inc. and BillMyParents-CA changed its name to The SpendSmart Payments Company. We do not currently have an adequate level of operating revenues that would support profitable operations and we have a limited operating history. Because we have a limited operating history, our historical financial information is not a reliable indicator of future performance. Therefore, it is difficult to evaluate the business and prospects of our Company. Furthermore, our revised business focus is centered on our SpendSmart product and has been ongoing only since 2009. We have limited experience as to whether the Company will be popular with consumers. Failure to correctly evaluate our Company’s prospects could result in an investor’s loss of a significant portion or all of his investment in our Company.
OUR FAILURE TO OBTAIN ADDITIONAL ADEQUATE FINANCING WOULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS.
We cannot be certain that we will ever generate sufficient revenues and gross margin to achieve profitability in the future. Our failure to significantly increase revenues or to raise additional adequate and necessary financing would seriously harm our business and operating results. We have incurred significant costs in building, launching and marketing our SpendSmart Product. In addition, we have signed an agreement with an endorser that requires the expenditure of significant capital resources, including advances totaling close to $4 million. On November 30, and December 10, 2012 we closed on a private equity transactions whereby we raised $2,580,500 and $2,286,000, respectively, in net proceeds after deducting fees and expenses, however we will still require additional funding in order to operate our business. If we fail to achieve sufficient revenues and gross margin with our SpendSmart Product, or our revenues grow more slowly than anticipated, or if our operating or capital expenses increase more than is expected or cannot be reduced in the event of lower revenues, our business will be materially and adversely affected and an investor could suffer the loss of a significant portion or all of his investment in our Company.
THE CURRENT BANK THAT ISSUES OUR CARDS WILL NOT ISSUE CARDS THAT ARE RELATED TO CELEBRITY ENDORSEMENTS. WE HAVE ENTERED INTO AN AGREEMENT WITH ANOTHER BANKING INSTITUTION THAT WILL ISSUE OUR CARDS THAT RELATE TO CELEBRITY ENDORSEMENTS.
A current bank that issues our BMP cards will not issue pre-paid cards that relate to any celebrity endorsements. We have entered into an agreement with another banking institution that will issue our SpendSmart cards that are affiliated with celebrity endorsements. The current bank will continue to issue BMP cards, while the new bank will issue our SpendSmart cards.
WE FACE COMPETITION FROM OTHER ONLINE PAYMENT SYSTEMS.
We will face competition from other companies with similar product offerings. Many of these companies have longer operating histories, greater name recognition and substantially greater financial, technical and marketing resources than us. Many of these companies also have more extensive customer bases, broader customer relationships and broader industry alliances than us, including relationships with many of our potential customers. Increased competition from any of these sources could result in our failure to achieve and maintain an adequate level of customers and market share to support the cost of our operations.
WE HAVE LIMITED RESOURCES TO DEVELOP OUR PRODUCT OFFERINGS.
Our ability to successfully access the capital markets at the same time that our Company has required funding for the development and marketing of our product offerings is challenging. This has caused and will likely continue to cause us to restrict funding of the development of our products and to favor the development of one product offering over the other based on their relative estimated potentials for commercial success as evaluated by our management. We will require additional debt and/or equity financing to pursue our growth strategy. Given our limited operating history and existing losses, there can be no assurance that we will be successful in obtaining additional financing. Furthermore, the issuance by us of any additional securities pursuant to any future fundraising activities undertaken by us would dilute the ownership of existing shareholders and may reduce the price of our common stock. Furthermore, debt financing, if available, will require payment of interest and may involve restrictive covenants that could impose limitations on our operating flexibility. Our current focus is on our SpendSmart Cards. The failure of our SpendSmart Cards to be commercially successful would substantially harm our business and results of operations. Our failure to successfully obtain additional future funding may jeopardize our ability to continue our business and operations. Furthermore, in the future we may determine that it is in the best interest of our Company to severely curtail, license, jointly develop with a third party or sell one of our product offerings, which may be on terms which limit the revenue potential of the product offering to our Company.
WE RELY ON THIRD-PARTY SUPPLIERS AND DISTRIBUTORS THAT ARE SPECIFIC TO OUR BUSINESS AND DISTRIBUTION CHANNELS SUCH AS PROCESSORS, PROGRAMMERS, SOCIAL NETWORKS AND SECURITY ADVISORS.
We will be dependent on other companies to provide necessary products and services in connection with key elements of our business. Any interruption in our ability to obtain these services, or comparable quality replacements would severely harm our business and results of operations. Should any of these adverse contingencies result, they could substantially harm our business and results of operations and an investor could suffer the loss of a significant portion or all of his investment in our Company.
WE RELY ON OUR BANK ISSUERS TO ISSUE Spendsmart CARDS AND THIRD-PARTY CREDIT CARD MERCHANT PROCESSORS TO ALLOW OUR CUSTOMERS TO LOAD BALANCES ON THEIR SPENDSMART AND BMP CARDS AND THESE THIRD PARTIES COULD VIEW OUR PRE-PAID SPENDSMART AND BMP CARDS AND LIMITED FINANCIAL RESOURCES AS OVERLY RISKY.
BMP and SpendSmart Cards are issued by our bank issuers who are essential to our ability to market our products. Additionally, most of our customers load balances on their BMP and SpendSmart cards with a credit card. We are dependent on our bank issuers in order to market BMP and SpendSmart cards. Should one or more of our bank issuers judge our financial resources inadequate, it/they could terminate its/their relationship(s) with us, and we could no longer issue or service cards issued by that bank. This would require us to incur large expenses to obtain a new bank issuer(s), if obtaining such issuer were even possible.
We are also dependent on third party credit card merchant processors to allow our customers to load these balances on their BMP and SpendSmart cards. Many credit card merchant processors view the prepaid card industry which we operate in as high risk from a fraud and financial standpoint. While we take steps to reduce fraud in our business, our limited financial resources can be viewed as too risky by credit card merchant processors and cause them not to want to do business with us, or discontinue doing business with us. Since most of our customers load balances on their BMP and SpendSmart cards with a credit card, any interruption in our ability to obtain these services or comparable quality replacements, would severely harm our business and results of operations.
Should we lose the services of one or more of our bank issuers or those of a credit card merchant processor and not be able to replace them, our business and results of operations would be substantially impaired, and an investor could suffer the loss of a significant portion or all of his investment in our Company.
WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT AND FAILURE BY US OR THE BANK(S) THAT ISSUE(S) OUR CARDS TO COMPLY WITH APPLICABLE LAWS AND REGULATIONS COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL POSITION AND RESULTS OF OPERATIONS.
We operate in a highly regulated environment, and failure by us or one or more of the banks that issue our cards to comply with the laws and regulations to which we are subject could negatively impact our business. We are subject to a wide range of federal and state laws and regulations. In particular, our products and services are subject to an increasingly strict set of legal and regulatory requirements intended to protect consumers and to help detect and prevent money laundering, terrorist financing and other illicit activities. Many of these laws and regulations are evolving, unclear and inconsistent across various jurisdictions, and ensuring compliance with them is difficult and costly. Failure by us or our bank to comply with the laws and regulations to which we are or may become subject to could result in fines, penalties or limitations on our ability to conduct our business, or federal or state actions, any of which could significantly harm our reputation with consumers and other network participants, banks that issue our cards and regulators and could materially and adversely affect our business, operating results and financial condition.
CHANGES IN CREDIT CARD ASSOCIATION OR OTHER NETWORK RULES OR STANDARDS SET BY THE PAYMENT NETWORKS OR CHANGES IN CARD ASSOCIATION AND NETWORK FEES OR PRODUCTS OR INTERCHANGE RATES COULD ADVERSELY AFFECT OUR BUSINESS, FINANCIAL POSITION AND RESULTS OF OPERATIONS.
We and the banks that issue our cards are subject to card network association rules that could subject us to a variety of fines or penalties that may be levied by the card associations or networks for acts or omissions by us or businesses that work with us, including credit card merchant processors. The termination of the card association registrations held by us through any of the banks that issue our cards or any changes in card association or other network rules or standards, including interpretation and implementation of existing rules or standards, that increase the cost of doing business or limit our ability to provide our products and services could have an adverse effect on our business, operating results and financial condition. In addition, from time to time, card associations could increase the organization and/or processing fees that they charge, which could increase our operating expenses, reduce our profit margin and adversely affect our business, operating results and financial condition. Furthermore, a substantial portion of our operating revenues is derived from interchange fees, and we expect interchange revenues to someday potentially represent a significant percentage of our total operating revenues. The amount of interchange revenues that we earn is highly dependent on the interchange rates that the payment networks set and adjust from time to time. The enactment of the Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, required the Federal Reserve Board to implement regulations that have substantially limited interchange fees for many issuers. While we believe the interchange rates that may be earned by us are exempt from such limitations, in light of this legislation and recent attention generally on interchange rates in the United States, there can be no assurance that the interpretation or enforcement of interchange legislation or regulation will not impact our interchange revenues substantially. If interchange rates decline, whether due to actions by the payment networks, the banks that issue our cards or existing or future legislation, regulation or the interpretation or enforcement thereof, we would likely need to change our fee structure to compensate for lost interchange revenues. To the extent we increase the pricing of our products and services, we might find it more difficult to acquire new card customers and to maintain or grow card usage and customer retention, and we could suffer reputational damage and become subject to greater regulatory scrutiny. We also might have to discontinue certain products or services. As a result, our operating revenues, operating results, prospects for future growth and overall business could be materially and adversely affected.
CHANGES IN LAWS AND REGULATIONS TO WHICH WE ARE SUBJECT, OR TO WHICH WE MAY BECOME SUBJECT, MAY INCREASE OUR COSTS OF OPERATION, DECREASE OUR OPERATING REVENUES AND DISRUPT OUR BUSINESS.
Changes in laws and regulations or the interpretation or enforcement thereof may occur that could increase our compliance and other costs of doing business, require significant systems redevelopment, or render our products or services less profitable or obsolete, any of which could have an adverse effect on our results of operations. We could face more stringent anti-money laundering rules and regulations, as well as more stringent regulations, compliance with which could be expensive and time consuming. Changes in laws and regulations governing the way our products are sold or in the way those laws and regulations are interpreted or enforced could adversely affect our ability to distribute our products and the cost of providing those products and services. If onerous regulatory requirements were imposed on the sale of our products and services, the requirements could lead to a loss of retail distributors, which in turn could materially and adversely impact our operations. State and federal legislators and regulatory authorities have become increasingly focused on the banking and consumer financial services industries and continue to propose and adopt new legislation that could result in significant adverse changes in the regulatory landscape for financial institutions (including card issuing banks) and other financial services companies (including us). Changes in the way we or the banks that issue our cards could expose us and the banks that issue our cards to increased regulatory oversight, more burdensome regulation of our business, and increased litigation risk, each of which could increase our costs and decrease our operating margins. Additionally, changes to the limitations placed on fees, the interchange rates that can be charged or the disclosures that must be provided with respect to our products and services could increase our costs and decrease our operating revenues.
THE DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT MAY HAVE A SIGNIFICANT ADVERSE IMPACT ON OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
In July 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (“DFA”). The DFA, as well as regulations promulgated thereunder, could have a significant adverse impact on the Company’s business, results of operations and financial condition.
The DFA has resulted in increased scrutiny and oversight of consumer financial services and products, primarily through the establishment of the Consumer Financial Protection Bureau (“CFPB”) within the Federal Reserve. The CFPB has broad rulemaking and enforcement authority over providers of pre-paid cards, among other credit providers. The CFPB has the authority to write regulations under federal consumer financial protection laws, and to enforce those laws. The CFPB regulations have yet to be fully promulgated and depending on how the CFPB functions, it could have a material adverse impact on our business. The impact this new regulatory regime will have on the Company’s business is uncertain at this time.
Many provisions of the DFA require the adoption of rules to implement. In addition, the DFA mandates multiple studies, which could result in additional legislative or regulatory action. Therefore, the ultimate consequences of the DFA and its impact on our Company’s business, results of operations and financial condition remain uncertain.
WE ARE SUBJECT TO VARIOUS PRIVACY RELATED REGULATIONS, INCLUDING THE GRAMM-LEACH-BLILEY ACT WHICH MAY INCLUDE AN INCREASED COST OF COMPLIANCE.
We are subject to various laws, rules and regulations related to privacy, information security and data protection, including the Gramm-Leach-Bliley Act, and we could be negatively impacted by these laws, rules and regulations. The Gramm-Leach-Bliley Act guidelines require, among other things, that each financial institution develop, implement and maintain a written, comprehensive information security program containing safeguards that are appropriate to the financial institution’s size and complexity, the nature and scope of the financial institution’s activities and the sensitivity of any customer information at issue. Our management believes that we are currently operating in compliance with these regulations. However, continued compliance with these laws, rules and regulations regarding the privacy, security and protection of customer and employee data, or the implementation of any additional privacy rules and regulations, could result in higher compliance and technology costs for our Company.
OUR BUSINESS COULD SUFFER IF THERE IS A DECLINE IN THE USE OF PREPAID CARDS AS A PAYMENT MECHANISM OR THERE ARE ADVERSE DEVELOPMENTS WITH RESPECT TO THE PREPAID FINANCIAL SERVICES INDUSTRY IN GENERAL.
As the prepaid financial services industry evolves, consumers may find prepaid financial services to be less attractive than traditional or other financial services. Consumers might not use prepaid financial services for any number of reasons, including the general perception of our industry. For example, negative publicity surrounding other prepaid financial service providers could impact our business and prospects for growth to the extent it adversely impacts the perception of prepaid financial services among consumers. If consumers do not continue or decrease their usage of prepaid cards, our operating revenues may remain at current levels or decline. Predictions by industry analysts and others concerning the growth of prepaid financial services as an electronic payment mechanism may overstate the growth of an industry, segment or category, and you should not rely upon them. The projected growth may not occur or may occur more slowly than estimated. If consumer acceptance of prepaid financial services does not continue to develop or develops more slowly than expected or if there is a shift in the mix of payment forms, such as cash, credit cards, traditional prepaid cards and prepaid cards, away from our products and services, it could have a material adverse effect on our financial position and results of operations.
FRAUDULENT AND OTHER ILLEGAL ACTIVITY INVOLVING OUR PRODUCTS AND SERVICES COULD LEAD TO REPUTATIONAL DAMAGE TO US AND REDUCE THE USE AND ACCEPTANCE OF OUR CARDS AND RELOAD NETWORK.
Criminals are using increasingly sophisticated methods to engage in illegal activities involving prepaid/credit/debit cards or cardholder information, such as counterfeiting, fraudulent payment or refund schemes and identity theft. We rely upon third parties for some transaction processing services, which subjects us and our cardholders to risks related to the vulnerabilities of those third parties. A single significant incident of fraud or increases in the overall level of fraud involving our cards, could result in financial or reputational damage to us, which could reduce the use and acceptance of our cards, cause other channel members to cease doing business with us or lead to greater regulation that would increase our compliance costs.
A DATA SECURITY BREACH COULD EXPOSE US TO LIABILITY AND PROTRACTED AND COSTLY LITIGATION, AND COULD ADVERSELY AFFECT OUR REPUTATION AND OPERATING REVENUES.
We, the banks that issue our cards, network acceptance members and/or third-party processors receive, transmit and store confidential customer and other information in connection with the sale and use of our prepaid cards. Encryption software and the other technologies used to provide security for storage, processing and transmission of confidential customer and other information may not be effective to protect against data security breaches by third parties. The risk of unauthorized circumvention of such security measures has been heightened by advances in computer capabilities and the increasing sophistication of hackers. Improper access to our or these third parties’ systems or databases could result in the theft, publication, deletion or modification of confidential customer and other information. A data security breach of the systems on which sensitive cardholder data and account information are stored could lead to fraudulent activity involving our products and services, reputational damage and claims or regulatory actions against us. If we are sued in connection with any data security breach, we could be involved in protracted and costly litigation. If unsuccessful in defending that litigation, we might be forced to pay damages and/or change our business practices or pricing structure, any of which could have a material adverse effect on our operating revenues and profitability. We would also likely have to pay (or indemnify the banks that issue our cards for) fines, penalties and/or other assessments imposed as a result of any data security breach. Further, a significant data security breach could lead to additional regulation, which could impose new and costly compliance obligations. In addition, a data security breach at the bank that issues our cards, network acceptance members or third-party processors could result in significant reputational harm to us and cause the use and acceptance of our cards to decline, either of which could have a significant adverse impact on our operating revenues and future growth prospects.
OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY TECHNOLOGY SURROUNDING OUR SPENDSMART AND BMP CARDS IS UNCERTAIN.
Our future success may depend significantly on our ability to protect our proprietary rights to the intellectual property upon which our products and services will be based. Any patents we obtain in the future may be challenged by re-examination or otherwise invalidated or eventually be found unenforceable. Both the patent application process and the process of managing patent disputes can be time consuming and expensive. Competitors may attempt to challenge or invalidate our patents, or may be able to design alternative techniques or devices that avoid infringement of our patents, or develop products with functionalities that are comparable to ours. In the event a competitor infringes upon our patent or other intellectual property rights, litigation to enforce our intellectual property rights or to defend our patents against challenge, even if successful, could be expensive and time consuming and could require significant time and attention from our management. We may not have sufficient resources to enforce our intellectual property rights or to defend our patents against challenges from others.
WE ARE DEPENDENT UPON CONSUMER TASTES WITH RESPECT TO PREFERRED METHODS OF ONLINE PAYMENT FOR THE SUCCESS OF OUR PRODUCTS AND SERVICES.
Our product offerings’ acceptance by consumers and their consequent generation of revenues will depend upon a variety of unpredictable factors, including:
| · | Public taste, which is always subject to change; |
| · | The quantity and popularity of other payment systems available to the public; |
| · | The continued appeal and reputations of our celebrity spokespersons; and |
| · | The fact that the distribution and sales methods chosen for the products and services we market may be ineffective. |
For any of these reasons, our programs may be commercially unsuccessful. If we are unable to market products which are commercially successful, we may not be able to recoup our expenses and/or generate sufficient revenues. In the event that we are unable to generate sufficient revenues, we may not be able to continue operating as a viable business and an investor could suffer the loss of a significant portion or all of his investment in our Company.
OUR COMPANY IS ECONOMICALLY SENSITIVE TO GENERAL ECONOMIC CONDITIONS, INCLUDING CONTINUED WEAKENING OF THE ECONOMY; THEREFORE A REDUCTION IN CONSUMER PURCHASES OF DISCRETIONARY ITEMS COULD CONSEQUENTLY MATERIALLY IMPACT OUR COMPANY’S FUTURE REVENUES FROM SPENDSMART AND BMP CARDS FOR THE WORSE.
Consumer purchases are subject to cyclical variations, recessions in the general economy and the future economic outlook. Our results may be dependent on a number of factors impacting consumer spending, including general economic and business conditions; consumer confidence; wages and employment levels; the housing market; consumer debt levels; availability of consumer credit; credit and interest rates; fuel and energy costs; energy shortages; taxes; general political conditions, both domestic and abroad; and the level of customer traffic on social networking websites. Consumer purchases of discretionary items may decline during recessionary periods and at other times when disposable income is lower. A downturn or an uncertain outlook in the economy may materially adversely affect our business and the success of our BMP and SpendSmart Cards.
Financial Risks
OUR FINANCIAL STATEMENTS HAVE BEEN PREPARED ASSUMING THAT OUR COMPANY WILL CONTINUE AS A GOING CONCERN.
The factors described herein raise substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from this uncertainty. The report of our independent registered public accounting firm included an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern in their audit report for the fiscal years ended September 30, 2012 and 2011. If we cannot generate the required revenues and gross margin to achieve profitability or obtain additional capital on acceptable terms, we will need to substantially revise our business plan or cease operations and an investor could suffer the loss of a significant portion or all of his investment in our Company.
CURRENT MACRO-ECONOMIC CONDITIONS COULD ADVERSELY AFFECT THE FINANCIAL VIABILITY OF OUR COMPANY.
Continuing recessionary conditions in the global economy threaten to cause further tightening of the credit and equity markets and more stringent lending and investing standards. The persistence of these conditions could have a material adverse effect on our access to further needed capital. In addition, further deterioration in the economy could adversely affect our corporate results, which could adversely affect our financial condition and operations.
WE DO NOT EXPECT TO PAY DIVIDENDS FOR THE FORESEEABLE FUTURE, AND WE MAY NEVER PAY DIVIDENDS AND, CONSEQUENTLY, THE ONLY OPPORTUNITY FOR INVESTORS TO ACHIEVE A RETURN ON THEIR INVESTMENT IS IF A TRADING MARKET DEVELOPS AND INVESTORS ARE ABLE TO SELL THEIR SHARES FOR A PROFIT OR IF OUR BUSINESS IS SOLD AT A PRICE THAT ENABLES INVESTORS TO RECOGNIZE A PROFIT.
We currently intend to retain any future earnings to support the development and expansion of our business and do not anticipate paying cash dividends for the foreseeable future. Our payment of any future dividends will be at the discretion of our Board of Directors after taking into account various factors, including but not limited to our financial condition, operating results, cash needs, growth plans and the terms of any credit agreements that we may be a party to at the time. In addition, our ability to pay dividends on our common stock may be limited by state law. Accordingly, we cannot assure investors any return on their investment, other than in connection with a sale of their shares or a sale of our business. At the present time there is a limited trading market for our shares. Therefore, holders of our securities may be unable to sell them. We cannot assure investors that an active trading market will develop or that any third party will offer to purchase our business on acceptable terms and at a price that would enable our investors to recognize a profit.
OUR NET OPERATING LOSS (“NOL”) CARRY-FORWARD IS LIMITED.
We have recorded a valuation allowance amounting to our entire net deferred tax asset balance due to our lack of a history of earnings, possible statutory limitations on the use of tax loss carry-forwards generated in the past and the future expiration of our NOL. This gives rise to uncertainty as to whether the net deferred tax asset is realizable. Internal Revenue Code Section 382, and similar California rules, place a limitation on the amount of taxable income that can be offset by carry-forwards after a change in control (generally greater than a 50% change in ownership). As a result of these provisions, it is likely that given our acquisition of The SpendSmart Payments Company-CA, future utilization of the NOL will be severely limited. Our inability to use our Company’s historical NOL, or the full amount of the NOL, would limit our ability to offset any future tax liabilities with its NOL.
Corporate and Other Risks
LIMITATIONS ON DIRECTOR AND OFFICER LIABILITY AND INDEMNIFICATION OF OUR COMPANY’S OFFICERS AND DIRECTORS BY US MAY DISCOURAGE STOCKHOLDERS FROM BRINGING SUIT AGAINST AN OFFICER OR DIRECTOR.
Our Company’s articles of incorporation and bylaws provide, with certain exceptions as permitted by governing state law, that a director or officer shall not be personally liable to us or our stockholders for breach of fiduciary duty as a director, except for acts or omissions which involve intentional misconduct, fraud or knowing violation of law, or unlawful payments of dividends. These provisions may discourage stockholders from bringing suit against a director for breach of fiduciary duty and may reduce the likelihood of derivative litigation brought by stockholders on our behalf against a director.
WE ARE RESPONSIBLE FOR THE INDEMNIFICATION OF OUR OFFICERS AND DIRECTORS.
Should our officers and/or directors require us to contribute to their defense, we may be required to spend significant amounts of our capital. Our articles of incorporation and bylaws also provide for the indemnification of our directors, officers, employees, and agents, under certain circumstances, against attorney's fees and other expenses incurred by them in any litigation to which they become a party arising from their association with or activities on behalf of our Company. This indemnification policy could result in substantial expenditures, which we may be unable to recoup. If these expenditures are significant, or involve issues which result in significant liability for our key personnel, we may be unable to continue operating as a going concern.
OUR EMPLOYEES, EXECUTIVE OFFICERS, DIRECTORS AND INSIDER STOCKHOLDERS BENEFICIALLY OWN OR CONTROL A SUBSTANTIAL PORTION OF OUR OUTSTANDING COMMON STOCK, WHICH MAY LIMIT YOUR ABILITY AND THE ABILITY OF OUR OTHER STOCKHOLDERS, WHETHER ACTING ALONE OR TOGETHER, TO PROPOSE OR DIRECT THE MANAGEMENT OR OVERALL DIRECTION OF OUR COMPANY.
Additionally, this concentration of ownership could discourage or prevent a potential takeover of our Company that might otherwise result in an investor receiving a premium over the market price for his shares. Approximately half of our outstanding shares of common stock is beneficially owned and controlled by a group of insiders, including our employees, directors and executive officers. Accordingly, our employees, directors, executive officers and insider shareholders may have the power to control the election of our directors and the approval of actions for which the approval of our stockholders is required. If you acquire shares of our common stock, you may have no effective voice in the management of our Company. Such concentrated control of our Company may adversely affect the price of our common stock. Our principal stockholders may be able to control matters requiring approval by our stockholders, including the election of directors, mergers or other business combinations. Such concentrated control may also make it difficult for our stockholders to receive a premium for their shares of our common stock in the event we merge with a third party or enter into different transactions which require stockholder approval. These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock.
WE ARE DEPENDENT FOR OUR SUCCESS ON A FEW KEY EMPLOYEES.
Our inability to retain those employees would impede our business plan and growth strategies, which would have a negative impact on our business and the value of your investment. Our success depends on the skills, experience and performance of key members of our Company. Each of those individuals may voluntarily terminate his employment with our Company at any time. Were we to lose one or more of these key employees, we would be forced to expend significant time and money in the pursuit of a replacement, which would result in both a delay in the implementation of our business plan and the diversion of limited working capital. We do not maintain a key man insurance policy on any of our key employees.
SHOULD WE BE SUCCESSFUL IN TRANSITIONING TO A COMPANY GENERATING SIGNIFICANT REVENUES, WE MAY NOT BE ABLE TO MANAGE OUR GROWTH EFFECTIVELY, WHICH COULD ADVERSELY AFFECT OUR OPERATIONS AND FINANCIAL PERFORMANCE.
The ability to manage and operate our business as we execute our growth strategy will require effective planning. Significant rapid growth could strain our internal resources, leading to a lower quality of customer service, reporting problems and delays in meeting important deadlines resulting in loss of market share and other problems that could adversely affect our financial performance. Our efforts to grow could place a significant strain on our personnel, management systems, infrastructure and other resources. If we do not manage our growth effectively, our operations could be adversely affected, resulting in slower growth and a failure to achieve or sustain profitability.
Capital Market Risks
OUR COMMON STOCK IS THINLY TRADED, SO YOU MAY BE UNABLE TO SELL AT OR NEAR ASK PRICES OR AT ALL IF YOU NEED TO SELL YOUR SHARES TO RAISE MONEY OR OTHERWISE DESIRE TO LIQUIDATE YOUR SHARES.
There is limited market activity in our stock and we may be too small to attract the interest of many brokerage firms and analysts. We cannot give you any assurance that a broader or more active public trading market for our common stock will develop or be sustained. While we are trading on OTCQB, the trading volume we will develop may be limited by the fact that many major institutional investment funds, including mutual funds, as well as individual investors follow a policy of not investing in over-the-counter stocks and certain major brokerage firms restrict their brokers from recommending over-the-counter stocks because they are considered speculative, volatile, thinly traded and the market price of the common stock may not accurately reflect the underlying value of our Company. The market price of our common stock could be subject to wide fluctuations in response to quarterly variations in our revenues and operating expenses, announcements of new products or services by us, significant sales of our common stock, including “short” sales, the operating and stock price performance of other companies that investors may deem comparable to us, and news reports relating to trends in our markets or general economic conditions.
THE APPLICATION OF THE “PENNY STOCK” RULES TO OUR COMMON STOCK COULD LIMIT THE TRADING AND LIQUIDITY OF THE COMMON STOCK, ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK AND INCREASE YOUR TRANSACTION COSTS TO SELL THOSE SHARES.
As long as the trading price of our common stock is below $5 per share, our common stock will be subject to the “penny stock” rules, unless we otherwise qualify for an exemption from the “penny stock” definition. The “penny stock” rules impose additional sales practice requirements on certain broker-dealers who sell securities to persons other than established customers and accredited investors (generally those with a net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together with their spouse). These regulations, if they apply, require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the associated risks. Under these regulations, certain brokers who recommend such securities to persons other than established customers or certain accredited investors must make a special written suitability determination regarding such a purchaser and receive such purchaser’s written agreement to a transaction prior to sale. The Financial Industry Regulatory Authority, or FINRA, has adopted sales practice requirements which may also limit a stockholder's ability to buy and sell our stock. In addition to the "penny stock" rules described above, FINRA has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer's financial status, tax status, investment objectives and other information. These regulations may have the effect of limiting the trading activity of our common stock, reducing the liquidity of an investment in our common stock and increasing the transaction costs for sales and purchases of our common stock as compared to other securities. The stock market in general and the market prices for penny stock companies in particular, have experienced volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance. Stockholders should be aware that, according to SEC Release No. 34-29093, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include 1) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; 2) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; 3) boiler room practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; 4) excessive and undisclosed bid-ask differential and markups by selling broker-dealers; and 5) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses. The occurrence of these patterns or practices as well as the regulatory disclosure requirements set forth above could increase the volatility of our share price, may limit investors’ ability to buy and sell our securities and have an adverse effect on the market price for our shares of common stock.
WE MAY NOT BE ABLE TO ATTRACT THE ATTENTION OF MAJOR BROKERAGE FIRMS, WHICH COULD HAVE A MATERIAL ADVERSE IMPACT ON THE MARKET VALUE OF OUR COMMON STOCK.
Security analysts of major brokerage firms may not provide coverage of our common stock since there is no incentive to brokerage firms to recommend the purchase of our common stock. The absence of such coverage limits the likelihood that an active market will develop for our common stock. It will also likely make it more difficult to attract new investors at times when we require additional capital.
WE MAY BE UNABLE TO LIST OUR COMMON STOCK ON NASDAQ OR ON ANY SECURITIES EXCHANGE.
Although we intend to apply to list our common stock on NASDAQ in the future, we cannot assure you that we will be able to meet the initial listing standards, including the minimum per share price and minimum capitalization requirements, or that we will be able to maintain a listing of our common stock on this trading. Until such time as we qualify for listing on NASDAQ or another national securities exchange, our common stock will continue to trade on OTCQB or another over-the-counter quotation system where an investor may find it more difficult to dispose of shares or obtain accurate quotations as to the market value of our common stock. In addition, rules promulgated by the SEC impose various practice requirements on broker-dealers who sell securities that fail to meet certain criteria set forth in those rules to persons other than established customers and accredited investors. Consequently, these rules may deter broker-dealers from recommending or selling our common stock, which may further affect the liquidity of our common stock. It would also make it more difficult for us to raise additional capital.
FUTURE SALES OF OUR EQUITY SECURITIES COULD PUT DOWNWARD SELLING PRESSURE ON OUR SECURITIES, AND ADVERSELY AFFECT THE STOCK PRICE.
There is a risk that this downward pressure may make it impossible for an investor to sell his or her securities at any reasonable price, if at all. Future sales of substantial amounts of our equity securities in the public market, or the perception that such sales could occur, could put downward selling pressure on our securities, and adversely affect the market price of our common stock.
Item 2 –Unregistered Sales of Equity Securities and Use of Proceeds
None not previously disclosed.
Item 3 – Defaults upon Senior Securities
Not applicable.
Item 4 – Mine Safety Disclosures
Not applicable.
Item 5 – Other Information
None.
Item 6 – Exhibits
See Exhibit Index immediately following signatures.
SIGNATURES
In accordance with the requirements of the Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| The SpendSmart Payments Company, a Colorado corporation |
| | |
| By: | /s/ MICHAEL MCCOY |
| | Michael McCoy, Chief Executive Officer |
| | |
| October 21, 2013 |
| | |
| By: | /s/ KIM PETRY |
| | Kim Petry, Chief Financial Officer |
| | |
| October 21, 2013 |
Exhibit Index
Exhibit No. | | Description |
31.1* | | Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, by Chief Executive Officer |
31.2* | | Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, by Chief Financial Officer |
32.1* | | Certification pursuant to 18 U.S.C. §1350 by Chief Executive Officer |
32.2* | | Certification pursuant to 18 U.S.C. §1350 by Chief Financial Officer |
* | | Filed as an exhibit to this report |