SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
Commission file number: 0-28152
Affinity Technology Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware 57-0991269
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Affinity Technology Group, Inc.
8807-A Two Notch Road
Columbia, SC 29223
(Address of principal executive offices)
(Zip code)
(803) 758-2511
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No _X_
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No _X_
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
42,215,096 shares of Common Stock, $0.0001 par value, as of November 1, 2005.
AFFINITY TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
INDEX
PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2005 and
December 31, 2004................................................... 3
Condensed Consolidated Statements of Operations for the three and
nine months ended September 30, 2005 and 2004....................... 4
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 2005 and 2004................................... 5
Notes to Condensed Consolidated Financial Statements.................. 6
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................. 13
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk....... 18
ITEM 4. Controls and Procedures.......................................... 18
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings................................................ 18
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds...... 19
ITEM 3. Defaults Upon Senior Securities.................................. 19
ITEM 6. Exhibits......................................................... 20
Signature.................................................................. 20
Statements in this report (including Management's Discussion
and Analysis of Financial Condition and Results of Operations) that are not
descriptions of historical facts, such as statements about the Company's future
prospects and cash requirements, are forward-looking statements and are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Actual results may vary due to risks and uncertainties,
including the Company's very limited capital resources and the possibility that
it may be unable to raise additional capital in amounts sufficient to permit it
to continue operations; the risk that the Company may lose all or part of the
claims covered by its patents as a result of existing and future challenges to
its patents; the risk that its patents may be subject to additional
reexamination by the U.S. Patent and Trademark Office or challenge by third
parties; the possibility that all or some of the holders of the convertible
secured notes issued by the Company may take action to collect the amounts
outstanding under these notes; the result of ongoing litigation; and
unanticipated costs and expenses affecting the Company's cash position. If the
Company is not able to raise additional capital, it will be forced to consider
alternatives for winding down its business, which may include offering its
patents for sale or filing for bankruptcy protection. Moreover, if any holder of
the convertible notes issued by the Company takes action to collect the amounts
owed by the Company under these notes, the Company will be forced to consider
alternatives for winding down its business, which may include offering its
patents for sale or filing for bankruptcy protection. These and other factors
discussed in the Company's filings with the Securities and Exchange Commission,
including the information set forth under the caption "Business Risks" in Item 1
of the Company's Annual Report on Form 10-K for the year ended December 31,
2004, may cause actual results to differ materially from those anticipated.
2
Part I. Financial Information
Item 1. Financial Statements
Affinity Technology Group, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
September 30,
2005 December 31,
(Unaudited) 2004
----------------------------------
Assets
Current assets:
Cash and cash equivalents $ 15,307 $ 62,756
Prepaid expenses 25,898 47,235
----------------------------------
Total current assets 41,205 109,991
Property and equipment, net 6,023 11,249
----------------------------------
Total assets $ 47,228 $ 121,240
==================================
Liabilities and stockholders' deficiency
Current liabilities:
Accounts payable $ 86,912 $ 21,502
Accrued expenses 595,524 417,219
Convertible notes 1,276,336 1,181,336
Deferred revenue 1,471 14,706
----------------------------------
Total current liabilities 1,960,243 1,634,763
----------------------------------
Commitments and contingent liabilities
Stockholders' deficiency:
Common stock, par value $0.0001; authorized
60,000,000 shares, issued 44,383,104 and 44,230,910
shares at September 30, 2005 and December 31, 2004,
respectively 4,438 4,423
Additional paid-in capital 70,695,797 70,665,373
Treasury Stock, at cost (2,168,008 shares at
September 30, 2005 and December 31, 2004) (3,505,287) (3,505,287)
Accumulated deficit (69,107,963) (68,678,032)
----------------------------------
Total stockholders' deficiency (1,913,015) (1,513,523)
----------------------------------
Total liabilities and stockholders' deficiency $ 47,228 $ 121,240
==================================
See accompanying notes to Condensed Consolidated Financial Statements.
3
Affinity Technology Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
-------------------------- --------------------------
Revenues:
Patent license revenue $ 4,411 $ 4,411 $ 13,235 $ 263,235
Other income - 18,600 - 18,600
-------------------------- --------------------------
Total revenue 4,411 23,011 13,235 281,835
Costs and expenses:
Cost of revenues 442 442 1,324 63,824
General and administrative expenses 113,912 142,685 369,418 599,678
-------------------------- --------------------------
Total cost and expenses 114,354 143,127 370,742 663,502
-------------------------- --------------------------
Operating loss (109,943) (120,116) (357,507) (381,667)
Other income (expense)
Interest income 85 445 146 1,640
Interest expense (25,118) (24,126) (72,570) (72,335)
Litigation accrual reversal - 386,148 - 386,148
-------------------------- --------------------------
Net income (loss) $ (134,976) $ 242,351 $ (429,931) $ (66,214)
========================== ==========================
Net income (loss) per share -
basic and diluted: $ (0.00) $ 0.01 $ (0.01) $ (0.00)
========================== ==========================
Shares used in computing net
income (loss) per share 42,215,096 41,914,485 42,196,699 41,883,646
========================== ==========================
See accompanying notes to Condensed Consolidated Financial Statements.
4
Affinity Technology Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended
September 30,
2005 2004
----------------------------------
Operating activities
Net loss $ (429,931) $ (66,214)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 5,226 6,213
Writedown of organizational costs - 1,147
Deferred revenue (13,235) (13,235)
Litigation accrual reversal - (386,148)
Other (305) (15,100)
Changes in current assets and liabilities:
Other current assets 21,337 (37,300)
Accounts payable and accrued expenses 249,154 66,769
----------------------------------
Net cash used in operating activities (167,754) (443,868)
Investing activities
Sale of property and equipment, net 305 17,588
----------------------------------
Net cash provided by investing activities 305 17,588
Financing activities
Proceeds from convertible notes 120,000 25,000
----------------------------------
Net cash provided by financing activities 120,000 25,000
----------------------------------
Net decrease in cash (47,449) (401,280)
Cash and cash equivalents at beginning of period 62,756 578,398
----------------------------------
Cash and cash equivalents at end of period $ 15,307 $ 177,118
==================================
Supplemental cash flow information:
Income taxes paid $ - $ -
==================================
Interest paid $ - $ -
==================================
See accompanying notes to Condensed Consolidated Financial Statements.
5
Affinity Technology Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Statements
(Unaudited)
1. The Company - Going Concern
Affinity Technology Group, Inc. (the "Company") was formed to develop
and market technologies that enable financial institutions and other businesses
to provide consumer financial services electronically with reduced or no human
intervention. Products and services previously offered by the Company include
its DeciSys/RT(R) loan processing system, which automated the processing and
consummation of consumer financial services transactions; the Affinity Automated
Loan Machine (the ALM), which allowed an applicant to apply for and, if
approved, obtain a loan in as little as ten minutes; the Mortgage ALM, which
allowed an applicant to apply for a mortgage loan; e-xpertLender(R), which
permitted a financial institution to make automated lending decisions through
its call centers and branches; iDEAL, which permitted automobile lenders to make
automobile lending decisions for loan applications originated at automobile
dealers; and rtDS, which permitted lenders to deliver credit decisions to
applicants over the Internet. Due to capital constraints, the Company has
suspended all efforts to further develop, market and operate these products and
services. The Company's last processing contract terminated in late 2002, and
the Company has no plans in the near term to engage in further sales or other
activities related to its products or services, other than to attempt to license
certain of the patents that it owns. Currently, the Company's business
activities consist exclusively of attempting to enter into license agreements
with third parties to license the Company's rights under certain of its patents.
In conjunction with its product development activities, the Company
applied for and obtained three patents. The Company has been granted two patents
covering its fully-automated loan processing systems (U. S. Patents No.
5,870,721 and 5,940,811). In August 2000, the U.S. Patent and Trademark Office
issued to the Company a patent covering the fully-automated establishment of a
financial account, including credit accounts (U. S. Patent No. 6,105,007). In
addition, in 1997 the Company acquired a patent that covers the automated
processing of an insurance binder through a kiosk (U. S. Patent No. 5,537,315).
Both of the Company's patents covering fully automated loan processing
systems have been subject to reexamination by the U.S. Patent and Trademark
Office (the "PTO") due to challenges to such patents by third parties. On
January 28, 2003, the Company received a Reexamination Certificate (U. S. Patent
No. 5,870,721 C1) from the PTO which formally concluded the reexamination of U.
S. Patent No. 5,870,721. On March 30, 2005, the Company received a Notice of
Intent to Issue Ex Parte Reexamination Certificate from the PTO indicating that
the reexamination of its other loan processing patent (U. S. Patent No.
5,940,811) had been completed. The Company expects to receive the Reexamination
Certificate for this patent in due course.
On March 26, 2004, the Company was notified by Federated Department
Stores, Inc. ("Federated") and Ameritrade Holding Corporation ("Ameritrade")
that they had jointly filed a request with the PTO to reexamine U. S. Patent No.
6,105,007. On June 23, 2004, the Company received notification that the PTO had
granted the request for reexamination. The Company has lawsuits pending against
Federated and Ameritrade in the Columbia Division of the United States District
Court for the State of South Carolina (the "Columbia Federal Court") in which it
claims that both Federated and Ameritrade infringe U. S. Patent No. 6,105,007.
The Company has jointly, with Federated and Ameritrade, requested the Columbia
Federal Court to stay the lawsuits against Federated and Ameritrade pending
resolution of the reexamination of U. S. Patent No. 6,105,007. It is likely that
it will take an extended period of time to complete the reexamination
proceedings and the related litigation with Federated and Ameritrade. Moreover,
the reexamination of U. S. Patent No. 6,105,007 has adversely affected the
Company's patent licensing program and impeded its ability to raise additional
capital resources to continue its operations.
In November 2003, Household International, Inc. ("Household") filed a
declaratory judgment action against the Company in the United States District
Court in Wilmington, Delaware (the "Delaware Federal Court"). In its complaint
Household requested the Delaware Federal Court to rule that Household was not
infringing any of the claims of certain of the Company's patents (U.S. Patent
No. 5,870,721 C1, No. 5,940,811, and No. 6,105,007) and that these patents are
not valid. The Company filed counterclaims against Household claiming that
Household infringes U.S. Patent Nos. 5,870,721 C1, 5,940,811 and 6,105,007. The
Company also filed a motion with the Delaware Federal Court to transfer the case
to the Columbia Federal Court. In April 2004, the Delaware Federal Court granted
6
the Company's motion to transfer the case to Columbia Federal Court. As
discussed above, the PTO has granted the reexamination request filed by
Federated and Ameritrade relating to U. S. Patent No. 6,105,007. The Company
jointly, with Household, requested and received a stay of the Household action
from the Columbia Federal Court pending the resolution of the PTO's
reexamination of U. S. Patent No. 6,105,007.
It is possible that third parties may bring additional actions to
contest all or some of the Company's patents. The Company can make no assurances
that it will not lose all or some of the claims covered by its existing patents.
To date, the Company has generated substantial operating losses and has
been required to use a substantial amount of cash resources to fund its
operations. At September 30, 2005, the Company had cash and cash equivalents of
$15,307. The Company has informal arrangements with certain vendors and officers
under which these vendors and officers have agreed to defer all or part of the
amounts payable to them until the Company has adequate resources to do so. The
Company must raise additional capital to fund accrued operating expenses and
continue its operations. Unless the Company raises additional capital, it will
have to consider alternatives for winding down its business, which may include
offering its patents for sale or filing for bankruptcy protection. Moreover, the
Company currently does not have the resources to repay the principal and accrued
interest outstanding under its convertible secured notes, which have become due
and payable in full as discussed in the following paragraphs. If any holder of
these notes takes action to collect the amounts owed by the Company under these
notes, the Company will be forced to consider alternatives for winding down its
business, which may include offering its patents for sale or filing for
bankruptcy protection.
In 2002 the Company initiated a convertible note program under which it
is authorized to issue up to $1,500,000 principal amount of its notes. To date,
the Company has issued an aggregate of $1,400,336 principal amount of notes
under this program. These notes bear interest at 8%, are convertible into the
Company's common stock at a conversion rate of $.20 per share, and are secured
by the Company's equity interest in decisioning.com, Inc., which owns the
Company's patent portfolio. The outstanding notes include a note in the
principal amount of $125,000 acquired on June 3, 2002 by the Company's Chief
Executive Officer and a note in the principal amount of $100,000 acquired on
November 5, 2003 by a subsidiary of The South Financial Group, which at the time
owned approximately 12% of the Company's outstanding capital stock. (The South
Financial Group has transferred its stock in the Company to The South Financial
Group Foundation.) The full amount of principal and interest under these notes
generally becomes payable in full on the second anniversary of the date on which
these notes were issued. However, under the terms of the notes, the full amount
of principal and interest under all notes becomes immediately due and payable in
certain events, including bankruptcy or similar proceedings involving the
Company, a default in the payment of principal and interest under any note, or a
change in control of the Company.
On June 2, 2004, notes with a principal amount of $756,336 became due
and payable. Since that time, additional notes with an aggregate principal
amount of $375,000 have matured. Because the Company is currently in default
regarding payment of principal and interest due under certain of the notes, the
full amount of principal and interest outstanding under all notes has become due
and payable. Accordingly, the full amount of principal and accrued interest
under all of these notes is shown as a current liability of the Company as of
September 30, 2005 and December 31, 2004. As of September 30, 2005, and December
31, 2004, the amount of principal and accrued interest outstanding under all of
the notes was $1,545,280 and $1,383,149, respectively.
Under the terms of the note purchase agreement that governs the
Company's convertible note program, the Company previously was not permitted to
issue any additional notes if there was an existing default under any of the
notes. As discussed above, because the Company currently is in default regarding
payment of principal and interest due under certain of the notes, it was not
permitted to issue any additional notes under the note purchase agreement. In
May 2005, the note purchase agreement was amended to remove this provision.
Following this amendment, in May 2005 and August 2005 the Company issued an
additional $75,000 and $45,000, respectively, principal amount of notes.
To remain viable, the Company must generate working capital through the
sale of patent licenses or by raising additional capital. To date, the Company
generally has been unable to enter into licensing agreements with potential
licensees upon terms that are acceptable to the Company. As discussed above, the
Company has been forced to become involved in litigation with alleged
infringers. The Company believes that these lawsuits may take an extended period
of time to complete, and no assurance can be given that the Company will have
the resources necessary to complete these lawsuits or that it will be successful
7
in obtaining a favorable outcome. Moreover, the ongoing reexamination of U. S.
Patent No. 6,105,007 will likely take an extended period of time to complete and
adversely affect the Company's ability to enter into other licensing agreements.
Accordingly, to remain viable it is critical that the Company raise additional
capital. The uncertainties of these litigation matters, the reexamination of U.
S. Patent No. 6,105,007, and other factors affecting the Company's short and
long-term liquidity discussed above have impeded and will likely continue to
impede the Company's ability to raise additional capital. To maintain the
minimal resources necessary to support its current operations, prosecute the
reexamination of U. S. Patent No. 6,105,007, and execute a patent licensing
strategy, the Company does not believe that substantial additional reductions in
its operating expenses are feasible. No assurances can be given that the Company
will be able to raise additional capital or generate working capital from its
patent licensing business.
The Company is a defendant in a lawsuit brought by Temple Ligon, who
claims that the Company breached an agreement to give him a 1% equity interest
in the Company in consideration of services he claims to have performed in 1993
and 1994 in conjunction with the formation of the Company. In January 2004, this
litigation resulted in a jury verdict against the Company of $382,148. Following
this verdict, the Company filed post-trial motions with the trial court in
which, among other things, it claimed that the jury verdict should be set aside.
On July 23, 2004, the trial judge granted the Company's motions, set aside the
jury verdict, and ordered entry of a judgment in favor of the Company. The
plaintiff has appealed the trial judge's ruling to the South Carolina Court of
Appeals. If the Company becomes obligated to pay more than an insignificant
amount of damages in connection with this litigation or if the Company is forced
to retry this case, it will be forced to consider alternatives for winding down
its business, which may include offering its patents for sale or filing for
bankruptcy protection.
There is substantial doubt about the Company's ability to continue as a
going concern. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets or amounts and classification of liabilities that may result from this
uncertainty. However, management believes that any adjustments to reflect the
possible future effects on the recoverability and classification of assets and
amounts of liabilities would not materially change the Company's financial
position.
2. Basis of Presentation
The accompanying unaudited financial statements of the Company have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. The balance sheet at December 31, 2004 has been derived
from the audited consolidated financial statements at that date, but does not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements.
The accompanying unaudited condensed consolidated financial statements
reflect all adjustments (consisting of normal, recurring accruals) which, in the
opinion of management, are necessary for a fair presentation of the results for
the periods shown. The results of operations for such periods are not
necessarily indicative of the results expected for the full year or for any
future period. The accompanying financial statements should be read in
conjunction with the audited consolidated financial statements of the Company
for the year ended December 31, 2004.
In accordance with management's oversight of the Company's operations,
the Company conducts its business in one industry segment - financial services
technology (see Note 7).
3. New Accounting Standards
The following is a summary of recent authoritative pronouncements that
affect accounting, reporting, and disclosure of financial information by the
Company:
In December 2004, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payments (SFAS 123R). This accounting standard, which is effective
for interim and annual periods beginning after January 1, 2006, requires the
recognition of compensation expense related to stock options under SFAS 123. The
United States Securities and Exchange Commission (SEC) announced on April 14,
8
2005 that it approved a phased-in implementation process for SFAS 123R. Under
the new SEC implementation process, the Company's effective date for adopting
SFAS 123R was extended six months. The Company plans to adopt SFAS 123R
prospectively in the first quarter of 2006 with an anticipated impact to
earnings per share of less than $0.01 per share in 2006.
In May 2005, the FASB issued Statement of Financial Accounting
Standards No. 154 (SFAS 154), "Accounting Changes and Error Corrections - a
replacement of APB Opinion No. 20 and FASB Statement No. 3". SFAS 154 requires,
unless impracticable, retrospective application to prior periods' financial
statements of changes in accounting principle. SFAS 154 also requires that
retrospective application of a change in accounting principle be limited to the
direct effects of the change. Indirect effects of a change in accounting
principle should be recognized in the period of the accounting change. The new
standard is effective for accounting changes and corrections of errors made in
fiscal years beginning after December 15, 2005. The Company will adopt the
provisions of SFAS 154, as applicable, beginning in fiscal 2006 and does not
anticipate that the adoption of this standard will have a material effect on the
Company's consolidated results of operations, financial position, or cash flows.
Other accounting standards that have been issued or proposed by the
FASB or other standards-setting bodies that do not require adoption until a
future date are not expected to have a material impact on the Company's
consolidated financial statements upon adoption.
4. Stock Based Compensation
The Company accounts for stock options in accordance with APB Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, no
compensation expense is recognized for stock or stock options issued at fair
value. For stock options granted at exercise prices below the estimated fair
value, the Company records deferred compensation expense for the difference
between the exercise price of the shares and the estimated fair value. The
deferred compensation expense is amortized ratably over the vesting period of
the individual options. For performance based stock options, the Company records
compensation expense related to these options over the performance period.
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock Based Compensation" ("SFAS 123"), as amended by FASB Statements No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure" ("SFAS
148"), provides an alternative to APB 25 in accounting for stock based
compensation issued to employees. SFAS 123 provides for a fair value based
method of accounting for employee stock options and similar equity instruments.
However, for companies that continue to account for stock based compensation
arrangements under APB 25, SFAS 123 requires disclosure of the pro forma effect
on net income and earnings per share as if the fair value based method
prescribed by SFAS 123 had been applied. Until the Company adopts SFAS 123R as
discussed above in Note 1, the Company intends to continue to account for stock
based compensation arrangements under APB No. 25 and has adopted the pro forma
disclosure requirements of SFAS 123.
9
Had compensation cost for options granted under the Company's
stock-based compensation plans been determined based on the fair value at the
grant dates consistent with SFAS 123, the Company's net income and earnings per
share would have changed to the pro forma amounts listed below:
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
------------------------ ------------------------
Net loss:
As reported $ (134,976) $ 242,351 $ (429,931) $ (66,214)
Add: stock-based compensation expense
included in reported net income - - - -
Deduct: stock-based compensation
expense determined under the fair
value based method for all awards (899) (4,402) (5,701) (18,736)
------------------------ ------------------------
Pro forma net loss $ (135,875) $ 237,949 $ (435,632) $ (84,950)
======================== ========================
Net loss per common share:
As reported:
Basic and diluted $ (0.00) $ 0.01 $ (0.01) $ (0.00)
Pro forma:
Basic and diluted $ (0.00) $ 0.01 $ (0.01) $ (0.00)
The pro forma disclosures required by SFAS 123 regarding net loss and
net loss per share are stated as if the Company had accounted for stock options
using fair values. Compensation expense is recognized on a straight-line basis
over the vesting period of each option installment. Using the Black-Scholes
option-pricing model, the fair value at the date of grant for these options was
estimated using the following assumptions: expected volatility, 85% to 142%;
risk free rate of return, 1.99% to 6.60%; dividend yield, 0%; and expected
option life, 3 years.
The Black-Scholes and other option pricing models were developed for
use in estimating fair value of traded options, which have no vesting
restrictions and are fully transferable. In addition, option-pricing models
require the input of highly subjective assumptions. The Company's employee stock
options have characteristics significantly different than those of traded
options, and changes in the subjective assumptions can materially affect the
fair value estimate. Accordingly, in management's opinion, these existing models
may not necessarily provide a reliable single measure of the fair value of
employee stock options.
5. Net Loss Per Share of Common Stock
Net loss per share of Common Stock amounts presented on the face of the
consolidated statements of operations have been computed based on the weighted
average number of shares of Common Stock outstanding in accordance with the SFAS
No. 128, "Earnings Per Share." Stock warrants and stock options were not
included in the calculation of diluted earnings or loss per share because the
Company has either experienced an operating loss in the period presented and,
therefore, the effect would be anti-dilutive or the exercise price of the
potentially dilutive security is greater than the average share price during the
period presented.
6. Convertible Notes
The Company has issued convertible secured notes (the "notes") to
certain investors as part of its capital raising initiatives. As of September
30, 2005, the Company had issued an aggregate of $1,400,336 in principal amount
of notes under this program. The notes bear interest at 8% and are
collateralized by the Company's equity interest in its wholly-owned subsidiary,
decisioning.com. decisioning.com is the Company's patent licensing subsidiary
and owns the Company's patent portfolio. The notes are convertible into the
Company's common stock at a conversion rate of $.20 per share. The Company may
prepay the notes subject to a prepayment penalty of 8% and 4% if the prepayment
occurs within the first twelve months or second twelve months, respectively. The
full amount of principal and interest under the notes generally becomes payable
in full on the second anniversary of the date on which these notes were issued.
10
However, under the terms of the notes, the full amount of principal and interest
under all notes becomes immediately due and payable in certain events, including
bankruptcy or similar proceedings involving the Company, a default in the
payment of principal and interest under any note, or a change in control of the
Company.
On June 2, 2004, notes with a principal amount of $756,336 became due
and payable. Since that time, additional notes with an aggregate principal
amount of $375,000 have matured. Because the Company is currently in default
regarding payment of principal and interest due under certain of the notes, the
full amount of principal and interest outstanding under all notes has become due
and payable. Accordingly, the full amount of principal and accrued interest
under all of these notes is shown as a current liability of the Company as of
September 30, 2005 and December 31, 2004. As of September 30, 2005, and December
31, 2004, the amount of principal and accrued interest outstanding under all of
the notes was $1,545,280 and $1,383,149, respectively.
The notes issued by the Company include a note in the principal amount
of $125,000 issued in 2002 to the Company's Chairman and Chief Executive Officer
and a note in the principal amount of $100,000 issued in 2003 to a subsidiary of
The South Financial Group, which at the time owned approximately 12% of the
Company's outstanding common stock. (The South Financial Group has transferred
its stock in the Company to The South Financial Group Foundation.)
The notes issued by the Company also include a note in the original
principal amount of $205,336 issued in 2002 to AMRO International, S.A. ("AMRO")
in satisfaction of the principal and accrued interest outstanding under a
convertible debenture previously issued to AMRO. To date, AMRO has converted
$124,000 principal amount and $18,081 accrued interest under its note into an
aggregate of 710,407 shares of the Company's common stock.
The contractual maturities of the principal of the Company's 8%
convertible notes are as follows:
September 30, December 31,
Maturity Date 2005 2004
----------------------- -------------------------------
June 2004 $ 706,336 $731,336
March 2005 200,000 200,000
August 2005 25,000 25,000
November 2005 150,000 150,000
December 2005 50,000 50,000
January 2006 25,000 25,000
May 2007 75,000 -
August 2007 45,000 -
-------------- --------------
1,276,336 1,181,336
Less: current portion (1,276,336) (1,181,336)
-------------- --------------
Long-term portion $ - $ -
============== ==============
7. Segment Information
The Company conducts its business within one industry segment -
financial services technology. To date, all revenues generated have been from
transactions with North American customers.
8. Commitments and Contingencies
The Company and its founder, Jeff Norris, are defendants in a lawsuit
filed by Temple Ligon on November 30, 1996 in the Court of Common Pleas for the
County of Richland in Columbia, South Carolina. Mr. Ligon claims, among other
things, that the Company and Mr. Norris breached an agreement to give him a 1%
equity interest in the Company in consideration of services Mr. Ligon claims to
have performed in 1993 and 1994 in conjunction with the formation of the
Company, and seeks monetary damages of $5,463,000. This lawsuit initially
resulted in a jury verdict against the Company of $68,000. However, Mr. Ligon
subsequently requested and was granted a new trial. In January 2004, this
lawsuit resulted in another jury verdict against the Company of $382,148.
Following this verdict, the Company filed post-trial motions with the trial
11
court in which, among other things, it claimed that the jury verdict should be
set aside. On July 23, 2004, the trial judge granted the Company's motions, set
aside the jury verdict, and ordered entry of a judgment in favor of the Company.
Mr. Ligon has appealed the trial judge's ruling to the South Carolina Court of
Appeals. If the Company becomes obligated to pay more than an insignificant
amount of damages in connection with this litigation or if the Company is forced
to retry the case, it will be forced to consider alternatives for winding down
its business, which may include offering its patents for sale or filing for
bankruptcy protection.
The Company is involved in three other lawsuits in which the Company
has alleged infringement by third parties of its patents.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
Statements in this report (including Management's Discussion and
Analysis of Financial Condition and Results of Operations) that are not
descriptions of historical facts, such as statements about the Company's future
prospects and cash requirements, are forward-looking statements and are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Actual results may vary due to risks and uncertainties,
including the Company's very limited capital resources and the possibility that
it may be unable to raise additional capital in amounts sufficient to permit it
to continue operations; the risk that the Company may lose all or part of the
claims covered by its patents as a result of existing and future challenges to
its patents; the risk that its patents may be subject to additional
reexamination by the U.S. Patent and Trademark Office or challenge by third
parties; the possibility that all or some of the holders of the convertible
secured notes issued by the Company may take action to collect the amounts
outstanding under these notes; the result of ongoing litigation; and
unanticipated costs and expenses affecting the Company's cash position. If the
Company is not able to raise additional capital, it will be forced to consider
alternatives for winding down its business, which may include offering its
patents for sale or filing for bankruptcy protection. Moreover, if any holder of
the convertible notes issued by the Company takes action to collect the amounts
owed by the Company under these notes, the Company will be forced to consider
alternatives for winding down its business, which may include offering its
patents for sale or filing for bankruptcy protection. These and other factors
discussed in the Company's filings with the Securities and Exchange Commission,
including the information set forth under the caption "Business Risks" in Item 1
of the Company's Annual Report on Form 10-K for the year ended December 31,
2004, may cause actual results to differ materially from those anticipated.
Overview
Affinity Technology Group, Inc. (the "Company") was formed to develop
and market technologies that enable financial institutions and other businesses
to provide consumer financial services electronically with reduced or no human
intervention. Products and services previously offered by the Company include
its DeciSys/RT(R) loan processing system, which automated the processing and
consummation of consumer financial services transactions; the Affinity Automated
Loan Machine (the ALM), which allowed an applicant to apply for and, if
approved, obtain a loan in as little as ten minutes; the Mortgage ALM, which
allowed an applicant to apply for a mortgage loan; e-xpertLender(R), which
permitted a financial institution to make automated lending decisions through
its call centers and branches; iDEAL, which permitted automobile lenders to make
automobile lending decisions for loan applications originated at automobile
dealers; and rtDS, which permitted lenders to deliver credit decisions to
applicants over the Internet. Due to capital constraints, the Company has
suspended all efforts to further develop, market and operate these products and
services. The Company's last processing contract terminated in late 2002, and
the Company has no plans in the near term to engage in further sales or other
activities related to its products or services, other than to attempt to license
certain of the patents that it owns. Currently, the Company's business
activities consist exclusively of attempting to enter into license agreements
with third parties to license the Company's rights under certain of its patents.
In conjunction with its product development activities, the Company
applied for and obtained three patents. The Company has been granted two patents
covering its fully-automated loan processing systems (U. S. Patents No.
5,870,721 and 5,940,811). In August 2000, the U.S. Patent and Trademark Office
(the "PTO") issued to the Company a patent covering the fully-automated
establishment of a financial account, including credit accounts (U. S. Patent
No. 6,105,007). In addition, in 1997 the Company acquired a patent that covers
the automated processing of an insurance binder through a kiosk (U. S. Patent
No. 5,537,315).
Both of the Company's patents covering fully automated loan processing
systems have been subject to reexamination by the PTO due to challenges to such
patents by third parties. On January 28, 2003, the Company received a
Reexamination Certificate (U. S. Patent No. 5,870,721 C1) from the PTO which
formally concluded the reexamination of U. S. Patent No. 5,870,721. On March 30,
2005, the Company received a Notice of Intent to Issue Ex Parte Reexamination
Certificate from the PTO indicating that the reexamination of its other loan
processing patent (U. S. Patent No. 5,940,811) had been completed. The Company
expects to receive the Reexamination Certificate for this patent in due course.
13
On March 26, 2004, the Company was notified by Federated Department
Stores, Inc. ("Federated") and Ameritrade Holding Corporation ("Ameritrade")
that they had jointly filed a request with the PTO to reexamine U. S. Patent No.
6,105,007. On June 23, 2004, the Company received notification that the PTO had
granted the request for reexamination. The Company has lawsuits pending against
Federated and Ameritrade in the Columbia Division of the United States District
Court for the State of South Carolina (the "Columbia Federal Court") in which it
claims that both Federated and Ameritrade infringe U. S. Patent No. 6,105,007.
The Company has jointly, with Federated and Ameritrade, requested the Columbia
Federal Court to stay the lawsuits against Federated and Ameritrade pending
resolution of the reexamination of U. S. Patent No. 6,105,007. It is likely that
it will take an extended period of time to complete the reexamination
proceedings and the related litigation with Federated and Ameritrade. Moreover,
the reexamination of U. S. Patent No. 6,105,007 has adversely affected the
Company's patent licensing program and impeded its ability to raise additional
capital resources to continue its operations.
In November 2003, Household International, Inc. ("Household") filed a
declaratory judgment action against the Company in the United States District
Court in Wilmington, Delaware (the "Delaware Federal Court"). In its complaint
Household requested the Delaware Federal Court to rule that Household was not
infringing any of the claims of certain of the Company's patents (U.S. Patent
No. 5,870,721 C1, No. 5,940,811, and No. 6,105,007) and that these patents are
not valid. The Company filed counterclaims against Household claiming that
Household infringes U. S. Patent Nos. 5,870,721 C1, 5,940,811 and 6,105,007. The
Company also filed a motion with the Delaware Federal Court to transfer the case
to the Columbia Federal Court. In April 2004, the Delaware Federal Court granted
the Company's motion to transfer the case to Columbia Federal Court. As
discussed above, the PTO has granted the reexamination request filed by
Federated and Ameritrade relating to U. S. Patent No. 6,105,007. The Company
jointly, with Household, requested and received a stay of the Household action
from the Columbia Federal Court pending the resolution of the PTO's
reexamination of U. S. Patent No. 6,105,007.
It is possible that third parties may bring additional actions to
contest all or some of the Company's patents. The Company can make no assurances
that it will not lose all or some of the claims covered by its existing patents.
To date, the Company has generated substantial operating losses and has
been required to use a substantial amount of cash resources to fund its
operations. At September 30, 2005, the Company had cash and cash equivalents of
$15,307. The Company has informal arrangements with certain vendors and officers
under which these vendors and officers have agreed to defer all or part of the
amounts payable to them until the Company has adequate resources to do so. The
Company must raise additional capital to fund accrued operating expenses and
continue its operations. Unless the Company raises additional capital, it will
have to consider alternatives for winding down its business, which may include
offering its patents for sale or filing for bankruptcy protection. Moreover, the
Company currently does not have the resources to repay the principal and accrued
interest outstanding under its convertible secured notes, which have become due
and payable in full as discussed in the following paragraphs. If any holder of
these notes takes action to collect the amounts owed by the Company under these
notes, the Company will be forced to consider alternatives for winding down its
business, which may include offering its patents for sale or filing for
bankruptcy protection.
In 2002 the Company initiated a convertible note program under which it
is authorized to issue up to $1,500,000 principal amount of its notes. To date,
the Company has issued an aggregate of $1,400,336 principal amount of notes
under this program. These notes bear interest at 8%, are convertible into the
Company's common stock at a conversion rate of $.20 per share, and are secured
by the Company's equity interest in decisioning.com, Inc., which owns the
Company's patent portfolio. The outstanding notes include a note in the
principal amount of $125,000 acquired on June 3, 2002 by the Company's Chief
Executive Officer and a note in the principal amount of $100,000 acquired on
November 5, 2003 by a subsidiary of The South Financial Group, which at the time
owned approximately 12% of the Company's outstanding capital stock. (The South
Financial Group has transferred its stock in the Company to The South Financial
Group Foundation.) The full amount of principal and interest under these notes
generally becomes payable in full on the second anniversary of the date on which
these notes were issued. However, under the terms of the notes, the full amount
of principal and interest under all notes becomes immediately due and payable in
certain events, including bankruptcy or similar proceedings involving the
Company, a default in the payment of principal and interest under any note, or a
change in control of the Company.
On June 2, 2004, notes with a principal amount of $756,336 became due
and payable. Since that time, additional notes with an aggregate principal
amount of $375,000 have matured. Because the Company is currently in default
14
regarding payment of principal and interest due under certain of the notes, the
full amount of principal and interest outstanding under all notes has become due
and payable. Accordingly, the full amount of principal and accrued interest
under all of these notes is shown as a current liability of the Company as of
September 30, 2005 and December 31, 2004. As of September 30, 2005, and December
31, 2004, the amount of principal and accrued interest outstanding under all of
the notes was $1,545,280 and $1,383,149, respectively.
Under the terms of the note purchase agreement that governs the
Company's convertible note program, the Company previously was not permitted to
issue any additional notes if there was an existing default under any of the
notes. As discussed above, because the Company currently is in default regarding
payment of principal and interest due under certain of the notes, it was not
permitted to issue any additional notes under the note purchase agreement. In
May 2005, the note purchase agreement was amended to remove this provision.
Following this amendment, in May 2005 and August 2005 the Company issued an
additional $75,000 and $45,000, respectively, principal amount of notes.
To remain viable, the Company must generate working capital through the
sale of patent licenses or by raising additional capital. To date, the Company
generally has been unable to enter into licensing agreements with potential
licensees upon terms that are acceptable to the Company. As discussed above, the
Company has been forced to become involved in litigation with alleged
infringers. The Company believes that these lawsuits may take an extended period
of time to complete, and no assurance can be given that the Company will have
the resources necessary to complete these lawsuits or that it will be successful
in obtaining a favorable outcome. Moreover, the ongoing reexamination of U. S.
Patent No. 6,105,007 will likely take an extended period of time to complete and
adversely affect the Company's ability to enter into other licensing agreements.
Accordingly, to remain viable it is critical that the Company raise additional
capital. The uncertainties of these litigation matters, the reexamination of U.
S. Patent No. 6,105,007, and other factors affecting the Company's short and
long-term liquidity discussed above have impeded and will likely continue to
impede the Company's ability to raise additional capital. To maintain the
minimal resources necessary to support its current operations, prosecute the
reexamination of U. S. Patent No. 6,105,007, and execute a patent licensing
strategy, the Company does not believe that substantial additional reductions in
its operating expenses are feasible. No assurances can be given that the Company
will be able to raise additional capital or generate working capital from its
patent licensing business.
The Company is a defendant in a lawsuit brought by Temple Ligon, who
claims that the Company breached an agreement to give him a 1% equity interest
in the Company in consideration of services he claims to have performed in 1993
and 1994 in conjunction with the formation of the Company. In January 2004, this
litigation resulted in a jury verdict against the Company of $382,148. Following
this verdict, the Company filed post-trial motions with the trial court in
which, among other things, it claimed that the jury verdict should be set aside.
On July 23, 2004, the trial judge granted the Company's motions, set aside the
jury verdict, and ordered entry of a judgment in favor of the Company. The
plaintiff has appealed the trial judge's ruling to the South Carolina Court of
Appeals. If the Company becomes obligated to pay more than an insignificant
amount of damages in connection with this litigation or if the Company is forced
to retry the case, it will be forced to consider alternatives for winding down
its business, which may include offering its patents for sale or filing for
bankruptcy protection.
Critical Accounting Policies
The Company applies certain accounting policies, which are critical to
understanding the Company's results of operations and the information presented
in the condensed consolidated financial statements. The Company considers
critical accounting policies to be those that require more significant judgments
and estimates in the preparation of our financial statements, the most critical
of which pertains to the valuation reserve on net deferred tax assets. The
Company records a valuation allowance to reduce its deferred tax assets to the
amount that it estimates is more likely than not to be realized. As of September
30, 2005 and December 31, 2004, the Company recorded a valuation allowance that
reduced its deferred tax assets to equal its deferred tax liability.
15
Results of Operations
Revenues
Patent license revenue. The Company recognized patent licensing
revenues of $4,411 and $13,235 for the three and nine month periods ended
September 30, 2005, respectively, compared to $4,411 and $263,235 in the
corresponding periods in 2004. During the three and nine month periods ended
September 30, 2005, and September 30, 2004, the Company recognized $4,411 and
$13,235, respectively, related to a three-year license agreement entered into in
2002. Of the revenues recognized during the nine month period ended September
30, 2004, $250,000 was related to a settlement agreement entered into in January
2004 with an institution that formerly maintained a system that permitted
consumers to apply for credit cards over the Internet. These revenues are not
recurring.
Costs and Expenses
Cost of revenues. Cost of revenues for the three and nine month periods
ended September 30, 2005 was $442 and $1,324, respectively, compared to $442 and
$63,824 for the corresponding periods in 2004. Cost of revenues consists of
commissions paid to the Company's patent licensing representatives. The decrease
in cost of revenues during the nine months ended September 30, 2005 compared to
the corresponding period in 2004 is attributable to a settlement agreement
entered into in the first quarter of 2004 for which commissions of $62,500 were
paid to the Company's patent licensing representatives.
General and administrative expenses. General and administrative
expenses totaled $113,912 and $369,418 for the three and nine month periods
ended September 30, 2005, respectively, compared to $142,685 and $599,678 in the
corresponding periods in 2004. The decrease of $28,773 for the three month
period ended September 30, 2005, compared to the same period in 2004 was due
primarily to reduced compensation, legal expenses and rent expenses incurred in
2005 compared to 2004. The decrease of $230,260 for the nine month period ended
September 30, 2005, compared to the same period in 2004 was due primarily to
reduced rent and legal expenses incurred in 2005 as compared to 2004. The
reduction in legal expenses was primarily attributable to the expenses
associated with the Temple Ligon trial of approximately $175,000 incurred in
early 2004 which were nonrecurring in 2005.
Interest expense. Interest expense for the three and nine month periods
ended September 30, 2005, was $25,118 and $72,570, respectively, compared to
$24,126 and $72,335 for the corresponding periods in 2004. Interest expense is
related to the Company's convertible notes which accrue interest at 8%.
Convertible note principal outstanding at September 30, 2005, December 31, 2004,
and September 30, 2004 totaled $1,276,336, $1,181,336, and $1,206,336,
respectively.
Litigation accrual reversal. The Company has been a defendant in a
lawsuit which resulted in a jury verdict against the Company of $382,148 in
January 2004. The Company recorded a reserve for the estimated loss in this
litigation of $386,148 in the fourth quarter of 2003 as a result of the jury
verdict. In July 2004 the trial judge ruled on post-trial motions submitted by
the Company and set aside the jury verdict.
Liquidity and Capital Resources
The Company has generated net losses of $69,107,963 since its inception
and has financed its operations primarily through net proceeds from its initial
public offering in May 1996 and cash generated from operations and other
financing transactions. Net proceeds from the Company's initial public offering
were $60,088,516.
To date, the Company has generated substantial operating losses and has
been required to use a substantial amount of cash resources to fund its
operations. At September 30, 2005, the Company had cash and cash equivalents of
$15,307. The Company has informal arrangements with certain vendors and officers
under which these vendors and officers have agreed to defer all or part of the
amounts payable to them until the Company has adequate resources to do so. The
Company must raise additional capital to fund accrued operating expenses and
continue its operations. Unless the Company raises additional capital, it will
have to consider alternatives for winding down its business, which may include
offering its patents for sale or filing for bankruptcy protection. Moreover, the
Company currently does not have the resources to repay the principal and accrued
interest outstanding under its convertible secured notes, which have become due
and payable in full as discussed in the following paragraphs. If any holder of
these notes takes action to collect the amounts owed by the Company under these
notes, the Company will be forced to consider alternatives for winding down its
business, which may include offering its patents for sale or filing for
bankruptcy protection.
16
In 2002 the Company initiated a convertible note program under which it
is authorized to issue up to $1,500,000 principal amount of its notes. To date,
the Company has issued an aggregate of $1,400,336 principal amount of notes
under this program. These notes bear interest at 8%, are convertible into the
Company's common stock at a conversion rate of $.20 per share, and are secured
by the Company's equity interest in decisioning.com, Inc., which owns the
Company's patent portfolio. The outstanding notes include a note in the
principal amount of $125,000 acquired on June 3, 2002 by the Company's Chief
Executive Officer and a note in the principal amount of $100,000 acquired on
November 5, 2003 by a subsidiary of The South Financial Group, which at the time
owned approximately 12% of the Company's outstanding capital stock. (The South
Financial Group has transferred its stock in the Company to The South Financial
Group Foundation.) The full amount of principal and interest under these notes
generally becomes payable in full on the second anniversary of the date on which
these notes were issued. However, under the terms of the notes, the full amount
of principal and interest under all notes becomes immediately due and payable in
certain events, including bankruptcy or similar proceedings involving the
Company, a default in the payment of principal and interest under any note, or a
change in control of the Company.
On June 2, 2004, notes with a principal amount of $756,336 became due
and payable. Since that time, additional notes with an aggregate principal
amount of $375,000 have matured. Because the Company is currently in default
regarding payment of principal and interest due under certain of the notes, the
full amount of principal and interest outstanding under all notes has become due
and payable. Accordingly, the full amount of principal and accrued interest
under all of these notes is shown as a current liability of the Company as of
September 30, 2005 and December 31, 2004. As of September 30, 2005, and December
31, 2004, the amount of principal and accrued interest outstanding under all of
the notes was $1,545,280 and $1,383,149, respectively.
Under the terms of the note purchase agreement that governs the
Company's convertible note program, the Company previously was not permitted to
issue any additional notes if there was an existing default under any of the
notes. As discussed above, because the Company currently is in default regarding
payment of principal and interest due under certain of the notes, it was not
permitted to issue any additional notes under the note purchase agreement. In
May 2005, the note purchase agreement was amended to remove this provision.
Following this amendment, in May 2005 and August 2005 the Company issued an
additional $75,000 and $45,000, respectively, principal amount of notes.
To remain viable, the Company must generate working capital through the
sale of patent licenses or by raising additional capital. To date, the Company
generally has been unable to enter into licensing agreements with potential
licensees upon terms that are acceptable to the Company. As discussed above, the
Company has been forced to become involved in litigation with alleged
infringers. The Company believes that these lawsuits may take an extended period
of time to complete, and no assurance can be given that the Company will have
the resources necessary to complete these lawsuits or that it will be successful
in obtaining a favorable outcome. Moreover, the ongoing reexamination of U. S.
Patent No. 6,105,007 will likely take an extended period of time to complete and
adversely affect the Company's ability to enter into other licensing agreements.
Accordingly, to remain viable it is critical that the Company raise additional
capital. The uncertainties of these litigation matters, the reexamination of U.
S. Patent No. 6,105,007, and other factors affecting the Company's short and
long-term liquidity discussed above have impeded and will likely continue to
impede the Company's ability to raise additional capital. To maintain the
minimal resources necessary to support its current operations, prosecute the
reexamination of U. S. Patent No. 6,105,007, and execute a patent licensing
strategy, the Company does not believe that substantial additional reductions in
its operating expenses are feasible. No assurances can be given that the Company
will be able to raise additional capital or generate working capital from its
patent licensing business.
Net cash used during the nine months ended September 30, 2005, to fund
operations was approximately $168,000, compared to approximately $444,000 used
to fund operations for the same period in 2004. The decrease in cash used to
fund operations in the first nine months of 2005 primarily reflects increased
deferral in the payment of certain operating expenses, which is reflected as an
increase in accounts payable and accrued expenses on the September 30, 2005
balance sheet compared to the December 31, 2004 balances, and a reduction in
prepaid expenses during 2005. At September 30, 2005 cash and liquid investments
were $15,307, as compared to $62,756 at December 31, 2004. At September 30, 2005
working capital was a deficit of $1,919,038 as compared to a deficit of
$1,524,772 at December 31, 2004.
17
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company does not believe that its current business exposes it to
significant market risk for changes in interest rates.
Item 4. Controls and Procedures
The Company has carried out an evaluation, under the supervision and
with the participation of the Company's Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures as defined in Rule 13a-15 of the
Securities Exchange Act of 1934 (the "Exchange Act"). Based upon that
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were effective
as of September 30, 2005, in recording, processing, summarizing and reporting
information required to be disclosed by the Company (including consolidated
subsidiaries) in the Company's Exchange Act filings.
There were no changes in the Company's internal controls over financial
reporting that occurred during the Company's most recent fiscal quarter that
materially affected, or are reasonably likely to materially affect, the
Company's internal controls over financial reporting.
Part II. Other Information
Items 4 and 5 are not applicable.
Item 1. Legal Proceedings
The Company and its founder, Jeff Norris, are defendants in a lawsuit
filed by Temple Ligon on November 30, 1996 in the Court of Common Pleas for the
County of Richland in Columbia, South Carolina. Mr. Ligon claims, among other
things, that the Company and Mr. Norris breached an agreement to give him a 1%
equity interest in the Company in consideration of services Mr. Ligon claims to
have performed in 1993 and 1994 in conjunction with the formation of the
Company, and seeks monetary damages of $5,463,000. This lawsuit initially
resulted in a jury verdict against the Company of $68,000. However, Mr. Ligon
subsequently requested and was granted a new trial. In January 2004, this
lawsuit resulted in another jury verdict against the Company of $382,148.
Following this verdict, the Company filed post-trial motions with the trial
court in which, among other things, it claimed that the jury verdict should be
set aside. On July 23, 2004, the trial judge granted the Company's motions, set
aside the jury verdict, and ordered entry of a judgment in favor of the Company.
Mr. Ligon has appealed the trial judge's ruling to the South Carolina Court of
Appeals. If the Company becomes obligated to pay more than an insignificant
amount of damages in connection with this litigation or if the Company is forced
to retry the case, it will be forced to consider alternatives for winding down
its business, which may include offering its patents for sale or filing for
bankruptcy protection.
In June 2003, the Company filed a lawsuit against Federated Department
Stores, Inc., and certain of its subsidiaries ("Federated") alleging that
Federated has infringed one of the Company's patents (U. S. Patent No.
6,105,007). In September 2003, the Company filed a similar lawsuit against
Ameritrade Holding Corporation and its subsidiary, Ameritrade, Inc.
("Ameritrade"), alleging infringement of the same patent. Both lawsuits were
filed in the United States District Court in Columbia, South Carolina ("Columbia
Federal Court"), and both seek unspecified damages. On March 26, 2004, the
Company was notified by Federated and Ameritrade that they had jointly filed a
request with the PTO to reexamine U. S. Patent No. 6,105,007. On June 23, 2004,
the Company received notification that the PTO had granted the request for
reexamination. The Company has jointly, with Federated and Ameritrade, requested
the Columbia Federal Court to stay the lawsuits against Federated and Ameritrade
pending resolution of the reexamination of U. S. Patent No. 6,105,007. It is
likely that it will take an extended period of time to complete the
reexamination proceedings and the related litigation with Federated and
Ameritrade. Moreover, the reexamination of U. S. Patent No. 6,105,007 will
likely have a material adverse effect on the Company's patent licensing program
and its ability to attract additional capital resources in order to continue its
operations.
18
In November 2003, Household International, Inc. ("Household") filed a
declaratory judgment action against the Company in United States District Court
in Wilmington, Delaware (the "Delaware Federal Court"). In its complaint
Household requested the Delaware Federal Court to rule that Household was not
infringing any of the claims of certain of the Company's patents (U.S. Patent
No. 5,870,721 C1, No. 5,940,811, and No. 6,105,007) and that these patents are
not valid. The Company filed counterclaims against Household claiming that
Household infringes U. S. Patent Nos. 5,870,721 C1, 5,940,811 and 6,105,007. The
Company also filed a motion with the Delaware Federal Court to transfer the case
to the Columbia Federal Court. In April 2004, the Delaware Federal Court granted
the Company's motion to transfer the case to Columbia Federal Court. As
discussed previously, the PTO has granted the reexamination request filed by
Federated and Ameritrade relating to U. S. Patent No. 6,105,007. The Company
jointly, with Household, requested and received a stay of the Household action
from the Columbia Federal Court pending the resolution of the PTO's
reexamination of U. S. Patent No. 6,105,007.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) On August 12, 2005, the Company issued $45,000 principal amount of
its convertible secured notes to an accredited investor for cash
in a transaction exempt from registration pursuant to Rule 506 of
Regulation D and Section 4(2) of the Securities Act of 1933. These
notes are convertible into shares of common stock of the Company
at a price of $0.20 per share.
(b) Not applicable.
(c) Not applicable.
Item 3. Defaults Upon Senior Securities
In 2002 the Company initiated a convertible note program under which it
is authorized to issue up to $1,500,000 principal amount of its notes. To date,
the Company has issued an aggregate of $1,400,336 principal amount of
convertible secured notes under this program. These notes bear interest at 8%,
are convertible into the Company's common stock at a conversion rate of $.20 per
share, and are secured by the Company's equity interest in decisioning.com,
Inc., which owns the Company's patent portfolio. The full amount of principal
and interest under these notes generally becomes payable in full on the second
anniversary of the date on which these notes were issued. However, under the
terms of the notes, the full amount of principal and interest under all notes
becomes immediately due and payable in certain events, including bankruptcy or
similar proceedings involving the Company, a default in the payment of principal
and interest under any note, or a change in control of the Company.
On June 2, 2004, notes with a principal amount of $756,336 became due
and payable. Since that time, additional notes with an aggregate principal
amount of $375,000 have matured. Because the Company is currently in default
regarding payment of principal and interest due under certain of the notes, the
full amount of principal and interest outstanding under all notes has become due
and payable. Accordingly, the full amount of principal and accrued interest
under all of these notes is shown as a current liability of the Company as of
September 30, 2005 and December 31, 2004. As of the date of this report, the
amount of principal and accrued interest outstanding under all of the notes was
$1,558,043.
If any holder of these notes takes action to collect the amounts owed
by the Company under these notes, the Company will be forced to consider
alternatives for winding down its business, which may include offering its
patents for sale or filing for bankruptcy protection.
19
Item 6. Exhibits
Exhibit Number Description
3.1 Certificate of Incorporation of Affinity Technology Group,
Inc., which is hereby incorporated by reference to Exhibit
3.1 to the Registration Statement on Form S-1 of Affinity
Technology Group, Inc. (File No. 333-1170).
3.2 Bylaws of Affinity Technology Group, Inc., which is hereby
incorporated by reference to Exhibit 3.2 to the Registration
Statement on Form S-1 of Affinity Technology Group, Inc.
(File No. 333-1170).
4 Letter Agreement, dated April 4, 2005, between Affinity
Technology Group, Inc. and the holders of a majority of the
outstanding principle amount of the 8% Convertible Secured
Notes.
31 Rule 13a-14(a) / 15d-14(a) Certifications
32 Section 1350 Certifications
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Affinity Technology Group, Inc.
By: /s/ Joseph A. Boyle
-------------------
Joseph A. Boyle
Chairman, President, Chief Executive Officer and Chief Financial Officer
(principal executive and financial officer)
Date: November 14, 2005
20