As filed with the Securities and Exchange Commission on September 15, 2006
Registration No. 333-128039
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
Form SB-2/A
Amendment No. 3
Registration Statement Under The Securities Act of 1933
DIRECT INSITE CORP.
-------------------
( Name of small business issuer as specified in its charter)
Delaware 7373 11-2895590
------------- ---- -----------
(State or other Jurisdiction (Primary Standard Industrial (IRS Employer
of Incorporation or Classification Code Number) Identification
Organization) Number)
80 Orville Drive, Bohemia, New York 11716 (631) 873-2900
(Address and Telephone Number of Principal Executive Offices)
80 Orville Drive, Bohemia, New York 11716 (631) 873-2900
(Address of Principal Place of Business or Intended Principal Place of Business)
James A. Cannavino
80 Orville Drive
Bohemia, New York 11716 (631) 873-2900
(Name, Address and Telephone Number of Agent for Service)
Copies to:
David H. Lieberman, Esq.
Beckman, Lieberman & Barandes, LLP
100 Jericho Quadrangle, Suite 329
Jericho, New York 11753
(516) 433-1200
(516) 433-5858 Facsimile
Approximate Date of Proposed Sale to the Public: As soon as practicable after
this Registration Statement becomes effective.
If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering [ ].
If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering [ ].
If this form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering [ ].
If delivery of the prospectus is expected to be made pursuant to Rule 434, check
the following box [ ].
CALCULATION OF REGISTRATION FEE
======================================= ================= ===================== ======================== ======================
Proposed Maximum Proposed Maximum
Title of Each Class of Amount to be Offering Price Per Aggregate Offering Amount of
Securities to be Registered (1) Registered(1) Security(2) Price (2) Registration Fee (4)
- --------------------------------------- ----------------- --------------------- ------------------------ ----------------------
Common Stock, $0.0001 par value,
issuable upon exercise of Common
Stock Purchase Warrants dated
March 29, 2005 (3) 750,000 $0.72 $540,000.00 $57.78
- --------------------------------------- ----------------- --------------------- ------------------------ ----------------------
Common Stock, $0.0001 par value,
issuable upon exercise of Common
Stock Purchase Warrants dated July
12, 2005 (3) 250,000 $0.72 $180,000.00 $19.26
- --------------------------------------- ----------------- --------------------- ------------------------ ----------------------
Total 1,000,000 $720,000.00 $77.04
======================================= ================= ===================== ======================== ======================
<FN>
(1) Relates to the resale of these shares of common stock by certain selling
security-holders.
(2) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(c) under the Securities Act of 1933, as amended (the
"Securities Act"). Pursuant to Rule 457(c) under the Securities Act, the
proposed maximum offering price of each share of the Registrant's common
stock is estimated to be the average of the high and low sales price of a
share as of a date five business days before the filing of this
registration statement. Accordingly, the Registrant has used $0.72 as such
price per share, which is the average of the high and low of $0.72 reported
by the OTC Bulletin Board on August 30, 2005.
(3) Pursuant to Rule 416 under the Securities Act, this registration statement
also relates to such indeterminate number of shares of common stock as may
become issuable by reason of stock splits, stock dividends, anti-dilution
adjustments and similar transactions in accordance with the provisions of
the common stock purchase warrants.
(4) The Registrant previously paid $91.53 for the registration fee on September
1, 2005.
</FN>
We hereby amend this Registration Statement on such date or dates as may be
necessary to delay its effective date until we have filed a further amendment
which specifically states that this Registration Statement shall thereafter
become effective in accordance with Section 8(a) of the Securities Act of 1933,
as amended, or until this Registration Statement shall become effective on such
date as the Commission, acting pursuant to said Section 8(a), may determine.
The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell or a solicitation of an offer to buy these securities in any state where
the offer is not permitted.
SUBJECT TO COMPLETION, DATED SEPTEMBER 15, 2006
Preliminary Prospectus
1,000,000 Shares
DIRECT INSITE CORP.
Common Stock
This prospectus relates to the resale shares of common stock of Direct
Insite Corp. by certain of our security-holders, referred to as selling
security-holders throughout this document. The selling security-holders are
offering to sell up to 1,000,000 shares of our common stock. We will not receive
any proceeds from the resale of shares by the selling security-holders, which
include:
up to 750,000 shares are issuable upon the exercise of our common
stock purchase warrants dated March 29, 2005
up to 250,000 shares are issuable upon the exercise of our common
stock purchase warrants dated July 12, 2005
All of the shares being offered by this prospectus are being offered by the
selling security-holders named in this prospectus. This offering is not being
underwritten. We will not receive any of the proceeds from the sale of the
shares of our common stock in this offering. If the March 29, 2005 warrants are
exercised so that the underlying shares may be sold, we will receive the
exercise price of the warrants, which is $.01 per share. If the July 12, 2005
warrants are exercised so that the underlying shares may be sold, we will
receive the exercise price of the warrants, which is $1.00 per share. There can
be no assurance, however, that all or any of the warrants will be exercised. The
selling security-holders identified in this prospectus, or their pledgees,
donees, transferees or other successors-in-interest, may offer the common stock
or interests therein from time to time through public or private transactions at
prevailing market prices, at prices related to prevailing market prices, or at
privately negotiated prices. We will pay all expenses of registering this
offering of securities.
The common stock is traded in the over-the-counter market and prices are
quoted on the over-the-counter Bulletin Board under the symbol "DIRI.OB." On
August 28, 2006 the closing price per share of our common stock was $.25. Except
under certain circumstances, the selling security-holders will sell the shares
from time to time through independent brokerage firms in the over-the-counter at
market prices prevailing at the time of sale.
INVESTING IN OUR COMMON STOCK INVOLVES RISK. SEE "RISK FACTORS" BEGINNING ON
PAGE 4.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS
APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR
ADEQUACY OF THE PROSPECTUS. ANY REPRESENTATIONS MADE TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is ___________ , 2006.
Table of Contents
SUMMARY 3
RISK FACTORS 4
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS 7
USE OF PROCEEDS 8
SELLING SECURITY-HOLDERS 8
PLAN OF DISTRIBUTION 9
LEGAL PROCEEDINGS 11
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS 11
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 13
DESCRIPTION OF SECURITIES 15
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT
LIABILITIES 17
DESCRIPTION OF BUSINESS 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION 28
DESCRIPTION OF PROPERTY 43
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 43
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 44
EXECUTIVE COMPENSATION 46
EXPERTS 48
LEGAL MATTERS 48
WHERE YOU CAN FIND MORE INFORMATION 48
You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with different information. We are not
making an offer of these securities in any state where the offer is not
permitted. You should not assume that the information contained in this
prospectus is accurate as of any date other than the date on the front of this
prospectus.
2
SUMMARY
This summary highlights information contained elsewhere in the prospectus.
You should read the entire prospectus carefully; especially the risks of
investing in the securities discussed under "Risk Factors" and the financial
statements and related notes included elsewhere in this prospectus before
deciding to invest in our common stock.
Our Company
Direct Insite Corp. was organized under the name Unique Ventures, Inc.
under the laws of the State of Delaware on August 27, 1987. In August, 2000, we
changed our name to Direct Insite Corp. which the Board of Directors believed
was more in line with our business plans. Our principal executive offices are
located at 80 Orville Drive, Bohemia, New York. Our telephone number is (631)
873-2900. Unless the context requires otherwise, all references to "we," "our,"
"us," "company," "registrant," "Direct Insite" or "management" refers to Direct
Insite Corp. and its subsidiaries.
We primarily operate as an application service provider ("ASP"), providing
an integrated transaction based "fee for service" offering called Invoices
On-Line (IOL), an electronic invoice presentment and payment (EIP&P) service
that processes high volumes of transactional data for invoice presentment
purposes delivered via the Internet on a global basis on behalf of our
customers. IOL is our primary offering and it is a globally delivered service
that provides electronic invoice presentation in the Americas, Europe and Asia,
including 28 different countries around the globe and in more than 13 languages
and currencies. We currently host several million invoices that are accessible
"on-line" via the Internet 24 hours per day, seven days per week, 365 days per
year. IOL is a uniquely positioned service offering in the industry. The service
is designed to handle the complex invoicing found in today's global business
environment. The solution allows Global 1000 companies to receive, route,
approve and pay invoices on-line in the local language and currency. By
automating the traditional paper-based invoicing process, customers now have
easy and quick access to line-item billing information, reporting and analytics.
With the enhanced level of accuracy provided by IOL, invoice disputes are
greatly reduced and overall customer satisfaction is substantially increased.
We also provide Custom Engineering Services which are single contractual
agreements involving modification or customization of the Company's proprietary
ASP software solution. Additionally, we provide service offerings in the form of
our patented dbExpressTM technology, a management information tool that allows
users to visually data mine large volumes of transactional data via the
Internet. A complete Internet Customer Care tool set integrated with the EIP&P
product set is also available. We operate fully redundant data centers located
at our main office in Bohemia, N.Y. and in Newark, NJ. Our facility in New
Jersey is space leased at an International Business Machines ("IBM"), e-business
Hosting Center. This co-location / redundancy feature enables us to offer
virtually down time free service.
This suite of services enables us to provide a comprehensive Internet
delivered service from the raw transaction record through all of the internal
workflow management processes including an electronically delivered invoice with
customer analytics. This comprehensive service offering provides back office
operations, reduces our customers' costs and provides for improved customer
service by providing the end customer with easy access to all of the detailed
information about their bill.
Currently, IBM, our largest customer, representing approximately 66.8% and
69.0% of revenue for the three and six month periods ended June 30, 2006,
respectively and 66.2% and 69.9% of our revenue for the three and six month
periods ended June 30, 2005, respectively, utilizes our suite of IOL products
and services to allow their customers from around the globe to receive, analyze,
dispute and cost allocate all of their invoice related information in their
local language and currency via the Internet 24 hours a day, 7 days a week, 365
days a year. IBM accounted for 68% and 92% of our revenue for the years ended
3
December 31, 2005 and 2004, respectively. Our second Fortune 500 Company,
Electronic Data Systems Corp. ("EDS"), accounted for approximately 30.9% and
28.8% of revenue for the three and six month periods ended June 30, 2006,
respectively and 30.4% and 27.6% of revenue for the three and six month periods
ended June 30, 2005, respectively. EDS accounted for 28% and 7% of revenue for
the years ended December 31, 2005 and 2004, respectively.
The Offering
The selling security-holders may offer and sell up to 1,000,000 shares of
common stock, an amount equal to 20.1% of our currently outstanding common
stock. For a list of selling security-holders and the amount of shares that each
of them expects to sell, see "Selling Security-holders."
The offering is made by the selling security-holders for their benefit. We
will not receive any of the proceeds of their sale of common stock.
RISK FACTORS
You should carefully consider the factors described below and other
information contained in this prospectus. The risks and uncertainties described
below are not the only ones we face. Additional risks and uncertainties not
presently known to us, which we currently deem immaterial or which are similar
to those faced by other companies in our industry or business in general, may
also impair our business operations. If any of the following risks actually
occurs, our business, financial condition or results of operations could be
materially and adversely affected. In such case, the trading price of our common
stock could decline, and you may lose all or part of your investment. This
prospectus also contains forward-looking statements that involve risks and
uncertainties. Please refer to "Special Note Regarding Forward-Looking
Statements" included elsewhere in this prospectus.
Historically, our operations have not been profitable and we cannot guarantee
that they will become profitable in the future.
For the years ended December 31, 2005 and 2004, we sustained net losses of
$991,000, and $1,283,000, respectively. For the six months ended June 30, 2006
we had a net loss of $307,000. We continue to sustain losses in the current
fiscal year, and we cannot guarantee that we will achieve profitability in the
future.
We may not be able to obtain funds necessary for the ongoing operation of our
business on terms which are acceptable to us.
At June 30, 2006, we had a working capital deficit of $5,022,000. Based on
our current levels of operations and commitments, we believe we will need to
generate positive cash flows from operations in order to decrease our dependence
on outside financing. If we do not generate sufficient cash flow from
operations, adequate funds for us to operate our business on terms which we find
acceptable, whether equity financing, debt financing or from other sources, may
not be available when we need it and may result in significant dilution to our
existing security-holders. We have no additional bank or other credit facility
or other readily available access to debt financing. If we are unable to secure
additional funding when needed, we may be forced to decrease or eliminate
certain current or expansion activities. Ultimately, our inability to obtain
sufficient funds from operations or external sources would have a material
adverse effect on our financial condition and viability.
4
The large number of shares available for future sale may adversely effect the
market price of our stock.
We have 4,967,701 shares of common stock outstanding as of August 28, 2006,
of which approximately 2,500,000 shares are freely tradable. We also have
9,162,988 shares issuable upon the conversion of preferred stock, exercise of
options and exercise of warrants. If all of our outstanding options, warrants
and convertible securities were exercised or converted, we would have 14,130,689
shares outstanding. The issuance of such a large number of shares could have a
significant adverse effect on the market for, as well as the price of, our
common stock. A decline in the market price also may make the terms of future
financings using our common stock or using convertible debt more burdensome.
Our planned growth may cause a strain on our management and other resources.
We are pursuing a business strategy that has involved and is expected to
continue to involve significant growth over at least the next twelve months. We
cannot guarantee that we will be able to achieve our planned growth.
Accomplishing our objectives will depend upon a number of factors, including our
ability to develop products internally with emphasis on the exploitation of our
IOL products and dbExpress products. We may also incur development, acquisition
or expansion costs that represent a higher percentage of total revenues than
larger or more established companies, which may adversely affect our results of
operations.
We may not be able to compete favorably in the competitive information solutions
industry.
The market for our information solutions is intensely competitive. We face
competition from a broad range of competitors, many of whom have greater
financial, technical and marketing resources than we do. There can be no
assurance that we will be able to compete effectively with such entities.
Our operations are dependent upon key management personnel.
We believe that our continued success depends to a significant extent upon
the efforts and abilities of our senior management. In particular, the loss of
James Cannavino, our Chairman and Chief Executive Officer, or any of our other
executive officers or senior managers, could have a material adverse effect on
our business.
Two customers account for a significant percentage of our revenue.
We have two customers that accounted for approximately 97% and 99% of our
revenue for the years ended December 31, 2005 and 2004, respectively and 98% of
revenue for the six months ended June 30, 2006. The loss of either of these
customers would have a material adverse effect on our business, financial
condition and results of operations.
Our success depends upon protecting our intellectual property.
The computer software industry is characterized by extensive use of
intellectual property protected by copyright, patent and trademark laws. While
we believe that we do not infringe on the intellectual property rights of any
third parties in conducting our business, any allegations of infringement, or
disputes or litigations relating to infringement, could have a material adverse
affect on our business, financial condition and results of operations. If we
cannot prevent third parties from using our proprietary technology without our
consent or without compensating us for the use of the technology, we believe
that it could adversely effect our ability to compete. We cannot guarantee that
our patents and copyrights will effectively protect us from any copying or
emulation of our products in the future.
5
Our common stock is quoted on the OTC Bulletin Board, which may limit the
liquidity and price of those securities more than if our securities were quoted
or listed on the NASDAQ Stock Market or a national exchange.
Our common stock is currently quoted and traded on the OTC Bulletin Board
("OTCBB"), an NASD-sponsored and operated inter-dealer automated quotation
system for equity securities not included in the NASDAQ Stock Market or national
exchange. Quotation of our securities on the OTC Bulletin Board may limit the
liquidity and price of our securities more than if our securities were quoted or
listed on the NASDAQ Stock Market or a national exchange. Some investors may
perceive our securities to be less attractive because they are traded in the
over-the-counter market. Institutional and other investors may have investment
guidelines that restrict or prohibit investing in securities traded in the
over-the-counter market. The factors may have an adverse impact on the trading
and price of our securities.
Trading in our common stock has been limited, so investors may not be able
to sell as many of their shares as they want at prevailing prices.
The average daily volume of trading in our common stock for the three month
period ended August 31, 2006 was 4,617 shares. If limited trading in our common
stock continues, it may be difficult for investors who purchase shares of common
stock to sell such shares in the public market at any given time at prevailing
prices. Also, the sale of a large block of our common stock could depress the
market price of our common stock to a greater degree than a company that
typically has a higher volume of trading of its securities.
We cannot predict whether an active market for our common stock will
develop in the future. In the absence of an active trading market:
o Investors may have difficulty buying and selling or obtaining market
quotations;
o Market visibility for our common stock may be limited; and
o Lack of visibility for our common stock may have a depressive effect
on the market price for our common stock.
Our common stock is subject to the SEC's penny stock rules, broker-dealers may
experience difficulty in completing customer transactions and trading activity
in our securities may be severely limited.
Currently, we have net tangible assets less than $5,000,000 and our common
stock has a market price per share of less than $5.00. Therefore, transactions
in our common stock are subject to the "penny stock" rules promulgated under the
Securities Exchange Act of 1934. Under these rules, broker-dealers who recommend
such securities to persons other than institutional investors:
o Must make a special written suitability determination for the
purchaser;
o Receive the purchaser's written agreement to a transaction prior to
sale;
o Provide the purchaser with risk disclosure documents which identify
risks associated with investing in "penny stocks" and which describe
the market for these "penny stocks" as well as a purchaser's legal
remedies; and
o Obtain a signed and dated acknowledgment from the purchaser
demonstrating that the purchaser has actually received the required
risk disclosure document before a transaction in a "penny stock" can
be completed.
6
As a result of these requirements, broker-dealers may find it difficult
to effectuate customer transactions and trading activity in our stock will be
significantly limited. Accordingly, the market price of our stock and other
publicly traded securities may be depressed, and it may be more difficult to
sell our shares.
Our stock price may be volatile.
The stock market in general and the market for shares of technology
companies in particular, have experienced extreme price fluctuations, often
unrelated to the operating performance of the affected companies. Many
technology companies, including us, have experienced dramatic volatility in the
market prices of their common stock. If our future operating results are below
the expectations of stock market analysts and investors, our stock price may
decline. We cannot be certain that the market price of our common stock will
remain stable in the future. Our stock price may undergo fluctuations that are
material, adverse and unrelated to our performance.
Our charter provisions and statutory law may inhibit changes in control of our
company.
Our certificate of incorporation and bylaws contain provisions which may
discourage takeover attempts and hinder a merger, tender offer or proxy contest
targeting us, including transactions in which security-holders might receive a
premium for their shares. This may limit your ability as a stockholder to
approve a transaction that you may think is in your best interests. These
provisions could reduce the price that certain investors might be willing to pay
in the future for shares of common stock or preferred stock. Moreover, although
our ability to issue preferred stock may provide flexibility in connection with
possible acquisitions and other corporate purposes, such issuance may make it
more difficult for a third party to acquire, or may discourage a third party
from acquiring, a majority of our voting stock. Furthermore, we may in the
future adopt other measures that may delay, defer or prevent a change in
control. We may adopt some of these measures without any further vote or action
by security-holders.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
All statements other than statements of historical fact included in this
prospectus including, without limitation, statements under, "Management's
Discussion and Analysis or Plan of Operation" regarding our financial position,
business strategy and the plans and objectives of management for future
operations, are forward-looking statements. When used in this prospectus, words
such as "anticipate," "believe," "estimate," "expect," "intend" and similar
expressions, as such words or expressions relate to us or our management,
identify forward-looking statements. Such forward - looking statements are based
on the beliefs of management, as well as assumptions made by, and information
currently available to, our management. Actual results could differ materially
from those contemplated by the forward-looking statements as a result of certain
factors including but not limited to, fluctuations in future operating results,
technological changes or difficulties, management of future growth, expansion of
international operations, the risk of errors or failures in our software
products, dependence on proprietary technology, competitive factors, risks
associated with potential acquisitions, the ability to recruit personnel, and
the dependence on key personnel. Such statements reflect the current views of
management with respect to future events and are subject to these and other
risks, uncertainties and assumptions relating to the operations, results of
operations, growth strategy and liquidity. All subsequent written and oral
forward-looking statements attributable to us or persons acting on our behalf
are expressly qualified in their entirety by this paragraph.
7
USE OF PROCEEDS
This prospectus relates to shares of our common stock that may be offered
and sold from time to time by the selling security-holders. We will not receive
any of the proceeds from the sale of shares of common stock in this offering. If
the selling security-holders exercise their warrants, we will receive the
exercise price of the warrants, which is currently $0.01 per share for the
warrants dated March 29, 2005 (750,000 warrants) and $1.00 per share for the
warrants dated July 12, 2005 (250,000 warrants). We intend to use the net
proceeds from the exercise of the warrants for our general working capital
needs. There can be no assurance that all, or any, of the warrants will be
exercised.
SELLING SECURITY-HOLDERS
On March 29 2005 we entered into a Securities Purchase Agreement with Sigma
Opportunity Fund LLC ("Sigma") and Metropolitan Venture Partners II, L.P.
("MetVP"), collectively the "Buyers", whereby the Buyers purchased Senior
Subordinated Secured notes (the "Note Purchase") in the aggregate amount of
$750,000. The notes bear interest at the rate of five percent (5%) per year
beginning June 28, 2005 and mature on the earlier to occur of (i) September 29,
2006; (ii) the date on which demand for payment of the Grid Demand Promissory
Note, dated as of June 27, 2005 payable to JPMorgan Chase Bank is made, and
(iii) the due date of the loan payment to JPMorgan Chase Bank pursuant to such
Grid Demand Promissory Note, including if due on demand and whether or not
demand for payment is actually made. Interest is payable in cash or shares of
our common stock, at the Buyer's election. In the event we do not approve the
payment of interest by issuing shares in lieu of cash and do not pay the cash by
the interest payment date, we must issue shares of common stock. The number of
shares to be issued is determined by dividing the average price per share of our
common stock for the ten (10) trading days immediately preceding an interest
payment date into the dollar amount of interest which would have been payable if
paid in cash. The first interest payment date was October 31, 2005. In
connection with the Note Purchase the Buyers were issued warrants to purchase
750,000 of our common shares. The exercise price of the warrants was $0.90 per
share of common stock subject to adjustment on the occurrence of certain events.
Sigma had the right to lead a "Follow-on Financing." In the event that the
Follow-on-Financing did not occur, the exercise price of the warrants would be
$0.01 per common share. As of the date hereof, we have elected not to pursue the
Follow-on-Financing with Sigma and therefore the exercise price of the warrants
is $0.01 per share. Michael Levin, a Managing Director of MetVP, serves as a
member of our Board of Directors.
On June 30, 2005, we concluded a new line of credit in the principal amount
of $500,000 with JPMorgan Chase Bank evidenced by a Grid Demand Promissory Note
(the "Credit Facility) replacing a prior credit facility dated June 27, 2003,
under substantially similar terms, but extending the original Maturity Date to
June 30, 2007. As a condition precedent to providing the Credit Facility, the
JPMorgan Chase Bank required guarantees of our obligations from Tall Oakes Group
LLC ("Tall Oaks") and Lawrence Hite (managing member of Tall Oaks) and a
collateral agreement from Tall Oaks. In consideration of the issuance of such
guarantee and delivery of the collateral agreement, we entered into an Amended
and Restated Reimbursement Agreement with Tall Oaks Group pursuant to which, on
July 12, 2005, we issued and delivered to Tall Oaks warrants with an initial
exercise price of $1.00 per share to purchase an aggregate of 500,000 shares of
the common stock of Company.
The following table sets forth information concerning the resale of the
shares of common stock by the selling security-holders. We will not receive any
proceeds from the resale of the common stock by the selling security-holders. We
will receive proceeds from the exercise of warrants in the event that they are
exercised, however there can be no assurance that all or any of the warrants
will be exercised. The table below assumes that all the shares registered below
are sold by the selling security-holders.
8
The following table sets forth the name of each person who is offering the
resale of shares of common stock by this prospectus, the number of shares of
common stock beneficially owned by each person, the number of shares of common
stock that may be sold in this offering and the number of shares of common stock
each person will own after the offering, assuming they sell all of the shares
being offered. Unless otherwise indicated, each of the following persons has
sole voting and investment power with respect to the shares of common stock set
forth opposite their respective names. None of the selling security-holders is
an affiliate of a registered broker-dealer.
- ------------------------------ ------------------- --------------- ----------------- ---------------- -----------------
Number of shares Number of
beneficially shares
owned before the Number of beneficially
offering shares being owned after
Selling Securityholder Percentage offered the offering Percentage
- ------------------------------ ------------------- --------------- ----------------- ---------------- -----------------
Sigma Opportunity Fund, LLC
650,000(1) 11.6% 650,000(1) 0 0
- ------------------------------ ------------------- --------------- ----------------- ---------------- -----------------
Metropolitan Venture
Partners II, L.P. 2,228,974(2) 31.2% 100,000(3) 2,128,974 30.2%
- ------------------------------ ------------------- --------------- ----------------- ---------------- -----------------
Tall Oaks Group LLC 1,162,406(4) 19.2% 250,000(5) 912,406 15.7%
- ------------------------------ ------------------- --------------- ----------------- ---------------- -----------------
<FN>
(1) Includes 650,000 shares issuable upon the exercise of warrants. Thom Waye
holds voting and investment control over the shares held by Sigma. Mr. Waye is
the Manager of Sigma Capital Advisors, LLC, which is the Managing Member of
Sigma Opportunity Fund LLC,
(2) Includes 1,346,800 shares issuable upon the conversion of Series A
Convertible Preferred Stock,and 840,010 shares issuable upon exercise of options
and warrants. Metropolitan Venture Partners (Advisors) L.P holds voting and
investment control over the shares held by Metropolitan Venture Partners II,
L.P. Mr. Levin is the Managing Director of Metropolitan Venture Partners Corp.,
which is the general partner of Metropolitan Venture Partners (Advisors) L.P.,
which, in turn, is the general partner of Metropolitan Venture Partners II, L.P.
Mr. Levin is a member of our Board of Directors.
(3) Includes 100,000 shares issuable upon exercise of warrants.
(4) Includes 1,084,219 shares issuable upon exercise of options and warrants.
Mr. Lawrence Hite holds voting and investment control over the shares held by
Tall Oaks Group LLC. Mr. Hite is the General Manager of Tall Oaks Group LLC.
(5) Represents shares underlying warrants.
</FN>
PLAN OF DISTRIBUTION
We are registering shares of common stock for resale, including common
stock underlying certain warrants, and payable as interest on certain notes, on
behalf of the selling security-holders. The common stock may be sold in one or
more transactions at fixed prices, at prevailing market prices at the time of
sale, at prices related to the prevailing market prices, at varying prices
determined at the time of sale, or at negotiated prices. These sales may be
effected at various times in one or more of the following transactions, or in
other kinds of transactions:
o in the over-the-counter market;
9
o in private transactions and transactions otherwise than on these
exchanges or systems or in the over-the-counter market;
o in connection with short sales of the shares;
o by pledge to secure or in payment of debt and other obligations;
o through the writing of options, whether the options are listed on an
options exchange or otherwise;
o in connection with the writing of non-traded and exchange-traded call
options, in hedge transactions and in settlement of other transactions
in standardized or over-the-counter options;
o on any national exchange on which the shares are listed or any
automatic quotation system through which shares are quoted;
o through put and call transactions; or
o through a combination of any of the above transactions.
The selling security-holders may sell their shares at prevailing market
prices, prices related to prevailing market prices or at privately negotiated
prices. The selling security-holders and their successors, including their
transferees, pledgees or donees or their successors, may sell the common stock
directly to the purchasers or through underwriters, broker-dealers or agents,
who may receive compensation in the form of discounts, concessions or
commissions from the selling security-holders or the purchasers. These
discounts, concessions or commissions as to any particular underwriter,
broker-dealer or agent may be in excess of those customary in the types of
transactions involved.
Negotiated transactions may include:
o purchases by a broker-dealer as principal and resale by such
broker-dealer for its account pursuant to this prospectus;
o ordinary brokerage transactions and transactions in which a broker
solicits purchasers; or
o block trades in which a broker-dealer so engaged will attempt to sell
the shares as agent but may take a position and resell a portion of
the block as principal to facilitate the transaction.
We entered into registration rights agreements for the benefit of certain
of the selling security-holders to register the common stock under applicable
federal and state securities laws. The registration rights agreements provide
for cross-indemnification of the selling security-holders and us and our
respective directors, officers and controlling persons against specific
liabilities in connection with the offer and sale of the common stock, including
liabilities under the Securities Act. We will pay substantially all of the
expenses incurred by the selling security-holders incident to the registration
of the offering and sale of the common stock.
During such time as the selling security-holders may be engaged in a
distribution of the securities we are registering by this registration
statement, they are required to comply with the applicable provisions of the
Securities Exchange Act and the rules and regulations thereunder, including
Regulation M. Regulation M may limit the timing of purchases and sales of our
10
securities. These restrictions may affect the marketability of our common stock
and the ability of any person to engage in market-making activities with respect
to our common stock. The selling security-holders may, however, engage in short
sales in accordance with Rule 104 of Regulation M. Short sales, if engaged in by
the selling security-holders, may effect the market price of our common stock.
Regulation M specifically prohibits short sales that are the result of
fraudulent, manipulative or deceptive practices. Selling security-holders are
required to consult with their own legal counsel to ensure compliance with
Regulation M.
LEGAL PROCEEDINGS
We are not currently involved in any legal or regulatory proceeding or
arbitration, the outcome of which is expected to have a material adverse effect
on our business.
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
As of August 28, 2006, the names, ages and positions of the directors and
executive officers of the Company are as follows:
Name Age Position Committee Member
---- --- -------- ----------------
James A Cannavino 62 Chairman of the Board of Directors
and Chief Executive Officer
Bernard Puckett (1) 61 Member of the Board of Directors Audit, Compensation
Dennis Murray 60 Member of the Board of Directors Audit, Compensation
Carla Steckline 49 Member of the Board of Directors Audit, Compensation
Michael Levin (2) 33 Member of the Board of Directors
Matthew E. Oakes 43 Executive Vice-President and
Chief Operating Officer
Christopher Cauley 37 Executive Vice-President Sales and
Marketing
Arnold Leap 38 Executive Vice-President and Chief
Technical Officer
Michael J. Beecher 61 Chief Financial Officer and Secretary
<FN>
- ---------
(1) Mr. Puckett was appointed to the Board of Directors in February 2004,
succeeding Mr. Charles Feld who had previously resigned to assume new
responsibilities at EDS.
(2) Mr. Levin was appointed to the Board of Directors in February 2005 to
succeed Mr. Peter Yunich who resigned for personal reasons. Mr. Levin is
Managing Director of Metropolitan Venture Partners.
</FN>
James A. Cannavino has been our Chairman of the Board and a director since
March 2000, and Chief Executive Officer since December 2002. From September of
1997 to April of 2000 he was the non-executive Chairman of Softworks, Inc (a
then wholly owned subsidiary of the Company), which went public and was later
sold to EMC. Mr. Cannavino was also the Chief Executive Officer and Chairman of
the Board of Directors of CyberSafe, Inc., a corporation specializing in network
security from April 1998 to July 2001. In August, 1995, he was appointed as
President and Chief Operating Officer of Perot Systems Corporation and in 1996
was elected to serve as Chief Executive Officer through July 1997. During his
tenure at Perot he was responsible for all the day-to-day global operations of
the company, as well as for strategy and organization. Prior to that he served
as a Senior Vice President at IBM, responsible for strategy and development. Mr.
11
Cannavino held various positions at IBM for over thirty years beginning in 1963.
Mr. Cannavino led IBM's restructuring of its $7 billion PC business to form the
IBM PC Company. He also served on the IBM Corporate Executive Committee and
Worldwide Management Council, and on the board of IBM's integrated services and
solutions company. Mr. Cannavino presently serves on the Boards of the National
Center for Missing and Exploited Children, the International Center for Missing
and Exploited Children, and Verio. He recently was Chairman of the Board of
Marist College in Poughkeepsie, New York and continues to serve on the board.
Mr. Cannavino will serve on the Board until his successor is elected.
Bernard Puckett is Chairman of the Board of Openwave Systems, Inc., a
leading provider of open IP-based communication infrastructure software and
applications. Mr. Puckett was formerly the President and Chief Executive Officer
of Mobile Telecommunications Technology Corp. ("Mtel"). Prior to joining Mtel,
Mr. Puckett spent 26 years with IBM where he was Senior Vice-president -
Corporate Strategy and Development. He also held positions in marketing,
finance, product development, manufacturing and new business development during
his tenure at IBM. He also serves on the board of directors of IMS Health
(NYSE:RX). Mr. Puckett was appointed to our Board of Directors in February 2004
and will serve in such capacity until his successor is elected.
Dr. Dennis J. Murray has been President of Marist College since 1979. Early
in his tenure, he identified the importance of technology in higher education
and made it one of the central themes of his administration. He developed an
innovative joint study with the IBM Corporation, which resulted in Marist
becoming one of the nations most technologically advanced liberal arts colleges.
Marist was one of the first colleges or universities in the country to have a
fully networked campus, and currently operates on an IBM e-server zSeries 900
processor with a z/OS operating system. Dr. Murray has been a strong supporter
of the Linux operating system and recently initiated a Linux Research and
Development Center at Marist. Dr. Murray serves on the boards of the Franklin
and Eleanor Roosevelt Institute, McCann Foundation, and the New York State
Greenway Conservancy, which oversees the Hudson River Valley National Heritage
Area. He is also the author of two books on nonprofit management, editor of
three books on government and public affairs, and co-author of a guide to
corporate-sponsored university research in biotechnology. Dr. Murray has been a
member of the Board of Directors since March 2000, and will serve in such
capacity until his successor is elected.
Carla J. Steckline was the Attorney General for the State of Kansas from
1994 through January 2003. Attorney General Steckline also served as Vice
President of the National Association of Attorneys General. She is also a member
of the Board of Directors of the American Legacy Foundation, the national Center
for Missing and Exploited Children, the National Crime Prevention Council and
the Council of State Governments. In addition, she is a member of the Board of
Governors of the University of Kansas School of Law and a member of the Kansas
Children's Cabinet. Attorney General Steckline recently was honored with the
Distinguished Service to Kansas' Children Award. Ms. Steckline has been a member
of the Board of Directors since April 2000, and will serve in such capacity
until her successor is elected.
Michael Levin is Managing Director of Metropolitan Venture Partners Corp.,
a venture capital firm he co-founded in 1999. In his role, Mr. Levin negotiates
and manages investments, as well as oversees the financial and operational
management of the firm. He also serves as an active Board member and works
closely with portfolio companies on strategic growth and ensuring proper fiscal
discipline. Prior to MetVP, Mr. Levin developed and managed hedge funds for the
Man Group plc and Larry Hite. Mr. Levin was graduated Magna Cum Laude from The
Wharton School at the University of Pennsylvania with a concentration in
Finance. He is also an alumnus of Phillips Exeter Academy.
Matthew Oakes was recently appointed Chief Operating Officer and Executive
Vice President - Client Services. Prior to this he held the position of
Executive Vice President - Client Services after serving as Director of Business
Operations in the Company since November of 2002. Prior to his joining the
12
Company, Mr. Oakes served three years as the Operations Officer for Direct Media
Networks a New York based e-commerce and technology company. He held executive
positions in Westinghouse Communities Inc. including "Managing Director of
Operations" for the Pelican Bay Community in Naples, Florida. Mr. Oakes received
a JD degree from Nova Southeastern University and holds an MBA in finance. He is
a 1993 graduate with a Bachelors Degree in Business from Cornell University. He
served with the United States Marines prior to attending Cornell.
Christopher Cauley was recently appointed Executve Vice President of Sales
and Marketing. Mr. Cauley joined the Company in August 2005 as Vice President of
Business Development. Prior to joining Direct Insite from 1998 to 2005 Mr.
Cauley was Senior Manager for Sales & Business Consulting for Avolent, Inc.,
where he led a team of sales consultants responsible for selling the Company's
Business to Business ("B2B") financial relationship management and electronic
invoice presentment and payment internet application suite. During his tenure
with Avolent, Mr. Cauley managed sales consulting strategy and closed several
large contracts with Fortune 500 companies. Mr. Cauley previously worked for
American Management Systems, Inc. (AMS) as a Principle Project Manager and
Solutions Analyst in AMS' Financial Services and Telecommunications Industry
Groups. At AMS, he acquired in-depth knowledge of system integration and the
development of financial and customer care billing systems. Mr. Cauley earned
his Bachelor of Science Degree in Business Administration from Virginia
Polytechnic Institute and State University in Blacksburg, Virginia.
Arnold Leap has been Executive Vice President and Chief Technology Officer
since November 2000. From March 1998 until November 2000 he held the position of
Chief Information Officer. Mr. Leap originally was hired in February 1997 as the
Company's Director of Development and Engineering and held the position until
March 1998. Prior to his joining Direct Insite, Mr. Leap was the MIS
Manager/Director of AMP Circuits, Inc., and a subsidiary of AMP, Inc. from1993
to February 1997. His responsibilities at AMP Circuits, Inc. included day-to-day
information systems operation as well as the development and implementation of a
consolidated ERP and financial system.
Michael J. Beecher, CPA, joined the Company as Chief Financial Officer in
December 2003. Prior to joining Direct Insite Mr. Beecher was Chief Financial
Officer and Treasurer of FiberCore, Inc., a publicly held company in the
fiber-optics industry. From 1989 to 1995 he was Vice-President Administration
and Finance at the University of Bridgeport. Mr. Beecher began his career in
public accounting with Haskins & Sells, an international public accounting firm.
He is a graduate of the University of Connecticut, a Certified Public Accountant
and a member of the American Institute of Certified Public Accountants.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of shares of voting
stock of the Company, as of August 28, 2006 of (i) each person known by the
Company to beneficially own 5% or more of the shares of outstanding common
stock, based solely on filings with the Securities and Exchange Commission, (ii)
each of the Company's executive officers and directors and (iii) all of the
Company's executive officers and directors as a group. Except as otherwise
indicated, all shares are beneficially owned, and the persons named as owners
hold investment and voting power.
13
Common Stock Rights to Acquire Total Beneficially
Beneficially Beneficial Ownership Through Exercise Owned as % of
Name of Beneficial Owner (1) Owned of Options and Warrants Within 60 Days Outstanding Shares (2)
- -------------------------------------------------------------------------------------------------------------
Metropolitan Venture
Partners II, L.P. 42,164 2,186,810 31.2%
Tall Oaks Group, LLC 78,167 1,084,219 19.2%
Sigma Opportunity Fund, LLP -- 650,000 11.6%
James Cannavino 558,075 1,585,950 32.7%
Bernard Puckett 53,359 100,813 3.0%
Dennis Murray 172,042 72,100 4.8%
Carla Steckline 109,862 66,743 3.5%
Michael Levin 2,000 -- *
Robert Carberry 232,210 460,500 12.8%
Matthew Oakes 56,356 178,000 4.6%
Arnold Leap 100,394 231,500 6.4%
Christopher Cauley 49,944 89,390 2.8%
Michael Beecher 36,590 60,000 1.9%
All Officers and Directors
as a Group (9 persons) 1,138,622 2,384,496 47.9%
- -------
<FN>
* = Less than 1%
Footnotes
(1) The address of the holder is 80 Orville Drive, Suite 200, Bohemia, New
York 11716, except for Metropolitan Venture Partners II, L.P. and Tall
Oaks Group, LLC which is 432 Park Avenue South, 12th Floor, New York,
NY 10010 and Sigma Opportunity Fund, LLC which is 800 Third Avenue,
New York, NY 10022.
(2) Based upon 4,967,701 common shares outstanding as of August 28, 2006,
plus outstanding options and warrants exercisable within 60 days and
Series A Stock convertible into common shares owned by above named
parties.
</FN>
14
DESCRIPTION OF SECURITIES
Our authorized capital consists of 50,000,000 shares of common stock
$0.0001 par value, of which 4,967,701 shares were outstanding as of August 28,
2006. In addition, our authorized capital includes 2,000,000 shares of preferred
stock of which we are authorized to issue 134,680 shares of Series A Convertible
Preferred Stock, 1,000 shares of Series B Redeemable Preferred Stock, 2,000
shares of Series C Redeemable Preferred Stock and 1,500 shares of Series D
Redeemable Preferred Stock. As of August 18, 2006, there were 134,680 shares of
our Series A Convertible Preferred outstanding, 974 shares of our Series B
Redeemable Preferred Stock outstanding, 2,000 shares of our Series C Redeemable
Preferred outstanding and 100 shares of our Series D Redeemable Preferred
outstanding.
Set forth below is a summary description of certain provisions relating to our
capital stock contained in and qualified in its entirety by our Articles of
Incorporation and by-laws and under the Delaware Law.
Common Stock
Holders of common stock are entitled to one vote for each share of common
stock owned of record on all matters to be voted on by security-holders. Our
Articles of Incorporation do not contain any special voting provisions, and no
corporate action requires a greater than majority vote of security-holders.
Cumulative voting is not permitted in the election of directors.
The holders of common stock are entitled to receive such dividends, if any,
as may be declared from time to time by the Board of Directors, in its
discretion, from funds legally available therefor.
The common stock has no preemptive or other subscription rights, and there
are no conversion rights or redemption provisions. All outstanding shares of
common stock are validly issued, fully paid, and non-assessable.
Series A Convertible Preferred
The board of directors has designated and authorized the issuance of
134,680 shares of Series A Convertible Preferred Stock of which 134,680 shares
are outstanding.
Conversion
Each share of Series A Convertible Preferred is convertible into 10 shares
of our common stock.
Voting Rights
Series A Convertible Preferred shares shall vote together with all other
classes on all actions to be taken by our security-holders. Each share of Series
A Convertible Preferred shall entitle the holder to such number of votes as
shall equal the number of shares of common stock into which each share of Series
A Convertible Preferred is then convertible.
Liquidation
Upon any liquidation or dissolution, holders of Series A Convertible
Preferred shall be entitled to receive $2,750,000 plus an amount equal to all
dividends accrued but unpaid.
15
Rank
Series A Convertible Preferred shall rank senior to all classes of capital
stock other than the Series B Redeemable Preferred Stock.
Dividends
Holders of Series A Convertible Preferred shares are entitled to dividends
at the rate of 9-1/2% per annum.
Series B Preferred
The board of directors has designated and authorized the issuance of 1,000
shares of Series B Redeemable Preferred Stock of which 974 shares are
outstanding.
Redemption
The Series B Redeemable Preferred shares are redeemable by us at any time.
The redemption price is $1,000 per share plus accrued and unpaid dividends.
Voting Rights
The holders of Series B Redeemable Preferred Stock have no voting rights.
Dividends
Holders of Series B Redeemable Preferred are entitled to dividends at the
rate of 12% per year, payable quarterly.
Rank
Series B Redeemable Preferred shares shall rank senior to all classes of
capital stock.
Series C Preferred
The board of directors has designated and authorized the issuance of 2,000
shares of Series C Redeemable Preferred Stock of which 2,000 shares are
outstanding.
Redemption
The Series C Redeemable Preferred shares are redeemable by us at anytime.
The redemption price is $1,000 per share plus accrued and unpaid dividends.
Voting Rights
The holders of Series C Redeemable Preferred have no voting rights.
16
Dividends
The holders of Series C Redeemable Preferred are entitled to dividends at
the rate of 9-1/2% per annum.
Rank
Holders of Series C Redeemable Preferred are entitled to preference in the
payment of dividends and distribution of assets upon liquidation to all classes
of capital stock except for the Series B Preferred.
Series D Redeemable Preferred
The board of directors has designated and authorized the issuance of 1,500
shares of Series D Redeemable Preferred Stock, of which 100 shares are
outstanding.
Redemption
The Series D Redeemable Preferred shares are redeemable by us at any time.
The redemption price is $1,000 per share plus accrued and unpaid dividends.
Voting Rights
The holders of Series D Redeemable Preferred have no voting rights.
Dividends
The holders of Series D Redeemable Preferred are entitled to dividends at
the rate of 9-1/2% per year, payable quarterly commencing April 1, 2006.
Rank
The holders of Series D Redeemable Preferred have preference in the payment
of dividends and distribution of assets upon liquidation to all classes of
capital stock except for the Series A, B and C Preferred Stock.
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES
ACT LIABILITIES
Our Certificate of Incorporation and By-Laws provide our directors with
protection for breaches of their fiduciary duties to us and our
security-holders. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to our directors, officers or persons
controlling us, we have been advised that it is the SEC's opinion that such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable.
17
DESCRIPTION OF BUSINESS
Overview
Direct Insite Corp. and its subsidiaries (hereinafter referred to at times
as "Direct Insite" or the "Company"), was organized under the name Unique
Ventures, Inc. as a public company, under the laws of the State of Delaware on
August 27, 1987. In August, 2000, we changed our name to Direct Insite Corp.
which the Board of Directors believed was more in line with our new direction.
In March, 2000, Mr. James A. Cannavino was elected a board member and
Chairman of the Board. Shortly thereafter, Dr. Dennis Murray, president of
Marist College and Mr. Charles Feld, Founder and Chief Executive Officer of the
Feld Group, and Chief Information Officer of First Data Resources and the former
Chief Information Officer of Delta Air Lines, were elected to our Board of
Directors. In April, 2000, Mrs. Carla J. Steckline, the then attorney general of
the state of Kansas, was elected to serve as a member of the Board. As part of
the terms and conditions of our financing transaction with Metropolitan Venture
Partners II, L.P., a private equity investment firm, ("Metropolitan"), Mr. Peter
Yunich, their managing partner, was elected to our Board in September, 2002. In
February 2004, Mr. Bernard Puckett, Chairman of the Board of Openwave Systems,
Inc. and former Senior Vice President of Strategy and Business Development at
IBM, was appointed to our Board, replacing Mr. Feld, who had previously resigned
to assume new responsibilities at Electronic Data Systems ("EDS"). In February
2005, Mr. Michael Levin, Managing Director of Metropolitan Venture Partners
Corp., was appointed to the board to succeed Mr. Yunich who resigned from the
board for personal reasons.
Our Current Business
We primarily operate as an application service provider ("ASP"), providing
an integrated transaction based "fee for service" offering called Invoices
On-Line (IOL), an electronic invoice presentment and payment (EIP&P) service
that processes high volumes of transactional data for invoice presentment
purposes delivered via the Internet on a global basis on behalf of our
customers. IOL is our primary offering and it is a globally delivered service
that provides electronic invoice presentation in the Americas, Europe and Asia,
including 28 different countries around the globe and in more than 13 languages
and currencies. We currently host several million invoices that are accessible
"on-line" via the Internet 24 hours per day, seven days per week, 365 days per
year. IOL is a uniquely positioned service offering in the industry. The service
is designed to handle the complex invoicing found in today's global business
environment. The solution allows Global 1000 companies to receive, route,
approve and pay invoices on-line in the local language and currency. By
automating the traditional paper-based invoicing process, customers now have
easy and quick access to line-item billing information, reporting and analytics.
With the enhanced level of accuracy provided by IOL, invoice disputes are
greatly reduced and overall customer satisfaction is substantially increased.
We also provide Custom Engineering Services which are single contractual
agreements involving modification or customization of the Company's proprietary
ASP software solution. Additionally, we provide service offerings in the form of
our patented dbExpressTM technology, a management information tool that allows
users to visually data mine large volumes of transactional data via the
Internet. A complete Internet Customer Care tool set integrated with the EIP&P
product set is also available. We operate fully redundant data centers located
at our main office in Bohemia, N.Y. and in Newark, NJ. Our facility in New
Jersey is space leased at an International Business Machines ("IBM"), e-business
Hosting Center. This co-location / redundancy feature enables us to offer
virtually down time free service.
This suite of services enables us to provide a comprehensive Internet
delivered service from the raw transaction record through all of the internal
workflow management processes including an electronically delivered invoice with
customer analytics. This comprehensive service offering provides back office
18
operations, reduces our customers' costs and provides for improved customer
service by providing the end customer with easy access to all of the detailed
information about their bill.
Currently, IBM, our largest customer, representing approximately 66.8% and
69.0% of revenue for the three and six month periods ended June 30, 2006,
respectively and 66.2% and 69.9% of our revenue for the three and six month
periods ended June 30, 2005, respectively, utilizes our suite of IOL products
and services to allow their customers from around the globe to receive, analyze,
dispute and cost allocate all of their invoice related information in their
local language and currency via the Internet 24 hours a day, 7 days a week, 365
days a year. IBM accounted for 68% and 92% of our revenue for the years ended
December 31, 2005 and 2004, respectively. Our second Fortune 500 Company,
Electronic Data Systems Corp. ("EDS"), accounted for approximately 30.9% and
28.8% of revenue for the three and six month periods ended June 30, 2006,
respectively and 30.4% and 27.6% of revenue for the three and six month periods
ended June 30, 2005, respectively. EDS accounted for 28% and 7% of revenue for
the years ended Decmber 31, 2005 and 2004, respectively.
Recent Financing
On June 30, 2005, we obtained a new line of credit in the principal amount
of $500,000 with JPMorgan Chase Bank evidenced by a Grid Demand Promissory Note
(the "Credit Facility) replacing a prior credit facility dated June 27, 2003,
under substantially similar terms, but extending the original Maturity Date to
June 30, 2007. As a condition precedent to providing the Credit Facility, the
JPMorgan Chase Bank required guarantees of our obligations from Tall Oaks and
Lawrence Hite (managing member of Tall Oaks) and a collateral agreement from
Tall Oaks. In consideration of the issuance of such guarantee and delivery of
the collateral agreement, on July 12, 2005, Company issued and delivered to Tall
Oaks warrants with an initial exercise price of $1.00 per share to purchase an
aggregate of 500,000 shares of the common stock of Company.
In March 2005, the Company entered into a Securities Purchase Agreement
(the "Agreement") with Sigma Opportunity Fund LLC ("Sigma") and Metropolitan
Venture Partners II, L.P. ("MetVP"), collectively the "Buyers", whereby the
Buyers purchased Senior Subordinated Secured Notes (the "Note Purchase") in the
aggregate amount of $750,000. The notes bear interest at the rate of five
percent (5%) per year beginning June 28, 2005, and are payable quarterly in cash
or common stock at the option of the Buyers. The Notes mature on the earlier to
occur of (i) September 29, 2006, or (ii) the date on which demand for payment of
the loan payable to JPMorgan Chase Bank is made. In connection with the note
purchase the Buyers were issued warrants to purchase 750,000 common shares of
the Company. The initial exercise price of the warrants was $0.90 per share of
common stock.
Sigma had an exclusive right to lead a "Follow-on-Financing" for 45 days
following the closing and the Company had granted Sigma additional time. In the
event that the Follow-on-Financing had occurred the exercise price of the
warrants issued in conjunction with the Note Purchase would have been adjusted
as agreed between the Company and the buyers. The Follow-on-Financing was not
consummated; as such, the exercise price of the warrants was reduced to $0.01
per common share.
Under the terms of the agreement, on September 1, 2005 the Company filed
with the Securities and Exchange Commission a Registration Statement to register
a number of common shares equal to the maximum number of shares that would be
issuable to the Buyers in payment of interest on the notes through the maturity
date plus a number of common shares issuable upon exercise of the warrants. The
Company is required to pay liquidating damages in the amount of 1% per month of
the purchase price paid for the first two months and 2% for the remaining months
to the buyers upon the occurrence of the following events:
19
1. Failure to file a registration statement by August 30, 2005.
2. Failure to have the registration statement declared effective by
December 31, 2005.
3. Failure to maintain the effectiveness of the registration statement
until the earlier of (a) March 29, 2008, (b) the date whereby all the
securities may be sold pursuant to Rule 144 (c) the date on which the
Buyers no longer hold the securities.
4. Failure to be listed on the OTC Bulletin Board, American Stock
Exchange, Nasdaq, Nasdaq SmallCap or New York Stock Exchange.
5. Failure to timely deliver warrant or interest shares.
As such under the provisions of EITF 00-19 "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock" the Company was required to record the warrants issued as a derivative
liability at fair value on the date of issuance. (See Note 18) In accordance
with SFAS 133 "Accounting for Derivative Instruments and Hedging Activities", at
each reporting this liability will be adjusted for changes in its fair value.
The fair value of the warrants is determined using the Black Scholes valuation
model. Actual period close common stock prices, applicable volatility rates and
the period close risk free interest rate for the warrants expected remaining
useful life are the key assumptions used in the valuation calculation. Period to
period changes in fair value will be recorded as either an addition or charge to
earnings. These additions or charges have no cash effect over the life of the
instrument. The change in the fair value of the warrants for the year ended
December 31, 2005 was $105,000 and ($269,000) for the six months ended June 30,
2006.
The Company recorded a debt discount of $565,000 based on the residual
value of the proceeds received and the fair value of the warrants. This discount
is being amortized over the life of the loan using the effective interest rate
method. Amortization of $189,000 and $222,000 was recorded as interest expense
for the year ended December 31, 2005 and for the six months ended June 30, 2006,
respectively.
In November 2004 the Board of Directors authorized us to sell up to 1,500
shares of Series D Redeemable Preferred Stock ("Series D Preferred") at $1,000
per share. The holders of Series D Preferred are entitled to dividends, on a
cumulative basis, at the rate of 9-1/2% per year, compounded and payable
quarterly beginning on April 1, 2006. The holders of Series D Preferred have
preference in the payment of dividends and, in the event of liquidation, to all
classes of capital stock of the Company except for the Series A, B and C
Preferred Stock. As of December 31, 2004 we had sold 100 shares of Series D
Preferred and received proceeds of $100,000. The buyer was issued warrants to
purchase 90,909 common shares at an exercise price of $2.03 per share in
conjunction with the sale.
In December 2003 the Board of Directors authorized us to sell up to 1,500
shares of Series C Redeemable Preferred Stock ("Series C Preferred") at $1,000
per share and in April 2004 the Board authorized the sale of an additional 500
shares. The holders of Series C Preferred are entitled to dividends, on a
cumulative basis, at the rate of 9-1/2% per year, compounded and payable
quarterly beginning on October 1, 2005. The holders of Series C Preferred have
preference in the payment of dividends and, in the event of liquidation, to all
classes of capital stock of the Company except for the Series B Preferred Stock.
As of December 31, 2004 we had sold 2000 shares of Series C Preferred and
received proceeds of $2,000,000 less expenses of $140,000. Of the total shares
sold Metropolitan has purchased 540 shares, our Chairman and Chief Executive
Officer of the Company purchased 200 shares and certain Directors purchased 105
shares. The proceeds were used for working capital purposes.
In June 2003, the Company's Board of Directors approved the exchange of the
then outstanding obligations to our Chairman and Chief Executive Officer, Markus
& Associates and Tall Oaks Group, LLC for 974 shares of Series B Preferred Stock
at an exchange ratio of $1,000 of debt per share ("Price Per Share"). The Series
B Preferred was issued as follows:
o 266 shares were exchanged for $266,000 of debt obligation to our
Chairman and Chief Executive Officer;
20
o 208 shares were exchanged for $208,000 of debt obligation to Markus &
Associates; and
o 500 shares were exchanged for $500,000 of debt obligation to Tall Oaks
Group, LLC.
Each of the Series B Preferred shares is entitled to mandatory dividends,
payable quarterly, commencing on the first day of the calendar quarter after the
date of issuance, at the rate of 12% per annum. Additionally, the Series B
Preferred shares are redeemable, at the sole option of the Company, on or after
March 31, 2005. Upon redemption, the holders of the Series B Preferred shall be
entitled to receive, for each share of Series B Preferred outstanding, an amount
equal to the Price Per Share plus accrued and unpaid dividends.
Between September 2002 and June 2003, the Company sold a total of 134,680
shares of Series A Convertible Preferred Stock, ("Series A Preferred") in
consideration for the gross amount of $2,750,000 to Metropolitan Venture
Partners II, L.P. Each share of Series A Preferred is convertible into 10 shares
of common stock of the Company. The Series A Preferred is automatically
convertible into common shares on September 25, 2008. The holders of the Series
A Preferred ("the Holders") are entitled to dividends, on a cumulative basis, at
the rate of 9-1/2% per annum, compounded quarterly and payable on February 1,
2005 and September 25, 2005. The payment of the first dividend was originally
scheduled for September 25, 2004, however, the Company and the Holders agreed to
defer this payment until February 1, 2005. As consideration for the deferral of
the dividend payment, the Company agreed to pay the Holders a premium of 7.5% of
the dividend. In May 2004 the Company and the Holders further agreed to grant
the Company the right, in its sole discretion, to defer the payment of the
dividend scheduled to be paid on February 1, 2005 until February 1, 2006. In the
event the Company elected to pay the dividend on February 1, 2006 the Holders
would receive a premium of $129,000. In December 2004 the Company exercised its
right to defer payment of this dividend until February 1, 2006. Also, the
Company and the Holders further agreed to grant the Company the right, in its
sole discretion, to defer the payment of the dividend scheduled to be paid on
September 25, 2005 until February 1, 2006. As a result of this deferment, the
Company agreed to pay a premium of $26,000.
At June 30, 2006 there were $2,123,000 of dividends accrued and unpaid for
Preferred Holders and remain unpaid as of August 18, 2006. Management believes
the Company is precluded from paying dividends at this time pursuant to Delaware
General Corporate Law.
Discontinued Products and Services
In 2001 we acquired Platinum Communications, Inc. ("Platinum"), a Dallas,
Texas based company, which marketed its integrated proprietary back office
software solutions, Account Management Systems ("AMS" or sometimes referred to
as "TAMS") to the telecommunications industry either as a license or as an ASP.
As a result of the lack of development of the Platinum business and to focus our
resources on our core business, in December 2003, we decided to close the
operations of Platinum. For the year ended December 31, 2005 Platinum incurred a
loss of $17,000. For the six months ended June 30, 2006 Platinum had a loss of
$4,000. For the year ended December 31, 2004 the Company recognized income from
the discontinued operations of $288,000 as a result of settling certain
liabilities of the Platinum operation for less than the original obligation. The
income (loss) is reflected as Income (Loss) from Discontinued Operations in the
accompanying Consolidated Statements of Operations.
Products and Services
We currently operate in one business segment, the Electronic Billing
Presentment and Payment ("EBP&P") sector, and, during the years 2005 and 2004,
have provided two primary forms of service offerings: EBP&P Application Service
Provider ("ASP") Services, and Custom Engineering Services.
Within the ASP offering we provide two primary services:
o Invoices On Line, an EBP&P offering, and;
21
o dbExpress, a data visualization and mining service
Invoices On Line
IOL is an advanced web-based electronic invoice presentment, workflow
management; reporting and data interrogation/analysis platform designed for
large enterprise customers conducting business internationally. Direct Insite's
web-based service offering has been operational since 2002 and is currently
delivering invoices to users in the Americas, Europe, the Middle East and Africa
(EMEA) and the Asia Pacific geographic regions. We are planning on supporting
additional geographies and languages throughout the course of 2005.
From a system user perspective, IOL is operated on behalf of an enterprise
that delivers goods and services to a customer. Subsequent to delivery, IOL
would be the vehicle for the service provider or "Biller" to present an invoice
to the customer, who would become the "Payer" of an invoice. IOL provides the
following functions on behalf of the Biller to the customer or Payer:
o Summary View of Invoice. IOL enables the Payer to view a collection of
all invoices being presented to the Payer and further allows the payer to view a
summary of the amount due for goods and services. This allows the Payer to view
the total amount due as well as a summary of the collection of goods and
services delivered.
o Complex Presentment. (Data centric views). Historically, paper invoices
have been used by Billers as the primary vehicle to communicate the types of
goods and services delivered to customers. Because of the fundamental
limitations of the amount of detail that could be present in a "single sheet"
paper invoice, there was a general lack of detail provided to the customers. The
result of the absence of detail resulted in calls to the biller in order to
obtain more information. IOL is based on a hierarchical data structure that
allows the user the convenience of seeing a high level summary of all invoices
or to "drill down" on any given invoice or any line item of an invoice. This
"Data-centric" model conveniently supports high level summary or low level
explanatory information to satisfy the customers needs to understand, verify and
pay the invoice.
o Data Mining and Visualization. Another benefit of data-centricity is the
ability to utilize the dbExpress data mining technology across the entire
enterprise to analyze line item detail information - not just a single operating
unit or limited geographical area of the business. Additionally, IOL provides a
significant archiving capability such that 12 to 24 months of historical
invoicing/charges can be data mined for trend and optimization opportunities.
The results of the mining activity are presented in a highly visualized manner
to the user.
o Notification. Email notification is used to provide invoice alerts,
disputes, workflow, administration, invoice status and payment timing.
o Multi-tiered Accounts. This capability is used for allocating portions of
an invoice across complex, payer organizational structures with multiple levels
of management and associated viewing rights and/or privileges often found in
large enterprise accounts.
o Workflow Management. Enables the user to electronically route the invoice
through the approval chain; passing the designated portions of an invoice to
necessary parties for approval. This will also assist the user's ability to
verify whether the approving parties have received the invoice and if the
portion has been reviewed, approved or disputed..
o Dispute Management. This capability supports the ability of the
customer/payer to dispute a charge at the invoice level or at the level of any
line time within the invoice. Once invoked, the billing dispute function
provides for automatic "forms fill" of the information related to the dispute
and automatically routes the dispute to the appropriate customer support
organization.
22
o Payment and Remittance. This facility supports multiple payment options
such as full payment, schedule payment and auto payment. The system also
supports balance-forward accounting or open invoice accounting. Pre-scheduled
payments are also supported by the system.
o Billing Inquiry (or Trouble Ticket). The process of customer or payer
registering a disagreement with a given line item of the invoice or simply
needing to require a clarification of additional supporting data is supported
through the Billing Inquiry function".
o Report Capabilities. Users can track orders, disputes, billing inquires,
payments and system usage. This reporting function is driven by an online
analytical processing (OLAP) tool that plugs into the user's database. This text
reporting capability complements the graphical representation of results that is
the output of the dbExpress data-mining tool.
dbExpress
Background
dbExpress has been in use in various forms for more than ten years.
dbExpress is a software tool which assists end users in the retrieval and
visualization of all types of data. It allows customers to access and analyze
high volumes of information quickly and easily. With the patented data mining
technology found in dbExpress, high volumes of detailed information is presented
in our unique interface known as a "Filescape". With dbExpress, the customer may
create graphs, reports, or simply list the customer information for easy
viewing. dbExpress simplifies the preparation of traditional reports by giving
the customer the ability to view billing data interactively using simple
point-and-click mouse operation. With dbExpress, the customer is given the
ability to drill down into detail information allowing the customer to identify
data trends and "cause and effect" relationships in an interactive, graphical
format.
Addresses Internet Bandwidth Limitations
dbExpress is a data analysis tool that addresses a major Internet problem,
that of high data volume and limited bandwidth. This limitation is currently
responsible for the lengthy delays associated with data downloading. dbExpress
is a web based reporting and analysis system that was introduced to deliver all
of the functionality of traditional data mining systems with the added advantage
of managing large volumes of detailed transactions on a centralized information
server that is accessible via the Internet. dbExpress runs in common web
browsers such as Internet Explorer 5.X (and newer versions) plus Netscape
Navigator 4.X (and newer versions). Customers may interact with and report on
large monthly billing period data via remote Internet access.
Advantages of dbExpress
All Data Indexed - Unlike traditional database products, dbExpress
pre-computes data access indexes associated with all data relationships of
interest. This eliminates the need to compute such access mechanisms on a case
by case basis. The users of dbExpress are free to "question" the database across
a wide range of relationships and massive amounts of data with far less time
delay as compared to the standard database query systems. Furthermore, the
presentment of the "search results" is in the form of graphical "filescapes"
that can be "visually drilled down" to further understand the information
relationships.
Graphics Driven - The data is delivered via the Internet with simple
browser technology thereby allowing an authorized Internet user to manipulate
huge databases in seconds.
High Power / Low Cost - dbExpress(TM) enables users to analyze millions of
23
records over the Internet without the need to first download the data being
analyzed.
Better Access to Information - dbExpress(TM) improves the accessibility to
databases created by database management systems (DBMS) by eliminating the need
to write queries in computer code and facilitates data searches through the use
of graphical query tools. We believe that this results in more timely and better
quality business decision-making.
Broader Access to Information. - dbExpress(TM) enables a broader population
within an organization to visually and interactively mine data without the need
or support from internal or external management information system (MIS)
professionals. dbExpress(TM) performs these tasks faster than conventional
database systems.
Ease of Use - dbExpress(TM) utilizes a simple "point-and-click" navigation
approach, which enables the user to view and analyze data down to the lowest
level of detail. dbExpress(TM) provides powerful functionality via the Internet
that allows the exploration of data patterns, trends, and exceptions. Data
searches, queries and analyses can be converted to sophisticated, simple to use
presentations providing integrated business graphics and report writing
capabilities.
Interfaces With Leading Databases and Other Tools - dbExpress(TM) provides
direct access to leading databases and can be exported to popular spreadsheets,
report writers, graphics packages and word processors.
Integrates Data From Multiple Vendors - When dbExpress(TM) reads a
database, it creates its own summaries of information through a proprietary
process. This permits users to access and compare information contained in
enterprise-wide databases created by different vendors simultaneously in the
dbExpress' user-friendly environment.
Works in Common Operating Environments - dbExpress(TM) operates in
virtually all file server and peer-to-peer networking environments providing
secure visual data mining functionality through Internet browsers.
High Processing Speed - Once a database source has been processed,
dbExpress(TM) employs proprietary matrix storage technology rather than
rereading each data element in that database. The elimination of this rereading
step increases the speed of data access, enabling ad-hoc analysis at a rate that
has been demonstrated to be far faster than possible with any other system.
Security, Access and Storage - In order to meet the archival requirements
of customers, the Company produces CDs of each month's billing details. In order
to provide this service, the Company has put into place a fully redundant data
center. The archive service is available 24 hours a day, 7 days a week, 365 days
a year.
Historically, our primary product offering was dbExpress, the visual data
analysis platform described for use by Fortune 500 companies to consolidate
communications traffic for the purpose of system analysis and contract
compliance. The telecommunication offerings were expanded with the acquisition
of a telecommunications asset management system suite of back office
communications management software products. This suite of offerings provided
the capability to manage complex high volume communications services within the
large enterprise; work flow management, service provisioning, transaction
rating, billing and analysis, A/R and cash application and electronic
intra/inter company invoicing.
During 2001, we enhanced our service offerings by combining electronic
invoice presentment and payment functionality with dbExpress. This combination
provides Internet-based services to customers in the form of an electronic
invoice capable of delivering both summary and detailed billing information with
24
the ability to data mine high volume of internet transactions that large
companies generate. This "data centric" approach is a significant departure from
the industry standard "document centric" approach that delivered print stream
images over the Internet and not the line item detail. This approach, and the
addition of payment capabilities, formed the basis for our enhanced Electronic
Bill Presentment and Payment offering referred to as Invoices on Line which was
brought to market in 2002. This combined set of services has allowed Direct
Insite to significantly expand its market opportunities to include any large
enterprise in a given industry sector that seeks to provide their customers with
an electronic invoice with the associated line item detail information and with
the associated reports and data mining capabilities.
Previously, all of the electronic reporting and analysis capabilities of
dbExpress were being delivered in support of the traditional paper-based billing
system. For simple or low volume detail accounts, electronically delivered
invoices are primarily a reproduction of the print stream. We believe that
electronic invoices delivered to large enterprise customers require the ability
to deliver all of the line item detail to support the summary billing
information as well as the tools necessary to mine that data. IOL offers to this
market electronic presentation of invoices along with the tools to verify the
detail behind the invoice. The Direct Insite offering is a "data centric"
solution built on delivering summary billing information constructed from the
underlying detail data contained in an underlying database. Because the
supporting detail information, analysis and reporting tools are made available
to the end user, costs are reduced for both the provider and customer while
improving customer service through customer self care. We believe that this is a
critical component and a compelling reason to encourage potential customers to
adopt our electronic invoice presentment and payment service.
Sales and Marketing
CHANNELS TO MARKET
We have two primary channels to market - direct through our sales
representatives and indirect through channel and strategic partners. These
channels are supported by a technical sales support group.
Direct
We have recently employed a new sales executive and independent agents. In
addition, our directors and executives are involved in new client development
and the establishment of channel partnerships.
Indirect
We are pursuing both reseller and strategic partner relationships to
further develop existing account relationships and to increase market coverage.
These relationships can also expand our offerings, therefore we are seeking to
establish partnerships with other companies that offer complementary products
and services such as supply chain management and payment services. The use of
the indirect channel provides access to additional engineering and professional
resources to implement our EBP&P service offering.
25
IBM RESELLER AGREEMENT
The Company signed a reseller agreement with IBM on August 4, 2003. This
agreement provides IBM with the ability to sell the Invoice on Line service
offering to its customers. The Company supports this sales activity by providing
Subject Matter Experts (SME's) to assist the IBM sales organization.
TECHNICAL SALES SUPPORT AND POST-SALES ACCOUNT MANAGEMENT
We have a pre-sales support staff and add post sales support to the
existing account management group as we secure new business. This group is
responsible for technical sales presentations, developing proposals and pricing,
contract administration and then account management upon completion.
Research and Development
The computer software industry is characterized by rapid technological
change, which requires ongoing development and maintenance of software products.
It is customary for modifications to be made to a software product as experience
with its use grows or changes in manufacturers' hardware and software so
require.
We believe that our research and development staff, many with extensive
experience in the industry, represents a significant competitive advantage. As
of June 30, 2006, our research and development group consists of 18 employees.
Further, when needed, we retain the services of independent professional
consultants. We seek to recruit highly qualified employees, and our ability to
attract and retain such employees is expected to be a principal factor in our
success in maintaining a leading technological position. For the years ended
December 31, 2005 and 2004, research and development expenses were approximately
$2,668,000, and $2,227,000, respectively. We believe that investments in
research and development are required in order to remain competitive.
Competition
We believe our primary competitors are:
Avolent is a privately held San Francisco based provider of enterprise software
for Financial Relationship Management (FRM) that include electronic invoice
presentment and payment (EIPP), online account management, process management,
enterprise employee access, and decision support. Founded in 1995, Avolent has
primarily focused on the financial services, healthcare, technology and utility
markets.
Bottomline Technologies (NASDAQ: EPAY) was established in 1989 and provides a
Business to Business ("B2B") EBPP solution, primarily to financial institutions
and the legal services markets. The company's products include software designed
to automate the disbursement process for banks and their corporate customers'
anti-fraud and electronic commerce payment software. Bottomline focuses on cash
management and financial-related remittance, reporting and audit data. The
company has over 500 employees and is based in Portsmouth, NH.
Harbor Payments, Inc., a privately held company based in Atlanta, Georgia
provides invoice presentment and payment solutions to large enterprise clients.
In July 2005, Harbor acquired the EIPP business of Emergis Technologies, Inc.
and the EIPP business of Velosant LP in 2004.
CheckFree Corporation (Nasdaq:CKFR) provides online billing and payment for
companies on the Web. Primarily focused on the B2C market, consumers receive and
pay bills online through CheckFree-managed services. CheckFree was founded in
1981 in Columbus, Ohio. The company is now headquartered in Atlanta, GA with
offices across the U.S,, in Canada and in the UK.
26
Docucorp International, Inc.,(Nasdaq: DOCC) is based in Dallas Tx, and provides
enterprise software products and professional services related to its
information software products. They also provides application service provider
(ASP) hosting service to provide processing, print, mail, archival and Internet
delivery of documents for insurance, utilities, bank and mutual fund statements,
invoices, call center correspondence and EBP&P.
DST Systems Inc., is a Kansas City based provider of integrated paper and
electronic statements, bills, marketing and compliance pieces, and other
documents, that primarily service the communications, financial, insurance and
utility markets for B2C and B2B applications.
Edocs, Inc., a subsidiary of Siebel Systems, Inc., based in Natick NH with its
primary business model focused on providing online account management and
billing software to the global large enterprise market. The company has
approximately 250 employees and is focused on providing their B2B and B2C
products to the telecommunications, utility, healthcare, transportation,
security, real estate, retail and leasing industries, as well as financial
services firms with B2B electronic statement and presentment needs.
Pitney Bowes docSense (docSense) is a wholly-owned subsidiary of Pitney Bowes
(NYSE: PBI). docSense targets the B2C, B2B and internal messaging markets and
provides solutions for the creation and distribution of documents in paper and
digital forms. Pitney Bowes provides solutions for government, utility, and
insurance markets. It focuses on bills and primarily the B2C market.
Many of our current and potential competitors have greater name
recognition, larger installed customer bases, longer operating histories, and
substantially greater financial, technical and marketing resources than Direct
Insite. We cannot assume that current and potential competitors will not develop
products that may be or may be perceived to be more effective or responsive to
technological change than are our current or future products or that our
technologies and products will not be rendered obsolete by such developments.
Increased competition could result in price reductions, reduced margins or loss
of market share, any of which could have a material adverse effect on our
business, operating results and financial condition.
Employees
We had 46 employees, all in the United States, at June 30, 2006, including
31 in technical support, (including research and development), 7 in marketing,
sales and support services, and 8 in corporate finance and administration. Our
future success will depend in part upon our continued ability to attract and
retain highly skilled and qualified personnel. We believe that our relations
with our employees are good, and we have no collective bargaining agreements
with any labor unions.
Intellectual Property
We have two federally registered trademarks, which we rely upon:
"dbExpress(TM)" and "dbACCEL(TM)". In addition, we received a patent for the
proprietary aspects of our dbExpress technology in 1994, and a second, expanded
patent on that technology in 1995, which broadened the claims regarding the
product's graphical interface and indexing. No assurance can be given that our
patents and copyrights will effectively protect us from any copying or emulation
of our products in the future.
We also rely on proprietary knowledge and employ various methods, including
confidentiality agreements, to protect our software codes, concepts, ideas and
documentation of our proprietary technology.
Despite these efforts, unauthorized parties may attempt to copy aspects of
our products, obtain and use information that we regard as proprietary or
misappropriate our copyrights, trademarks, trade dress and similar proprietary
27
rights. In addition, the laws of some foreign countries do not protect
proprietary rights to as great an extent as do the laws of the United States.
Our means of protecting our proprietary rights may not be adequate. In addition,
our competitors might independently develop similar technology or duplicate our
products or circumvent any patents or our other intellectual property rights.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
FOR THE SIX MONTHS ENDED JUNE 30, 2006
Forward looking statements
All statements other than statements of historical fact included in this
Form 10-QSB including, without limitation, statements under, "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
regarding the Company's financial position, business strategy and the plans and
objectives of management for future operations, are forward-looking statements.
When used in this Form 10-QSB, words such as "anticipate," "believe,"
"estimate," "expect," "intend" and similar expressions, as they relate to the
Company or its management, identify forward-looking statements. Such
forward-looking statements are based on the beliefs of management, as well as
assumptions made by, and information currently available to, the Company's
management. Actual results could differ materially from those contemplated by
the forward-looking statements as a result of certain factors including but not
limited to, fluctuations in future operating results, technological changes or
difficulties, management of future growth, the risk of errors or failures in the
Company's software products, dependence on proprietary technology, competitive
factors, risks associated with potential acquisitions, the ability to recruit
personnel and the dependence on key personnel. Such statements reflect the
current views of management with respect to future events and are subject to
these and other risks, uncertainties and assumptions relating to the operations,
results of operations, growth strategy and liquidity of the Company. All
subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified in their
entirety by this paragraph.
Overview
We primarily operate as an application service provider ("ASP"), providing
an integrated transaction based "fee for service" offering called Invoices
On-Line (IOL), an electronic invoice presentment and payment (EIP&P) service
that processes high volumes of transactional data for invoice presentment
purposes delivered via the Internet on a global basis on behalf of our
customers. IOL is our primary offering and it is a globally delivered service
that provides electronic invoice presentation in the Americas, Europe and Asia,
including 28 different countries around the globe and in more than 13 languages
and currencies. We currently host several million invoices that are accessible
"on-line" via the Internet 24 hours per day, seven days per week, 365 days per
year. IOL is a uniquely positioned service offering in the industry. The service
is designed to handle the complex invoicing found in today's global business
environment. The solution allows Global 1000 companies to receive, route,
approve and pay invoices on-line in the local language and currency. By
automating the traditional paper-based invoicing process, customers now have
easy and quick access to line-item billing information, reporting and analytics.
With the enhanced level of accuracy provided by IOL, invoice disputes are
greatly reduced and overall customer satisfaction is substantially increased.
We also provide Custom Engineering Services which are single contractual
agreements involving modification or customization of the Company's proprietary
ASP software solution. Additionally, we provide service offerings in the form of
our patented dbExpressTM technology, a management information tool that allows
28
users to visually data mine large volumes of transactional data via the
Internet. A complete Internet Customer Care tool set integrated with the EIP&P
product set is also available. We operate fully redundant data centers located
at our main office in Bohemia, N.Y. and in Newark, NJ. Our facility in New
Jersey is space leased at an International Business Machines ("IBM"), e-business
Hosting Center. This co-location / redundancy feature enables us to offer
virtually down time free service.
This suite of services enables us to provide a comprehensive Internet
delivered service from the raw transaction record through all of the internal
workflow management processes including an electronically delivered invoice with
customer analytics. This comprehensive service offering provides back office
operations, reduces our customers' costs and provides for improved customer
service by providing the end customer with easy access to all of the detailed
information about their bill.
Currently, IBM, our largest customer, representing approximately 66.8% and
69.0% of revenue for the three and six month periods ended June 30, 2006,
respectively and 66.2% and 69.9% of our revenue for the three and six month
periods ended June 30, 2005, respectively, utilizes our suite of IOL products
and services to allow their customers from around the globe to receive, analyze,
dispute and cost allocate all of their invoice related information in their
local language and currency via the Internet 24 hours a day, 7 days a week, 365
days a year. Our second Fortune 500 Company, Electronic Data Systems Corp.
("EDS"), accounted for approximately 30.9% and 28.8% of revenue for the three
and six month periods ended June 30, 2006, respectively and 30.4% and 27.6% of
revenue for the three and six month periods ended June 30, 2005, respectively.
Critical accounting policies
Principles of Consolidation
---------------------------
The consolidated financial statements include the accounts of our company
and our subsidiaries. All significant intercompany transactions and balances
have been eliminated in consolidation.
Revenue Recognition
-------------------
We record revenue in accordance with Statement of Position 97-2 "Software
Revenue Recognition", issued by the American Institute of Certified Public
Accountants (as modified by Statement of Position 98-9) and SEC Staff Accounting
Bulletin Topic 13 "Revenue Recognition in Financial Statements." In some
circumstances, we enter into arrangements whereby we are obligated to deliver to
our customer multiple products and/or services (multiple deliverables). In these
transactions, in accordance with the Emerging Issues Task Force Issue No. 00-21,
we allocate the total revenue to be earned among the various elements based on
their relative fair values. We recognize revenue related to the delivered
products or services only if:
o Any undelivered products or services are not essential to the functionality of
the delivered products or services;
o Payment for the delivered products or services is not contingent upon delivery
of the remaining products or services;
o We have an enforceable claim to receive the amount due in the event it does
not deliver the undelivered products or services and it is probable that such
amount is collectible;
o There is evidence of the fair value for each of the undelivered products or
services;
o Delivery of the delivered element represents the culmination of the earnings
process.
29
The following are the specific revenue recognition policies for each major
category of revenue.
ASP Services
------------
The Company provides transactional data processing services through its ASP
software solutions to its customers. The customer is charged a monthly fixed
rate on a per transaction basis or a fixed fee based on monthly transaction
volumes. Revenue is recognized as the services are performed.
Custom Engineering Services
---------------------------
The Company performs custom engineering services which are single
contractual agreements involving modification or customization of the Company's
proprietary ASP software solution. Progress is measured using the relative fair
value of specifically identifiable output measures (milestones). Revenue is
recognized at the lessor of the milestone amount when the customer accepts such
milestones or the percentage of completion of the contract following the
guidance of SOP 81-1, "Accounting for Performance of Construction-Type and
Certain Production Type Contracts".
Cost of Revenue
---------------
Cost of revenue in the condensed consolidated statements of operations is
presented along with operations, research and development costs and exclusive of
amortization and depreciation shown separately. Custom Engineering Services
costs related to uncompleted milestones are deferred and included in other
current assets, when applicable.
Property and Equipment
----------------------
Property and equipment are stated at cost and depreciated on a
straight-line basis over the estimated useful lives of the related assets.
Leasehold improvements are amortized over the terms of the respective leases or
the service lives of the related assets, whichever is shorter.
Capitalized lease assets are amortized over the shorter of the lease term
or the service life of the related assets.
Impairment of Long-Lived Assets
-------------------------------
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" we review
our long-lived assets, including capitalized software costs and property and
equipment, for impairment whenever events or changes in circumstances indicate
that the carrying amount of the assets may not be fully recoverable. To
determine if impairment exists, we compare the estimated future undiscounted
cash flows from the related long-lived assets to the net carrying amount of such
assets. Once it has been determined that impairment exists, the carrying value
of the asset is adjusted to fair value. Factors considered in the determination
of fair value include current operating results, trends and the present value of
estimated expected future cash flows.
Derivative Liabilities
On March 29, 2005, the Company entered into a Securities Purchase Agreement
with investors for secured notes and warrants. (See Note 8 of the accompanying
condensed consolidated financial statements). The warrant shares are subject to
registration rights penalties with provisions that are outside the control of
the Company. As such the detachable warrants are required to be recorded as
liabilities at their fair value on the date of issuance under the guidance on
EITF 00-19.
In accordance with SFAS No. 133 "Accounting for Derivative Instruments and
30
Hedging Activities", at each reporting period these liabilities will be adjusted
for changes in their fair value. The detachable warrants are valued using the
Black Scholes valuation model. Actual period close common stock prices,
applicable volatility rates, remaining contractual life and the period close
risk free interest rate for the instruments expected remaining life are the key
assumptions used in the Black Scholes valuation calculation. The
period-to-period changes in fair value will be recorded as either an addition or
charge to earnings. There is no cash effect to these additions or charges over
the life of these instruments. For the three and six months ended June 30, 2006
the Company recorded income of $299,000 and $269,000, respectively, for the
change in the fair value of these derivative instruments. For the three and six
months ended June 30, 2005 the Company recorded a charge of $92,000 as a result
of the change in fair value of these derivative instruments.
Income Taxes
------------
We account for income taxes using the liability method. The liability
method requires the determination of deferred tax assets and liabilities based
on the differences between the financial statement and income tax bases of
assets and liabilities, using enacted tax rates. Additionally, net deferred tax
assets are adjusted by a valuation allowance if, based on the weight of
available evidence, it is more likely than not that some portion or all of the
net deferred tax assets will not be realized.
Earnings per Share
------------------
We display earnings per share in accordance with SFAS No. 128, "Earnings
Per Share". SFAS No. 128 requires dual presentation of basic and diluted
earnings per share. Basic earnings per share includes no dilution and is
computed by dividing net income (loss) attributable to common shareholders by
the weighted average number of common shares outstanding for the period. Diluted
earnings per share include the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock. Outstanding stock options, warrants and other potential stock issuances
have been considered in the computation of diluted earnings per share to the
extent they were dilutive.
Concentrations and Fair Value of Financial Instruments
------------------------------------------------------
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and accounts
receivable. We perform ongoing credit evaluations of our customers' financial
condition and, generally, require no collateral from our customers. Unless
otherwise disclosed, the fair value of financial instruments approximates their
recorded value.
Use of Estimates
----------------
In preparing consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America, our
management makes estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the consolidated financial statements, as well as the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates.
Results of operations
For the three months ended June 30, 2006 we had income from operations of
$116,000 compared to a loss from operations of $170,000 in the same period in
2005. For the six months ended June 30, 2006 we had a loss from operations of
$176,000 compared to an operating loss of $380,000 for the same period in 2005.
31
The improvement in the operating profit/loss is principally due to the decrease
in operating costs as discussed below. Net income for the three months ended
June 30, 2006 was $226,000 compared to a loss of $402,000 for the same period in
2005. We had a net loss of $307,000 for the six months ended June 30, 2006
compared to a net loss of $687,000 for the same period in 2005.
For the three months ended June 30, 2006 revenue decreased $122,000 (5.3%)
to $2,196,000 compared to revenue of $2,318,000 for the same period in 2005.
This decrease is primarily the result of an increase in our core business, the
ASP IOL services, of $126,000 (8.8%) offset by a decrease of $244,000 (28.1%) in
revenue from engineering services and a small decrease of $4,000 in other
services. For the six months ended June 30, 2006 revenue decreased $187,000
(4.3%) to $4,211,000 compared to revenue of $4,398,000 for the six months ended
June 30, 2005. For the six months ended June 30, 2006 revenue from the ASP IOL
services increased $527,000 (20.4%) while revenue from engineering services
decreased $703,000 (39.4%). Engineering services revenue decreased principally
as the result of substantially completing deployment of our IOL service in all
major geographies for our largest customer, IBM, and completion of the initial
phases of our IOL service for EDS. We anticipate that revenue from engineering
services will increase as we begin new initiatives at both IBM and EDS and as we
expand our customer base.
Costs of operations, research and development decreased by $31,000 (3.0%)
to $1,003,000 for the three months ended June 30, 2006 and increased $19,000
(0.9%) to $2,066,000 for the six months ended June 30, 2006 compared to costs of
$1,034,000 and $2,047,000 for the three and six month periods ended June 30,
2005, respectively. These costs consist principally of salaries and related
expenses for software developers, programmers, custom engineers, network
services, and quality control and assurance. Also included are network costs,
costs of the production co-location facility and other expenses directly related
to our custom engineering and ASP services. For the three months ended June 30,
2006 the decrease is principally due to a decrease in professional fees of
$34,000, rent of $12,000 and phone expense of $8,000 offset by an increase in
purchased services of $37,000 and salaries of $9,000, while all other costs
decreased $23,000. For the six months ended June 30, 2006 the increase is due to
increases in salaries of $27,000, purchased services of $47,000 and auto
expenses of $11,000 offset by decrease in professional fees of $54,000. All
other costs decreased $12,000 for the six month period.
Sales and marketing costs were $350,000 and $813,000 for the three and six
month periods ended June 30, 2006, respectively, a decrease of $209,000 (37.3%)
for the three month period and a decrease of $218,000 (21.1%) for the six month
period compared to costs of $559,000 and $1,031,000 for the three and six month
periods ended June 30, 2005, respectively. Salaries and related costs decreased
$39,000 and $18,000 for the three and six month periods ended June 30, 2006,
respectively, while professional and consulting fees decreased $86,000 and
$113,000 for the three and six month periods, respectively. Additionally,
advertising and travel costs decreased $63,000 and $74,000 for the three and six
month periods ended June 30, 2006, respectively compared to the same periods in
2005.
General and administrative costs decreased $129,000 (16.5%) and $127,000
(8.6%) to $651,000 and $1,345,000 for the three and six month periods ended June
30, 2006, respectively, compared to the same periods in 2005. The decreases were
principally due to decreases in salaries and related costs of $34,000 and
$32,000 for the three and six month periods ended June 30, 2006, respectively.
In addition, rents, travel, personnel recruiting costs and commercial insurance
costs decreased a combined $74,000 and $101,000 for the three and six month
periods ended June 30, 2006, respectively, compared to cost for the same periods
in 2005.
Depreciation and amortization expense decreased by $39,000 (33.9%) and
$65,000 (28.5%) to $76,000 and $163,000 for the three and six month periods
ended June 30, 2006, respectively, compared to costs for the same periods in
2005. The decrease is primarily due to fully amortizing certain software costs
and other computer equipment.
For the three and six months ended June 30, 2006 we recorded a gain on the
revaluation of the warrant liability of $299,000 and 269,000, respectively
compared to a charge of $92,000 for the three and six month periods ended June
30, 2005.
32
For the three and six months ended June 30, 2006, interest expense
increased $23,000 and $129,000, respectively, principally due to the
amortization of debt discount of $97,000 and $222,000, for the three and six
month periods, respectively, offset by a decrease in interest due to lower rate
of borrowing under our receivables financing agreements.
Other expense net of other income was $32,000 and $62,000 for the three and
six months ended June 30, 2006 compared to other expense net of $1,000 for the
three and six months ended June 30, 2005. During the six months ended June 30,
2006 we realized a gain on the sale of an investment of $59,000. This was offset
by $75,000 due to penalties incurred in connection with the Sigma and MetVP
financing (see Note 8 to the Condensed Consolidated Financial Statements) and
$32,000 of expenses related to the settlement and termination of a consulting
agreement.
Financial Condition and Liquidity
For the six months ended June 30, 2006, we had net loss of $307,000
compared to a net loss of $687,000 for the same period in 2005. Cash provided by
continuing operations was $339,000 in the first six months of 2006 compared to
cash used in continuing operations of $472,000 for the same period in 2005, an
improvement of $811,000.
Cash provided by operations, including cash used for discontinued
operations, for the six months ended June 30, 2006 was $322,000, consisting of
the net loss of $307,000, reduced by non-cash expenses of $230,000, including
depreciation and amortization of property and equipment of $162,000,
amortization of debt discount of $222,000, amortization of deferred stock-based
compensation of $115,000 and the change in the fair value of the warrant
liability of ($269,000). In addition accounts receivable were reduced by
$482,000, prepaid expenses decreased $123,000, while accounts payable and
accrued expenses increased $225,000. This was offset by a decrease in deferred
revenue of $418,000.
Cash used in investing activities was $52,000 for the six months ended June
30, 2006, compared to $127,000 for same period in 2005. This was principally
expenditures for equipment.
Cash used in financing activities totaled $404,000 for the six months ended
June 30, 2006, compared to cash provided by financing activities of $468,000 for
the six months ended June 30, 2005. As noted above, we received proceeds from a
new loan financing of $750,000 in the first six months of 2005. We repaid
$77,000 of long-term debt and capital lease obligations in the first six months
of 2006 and the balance outstanding under short term revolving loans for
receivables financing decreased by $327,000 in 2006.
Management's Liquidity and Financing Plans
In order to meet our cash requirements and to achieve positive operating
cash flows we have and will continue to take various actions and steps that we
believe will enable us to attain these goals. These actions include:
o In March 2005 we closed a Bridge Loan financing with Sigma Capital
Partners LLC and Metropolitan Venture Partners II, L.P. and received
proceeds of $750,000 less legal fees of $55,000 (see Note 8).
o The holders of the Series A and Series B Preferred stock have
previously agreed to defer payment of dividends until February 1, 2006
33
and April 15, 2006, respectively. We may seek to defer these dividends
further. Management believes that we are precluded from paying these
dividends at this time pursuant to Delaware General Corporate Law.
o We may raise additional capital through private equity offerings and
borrowing. There is no assurance however that such capital would be
available to us, or if available, on terms and conditions that would
be acceptable. In 2004, we entered into an agreement with DIRI Rec
Fund LLC, a corporation formed and funded to loan funds to the Company
against accounts receivable, and may receive advances up to $250,000
from Diri Rec Fund (see Note 7 of the accompanying condensed
consolidated financial statements). Further, in June 2005, we renewed
for a period of two years the $500,000 loan previously scheduled to
mature on June 30, 2005 and the guarantors of this loan have consented
to this extension (see Note 8 of the accompanying condensed
consolidated financial statements). As noted above the guarantors were
issued warrants and we could receive proceeds of $500,000 from the
exercise of such warrants which expire on July 11, 2010, although
there is no assurance that these warrants will be exercised.
o We continue to strive to increase revenue through offering custom
engineering services, expanding and enhancing existing product
offerings such as IOL, and introducing new product offerings. In 2004
we entered into a new agreement to provide IOL services to a Fortune
500 company. Revenue from this new customer accounted for 30.9% and
28.8% of total revenue for the three and six months ended June 30,
2006. We anticipate that revenue from this new customer will continue
to increase in 2006 and beyond and expect to further broaden our
customer base in 2006, although there is no assurance that we will be
able to broaden this customer base.
o In 2006 we initiated a cost reduction plan that we believe will
significantly reduce our operating costs while still enabling us to
meet our commitments to our customers.
o We continue to expand our marketing efforts in order to increase the
customer base. In this regard, in 2003, we became a business partner
with IBM and through this relationship will work with IBM to achieve
sales to new customers. As a result of this relationship, in the first
quarter of 2006 we began deployment of our IOL service to a new
outsourcing customer of IBM. We will continue to pursue similar
channel partner opportunities. Also, in the third quarter 2005 we
employed a new sales and marketing executive to further expand our
sales efforts.
We believe that these plans and new initiatives as discussed above
will lead to positive cash flow and profitability. While we pursue these
goals we also believe that our ability to raise additional capital through
equity and debt placements will provide sufficient cash to meet cash
requirements at least through June 30, 2007. There can be no assurance,
however, that we will achieve the cash flow and profitability goals, or
that we will be able to raise additional capital sufficient to meet
operating expenses or implement its plans. In such event, we may have to
revise our plans and significantly reduce our operating expenses, which
could have an adverse effect on revenue and operations in the short term.
FOR THE YEAR ENDED DECEMBER 31, 2005
Discontinued Operations
In 2001 we acquired Platinum Communications, Inc. ("Platinum"), a Dallas,
Texas based company, which marketed its integrated proprietary back office
34
software solutions, Account Management Systems ("AMS" or sometimes referred to
as "TAMS") to the telecommunications industry either as a license or as an ASP.
As a result of the lack of development of the Platinum business and to focus our
resources on our core business, in December 2003 we decided to close the
operations of Platinum. For the year ended December 31, 2005 the Company
recognized a loss from discontinued operations of $17,000 and for the year ended
December 31, 2004 the Company recognized income from the discontinued operations
of $288,000 as a result of settling certain liabilities of the Platinum
operation for less than the original obligation. The income (loss) is reflected
as Income (Loss) from Discontinued Operations in the accompanying Consolidated
Statements of Operations.
Recent Financing
On June 30, 2005, we obtained a new line of credit in the principal amount
of $500,000 with JPMorgan Chase Bank evidenced by a Grid Demand Promissory Note
(the "Credit Facility) replacing a prior credit facility dated June 27, 2003,
under substantially similar terms, but extending the original Maturity Date to
June 30, 2007. As a condition precedent to providing the Credit Facility, the
JPMorgan Chase Bank required guarantees of our obligations from Tall Oaks and
Lawrence Hite (managing member of Tall Oaks) and a collateral agreement from
Tall Oaks. In consideration of the issuance of such guarantee and delivery of
the collateral agreement, on July 12, 2005, Company issued and delivered to Tall
Oaks Group L.L.C. warrants with an initial exercise price of $1.00 per share to
purchase an aggregate of 500,000 shares of the common stock of Company.
On March 29 2005 we entered into a Securities Purchase Agreement with Sigma
Opportunity Fund LLC ("Sigma") and Metropolitan Venture Partners II, L.P.
("MetVP"), collectively the "Buyers", whereby the Buyers purchased Senior
Subordinated Secured notes (the "Note Purchase") in the aggregate amount of
$750,000. The notes bear interest at the rate of five percent (5%) per year
beginning June 28, 2005 and mature on the earlier to occur of (i) September 29,
2006; (ii) the date on which demand for payment of the Grid Demand Promissory
Note, dated as of June 27, 2005 payable to JPMorgan Chase Bank is made, and
(iii) the due date of the loan payable to JPMorgan Chase Bank pursuant to such
Grid Demand Promissory Note, including if due on demand and whether or not
demand for payment is actually made. In connection with the note purchase the
Buyers were issued warrants to purchase 750,000 of our common shares. The
exercise price of the warrants is $0.90 per share of common stock subject to
adjustment on the occurrence of certain events. Sigma had the right to lead a
"Follow-on Financing." In the event that the Follow-on-Financing did not occur,
the exercise price of the warrants would be $0.01 per common share. As of the
date hereof, we have elected not to pursue the Follow-on-Financing with Sigma
and, as a result, the exercise price of the warrants is $0.01 per share. Under
the terms of the Securities Purchase Agreement, the Company is obligated to file
a registration statement to register shares underlying the warrants and interest
shares. In the event that the Company does not timely file a registrations
statement or the registration statement does not become effective, then the
holders are entitled to certain liquidated damages.
In November 2004 the Board of Directors authorized us to sell up to 1,500
shares of Series D Redeemable Preferred Stock ("Series D Preferred") at $1,000
per share. The holders of Series D Preferred are entitled to dividends, on a
cumulative basis, at the rate of 9-1/2% per year, compounded and payable
quarterly beginning on April 1, 2006. The holders of Series D Preferred have
preference in the payment of dividends and, in the event of liquidation, to all
classes of capital stock of the Company except for the Series A, B and C
Preferred Stock. As of December 31, 2004 we had sold 100 shares of Series D
Preferred and received proceeds of $100,000. The buyer was issued warrants to
purchase 90,909 common shares at an exercise price of $2.03 per share in
conjunction with the sale.
In December 2003 the Board of Directors authorized us to sell up to 1,500
shares of Series C Redeemable Preferred Stock ("Series C Preferred") at $1,000
per share and in April 2004 the Board authorized the sale of an additional 500
shares. The holders of Series C Preferred are entitled to dividends, on a
35
cumulative basis, at the rate of 9-1/2% per year, compounded and payable
quarterly beginning on October 1, 2005. The holders of Series C Preferred have
preference in the payment of dividends and, in the event of liquidation, to all
classes of capital stock of the Company except for the Series B Preferred Stock.
As of December 31, 2004 we had sold 2000 shares of Series C Preferred and
received proceeds of $2,000,000 less expenses of $140,000. Of the total shares
sold Metropolitan has purchased 540 shares, our Chairman and Chief Executive
Officer of the Company purchased 200 shares and certain Directors purchased 105
shares. The proceeds were used for working capital purposes.
In June 2003, the Company's Board of Directors approved the exchange of the
then outstanding obligations to our Chairman and Chief Executive Officer, Markus
& Associates and Tall Oaks Group, LLC for 974 shares of Series B Preferred Stock
at an exchange ratio of $1,000 of debt per share ("Price Per Share"). The Series
B Preferred was issued as follows:
o 266 shares were exchanged for $266,000 of debt obligation to our
Chairman and Chief Executive Officer;
o 208 shares were exchanged for $208,000 of debt obligation to Markus &
Associates; and
o 500 shares were exchanged for $500,000 of debt obligation to Tall Oaks
Group, LLC ("Tall Oaks").
Each of the Series B Preferred shares is entitled to mandatory dividends,
payable quarterly, commencing on the first day of the calendar quarter after the
date of issuance, at the rate of 12% per annum. Additionally, the Series B
Preferred shares are redeemable, at the sole option of the Company, on or after
March 31, 2005 (or prior to March 31, 2005 with the consent of
majority-in-interest holders of Series B Preferred shares). Upon redemption, the
holders of the Series B Preferred shall be entitled to receive, for each share
of Series B Preferred outstanding, an amount equal to the Price Per Share plus
accrued and unpaid dividends.
Between September 2002 and June 2003, the Company sold a total of 134,680
shares of Series A Convertible Preferred Stock, ("Series A Preferred") in
consideration for the gross amount of $2,750,000 to Metropolitan Venture
Partners II, L.P. Each share of Series A Preferred is convertible into 10 shares
of common stock of the Company. The Series A Preferred is automatically
convertible into common shares on September 25, 2008. The holders of the Series
A Preferred ("the Holders") are entitled to dividends, on a cumulative basis, at
the rate of 9-1/2% per annum, compounded quarterly and payable on February 1,
2005 and September 25, 2005. The payment of the first dividend was originally
scheduled for September 25, 2004, however, the Company and the Holders agreed to
defer this payment until February 1, 2005. As consideration for the deferral of
the dividend payment, the Company agreed to pay the Holders a premium of 7.5% of
the dividend. In May 2004 the Company and the Holders further agreed to grant
the Company the right, in its sole discretion, to defer the payment of the
dividend scheduled to be paid on February 1, 2005 until February 1, 2006. In the
event the Company elected to pay the dividend on February 1, 2006 the Holders
would receive a premium of $129,000. In December 2004 the Company exercised its
right to defer payment of this dividend until February 1, 2006. Also, the
Company and the Holders further agreed to grant the Company the right, in its
sole discretion, to defer the payment of the dividend scheduled to be paid on
September 25, 2005 until February 1, 2006. In the event the Company elects to
pay this dividend on February 1, 2006 the Holders would receive a premium of
$26,000. As of June 30, 2006 the Company has not paid any dividends to preferred
share holders.
Management believes the Company is precluded from paying these dividends at
this time pursuant to Delaware General Corporate Law.
Seasonality/Quantity Fluctuations
Revenue from ASP ongoing services generally is not subject to fluctuations
or seasonal flows. However, we believe that revenue derived from custom
engineering services will have a significant tendency to fluctuate based on
customer demand.
36
Other factors including, but not limited to, new product introductions,
domestic and international economic conditions, customer budgetary
considerations, and the timing of product upgrades may create fluctuations. As a
result of the foregoing factors, our operating results for any quarter are not
necessarily indicative of results for any future period.
Critical accounting policies
Principles of Consolidation
---------------------------
The consolidated financial statements include the accounts of our company
and our subsidiaries. All significant intercompany transactions and balances
have been eliminated in consolidation.
Revenue Recognition
-------------------
We record revenue in accordance with Statement of Position 97-2 "Software
Revenue Recognition", issued by the American Institute of Certified Public
Accountants (as modified by Statement of Position 98-9) and SEC Staff Accounting
Bulletin Topic 13 "Revenue Recognition in Financial Statements." In some
circumstances, we enter into arrangements whereby we are obligated to deliver to
our customer multiple products and/or services (multiple deliverables). In these
transactions, in accordance with the Emerging Issues Task Force Issue No. 00-21,
we allocate the total revenue to be earned among the various elements based on
their relative fair values. We recognize revenue related to the delivered
products or services only if:
o Any undelivered products or services are not essential to the functionality of
the delivered products or services;
o Payment for the delivered products or services is not contingent upon delivery
of the remaining products or services;
o We have an enforceable claim to receive the amount due in the event it does
not deliver the undelivered products or services and it is probable that such
amount is collectible;
o There is evidence of the fair value for each of the undelivered products or
services;
o Delivery of the delivered element represents the culmination of the earnings
process.
The following are the specific revenue recognition policies for each major
category of revenue.
ASP Services
------------
The Company provides transactional data processing services through its ASP
software solutions to its customers. The customer is charged a monthly fixed
rate on a per transaction basis or a fixed fee based on monthly transaction
volumes. Revenue is recognized as the services are performed.
Custom Engineering Services
------------------------------
The Company performs custom engineering services which are single
contractual agreements involving modification or customization of the Company's
proprietary ASP software solution. Progress is measured using the relative fair
value of specifically identifiable output measures (milestones). Revenue is
recognized at the lesser of the milestone amount when the customer accepts such
milestones or the percentage of completion of the contract following the
guidance of SOP 81-1, "Accounting for Performance of Construction-Type and
Certain Production Type Contracts".
37
Cost of Revenue
---------------
Cost of revenue in the consolidated statements of operations is presented
along with operations, research and development costs and exclusive of
amortization and depreciation shown separately. Custom Engineering Services
costs related to uncompleted milestones are deferred and included in other
current assets, when applicable.
Property and Equipment
----------------------
Property and equipment are stated at cost and depreciated on a
straight-line basis over the estimated useful lives of the related assets.
Leasehold improvements are amortized over the terms of the respective leases or
the service lives of the related assets, whichever is shorter.
Capitalized lease assets are amortized over the shorter of the lease term
or the service life of the related assets.
Impairment of Long-Lived Assets
-------------------------------
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" we review
our long-lived assets, including capitalized software costs and property and
equipment, for impairment whenever events or changes in circumstances indicate
that the carrying amount of the assets may not be fully recoverable. To
determine if impairment exists, we compare the estimated future undiscounted
cash flows from the related long-lived assets to the net carrying amount of such
assets. Once it has been determined that impairment exists, the carrying value
of the asset is adjusted to fair value. Factors considered in the determination
of fair value include current operating results, trends and the present value of
estimated expected future cash flows
Income Taxes
------------
We account for income taxes using the liability method. The liability
method requires the determination of deferred tax assets and liabilities based
on the differences between the financial statement and income tax bases of
assets and liabilities, using enacted tax rates. Additionally, net deferred tax
assets are adjusted by a valuation allowance if, based on the weight of
available evidence, it is more likely than not that some portion or all of the
net deferred tax assets will not be realized.
Earnings per Share
------------------
We display earnings per share in accordance with SFAS No. 128, "Earnings
Per Share". SFAS No. 128 requires dual presentation of basic and diluted
earnings per share. Basic earnings per share includes no dilution and is
computed by dividing net income (loss) attributable to common shareholders by
the weighted average number of common shares outstanding for the period. Diluted
earnings per share include the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock. Outstanding stock options, warrants and other potential stock issuances
have not been considered in the computation of diluted earnings per share
amounts since the effect of their inclusion would be anti-dilutive.
Concentrations and Fair Value of Financial Instruments
------------------------------------------------------
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and accounts
receivable. We perform ongoing credit evaluations of our customers' financial
condition and, generally, require no collateral from our customers. Unless
otherwise disclosed, the fair value of financial instruments approximates their
recorded value.
38
Use of Estimates
----------------
In preparing consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America, our
management makes estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the consolidated financial statements, as well as the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates.
Financial Condition and Liquidity
For the year ended December 31, 2005, we incurred a loss from continuing
operations of $974,000 compared to a loss from continuing operations of
$1,571,000 for the year ended December 31, 2004, an improvement of $597,000 or
38%. Cash provided by continuing operations for the year ended December 31, 2005
was $91,000 compared to cash used for operations of $1,050,000 for the year
ended December 31, 2004. Cash used for discontinued operations was $68,000 for
the year ended December 31, 2005 compared to $221,000 in 2004. We funded the
shortfall in cash from operations through the issuance of the Senior
Subordinated Secured Notes of $750,000 as discussed above under Recent
Financings.
Cash used in operations (including cash used for discontinued operations)
for the year ended December 31, 2005 was $23,000, consisting of the net loss
from continuing operations of $974,000, offset by non-cash expenses of $923,000,
including depreciation and amortization on property and equipment and debt
discount of $599,000, common stock and options issued for services valued at
$347,000 and amortization of deferred stock based compensation of $87,000,
offset by a change in the fair value of warrants of $105,000. Cash from
operations was increased by a decrease in accounts receivable and prepaid
expenses and other current assets of $80,000, offset by an increase in other
assets of $35,000, a decrease accounts payable and accrued expenses of $76,000
and an increase in deferred revenue of $173,000. Additionally, net cash used in
discontinued operations was $68,000.
Cash used in investing activities was $223,000 for the year ended December
31, 2005, compared to $114,000 for the previous year. This was principally
expenditures for equipment in 2005 and 2004.
Cash from financing activities totaled $258,000 for the year ended December
31, 2005, compared to $1,616,000 in the prior year. We received net proceeds
from issuance of Senior Subordinated Secured notes of $750,000. Advances from
credit lines for receivable financing decreased $317,000 for the year ended
December 31, 2005 and we made repayments on lines of credit and capital leases
of $175,000.
As a result of these operating, investing and financing activities cash
increased by $58,000 to $364,000 at December 31, 2005.
Results of Operations
IBM continues to be our largest customer accounting for 68% and 92% of
total revenue for the years ended December 31, 2005 and 2004, respectively. We
derive revenue from IBM from the sale of our Invoices On Line ("IOL") managed
services (ASP) as well as custom engineering services. During the second half of
2001, we entered into an agreement with IBM wherein for a per transaction fee,
we enable IBM to present invoices to their customers via the Internet. Our IOL
service is an electronic invoice presentment and payment system ("EIP&P")
offering and has been expanded to include additional functionality. In March
2002, the parties signed a new agreement, which allows IBM to expand this EIP&P
offering to more of its customers, both domestic and international. Also in 2004
we added our second Fortune 500 company, EDS, to our customer base and this
39
customer accounted for approximately 28% and 7% of revenue for the years ended
December 31, 2005 and 2004, respectively. We continue to actively pursue new
sales opportunities to reduce sales concentration.
For the year ended December 31, 2005 revenue from continuing operations
increased $1,312,000 or 17.4% to $8,870,000 compared to revenue from continuing
operations of $7,558,000 in 2004. The increase is primarily due to an increase
in IOL and Customer Presentable Invoice ("CPI") services, our ASP service
offerings and engineering services of $1,802,000, offset by a decrease of
$490,000 in telecommunications management services ("TAMS"). The increase in
revenue from ASP services was the result of further deploying our ASP services
in Europe and the Asia Pacific regions and IOL services to a new customer. The
decrease in the TAMS services resulted from a decrease in demand and our focus
on our EIP&P ASP services. We expect that new projects begun in late 2005 and
the addition of new customers and new projects in 2006 will lead to an increase
in our ASP and custom engineering revenue in 2006.
Costs of operations, research and development increased by $404,000 (11.2%)
to $4,024,000 for the year ended December 31, 2005 compared to the costs in
2004. These costs consist principally of salaries and related expenses for
software developers, programmers, custom engineers, network services, and
quality control and assurance. Also included are network costs, costs of the
production co-location facility and other expenses directly related to our
custom engineering and ASP production services. The increase in costs is
principally due to increases in staffing costs of $293,000, and professional
fees of $55,000, offset by a decrease in rent for our co-location production
facility of $26,000. All other operating expenses combined increased
approximately $82,000 net.
Sales and marketing costs were $1,984,000 for the year ended December 31,
2005, an increase of $308,000 or 18.4% compared to the same costs in 2004.
Consulting and professional fees increased by $219,000 principally from
reassignment of other consulting fees from other departments. Travel and
entertainment costs increased $68,000 and all other costs increased $21,000,
net.
General and administrative costs increased $62,000 or 2.1% to $3,002,000
for the year ended December 31, 2005 compared to costs of $2,940,000 in 2004.
Salaries and related costs increased $226,000 principally due to a restoration
in 2005 of salary reductions in 2004. Legal and accounting fees increased
$225,000 due to the costs incurred for new financing and the fees incurred to
file a registration statement for shares underlying warrants issued in
conjunction with the new financing. This was partially offset by a decrease in
travel and entertainment costs of $76,000 and a decrease in commercial insurance
costs of $100,000. All other general and administrative costs had a net decrease
of $213,000.
Depreciation and amortization expense decreased by $127,000 (23.6%)
primarily due to fully amortizing certain software costs and other computer
equipment.
Interest expense increased by $209,000 primarily due to the issuance of the
Senior Subordinated Secured Notes and the related warrants. The value of the
warrants issued with this financing is accounted for as debt discount and
amortized to interest expense over the life of the loan.
Net Operating Loss Carry Forwards
At December 31, 2005, the Company has net operating loss carryforwards
("NOLs") remaining of approximately $79 million, which may be available to
reduce taxable income, if any. These NOLs expire through 2025. However, Internal
Revenue Code Section 382 rules limit the utilization of NOLs upon a change in
control of a company. The Company has not completed a recent evaluation of
whether a change in control has taken place. If it is determined that a change
in control has taken place, utilization of its NOLs will be subject to severe
limitations in future periods, which would have the effect of eliminating
substantially all of the future income tax benefits of the NOLs.
40
New Accounting Pronouncements
In June 2005, the EITF reached consensus on Issue No. 05-2, "The Meaning of
`Conventional Convertible Debt Instrument' in EITF Issue No. 00-19, `Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock.'" Issue 00-19 is used to evaluate whether embedded
derivatives should be bifurcated under SFAS No. 133, "Accounting For Derivative
Instruments and Hedging Activities", as amended. Specifically, SFAS 133 provides
guidance as to when an issuer is required to bifurcate a conversion option that
is embedded in convertible debt. However, Issue 00-19 does not define
"conventional convertible debt instrument." Given the development of numerous
contractual terms that may be included in a convertible debt instrument, it is
not clear when a convertible debt instrument is "conventional." We do not
believe that our redeemable preferred stock and related warrants meet the
definition of conventional convertible debt and as a result Issue No. 00-19
applies to the liability treatment of these instruments. As such the adoption of
EITF 05-2 had an effect on the Company's results of operations and its financial
condition (see Note 8 of the accompanying Consolidated Financial Statements).
In June 2005, the EITF reached consensus on Issue No. 05-6, Determining the
Amortization Period for Leasehold Improvements ("EITF 05-6"). EITF 05-6 provides
guidance on determining the amortization period for leasehold improvements
acquired in a business combination or acquired subsequent to lease inception.
The guidance in EITF 05-6 will be applied prospectively and is effective for
periods beginning after June 29, 2005. EITF 05-6 did not have a material effect
on the Company's financial position or results of operations.
In September 2005, the FASB ratified the EITF Issue No. 05-7, "Accounting
for Modifications to Conversion Options Embedded in Debt Instruments and Related
Issues," which addresses whether a modification to a conversion option that
changes its fair value effects the recognition of interest expense for the
associated debt instrument after the modification, and whether a borrower should
recognize a beneficial conversion feature, not a debt extinguishment, if a debt
modification increases the intrinsic value of the debt (for example, the
modification reduces the conversion price of the debt). The adoption of the
Issue may have a material effect on our consolidated financial position or
results of operations in future periods.
In September 2005, the FASB also ratified the EITF's Issue No. 05-8,
"Income Tax Consequences of Issuing Convertible Debt with a Beneficial
Conversion Feature," which discusses whether the issuance of convertible debt
with a beneficial conversion feature results in a basis difference arising from
the intrinsic value of the beneficial conversion feature on the commitment date
(which is treated recorded in the stockholder's equity for book purposes, but as
a liability for income tax purposes) and, if so, whether that basis difference
is a temporary difference under SFAS No. 109, "Accounting for Income Taxes." The
adoption of the Issue is not expected to have a material effect on our
consolidated financial position or results of operations in future periods.
In February 2006, the FASB issued SFAS No. 155 "Accounting for Certain
Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140"
("SFAS 155"). SFAS 155 clarifies certain issues relating to embedded derivatives
and beneficial interests in securitized financial assets. The provisions of SFAS
155 are effective for all financial instruments acquired or issued after fiscal
years beginning after September 15, 2006. The Company is currently assessing the
impact that the adoption of SFAS 155 will have on its results of operations and
financial position.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets" ("SFAS 156"), which amends SFAS 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities", with
respect to the accounting for separately recognized servicing assets and
servicing liabilities. SFAS 156 permits the choice of the amortization method or
41
the fair value measurement method, with changes in fair value recorded in
income, for the subsequent measurement for each class of separately recognized
servicing assets and servicing liabilities. The statement is effective for years
beginning after September 15, 2006, with earlier adoption permitted. The Company
is currently evaluating the effect that adopting this statement will have on the
Company's financial position and results of operations.
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123R, "Share-Based Payment." SFAS No. 123R eliminates the alternative
to use APB No. 25's intrinsic value method of accounting that was provided in
SFAS No 123 as originally issued. SFAS No. 123R requires entities to recognize
the cost of employee services in exchange for awards of equity instruments based
on the grant-date fair value of those awards (with limited exceptions). That
cost will be recognized over the period during which the employee is required to
provide the service in exchange for the award. No compensation cost is
recognized for equity instruments for which employees do not render the
requisite service. SFAS No. 123R requires entities to initially measure the cost
of employee services received in exchange for an award of liability instruments
based on its current fair value; the fair value of the award will be remeasured
at each reporting date through the settlement date. Changes in fair value during
the requisite service period will be recognized as compensation cost over that
period. The grant date fair value of employee share options and similar
instruments will be estimated using option-pricing models adjusted for the
unique characteristics of those instruments. SFAS No. 123R is effective as of
the beginning of the Company's interim reporting period that begins January 1,
2006. Based on the employee options outstanding at December 31, 2005, the
utilization of the modified prospective transitional provisions of SFAS No. 123R
will not have a material adverse effect on the Company's consolidated financial
position or results of operations as substantially all outstanding options were
vested prior to December 31, 2005. There is approximately $129,000 of future
costs, utilizing the fair value method, that will be expensed over a three year
period from 2006 through 2008. Additionally, the Company will utilize the fair
value method for any future instruments issued after the implementation date.
In December 2004, the FASB issued FAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29." This Statement eliminates the
exception from fair value measurement for nonmonetary exchanges of similar
productive assets in paragraph 21(b) of APB Opinion No. 29 and replaces it with
an exception for exchanges that do not have commercial substance. This Statement
specifies that a nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of the
exchange. The provisions of this Statement are effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. The
adoption of SFAS No. 153 is not expected to have a material impact on the
Company's consolidated financial position, liquidity, or results of operations.
In September 2004, the EITF issued statement EITF Issue No. 04-08, "The
Effect of Contingently Convertible Debt on Diluted Earnings per Share" ("EITF
04-08"). Contingently convertible debt instruments are generally convertible
into common shares of an issuer after the common stock price has exceeded a
predetermined threshold for a specified period of time (the "market price
contingency"). EITF 04-08 requires that shares issuable upon conversion of
contingently convertible debt be included in diluted earnings per share
computations regardless of whether the market price contingency contained in the
debt instrument has been met. EITF 04-08 is effective for reporting periods
ending after December 15, 2004 and requires restatement of prior periods to the
extent applicable. The adoption of this statement is not expected to have an
effect on the Company's calculation of EPS.
In June 2006 the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109". This
Interpretation prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken or
42
expected to be taken in a tax return, and provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. This Interpretation is effective for fiscal years
beginning after December 15, 2006. The Company is assessing the impact of this
Interpretation on its financial statements, but does not expect it to have a
material effect.
DESCRIPTION OF PROPERTY
We currently maintain leased facilities in the locations listed below:
- -------------------------- ----------------------- -------------------- ------------------------ -------------------
Description Location Square Footage Lease term Annual Rental Cost
- -------------------------- ----------------------- -------------------- ------------------------ -------------------
Corporate office Bohemia, NY 5,000 8/1/06 - 6/30/07 $ 94,900
Satellite office Deerfield Beach , FL 1,721 11/1/05 - 10/31/08 $37,981
Co-location facility Newark, NJ Note 1 4/1/06 - 3/31/08 $85,656
<FN>
Note 1. We are obligated under the terms of an agreement with our major customer
to maintain a co-location site at an IBM eHosting facility in Newark, New Jersey
or an agreed on alternative location. The redundant facility provides us with,
among other things, switches, routers, racks, connections to Internet network
access points, at a variety of bandwidths, various levels on monitoring, and
access to problem management support. The lease expires on March 31, 2008.
</FN>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In December 1999, the Company entered into various agreements with S.J. &
Associates, Inc. (including its affiliates are collectively referred to as
"SJ"), an advisor to the Company and its' Board of Directors, for various
services that provide for the following compensation:
o During the quarter ended June 30, 2006, the Company terminated and
settled the consulting agreement with Mountain Meadow Farm and its
associates, including SJ Associates (collectively "Mountain Meadow") .
As part of the settlement the Company agreed to issue Mountain Meadow
90,638 restricted common shares valued at $34,000 and to pay for the
costs of medical, life and certain other insurance through December
31, 2013 with the cost for such insurance not to exceed $200,000 in
the aggregate or $50,000 in any 12 month period. At June 30, 2006, the
Company has recorded a liability of $168,000 representing the
estimated present value of this obligation.
o Metropolitan Venture Partners Corp. provides financial advisory
services to the Company. The Company incurred $20,000 and $51,000
during the years ended December 31, 2005 and 2004, respectively for
these services.
o The Company has a consulting agreement with DCL Consulting whereby DCL
provides quality assurance testing for the Company. In 2005 the
Company incurred $23,000 for these services. There were no costs for
DCL in 2004. The spouse of an officer of the Company is owner and
principal employee of DCL.
o The Company receives advisory services from Tall Oaks Group and
Lawrence Hite. In 2005 and 2004 the Company incurred costs of $18,000
and $36,000, respectively for such services.
43
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information
Our common stock is traded on the Over-The -Counter Bulletin Board since
October 24, 2003. Previously our stock was traded on NASDAQ SmallCap market
since September 23, 1992. The following table sets forth the high and low sales
prices for our common stock by the quarters indicated:
High Low
---- ---
2004
First Quarter 1.200 0.560
Second Quarter 2.450 0.780
Third Quarter 2.500 1.500
Fourth Quarter 2.400 1.600
2005
First Quarter 1.750 0.760
Second Quarter 0.970 0.620
Third Quarter 0.930 0.530
Fourth Quarter 0.790 0.590
2006
First Quarter 0.710 0.070
Second Quarter 0.680 0.200
Third Quarter to August 31, 2006 0.350 0.170
(b) As of July 31, 2006, there were 2,570 shareholders of record. We
estimate that there are approximately 10,700 shareholders, including
shareholders whose shares are held in the name of their brokers or stock
depositories.
(c) There were no cash dividends or other cash distributions made by us
during the year ended December 31, 2005 to common shareholders. In 2003, we paid
dividends of $30,000 to Preferred Series B shareholders. Further dividend policy
will be determined by our Board of Directors based on our earnings, financial
condition, capital requirements and other then existing conditions. It is
anticipated that cash dividends will not be paid to the holders of our common
stock in the foreseeable future.
(d) Equity Compensation Plan Information. The following table shows Equity
Compensation Plan information as of December 31, 2005:
Equity Compensation Plan Information
- ------------------------------- ---------------------------- ---------------------------- ----------------------------
Number of securities
remaining available for
Number of securities to be future issuance under
issued upon exercise of Weighted-average exercise equity compensation plans
outstanding options, price of outstanding (excluding securities
Plan category warrants and options, warrants and reflected in column
rights (a) rights (b) (a)) (c)
- ------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity compensation plans
approved by security-holders 1,871,573 $1.49 34,188
- ------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity compensation plans not
approved by security-holders 2,982,177 $1.12 1,235,745
- ------------------------------- ---------------------------- ---------------------------- ----------------------------
Total 4,853,750 $1.26 1,269,933
- ------------------------------- ---------------------------- ---------------------------- ----------------------------
44
EXECUTIVE COMPENSATION
The following table sets forth the annual and long-term compensation with
respect to the Chief Executive Officer and each of the other executive officers
of the Company who received more than $100,000 for services rendered for the
year ended December 31, 2005.
Summary Compensation Table
Annual Compensation Long-Term Compensation
Restricted Securities
Name and Fiscal Other Annual Stock Awards Underlying
Principal Position Year Salary Bonus Compensation Options/Warrants
- ---------------------------------------------------------------------------------------------------------------
James A. Cannavino (1) 2005 $144,000 $ -- $ -- $ 31,000 350,000
Chief Executive 2004 496,000 -- -- 4,000 --
Officer 2003 156,000 -- -- 54,000 708,000
Robert Carberry (2) 2005 $192,000 $ 20,000 $ -- $ 24,000 200,000
President 2004 192,000 -- -- -- --
2003 177,000 -- -- -- 203,000
Anthony Coppola (3) 2005 $155,000 $ -- $ -- $ 31,000 --
V.P. Program 2004 145,000 -- -- -- --
Management 2003 157,000 4,000 26,000 -- 3,000
Arnold Leap (4) 2005 $166,923 $ -- $ -- $ 34,000 --
Chief Technology
Officer 2004 145,000 -- -- -- --
2003 158,000 26,000 -- -- 103,000
Michael Beecher (5) 2005 $124,615 $ -- $ -- $ 26,000 --
Chief Financial
Officer and 2004 106,000 -- -- -- 30,000
Secretary 2003 3,000 -- -- -- 30,000
Matthew Oakes (6) 2005 $129,417 $ -- $ -- $ 35,000 100,000
Executive Vice- 2004 $106,250 $ -- $ -- $ 11,400
President 2003 $115,176 $ -- $ --
Footnotes
- ---------
<FN>
(1) Mr. Cannavino was appointed CEO December 7, 2002. Mr. Cannavino received
$31,000 in stock compensation during 2005. Pursuant to his January 2003
employment agreement, Mr. Cannavino received 45,000 shares of common stock
valued at $54,000 in 2003 and 5,000 shares of common stock valued at $4,000
in 2004.
(2) Mr. Carberry was appointed President in December 2002. During 2005, Mr.
Carberry received $24,000 in stock compensation and a $20,000 bonus in
2005. During 2002, Mr. Carberry received 111,665 shares valued at $139,000
in lieu of cash for services rendered.
(3) Mr. Coppola received $31,000 in stock compensation during 2005. In 2003 the
Company paid a $50,000 sales commission earned by a sales consulting firm
that is wholly owned by Mr. Coppola. In 2003 the Company paid $26,000 for
services rendered by this same consulting firm. Mr. Coppola also earned a
$4,000 cash performance bonus in 2003.
(4) Mr. Leap received $34,000 in stock compensation during 2005. Mr. Leap also
earned a cash performance bonus totaling $26,000 for year 2003.
(5) Mr. Beecher was appointed Chief Financial Officer and Secretary effective
December 16, 2003. Mr. Beecher received $26,000 in stock compensation
during 2005.
(6) Mr. Oakes was appointed Executive Vice President in August 2005. Mr. Oakes
received $35,000 in stock compensation during 2005.
</FN>
45
Option/SAR Grants in Last Fiscal Year
During 2005 the following options grants were made to the named executive
officers:
% of Total
Options
Number of Granted Hypothetical
Options Employees Exercise Expiration Value at
Name Granted in Fiscal Year Price Date Grant Date
- ------------------------------------------------------------------------------ ---------------------------
James Cannavino 350,000 42.4% $ 0.62 12/30/2012 $152,000
Robert Carberry 100,000 12.1% $ 0.50 04/30/2010 $ 20,000
100,000 12.1% $ 0.70 04/30/2010 $ 43,000
Matthew Oakes 100,000 12.1% $ 0.65 08/31/2010 $ 41,000
The hypothetical value of the options as of their date of grant has been
calculated using the Black-Scholes option-pricing model, as permitted by SEC
rules, based upon various assumptions, which include: expected volatility
ranging from 71.1% to 72.6%, risk free interest rate of 4.0% and expected lives
ranging from 5.00 to 7.00 years. The approach used in developing the assumptions
upon which the Black-Scholes valuations were calculated is consistent with the
requirements of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation." It should be noted that this model is only one
method of valuing options, and the Company's use of the model should not be
interpreted as an endorsement of its accuracy. The actual value of the options
may be significantly different, and the value actually realized, if any, will
depend upon the excess of the market value of the common stock over the option
exercise price at the time of exercise.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option
Values
The following table set forth certain information with respect to stock
option exercises by the named executive officers during the fiscal year ended
December 31, 2005, and the value of unexercised options held by them at fiscal
year-end.
Number of Unexercised Options Value of Unexercised In-the
at Fiscal Year End -Money Options at Fiscal Year
End (1)
Shares
Name Acquired Value Realized Exercisable Unexercisable Exercisable Unexercisable
On Exercise ($)
(#)
James Cannavino -- -- 1,419,000 -- $ -- $ --
Robert Carberry -- -- 460,500 -- 12,000 --
Anthony Coppola -- -- 155,500 -- -- --
Michael Beecher -- -- 60,000 -- -- --
Arnold Leap -- -- 231,500 -- -- --
Matthew Oakes -- -- 163,000 -- -- --
<FN>
Footnotes
- ---------
(1) Market Value of the Company's common stock on December 31, 2005, was $0.62.
There were 100,000 in-the-money options at year end, valued at $12,000.
</FN>
46
EXPERTS
The financial statements of Direct Insite Corp. as of December 31, 2005 and
2004, and for each of the two years in the period ended December 31, 2005,
included in this prospectus have been audited by Marcum & Kliegman LLP, an
independent registered public accounting firm, as stated in its reports
appearing herein. These financial statements have been so included in reliance
upon the reports of such firm given upon their authority as experts in
accounting and auditing.
LEGAL MATTERS
Certain legal matters with respect to the validity of the shares of common
stock being offered hereby will be passed on for us by Beckman, Lieberman &
Barandes, LLP.
WHERE YOU CAN FIND MORE INFORMATION
The effectiveness of this registration statement will render us subject to the
informational requirements of the Exchange Act, and, we will file reports, proxy
statements and other information with the Securities and Exchange Commission as
required by federal law. These reports, proxy statements and other information
can be inspected and copied at the public reference facilities maintained by the
Securities Exchange Commission Investors may read and copy any of these reports,
statements, and other information at the SEC's public reference room located at
100 F. Street, N.E,, , Washington, D.C., 20549, or any of the SEC's other public
reference rooms. Investors should call the SEC at l-800-SEC-0330 for further
information on these public reference rooms upon payment of the fees prescribed
by the Securities Exchange Commission. These SEC filings are also available free
at the SEC's web site at www.sec.gov.
This prospectus does not contain all of the information set forth in the
registration statement, parts of which are omitted to comply with the rules and
regulations of the Securities Exchange Commission. For further information,
please see the registration statement in its entirety.
47
DIRECT INSITE CORP. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2005 and 2004
CONTENTS
- --------------------------------------------------------------------------------
Page
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F-1
FINANCIAL STATEMENTS
- --------------------
Consolidated Balance Sheets F-2
Consolidated Statements of Operations F-4
Consolidated Statement of Shareholders' Deficiency F-5
Consolidated Statements of Cash Flows F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-9 - F-31
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
To the Audit Committee of the
Board of Directors and Shareholders of
Direct Insite Corp. and Subsidiaries
Bohemia, New York
We have audited the accompanying consolidated balance sheets of Direct Insite
Corp. and Subsidiaries (the "Company") as of December 31, 2005 and 2004 and the
related consolidated statements of operations, shareholders' deficiency, and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Company as of
December 31, 2005 and 2004 and the consolidated results of its operations and
its cash flows for the years then ended in conformity with generally accepted
accounting principles (United States).
/s/ Marcum & Kliegman LLP
Marcum & Kliegman LLP
Melville, NY
April 13, 2006
F-1
DIRECT INSITE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31, 2005 and 2004
- --------------------------------------------------------------------------------------------------------------------
ASSETS
------ 2005 2004
---------------- -----------------
CURRENT ASSETS
- --------------
Cash and cash equivalents $ 364 $ 306
Accounts receivable, net of allowance for doubtful accounts of
$0 in 2005 and $2 in 2004 1,858 1,871
Prepaid expenses and other current assets 195 262
--------- ---------
Total Current Assets 2,417 2,439
PROPERTY AND EQUIPMENT, Net 446 577
- ----------------------
OTHER ASSETS 318 285
- ------------ --------- ---------
TOTAL ASSETS $3,181 $3,301
====== ======
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
DIRECT INSITE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31, 2005 and 2004
- ----------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
----------------------------------------
2005 2004
--------------- ---------------
CURRENT LIABILITIES
- -------------------
Lines of credit $ 620 $ 668
Current portion of capital lease obligations 99 114
Notes payable, net of discount of $375 375 --
Warrant liability 459 --
Short-term revolving loans 695 1,012
Accounts payable and accrued expenses 1,962 2,086
Deferred revenue 796 623
Dividends payable, current 1,775 376
Liabilities from discontinued operations, current portion 61 112
----------- ------------
Total Current Liabilities 6,842 4,991
OTHER LIABILITIES
- -----------------
Capital lease obligations, net of current portion 73 125
Dividends payable, net of current portion
-- 722
-- ------------
TOTAL LIABILITIES 6,915 5,838
----------- -----------
COMMITMENTS AND CONTINGENCIES
- -----------------------------
SHAREHOLDERS' DEFICIENCY
- ------------------------
Preferred stock, $0.0001 par value; 2,000,000 shares authorized;
Series A Convertible Preferred, 134,680 issued
and outstanding in 2005 and 2004; liquidation
preference of $2,750,000;
Series B Redeemable Preferred, 974 issued and outstanding in -- --
2005 and 2004; liquidation preference of $974,075;
Series C Redeemable Preferred, 2,000 issued and -- --
outstanding in 2005 and 2004; liquidation preference of $2,000,000;
Series D Redeemable Preferred, 100 shares issued and outstanding, -- --
liquidation preference of $100,000 in 2004;
Common stock, $.0001 par value; 50,000,000 shares
authorized; 4,972,955 and 4,547,013 shares issued in
2005 and 2004, respectively; and 4,933,028 and 4,507,086
shares outstanding in 2005 and 2004, respectively -- --
Additional paid-in capital 113,039 112,484
Deferred stock based compensation (134) (50)
Accumulated deficit (116,311) (114,643)
--------- ---------
(3,406) (2,209)
Common stock in treasury, at cost; 24,371 shares in 2005
and 2004 (328) (328)
----------- -----------
TOTAL SHAREHOLDERS' DEFICIENCY (3,734) (2,537)
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIENCY $ 3,181 $ 3,301
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
DIRECT INSITE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
For the Years Ended December 31, 2005 and 2004
- -----------------------------------------------------------------------------------------------------------------
2005 2004
-------------- ------------
REVENUES $ 8,870 $ 7,558
- -------- ------------ ------------
COSTS AND EXPENSES
- ------------------
Operations, research and development 4,024 3,620
Sales and marketing 1,984 1,676
General and administrative 3,002 2,940
Amortization and depreciation 410 537
------------ ------------
TOTAL OPERATING EXPENSES 9,420 8,773
------------ ------------
OPERATING LOSS (550) (1,215)
------------ ------------
OTHER (INCOME) EXPENSE
- ----------------------
Change in fair value of warrant (105) --
Interest expense, net 527 318
Other expense -- 33
------------ ------------
TOTAL OTHER EXPENSE 422 351
------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES (972) (1,566)
- --------------------------------------
PROVISION FOR INCOME TAXES 2 5
- --------------------------- ------------ ------------
LOSS FROM CONTINUING OPERATIONS (974) (1,571)
- --------------------------------
(LOSS) INCOME FROM DISCONTINUED OPERATIONS (17) 288
- ------------------------------------------ ------------ ------------
NET LOSS (991) (1,283)
- --------
PREFERRED STOCK DIVIDENDS (677) (716)
- ------------------------- ------------ ------------
NET LOSS ATTRIBUTABLE TO COMMON
- -------------------------------
SHAREHOLDERS $ (1,668) $ (1,999)
------------ =========== =========
BASIC AND DILUTED LOSS PER SHARE:
- --------------------------------
Loss from continuing operations attributable to common shareholders $(0.36) $(0.53)
Income from discontinued operations 0.00 0.07
------------ ------------
Net loss attributable to common shareholders $(0.36) $(0.46)
============ ============
BASIC AND DILUTED WEIGHTED AVERAGE
- ----------------------------------
COMMON SHARES OUSTANDING 4,684 4,285
------------------------ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
DIRECT INSITE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIENCY
For the Years Ended December 31, 2005 and 2004 (in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
Preferred Stock
----------------------------------------
Additional Deferred
Paid-in Stock Based Accumulated Treasury
Series A Series B Series C Series D Common Stock Capital Compensation Defecit Stock Total
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Amount
------------------------------------------------------------------------------------------------------------------
BALANCE - December 135 $ -- 1 $ -- 1 $ -- $ -- $ -- 4,040 $ -- $110,582 $ -- $(112,644) $(328) $(2,390)
31, 2003
Common stock
issued for
services -- -- -- -- -- -- -- -- 157 -- 215 (50) -- -- 165
Common stock
issued in
settlement
of liabilities -- -- -- -- -- -- -- -- 310 -- 257 -- -- -- 257
Series C Preferred
stock issued for
Cash, net of fees
of $80 -- -- -- -- 1 -- -- -- -- -- 1,330 -- -- -- 1,330
Series D Preferred
stock issued for
Cash -- -- -- -- -- -- -- -- -- -- 100 100
Dividends declared,
preferred
Stock -- -- -- -- -- -- -- -- -- -- -- -- (716) -- (716)
Net loss -- -- -- -- -- -- -- -- -- -- -- -- (1,283) -- (1,283)
-------------------------------------------------------------------------------------------------------------------
BALANCE - December
31, 2004 135 $ -- 1 $ -- 2 $ -- $ -- $ -- 4,507 $ -- $ 112,484 $ 50 $(114,643) $(328) $(2,537)
====== ===== ===== ===== ==== ==== ==== ==== ===== ==== ========= ==== ========= ===== =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
DIRECT INSITE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIENCY, continued
For the Years Ended December 31, 2005 and 2004 (in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
Preferred Stock
----------------------------------------
Additional Deferred
Paid-in Stock Based Accumulated Treasury
Series A Series B Series C Series D Common Stock Capital Compensation Defecit Stock Total
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Amount
------------------------------------------------------------------------------------------------------------------
BALANCE - December
31, 2004 135 $ -- 1 $ -- 2 $ -- $ -- $ -- 4,507 $ -- $112,484 $ (50) $(114,643) $(328) $(2,537)
Common stock and
options issued
for services -- -- -- -- -- -- -- -- 426 -- 371 (29) -- -- 342
Warrants issued
in connection
with guarantee
of line of credit 142 (142) --
Amortization of
deferred stock
based compensation 87 87
Reduction of fees
in connection
with Series C
Preferred stock
-- -- -- -- -- -- -- -- -- -- 42 -- -- -- 42
Dividends
declared,
preferred Stock -- -- -- -- -- -- -- -- -- -- -- -- (677) -- (677)
Net loss -- -- -- -- -- -- -- -- -- -- -- -- (991) -- (991)
-------------------------------------------------------------------------------------------------------------------
BALANCE - December
31, 2005
135 $ -- 1 $ -- 2 $ -- $ -- $ -- 4,993 $ -- $113,039 $(134) $(116,311) $(328) $(3,734)
====== ===== ===== ===== ==== ==== ==== ==== ====== ==== ======== ==== ========= ===== =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
DIRECT INSITE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the Years Ended December 31, 2005 and 2004
- -------------------------------------------------------------------------------------------------------------------------
2005 2004
----------------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES
- ------------------------------------
Loss from continuing operations $ (974) $ (1,571)
Adjustments to reconcile loss from continuing operations
to net cash used in continuing operations:
Amortization and depreciation:
Property and equipment 408 534
Other 2 3
Discount on debt 189 --
Common stock and options issued for services 342 165
Amortization of deferred stock based compensation 87 --
Change in fair value of warrants (105)
Other -- 10
Changes in operating assets and liabilities:
Accounts receivable 13 (803)
Prepaid expenses and other current assets 67 (47)
Other assets (35) 37
Accounts payable and accrued expenses (76) 95
Deferred revenue 173 527
------------ ------------
Net cash provided by (used in) continuing operations 91 (1,050)
------------- -----------
(Loss) income from discontinued operations (17) 288
Change in:
Assets and liabilities from discontinued operations (51) (509)
------------- ------------
Net cash used in discontinued operations (68) (221)
------------ -----------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES $ 23 $ (1,271)
--------- --------
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
DIRECT INSITE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
For the Years Ended December 31, 2005 and 2004
- ---------------------------------------------------------------------------------------------------------------------
2005 2004
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Expenditures for property and equipment $ (223) $ (114)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sales of preferred stock, net -- 1,430
(Repayment on) advances from short-term revolving loans, net (317) 427
Proceeds from long-term debt, net of fees 750 --
Repayments of lines of credit, net (48) (68)
Repayments of capital lease obligations (127) (173)
----------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 258 1,616
---------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 58 231
CASH AND CASH EQUIVALENTS - Beginning 306 75
- ------------------------- ----------- -----------
CASH AND CASH EQUIVALENTS - Ending $ 364 $ 306
- ------------------------- ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Nature of Business
------------------
Direct Insite Corp. and subsidiaries (the "Company"), primarily operate as an
application service provider ("ASP"), that markets an integrated transaction
based "fee for service" offering called Invoices On-Line (IOL), an electronic
invoice presentment and payment (EIP&P) service that processes high volumes of
transactional data for invoice presentment purposes delivered via the Internet
on a global basis.
The Company also provides additional service offerings in the form of its
patented dbExpress TM technology, a management information tool that allows
users to visually data mine large volumes of transactional data via the
Internet. A complete Internet Customer Care tool set integrated with the EIP&P
product set is also available. The Company operates fully redundant data centers
located at its main office in Bohemia, N.Y. and in an IBM co-location facility
in Newark, NJ.
Management's liquidity plans are discussed in Note 13. Also, as described in
Note 16, the Company has two major customers that accounted for approximately
97.1% and 98.9% of the Company's revenue for the years ended December 31 2005
and 2004, respectively. Loss of these customers would have a material adverse
effect on the Company.
NOTE 2 - Significant Accounting Policies
-------------------------------
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of Direct Insite
Corp. and its subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation.
Revenue Recognition
- -------------------
The Company records revenue in accordance with Statement of Position 97-2
"Software Revenue Recognition", issued by the American Institute of Certified
Public Accountants (as modified by Statement of Position 98-9) and SEC Staff
Accounting Bulletin Topic 13 "Revenue Recognition in Financial Statements." In
some circumstances, the Company enters into arrangements whereby it is obligated
to deliver to its customer multiple products and/or services (multiple
deliverables). In these transactions, in accordance with the Emerging Issues
Task Force ("EITF") Issue No. 00-21, the Company allocates the total revenue to
be earned among the various elements based on their relative fair values. The
Company recognizes revenue related to the delivered products or services only
if:
O Any undelivered products or services are not essential to the functionality of
the delivered products or services;
O Payment for the delivered products or services is not contingent upon delivery
of the remaining products or services;
O The Company has an enforceable claim to receive the amount due in the event it
does not deliver the undelivered products or services and it is probable that
such amount is collectible;
O There is evidence of the fair value for each of the undelivered products or
services;
F-9
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - Significant Accounting Policies, continued
-------------------------------
O Delivery of the delivered element represents the culmination of the earnings
process.
The following are the specific revenue recognition policies for each major
category of revenue.
ASP Services
- ------------
The Company provides transactional data processing services through its ASP
software solutions to its customers. The customer is charged a monthly fixed
rate on a per transaction basis or a fixed fee based on monthly transaction
volumes. Revenue is recognized as the services are performed.
Custom Engineering Services
- ---------------------------
The Company performs custom engineering services which are single contractual
agreements involving modification or customization the Company's proprietary ASP
software solution. Progress is measured using the relative fair value of
specifically identifiable output measures (milestones). Revenue is recognized at
the lessor of the milestone amount when the customer accepts such milestones or
the percentage of completion of the contract following the guidance of SOP 81-1,
"Accounting for Performance of Construction-Type and Certain Production Type
Contracts".
Cost of Revenue
- ---------------
Cost of revenue in the consolidated statements of operations is presented along
with research and development costs and exclusive of amortization and
depreciation shown separately. Custom Service Engineering costs related to
uncompleted milestones are deferred and included in other current assets, when
applicable.
Property and Equipment
- ----------------------
Property and equipment are stated at cost and depreciated on a straight-line
basis over the estimated useful lives of the related assets. Leasehold
improvements are amortized over the terms of the respective leases or the
service lives of the related assets, whichever is shorter.
Capitalized lease assets are amortized over the shorter of the lease term or the
service life of the related assets.
Software Costs
- --------------
Costs associated with the development of software products are generally
capitalized once technological feasibility is established. Purchased software
technologies are recorded at cost and software technologies acquired in purchase
business transactions are recorded at their estimated fair value. Software costs
are amortized using the greater of the ratio of current revenue to total
projected revenue for a product or the straight-line method over its estimated
useful life. Amortization of software costs begins when products become
available for general customer release. Costs incurred prior to establishment of
technological feasibility are expensed as incurred and are included in
"operations, research and development" in the accompanying consolidated
statements of operations, and amount to $2,668,000 and $2,227,000 for the years
2005 and 2004, respectively.
Impairment of Long-Lived Assets
- -------------------------------
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" the Company
reviews its long-lived assets, including capitalized software costs and property
and equipment, for impairment whenever events or changes in circumstances
indicate that the carrying amount of the assets may not be fully recoverable. To
determine if impairment exists, the Company compares the estimated future
undiscounted cash flows from the related long-lived assets to the net carrying
amount of such assets. Once it has been determined that impairment exists, the
carrying value of the asset is adjusted to fair value. Factors considered in the
determination of fair value include current operating results, trends and the
present value of estimated expected future cash flows.
F-10
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - Significant Accounting Policies, continued
-------------------------------
Income Taxes
- ------------
The Company accounts for income taxes using the liability method. The liability
method requires the determination of deferred tax assets and liabilities based
on the differences between the financial statement and income tax bases of
assets and liabilities, using enacted tax rates. Additionally, net deferred tax
assets are adjusted by a valuation allowance if, based on the weight of
available evidence, it is more likely than not that some portion or all of the
net deferred tax assets will not be realized.
Earnings per Share
- ------------------
The Company displays earnings per share in accordance with SFAS No. 128,
"Earnings Per Share". SFAS No. 128 requires dual presentation of basic and
diluted earnings per share. Basic earnings per share includes no dilution and is
computed by dividing net income (loss) attributable to common shareholders by
the weighted average number of common shares outstanding for the period. Diluted
earnings per share include the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock. Outstanding stock options, warrants and other potential stock issuances
have not been considered in the computation of diluted earnings per share
amounts since the effect of their inclusion would be anti-dilutive.
Securities that could potentially dilute basic earnings per share ("EPS") in the
future, that were not included in the computation of diluted EPS because to do
so would have been anti-dilutive for the periods presented, consist of the
following (shares are in thousands):
December 31,
--------------------------------
2005 2004
---- ----
---------------- ---------------
Options to purchase common stock 4,854 4,645
Warrants to purchase common stock 3,332 2,082
Series A Convertible Preferred Stock 1,347 1,347
----- -----
Total Potential Common Shares as of December 31, 9,533 8,074
===== =====
There were no shares or options issued subsequent to December 31, 2005 through
March 31, 2006.
Cash and Cash Equivalents
- -------------------------
The Company considers all investments with original maturities of three
months or less to be cash equivalents.
Allowance For Doubtful Accounts
- -------------------------------
The allowance for doubtful accounts reflects management's best estimate of
probable losses inherent in the account receivable balance. Management
determines the allowance based on known troubled accounts, historical
experience, and other currently available evidence. At December 31, 2005,
an allowance for doubtful accounts is not provided since, in the opinion of
management, all accounts are deemed collectible.
F-11
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - Significant Accounting Policies, continued
-------------------------------
Advertising and Promotional Costs
- ---------------------------------
Advertising and promotional costs are reported in "Sales and marketing" expense
in the consolidated statements of operations and are expensed as incurred.
Advertising and promotional costs for the years ended December 31, 2005 and 2004
was $41,000 and $31,000, respectively.
Reclassifications
- -----------------
Certain reclassifications have been made to the consolidated financial
statements shown for the prior year in order to have them conform to the current
year's classifications.
Concentrations and Fair Value of Financial Instruments
- ------------------------------------------------------
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash and accounts receivable. At December 31,
2005, the Company has cash and cash equivalents at two banks which exceed FDIC
limits. Concentrations of credit risk with respect to accounts receivable are
disclosed in Note 16. The Company performs ongoing credit evaluations of its
customers' financial condition and, generally, requires no collateral from its
customers. Unless otherwise disclosed, the fair value of financial instruments
approximates their recorded value.
Use of Estimates
- ----------------
In preparing consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America, management makes
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the consolidated financial statements, as well as the reported amounts of
revenue and expenses during the reporting period. Disclosures that are
particularly sensitive to estimation include management's plans, as disclosed in
Note 13. Actual results could differ from those estimates.
New Accounting Pronouncements
- -----------------------------
In June 2005, the EITF reached consensus on Issue No. 05-2, "The Meaning of
`Conventional Convertible Debt Instrument' in EITF Issue No. 00-19, `Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock.'" Issue 00-19 is used to evaluate whether embedded
derivatives should be bifurcated under SFAS No. 133, "Accounting For Derivative
Instruments And Hedging Activities", as amended. Specifically, SFAS 133 provides
guidance as to when an issuer is required to bifurcate a conversion option that
is embedded in convertible debt. However, Issue 00-19 does not define
"conventional convertible debt instrument." Given the development of numerous
contractual terms that may be included in a convertible debt instrument, it is
not clear when a convertible debt instrument is "conventional." The company does
not believe that certain warrants meet the definition of conventional
convertible debt and as a result Issue No. 00-19 applies to the liability
treatment of these instruments. As such the adoption of the Issue had an effect
on the Company's financial position and results of operations (see Note 8).
In June 2005, the EITF reached consensus on Issue No. 05-6, Determining the
Amortization Period for Leasehold Improvements ("EITF 05-6"). EITF 05-6 provides
guidance on determining the amortization period for leasehold improvements
acquired in a business combination or acquired subsequent to lease inception.
The guidance in EITF 05-6 will be applied prospectively and is effective for
periods beginning after June 29, 2005. EITF 05-6 did not have a material effect
on the Company's financial position or results of operations.
In September 2005, the FASB ratified the EITF Issue No. 05-7, "Accounting for
Modifications to Conversion Options Embedded in Debt Instruments and Related
Issues," which addresses whether a modification to a conversion option that
changes its fair value effects the recognition of interest expense for the
associated debt instrument after the modification, and whether a borrower should
F-12
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
recognize a beneficial conversion feature, not a debt extinguishment, if a debt
modification increases the intrinsic value of the debt (for example, the
modification reduces the conversion price of the debt). The adoption of the
Issue may have a material effect on our consolidated financial position or
results of operations in future periods.
In September 2005, the FASB also ratified the EITF's Issue No. 05-8, "Income Tax
Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature,"
which discusses whether the issuance of convertible debt with a beneficial
conversion feature results in a basis difference arising from the intrinsic
value of the beneficial conversion feature on the commitment date (which is
recorded in the stockholder's equity for book purposes, but as a liability for
income tax purposes) and, if so, whether that basis difference is a temporary
difference under SFAS No. 109, "Accounting for Income Taxes." The adoption of
the Issue is not expected to have a material effect on our consolidated
financial position or results of operations in future periods.
In February 2006, the FASB issued SFAS No. 155 "Accounting for Certain
Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140"
("SFAS 155"). SFAS 155 clarifies certain issues relating to embedded derivatives
and beneficial interests in securitized financial assets. The provisions of SFAS
155 are effective for all financial instruments acquired or issued after fiscal
years beginning after September 15, 2006. The Company is currently assessing the
impact that the adoption of SFAS 155 will have on its results of operations and
financial position.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets" ("SFAS 156"), which amends SFAS 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities", with
respect to the accounting for separately recognized servicing assets and
servicing liabilities. SFAS 156 permits the choice of the amortization method or
the fair value measurement method, with changes in fair value recorded in
income, for the subsequent measurement for each class of separately recognized
servicing assets and servicing liabilities. The statement is effective for years
beginning after September 15, 2006, with earlier adoption permitted. The Company
is currently evaluating the effect that adopting this statement will have on the
Company's financial position and results of operations.
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123R, "Share-Based Payment." SFAS No. 123R eliminates the alternative
to use APB No. 25's intrinsic value method of accounting that was provided in
SFAS No 123 as originally issued. SFAS No. 123R requires entities to recognize
the cost of employee services in exchange for awards of equity instruments based
on the grant-date fair value of those awards (with limited exceptions). That
cost will be recognized over the period during which the employee is required to
provide the service in exchange for the award. No compensation cost is
recognized for equity instruments for which employees do not render the
requisite service. SFAS No. 123R requires entities to initially measure the cost
of employee services received in exchange for an award of liability instruments
based on its current fair value; the fair value of the award will be remeasured
at each reporting date through the settlement date. Changes in fair value during
the requisite service period will be recognized as compensation cost over that
period. The grant date fair value of employee share options and similar
instruments will be estimated using option-pricing models adjusted for the
unique characteristics of those instruments. SFAS No. 123R is effective as of
the beginning of the Company's interim reporting period that begins January 1,
2006. Based on the employee options outstanding at December 31, 2005, utilizing
the modified prospective transitional provisions of SFAS No. 123R will not have
a material adverse effect on the Company's consolidated financial position or
results of operations as substantially all outstanding options were vested prior
to December 31, 2005. There is approximately $129,000 of future costs, utilizing
the fair value method, that will be expensed over a three year period from 2006
through 2008. Additionally, the Company will utilize the fair value method for
any future instruments issued after the implementation date.
F-13
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2004, the FASB issued FAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29." This Statement eliminates the
exception from fair value measurement for nonmonetary exchanges of similar
productive assets in paragraph 21(b) of APB Opinion No. 29 and replaces it with
an exception for exchanges that do not have commercial substance. This Statement
specifies that a nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of the
exchange. The provisions of this Statement are effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. The
adoption of SFAS No. 153 is not expected to have a material impact on the
Company's consolidated financial position, liquidity, or results of operations.
In September 2004, the EITF issued statement EITF Issue No. 04-08, "The
Effect of Contingently Convertible Debt on Diluted Earnings per Share" ("EITF
04-08"). Contingently convertible debt instruments are generally convertible
into common shares of an issuer after the common stock price has exceeded a
predetermined threshold for a specified period of time (the "market price
contingency"). EITF 04-08 requires that shares issuable upon conversion of
contingently convertible debt be included in diluted earnings per share
computations regardless of whether the market price contingency contained in the
debt instrument has been met. EITF 04-08 is effective for reporting periods
ending after December 15, 2004 and requires restatement of prior periods to the
extent applicable. The adoption of this statement is not expected to have an
effect on the Company's calculation of EPS.
Stock Options and Similar Equity Instruments
- --------------------------------------------
As permitted under Statement of Financial Accounting Standards ("SFAS") No. 148,
"Accounting for Stock-Based Compensation--Transition and Disclosure", which
amended SFAS No. 123, "Accounting for Stock-Based Compensation", the Company has
elected to continue to follow the intrinsic value method in accounting for its
stock-based employee compensation arrangements as defined by Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees", and related interpretations including FASB Interpretation ("FIN")
No. 44, "Accounting for Certain Transactions Involving Stock Compensation", an
interpretation of APB No. 25. The following table illustrates the effect on net
loss and net loss per share if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee compensation (in
thousands, except per share data):
As discussed in Note 2, FAS No. 123R will require the Company to expense stock
options based on grant date fair value in its financial statements. The effect
of expensing stock options on the Company's results of operations using a
Black-Scholes option-pricing model is presented in the following pro forma
table:
2005 2004
---------- ------------
Net loss attributable to common shareholders
As reported $(1,668) $(1,999)
Add: Stock-based employee compensation expense included in
reported net loss 7 --
Less: Stock-based employee compensation expense determined
under fair value-based method for all awards (1,000) (929)
-------- -------
Pro forma $(2,661) $(2,928)
======== =======
Basic and diluted net loss per share
As reported $(0.36) $(0.46)
======== =======
Pro forma $(0.57) $(0.68)
======== =======
F-14
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of Company common stock options granted to employees are
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions: (1) expected volatility of 71.1% to 72.6% in 2005 and
68.1% to 75.5% in 2004(2) risk-free interest rates ranging from 4.0% to 4.5% in
2005 and 4.8% in 2004 and (3) expected lives ranging from 4.3 to 7.0 years in
2005 and 5.0 years in 2004.
During 2005 the Company accelerated the vesting of certain options in
anticipation of adoption of SFAS 123R to avoid $304,000 of future compensation
expense.
NOTE 3 - Discontinued Operations
-----------------------
Platinum Communications, Inc.
- -----------------------------
In 2001, the Company and Platinum Communications, Inc. ("Platinum") completed a
merger under an Agreement and Plan of Merger ("Merger Agreement"). Under the
Merger Agreement, a newly formed wholly owned subsidiary of the Company acquired
all of the outstanding common stock of Platinum. As a result of the lack of
development of the Platinum business and to focus the Company's resources on its
core business, in December 2003, the Company decided to close the operations of
Platinum. Accordingly, the results of operations and the assets and liabilities
of Platinum are presented as discontinued operations for both the current and
prior period. The income is reflected as income from discontinued operations in
the accompanying condensed consolidated statements of operations. The following
table reflects the results of the discontinued operations of Platinum for the
years ended December 31, 2005 and 2004, respectively:
2005 2004
------------------------------
(In thousands)
Other (expense) income - net $ (9) $ 297
Costs associated with shut-down of operations:
Interest expense, net (8) (9)
---------- ----------
Total income and (costs and expenses) (17) 288
----------- ---------
Income (loss) from discontinued operations $ (17) $ 288
========= ========
For the year ended December 31, 2005 the Company recognized losses from the
discontinued operations of $17,000 principally as a result of settling certain
liabilities of the Platinum operation and for interest expense on certain lines
of credit.
Platinum has three lines of credit, which were assumed in connection with the
Platinum acquisition. These lines have various expiration dates. One line has no
expiration date and bears an interest rate of prime (7.25% at December 31, 2005)
plus 1%, is collateralized by substantially all the assets of Platinum, and is
personally guaranteed by one of the former officers of Platinum. The second line
expired in May 2003 and bears an interest rate of 10%. The third line contains
no expiration date and bears an interest rate of 16.74%. The total obligation
under these three lines of credit as of December 31, 2005 is $41,000.
The following table reflects the assets and liabilities from the discontinued
operations of Platinum as of December 31, 2005 and 2004:
F-15
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31,
2005 2004
----------------------------------
(In thousands)
LIABILITIES
-----------
Accounts payable and accrued expenses $ 20 $ 41
Current portion of long-term debt 41 71
---- -----
Total Current Liabilities From Discontinued Operations $ 61 $112
===== ====
NOTE 4 - Accounts Receivable and Short-term Revolving Loans
--------------------------------------------------
The Company has an Accounts Receivable Purchase Agreement with a Bank,
whereby the Company from time to time may assign some of their accounts
receivable to the Bank on a full recourse basis. Upon specific invoice
approval, an advance of 80% of the underlying receivable is provided to the
Company. The remaining balance (20%), less an administrative fee of
approximately 0.5% plus interest at the rate of 1 1/2% per month, is paid
to the Company once the customer has paid. Under the Agreement, the maximum
amount of all assigned receivables outstanding at any time shall not exceed
$1.5 million. The primary term of the agreement was for one year beginning
October 2001, and continues until due notice of termination is given at any
time by either party to the agreement. At December 31, 2005, the Company
had assigned approximately $869,000 of accounts receivable to the Bank and
received advances of $695,000 from the Bank.
In May 2004, the Company entered into an Agreement with DIRI Rec Fund LLC
(the "Rec Fund") whereby the Company may assign certain accounts receivable
on a full recourse basis to the Rec Fund as security for advances (loans).
The Rec Fund was established solely to advance funds to the Company upon
the assignment of receivables. The Rec Fund is administered by a third
party trustee. Certain shareholders of the Company and a Director of the
Company, are the principal investors in the Rec Fund. Under the Agreement,
the Company pays interest at the rate of one (1) percent per month on the
maximum purchase amount (as defined in the agreement) of the Rec Fund and
pays the administrative costs of the Rec Fund which approximate $12,000 per
year. At December 31, 2005 the Company had no outstanding advances from the
Rec Fund.
NOTE 5 - Prepaid Expenses and Other Current Assets
------------------------------------------
Prepaid expenses and other current assets consist of the following:
December 31,
2005 2004
--------------------------
(In thousands)
Prepaid expenses $ 174 $ 239
Employee notes and loans receivable 21 23
------ ------
$ 195 $ 262
====== ======
F-16
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - Property and Equipment
----------------------
Property and equipment consist of the following:
December 31, Useful life
2005 2004 in Years
------------------------------ --------------
(in thousands)
Computer equipment and purchased software $ 6,332 $ 6,078 3
Furniture and fixtures 455 446 5 - 7
Automobile 44 30 3
------- -------
6,831 6,554
Less: accumulated deprecation and amortization (6,385) (5,977)
------- -------
Property and Equipment, Net $ 446 $ 577
======== ========
Depreciation and amortization expense related to property and equipment for
the years ended December 31, 2005 and 2004 was $408,000 and $534,000,
respectively.
NOTE 7 - Accounts Payable and Accrued Expenses
-------------------------------------
Accounts payable and accrued expenses consist of the following:
December 31,
2005 2004
-------------------------------
(in thousands)
Trade accounts payable $ 515 $ 809
Sales taxes payable 539 539
Accrued payroll and benefits 253 253
Other accrued expenses 655 485
------- -------
$1,962 $2,086
====== ======
NOTE 8 - Debt
----
Notes payable
-------------
At December 31, 2005 notes payable consist of the notes as described below
of $750,000 less debt discount of $375,000.
In March 2005, the Company entered into a Securities Purchase Agreement
(the "Agreement") with Sigma Opportunity Fund LLC ("Sigma") and
Metropolitan Venture Partners II, L.P. ("MetVP"), collectively the
"Buyers", whereby the Buyers purchased Senior Subordinated Secured Notes
(the "Note Purchase") in the aggregate amount of $750,000. The notes bear
interest at the rate of five percent (5%) per year beginning June 28, 2005,
and are payable quarterly in cash or common stock at the option of the
Buyers. The Notes mature on the earlier to occur of (i) September 29, 2006,
or (ii) the date on which demand for payment of the loan payable to
JPMorgan Chase Bank is made. In connection with the note purchase the
Buyers were issued warrants to purchase 750,000 common shares of the
Company. The initial exercise price of the warrants was $0.90 per share of
common stock.
F-17
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - Debt, continued
----
Notes payable, continued
------------------------
Sigma had an exclusive right to lead a "Follow-on-Financing" for 45 days
following the closing and the Company had granted Sigma additional time. In
the event that the Follow-on-Financing had occurred the exercise price of
the warrants issued in conjunction with the Note Purchase would have been
adjusted as agreed between the Company and the buyers. The
Follow-on-Financing was not consummated; as such, the exercise price of the
warrants was reduced to $0.01 per common share.
Under the terms of the agreement, on September 1, 2005 the Company filed
with the Securities and Exchange Commission a Registration Statement to
register a number of common shares equal to the maximum number of shares
that would be issuable to the Buyers in payment of interest on the notes
through the maturity date plus a number of common shares issuable upon
exercise of the warrants. The Company is required to pay liquidating
damages in the amount of 1% per month of the purchase price paid for the
first two months and 2% for the remaining months to the buyers upon the
occurrence of the following events:
1. Failure to file a registration statement by August 30, 2005
2. Failure to have the registration statement declared effective by
December 31, 2005
3. Failure to maintain the effectiveness of the registration
statement until the earlier of (a) March 29, 2008, (b) the date
whereby all the securities may be sold pursuant to Rule 144 (c)
the date on which the Buyers no longer hold the securities
4. Failure to be listed on the OTC Bulletin Board, American Stock
Exchange, NASDAQ, NASDAQ SmallCap or New York Stock Exchange 5.
Failure to timely deliver warrant or interest shares.
As such under the provisions of EITF 00-19 "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's
Own Stock" the Company was required to record the warrants issued as a
derivative liability at fair value on the date of issuance. (See Note 18)
In accordance with SFAS 133 "Accounting for Derivative Instruments and
Hedging Activities", at each reporting this liability will be adjusted for
changes in its fair value. The fair value of the warrants is determined
using the Black Scholes valuation model. Actual period close common stock
prices, applicable volatility rates and the period close risk free interest
rate for the warrants expected remaining useful life are the key
assumptions used in the valuation calculation. Period to period changes in
fair value will be recorded as either an addition or charge to earnings.
These additions or charges have no cash effect over the life of the
instrument. The change in the fair value of the warrants for the year ended
December 31, 2005 was $105,000.
The Company recorded a debt discount of $565,000 based on the residual
value of the proceeds received and the fair value of the warrants. This
discount is being amortized over the life of the loan using the effective
interest rate method. Amortization of $189,000 was recorded as interest
expense during the year ended December 31, 2005
Lines of credit
---------------
On June 30, 2005, the Company obtained a new line of credit in the
principal amount of $500,000 with JPMorgan Chase Bank evidenced by a Grid
Demand Promissory Note (the "Credit Facility) replacing a prior credit
facility dated June 27, 2003, under substantially similar terms, but
extending the original Maturity Date to June 30, 2007. As a condition
precedent to providing the Credit Facility, the JPMorgan Chase Bank
required guarantees of our obligations from Tall Oaks L.L.C. ("Tall Oaks")
and Lawrence Hite (managing member of Tall Oaks) and a collateral agreement
F-18
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - Debt, continued
- ------------------------
from Tall Oaks. In consideration of the issuance of such guarantee and
delivery of the collateral agreement, on July 12, 2005, the Company issued
and delivered to Tall Oaks Group L.L.C. warrants with an initial exercise
price of $1.00 per share to purchase an aggregate of 500,000 shares of the
common stock of Company.
The LoC permits two forms of draw down; one based upon prime rate, the
second based upon LIBOR. The Company elected to draw down $500,000 applying
the terms and conditions set forth for LIBOR. The interest rate is the JPMC
reserve adjusted LIBOR plus 2.30%. As of December 31, 2005, the balance
outstanding was $500,000 and the applied interest rate was 6.49%.
Also in 2003, the Company obtained, and fully drew upon, a second line of
credit from Sterling National Bank ("Sterling") in the amount of $250,000.
The line is guaranteed by the Company's chairman, secured by the assets of
the Company and carries an interest rate of 7%. Repayments are calculated
monthly at 2.778% of the outstanding balance, plus finance charges, and
continue until the line is fully paid. At December 31, 2005, the Company
had an outstanding balance of approximately $120,000 under the line of
credit.
Capitalized lease obligations
-----------------------------
The Company has equipment under capital lease obligations expiring at
various times through 2006. The assets and liabilities under capital leases
are recorded at the lower of the present values of the minimum lease
payments or the fair values of the assets.
As of December 31, 2005 minimum future lease payments under these capital
leases are:
Year Ending
December 31, Amount
----------------------------------------------- ---------------------
(in
thousands)
2006 $ 132
2007 54
2008 22
--------
Total minimum lease payments 208
Less: amounts representing interest (36)
--------
Net minimum lease payments 172
Current portion 99
--------
Long term portion $ 73
=======
The interest rates pertaining to these capital leases range from 6.9% to 19.2%,
and the net book value of the related assets is approximately $159,000 as of
December 31, 2005.
F-19
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - Shareholders' Equity (Deficiency)
--------------------------------
Preferred Stock
---------------
Year Ended December 31, 2004
----------------------------
In 2004 the Board of Directors authorized the sale of up to 1,500 shares of
Series D Redeemable Preferred Stock ("Series D Preferred") at $1,000 per
share. The holders of Series D Preferred are entitled to dividends, on a
cumulative basis, at the rate of 9-1/2% per year, compounded and payable
quarterly beginning on April 1, 2006. The holders of Series D Preferred
have preference in the payment of dividends and, in the event of
liquidation, to all classes of capital stock of the Company except for the
Series A, B and C Preferred Stock. As of December 31, 2004, 100 shares of
Series D Preferred had been sold and the Company received proceeds of
$100,000. The buyer was issued warrants to purchase 90,909 common shares at
an exercise price of $2.03 per share in conjunction with the sale. At
December 31, 2005 there were $12,000 of dividends accrued and unpaid for
Series D Preferred Holders.
In 2004, the Board authorized the sale of an additional 500 shares of its
non-voting Series C Redeemable Preferred Stock ("Preferred Stock - C"). The
holders of Preferred Stock - C are entitled to dividends at the rate of
9-1/2% per annum, payable quarterly in arrears beginning October 1, 2005.
The Company has the option to redeem issued shares of Preferred Stock - C,
in whole or in part, at any time, with the redemption price equal to the
purchase price plus accrued and unpaid dividends. For each share of
Preferred Stock - C purchased, each investor received a Warrant to purchase
the number of shares of the Company's common stock equal to the exchange
ratio of $1,000 of price per share ("Price Per Share") divided by 123% of
the closing price per share of the Company's common stock on the trading
day immediately prior to the date of issuance of the Warrant. During 2004
the Company sold 1,410 shares of Preferred Stock - C for proceeds of
$1,410,000, and issued 1,159,629 warrants in connection with the issuance.
Metropolitan was issued 200,000 warrants with an exercise price of $2.125
to purchase common stock of the Company for services in connection with the
transaction. As of December 31, 2005, 1,990,779 warrants are outstanding in
connection with the issuances of Preferred Stock - C. The warrants expire
in 2008 and 2009 and have exercise prices ranging from $0.86 to $2.13 per
common share. The proceeds were used for working capital purposes. As of
December 31, 2005, approximately $357,000 in dividends is accrued for the
Preferred Stock - C holders.
During 2002 and 2003, the Company sold Series A Convertible Preferred Stock
("Series A Preferred") to Metropolitan Venture Partners II, L.P.
("Metropolitan"), a private equity investment firm. Each share of Series A
Preferred is convertible into 10 shares of common stock of the Company.
Under the terms of the Series A Preferred the shares automatically convert
to common shares under certain events with a final automatic conversion
date of September 25, 2008. The holders of the Series A Preferred ("the
Holders") are entitled to dividends, on a cumulative basis, at the rate of
9-1/2% per annum, compounded quarterly and payable on February 1, 2005 and
September 25, 2005. The Holders have certain demand and piggyback
registrations rights for the Common Stock issuable upon conversion of the
Series A Preferred. The payment of the first dividend was originally
scheduled for September 25, 2004, however, the Company and the Holders
agreed to defer this payment until February 1, 2005. As consideration for
the deferral of the dividend payment, the Company agreed to pay the Holders
a premium of 7.5% of the dividend. In May 2004, the Company and the Holders
further agreed to grant the Company the right, in its sole discretion, to
defer the payment of the dividend scheduled to be paid on February 1, 2005
until February 1, 2006. In the event the Company elected to pay the
dividend on February 1, 2006 the Holders would receive a premium of
$129,000. Also, the Company and the Holders further agreed to grant the
Company the right, in its sole discretion, to defer the payment of the
dividend scheduled to be paid on September 25, 2005 until February 1, 2006.
As a result of this deferment, the Company agreed to pay a premium of
$26,000. At December 31, 2005 there were $1,075,000 of dividends accrued
and unpaid for Series A Preferred Holders and remain unpaid as of March 31,
2006.
F-20
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - Shareholders' Equity (Deficiency), continued
--------------------------------
In June 2003, the Company's Board of Directors approved the exchange of
$974,000 of outstanding debt owed to its Chairman and current Chief
Executive Officer, Markus & Associates (an affiliate of SJ, Note 11) and
Tall Oaks Group, LLC (an affiliate of Metropolitan) for 974 shares of
Preferred Stock - B at the Price Per Share of $1,000. The Preferred Stock -
B was issued as follows:
o 266 shares were exchanged for $266,000 of debt obligation to the
Company's Chairman and current Chief Executive Officer;
o 208 shares were exchanged for $208,000 of debt obligation to Markus &
Associates; and
o 500 shares were exchanged for $500,000 of debt obligation to Tall Oaks
Group, LLC.
Each of the Preferred Stock - B shares is entitled to mandatory dividends,
payable quarterly, commencing on the first day of the calendar quarter
after the date of issuance, at the rate of 12% per annum. Additionally, the
Preferred Stock - B shares were redeemable, at the sole option of the
Company, on or after March 31, 2005 (or prior to March 31, 2005 with the
consent of majority-in-interest holders of Preferred Stock - B shares).
Upon redemption, the holders of the Preferred Stock - B shall be entitled
to receive, for each share of Preferred Stock - B outstanding, an amount
equal to the price per share plus accrued and unpaid dividends. As of
December 31, 2005, approximately $331,000 in dividends were payable to the
Preferred Stock - B holders.
Management believes the Company is precluded from paying dividends at this
time pursuant to Delaware General Corporate Law.
Common Stock, Options and Warrants Issuances
--------------------------------------------
Year Ended December 31, 2005
----------------------------
During 2005, the Company issued 425,942 unregistered shares of common stock
and 2,080,000 options and warrants to purchase common shares as follows:
o The Company issued 311,002 shares, valued at $244,000, to employees
and consultants for services;
o The Company issued 114,940 shares, valued at $98,000, to its Directors
for their services.
o In connection with the issuance of the Senior Subordinated Secured
Notes (see Note 8) the Company issued 750,000 warrants to purchase
common shares with an exercise price of $0.01 per share. The warrants
have a fair value of $565,000 which was recorded as debt discount. The
Company amortized $189,000 to interest expense for the year ended
December 31, 2005.
o The Company issued 500,000 warrants with a fair value of $142,000 as
compensation for the guarantee of a line of credit recorded as
deferred stock based compensation (see Note 8). For the year ended
December 31, 2005, the expense related to the guarantee was
approximately $35,000.
o The Company issued 5,000 options to purchase common stock to an
employee. The options vested upon issuance and have an exercise price
of $1.65 per share. The options had a fair value of approximately
$5,000 at the date of grant.
o The Company issued 100,000 options to purchase common stock to an
employee. The options vest ratably over 3 years and have an exercise
price of $0.65 per share. The options had a fair value of
approximately $41,000 at the date of grant.
o The Company issued 175,000 options to purchase common stock to an
F-21
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - Shareholders' Equity (Deficiency), continued
--------------------------------
employee. The options vested 20% upon issuance and the balance vest
ratably over 3 years and have an exercise price of $0.65 per share.
The options had a fair value of approximately $71,000 at the date of
grant. The Company also granted 25,000 shares of common stock which
vest over two years. The stock had a fair value of $18,000 at the date
of grant which was recorded as deferred stock based compensation and
is being amortized to compensation expense over two years. For the
year ended December 31, 2005 $3,000 was recorded as compensation
expense.
o Under the terms of an employment agreement, the Company issued to its
president 100,000 options to purchase common shares at an exercise
price of $0.50 per share. These options have an intrinsic value of
$20,000 which was recorded as deferred stock based compensation and
will be amortized over 26 months. During the year ended December 31,
2005, $7,000 was amortized as compensation expense. In addition, the
Company issued to its president 100,000 options to purchase common
shares at the market price on the date of the grant. The options had a
fair value of $43,000 at the date of grant.
o The Company issued its Chairman and Chief Executive Officer 350,000
options to purchase common stock at an exercise price of $0.62 per
share. The options had a fair value of $152,000 at the date of the
grant.
Year Ended December 31, 2004
----------------------------
During 2004, the Company issued 466,611 unregistered shares of common stock
as follows:
o 15,000 shares of common stock valued at $12,000 pursuant to an
employment agreement with the Company's Chief Executive Officer as
follows: 5,000 shares valued at $4,000 for services for the quarter
ended March 31, 2004, and 10,000 shares valued at $8,000 for services
rendered and costs recorded in the year 2003.
o 82,509 shares valued at $75,000 to directors for service on the Board
of Directors and Committees of the Board for services rendered and
accrued during 2003.
o 111,752 shares valued at $139,000 to directors for service on the
Board of Directors and Committees of the Board for the year 2004;
o 35,000 shares valued at $26,000 to an employee for services rendered
and accrued during 2003;
o 27,027 shares of non-vested common stock valued at $50,000 to an
employee of the Company pursuant to an employment agreement which was
recorded as deferred stock based compensation at December 31, 2004.
The shares vest ratably through November 29, 2005 ;
F-22
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - Shareholders' Equity (Deficiency), continued
--------------------------------
o 182,700 shares valued at $148,000 to consultants for services rendered
and accrued during 2003;
o 6,666 shares valued at $13,000 to consultants for services rendered in
2004;
o 5,957 shares valued at $10,000 to employees for services rendered in
2004;
Stock Option Plans
------------------
In 2004, the Company's Board of Directors authorized and adopted the 2004
Stock / Stock Option Plan whereby 1,000,000 shares of its common stock were
reserved for issuance under the Plan. The 2004 Plan is divided into two
separate equity programs: an option grant program and a stock issuance
program. Under the stock issuance program, the purchase price per share is
fixed by the Board of Directors or compensation committee but cannot be
less than the fair market value of the common stock on the issuance date.
As of December 31, 2005, there are 745,000 shares available to be issued
pursuant to this plan.
In 2005, the Company authorized the 2005 Stock / Stock Option Plan whereby
1,100,000 shares of its common stock were reserved for issuance under the
Plan. The 2005 Plan is divided into two separate equity programs: an option
grant program and a stock issuance program. Under the stock issuance
program, the purchase price per share is fixed by the Board of Directors or
compensation committee but cannot be less than the fair market value of the
common stock on the issuance date. As of December 31, 2005, there are
435,060 shares available to be issued pursuant to this plan. The plan must
be approved by the Board of Directors.
The Company grants options under multiple stock-based compensation plans
that do not differ substantially in the characteristics of the awards. The
following is a summary of stock option activity for 2005 and 2004, relating
to all of the Company's common stock plans (shares are in thousands):
Weighted
Average
Exercise
Shares Price
------------------ -------------------
Outstanding at January 1, 2004 4,442 $ 1.63
Granted 350 1.63
Exercised -- --
Forfeited (147) 1.60
--------
Outstanding at December 31, 2004 4,645 1.63
Granted 830 0.63
Exercised -- --
Forfeited (621) 3.22
--------
Outstanding at December 31, 2005 4,854 1.25
========
Exercisable at December 31, 2005 4,639 1.26
========
F-23
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - Shareholders' Equity (Deficiency), continued
--------------------------------
Stock Option Plans, continued
------------------
The following table summarizes stock option information as of December 31,
2005:
Options Outstanding
-------------------
Exercise Prices Number Outstanding Weighted Average Options Exercisable
Remaining
Contractual Life
- -----------------------------------------------------------------------------------------------------
$0.50 to $0.75 1,490,000 4.41 years 1,349,000
$0.76 to $1.10 462,000 1.99 years 463,000
$1.16 800,000 2.16 years 800,000
$1.20 to $1.63 797,000 0.83 years 778,000
$1.75 to $2.19 1,305,000 2.02 years 1,237,000
--------- ---------
Total 4,854,000 2.58 years 4,627,000
========= =========
A total of 1,270,000 and 1,130,000 shares of the Company's common stock are
reserved for options, warrants and contingencies at December 31, 2005 and
2004, respectively.
Total compensation costs recognized for stock option awards amounted to $
7,000 and $0 for the years ended December 31, 2005 and 2004, respectively.
Compensation cost represents the fair value of options granted to
non-employees and the intrinsic value of options granted to employees.
Warrants
--------
At December 31, 2005, the Company had warrants outstanding to purchase
3,331,688 shares of common stock. The warrants have exercise prices ranging
from $0.01 to $2.28 and contracted lives from 5 to 7 years.
NOTE 10 - Income Taxes
------------
The following table summarizes components of the provision for current and
deferred income taxes for the years ended December 31, 2005 and 2004:
December 31,
2005 2004
---------------- -----------------
(in thousands)
Current
Federal $ -- $ --
State and other 2 5
----------- -----------
Total 2 5
----------- -----------
Deferred
Federal -- --
State and other -- --
----------- -----------
Total 2 5
----------- -----------
Provision for Income Taxes $ 2 $ 5
========== ===========
F-24
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - Income Taxes, continued
------------
The following table summarizes the significant differences between the U.S.
Federal statutory tax rate and the Company's effective tax rate for
financial statement purposes for the years ended December 31, 2005 and
2004:
December 31,
2005 2004
----------------- --------------
U.S. Federal statutory tax rate 35% 35%
Permanent items (4) (3)
Other 0 1
Increase in valuation allowance (31) (33)
----------------- --------------
0% (0)%
================ ==============
The tax effects of temporary differences that give rise to deferred tax
assets and liabilities are summarized as follows:
December 31,
2005 2004
----------------- ----------------
(in thousands)
Deferred tax assets
Net operating loss carryforwards $ 28,627 $ 28,465
Tax credit carryforward 733 733
Fixed and intangible assets 93 130
Deferred revenue 335 262
Unrealized loss on securities 577 577
Accruals 240 104
---------- ----------
30,605 30,271
Valuation allowance (30,605) (30,271)
---------- ----------
Deferred tax assets $ 0 $ 0
========== ==========
At December 31, 2005, the Company has federal and state net operating loss
carryforwards ("NOLs") remaining of approximately $79 million and $33
million, respectively, which may be available to reduce taxable income, if
any. These NOLs expire through 2025. However, Internal Revenue Code Section
382 rules limit the utilization of NOLs upon a change in control of a
company. During 2005, the Company performed a preliminary evaluation as to
whether a change in control had taken place. Management believes that there
has been no change in control as such applies to Section 382. However, if
it is determined that a change in control has taken place, either
historically or in the future, utilization of its NOLs could be subject to
severe limitations, which could have the effect of eliminating
substantially all of the future income tax benefits of the NOLs.
F-25
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - Related Party and Other Transactions
------------------------------------
S.J. & Associates, Inc.
-----------------------
In December 1999, the Company entered into an agreement with S.J. &
Associates, Inc. (including its affiliates, collectively referred to as
"SJ"), an advisor to the Company and its Board of Directors, for various
services that provide for the following compensation:
o The Company entered into a consulting agreement with SJ initially
terminating on May 31, 2007.
o Pursuant to the agreement, SJ is entitled to monthly compensation of
$15,000. The Company will supply SJ an office/temporary living
accommodations and reimbursement for auto leases at a cost not to
exceed $9,900 per month. Pursuant to the agreement, SJ is entitled to
a financing fee equal to 4% of the gross proceeds (or the gross
transaction value) of any of the following events (i) financing(s)
(either debt or equity), (ii) sale of the Company's stock, (iii) an
acquisition made by the Company, and (iv) the sale of the Company or
merger of the Company with another entity. SJ is also entitled to an
annual bonus at the discretion of the Company's Board of Directors.
With no further approval, SJ is entitled to be reimbursed for other
expenses not to exceed $2,000 per month, plus other reasonable
expenses upon approval. Upon completion of the initial term of the
agreement, SJ will continue to provide consulting services for an
additional 7 1/2 year period. Minimum compensation during this
additional period is approximately $5,500 per month. During 2005 and
2004, the Company incurred $154,000 and $124,000, respectively, of
consulting expenses with SJ. The consulting expense was paid in cash
and stock in 2005 and in cash in 2004. In addition, in 2004, SJ earned
$32,400 of fees related to the sales and issuance of Series C
Preferred stock and was reimbursed for other expenses in accordance
with the consulting agreement.
o Metropolitan Venture Partners Corp. provides financial advisory
services to the Company. The Company incurred $20,000 and $51,000
during the years ended December 31, 2005 and 2004, respectively for
these services.
o The Company has a consulting agreement with DCL Consulting whereby DCL
provides quality assurance testing for the Company. In 2005 the
Company incurred $23,000 for these services. There were no costs for
DCL in 2004. The spouse of an officer of the Company is owner and
principal employee of DCL.
o The Company receives advisory services from Tall Oaks Group and
Lawrence Hite. In 2005 and 2004 the Company incurred costs of $18,000
and $36,000, respectively for such services.
NOTE 12 - Commitments and Contingencies
- ---------------------------------------
Operating Leases
----------------
Operating leases are primarily for office space, co-location, equipment and
automobiles. At December 31, 2005, the future minimum lease payments under
operating leases are summarized as follows:
Year Ending
December 31, Amount
-----------------------------------------------
(in thousands)
2006 $ 372
2007 146
2008 64
--------
Total $582
========
Rent expense approximated $802,000 and $872,000 for the years ended
December 31, 2005 and 2004, respectively.
F-26
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - Commitments and Contingencies, continued
- --------------------------------------------------
Employment Agreements
---------------------
The Company extended its services agreement with its Chief Executive
Officer on December 5, 2003. The agreement expires August 24, 2007. The
extended agreement calls for compensation of $15,000 per month and 360,000
options, vesting 7,500 per month for the term of the agreement (48 months),
to purchase the Company's common stock at an exercise price of $1.16, the
closing price of the Company's common stock on the date the agreement was
effective. The agreement provides for reimbursement of reasonable out of
pocket business expenses and further provides for living and travel
expenses not to exceed $11,000 per month.
The Company entered into an employment and consulting agreement with its
President effective January 1, 2003. The agreement was amended on January
1, 2006. The employment term of the agreement expires June 30, 2006 and is
followed by a consulting period which ends December 31, 2008. During the
employment term compensation is based on an annual salary of $240,000. In
addition the President received options to purchase 100,000 shares of the
Company's common stock at $0.50 per share which vest ratably over a period
of 26 months and an additional option to purchase 100,000 shares of the
Company's common stock at market price on the date of grant which vest on
an equal monthly basis over a period of 36 months. During the employment
term and for 90 days thereafter the President may be reimbursed for
reasonable out-of-pocket expenses and temporary living accommodations not
to exceed $2,500 per month. During the employment term he also receives a
transportation allowance of $600 per month and the cost for transportation
to his home. During the consulting term of the agreement compensation will
be $12,000 per month and duties during the consulting term include
consultation with senior executives concerning the Company's respective
businesses and operations.
NOTE 13 - Management's Liquidity Plans
- --------------------------------------
In order to meet cash requirements and to achieve positive operating cash flows
the Company has and will continue to take various actions and steps that the
management believes will enable it to attain these goals. These actions include:
o In March 2005 the Company closed a Bridge Loan financing with Sigma
Capital Partners LLC and Metropolitan Venture Partners II, L.P. and
received proceeds of $750,000 less legal fees of $55,000 (see Note 8
to the consolidated financial statements).
o The Company and the holders of the Series A and Series B Preferred
stock have previously agreed to defer payment of dividends until
February 1, 2006 and April 15, 2006, respectively. The Company may
seek to defer these dividends further. Management believes the Company
is precluded from paying these dividends at this time pursuant to
Delaware General Corporate Law.
o The Company may raise additional capital through private equity
offerings and borrowing. There is no assurance however that such
capital would be available to the Company, or if available, on terms
and conditions that would be acceptable. In 2004, the Company received
net proceeds from the sale of Preferred Stock of $1,430,000. Also in
2004 the Company entered into an agreement with DIRI Rec Fund LLC, a
corporation formed and funded to loan funds to the Company against
accounts receivable, and may receive advances up to $250,000 from Diri
Rec Fund (see Note 5). Further, in June 2005 the Company renewed for a
period of two years the $500,000 loan previously scheduled to mature
on June 30, 2005 and the guarantors of this loan have consented to
this extension (see Note 8). As noted above the guarantors were issued
F-27
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - Management's Liquidity Plans (continued)
- -------------------------------------------------
warrants and the Company could receive proceeds of $500,000 from the
exercise of such warrants which expire on July 11, 2010, although
there is no assurance that these warrants will be exercised.
o The Company continues to strive to increase revenue through offering
custom engineering services, expanding and enhancing existing product
offerings such as IOL, and introducing new product offerings. In 2004
we entered into a new agreement to provide IOL services to a Fortune
100 company. Revenue from this new customer accounted for 28% of total
revenue for the year ended December 31, 2005. Management anticipates
that revenue from this new customer will continue to increase in 2006
and beyond and expects to further broaden our customer base in 2006,
although there is no assurance that the Company will be able to
broaden this customer base.
o The Company continues to expand its marketing efforts in order to
increase the customer base. In this regard, in 2003, we became a
business partner with IBM and through this relationship will work with
IBM to achieve sales to new customers. We will continue to pursue
similar channel partner opportunities. Also, in the third quarter 2005
we employed a new sales and marketing executive to further expand our
sales efforts.
Management believes that these plans and new initiatives as discussed above will
lead to positive cash flows and profitability. While the Company pursues these
goals the Company also believes that its ability to raise additional capital
through equity and debt placements will provide sufficient cash to meet cash
requirements at least through December 31, 2006. There can be no assurance,
however, that the Company will achieve the cash flow and profitability goals, or
that it will be able to raise additional capital sufficient to meet operating
expenses or implement its plans. In such event, the Company may have to revise
its plans and significantly reduce its operating expenses, which could have an
adverse effect on revenue and operations in the short term.
NOTE 14 - Consolidated Statements of Cash Flows
- -----------------------------------------------
Supplemental disclosure of cash flow information for the years ended
December 31, 2005 and 2004 is summarized as follows:
Year ended December 31,
2005 2004
----------------- -------------------
(in thousands)
Interest paid $282 $308
==== ====
Income taxes paid $ 2 $ 5
===== =====
Non-cash investing and financing activities for the years ended December
31, 2005 and 2004 are summarized as follows:
F-28
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - Consolidated Statements of Cash Flows (continued)
- ----------------------------------------------------------
Year Ended December 31,
2005 2004
--------------- ------------------
(in thousands)
Dividends accrued and unpaid $ 677 $ 716
====== ======
Capitalized leases incurred $ 54 $ 226
====== ======
Issuance of common shares in settlement of liabilities $ 0 $ 257
====== ======
NOTE 15 - Products and Services
- -------------------------------
The Company and its subsidiaries currently operate in one business segment
and have, during the years 2005 and 2004, provided two separate products:
ASP Services and Custom Engineering Services. Refer to Note 1 for a
detailed description of these products and services.
Year Ended December 31,
2005 2004
----------------- -------------
(in thousands)
ASP fees $5,885 $4,580
Custom Engineering fees 2,985 2,978
------ ------
Total Revenue $8,870 $7,558
====== ======
NOTE 16 - Major Customers
- -------------------------
For the year ended December 31, 2005, IBM and Electronic Data Systems Corp.
("EDS") accounted for 68% and 28%, respectively, of the Company's revenue.
In 2004, IBM and EDS accounted for 92% and 7% of revenue, respectively.
Accounts receivable from these two customers at December 31, 2005 and 2004,
amounted to $1,833,000 and $1,869,000, respectively. Loss of these two
customers would have a material adverse effect on the Company.
NOTE 17 - Net Loss Per Share
- ----------------------------
The following chart provides a reconciliation of information used in
calculating the per share amounts:
(in thousands, except per share data)
Year Ended December 31,
2005 2004
----------------- ----------------
Numerator for loss per share:
Loss from continuing operations before discontinued operations $ (974) $ (1,571)
Preferred stock dividends (677) (716)
----------------- ----------------
Loss from continuing operations attributable to common
Shareholders before discontinued operations $(1,651) $ (2,287)
================= ================
Denominator for loss per share*: 4,684 4,285
================= ================
Basic and diluted income (loss) per share:
Loss from continuing operations attributable to common
shareholders before discontinued operations $(0.36) $(0.53)
Income (loss) from discontinued operations 0.00 0.07
----------------- ----------------
Net loss attributable to common shareholders $(0.36) $(0.46)
================= ================
F-29
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - Net Loss Per Share (continued)
- ---------------------------------------
* The effect of dilutive securities (stock options, Series A convertible
preferred stock and warrants) have not been included herein as their
inclusion would be anti- dilutive.
Note 18 - Restatement of 2005 Interim Periods (unaudited)
- ---------------------------------------------
The Company is restating its condensed consolidated financial statements for the
quarters ended March 31, 2005, June 30, 2005 and September 30, 2005 to correct
the accounting for warrants issued in connection with its March 29, 2005 sale of
Senior Subordinated Notes (See Note 8). The corrected accounting reflects the
warrants as a derivative liability under the guidance of EITF 00-19 and the
resultant debt discount on the notes determined on the residual value basis. The
Company previously accounted for the warrants as equity and the resultant debt
discount on the notes was determined on a relative fair value basis.
The effects of the restatement on specific amounts provided in the condensed
consolidated financial statements is as follows:
Condensed Consolidated Balance Sheet:
March 31, 2005
As previously reported As Restated
Note payable, net of discount $ 492 $ 356
Warrant liability $ -- $ 394
Total liabilities $ 5,646 $ 5,904
Additional paid-in-capital $112,760 $112,502
Total stockholders' deficiency $ (2,678) $( 2,936)
Condensed Consolidated Balance Sheet:
June 30, 2005
As previously reported As Restated
Note payable, net of discount $ 535 $ 404
Warrant liability $ -- $ 486
Total liabilities $ 5,846 $ 6,201
Additional paid-in-capital $112,867 $112,609
Total stockholders' deficiency $ (3,033) $ (3,388)
F-30
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 18 - Restatement of 2005 Interim Periods (unaudited) (continued)
- ---------------------------------------------
Condensed Consolidated Statements of Operations
Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
As previously As previously
reported As Restated reported As Restated
Interest expense, net $ (125) $ (130) $ (200) $ (205)
Change in value of warrants $ -- $ ( 92) $ -- $ ( 92)
Loss from continuing operations $ (296) $ (393) $ (581) $ (678)
Net loss $ (305) $ (402) $ (590) $ (687)
Net loss attributable to common shareholders $ (476) $ (573) $ (915) $ (1,012)
Earnings per share:
Loss from continuing operations
attributable to common shareholders $ (0.10) $ (0.12) $ (0.20) $ (0.22)
Loss attributable to common shareholders $ (0.10) $ (0.12) $ (0.20) $ (0.22)
Condensed Consolidated Balance Sheet:
September 30, 2005
As previously reported As Restated
Note payable, net of discount $ 527 $ 297
Warrant liability -- $ 444
Total liabilities $ 5,625 $ 5,839
Additional paid-in-capital $ 113,301 $ $112,979
Total stockholders' deficiency $ (2,969) $ (3,183)
Condensed Consolidated Statements of Operations
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
As previously As previously
reported As Restated reported As Restated
Interest expense, net $ (148) $ (156) $ (348) $ (361)
Change in value of warrants $ -- $ 212 $ -- $ 120
(Loss) income from continuing operations $ ( 74) $ 130 $ (656) $ (548)
Net (loss) income $ ( 76) $ 128 $ (666) $ (558)
Net loss attributable to common shareholders
$ (240) $ ( 36) $ (1,155) $ (1,047)
Earnings per share:
Loss from continuing operations
attributable to common shareholders $ (0.05) $ (0.01) $ (0.25) $ (0.23)
Loss attributable to common shareholders
$ (0.05) $ (0.01) $ (0.25) $ (0.23)
F-31
DIRECT INSITE CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Six Months Ended June 30, 2006
CONTENTS
- -------------------------------------------------------------------------------------------------------------------
Condensed Consolidated Balance Sheets as of June 30, 2006 (Unaudited) and
December 31, 2005 ................................................................................. F-33
Condensed Consolidated Statements of Operations
For the Three and Six Months Ended June 30, 2006 and 2005 (Unaudited).............................. F-34
Condensed Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2006 and 2005 (Unaudited)........................................ F-35
Notes to Condensed Consolidated Financial Statements (Unaudited) ....................................F-36 - F-46
F-32
DIRECT INSITE CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2006 AND DECEMBER 31, 2005
(In thousands, except share data)
June 30, December 31,
2006 2005
--------------------- --------------------
(Unaudited) (Audited)
ASSETS
Current assets
Cash and cash equivalents $ 230 $ 364
Accounts receivable, net of allowance for doubtful accounts of
$0 in 2006 and 2005 1,376 1,858
Prepaid expenses and other current assets 71 195
--------------------- --------------------
Total current assets 1,677 2,417
Property and equipment, net 393 446
Other assets 317 318
--------------------- --------------------
TOTAL ASSETS $ 2,387 $ 3,181
==================== ====================
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
Current liabilities
Short-term revolving loans $ 368 $ 695
Current portion of capital lease obligations 83 99
Notes payable, net of discount 1,251 995
Accounts payable and accrued expenses 2,258 1,962
Dividends payable, current 2,123 1,775
Deferred revenue 378 796
Warrant liability 190 459
Liabilities from discontinued operations _ _
48 61
--------------------- --------------------
Total current liabilities 6,699 6,842
Capital lease obligations, net of current portion 35 73
--------------------- --------------------
Total liabilities 6,734 6,915
--------------------- --------------------
Commitments and contingencies
Shareholders' deficiency
Preferred stock, $0.0001 par value; 2,000,000 shares authorized;
Series A Convertible Preferred, 134,680 issued and outstanding
in 2006 and 2005; liquidation preference of $2,750,000 in 2006 and
2005 - -
Series B Redeemable Preferred, 974 shares issued and outstanding in
2006 and 2005; liquidation preference of $974,075 in 2006 and 2005 - -
Series C Redeemable Preferred, 2,000 shares issued and outstanding
in 2006 and 2005; liquidation preference of $2,000,000 in 2006 and 2005
Series D Redeemable Preferred, 100 shares issued and outstanding
in 2006 and 2005; liquidation preference of $100,000 in 2006 and 2005
Common stock, $0.0001 par value; 50,000,000 shares authorized;
4,942,899 and 4,972,955 shares issued in 2006 and 2005, respectively;
and 4,902,972 and 4,933,028 shares outstanding in 2006 and 2005,
respectively - -
Additional paid-in capital 113,128 113,039
Unearned compensation (180) (134)
Accumulated deficit (116,311) (116,967)
--------------------- --------------------
(4,019) (3,406)
Common stock in treasury, at cost - 24,371 shares (328) (328)
--------------------- --------------------
Total shareholders' deficiency (4,347) (3,734)
--------------------- --------------------
TOTAL LIABILITIES AND SHAREHODERS' DEFICIENCY $ 2,387 3,181
==================== ====================
See notes to condensed consolidated financial statements
F-33
DIRECT INSITE CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(In thousands, except share data)
Three Months Ended Six Months Ended
------------------ ----------------
June 30, June 30,
-------- --------
2006 2005 2006 2005
(restated) (restated)
--------------- ---------------- ----------------- ---------------
Revenue $ 2,196 $ 2,318 $ 4,211 $ 4,398
--------------- ---------------- ----------------- ---------------
Costs and expenses
Operations, research and development 1,003 1,034 2,066 2,047
Sales and marketing 350 559 813 1,031
General and administrative 651 780 1,345 1,472
Amortization and depreciation 76 115 163 228
--------------- ---------------- ----------------- ---------------
2,080 2,488 4,387 4,778
--------------- ---------------- ----------------- ---------------
Operating income (loss) 116 (170) (176) (380)
Other (income) and expenses
Change in fair value of warrant liability (299) 92 (269) 92
Other (income) expense, net 32 1 62 1
Interest expense, net 153 130 334 205
--------------- ---------------- ----------------- ---------------
Income (loss) from continuing operations 230 (393) (303) (678)
Loss from discontinued operations (4) (9) (4) (9)
--------------- ---------------- ----------------- ---------------
Net income (loss) 226 (402) (307) (687)
Preferred stock dividends
(176) (171) (348) (325)
--------------- ---------------- ----------------- ---------------
Net income (loss) attributable to common shareholders $ 50 $ (573) $ (655) $ (1,012)
================ ================= ================== ===============
Basic and diluted income (loss) per share:
Basic and diluted income (loss) from
continuing operations $ 0.01 $ (0.12) $ (0.13) $ (0.22)
================ ================= ================== ===============
Basic and diluted (loss) per share from discontinued
operations 0.00 0.00 0.00 0.00
--------------- ---------------- ----------------- ---------------
Basic and diluted income (loss) per share $ 0.01 $ (0.12) $ (0.13) $ (0.22)
================ ================= ================== ===============
Basic weighted average common shares outstanding 4,881 4,600 4,907 4,560
================ ================= ================== ===============
Diluted weighted average common shares outstanding
5,619 4,600 4,907 4,560
================ ================= ================== ===============
See notes to condensed consolidated financial statements
F-34
DIRECT INSITE CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(In thousands, except share data)
2006 2005
(Restated)
----------------- ------------------
Cash flows from operating activities
Loss from continuing operations $ (303) $ (678)
Adjustments to reconcile loss from continuing operations
to net cash used in continuing operations:
Amortization and depreciation:
Property and equipment 162 229
Discount on debt 222 48
Common stock and options issued for services -- 113
Amortization of deferred stock based compensation 115 36
Change in fair value of warrant liability (269) 92
Changes in operating assets and liabilities:
Accounts receivable 482 172
Prepaid expenses and other current assets 123 102
Other assets -- (20)
Accounts payable and accrued expenses 225 57
Deferred revenue (418) (623)
------------- --------------
Net cash provided by (used in) continuing operations 339 (472)
-------------- --------------
Cash flows from discontinued operations:
(Loss) from discontinued operations (4) (9)
Change in:
Assets and liabilities from discontinued operations (13) (38)
---------------- ---------------
Net cash used in discontinued operations (17) (47)
---------------- ---------------
Net cash provided by (used in) operating activities 322 (519)
-------------- -------------
Cash flows used in investing activities
Expenditures for property and equipment (52) (127)
-------------- ----------------
Cash flows from financing activities
Repayments of revolving loans, net (327) (188)
Proceeds from short-term notes -- 750
Repayments of long-term debt (77) (94)
-------------- ---------------
Net cash (used in) provided by financing activities (404) 468
--------------- --------------
Net decrease in cash and cash equivalents (134) (178)
Cash and cash equivalents - beginning of period 364 306
--------------- --------------
Cash and cash equivalents - end of period $ 230 $ 128
============== ==============
Cash paid for interest
$ 81 $ 78
============== ==============
Non-cash investing and financing activities:
Equipment acquired through issuance of note payable $ 56 $ -
============== ==============
Debt discount on loans
$ -- $ 394
============== ==============
Issuance of common shares and options to purchase
common shares for services and fees $ -- $ 12
============== ==============
See notes to condensed consolidated financial statements
F-35
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
1. Interim Financial Information
The condensed consolidated balance sheet as of June 30, 2006, and the
condensed consolidated statements of operations and cash flows for the
three and six month periods ended June 30, 2006 and 2005, have been
prepared by the Company and are not audited. These interim financial
statements include all adjustments which management considers necessary for
a fair presentation of the financial statements and consist of normal
recurring items. The results of operations for the six month period ended
June 30, 2006, are not necessarily indicative of results that may be
expected for any other interim period or for the full year.
These unaudited condensed consolidated financial statements should be read
in conjunction with the consolidated financial statements and notes thereto
for the year ended December 31, 2005 included in the Company's Form-10KSB.
The accounting policies used in preparing these unaudited condensed
consolidated financial statements are consistent with those described in
the December 31, 2005 consolidated financial statements.
2. The Company
Direct Insite Corp. and subsidiaries (the "Company"), primarily operate as
an application service provider ("ASP"), that markets an integrated
transaction based "fee for service" offering called Invoices On-Line (IOL),
an electronic invoice presentment and payment (EIP&P) service that
processes high volumes of transactional data for invoice presentment
purposes delivered via the Internet on a global basis.
The Company also provides Custom Engineering Services which are single
contractual agreements involving modification or customization of the
Company's proprietary ASP software solution. Additionally the Company
provides service offerings in the form of its patented dbExpress TM
technology, a management information tool that allows users to visually
data mine large volumes of transactional data via the Internet. A complete
Internet Customer Care tool set integrated with the EIP&P product set is
also available. The Company operates fully redundant data centers located
at its main office in Bohemia, N.Y. and in an IBM co-location facility in
Newark, NJ.
Management's liquidity plans are discussed in Note 11. Also, as described
in Note 10, the Company has two customers that accounted for approximately
69.0% and 28.8% of the Company's revenue for the six month period ended
June 30, 2006 and 69.9% and 27.6% of revenue for the six month period ended
June 30, 2005. Loss of either of these customers would have a material
adverse effect on the Company.
3. Stock Based Compensation
Stock Options
-------------
Effective January 1, 2006, the Company adopted the fair value recognition
provisions of Statement of Financial Accounting Standards ("SFAS") No,
123(Revised 2004), "Share-Based Payment", ("SFAS 123(R)"), using the
modified-prospective-transition method. As a result, for the three and six
month periods ended June 30, 2006, the Company recorded $20,000 ($0.00 per
share) and $48,000 ($0.01 per share), respectively, in compensation expense
for the fair value of options. At June 30, 2006, there was $90,000 of total
F-36
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
3. Stock Based Compensation (continued)
unrecognized compensation costs related to stock options granted which is
expected to be recognized over a weighted average period of 2.0 years.
Nonqualified and incentive stock options have been granted to directors,
officers and employees of the Company under our Stock Option Plans. Options
generally vest over 3 years and expire five years from the date of the
grant. At June 30, 2006, 6,720,000 shares were authorized for issuance
under the stock option plans. Awards that expire or are cancelled without
delivery of shares generally become available for issuance under the plans.
The Company issues new shares to satisfy stock option exercises. There were
no options granted during the six months ended June 30, 2006.
A summary of option activity under the plans for the six months ended June
30, 2006 is as follows:
------------------------------- ------------------- ------------------------ -------------------- ----------------------
Weighted Average
Weighted Average Remaining Aggregate Intrinsic
Shares Exercise Price Term Contractual Value
(in thousands) (in years) (in thousands)
------------------------------- ------------------- ------------------------ -------------------- ----------------------
Balance, December 31, 2005 4,854 $1.25
------------------------------- ------------------- ------------------------ -------------------- ----------------------
Granted --
------------------------------- ------------------- ------------------------ -------------------- ----------------------
Exercised --
------------------------------- ------------------- ------------------------ -------------------- ----------------------
Canceled 610
------------------------------- ------------------- ------------------------ -------------------- ----------------------
Forfeited --
------------------------------- ------------------- ------------------------ -------------------- ----------------------
Balance, June 30, 2006 4,244 $1.23 2.3 $--
------------------------------- ------------------- ------------------------ -------------------- ----------------------
Exercisable, June 30, 2006 4,098 $1.24 2.3 $--
------------------------------- ------------------- ------------------------ -------------------- ----------------------
A summary of the status of the Company's non-vested shares as of June 30,
2006 and changes during the six months ended June 30, 2006 is presented
below:
- ---------------------------------------- -------------------------------------- ----------------------------------------------
Non-vested Shares Shares (000) Weighted-average Grant Date Fair Value
- ---------------------------------------- -------------------------------------- ----------------------------------------------
Non-vested at January 1, 2006 211 $0.65
- ---------------------------------------- -------------------------------------- ----------------------------------------------
Granted -- $ --
- ---------------------------------------- -------------------------------------- ----------------------------------------------
Vested 65 $0.73
- ---------------------------------------- -------------------------------------- ----------------------------------------------
Forfeited 0 $ --
--------------------------------------
- ---------------------------------------- -------------------------------------- ----------------------------------------------
Non-vested at June 30, 2006 146 $0.61
=====================================
- ---------------------------------------- -------------------------------------- ----------------------------------------------
The total fair value of shares vested during the six months ended June 30,
2006 was $48,000.
Prior to January 1, 2006, the Company's stock-based employee compensation
plans were accounted for under the recognition and measurement provisions
of Accounting Principles Board Opinion ("APB") No. 25, "Accounting for
Stock Issued to Employees" ("APB No. 25"), and related Interpretations, as
permitted by Financial Accounting Standards Board ("FASB") Statement No.
123, "Accounting for Stock-Based Compensation", ("SFAS 123"). The Company
did not recognize stock-based compensation cost in its statements of
operations for periods prior to January 1, 2006 as options granted had an
exercise price equal to the market value of the underlying common stock on
the date of the grant. However, compensation expense was recognized under
F-37
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
3. Stock Based Compensation (continued)
APB No. 25 for certain options granted to an employee and certain non
employees of the Company based upon the intrinsic value (the difference
between the exercise price at the date of the grant and the deemed fair
value of the common stock).
Three and Six Months Ended June 30, 2005
----------------------------------------
As was permitted under SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure", which amended SFAS No. 123, the
Company elected to continue to follow the intrinsic value method in
accounting for its stock-based employee compensation arrangements as
defined by APB No. 25, and related interpretations including FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation", an interpretation of APB No. 25. The following table
illustrates the effect on net loss and net loss per share if the Company
had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation (in thousands, except per share data):
-------------------- --------------------
Three Months Ended Six Months Ended
June 30, June 30,
2005 2005
(restated) (restated)
-------------------- --------------------
Net (loss) income attributable to common shareholders
As reported $ (573) $ (1,012)
Less: Stock-based employee compensation
expense determined under fair value-based
method for all awards (161) (317)
----------- -------------
Pro forma $ (734) $ (1,329)
=========== ==============
Basic and diluted net loss per share
As reported $ (0.12) $ (0.22)
=========== ==============
Pro forma $ (0.16) $ (0.29)
=========== ==============
The fair value of Company common stock options granted to employees was
estimated on the date of grant using the Black-Scholes option-pricing model
with the following assumptions: (1) expected volatility of 71.9% in 2005,
(2) risk-free interest rates of 4.50% in 2005, (3) expected term of 4.75
years in 2005, and (4) expected dividend rate of 0.0% in 2005. There were
no option grants during the six months ended June 30, 2006.
4. Restatement of Prior Periods
The Company has restated its condensed consolidated financial statements
for the three and six month periods ended June 30, 2005 to correct the
accounting for warrants issued in connection with its March 29, 2005 sale
of Senior Subordinated Notes (See Note 8). The corrected accounting
reflects the warrants as a derivative liability under the guidance of SFAS
133 and EITF 00-19 and the resultant debt discount on the notes determined
on the residual value basis. The Company previously accounted for the
warrants as equity and the resultant debt discount on the notes was
determined on a relative fair value basis.
F-38
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
4. Restatement of Prior Periods (continued)
The effects of the restatement on the condensed consolidated financial
statements for the three and six month periods ended June 30, 2005 were:
Condensed Consolidated Balance Sheet:
June 30, 2005
---------------------------------------- --------------------------- -----------------------
As previously reported As Restated
---------------------------------------- --------------------------- -----------------------
Note payable, net of discount $ 535 $ 404
---------------------------------------- --------------------------- -----------------------
Warrant liability $ -- $ 486
---------------------------------------- --------------------------- -----------------------
Total liabilities $ 5,846 $ 6,201
---------------------------------------- --------------------------- -----------------------
Additional paid-in-capital $ 112,867 $ 112,609
---------------------------------------- --------------------------- -----------------------
Total shareholders' deficiency $ (3,033) $ (3,388)
---------------------------------------- --------------------------- -----------------------
Condensed Consolidated Statements of Operations
Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
- -------------------------------------------------- ---------------- ------------------ ------------------ ------------------
As previously As previously
reported As Restated reported As Restated
- -------------------------------------------------- ---------------- ------------------ ------------------ ------------------
Interest expense, net $ (125) $ (130) $ (200) $ (205)
- -------------------------------------------------- ---------------- ------------------ ------------------ ------------------
Change in value of warrants $ -- $ ( 92) $ -- $ ( 92)
- -------------------------------------------------- ---------------- ------------------ ------------------ ------------------
Loss from continuing operations $ (296) $ (393) $ (581) $ (678)
- -------------------------------------------------- ---------------- ------------------ ------------------ ------------------
Net loss $ (305) $ (402) $ (590) $ (687)
- -------------------------------------------------- ---------------- ------------------ ------------------ ------------------
Net loss attributable to common shareholders $ (476) $ (573) $ (915) $ (1,012)
- -------------------------------------------------- ---------------- ------------------ ------------------ ------------------
Earnings per share:
- -------------------------------------------------- ---------------- ------------------ ------------------ ------------------
Loss from continuing operations attributable
to common shareholders $ (0.10) $ (0.12) $ (0.20) $ (0.22)
- -------------------------------------------------- ---------------- ------------------ ------------------ ------------------
Loss attributable to common shareholders $ (0.10) $ (0.12) $ (0.20) $ (0.22)
- -------------------------------------------------- ---------------- ------------------ ------------------ ------------------
5. Reclassifications
Certain reclassifications have been made to the condensed consolidated
financial statements shown for the prior period in order to have it conform
to the current period's classifications.
6. Discontinued Operations
In 2001, the Company and Platinum Communications, Inc. ("Platinum")
completed a merger under an Agreement and Plan of Merger ("Merger
Agreement"). Under the Merger Agreement, a newly formed wholly owned
subsidiary of the Company acquired all of the outstanding common stock of
Platinum. As a result of the lack of development of the Platinum business
and to focus the Company's resources on its core business, in December
2003, the Company decided to close the operations of Platinum. Accordingly,
the assets and liabilities of Platinum are presented as discontinued
operations for both the current and prior period. At June 30, 2006,
liabilities of the discontinued operation consist of loans and accounts
payable of $48,000.
F-39
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
7. Accounts Receivable and Revolving Loans
The Company has an Accounts Receivable Purchase Agreement with a Bank,
whereby the Company from time to time may assign some of their accounts
receivable to the Bank on a full recourse basis. Upon specific invoice
approval, an advance of 80% of the underlying receivable is provided to the
Company. The remaining balance (20%), less an administrative fee of
approximately 0.5% plus interest at the rate of 1 1/2% per month, is paid
to the Company once the customer has paid. The maximum amount of all
assigned receivables outstanding at any time shall not exceed $1.5 million.
The initial term of the agreement was for one year, and continues until due
notice of termination is given at any time by either party to the
agreement. At June 30, 2006, the Company had assigned approximately
$212,000 of accounts receivable to the Bank and received advances of
$170,000.
In May 2004, the Company entered into an Agreement with DIRI Rec Fund LLC
(the "Rec Fund") whereby the Company may assign certain accounts receivable
on a full recourse basis to the Rec Fund as security for advances (loans).
The Rec Fund was established solely to advance funds to the Company upon
the assignment of receivables. The Rec Fund is administered by a third
party trustee. Certain shareholders of the Company and a Director of the
Company are the principal investors in the Rec Fund. Under the Agreement,
the Company pays interest at the rate of one (1) percent per month on the
maximum purchase amount (as defined in the agreement) of the Rec Fund and
pays the administrative costs of the Rec Fund which approximate $12,000 per
year. At June 30, 2006 the Rec Fund had a total principal available for
assignment of $250,000 and the Company had outstanding advances from the
Rec Fund of $198,000 resulting in an unused availability under the
agreement of $52,000.
8. Debt
Notes payable
-------------
At June 30, 2006 notes payable consist of the notes as described below of
$750,000 less debt discount of $153,000, an equipment term note of $53,000
and lines of credit of $602,000 as further described below.
In March 2005, the Company entered into a Securities Purchase Agreement
(the "Agreement") with Sigma Opportunity Fund LLC ("Sigma") and
Metropolitan Venture Partners II, L.P. ("MetVP"), collectively the
"Buyers", whereby the Buyers purchased Senior Subordinated Secured Notes
(the "Note Purchase") in the aggregate amount of $750,000. The notes bear
interest at the rate of five percent (5%) per year beginning June 28, 2005,
and are payable quarterly in cash or common stock at the option of the
Buyers. The Notes mature on the earlier to occur of (i) September 29, 2006,
or (ii) the date on which demand for payment of the loan payable to
JPMorgan Chase Bank ("JPMC") is made. In connection with the note purchase
the Buyers were issued warrants to purchase 750,000 common shares of the
Company. The initial exercise price of the warrants was $0.90 per share of
common stock.
Sigma had an exclusive right to lead a "Follow-on-Financing" for 45 days
following the closing and the Company had granted Sigma additional time. In
F-40
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
8. Debt (continued)
the event that the Follow-on-Financing had occurred the exercise price of
the warrants issued in conjunction with the Note Purchase would have been
adjusted as agreed between the Company and the buyers. The
Follow-on-Financing was not consummated; as such, the exercise price of the
warrants was reduced to $0.01 per common share.
Under the terms of the agreement, on September 1, 2005 the Company filed
with the Securities and Exchange Commission a Registration Statement to
register a number of common shares equal to the maximum number of shares
that would be issuable to the Buyers in payment of interest on the notes
through the maturity date plus a number of common shares issuable upon
exercise of the warrants. The Company is required to pay liquidating
damages in the amount of 1% per month of the purchase price paid for the
first two months and 2% for the remaining months to the buyers upon the
occurrence of the following events:
1. Failure to file a registration statement by August 30, 2005
2. Failure to have the registration statement declared effective by
December 31, 2005
3. Failure to maintain the effectiveness of the registration
statement until the earlier of (a) March 29, 2008, (b) the date
whereby all the securities may be sold pursuant to Rule 144 (c)
the date on which the Buyers no longer hold the securities
4. Failure to be listed on the OTC Bulletin Board, American Stock
Exchange, NASDAQ, NASDAQ SmallCap or New York Stock Exchange
5. Failure to timely deliver warrant or interest shares.
The Company has accrued $75,000 of liquidated damages as of June 30, 2006.
As such under the provisions of EITF 00-19 "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's
Own Stock" the Company was required to record the warrants issued as a
derivative liability at fair value on the date of issuance. (See Note 18)
In accordance with SFAS 133 "Accounting for Derivative Instruments and
Hedging Activities", at each reporting this liability will be adjusted for
changes in its fair value. The fair value of the warrants is determined
using the Black Scholes valuation model. Actual period close common stock
price ($0.26), applicable volatility rates (74.9%), remaining contractual
life (5.8 years), and the period close risk free interest rate (5.1%) for
the warrants expected remaining useful life are the key assumptions used in
the valuation calculation. Period to period changes in fair value will be
recorded as either an addition or charge to earnings. These additions or
charges have no cash effect over the life of the instrument. The change in
the fair value of the warrants for the three and six months ended June 30,
2006 was $299,000 and $269,000, respectively, and is included in other
income and expense, net in the condensed consolidated financial statement
of operations.
The Company recorded a debt discount of $565,000 based on the residual
value of the proceeds received and the fair value of the warrants. This
discount is being amortized over the life of the loan using the effective
interest rate method. Amortization of $97,000 and $222,000 was recorded as
interest expense during the three and six month periods ended June 30,
2006, respectively.
In April 2006, the Company borrowed $56,000 from a finance company to
purchase computer equipment. The note is secured by the equipment
purchased, is payable over 36 months in equal monthly installments of
principal and interest of $1,800 and bears interest at 9.3% per annum.
F-41
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
8. Debt (continued)
Lines of credit
---------------
On June 30, 2005, the Company obtained a new line of credit in the
principal amount of $500,000 with JPMC evidenced by a Grid Demand
Promissory Note (the "Credit Facility) replacing a prior credit facility
dated June 27, 2003, under substantially similar terms, but extending the
original Maturity Date to June 30, 2007. As a condition precedent to
providing the Credit Facility, the JPMC required guarantees of our
obligations from Tall Oaks Group L.L.C. ("Tall Oaks") and Lawrence Hite
(managing member of Tall Oaks) and a collateral agreement from Tall Oaks.
In consideration of the issuance of such guarantee and delivery of the
collateral agreement, on July 12, 2005, the Company issued and delivered to
Tall Oaks warrants with an initial exercise price of $1.00 per share to
purchase an aggregate of 500,000 shares of the common stock of Company.
The LoC permits two forms of draw down; one based upon prime rate, the
second based upon LIBOR. The Company elected to draw down $500,000 applying
the terms and conditions set forth for LIBOR. The interest rate is the JPMC
reserve adjusted LIBOR plus 2.30%. As of June 30, 2006, the balance
outstanding was $500,000 and the applied interest rate was 7.05%.
Also in 2003, the Company obtained, and fully drew upon, a second line of
credit from Sterling National Bank ("Sterling") in the amount of $250,000.
The line is guaranteed by the Company's chairman, secured by the assets of
the Company and carries a variable interest rate equal to Sterling's base
rate plus 2.0% (11.0% at June 30, 2006).
Repayments are calculated monthly at 2.778% of the outstanding balance,
plus finance charges, and continue until the line is fully paid. At June
30, 2006, the Company had an outstanding balance of approximately $102,000
under the line of credit.
Capitalized lease obligations
The Company has equipment under capital lease obligations expiring at
various times through 2008. The assets and liabilities under capital leases
are recorded at the lower of the present values of the minimum lease
payments or the fair values of the assets. The interest rates pertaining to
these capital leases range from 6.9% to 19.2%, and the net book value of
the related assets is approximately $111,000 as of June 30, 2006.
9. Shareholders' Deficiency
Common Stock and Option Issuances
During the six months ended June 30, 2006, the Company issued 37,444 shares
of common stock valued at $23,000 to an employee as compensation. No
options were issued during the six months ended June 30, 2006.
Earnings Per Share
------------------
The Company displays earnings per share in accordance with SFAS No. 128,
"Earnings Per Share". SFAS No. 128 requires dual presentation of basic and
diluted earnings per share ("EPS"). Basic EPS includes no dilution and is
F-42
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
9. Shareholders' Deficiency (continued)
computed by dividing net income (loss) attributable to common shareholders
by the weighted average number of common shares outstanding for the period.
Diluted EPS includes the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into
common stock.
Securities that could potentially dilute basic EPS in the future consist of
the following (in thousands):
Options to purchase common stock 4,244
Warrants to purchase common stock 3,332
Series A Convertible preferred stock 1,347
-----
Total potential common shares as of June 30, 2006 8,923
=====
10. Products and Services
The Company and its subsidiaries currently operate in one business segment
and provide two separate products: ASP services and custom engineering
services.
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- -----------------------------
2006 2005 2006 2005
------------------ -------------- -------------- --------------
ASP IOL fees $1,565 $1,439 $ 3,116 $2,589
Other ASP services 8 12 15 26
Custom engineering fees 623 867 1,080 1,783
------------------ -------------- -------------- --------------
Total Revenue $2,196 $2,318 $4,211 $4,398
================== ============== ============== ==============
Major Customers
---------------
For the three months ended June 30, 2006 the Company had two major
customers that accounted for 66.8% and 30.9% of the Company's total
revenue. These two customers accounted for 69.0% and 28.8% of revenue for
the six months ended June 30, 2006. These customers accounted for 66.2% and
30.4% of total revenue for the three months ended June 30, 2005 and 69.9%
and 27.6% of revenue for the six months ended June 30, 2005. Accounts
receivable from these customers amounted to $1,334,000 and $1,833,000 at
June 30, 2006 and December 31, 2005, respectively.
11. Management's Liquidity Plans
In order to meet cash requirements and to achieve positive operating cash
flows the Company has and will continue to take various actions and steps
that the management believes will enable it to attain these goals. These
actions include:
o In March 2005 the Company closed a Bridge Loan financing with Sigma Capital
Partners LLC and Metropolitan Venture Partners II, L.P. and received
proceeds of $750,000 less legal fees of $55,000 (see Note 8).
F-43
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
11. Management's Liquidity Plans (continued)
o The Company and the holders of the Series A and Series B Preferred
stock have previously agreed to defer payment of dividends until
February 1, 2006 and April 15, 2006, respectively. The Company may
seek to defer these dividends further. Management believes the Company
is precluded from paying these dividends at this time pursuant to
Delaware General Corporate Law.
o The Company may raise additional capital through private equity
offerings and borrowing. There is no assurance however that such
capital would be available to the Company, or if available, on terms
and conditions that would be acceptable. In 2004, the Company entered
into an agreement with DIRI Rec Fund LLC, a corporation formed and
funded to loan funds to the Company against accounts receivable, and
may receive advances up to $250,000 from Diri Rec Fund (see Note 5).
Further, in June 2005 the Company renewed for a period of two years
the $500,000 loan previously scheduled to mature on June 30, 2005 and
the guarantors of this loan have consented to this extension (see Note
8). As noted above the guarantors were issued warrants and the Company
could receive proceeds of $500,000 from the exercise of such warrants
which expire on July 11, 2010, although there is no assurance that
these warrants will be exercised.
o The Company continues to strive to increase revenue through offering
custom engineering services, expanding and enhancing existing product
offerings such as IOL, and introducing new product offerings. In 2004
we entered into a new agreement to provide IOL services to a Fortune
500 company. Revenue from this new customer accounted for 30.9% and
28.8% of total revenue for the three and six months ended June 30,
2006. Management anticipates that revenue from this new customer will
continue to increase in 2006 and beyond and expects to further broaden
our customer base in 2006, although there is no assurance that the
Company will be able to broaden this customer base.
o In 2006 the Company initiated a cost reduction plan that management
believes will significantly reduce operating costs while still
enabling the Company to meet its commitments to its customers.
o The Company continues to expand its marketing efforts in order to
increase the customer base. In this regard, in 2003, we became a
business partner with IBM and through this relationship will work with
IBM to achieve sales to new customers. We will continue to pursue
similar channel partner opportunities. Also, in the third quarter 2005
we employed a new sales and marketing executive to further expand our
sales efforts.
Management believes that these plans and new initiatives as discussed above will
lead to positive cash flows and profitability. While the Company pursues these
goals the Company also believes that its ability to raise additional capital
through equity and debt placements will provide sufficient cash to meet cash
requirements at least through June 30, 2007. There can be no assurance, however,
that the Company will achieve the cash flow and profitability goals, or that it
will be able to raise additional capital sufficient to meet operating expenses
or implement its plans. In such event, the Company may have to revise its plans
and significantly reduce its operating expenses, which could have an adverse
effect on revenue and operations in the short term.
F-44
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
12. New Accounting Pronouncements
In June 2005, the EITF reached consensus on Issue No. 05-2, "The Meaning of
`Conventional Convertible Debt Instrument' in EITF Issue No. 00-19,
`Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock.'" Issue 00-19 is used to
evaluate whether embedded derivatives should be bifurcated under SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", as
amended. Specifically, SFAS 133 provides guidance as to when an issuer is
required to bifurcate a conversion option that is embedded in convertible
debt. However, Issue 00-19 does not define "conventional convertible debt
instrument." Given the development of numerous contractual terms that may
be included in a convertible debt instrument, it is not clear when a
convertible debt instrument is "conventional." The company does not believe
that certain warrants meet the definition of conventional convertible debt
and as a result Issue No. 00-19 applies to the liability treatment of these
instruments (see Note8). As such the adoption of the Issue had an effect on
the Company's financial position and results of operations (see Note 8).
In September 2005, the FASB ratified the EITF Issue No. 05-7, "Accounting
for Modifications to Conversion Options Embedded in Debt Instruments and
Related Issues," which addresses whether a modification to a conversion
option that changes its fair value effects the recognition of interest
expense for the associated debt instrument after the modification, and
whether a borrower should recognize a beneficial conversion feature, not a
debt extinguishment, if a debt modification increases the intrinsic value
of the debt (for example, the modification reduces the conversion price of
the debt). The adoption of the Issue may have a material effect on our
consolidated financial position or results of operations in future periods.
In September 2005, the FASB ratified the EITF's Issue No. 05-8, "Income Tax
Consequences of Issuing Convertible Debt with a Beneficial Conversion
Feature," which discusses whether the issuance of convertible debt with a
beneficial conversion feature results in a basis difference arising from
the intrinsic value of the beneficial conversion feature on the commitment
date (which is recorded in the stockholder's equity for book purposes, but
as a liability for income tax purposes) and, if so, whether that basis
difference is a temporary difference under SFAS No. 109, "Accounting for
Income Taxes." The adoption of the Issue is not expected to have a material
effect on our consolidated financial position or results of operations in
future periods.
In February 2006, the FASB issued SFAS No. 155 "Accounting for Certain
Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and
140" ("SFAS 155"). SFAS 155 clarifies certain issues relating to embedded
derivatives and beneficial interests in securitized financial assets. The
provisions of SFAS 155 are effective for all financial instruments acquired
or issued after fiscal years beginning after September 15, 2006. The
Company is currently assessing the impact that the adoption of SFAS 155
will have on its results of operations and financial position.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets" ("SFAS 156"), which amends SFAS 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities", with respect to the accounting for separately recognized
servicing assets and servicing liabilities. SFAS 156 permits the choice
of the amortization method or the fair value measurement method, with
changes in fair value recorded in income, for the subsequent measurement
for each class of separately recognized servicing assets and servicing
liabilities. The statement is effective for years beginning after
September 15, 2006, with earlier adoption permitted. The Company is
F-45
DIRECT INSITE CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
12. New Accounting Pronouncements (continued)
currently evaluating the effect that adopting this statement will have on
the Company's financial position and results of operations.
In June 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109".
This Interpretation prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return, and provides
guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition. This
Interpretation is effective for fiscal years beginning after December 15,
2006. The Company is assessing the impact of this Interpretation on its
financial statements, but does not expect it to have a material effect.
13. Related Party Transactions
During the quarter ended June 30, 2006, the Company terminated and settled
the consulting agreement with Mountain Meadow Farm and its associates,
including SJ Associates (collectively "Mountain Meadow") . As part of the
settlement the Company agreed to issue Mountain Meadow 90,638 restricted
common shares valued at $34,000 and to pay for the costs of medical, life
and certain other insurance through December 31, 2013 with the cost for
such insurance not to exceed $200,000 in the aggregate or $50,000 in any 12
month period. At June 30, 2006, the Company has recorded a liability of
$168,000 representing the estimated present value of this obligation.
F-46
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 24. Indemnification of Directors
Under the provisions of the Certificate of Incorporation and By-Laws of
Registrant, each person who is or was a director or officer of Registrant
shall be indemnified by Registrant as of right to the full extent permitted
or authorized by the General Corporation Law of Delaware.
Under such law, to the extent that such person is successful on the merits
in the defense of a suit or proceeding brought against him by reason of the
fact that he is a director or officer of Registrant, he shall be
indemnified against expenses (including attorneys' fees) reasonably
incurred in connection with such action.
If unsuccessful in defense of a third-party civil suit or a criminal suit
is settled, such a person shall be indemnified under such law against both
(1) expenses (including attorneys' fees) and (2) judgments, fines and
amounts paid in settlement if he acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, the best interests of
Registrant, and with respect to any criminal action, had no reasonable
cause to believe his conduct was unlawful.
If unsuccessful in defense of a suit brought by or in the right of
Registrant, or if such suit is settled, such a person shall be indemnified
under such law only against expenses (including attorneys' fees) incurred
in the defense or settlement of such suit if he acted in good faith and in
a manner he reasonably believed to be in, or not opposed to, the best
interests of Registrant, except that if such a person is adjudicated to be
liable in such suit for negligence or misconduct in the performance of his
duty to Registrant, he cannot be made whole even for expenses unless the
court determines that he is fairly and reasonably entitled to be
indemnified for such expenses.
The officers and directors of registrant are covered by officers' and
directors' liability insurance. The policy coverage is $10,000,000, which
includes reimbursement for costs and fees. There is a maximum aggregate
deductible for each loss under the policy of $200,000.
Item 25. Other Expenses of Issuance and Distribution
The estimated expenses of the distribution, all of which are to be
borne by us, are as follows. All amounts are estimates except the
Securities and Exchange Commission registration fee:
Registration Fee $ 92
Accounting Fees and Expenses 20,000
Legal Fees and Expenses 50,000
Miscellaneous 4,908
---------
Total $ 75,000
=========
Item 26. Recent Sales of Unregistered Securities
On June 30, 2005, the Company obtained a new line of credit in the
principal amount of $500,000 with JPMorgan Chase Bank evidenced by a Grid Demand
Promissory Note (the "Credit Facility) replacing a prior credit facility dated
June 27, 2003, under substantially similar terms, but extending the original
Maturity Date to June 30, 2007. As a condition precedent to providing the Credit
Facility, the JPMorgan Chase Bank required guarantees of our obligations from
Tall Oaks L.L.C. ("Tall Oaks") and Lawrence Hite (managing member of Tall Oaks)
and a collateral agreement from Tall Oaks. In consideration of the issuance of
such guarantee and delivery of the collateral agreement, on July 12, 2005, the
II-1
Company issued and delivered to Tall Oaks Group L.L.C. warrants with an initial
exercise price of $1.00 per share to purchase an aggregate of 500,000 shares of
the common stock of Company.
In March 2005, the Company entered into a Securities Purchase Agreement
(the "Agreement") with Sigma Opportunity Fund LLC ("Sigma") and Metropolitan
Venture Partners II, L.P. ("MetVP"), collectively the "Buyers", whereby the
Buyers purchased Senior Subordinated Secured Notes (the "Note Purchase") in the
aggregate amount of $750,000. The notes bear interest at the rate of five
percent (5%) per year beginning June 28, 2005, and are payable quarterly in cash
or common stock at the option of the Buyers. The Notes mature on the earlier to
occur of (i) September 29, 2006, or (ii) the date on which demand for payment of
the loan payable to JPMorgan Chase Bank is made. In connection with the note
purchase the Buyers were issued warrants to purchase 750,000 common shares of
the Company. The initial exercise price of the warrants was $0.90 per share of
common stock. Sigma had an exclusive right to lead a "Follow-on-Financing" for
45 days following the closing and the Company had granted Sigma additional time.
In the event that the Follow-on-Financing had occurred the exercise price of the
warrants issued in conjunction with the Note Purchase would have been adjusted
as agreed between the Company and the buyers. The Follow-on-Financing was not
consummated; as such, the exercise price of the warrants was reduced to $0.01
per common share.
In November 2004 the Board of Directors authorized us to sell up to 1,500
shares of Series D Redeemable Preferred Stock ("Series D Preferred") at $1,000
per share. The holders of Series D Preferred are entitled to dividends, on a
cumulative basis, at the rate of 9-1/2% per year, compounded and payable
quarterly beginning on April 1, 2006. The holders of Series D Preferred have
preference in the payment of dividends and, in the event of liquidation, to all
classes of capital stock of the Company except for the Series A, B and C
Preferred Stock. As of December 31, 2004 we had sold 100 shares of Series D
Preferred and received proceeds of $100,000. The buyer was issued warrants to
purchase 90,909 common shares at an exercise price of $2.03 per share in
conjunction with the sale.
In December 2003 the Board of Directors authorized us to sell up to 1,500
shares of Series C Redeemable Preferred Stock ("Series C Preferred") at $1,000
per share and in April 2004 the Board authorized the sale of an additional 500
shares. The holders of Series C Preferred are entitled to dividends, on a
cumulative basis, at the rate of 9-1/2% per year, compounded and payable
quarterly beginning on October 1, 2005. The holders of Series C Preferred have
preference in the payment of dividends and, in the event of liquidation, to all
classes of capital stock of the Company except for the Series B Preferred Stock.
As of December 31, 2004 we had sold 2000 shares of Series C Preferred and
received proceeds of $2,000,000 less expenses of $140,000. Of the total shares
sold Metropolitan has purchased 540 shares, our Chairman and Chief Executive
Officer of the Company purchased 200 shares and certain Directors purchased 105
shares. The proceeds were used for working capital purposes.
In June 2003, the Company's Board of Directors approved the exchange of the
then outstanding obligations to our Chairman and Chief Executive Officer, Markus
& Associates and Tall Oaks Group, LLC for 974 shares of Series B Preferred Stock
at an exchange ratio of $1,000 of debt per share ("Price Per Share"). The Series
B Preferred was issued as follows:
o 266 shares were exchanged for $266,000 of debt obligation to our
Chairman and Chief Executive Officer;
o 208 shares were exchanged for $208,000 of debt obligation to Markus &
Associates; and
o 500 shares were exchanged for $500,000 of debt obligation to Tall Oaks
Group, LLC.
Each of the Series B Preferred shares is entitled to mandatory dividends,
payable quarterly, commencing on the first day of the calendar quarter after the
date of issuance, at the rate of 12% per annum. Additionally, the Series B
Preferred shares are redeemable, at the sole option of the Company, on or after
March 31, 2005. Upon redemption, the holders of the Series B Preferred shall be
entitled to receive, for each share of Series B Preferred outstanding, an amount
equal to the Price Per Share plus accrued and unpaid dividends.
Between September 2002 and June 2003, the Company sold a total of 134,680
II-2
shares of Series A Convertible Preferred Stock, ("Series A Preferred") in
consideration for the gross amount of $2,750,000 to Metropolitan Venture
Partners II, L.P. Each share of Series A Preferred is convertible into 10 shares
of common stock of the Company. The Series A Preferred is automatically
convertible into common shares on September 25, 2008. The holders of the Series
A Preferred ("the Holders") are entitled to dividends, on a cumulative basis, at
the rate of 9-1/2% per annum, compounded quarterly and payable on February 1,
2005 and September 25, 2005. The payment of the first dividend was originally
scheduled for September 25, 2004, however, the Company and the Holders agreed to
defer this payment until February 1, 2005. As consideration for the deferral of
the dividend payment, the Company agreed to pay the Holders a premium of 7.5% of
the dividend. In May 2004 the Company and the Holders further agreed to grant
the Company the right, in its sole discretion, to defer the payment of the
dividend scheduled to be paid on February 1, 2005 until February 1, 2006. In the
event the Company elected to pay the dividend on February 1, 2006 the Holders
would receive a premium of $129,000. In December 2004 the Company exercised its
right to defer payment of this dividend until February 1, 2006. Also, the
Company and the Holders further agreed to grant the Company the right, in its
sole discretion, to defer the payment of the dividend scheduled to be paid on
September 25, 2005 until February 1, 2006. As a result of this deferment, the
Company agreed to pay a premium of $26,000. At December 31, 2005 there were
$1,075,000 of dividends accrued and unpaid for Series A Preferred Holders and
remain unpaid as of March 31, 2006.
Item 27.
EXHIBITS
3.1 (a) Certificate of Incorporation, as amended. (Incorporated by reference to
Exhibit 3(a) of Form S-1 Registration Statement).(1)
(b) Certificate of Amendment (Change in Name) (Incorporated by reference
to Exhibit 3(a) of Form S-1 Registration Statement).(1)
(c) Certificate of Amendment (Change in Name) (Incorporated by reference
to Exhibit 3(a) of Form S-1 Registration Statement).(1)
(d) Certificate of Amendment (Authorizing Increase in Shares of Common
Stock) (Incorporated by reference to Exhibit 3 (i) (d) to Form 10-K
for the year ended 1995).
(e) Certificate of Amendment (Authorizing one for ten reverse-stock split
as of March 30, 1998). (1)
(f) Certificate of Designation, Preferences and Rights of Series A
Convertible Preferred Stock filed October 3, 2002 (Incorporated by
reference to Exhibit 3.1 to the Company's Current Report on Form 8-K
dated September 25, 2002).
(g) Certificate of Amendment of Certificate of Designation, Preferences
and Rights of Series A Convertible Preferred Stock filed December 20,
2002 (Incorporated by reference to Exhibit 3.2 of Company's Current
Report on Form 8-K dated December 24, 2002).
(h) Certificate of Amendment of Certificate of Designation, Preferences
and Rights of Series A Convertible Preferred Stock filed January 2,
2003 (Incorporated by reference to Exhibit 3.3 of Company's Current
Report on Form 8-K dated January 2, 2003).
(i) Certificate of Designation, Preferences and Rights of Series B
Redeemable Preferred Stock filed December 10, 2003 (Incorporated by
reference to Exhibit 3(i) of the Company's Annual Report on Form
10-KSB filed April 14, 2004).
(j) Certificate of Designation, Preferences and Rights of Series C
redeemable Preferred Stock filed December 16, 2003 (Incorporated by
reference to Exhibit 3(j) of the Company's Annual Report on Form
10-KSB filed April 14, 2004).
(k) Certificate of Amendment of Certificate of Designation, Preferences
and Rights of Series C Preferred Stock filed March 29, 2005
(Incorporated by reference to Exhibit 3(k) of the Company's Annual
Report on Form 10-KSB filed April 29, 2005).
(l) Certificate of Designation, Preferences and Rights of Series D
Redeemable Preferred Stock filed October 7, 2004. (4)
3.2 By-Laws. (Incorporated by reference to Exhibit 3(d) to the Company's
Form S-1 Registration Statement).(1)
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4.1 Form of Common Stock Certificate. (Incorporated by reference to
Exhibit 4 to the Company's Form S-1 Registration Statement).(1)
4.2 Rights Agreement dated as of August 28, 2001 between the Company and
Manhattan Transfer Registrar Company, as Rights Agent. (Incorporated
by reference to Exhibit 4 to the Company's Form 8-K dated August 28,
2001.
4.3 Securities Purchase Agreement between the Company, Sigma Opportunity
Fund, LLC and Metropolitan Venture Partners II, L.P. (Incorporated by
reference to Exhibit 4.1 of the Current Report on Form 8-K filed March
31, 2005).
4.4 Form of Senior Subordinated Secured Note (Incorporated by reference to
Exhibit 4.2 of the Current Report on Form 8-K filed March 31, 2005).
4.5 Form of Common Stock Purchase Warrant (Incorported by reference to
Exhibit 4.3 of the Current Report on Form 8-K filed on March 31,
2005.)
4.6 Common Stock Purchase Warrant issued July 12, 2005 to Tall Oaks Group
L.L.C. (5)
5 Opinion of Beckman, Lieberman & Barandes, LLP. (5)
10.1 Directors, Officers and Consultants 1993 Stock Option Plan
(Incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-8 filed on June 28, 1995).
10.2 Employees 1993 Stock Option Plan (Incorporated by reference to Exhibit
4.2 to the Company's Registration Statement on Form S-8 filed on June
28, 1995).
10.3 1995 Incentive Stock Plan (Incorporated by reference to Exhibit 5 to
the Company's Proxy Statement filed on January 29, 1996).
10.4 2000 Stock Option Plan (Incorporated by reference to Exhibit 10.4 to
the Company's Annual Report on Form 10-K for the year ended December
31, 2001).
10.5 2001 Stock Option/Stock Issuance Plan (Incorporated by reference to
Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2001).
10.6 2001-A Stock Option/Stock Issuance Plan. (Incorporated by reference to
Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2001).
10.7 2002 Stock Option/Stock Issuance Plan (Incorporated by reference to
Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2001).
10.8 2003 Stock Option /Stock Issuance Plan. (2)
10.9 Lease Extension Agreement between Atrium Executive Center and the
Company (Incorporated by reference to Exhibit 10 (g) (ii) to the
Company's Annual Report on Form 10-K for the year ended December 31,
1993).
10.10 Offer to Purchase dated December 23, 1999, among Eagle Merger Corp.,
EMC Corporation and the Company (Incorporated by reference to Exhibit
1 to the Company's Form 8-K filed on February 9, 2000).
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10.11 Indemnification Agreement dated December 21, 1999, among EMC
Corporation, Eagle Merger Corp. and the Company (Incorporated by
reference to Exhibit 2 to the Company's Form 8-K filed on February 9,
2000).
10.12 Indemnification Agreement dated December 21, 1999, between Softworks,
Inc. and the Company (Incorporated by reference to Exhibit 3 to the
Company's Form 8-K filed on February 9, 2000).
10.13 Escrow Agreement dated December 21, 1999, among EMC Corporation,
Eagle Merger Corp., the Company and State Street Bank and Trust
Company, Inc. as escrow agent (Incorporated by reference to Exhibit 4
to the Company's Form 8-K filed on February 9, 2000).
10.14 Exchange Agreement, dated February 10, 2000, among the Company,
NetWolves Corporation and ComputerCOP Corp. (Incorporated by reference
to Exhibit 10.1 to the Company's Form 8-K filed on March 2, 2000).
10.15 Agreement and Plan of Merger by and among Platinum Acquisition Corp.,
the Company, Platinum Communications, Inc., Kevin Ford and Ken Tanoury
dated May 10, 2001 (Incorporated by reference to Exhibit 10.1 to the
Company's Report on Form 10-Q for the quarter ended June 30, 2001).
10.16 Employment Agreement between the Company and Kevin Ford dated May 10,
2001 (Incorporated by reference to Exhibit 10.2 to the Company's
Report on Form 10-Q for the quarter ended June 30, 2001).
10.17 Employment Agreement between the Company and Ken Tanoury dated May
10, 2001 (Incorporated by reference to Exhibit 10.3 to the Company's
Report on Form 10-Q for the quarter ended June 30, 2001).
.. 10.18 Employment Agreement between the Company and Anthony Coppola dated
December 1, 2001 (Incorporated by reference to Exhibit 10.17 to the
Company's Annual Report on Form 10-K for the year ended December 31,
2001).
10.19 Services Agreement between the Company and James A. Cannavino dated
January 25, 2003. (2)
10.20 Stock Purchase and Registration Rights Agreement between the Company
and Metropolitan Venture Partners II, L.P. dated as of September 25,
2002 (Incorporated by reference to Exhibit 10.1 of Registrant's
Current Report on Form 8-K dated September 25, 2002).
10.21 Stock Purchase and Registration Rights Agreement between the Company
and Metropolitan Venture Partners II, L.P. dated as of December 24,
2002 (Incorporated by reference to Exhibit 10.1 of Registrant's
Current Report on Form 8-K dated December 24, 2002).
10.22 Promissory Note between the Company and Tall Oaks Group LLC dated
January 13, 2003.(2)
10.23 Amendment and Notice dated January 13, 2003 by and among the Company,
Metropolitan Venture Partners II, L.P. and Tall Oaks Group L.L.C. (2)
10.24 Form of Subscription Agreement for Series C Redeemable Preferred
Stock (3)
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10.25 Employment and Consulting Agreement between the Company and Robert L.
Carberry (Incorporated by reference to Exhibit 10.2 of registrant's
Current Report on Form 8-K dated December 5, 2003).
10.26 Amended and Restated Reimbursement Agreement dated as of June 27,
2005 by and among the Company, Lawrence D. Hite and Tall Oaks Group
L.L.C. (5)
23.1 Consent of Marcum & Kliegman, LLP.
23.2 Consent of Beckman, Lieberman & Barandes, LLP (included in Exhibit 5
hereof). (5)
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(1) Filed with Form S-1, Registration Statement of the Company Reg. No 33-47322
and are incorporated herein by reference.
(2) Incorporated by reference to the Company's Annual Report on Form-10K filed
April 15, 2003.
(3) Incorporated by reference to the Company's Annual Report on Form-10K filed
April 14, 2004.
(4) Incorporated by reference to the Company's Registration Statement on Form
SB-2, No. 333- 128039 filed September 1, 2005.
(5) Incorporated by reference to Amendment No. 1 to the Company's Registration
Statement on Form SB-2, No. 333-128039, filed December 8, 2005.
Item 28. Undertakings
A. Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to our directors, officers and controlling persons
pursuant to the foregoing provisions, or otherwise, we have been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities, other than the payment by us of expenses incurred or paid by
our director, officer or controlling person in the successful defense of any
action, suit or proceeding, is asserted by such director, officer or controlling
person in connection with the securities being registered, we will, unless in
the opinion of our counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act of 1933 and will be governed by the final adjudication of such issue.
B. We hereby undertake:
(1) To file, during any period in which offers or sales are being made, a
post--effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a) (3) of the
Securities Act of 1933;
(ii) To specify in the prospectus any facts or events arising after
the effective date of the Registration Statement or most recent
post--effective amendment thereof which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
Registration Statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered, if the total dollar value of
securities offered would not exceed that which was registered, and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Securities and
Exchange Commission pursuant to Rule 424(b), Section 230.424(b) of
Regulation S--B, if, in the aggregate, the changes in volume and price
represent no more than a 20% change in the maximum aggregate offering price
set forth in the "Calculation of Registration Fee" table in the effective
Registration Statement; and
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(iii) To include any additional or changed material information with
respect to the plan of distribution not previously disclosed in the
Registration Statement or any material change to such information in the
Registration Statement.
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post--effective amendment shall be deemed to be a new
Registration Statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post--effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
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SIGNATURES
In accordance with the requirements of the Securities Act of 1933, as
amended, the registrant certifies that it has reasonable grounds to believe that
it meets all of the requirements for filing on Form SB-2 and authorized this
Amendment No. 3 to the registration statement to be signed on its behalf by the
undersigned in the city of Bohemia, State of New York on the 15th day of
September, 2006.
DIRECT INSITE CORP.
By: /s/ James A. Cannavino
James A. Cannavino
Chairman of the Board,
Chief Executive Officer
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below on September 15, 2006 by the
following persons in the capacities indicated.
/s/ James A. Cannavino Chairman of the Board,
James A. Cannavino Chief Executive Officer
/s/ Michael J. Beecher
Michael J. Beecher Chief Financial Officer,
Principal Accounting Officer and Secretary
Bernard Puckett Director
* Dennis J. Murray
Dennis J. Murray Director
Carla J. Steckline Director
* Michael Levin
Michael Levin Director
/s/ James A. Cannavino
James A. Cannavino
Attorney-in-Fact