Notes to Consolidated Financial Statements
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited consolidated financial statements
have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”)
for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP
for complete financial statements. In the opinion of management, such statements include all adjustments (consisting only of normal
recurring items) which are considered necessary for fair presentation of the consolidated financial statements of JetPay Corporation
and its subsidiaries (collectively, the “Company” or “JetPay”) as of June 30, 2014. The results of operations
for the three and six months ended June 30, 2014 and 2013 are not necessarily indicative of the operating results for the full
year. It is recommended that these consolidated financial statements be read in conjunction with the consolidated financial statements
and related disclosures for the year ended December 31, 2013 included in the Annual Report on Form 10-K filed with the Securities
and Exchange Commission (“SEC”) on March 31, 2014.
Note 2. Organization and Business Operations
The Company was incorporated in Delaware on November 12, 2010
as a blank check company whose objective was to acquire, through a merger, share exchange, asset acquisition, stock purchase, plan
of arrangement, recapitalization, reorganization or other similar business combination, one or more operating businesses. Until
December 28, 2012, the Company’s efforts were limited to organizational activities, its initial public offering (the “Offering”)
and the search for suitable business acquisition transactions.
Effective August 2, 2013, Universal Business Payment Solutions
Acquisition Corporation changed its name to JetPay Corporation with the filing of its Amended and Restated Certificate of Incorporation.
The Company’s ticker symbol on the Nasdaq Capital Market (“NASDAQ”) changed from “UBPS” to “JTPY”
effective August 12, 2013. The name JetPay Corporation describes the Company as being in the payment processing business, providing
fast, safe, and secure payment services.
The Company currently operates in two business segments, the
Payment Processing Segment, which is an end-to-end processor of credit and debit card and ACH payment transactions for businesses
with a focus on those processing internet transactions and recurring billings and the Payroll Processing Segment, which is a full-service
payroll and related payroll tax payment processor. The Company also initiated operations for JetPay Card Services in the fourth
quarter of 2013, a division that is focused on providing low-cost money management and payment services to un-banked and under-banked
employees of its business customers and other consumers. The activity within the JetPay Card Services division was not material
for the three and six months ended June 30, 2014. The Company entered the payment processing and the payroll processing businesses
upon consummation of the acquisitions of JetPay, LLC (“JetPay Payment Services”) and AD Computer Corporation (“ADC”
or “JetPay Payroll Services”) on December 28, 2012 (the “Completed Transactions”). Assets acquired and
liabilities assumed in the Completed Transactions were recorded on the Company’s Consolidated Balance Sheets as of the respective
acquisition dates based upon their estimated fair values at such date. The results of operations of businesses acquired by the
Company have been included in the statements of operations since their date of acquisition. The excess of the purchase price over
the estimated fair values of the underlying identifiable assets acquired and liabilities assumed was allocated to goodwill.
The consolidated financial statements as of December 31, 2013
and the three and six months ended June 30, 2014 include the accounts of JetPay and its wholly owned subsidiaries, JetPay Payment
Services and JetPay Payroll Services. All significant inter-company transactions and balances have been eliminated in consolidation.
In order to fund its working capital requirements, the Company
expects that the historic cash flow of the acquired companies will provide sufficient liquidity to meet its current operating requirements.
The Company believes that JetPay, LLC and ADC will generate cash flows sufficient to cover its working capital needs. In addition
to funding ongoing working capital needs, the Company’s cash requirements for the next twelve months ending June 30, 2015
include, but are not limited to: principal and interest payments on long-term debt of approximately $2.3 million; the payoff of
$10 million of secured convertible notes maturing on December 31, 2014 to the extent such notes are not converted into common stock
by the note holders; $2.0 million of deferred consideration due to the stockholders of ADC on December 28, 2014; a $492,000 promissory
note to a related party maturing on September 30, 2014, as extended; planned capital expenditures of approximately $250,000
to $300,000; and the possible funding of future acquisitions or new business initiatives. The Company expects to fund its cash needs,
including capital required for acquisitions, with cash flow from its operating activities, equity investments and borrowings. As
disclosed in
Note 8. Redeemable Convertible Preferred Stock
, on October 11, 2013, the Company was successful in selling
an initial 33,333 shares of Series A Convertible Preferred Stock (“Series A Preferred”) to Flexpoint Fund II, L.P.
(“Flexpoint”) for an aggregate of $10 million, less certain costs, and an additional 4,667 shares of Series A Preferred
on April 14, 2014 for $1.4 million. The Company also sold an initial 2,565 shares of Series A-1 Convertible Preferred Stock (“Series
A-1 Preferred”) to Ithan Creek Master Investors (Cayman) L.P. (“Wellington”) for an aggregate of $769,500, less
certain issuance costs. The Company has an agreement to potentially sell an additional $28.6 million of Series A Preferred to Flexpoint
and an additional $1.93 million of Series A-1 Preferred to Wellington. Such additional funds, if any, will be used to repay the
$10 million secured convertible notes maturing in December 2014, if such notes are not converted into common stock, and as partial
consideration for future acquisitions. The Company cannot provide any assurance that it will be successful in securing new financing
or that it will secure such future financing with commercially acceptable terms. If the Company is unable to raise additional capital,
it may need to limit its future growth plans.
Note 3. Summary of Significant Accounting
Policies
Critical accounting policies are defined as those that are reflective
of significant judgments and uncertainties, and may potentially result in materially different results under different assumptions
and conditions. The Company’s critical accounting policies are described below.
Use of Estimates
The accompanying financial statements have been prepared in
accordance with U.S. GAAP and pursuant to the accounting
and disclosure rules and regulations of the SEC. The preparation of these financial statements requires the Company to make estimates
and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent
assets and liabilities at the date of the Company’s financial statements. Such estimates include, but are not limited to,
the value of purchase consideration of acquisitions; valuation of accounts receivable, reserves for chargebacks, goodwill, intangible
assets, and other long-lived assets; legal contingencies; assumptions used in the calculation of stock-based compensation; and
in the calculation of income taxes. Actual results may differ from these estimates under different assumptions or conditions.
Revenue Recognition and Deferred Revenue
The Company recognizes revenue in general when the following
criteria have been met: persuasive evidence of an arrangement exists, a customer contract or purchase order exists and the fees
are fixed and determinable, no significant obligations remain and collection of the related receivable is reasonably assured. Allowances
for chargebacks, discounts and other allowances are estimated and recorded concurrent with the recognition of revenue and are primarily
based on historic rates.
Revenues from the Company’s credit and debit card processing
operations are recognized in the period services are rendered as the Company processes credit and debit card transactions for its
merchant customers or for merchant customers of its Independent Sales Organization (“ISO”) clients. The majority of
the Company’s revenue within its credit and debit card processing business is comprised of transaction-based fees, which
typically constitute a percentage of dollar volume processed, or a fee per transaction processed. In the case where the Company
is only the processor of transactions, it charges transaction fees only and records these fees as revenues. In the case of merchant
contracts or contracts with ISOs for whom it processes credit and debit card transactions for the ISO’s merchant customers,
revenue is primarily comprised of fees charged to the merchant, as well as a percentage of the processed sale transaction. The
Company’s contracts in most instances involve three parties: the Company, the merchant, and the sponsoring bank. Under certain
of these sales arrangements, the Company’s sponsoring bank collects the gross revenue from the merchants, pays the interchange
fees and assessments to the credit card associations, collects their fees and pays the Company a net residual payment representing
the Company’s fee for the services provided. Accordingly, under these arrangements, the Company records the revenue net of
interchange, credit card association assessments and fees and the sponsoring bank’s fees. Effective June 1, 2013, a majority
of the Company’s merchant contract and ISO merchant customer credit and debit card transactions business was transferred
to a new sponsoring bank whereby the Company is billed directly for certain fees by the credit card associations and the processing
bank. In this instance, revenues and cost of revenues include the credit card association fees and assessments and the sponsoring
bank’s fees which are billed to the Company and for which it assumes credit risk. The impact of this change resulted in an
increase in revenues and cost of revenues of approximately $572,000 and $1.54 million for the three and six months ended June 30,
2014, respectively. In all instances, the Company recognizes processing revenues net of interchange fees, which are assessed to
its merchant and ISO merchant customers on all processed transactions. Interchange rates and fees are not controlled by the Company.
The Company effectively functions as a clearing house collecting and remitting interchange fee settlement on behalf of issuing
banks, debit networks, credit card associations and their processing customers. Additionally, the Company’s direct merchant
customers have the liability for any charges properly reversed by the cardholder. In the event, however, that the Company is not
able to collect such amount from the merchants due to merchant fraud, insolvency, bankruptcy or any other reason, it may be liable
for any such reversed charges. The Company requires cash deposits, guarantees, letters of credit and other types of collateral
by certain merchants to minimize any such contingent liability, and it also utilizes a number of systems and procedures to manage
merchant risk. The Company has historically experienced losses due to chargebacks resulting from merchant defaults.
Revenues from the Company’s payroll processing operation
are recognized in the period services are rendered and earned under service arrangements with clients where service fees are fixed
or determinable and collectability is reasonably assured. Certain processing services are provided under annual service arrangements
with revenue recognized over the service period based on when the efforts and costs are expended. The Company’s service revenue
is largely attributable to payroll-related processing services where the fees are based on a fixed amount per processing period
or a fixed amount per processing period plus a fee per employee or transaction processed. The revenue earned from delivery service
for the distribution of certain client payroll checks and reports is included in processing revenue, and the costs for delivery
are included in selling, general, and administrative expenses in the Consolidated Statements of Operations.
Interest on funds held for clients is earned primarily on funds
that are collected from clients before due dates for payroll tax administration services and for employee payment services, and
invested until remittance to the applicable tax or regulatory agencies or client employee. These collections from clients are typically
remitted from 1 to 30 days after receipt, with some items extending to 90 days. The interest earned on these funds is included
in total revenue on the Consolidated Statements of Operations because the collecting, holding, and remitting of these funds are
critical components of providing these services.
Reserve for Chargeback Losses
Disputes between a cardholder and a merchant periodically arise
as a result of, among other things, cardholder dissatisfaction with merchandise quality or merchant services. Such disputes may
not be resolved in the merchant’s favor. In these cases, the transaction is “charged back” to the merchant, which
means the purchase price is refunded to the customer through the merchant’s bank and charged to the merchant. If the merchant
has inadequate funds, JetPay, LLC may in certain circumstances bear the credit risk for the full amount of the transaction. JetPay,
LLC evaluates the risk for such transactions and estimates the potential loss for chargebacks based primarily on historical experience
and records a loss reserve accordingly. JetPay, LLC believes its reserve for chargeback losses is adequate to cover both the known
probable losses and the incurred but not yet reported losses at the balance sheet dates. Chargeback reserves totaling $291,000
and $262,000 were recorded as of June 30, 2014 and December 31, 2013, respectively, and are included in accounts payable and accrued
expenses.
Fair Value of Financial Instruments
The carrying amounts of financial instruments, including cash
and cash equivalents, restricted cash, settlement processing assets and liabilities, accounts receivable, prepaid expenses and
other current assets, other assets, accounts payable and accrued expenses, other current liabilities and deferred revenue, approximated
fair value as of the balance sheet date presented, because of the relatively short maturity dates on these instruments. The carrying
amounts of the financing arrangements approximate fair value as of the balance sheet date presented, because interest rates on
these instruments approximate market interest rates after consideration of stated interest rates, anti-dilution protection and
associated warrants.
Concentration of Credit Risk
Financial instruments that potentially expose the Company to
concentration of credit risk consist primarily of cash and cash equivalents and accounts receivable. The Company’s cash and
cash equivalents are deposited with major financial institutions. At times, such deposits may be in excess of the Federal Deposit
Insurance Corporation insurable amount.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original
maturities of three months or less when purchased to be cash equivalents.
Accounts Receivable
The Company’s accounts receivable are due from its merchant
processing and its payroll customers. Credit is extended based on evaluation of customers’ financial condition and, generally,
collateral is not required. Payment terms vary and amounts due from customers are stated in the financial statements net of an
allowance for doubtful accounts. Accounts which are outstanding longer than the payment terms are considered past due. The Company
determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due,
the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the condition
of the general economy and the industry as a whole. The Company writes off accounts receivables when they are deemed uncollectible.
Settlement Processing Assets and Obligations
Funds settlement refers to the process of transferring funds
for sales and credits between card issuers and merchants. Depending on the type of transaction, either the credit card interchange
system or the debit network is used to transfer the information and funds between the sponsoring bank and card issuing bank to
complete the link between merchants and card issuers. In certain of the Company’s processing arrangements, merchant funding
primarily occurs after the sponsoring bank receives the funds from the card issuer through the card networks creating a net settlement
obligation on the Company’s balance sheet. In a limited number of other arrangements, the sponsoring bank funds the merchants
before it receives the net settlement funds from the card networks, creating a net settlement asset on the Company’s balance
sheet. Additionally, certain of the Company’s sponsoring banks collect the gross revenue from the merchants, pay the interchange
fees and assessments to the credit card associations, collect their fees for processing and pay the Company a net residual payment
representing the Company’s fees for the services. In these instances, the Company does not reflect the related settlement
processing assets and obligations in its consolidated balance sheet.
Timing differences in processing credit and debit card and ACH
transactions, as described above, interchange expense collection, merchant reserves, sponsoring bank reserves, and exception items
result in settlement processing assets and obligations. Settlement processing assets consist primarily of the Company’s receivable
from merchants for the portion of the discount fee related to reimbursement of the interchange expense, its receivable from the
processing bank for transactions the Company has funded merchants in advance of receipt of card association funding, merchant reserves
held, sponsoring bank reserves and exception items, such as customer chargeback amounts receivable from merchants. Settlement processing
obligations consist primarily of merchant reserves, the Company’s liability to the processing bank for transactions for which
it has received funding from the members but have not funded merchants and exception items.
Property and Equipment
Property and equipment acquired in the Company’s recent
business acquisitions have been recorded at estimated fair value. The Company records all other property and equipment acquired
in the normal course of business at cost. Depreciation is recorded using the straight-line method over the estimated useful lives
of the assets, which are generally as follows: leasehold improvements – shorter of economic life or initial term of the related
lease; machinery and equipment – 5 to 15 years; and furniture and fixtures – 5 to 10 years. Significant additions or
improvements extending assets’ useful lives are capitalized; normal maintenance and repair costs are expensed as incurred.
Goodwill
Goodwill represents the premium paid over the fair value of
the net tangible and identifiable intangible assets acquired in the Company’s business combinations. The Company performs
a goodwill impairment test on at least an annual basis. Application of the goodwill impairment test requires significant judgments,
including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth
for the businesses, the useful life over which cash flows will occur and determination of the Company’s weighted average
cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and/or conclusions
on goodwill impairment for each reporting unit. The Company conducts its annual goodwill impairment test as of December 31 of each
year or more frequently if indicators of impairment exist. The Company periodically analyzes whether any such indicators of impairment
exist. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators
may include a sustained significant decline in our stock price and market capitalization, a significant adverse change in legal
factors or in the business climate, unanticipated competition and/or slower expected growth rates, adverse actions or assessments
by a regulator, among others. The Company compares the fair value of its reporting unit to its respective carrying value, including
related goodwill. Future changes in the industry could impact the results of future annual impairment tests. The Company’s
annual goodwill impairment testing indicated there was no impairment as of December 31, 2013. There can be no assurance that future
tests of goodwill impairment will not result in impairment charges.
Identifiable Intangible Assets
Identifiable intangible assets consist primarily of customer
relationships, software costs, and tradenames. Certain tradenames are considered to have indefinite lives, and as such, are not
subject to amortization. These assets are tested for impairment using the undiscounted cash flow methodology annually and whenever
there is an impairment indicator. Estimating future cash flows requires significant judgment and projections may vary from cash
flows eventually realized. Several impairment indicators are beyond the Company’s control, and determining whether or not
they will occur cannot be predicted with any certainty. Customer relationships, trade names, and software costs are amortized on
a straight-line basis over their respective assigned estimated useful lives.
Impairment of Long–Lived Assets
The Company periodically reviews the carrying value of its long-lived
assets held and used at least annually or when events and circumstances warrant such a review. If significant events or changes
in circumstances indicate that the carrying value of an asset or asset group may not be recoverable, the Company performs a test
of recoverability by comparing the carrying value of the asset or asset group to its undiscounted expected future cash flows. Cash
flow projections are sometimes based on a group of assets, rather than a single asset. If cash flows cannot be separately and independently
identified for a single asset, the Company determines whether impairment has occurred for the group of assets for which it can
identify the projected cash flows. If the carrying values are in excess of undiscounted expected future cash flows, it measures
any impairment by comparing the fair value of the asset group to its carrying value. If the fair value of an asset or asset group
is determined to be less than the carrying amount of the asset or asset group, impairment in the amount of the difference is recorded.
The Company’s annual testing indicated there was no impairment as of December 31, 2013.
Series A and Series A-1 Preferred
The Company accounts for the redemption premium, beneficial
conversion feature and issuance costs on its Series A Preferred and its Series A-1 Preferred using the effective interest method,
accreting such amounts to its Series A Preferred and Series A-1 Preferred from the date of issuance to the earliest date of redemption.
Share-Based Compensation
The Company expenses employee share-based payments under Accounting
Standards Codification (“ASC”) Topic 718,
Compensation-Stock Compensation
, which requires compensation cost
for the grant-date fair value of share-based payments to be recognized over the requisite service period. The Company estimates
the grant-date fair value of the share-based awards issued in the form of options using the Black-Scholes option pricing model.
Loss per share
Basic (loss) income per share is computed by dividing net loss
by the weighted-average number of shares of common stock outstanding during the period. The dilutive effect of the conversion option
in the $10 million of Secured Convertible Promissory Notes (the “Notes”) of 3,333,333 shares of the Company’s
common stock, par value $0.001 per share (“Common Stock”), the effect of the conversion option in the Flexpoint Series
A Preferred Stock of 3,800,000 shares and the Wellington Series A-1 Preferred Stock of 256,500 shares of Common Stock at June 30,
2014, and the effect of exercisable stock options to purchase 231,249 shares of Common Stock granted under the Company’s
Stock Incentive Plan have been excluded from the loss per share calculation for the three and six months ended June 30, 2014 in
that the assumed conversion or exercise of these options would be anti-dilutive.
For the three and six months ended June 30, 2013, basic loss per share was computed using the weighted-average number of shares of common shares outstanding during the periods. The
dilutive effect of the conversion option in the Notes of 2,000,000 shares of Common Stock and potential issuable shares related
to the conversion option in the Ten Lords, Ltd. Promissory Note Payable of 1,000,000 shares of Common Stock, a total of 3,000,000
shares of Common Stock, have been excluded from the loss per share calculation in that the assumed conversion of the options would
be anti-dilutive.
Derivative Financial Instruments
The Company does not use derivative instruments to hedge exposures
to cash flow, market or foreign currency risks. The Company does review the terms of the convertible debt it issues to determine
whether there are embedded derivative instruments, including embedded conversion options, which are required to be bifurcated and
accounted for separately as derivative financial instruments. In circumstances where the host instrument contains more than one
embedded derivative instrument, including the conversion option that is required to be bifurcated, the bifurcated derivative instruments
are accounted for as a single, compound derivative instrument.
Bifurcated embedded derivatives are initially recorded at fair
value and are then revalued at each reporting date with changes in the fair value reported as non-operating income or expense.
When the equity or convertible debt instruments contain embedded derivative instruments that are to be bifurcated and accounted
for as liabilities, the total proceeds received are first allocated to the fair value of all the bifurcated derivative instruments.
The remaining proceeds, if any, are then allocated to the host instruments themselves, usually resulting in those instruments being
recorded at a discount from their face value. The discount from the face value of the convertible debt, together with the stated
interest on the instrument, is amortized over the life of the instrument through periodic charges recorded within other expense
(income), using the effective interest method.
Fair value measurements
The Company accounts for fair value measurements in accordance
with ASC Topic 820,
Fair Value Measurements and Disclosures
(“ASC Topic 820”)
,
which defines fair value,
establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair
value measurements.
ASC Topic 820 establishes a fair value hierarchy that prioritizes
the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices
in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level
3 measurements). The three levels of the fair value hierarchy under ASC Topic 820 are described below:
|
Level 1
|
Unadjusted quoted prices in active markets that
are accessible at the measurement date for identical, unrestricted assets or liabilities.
|
|
Level 2
|
Applies to assets or liabilities for which there are
inputs other than quoted prices included within Level 1 that are observable for the asset or liability such as quoted prices for
similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient
volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable
or can be derived principally from, or corroborated by, observable market data.
|
|
Level 3
|
Prices or valuation techniques that require inputs
that are both significant to the fair value measurement and unobservable (supported by little or no market activity).
|
The following table sets forth the Company’s financial
assets and liabilities measured at fair value by level within the fair value hierarchy. As required by ASC Topic 820, assets and
liabilities are classified in their entirety based on the level of input that is significant to the fair value measurement.
|
|
Fair Value at June 30, 2014
|
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities
|
|
$
|
320
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
320
|
|
Contingent consideration
|
|
$
|
842
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
842
|
|
Totals
|
|
$
|
1,162
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,162
|
|
|
|
Fair Value at December 31, 2013
|
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities
|
|
$
|
380
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
380
|
|
Contingent consideration
|
|
$
|
850
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
850
|
|
Totals
|
|
$
|
1,230
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,230
|
|
The following table sets forth a summary of the change in fair
value of the Company’s Level 3 financial liabilities that are measured at fair value on a recurring basis (in thousands):
|
|
For the Three months Ended
June 30,
|
|
|
For the Six months Ended
June 30,
|
|
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
Beginning balance
|
|
$
|
1,280
|
|
|
$
|
2,110
|
|
|
$
|
1,230
|
|
|
$
|
3,650
|
|
Change in fair value of derivative liability
|
|
|
(110
|
)
|
|
$
|
(250
|
)
|
|
|
(60
|
)
|
|
$
|
(1,340
|
)
|
Change in fair value of contingent cash consideration
|
|
|
(8
|
)
|
|
$
|
(130
|
)
|
|
|
(8
|
)
|
|
$
|
(580
|
)
|
Totals
|
|
$
|
1,162
|
|
|
$
|
1,730
|
|
|
$
|
1,162
|
|
|
$
|
1,730
|
|
Level 3 liabilities are valued using unobservable inputs to
the valuation methodology that are significant to the measurement of the fair value of the financial instrument. For fair value
measurements categorized within Level 3 of the fair value hierarchy, the Company’s accounting and finance department, which
reports to the Chief Financial Officer, determines its valuation policies and procedures. The development and determination of
the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s
accounting and finance department with support from the Company’s outside consultants which are approved by the Chief Financial
Officer. Level 3 financial liabilities consists of a derivative liability and contingent consideration related to the JetPay, LLC
acquisition for which there are no current markets such that the determination of fair value requires significant judgment or estimation.
Changes in fair value measurements categorized within Level 3 of the fair value hierarchy will be analyzed each period based on
changes in estimates or assumptions and recorded as appropriate.
The Level 3 financial liabilities are the result of recording
the Completed Transactions and related debt instruments as more fully described below.
In connection with the debt proceeds received under the Notes,
the Company recorded a derivative liability of $2.11 million on its consolidated balance sheet at December 28, 2012 related to
the conversion feature embedded in the Notes. The fair value of the derivative liability is classified within Level 3 of the fair
value hierarchy because it is valued using pricing models that incorporate management assumptions that cannot be corroborated with
observable market data. The fair value at June 30, 2014 of $320,000 was determined using a binomial option pricing valuation model
with the following assumptions: risk free interest rate: 0.06%; dividend yield: 0%; expected life of the option to convert of 0.50
years; and volatility: 22.6%. The change in fair value of this derivative liability of $(110,000) and $(60,000) for the three and
six months ended June 30, 2014, respectively, is recorded within other expenses (income) in the Company’s consolidated statements
of operations.
In addition to the consideration paid upon closing of the JetPay,
LLC acquisition, WLES, through December 28, 2017, is entitled to receive 833,333 shares of Common Stock if the trading price of
the Common Stock is at least $8.00 per share for any 20 trading days out of a 30 trading day period and $5,000,000 in cash if the
trading price of the Common Stock is at least $9.50 per share for any 20 trading days out of a 30 trading day period. This contingent
consideration was valued at $1.54 million at the date of acquisition based on utilization of option pricing models and was recorded
as a non-current liability for $700,000 and as additional paid-in capital for $840,000 at December 31, 2012. The stock-based component
value of $840,000 recorded at December 28, 2012 on the JetPay, LLC acquisition date, remains unchanged at June 30, 2014 as a result
of this component being recorded as equity. The fair value at June 30, 2014 of the cash-based contingent consideration, valued
at $2,000 was determined using a binomial option pricing model. The following assumptions were utilized in the June, 2014 calculations:
risk free interest rate: 1.19%; dividend yield: 0%; term of contingency of 3.50 years; and volatility: 26.2%.
The fair value of the Common Stock was derived from the per
share price of recent sales of the Common Stock at the valuation date. Management determined that the results of its valuation
are reasonable. The expected life represents the remaining contractual term of the derivative. The volatility rate was developed
based on analysis of the historical volatility rates of similarly situated companies (using a number of observations that was at
least equal to or exceeded the number of observations in the life of the derivative financial instrument at issue). The risk free
interest rates were obtained from publicly available US Treasury yield curve rates. The dividend yield is zero because the Company
has not paid dividends and does not expect to pay dividends in the foreseeable future.
The Company uses either a binomial option pricing model or the
Black-Scholes option valuation model to value Level 3 financial liabilities at inception and on subsequent valuation dates. These
models incorporate transaction details such as the Company’s stock price, contractual terms, maturity, risk free rates, as
well as volatility. A significant decrease in the volatility or a significant decrease in the Company’s stock price, in isolation,
would result in a significantly lower fair value measurement.
As of June 30, 2014, there were no transfers in or out of Level
3 from other levels in the fair value hierarchy.
In accordance with the provisions of ASC Topic 815,
Derivatives
and Hedging Activities
, the Company presented its derivative liability at fair value on its balance sheet, with the corresponding
change in fair value recorded in the Company’s consolidated statement of operations for the applicable reporting periods.
Income Taxes
The Company accounts for income taxes under ASC Topic 740,
Income
Taxes
(“ASC Topic 740”). ASC Topic 740 requires the recognition of deferred tax assets and liabilities for both
the expected impact of differences between the financial statements and tax basis of assets and liabilities and for the expected
future tax benefit to be derived from tax loss and tax credit carryovers. Deferred income tax expense (benefit) represents the
change during the period in the deferred income tax assets and deferred income tax liabilities. In establishing the provision for
income taxes and determining deferred income tax assets and liabilities, the Company makes judgments and interpretations based
on enacted laws, published tax guidance and estimates of future earnings. ASC Topic 740 additionally requires a valuation allowance
to be established when, based on available evidence; it is more likely than not that some portion or the entire deferred income
tax asset will not be realized.
ASC Topic 740 also clarifies the accounting for uncertainty
in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement
process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. For
those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities.
ASC Topic 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure
and transition. The Company is required to file income tax returns in the United States (federal) and in various state and local
jurisdictions. Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions
requiring recognition in the Company’s financial statements. The Company believes that its income tax positions and deductions
would be sustained upon examination and does not anticipate any adjustments that would result in material changes to its financial
position.
The Company’s policy for recording interest and penalties
associated with unrecognized tax benefits is to record such interest and penalties as interest expense and as a component of selling,
general and administrative expense, respectively. There were no amounts accrued for penalties or interest as of or during the three
and six months ended June 30, 2014 and 2013. Management does not expect any significant changes in its unrecognized tax benefits
in the next year.
Subsequent Events
Management evaluates events that have occurred after the balance
sheet date but before the financial statements are issued. Based upon the review, Management did not identify any recognized or
non-recognized subsequent events which would have required an adjustment or disclosure in the financial statements.
Recent Accounting Pronouncements
The Financial Accounting Standards Board (“FASB”)
has issued ASU No. 2014-12,
Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the
Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period
. This ASU requires
that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a
performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award.
This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance
target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service
has already been rendered. The amendments in this ASU are effective for annual periods and interim periods within those annual
periods beginning after December 15, 2015. Earlier adoption is permitted. The adoption of this standard is not expected to have
a material impact on the Company’s consolidated financial position and results of operations.
The FASB has issued ASU No. 2014-09,
Revenue from Contracts
with Customers
. This ASU supersedes the revenue recognition requirements in Accounting Standards Codification 605 -
Revenue
Recognition
and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes
revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which
the company expects to be entitled in exchange for those goods or services. This ASU is effective on January 1, 2017 and should
be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially
applying the ASU recognized at the date of initial application. The adoption of this standard is not expected to have a material
impact on the Company’s consolidated financial position and results of operations.
Note 4. Cash and Cash Equivalents Held in
Trust Account
Cash and cash equivalents in the trust account established upon
consummation of the Company’s initial public offering consisted of $1.95 million in a “held as cash” account
at December 31, 2012 and were disbursed to the redeeming stockholders on January 2, 2013.
Note 5. Property and Equipment, net of Accumulated
Depreciation and Amortization
|
|
June 30,
2014
|
|
|
December 31,
2013
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
Leasehold improvements
|
|
$
|
354
|
|
|
$
|
327
|
|
Equipment
|
|
|
703
|
|
|
|
507
|
|
Furniture and fixtures
|
|
|
223
|
|
|
|
195
|
|
Computer software
|
|
|
110
|
|
|
|
414
|
|
Vehicles
|
|
|
196
|
|
|
|
197
|
|
Total property and equipment
|
|
|
1,586
|
|
|
|
1,640
|
|
Less: accumulated depreciation and amortization
|
|
|
(500
|
)
|
|
|
(388
|
)
|
Property and equipment, net
|
|
$
|
1,086
|
|
|
$
|
1,252
|
|
Property and equipment at June 30, 2014 included $136,000 of
computer equipment, net of accumulated amortization that is subject to a capital lease obligation.
Depreciation expense was $103,100 and $102,800 for the three
months ended June 30, 2014 and 2013, respectively, and $206,000 and $199,100 for the six months ended June 30, 2014 and 2013, respectively.
Note 6. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following
(in thousands):
|
|
June 30,
2014
|
|
|
December 31,
2013
|
|
Trade accounts payable
|
|
$
|
1,893
|
|
|
$
|
2,105
|
|
Contingency accrual
|
|
|
-
|
|
|
|
2,811
|
|
ACH clearing liability
|
|
|
1,286
|
|
|
|
1,554
|
|
Accrued compensation
|
|
|
1,185
|
|
|
|
1,157
|
|
Accrued agent commissions
|
|
|
758
|
|
|
|
728
|
|
Related party payables
|
|
|
87
|
|
|
|
115
|
|
Other
|
|
|
3,689
|
|
|
|
3,684
|
|
Total
|
|
$
|
8,898
|
|
|
$
|
12,154
|
|
Note 7. Long-Term Debt, Notes Payable and
Capital Lease Obligation
Long-term debt and notes payable consist of the following:
|
|
June 30,
2014
|
|
|
December 31,
2013
|
|
|
|
(in thousands)
|
|
Secured convertible notes payable to various note holders, interest rate of 12.0% payable quarterly, notes maturing December 31, 2014, collateralized by a first lien security interest in 50% of the equity interests of JetPay, LLC. Note amount excludes unamortized discount for conversion option and derivative liability of $575,262 and $1.12 million at June 30, 2014 and December 31, 2013, respectively.
|
|
$
|
9,425
|
|
|
$
|
8,883
|
|
|
|
|
|
|
|
|
|
|
Term loan payable to Metro Bank, interest rate of 4.0% payable in monthly principal payments of $107,143 plus interest, maturing December 28, 2019, collateralized by the assets and equity interests of AD Computer Corporation and Payroll Tax Filing Services, Inc.
|
|
|
7,068
|
|
|
|
7,714
|
|
|
|
|
|
|
|
|
|
|
Unsecured promissory note payable to WLES, interest rate of 5.0% payable quarterly, note principal due on December 31, 2017. Note amount excludes unamortized fair value discount of $630,826 and $705,770 at June 30, 2014 and December 31, 2013, respectively.
|
|
|
1,701
|
|
|
|
1,626
|
|
|
|
|
|
|
|
|
|
|
Unsecured promissory notes payable to stockholders, interest rate of 4% payable at maturity, note principal due July 31, 2014. See
Note 12. Related Party Transactions.
|
|
|
492
|
|
|
|
492
|
|
|
|
|
|
|
|
|
|
|
Capital lease obligation related to computer equipment at JetPay, LLC, interest rate of 5.55%, due in monthly lease payments of $4,114, maturing in May 2017, collateralized by equipment.
|
|
|
136
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Notes payable related to vehicles at ADC.
|
|
|
19
|
|
|
|
30
|
|
|
|
|
18,841
|
|
|
|
18,745
|
|
Less current portion
|
|
|
(11,259
|
)
|
|
|
(10,674
|
)
|
|
|
$
|
7,582
|
|
|
$
|
8,071
|
|
The Metro Bank term loan agreement requires the Company to provide
Metro Bank with annual financial statements within 120 days of the Company’s year-end and quarterly financial statement within
60 days after the end of each quarter. The Metro agreement also contains certain annual financial covenants with which the Company
was in compliance as of June 30, 2014.
Maturities of long-term debt and capital lease obligation, excluding
fair value and conversion option debt discounts, are as follows for the twelve months ending June 30: 2015 – $11.8 million;
2016 – $1.3 million; 2017 – $1.3 million; 2018 – $3.6 million; 2019 – $1.3 million and $640,000 thereafter.
Note 8. Redeemable Convertible Preferred
Stock
On October 11, 2013, the Company issued 33,333 shares of Series
A Preferred to Flexpoint for an aggregate of $10 million less certain agreed-upon reimbursable expenses of Flexpoint (the “Initial
Closing”) pursuant to a Securities Purchase Agreement (the “Securities Purchase Agreement”) entered into on August
22, 2013. Additionally, on April 14, 2014, the Company issued 4,667 shares of Series A Preferred to Flexpoint for an aggregate
of $1.4 million. The proceeds of the initial $10 million investment were used to retire the Ten Lords, Ltd. note payable of $5.87
million maturing in December 2013 with the remainder used for general corporate purposes. The proceeds of the $1.4 million investment
were used to satisfy a portion of the EarlyBirdCapital, Inc. Award. See
Note 11
–
Commitments and Contingencies
.
As a result of the Award (as defined in Note 11), the Company was not able to satisfy one of the conditions to closing of the $1.4
million Series A Preferred purchase. Although Flexpoint agreed to waive this condition at the closing, for any subsequent closing
of the Series A Preferred, the Company will need to seek a waiver of the failure of this condition from Flexpoint.
The Series A Preferred is convertible into shares of Common
Stock. Any holder of Series A Preferred may at any time convert such holder’s shares of Series A Preferred into that
number of shares of Common Stock equal to the number of shares of Series A Preferred being converted multiplied by $300 and divided
by the then-applicable conversion price, initially $3.00. The conversion price of the Series A Preferred is subject to downward
adjustment upon the occurrence of certain events.
Under the Securities Purchase Agreement, the Company agreed
to sell to Flexpoint, and Flexpoint agreed to purchase, upon satisfaction of certain conditions, up to 134,000 shares of Series
A Preferred for an aggregate purchase price of up to $40 million. The Company’s obligation to issue and sell, and Flexpoint’s
obligation to purchase, the Series A Preferred is divided into three separate tranches: Tranche A, Tranche B and Tranche C.
Tranche A consists of $10 million worth of shares of Series A Preferred that was issued on October 11, 2013. Tranche B consists
of up to $10 million worth of shares of Series A Preferred, which Flexpoint will be obligated to purchase, subject to satisfaction
or waiver of certain conditions, from the Company if the Company is able to consummate a redemption any time after December 1,
2014 and prior to December 29, 2014 of the Notes. Tranche C consists of up to $20 million worth of shares of Series A Preferred
($18.6 million remaining available at June 30, 2014), plus any amounts not purchased under Tranche B, which Flexpoint has the option
to purchase at any time until the third anniversary of the Initial Closing. The shares of Series A Preferred issuable with respect
to Tranche A, Tranche B and Tranche C all have a purchase price of $300 per share.
The Series A Preferred has an initial liquidation preference
of $600 per share (subject to adjustment for any stock split, stock dividend or other similar proportionate reduction or increase
of the authorized number of shares of Common Stock) and will rank senior to the Company’s Common Stock with respect to distributions
of assets upon the Company’s liquidation, dissolution or winding up. Holders of Series A Preferred will have the right to
request redemption of any shares of Series A Preferred issued at least five years prior to the date of such request by delivering
written notice to the Company at the then applicable liquidation value per share, unless holders of a majority of the outstanding
Series A Preferred elect to waive such redemption request on behalf of all holders of Series A Preferred.
On May 5, 2014, the Company issued 2,565 shares of Series A-1
Preferred Wellington for an aggregate of $769,500, less certain agreed-upon reimbursable expenses of Wellington, pursuant to a
Securities Purchase Agreement dated May 1, 2014. Under the Securities Purchase Agreement, the Company agreed to sell to Wellington,
upon the satisfaction of certain conditions, up to 9,000 shares of Series A-1 Preferred at a purchase price of $300 per share for
an aggregate purchase price of up to $2,700,000. The proceeds of the initial $769,500 investment will be used for general corporate
purposes. The Series A-1 Preferred will be convertible into shares of the Company’s common stock, par value $0.001 (the “Common
Stock”) or, in certain circumstances, Series A-2 Convertible Preferred Stock, par value $0.001 per share (“Series A-2
Preferred”). The Preferred Stock can be converted into that number of shares of Common Stock equal to the number of shares
of Series A-1 Preferred being converted multiplied by $300 and divided by the then-applicable conversion price, which initially
will be $3.00. The conversion price of the series A-1 Preferred is subject to downward adjustment upon the occurrence of certain
events as defined in the Securities Purchase Agreement. Additionally, Wellington will have the option, but not the obligation,
to purchase up to the number of shares of Series A-1 Preferred equal to 6.75% of the cumulative number of shares of Series A Preferred
purchased by Flexpoint.
The Series A-1 Preferred will have an initial liquidation preference
of $600 per share and will rank senior to the Company’s Common Stock and
pari passu
with the Series A Preferred owned
by Flexpoint with respect to distributions of assets upon the Company’s liquidation, dissolution or winding up. Notwithstanding
the above, no holder of the Series A-1 Preferred can convert if, as a result of such conversion, such holder would beneficially
own 9.9% or more of the Company’s Common Stock. If at any time, no shares of Series A Preferred remain outstanding and shares
of Series A-1 Preferred remain outstanding because of the limitation in the preceding sentence, all shares of Series A-1 Preferred
shall automatically convert into shares of Series A-2 Preferred at a 1:1 ratio. Upon the occurrence of an Event of Noncompliance,
as defined in the Securities Purchase Agreement, the holders of a majority of the Series A Preferred may demand immediate redemption
of all or a portion of the Preferred Stock at the then-applicable liquidation value.
The Company considered the guidance of ASC Topic 480,
Distinguishing
Liabilities from Equity
, and ASC Topic 815,
Derivatives
, in determining the accounting treatment for the
convertible preferred stock instrument. The Company considered the economic characteristics and the risks of the host
contract based on the stated and implied substantive terms and features of the instrument; including, but not limited to, its
redemption features, voting rights, and conversions rights; and determined that the terms of the preferred stock were more
akin to an equity instrument than a debt instrument. The Series A Preferred shares are subject to redemption, at the option
of the holder, on or after the fifth anniversary of their original purchase. Accordingly, the convertible preferred shares
have been classified as temporary equity in the Company’s consolidated balance sheets. Upon issuance of the 33,333
shares of the Series A Preferred, the Company recorded as a reduction to the Series A Preferred and as Additional Paid-In
Capital a beneficial conversion feature of $1.5 million. The beneficial conversion feature represents the difference between
the effective conversion price and the fair value of the Series A Preferred as of the commitment date. There was no
beneficial conversion feature upon the April 14, 2014 issuance of 4,667 shares of Series A Preferred to Flexpoint or the May
5, 2014 issuance of 2,565 shares of Series A-1 Preferred to Wellington as a result of the price of the Company’s stock
at the date of the closing being below the conversion price of the preferred shares. The Company accounts for the beneficial
conversion feature, the liquidation preference, and the issuance costs related to the Series A Preferred and the Series A-1
Preferred using the effective interest method by accreting such amounts to its Series A Preferred and the Series A-1
Preferred from the date of issuance to the earliest date of redemption as a reduction to its total permanent equity
within the Company’s consolidated statement of changes in stockholders’ equity as a charge to Additional
Paid-In Capital. Any accretion recorded during the periods presented are also shown as a reduction to the income available
to common stockholders in the Company’s consolidated statements of operations when presenting basic and dilutive
per share information. Accretion for the three and six months ended June 30, 2014 was $538,000 and $1.05
million, respectively.
Upon the occurrence of an Event of Noncompliance, the holders
of a majority of the Series A Preferred may demand immediate redemption of all or a portion of the Series A Preferred at the then-applicable
liquidation value. Such holders may also exercise a right to have the holders of the Series A Preferred elect a majority
of the Board by increasing the size of the Board and filling such vacancies. Such right to control a minimum majority of
the Board would exist for so long as the Event of Noncompliance was continuing. An “Event of Noncompliance” shall have
occurred if: i) the Company fails to make any required redemption payment with respect to the Series A Preferred; ii) the Company
breaches the Securities Purchase Agreement after the Initial Closing, and such breach has not been cured with thirty days after
receipt of notice thereof; iii) the Company or any subsidiary makes an assignment for the benefit of creditors, admits its insolvency
or is the subject of an order, judgment or decree adjudicating such entity as insolvent, among other similar actions; iv) a final
judgment in excess of $5,000,000 is rendered against the Company or any subsidiary that is not discharged within 60 days thereafter;
or v) an event of default has occurred under either the Secured Convertible Note Agreement or the Loan and Security Agreement,
dated as of December 28, 2012 by and among ADC, PTFS and Metro Bank, and such event of default has not been cured within thirty
days after receipt of notice thereof.
Note 9. Stockholders’ Equity
Common Stock
On April 26, 2013, the Company issued 10,000 shares of Common
Stock, with a fair value of approximately $37,400, as compensation to a consultant for services rendered. Additionally, on January
30, 2014, the Company issued 1,396 shares of Common Stock with a fair market value of approximately $6,000, as additional compensation
to a consultant for services rendered.
Preferred Stock
The Company is authorized to issue 1,000,000 shares of preferred
stock with a par value of $0.001 per share with such designation, rights and preferences as may be determined from time to time
by the Company’s board of directors.
As of June 30, 2014 and December 31, 2013, there were no shares
of preferred stock issued or outstanding other than the Series A Preferred issued to Flexpoint and Series A-1 Preferred issued
to Wellington described above.
Stock-Based Compensation
ASC Topic 718,
Compensation-Stock Compensation
, requires
compensation expense for the grant-date fair value of share-based payments to be recognized over the requisite service period.
At a meeting of the Company’s stockholders held on July
31, 2013 (the “Meeting”), the Company’s stockholders approved the adoption of the Company’s 2013 Stock
Incentive Plan (the “Plan”). The Company granted options to purchase 325,000 shares of Common Stock under the Plan
during the three months ended September 30, 2013, all at an exercise price of $3.10 per share, options to purchase 675,000 shares
of Common Stock during the three months ended December 31, 2013, all at an exercise price of $3.00 per share, and options to purchase
165,000 shares of Common Stock during the six months ended June 30, 2014 all at an exercise price of $3.00 per share. The grant
date fair value of the options granted during the first half of 2014 was determined to be approximately $145,000 using the Black-Scholes
pricing model. Significant assumptions used in the valuation include expected term of 5.75 to 6.25 years, expected volatility of
38.23% to 45.17%, risk free interest rate of 1.75% to 2.10%, and expected dividend yield of 0%. Aggregated stock-based compensation
expense for the three and six months ended June 30, 2014 was $88,100 and $168,400, respectively. Unrecognized compensation expense
as of June 30, 2014, relating to non-vested common stock options is approximately $715,000 and is expected to be recognized through
2018. At June 30, 2014, no options had been exercised and 43,750 options had been forfeited.
Expected term: The Company’s expected term is based on
the period the options are expected to remain outstanding. The Company estimated this amount utilizing the “Simplified Method”
in that the Company does not have sufficient historical experience to provide a reasonable basis to estimate an expected term.
Risk-free interest rate: The Company uses the risk-free interest
rate of a U.S. Treasury Note with a similar term on the date of the grant.
Volatility: The Company calculates the volatility of the stock
price based on historical value and corresponding volatility of the Company’s peer group stock price for a period consistent
with the stock option expected term.
Dividend yield: The Company uses a 0% expected dividend yield
as the Company has not paid dividends to date and does not anticipate declaring dividends in the near future.
A summary of stock option activity for the six months ended
June 30, 2014 is presented below:
|
|
Number of
Options
|
|
|
Weighted Average
Exercise Price
|
|
Outstanding at December 31, 2013
|
|
|
1,000,000
|
|
|
$
|
3.03
|
|
Granted
|
|
|
165,000
|
|
|
|
3.00
|
|
Forfeited
|
|
|
(43,750
|
)
|
|
|
(3.04
|
)
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Outstanding at June 30, 2014
|
|
|
1,121,250
|
|
|
$
|
3.03
|
|
Exercisable at June 30, 2014
|
|
|
231,249
|
|
|
$
|
3.08
|
|
The weighted average remaining life of options outstanding at
June 30, 2014 was 8.33 years. The aggregate intrinsic value of the exercisable options at June 30, 2014 was $0.
Note 10. Income Taxes
The Company recorded income tax expense of $52,000 and $31,000
for the three months ended June 30, 2014 and 2013, respectively, and $104,000 and $58,000 for the six months ended June 30, 2014
and 2013, respectively. Income tax expense reflects the recording of state income taxes. The effective tax rates are approximately
(2.2)% and (1.9)% for the three months ended June 30, 2014 and 2013, respectively, and (2.8)% and (8.2)% for the six months ended
June 30, 2014 and 2013, respectively. The effective rate differs from the federal statutory rate for each year, primarily due to
state and local income taxes and changes to the valuation allowance.
JetPay, LLC is subject to and pays the Texas Margin Tax which
is considered to be an income tax in accordance with the provisions of the Income Taxes Topic in FASB, ASC and the associated interpretations.
There are no significant temporary differences associated with the Texas Margin Tax.
As of December 31, 2013, the Company had cumulative U.S. federal
and state net operating loss carryovers (“NOLs”) of approximately $6.2 million. These NOLs, if not utilized, expire
at various times through 2033. In accordance with Section 382 of the Internal Revenue Code, deductibility of the Company’s
NOLs may be subject to an annual limitation in the event of a change in control. Management will be performing a preliminary evaluation
as to whether a change in control has taken place.
In assessing the realization of deferred tax assets, Management
considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those
temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future
taxable income and tax planning strategies in making this assessment. After consideration of all of the information available,
Management believes that significant uncertainty exists with respect to future realization of the deferred tax assets, and has,
therefore, increased its valuation allowance against deferred tax assets by $1.5 million for the six months ended June 30, 2014
and $522,000 for the six months ended June 30, 2013, with a total valuation allowance of $5.8 million at June 30, 2014, representing
the amount of its deferred income tax assets in excess of the Company’s deferred income tax liabilities. The deferred tax
liability related to goodwill that is amortizable for tax purpose (“Intangibles”) will not reverse until such time,
if any, that the goodwill, which is considered to be an asset with an indefinite life for financial reporting purposes, becomes
impaired or sold. Due to the uncertain timing of this reversal, the temporary difference cannot be considered as future taxable
income for purposes of determining a valuation allowance. Therefore, the deferred tax liability related to tax deductible goodwill
Intangibles cannot be considered when determining the ultimate realization of deferred tax assets.
Note 11. Commitments and Contingencies
On January 16, 2013, the Company received notice that EarlyBirdCapital,
Inc. (“EBC”) had commenced arbitration proceedings (the “Claim”) against the Company with the International
Centre for Dispute Resolution (the “ICDR”). The Claim alleged that the Company breached a Letter Agreement, dated as
of May 9, 2011, with EBC by failing to pay EBC a cash fee of $2,070,000 and reimburse EBC for certain expenses upon the closing
of the Company’s initial business combination, which was consummated on December 28, 2012. As a result of such breach, EBC
sought the cash fee plus interest and attorney’s fees and expenses. In November 2013, the ICDR held arbitration proceedings
with respect to the Claim. On March 3, 2014, the ICDR rendered its decision and ordered the Company to pay the cash fee of $2,070,000
plus interest, attorney’s fees and expenses of approximately $740,000 within 30 days of the decision (the “Award”).
As previously reported, the Company accrued $2,136,000 relating to this matter as of December 31, 2012 and an additional $675,000
was recorded as SG&A expenses in the fourth quarter of 2013 for the legal fees and interest costs awarded to EBC as part of
the Award. In order to satisfy a portion of the Award, the Company entered into a Securities Purchase Agreement on March 28, 2014
(the “Common Stock SPA”) with each of Bipin C. Shah, its Chairman and Chief Executive Officer, and C. Nicholas Antich,
the President of JetPay Payroll Services. Pursuant to the Common Stock SPA, on April 4, 2014, the Company received aggregate proceeds
of $1.0 million and issued an aggregate of 333,333 shares of Common Stock to Messrs. Shah and Antich. Additionally, on April 14,
2014, the Company issued 4,667 shares of Series A Preferred to Flexpoint for an aggregate of $1.4 million under the Securities
Purchase Agreement. See
Note 8. Redeemable Convertible Preferred Stock
. The Company used the proceeds from the sale of common
stock, the proceeds from the Closing of the Series A Preferred to Flexpoint, and existing cash of $411,000 to fully satisfy its
obligations to EBC.
On or about March 13, 2012, a merchant of JetPay, LLC, Direct
Air, a charter travel company, abruptly ceased operations. Under U.S. Department of Transportation requirements, all charter travel
company customer charges for travel are to be deposited into an Escrow Account in a bank under a U.S. Department of Transportation
escrow program, and not released to the charter travel company until the travel has been completed. In the case of Direct Air,
such funds had historically been deposited into such U.S. Department of Transportation Escrow Account held at Valley National Bank
in New Jersey, and continued to be deposited through the date Direct Air ceased operations. At the time Direct Air ceased operations,
according to Direct Air’s Bankruptcy Trustee, there should have been in excess of $31 million in the Escrow Account, and
instead there was approximately $1 million at the time of Direct Air’s bankruptcy filing. As a result, Merrick Bank (“Merrick”),
JetPay, LLC’s sponsor with respect to this particular merchant, incurred chargebacks in excess $25 million. The chargeback
loss is insured through a Chartis Insurance Policy for chargeback loss that names Merrick as the primary insured. The policy has
a limit of $25 million. The deductible for the policy is $250,000. Merrick has sued Chartis Insurance (“Chartis”) for
payment under the claim. Under an agreement between Merrick and JetPay, LLC, JetPay, LLC is obligated to indemnify Merrick for
losses realized from such chargebacks that Merrick is unable to recover from other parties. In 2012, JetPay, LLC recorded a loss
for all chargebacks in excess of the $25 million, a $250,000 deductible on a related insurance policy, and $487,100 of legal fees
charged against JetPay, LLC’s cash reserve account by Merrick, all totaling $1,947,000. Additionally, legal fees totaling
$597,000 were charged against JetPay, LLC’s cash reserve account by Merrick during the six months ending June 30, 2013. In
December, 2013, Merrick, in addition to its suit against Chartis, also filed suit against Valley National Bank as Escrow Agent.
JetPay, LLC has received correspondence from Merrick of its intention to seek recovery for all unrecovered chargebacks and related
costs, but JetPay, LLC is currently not a party to any litigation from Merrick regarding this matter. Merrick and JetPay, LLC have
entered into a Forbearance Agreement pertaining to the Direct Air chargeback issue. The Direct Air situation has also caused other
unexpected expenses, such as higher professional fees and fees for chargeback processing. Additionally, pursuant to the terms of
its agreement with Merrick, Merrick has forced JetPay, LLC to maintain increased cash reserves in order to provide additional security
for any obligations arising from the Direct Air situation. Merrick continues to hold approximately $4.8 million of total reserves
related to the Direct Air matter as of June 30, 2014. The cash reserve balance was reduced by approximately $246,000 during the
six months ended June 30, 2014 for legal fees claimed and deducted from the reserve by Merrick in connection with settling the
MSC Cruise Lines matter as more fully described below. These reserves are recorded in Other Assets. On August 7, 2013, JetPay Merchant
Services, LLC (“JPMS”), a wholly owned subsidiary of JetPay, LLC and indirect wholly owned subsidiary of the Company,
together with WLES, L.P., (collectively, the “Plaintiffs”), filed suit in the U.S. District Court for the Northern
District of Texas, Dallas Division, against Merrick, Royal Group Services, LTD, LLC and Gregory Richmond (collectively, the “Defendants”).
The suit alleges that Merrick and Gregory Richmond (an agent of Royal Group Services) represented to JPMS that insurance coverage
was arranged through Chartis Specialty Insurance Company to provide coverage for JPMS against potential chargeback losses related
to certain of JPMS’s merchant customers, including Southern Sky Air Tours, d/b/a Direct Air. The complaint alleges several
other causes of action against the Defendants, including violation of state insurance codes, negligence, fraud, breach of duty
and breach of contract. Also, in August 2013, JPMS, JetPay, LLC, and JetPay ISO filed the second amendment to a previously filed
complaint against Merrick in the United States District Court for the District of Utah, adding to its initial complaint several
causes of action related to actions Merrick allegedly took during JetPay LLC’s transition to a new sponsoring bank in June
2013. Additionally, subsequent to this transition, Merrick invoiced the Company for legal fees incurred by Merrick totaling approximately
$1.98 million. The Company does not believe it has a responsibility to reimburse Merrick for these legal fees and intends to vigorously
dispute these charges. Accordingly, the Company has not recorded an accrual for these legal fees as of June 30, 2014.
As partial protection against any potential losses related to
Direct Air, the Company required that, upon closing of the Completed Transactions, 3,333,333 shares of Common Stock that was to
be paid to WLES as part of the JetPay, LLC purchase price be placed into an escrow account with JPMorgan Chase (“Chase”)
as the trustee. The Escrow Agreement for the account names Merrick, the Company, and WLES as parties. If JetPay, LLC suffers any
liability to Merrick as a result of the Direct Air matter; these shares are to be used in partial or full payment for any such
liability, with any remaining shares delivered to WLES. If JetPay, LLC is found to have any liability to Merrick because of this
issue, and these shares do not have sufficient value to fully cover such liability, the Company may be responsible for this JetPay,
LLC liability. On February 3, 2014, the Company received notice that Merrick had requested Chase to release the 3,333,333 shares
in the Escrow Account. Both JetPay and WLES informed Chase that they did not agree to the release, and the shares remain in escrow.
On August 23, 2013, the Company received notice that JPMS was
a party in a lawsuit brought by MSC Cruise Lines, a former customer. Merrick Bank Corporation (“Merrick”) is a co-defendant
in the lawsuit. MSC Cruise Lines is claiming approximately $2 million in damages and alleges that JPMS breached its agreement with
MSC by charging fees not specified in the agreement. The Company reached a settlement on the matter on July 31, 2014. Accordingly,
the Company has recorded a charge of $491,000 for the six months ended June 30, 2014, representing the settlement to MSC Cruise
Lines and certain legal fees claimed by Merrick in connection with settling the suit. An accrual of $312,500 for any potential
loss related to this matter remains as of June 30, 2014, to be deducted from the Merrick reserve account recorded in other assets
as described above.
In December 2013 the Company settled a lawsuit with M&A
Ventures in which it agreed to pay $400,000, with $100,000 to be paid in 2013 and the reminder in installments throughout 2014.
The Company recorded the $400,000 settlement within SG&A expense for the three months ended December 31, 2013 with a remaining
liability of $225,000 at June 30, 2014.
In December 2012, BCC Merchant Solutions, a former customer
of JetPay, LLC filed a suit against JetPay, LLC, Merrick Bank, and Trent Voigt in the Northern District of Texas, Dallas Division,
for $1.9 million, alleging that the parties by their actions, had cost BCC significant expense and lost customer revenue, The Company
believes that the basis of the suit regarding JetPay, LLC is groundless and intends to defend it vigorously. Accordingly, the Company
has not recorded an accrual for any potential loss related to this matter as of June 30, 2014.
The Company is a party to various other legal proceedings related
to its ordinary business activities. In the opinion of the Company’s management, none of these proceedings are material in
relation to our results of operations, liquidity, cash flows, or financial condition.
Note 12. Related Party Transactions
From December 2010 through December 2012, the Company issued
a series of principal amount unsecured promissory notes to UBPS Services, LLC (“UBPS Services”), an entity controlled
by Mr. Shah, CEO and Chairman of the Company, totaling $425,880. These notes were non-interest bearing and, except for $15,000,
were paid upon consummation of the Completed Transactions on December 28, 2012. Additionally, in February 2013 and June 2013, the
Company issued unsecured promissory notes to UBPS Services for $72,000 and $60,000, respectively. Total outstanding notes to UBPS
Services of $147,000 were repaid on October 15, 2013. The June 7, 2013 promissory note earned interest at an annual rate of 4%
with interest expense of $855 recorded in 2013. The February 2013 promissory note were non-interest bearing. All such transactions
were approved upon resolution and review by the Company’s Audit Committee of the terms of the notes to ensure that such terms
were no less favorable to the Company than those that would be available with respect to such transactions from unaffiliated third
parties.
On June 7, 2013, the Company also issued an unsecured promissory
note to Trent Voigt, Chief Executive Officer of JetPay, LLC, in the amount of $491,693. The note matures on September 30, 2014,
as extended, and bears interest at an annual rate of 4% with interest expense of $5,476 and $1,293 of interest expense was recorded
for the three months ended June 30, 2014 and 2013, respectively, and $10,454 and $1,293 of interest expense was recorded for the
six months ended June 30, 2014 and 2013, respectively. The transaction was approved upon resolution and review by the Company’s
Audit Committee of the terms of the note to ensure that such terms were no less favorable to the Company than those that would
be available with respect to such transactions from unaffiliated third parties.
JetPay Payroll Services’ headquarters are located in Center
Valley, Pennsylvania and consist of approximately 22,500 square feet leased from C. Nicholas Antich and Carol A. Antich. Mr. Antich
is the President of ADC. The rent is currently approximately $41,750 per month with annual 4% increases, on a net basis. The office
lease has an initial 10-year term expiring May 31, 2016. Rent expense under this lease was $129,000 and $122,000 for the three
months ended June 30, 2014 and 2013, respectively, and $258,000 and $242,450 for the six months ended June 30, 2014 and 2013, respectively.
JetPay Payroll Services shares office space and related facilities
with Serfass & Cremia, LLC, and the accounting firm of which Joel E. Serfass, a previous shareholder of PTFS, is a member.
Such office space consists of 4,300 square feet, located on one floor of a multi-tenant building in Bethlehem, Pennsylvania. Pursuant
to a cost sharing agreement among PTFS, Joel E. Serfass and Serfass & Cremia, LLC, PTFS pays an 85% share of the total expenses
of operating such facilities (which total expenses include office rental, equipment rental, telephone, utilities, maintenance,
repairs and other operating costs and a 15% administrative fee payable to Joel E. Serfass), which amounted to $8,216 for each of
the three months ended June 30, 2014 and 2013, respectively, and $16,432 for each of the six months ended June 30, 2014 and 2013,
respectively. The cost sharing agreement is terminable by any party with a 90 day notice.
JetPay Payment Processing retains a backup center in Sunnyvale,
Texas consisting of 1,600 square feet, rented for approximately $3,000 per month from JT Holdings, an entity controlled by Trent
Voigt, Chief Executive Officer of JetPay, LLC. The terms of the lease are commercial. Rent expense was $9,000 for each of the three
months ended June 30, 2014 and 2013, and $18,000 for each of the six months ended June 30, 2014 and 2013.
The above transactions with respect to JetPay Payroll Services
and JetPay Payment Processing were approved prior to the acquisition of ADC, PTFS and JetPay, LLC. Going forward, all related party
transactions with respect to such entities will be reviewed and approved by the Company’s Audit Committee to ensure that
the terms of such transactions are no less favorable to the Company than those that would be available with respect to such transactions
from unaffiliated third parties.
In connection with the closing of the JetPay, LLC acquisition,
the Company entered into a Note and Indemnity Side Agreement with JP Merger Sub, LLC, WLES and Trent Voigt (the “Note and
Indemnity Side Agreement”) dated as of December 28, 2012. Pursuant to the Note and Indemnity Side Agreement, the Company
agreed to issue a promissory note in the amount of $2,331,369 in favor of WLES. Interest accrues on amounts due under the note
at a rate of 5% per annum, and is payable quarterly. Interest expense was $29,466 for both the three months ended June 30, 2014
and 2013, and $58,608 for both the six months ended June 30, 2014 and 2013. The note is due in full on December 31, 2017. The note
can be prepaid in full or in part at any time without penalty. As partial consideration for offering the note, the Company and
JP Merger Sub, LLC agreed to waive certain specified indemnity claims against WLES and Mr. Voigt to the extent the losses under
such claims do not exceed $2,331,369.
On August 22, 2013, JetPay, LLC entered into a Master Service
Agreement with JetPay Solutions, LTD, a United Kingdom based entity 75% owned by WLES, an entity owned by Trent Voigt. The Company
initiated transaction business under this agreement beginning in April 2014 with $69,000 of revenue earned from JetPay Solutions,
LTD for the three and six months ended June 30, 2014.
On March 28, 2014, the Company entered into a Securities Purchase
Agreement (the “Common Stock SPA”) with each of Bipin C. Shah, its Chairman and Chief Executive Officer, and C. Nicholas
Antich, the President of JetPay Payroll Services. Pursuant to the Common Stock SPA, on April 4, 2014, the Company received aggregate
proceeds of $1.0 million and issued an aggregate of 333,333 shares of Common Stock to Messrs. Shah and Antich. The proceeds were
used to satisfy a portion of the EBC award.
Note 13. Segments
The Company currently operates in two business segments, the
Payment Processing Segment, which is an end-to-end processor of credit and debit card and ACH payment transactions to businesses
with a focus on those processing internet transactions and recurring billings, and the Payroll Processing Segment, which is a full-service
payroll and related payroll tax payment processor.
Segment operating results are presented below (in thousands).
The results reflect revenues and expenses directly related to each segment. The activity within the JetPay Card Services division
was not material through June 30, 2014, and accordingly was included in Corporate in the tables below. The Company does not evaluate
performance or allocate resources based on segment asset data, and therefore, such information is not presented.
|
|
For the three months ended June 30, 2014
|
|
|
|
Payment
Service
|
|
|
Payroll
Service
|
|
|
General/
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Processing revenue
|
|
$
|
4,687
|
|
|
$
|
3,038
|
|
|
$
|
1
|
|
|
$
|
7,726
|
|
Cost of processing revenue
|
|
|
2,941
|
|
|
|
1,781
|
|
|
|
11
|
|
|
|
4,733
|
|
Selling, general and administrative expense
|
|
|
1,832
|
|
|
|
1,029
|
|
|
|
547
|
|
|
|
3,408
|
|
Segment (loss) profit
|
|
$
|
(86
|
)
|
|
$
|
228
|
|
|
$
|
(557
|
)
|
|
$
|
(415
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment additions
|
|
$
|
16
|
|
|
$
|
29
|
|
|
$
|
13
|
|
|
$
|
58
|
|
Intangible assets and goodwill additions
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
For the three months ended June 30, 2013
|
|
|
|
Payment
Service
|
|
|
Payroll
Service
|
|
|
General/
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Processing revenue
|
|
$
|
4,374
|
|
|
$
|
2,918
|
|
|
$
|
-
|
|
|
$
|
7,292
|
|
Cost of processing revenue
|
|
|
2,828
|
|
|
|
1,753
|
|
|
|
-
|
|
|
|
4,581
|
|
Selling, general and administrative expense
|
|
|
1,225
|
|
|
|
863
|
|
|
|
454
|
|
|
|
2,542
|
|
Segment profit (loss)
|
|
$
|
321
|
|
|
$
|
302
|
|
|
$
|
(454
|
)
|
|
$
|
169
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment additions
|
|
$
|
38
|
|
|
$
|
20
|
|
|
$
|
-
|
|
|
$
|
58
|
|
Intangible assets and goodwill additions
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
For the six months ended June 30, 2014
|
|
|
|
Payment
Service
|
|
|
Payroll
Service
|
|
|
General/
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Processing revenue
|
|
$
|
9,290
|
|
|
$
|
6,604
|
|
|
$
|
1
|
|
|
$
|
15,895
|
|
Cost of processing revenue
|
|
|
5,886
|
|
|
|
3,521
|
|
|
|
14
|
|
|
|
9,421
|
|
Selling, general and administrative expense
|
|
|
2,828
|
|
|
|
2,030
|
|
|
|
1,325
|
|
|
|
6,183
|
|
Segment profit (loss)
|
|
$
|
576
|
|
|
$
|
1,053
|
|
|
$
|
(1,338
|
)
|
|
$
|
291
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total property and equipment
|
|
$
|
458
|
|
|
$
|
614
|
|
|
$
|
14
|
|
|
$
|
1,086
|
|
Property and equipment additions
|
|
$
|
56
|
|
|
$
|
73
|
|
|
$
|
13
|
|
|
$
|
142
|
|
Intangible assets and goodwill
|
|
$
|
33,442
|
|
|
$
|
19,415
|
|
|
$
|
-
|
|
|
$
|
52,857
|
|
Intangible assets and goodwill additions
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Total segment assets
|
|
$
|
54,828
|
|
|
$
|
70,662
|
|
|
$
|
2,155
|
|
|
$
|
127,645
|
|
|
|
For the six months ended June 30, 2013
|
|
|
|
Payment
Service
|
|
|
Payroll
Service
|
|
|
General/
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Processing revenue
|
|
$
|
8,625
|
|
|
$
|
6,356
|
|
|
$
|
-
|
|
|
$
|
14,981
|
|
Cost of processing revenue
|
|
|
5,306
|
|
|
|
3,459
|
|
|
|
-
|
|
|
|
8,765
|
|
Selling, general and administrative expense
|
|
|
2,212
|
|
|
|
1,753
|
|
|
|
1,030
|
|
|
|
4,995
|
|
Segment profit (loss)
|
|
$
|
1,107
|
|
|
$
|
1,144
|
|
|
$
|
(1,030
|
)
|
|
$
|
1,221
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total property and equipment
|
|
$
|
615
|
|
|
$
|
738
|
|
|
$
|
3
|
|
|
$
|
1,356
|
|
Property and equipment additions
|
|
$
|
67
|
|
|
$
|
104
|
|
|
$
|
3
|
|
|
$
|
174
|
|
Intangible assets and goodwill
|
|
$
|
34,340
|
|
|
$
|
20,536
|
|
|
$
|
-
|
|
|
$
|
54,876
|
|
Intangible assets and goodwill additions
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Total segment assets
|
|
$
|
51,833
|
|
|
$
|
68,920
|
|
|
$
|
3,448
|
|
|
$
|
124,201
|
|