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 March 31, 2017. The results of operations
for the three months ended March 31, 2017 and 2016 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, 2016 included in the Company’s Annual Report on Form 10-K filed with
the Securities and Exchange Commission (the “SEC”) on March 24, 2017.
Note 2. Organization and Business Operations
The Company was incorporated in Delaware on November 12, 2010 as
Universal Business Payment Solutions Acquisition Corporation, 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 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 Company currently operates in two business segments: the JetPay
Payment Processing Segment and the JetPay HR & Payroll Segment. The JetPay Payment Processing Segment is an end-to-end processor
of credit and debit card and ACH payment transactions that focuses on processing internet transactions and recurring billings
for traditional retailers and service providers. The JetPay HR & Payroll Segment provides human capital management (“HCM”)
services, including full-service payroll and related payroll tax payment processing, time and attendance, HCM services, low-cost
money management and payment services to unbanked and underbanked employees through prepaid debit cards, and services under the
Patient Protection and Affordable Care Act (the “Affordable Care Act”).
The Company entered the payment processing and the payroll processing
businesses upon consummation of the acquisitions of JetPay Payment Services, TX, LLC (f/k/a JetPay, LLC) (“JetPay Payments,
TX”) and JetPay HR & Payroll Services, Inc. (f/k/a A. D. Computer Corporation) (“JetPay HR & Payroll Services”)
on December 28, 2012. Additionally, on November 7, 2014, the Company acquired JetPay Payment Services, PA, LLC (f/k/a ACI Merchant
Systems, LLC) (“JetPay Payments, PA”), an independent sales organization specializing in relationships with banks,
credit unions and other financial institutions.
On June 2, 2016, the Company acquired JetPay Payment Services,
FL, LLC (f/k/a CollectorSolutions, Inc.) (“JetPay Payments, FL”), a payment processor specializing in the processing
of payments in the government and utilities channels.
The Company believes that the investments made in its technology,
infrastructure, and sales staff will help generate cash flows in the future sufficient to cover its working capital needs. The
Company may from time to time determine that additional investments are prudent to maintain and increase stockholder value. In
addition to funding ongoing working capital needs, the Company’s cash requirements for the next fifteen months ending June
30, 2018 include, but are not limited to, principal and interest payments on long-term debt and capital lease obligations of approximately
$5.0 million and estimated capital expenditures of $3.8 million.
The Company expects to fund its cash needs for the next fifteen
months, including debt service requirements, capital expenditures and possible future acquisitions, with cash flow from its operating
activities, sales of equity securities, including the recent sale of preferred stock and borrowings (see below), and through new
borrowings.
As disclosed in
Note 8. Redeemable Convertible Preferred
Stock
, between October 11, 2013 and October 18, 2016, the Company sold 99,666 shares of Series A Convertible Preferred Stock,
par value $0.001 per share (“Series A Preferred”), to Flexpoint for an aggregate of $29.9 million, less certain costs.
Additionally, on October 18, 2016, the Company sold 33,667 shares of Series A Preferred to Sundara Investment Partners, LLC (“Sundara”)
for $10.1 million, less certain costs. In connection with the sale of shares of Series A Preferred to Sundara, the Company also
entered into a Loan and Security Agreement with an affiliate of Sundara, LHLJ, Inc., for a term loan in the principal amount of
$9.5 million, with $5.175 million of the proceeds used to simultaneously satisfy the remaining balances of a term loan and a revolving
credit note payable to First National Bank of Pennsylvania (“FNB”) (the “Prior HR & Payroll Services Credit
Facility”). See
Note 7. Long-Term
Debt, Note Payable and Capital Lease Obligations
. Both Sundara and LHLJ
are owned and controlled by Laurence L. Stone, who was appointed as a director of the Company by the holders of Series A Preferred
shares in October 2018 in connection with the transactions. These transactions provided approximately $14.0 million of net working
capital, which the Company used and expects to use for general working capital needs, the payment of other debt instruments, and
for future capital needs, including a portion of the cost of potential future acquisitions. Finally, between May 5, 2014 and April
13, 2017, the Company sold 9,000 shares of Series A-1 Convertible Preferred Stock, par value $0.001 per share (“Series A-1
Preferred”), to an affiliate of Wellington Capital Management, LLP (“Wellington”) for an aggregate of $2.7 million.
In the past, the Company has been successful in obtaining loans
and selling its equity securities. To fund the Company’s current debt service needs, expand its technology platforms for
new business initiatives, and pursue possible future acquisitions, the Company may need to raise additional capital through loans
or additional sales of equity securities. The Company continues to investigate the capital markets for sources of funding, which
could take the form of additional debt, the restructuring of our current debt, or additional equity financing. The Company cannot
provide any assurance that it will be successful in securing new financing or restructuring its current debt 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
delay certain technology capital improvements, limit its planned level of capital expenditures and future growth plans or dispose
of operating assets to generate cash to sustain operations and fund ongoing capital investments.
Note 3. Business Acquisition
On June 2, 2016, JetPay completed its acquisition of CollectorSolutions,
Inc. pursuant to the terms of the Agreement and Plan of Merger, dated February 22, 2016 (the “Merger Agreement”),
by and among JetPay, CSI Acquisition Sub One, LLC, CSI Acquisition Sub Two, LLC, CollectorSolutions, Inc. and Gene M. Valentino,
in his capacity as representative of the shareholders of CSI. On October 21, 2016, CollectorSolutions changed its name to JetPay
Payment Services, FL, LLC. The acquisition of JetPay Payments, FL provided the Company with additional expertise in selling debit
and credit card processing services in the government and utilities channels through JetPay Payments, FL’s highly configurable
payment gateway, added incremental debit, credit, and e-check processing volumes and provided a base operation to sell the Company’s
payroll, HCM, processing and prepaid card services to JetPay Payments, FL’s customer base. The consolidated financial statements
include the accounts of JetPay Payments, FL since the acquisition date, June 2, 2016.
As consideration for the acquisition, the Company
initially issued 3.25 million shares of its common stock to the stockholders of JetPay Payments, FL and assumed approximately
$1.0 million of JetPay Payments, FL’s indebtedness. The 3.25 million shares of common stock, valued at $8.3 million at
the date of acquisition, included: (i) 587,500 shares placed in escrow at closing as partial security for the
indemnification obligations of the stockholders of JetPay Payments, FL and (ii) 500,000 shares placed in escrow at closing
which will be released or cancelled contingent upon JetPay Payments, FL achieving certain gross profit performance targets in
2016 and 2017. In addition to the shares of its common stock issued at the date of acquisition, the Company issued an
additional 54,601 shares on December 30, 2016 to JetPay Payments, FL’s former stockholders in connection with a
post-closing purchase price adjustment for working capital and debt levels as of the acquisition date pursuant to the Merger
Agreement. JetPay Payments, FL’s former stockholders will also be entitled to receive warrants to purchase up to
500,000 shares of the Company’s common stock, each with a strike price of $4.00 per share and a 10-year term from its
date of issuance, contingent upon JetPay Payments, FL achieving certain gross profit performance targets in 2018 and 2019.
This contingent stock and warrant consideration, recorded as a liability, was valued at $1,975,000 at the date of acquisition
utilizing a Monte Carlo simulation model. The fair value of the contingent consideration was $1,880,000 at March 31, 2017
(recorded within non-current other liabilities). See
Note 4. Summary of Significant Accounting Policies
. Based upon
the level of gross profit performance in 2016, the Company anticipates releasing from escrow 250,000 shares of its common
stock related to the 2016 earn-out provisions of the Merger Agreement. Additionally, in connection with the acquisition,
certain executives of JetPay Payments, FL were provided the right to purchase through a private placement, within twelve
months after closing, up to 300,000 shares of common stock in the aggregate at a price equal to the higher of $3.00 per share
and the volume-weighted average closing price of the stock of the Company for the twenty consecutive trading days ending
three trading days prior to closing. This stock purchase right was valued at $152,000 utilizing a Black-Sholes option pricing
model and is recorded as Additional Paid-In Capital at the date of acquisition.
In addition, the Company granted to each former stockholder of JetPay
Payments, FL a right to require the Company to repurchase up to 50% of the shares of common stock issued in connection with the
acquisition and continuously held by such stockholder if Flexpoint exercises its right to have the Company redeem its entire investment
in shares of Series A Preferred. In a buyback of up to 50% of the shares issued to JetPay Payments, FL’s former shareholders,
the Company would purchase each share of common stock issued for $4.00 per share. The Company accounts for its common stock subject
to possible redemption in accordance with the guidance in ASC 480
“Distinguishing Liabilities from Equity”.
Conditionally
redeemable common stock (including common stock that features redemption rights that are either within the control of the holder
or subject to redemption upon the occurrence of uncertain events not solely within the Company’s control) is classified as
temporary equity. At all other times, common stock is classified as stockholders’ equity. The common stock issued to JetPay
Payments, FL’s previous shareholders features certain redemption rights that are considered to be outside of the Company’s
control and subject to the occurrence of uncertain future events. Accordingly, at March 31, 2017, 50% of the estimated fair value
of the common stock issued in connection with the acquisition, or $3.52 million, is presented as temporary equity, outside of the
stockholders’ equity section of the Consolidated Balance Sheet.
The fair value of the identifiable assets acquired and liabilities
assumed in the JetPay Payments, FL acquisition as of the acquisition date includes: (i) $520,000 of cash, (ii) $537,000 for accounts
receivable; (iii) $113,000 for prepaid expenses and other assets; (iv) $10.6 million for settlement processing assets; (v) $93,000
for fixed assets; (vi) the assumption of $14.7 million of liabilities, including $9.95 million of settlement processing obligations
and approximately $1.0 million of long term debt; and (vii) approximately $12.1 million allocated to goodwill and other identifiable
intangible assets. Within the $12.1 million of acquired intangible assets, $7.2 million was assigned to goodwill, which is not
subject to amortization under U.S. GAAP. The Company does not expect to deduct for tax purposes the goodwill related to the JetPay
Payments, FL acquisition. The amount assigned to goodwill was deemed appropriate based on several factors, including: (i) the multiple
paid by market participants for businesses in the merchant card processing business; (ii) levels of JetPay Payments, FL’s
current and future projected cash flows; and (iii) the Company’s strategic business plan, which includes cross-marketing
the Company’s payroll, HCM, processing and prepaid card services to JetPay Payments, FL’s customer base as well as
offering merchant credit card processing services to the Company’s payroll and HCM customer base. The remaining intangible
assets were assigned to customer relationships for $4.1 million, software costs of $710,000, and tradename for $70,000. The Company
determined that the fair value of non-compete agreements with certain employees of JetPay Payments, FL was immaterial. Customer
relationships, software costs, and trade name were assigned a life of 12 years, 19 months, and 7 months, respectively.
Assets acquired and liabilities assumed in the JetPay Payments,
FL acquisition were recorded on the Company’s Consolidated Balance Sheets as of the acquisition date based upon their estimated
fair values at such date. The results of operations of the business acquired by the Company have been included in the Statements
of Operations since the 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 allocation of the JetPay Payments, FL purchase price and the
estimated fair market values of the JetPay Payments, FL assets acquired and liabilities assumed are shown below (in thousands):
Cash
|
|
$
|
520
|
|
Accounts receivable
|
|
|
537
|
|
Settlement processing assets
|
|
|
10,587
|
|
Prepaid expenses and other assets
|
|
|
113
|
|
Property and equipment, net
|
|
|
93
|
|
Goodwill
|
|
|
7,218
|
|
Identifiable intangible assets
|
|
|
4,881
|
|
Total assets acquired
|
|
|
23,949
|
|
|
|
|
|
|
Accounts payable and accrued expenses
|
|
|
1,794
|
|
Settlement processing obligations
|
|
|
9,951
|
|
Long term debt
|
|
|
1,049
|
|
Long term deferred tax liability
|
|
|
1,864
|
|
Total liabilities assumed
|
|
|
14,658
|
|
Net assets acquired
|
|
$
|
9,291
|
|
Unaudited pro forma results of operations for the three months ended
March 31, 2016, as if the Company and JetPay Payments, FL had been combined on January 1, 2016, follow. The pro forma results include
estimates and assumptions which management believes are reasonable. The pro forma results do not include any anticipated cost savings
or other effects of the planned integration of these entities, and are not necessarily indicative of the results that would have
occurred if the business combination had been in effect on the date indicated, or which may result in the future.
|
|
Unaudited Pro Forma Results of Operations
|
|
|
|
(In thousands, except per share information)
|
|
|
|
Three Months Ended March 31, 2016
|
|
|
|
(in thousands)
|
|
|
|
|
|
Revenues
|
|
$
|
16,012
|
|
Operating income
|
|
$
|
(353
|
)
|
Net loss
|
|
$
|
(834
|
)
|
Net loss applicable to common stockholders
|
|
$
|
(2,248
|
)
|
Net loss per share applicable to common stockholders
|
|
$
|
(0.13
|
)
|
Note 4. Summary of Significant Accounting Policies
Significant accounting policies are defined as those that are reflective
of significant judgments and uncertainties, and potentially result in materially different results under different assumptions
and conditions. The Company’s significant accounting policies are described below.
Use of Estimates, Presentation and Consolidation
The accompanying consolidated 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; the fair value of equity instruments classified as liabilities; and 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. These consolidated financial statements include our accounts and those of our wholly-owned subsidiaries
and all intercompany balances and transactions have been eliminated in consolidation.
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 third party clients. Third party clients include Independent Sales Organizations
(“ISOs”), Value Added Resellers (“VARs”), Independent Software Vendors (“ISVs”), and financial
institutions. 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 contracts pursuant to which the Company processes credit and debit card transactions for the third parties’
merchant customers, revenues are 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 to 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. Under the majority
of the Company’s sales arrangements, 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. In all of the above instances,
the Company recognizes processing revenues net of interchange fees, which are assessed to its merchant and third party 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.
JetPay Payments, FL functions as the merchant of record and has
the primary responsibility for providing end-to-end payment processing services for its clients. Clients contract with JetPay
Payments, FL for all credit card processing services including transaction authorization, settlement, dispute resolution, security
and risk management solutions, reporting and other value-added services. As such, JetPay Payments, FL is the primary obligor in
these transactions and is solely responsible for all processing costs, including interchange fees. Further, JetPay Payments, FL
sets prices as it deems reasonable for each merchant. The gross fees JetPay Payments, FL collects are intended to cover the interchange,
assessments, and other processing fees and include JetPay Payments, FL’s margin on the transactions processed. For these
reasons, JetPay Payments, FL is the principal obligor in the contractual relationship with its customers and therefore JetPay
Payments, FL records its revenues, including interchange and assessments, on a gross basis. Revenues reported by JetPay Payments,
FL include interchange fees of $2.8 million for the three months ended March 31, 2017. Other fees assessed by JetPay Payments,
FL to certain customers and remitted to partner entities for web and IVR supporting services provided by JetPay Payments, FL’s
partner entities are presented on a net basis. The Company follows the guidance provided in ASC Topic 605-45,
Revenue Recognition
- Principal Agent Considerations
. ASC 605-45 states that whether a company should recognize revenue based on the gross amount
billed to a customer or the net amount retained is a matter of judgment that depends on the facts and circumstances of the arrangement
and that certain factors are considered in the evaluation.
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 from certain
merchants to minimize any such contingent liability, and it also utilizes a number of systems and procedures to manage merchant
risk.
Revenues from the Company’s JetPay HR & Payroll Services
operations 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 revenues are 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 revenues earned
from delivery service for the distribution of certain client payroll checks and reports is included in processing revenues, and
the costs for delivery are included in selling, general, and administrative expenses on 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 between one (1) and thirty (30) days after receipt, with some items extending to ninety (90) days. The interest earned
on these funds is included in total revenues 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, the Company must bear the credit risk for the full amount of the transaction. The Company evaluates the risk
for such transactions and estimates the potential loss for chargebacks based primarily on historical experience and records a loss
reserve accordingly. The Company 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 $354,000 and $436,000 were
recorded as of March 31, 2017 and December 31, 2016, respectively.
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, funds held for clients,
accounts payable and client fund obligations, approximated fair value as of the balance sheet dates 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 dates 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, accounts receivable, settlement processing assets and funds held
for clients. 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.
Accounts Receivable
The Company’s accounts receivable are due from its merchant
credit card and its payroll customers. Credit is extended based on the evaluation of customers’ financial condition and,
generally, collateral is not required. Payment terms vary but are typically collected via Automated Clearing House (“ACH”)
payments originated by us two (2) to three (3) days following month end. 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 Funds 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 our 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 Consolidated 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 Consolidated
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 our portion of settlement assets
due from customers and receivable from merchants for the portion of the discount fee related to reimbursement of the interchange
expense, our receivable from the processing bank for transactions we have 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, our liability to the processing bank for transactions
for which we have received funding from the members but have not funded merchants and exception items.
Settlement assets, funds and obligations resulting from JetPay Payments,
FL’s processing services and associated settlement activities include settlement receivables due from credit card associations
and debit networks and certain cash accounts to which JetPay Payments, FL does not have legal ownership but has the right to use
the accounts to satisfy the related settlement obligations. JetPay Payments, FL’s corresponding settlement obligations are
for amounts payable to customers, net of processing fees earned by JetPay Payments, FL. Settlement receivables and payables for
credit and debit card transactions are recorded at the gross transaction amounts. The gross amounts are then processed through
JetPay Payments, FL’s settlement accounts, and JetPay Payments, FL retains its fees for the transactions upon settlement.
Settlement receivables for e-check transactions consist of only JetPay Payments, FL’s fees for the transactions. Settlement
receivables are generally collected within four (4) business days. Settlement obligations are generally paid within three (3) business
days, regardless of when the related settlement receivables are collected.
Property and Equipment
Property and equipment acquired in the Company’s 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 – five (5) to fifteen (15) years; and furniture and fixtures – five (5) to ten (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 are 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, 2016. Additionally,
no indicators of impairment occurred in the three months ended March 31, 2017. 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 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. Identifiable Intangible assets are amortized on a straight-line basis over their respective assigned estimated
lives; customer relationships use eight (8) to fifteen (15) years; tradenames use one (1) to three (3) years; and software costs
use one (1) to eight (8) years.
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, 2016. Additionally,
no indicators of impairment occurred in the three months ended March 31, 2017.
Convertible Preferred Stock
The Company accounts for the redemption premium, beneficial conversion
feature and issuance costs on or of its convertible preferred stock using the effective interest method, accreting such amounts
to its convertible preferred stock from the date of issuance to the earliest date of redemption.
Share-Based Compensation
The Company expenses employee share-based payments under 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 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 shares of Series
A Preferred and shares of Series A-1 Preferred of 16,949,152 and 754,898 shares of common stock, respectively, at March 31, 2017,
and the effect of 1,227,909 exercisable stock options granted under the Company’s 2013 Stock Incentive Plan (as amended and
restated, the “2013 Stock Incentive Plan”) at March 31, 2017 have been excluded from the loss per share calculation
for the three months ended March 31, 2017 in that the assumed conversion of these options would be anti-dilutive. The dilutive
effect of the conversion option in the shares of Series A Preferred and Series A-1 Preferred of 9,448,241 and 616,500 shares of
common stock, respectively, and the effect of 813,744 exercisable stock options granted under the Company’s 2013 Stock Incentive
Plan at March 31, 2016 have been excluded from the loss per share calculation for the three months ended March 31, 2016 in that
the assumed conversion of these 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 debt instruments it enters into 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 expenses (income), using the effective
interest method.
Fair Value Measurements
The Company accounts for fair value measurements in accordance with
ASC Topic No. 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 March
31, 2017
|
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent consideration
|
|
$
|
2,742
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,742
|
|
|
|
Fair Value at December 31, 2016
|
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent consideration
|
|
$
|
2,982
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,982
|
|
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
March 31,
|
|
|
|
2017
|
|
|
2016
|
|
Beginning balance
|
|
$
|
2,982
|
|
|
$
|
1,296
|
|
Change in fair value of JetPay Payments, TX contingent consideration
|
|
|
(35
|
)
|
|
|
36
|
|
Change in fair value of JetPay Payments, PA contingent consideration
|
|
|
-
|
|
|
|
10
|
|
Change in fair value of JetPay Payments, FL contingent consideration
|
|
|
109
|
|
|
|
-
|
|
Payment of JetPay Payments, PA contingent consideration
|
|
|
(314
|
)
|
|
|
(186
|
)
|
Totals
|
|
$
|
2,742
|
|
|
$
|
1,156
|
|
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 for the relevant periods consist of contingent consideration related to the JetPay Payments, TX,
JetPay Payments, PA and JetPay Payments, FL acquisitions 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.
In addition to the consideration paid upon closing of the JetPay
Payments, TX acquisition, WLES, L.P. (“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 $5.0 million 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 other 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 (the JetPay Payments, TX acquisition
date), remains unchanged at March 31, 2017 as a result of this component being recorded as equity. The fair value at March 31,
2017 of the cash-based contingent consideration, valued at $23,000, recorded within other current liabilities, was determined using
a binomial option pricing model. The following assumptions were utilized in the March 31, 2017 calculations: risk free interest
rate: 0.97%; dividend yield: 0%; term of contingency of 0.75 years; and volatility: 70.3%.
The fair value of the common stock was derived from the per share
price of the common stock at the valuation date. Management determined that the results of its valuation were 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 U.S. 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.
In addition to the consideration paid upon closing of the JetPay
Payments, PA acquisition, the previous unitholders were entitled to receive up to an additional $500,000 if certain net revenue
goals were achieved through October 31, 2016. This contingent consideration was valued at $400,000 at the date of acquisition,
$456,000 at December 31, 2015, $314,000 at December 31, 2016, and $0 at March 31, 2017, with $186,000 earned and paid to the previous
unitholders of JetPay Payments, PA in February 2016 and the remaining $314,000 paid on January 17, 2017.
In addition to the consideration paid upon closing of the JetPay
Payments, FL acquisition, the previous shareholders are entitled to receive up to an additional 500,000 shares of common stock
upon JetPay Payments, FL achieving certain gross profit performance targets in 2016 and 2017 and up to 500,000 warrants to purchase
shares of common stock, each with a strike price of $4.00 per share and a 10-year term from its date of issuance, upon JetPay Payments,
FL achieving certain gross profit performance targets in 2018 and 2019. This contingent consideration was valued at $1,975,000
at the date of acquisition, $1,770,000 at December 31, 2016 ($563,000 recorded within other current liabilities and $1.2 million
recorded within non-current other liabilities), and $1,880,000 at March 31, 2017 (recorded within non-current other liabilities), based on utilization of a Monte Carlo simulation to estimate the
variance and relative risk of achieving future gross profit performance targets. The key assumptions in applying the Monte Carlo
simulation included expected gross profit growth rates, the expected standard deviation and serial correlation of expected net
revenue growth rates as well as a normal distribution assumption.
The Company uses either a binomial option-pricing model with a Monte
Carlo simulation 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 March 31, 2017, 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 Consolidated Balance Sheets, 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 de-recognition, 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
months ended March 31, 2017 and 2016. 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, except as described
in
Note 14. Subsequent Events
.
Recently Adopted Accounting Standards
In November 2015, the Financial Accounting Standards
Board (“FASB”) issued Accounting Standards
Update (“ASU”) No. 2015-17,
Income Taxes (Topic 740): Balance Sheet Classification of Deferred
Taxes
. The ASU simplifies the presentation of deferred income taxes under U.S. GAAP by requiring that all deferred tax
assets and liabilities be classified as non-current. The guidance in ASU No. 2015-17 is effective for fiscal years beginning
after December 15, 2016, including interim periods within those fiscal years. The Company adopted this ASU and it did not
have a material impact on the Company’s consolidated financial statements.
In
March 2016, the FASB issued ASU No. 2016-09,
Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based
Payment Accounting
. This ASU makes targeted amendments to the accounting for employee share-based payments. This guidance
is to be applied using various transition methods such as full retrospective, modified retrospective, and prospective based on
the criteria for the specific amendments as outlined in the guidance. The guidance is effective for annual periods, and interim
periods within those annual periods, beginning after December 15, 2016. The Company adopted this ASU and it did not have a material
impact on the Company’s disclosures in the footnotes to its financial statements.
Recent Accounting Standards
In February 2016, the FASB issued ASU 2016-02,
Leases
(Topic 842)
. The ASU requires that a lessee recognize the assets and liabilities that arise from operating leases. A
lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a
right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months
or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease
assets and lease liabilities. In transition, lessees and lessors are required to recognize and measure leases at the
beginning of the earliest period presented using a modified retrospective approach. JetPay has not yet determined the effect
of the adoption of this standard on JetPay’s consolidated financial position and results of operations.
In March 2016, the FASB issued ASU No. 2016-08,
Revenue
from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)
. This
ASU amends the principal versus agent guidance in ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
,
which was issued in May 2014 (“ASU 2014-09”). Further, in April 2016, the FASB issued ASU No. 2016-10,
Revenue
from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing
. This ASU also amends ASU 2014-09
and is related to the identification of performance obligations and accounting for licenses. Most recently, in December 2016, the
FASB issued ASU No. 2016-20,
Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers
.
This amendment affects narrow aspects of the guidance issued in ASU 2014-09. The effective date and transition requirements for
all of these amendments to ASU 2014-09 are the same as those of ASU 2014-09, which was deferred for one year by ASU No. 2015-14,
Revenue
from Contracts with Customers (Topic 606): Deferral of the Effective Date
. That is, the guidance under these standards is to
be applied using a full retrospective method or a modified retrospective method, as outlined in the guidance, and is effective
for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted
only for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The Company is currently
evaluating the provisions of each of these standards and assessing their impact on the Company’s financial statements and
disclosures.
In June 2016, the FASB issued ASU 2016-13,
Financial
Instruments-Credit Losses (Topic 36): Measurement of Credit Losses on Financial Instruments
, which provides guidance that will
change the accounting for credit impairment. Under the new guidance, companies are required to measure all expected credit losses
for financial instruments held at the reporting date based on historic experience, current conditions and reasonable supportable
forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets
measured at amortized cost and applies to some off-balance sheet credit exposure. This new guidance will be effective for annual
reporting periods beginning after December 15, 2019, including interim periods within those annual reporting periods, and early
adoption is permitted. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s
financial statements and disclosures.
In August 2016, the FASB issued ASU 2016-15,
Statement of
Cash Flows: Clarification of Certain Cash Receipts and Cash Payments
(“ASU 2016-15”), which eliminates the
diversity in practice related to classification of certain cash receipts and payments in the statement of cash flows, by adding
or clarifying guidance on eight specific cash flow issues. This new guidance will be effective for annual reporting periods beginning
after December 15, 2017, and interim periods within those fiscal years and early adoption is permitted, including adoption in an
interim period. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s
financial statements and disclosures.
In November 2016, the FASB issued ASU 2016-18,
Statement of Cash
Flows (Topic 230): Restricted Cash
(“ASU 2016-18), which provides guidance that will require that a statement of cash
flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted
cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents
should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown
on the statement of cash flows. This new guidance will be effective for annual reporting periods beginning after December 15, 2017,
and interim periods within those fiscal years and early adoption is permitted, including adoption in an interim period. The Company
is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and
disclosures.
In January 2017, the FASB issued ASU 2017-01,
Business Combinations
(Topic 805): Clarifying the Definition of a Business.
This ASU clarifies the definition of a business when evaluating
whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This new guidance will
be effective for annual reporting periods beginning after December 15, 2017, including interim periods within those periods. The
Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements
and disclosures.
In January 2017, the FASB issued ASU 2017-04,
Intangibles—Goodwill
and Other (Topic 350)
. This ASU simplifies the subsequent measurement of goodwill by eliminating the second step of the goodwill
impairment test, which required computing the implied fair value of goodwill. Under the amendments in this update, an entity should
perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount.
An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value;
however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This new guidance
will be effective January 1, 2020. The Company is currently evaluating the provisions of this guidance and assessing its impact
on the Company’s consolidated financial statements and disclosures.
Note 5. Property and Equipment, net of Accumulated
Depreciation
|
|
March 31,
2017
|
|
|
December 31,
2016
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
Leasehold improvements
|
|
$
|
417
|
|
|
$
|
417
|
|
Equipment
|
|
|
1,782
|
|
|
|
1,710
|
|
Furniture and fixtures
|
|
|
336
|
|
|
|
330
|
|
Computer software
|
|
|
1,232
|
|
|
|
1,230
|
|
Vehicles
|
|
|
245
|
|
|
|
245
|
|
Assets in progress
|
|
|
382
|
|
|
|
83
|
|
Total property and equipment
|
|
|
4,394
|
|
|
|
4,015
|
|
Less: accumulated depreciation
|
|
|
(2,121
|
)
|
|
|
(1,890
|
)
|
Property and equipment, net
|
|
$
|
2,273
|
|
|
$
|
2,125
|
|
Property and equipment included $368,797 and $422,167 of computer
equipment as of March 31, 2017 and December 31, 2016, respectively, net of accumulated depreciation of $326,099 and $272,729 as
of March 31, 2017 and December 31, 2016, respectively, that is subject to capital lease obligations.
Assets in progress consist primarily of computer software for internal
use that will be placed into service upon completion.
Depreciation expense was $231,000 and $179,000 for the three months
ended March 31, 2017 and 2016.
Note 6. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following (in
thousands):
|
|
March 31,
2017
|
|
|
December 31,
2016
|
|
Trade accounts payable
|
|
$
|
2,955
|
|
|
$
|
3,438
|
|
ACH clearing liability
|
|
|
1,033
|
|
|
|
1,160
|
|
Accrued compensation
|
|
|
1,717
|
|
|
|
1,234
|
|
Accrued agent commissions
|
|
|
1,311
|
|
|
|
1,023
|
|
Related party payables
|
|
|
51
|
|
|
|
424
|
|
Other
|
|
|
3,553
|
|
|
|
3,542
|
|
Total
|
|
$
|
10,620
|
|
|
$
|
10,821
|
|
Note 7. Long-Term Debt, Notes Payable and Capital
Lease Obligations
Long-term debt, notes payable and capital lease obligations consist
of the following:
|
|
March 31,
2017
|
|
|
December 31,
2016
|
|
|
|
(in thousands)
|
|
Term loan payable to LHLJ, Inc., interest rate of 8% payable in monthly payments of $128,677, including principal and interest, beginning on October 18, 2016, maturing on October 31, 2021, collateralized by the assets and equity interests of JetPay HR & Payroll Services and JetPay Payments, FL. See
Note 12. Related Party Transactions.
|
|
$
|
9,171
|
|
|
$
|
9,371
|
|
|
|
|
|
|
|
|
|
|
Term loan payable to FNB, interest rate of 5.25% payable in monthly principal payments of $104,167 plus interest beginning on November 30, 2015, maturing November 6, 2021, collateralized by the assets and equity interests of JetPay Payments, PA.
|
|
|
5,729
|
|
|
|
6,042
|
|
|
|
|
|
|
|
|
|
|
Term note payable to Fifth Third Bank, interest rate of 4% payable in monthly payments of $27,317, including principal and interest, beginning on July 1, 2016, maturing November 30, 2019, collateralized by the assets and equity interests of JetPay Payments, FL.
|
|
|
853
|
|
|
|
925
|
|
|
|
|
|
|
|
|
|
|
Revolving promissory note payable to Fifth Third Bank, interest rate of LIBOR plus 2.00% (2.875% at March 31, 2017), maturing on June 2, 2017.
|
|
|
-
|
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
Promissory note payable to Merrick, interest rate of 12% beginning October 14, 2016 payable on the promissory note maturing on January 11, 2017, collateralized by the 3,333,333 shares of JetPay common stock issued to WLES and held in escrow. Paid in full on January 15, 2017.
|
|
|
-
|
|
|
|
5,000
|
|
|
|
|
|
|
|
|
|
|
Unsecured promissory note payable to stockholder, interest rate of 4% payable at maturity, note principal due September 30, 2017, as extended. See
Note 12. Related Party Transactions.
|
|
|
492
|
|
|
|
492
|
|
|
|
|
|
|
|
|
|
|
Capital lease obligations related to computer equipment and software at JetPay Payments, TX, interest rates of 5.55% to 8.55%, due in monthly lease payments of $28,844 in the aggregate maturing from May 2017 through December 2018, collateralized by equipment.
|
|
|
301
|
|
|
|
357
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16,546
|
|
|
|
22,207
|
|
Less current portion
|
|
|
(3,061
|
)
|
|
|
(8,074
|
)
|
Less unamortized deferred financing costs
|
|
|
(305
|
)
|
|
|
(339
|
)
|
|
|
$
|
13,180
|
|
|
$
|
13,794
|
|
The FNB term loan agreement requires the Company to provide FNB
with annual financial statements within 120 days of the Company’s year-end and quarterly financial statements within 60 days
after the end of each quarter. The FNB agreement also contains certain annual financial covenants with which the Company was in
compliance as of March 31, 2017.
On June 2, 2016, in connection with the closing of the Company’s
acquisition of JetPay Payments, FL, JetPay Payments, FL entered into a credit agreement with Fifth Third Bank to obtain a $1,068,960
term loan and a revolving line of credit facility of $500,000, in each case secured by all of JetPay Payments, FL’s assets.
The term note issued to Fifth Third Bank matures on November 30, 2019 and bears interest at 4.00%. The revolving note issued to
Fifth Third Bank matures on June 2, 2017 and bears interest at a rate of 2.00% plus the LIBOR Rate for the applicable interest
period. The term note and the revolving note are guaranteed by the Company. The underlying credit agreement with Fifth Third Bank
contains certain customary covenants, including a financial covenant related to JetPay Payments, FL’s fixed charge coverage
ratio, with which the Company was in compliance as of March 31, 2017.
On July 26, 2016, as part of its settlement of litigation with Merrick,
the Company agreed to issue two promissory notes in favor of Merrick in the amounts of $3,850,000 (the “$3.85MM Note”)
and $5,000,000 (the “$5MM Note” and, together with the $3.85MM Note, the “Notes”). The Notes were secured
by the 3,333,333 shares of JetPay’s common stock issued in the name of WLES and held in escrow pursuant to that certain Escrow
Agreement, dated December 28, 2012, by and among JetPay, WLES, Trent Voigt, Merrick and JPMorgan Chase (“Chase”). The
$3.85MM Note was paid in full on October 21, 2016 and the $5.00MM Note was paid in full on January 11, 2017.
Maturities of long-term debt and capital lease obligations, excluding
fair value and conversion option debt discounts, are as follows for the years ending March 31: 2018 – $3.1 million; 2019
– $2.6 million; 2020 – $2.5 million; 2021 – $2.3 million; 2022 – $6.1 million; and $0 thereafter.
Note 8. Redeemable Convertible Preferred Stock
Under a Securities Purchase Agreement entered into on August 22,
2013 (as amended, the “Series A Purchase Agreement”), the Company agreed to sell to Flexpoint, and Flexpoint agreed
to purchase, upon satisfaction of certain conditions, up to 133,333 shares of Series A Preferred for an aggregate purchase price
of up to $40.0 million in three tranches. The shares of Series A Preferred had a purchase price of $300 per share.
On October 11, 2013, the Company issued 33,333 shares of Series
A Preferred to Flexpoint for an aggregate of $10.0 million less certain agreed-upon reimbursable expenses of Flexpoint (the “Initial
Closing”) pursuant to the Series A Purchase Agreement. Additionally, the Company issued 4,667 shares of Series A Preferred
to Flexpoint on April 14, 2014 for an aggregate of $1.4 million; 20,000 shares on November 7, 2014 for $6.0 million; 33,333 shares
on December 28, 2014 for $10.0 million; and 8,333 shares on August 9, 2016 for $2.5 million. The proceeds of the initial $10.0
million investment were used to retire the note payable to Ten Lords, Ltd. of $5.9 million maturing in December 2013 with the remainder
used for general corporate purposes. The proceeds of the April 14, 2014 $1.4 million investment were used to satisfy a portion
of the Company’s liability to EarlyBirdCapital, Inc. arising from a March 3, 2014 arbitration decision. The proceeds of the
November 7, 2014 $6.0 million were used as partial consideration for the acquisition of JetPay Payments, PA. The proceeds of the
December 28, 2014 $10.0 million investment were used to redeem certain secured convertible preferred notes that matured on December
31, 2014. The proceeds of the August 9, 2016 $2.5 million investment were used for the payment of certain acquisition expenses
related to the JetPay Payments, FL acquisition and for general corporate purposes.
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, which was initially $3.00. Under the Series A Purchase Agreement, Flexpoint and Sundara Investment Partners,
LLC are provided with certain indemnification rights in the event of the incurrence of certain losses and expenses by the Company.
In April 2015, Flexpoint tendered to the Company a claim letter regarding an indemnification claim with respect to the EarlyBirdCapital
matter.
On August 6, 2015, in resolution of this claim, Flexpoint and the Company entered into a Letter Agreement,
whereby the conversion price of any of the Series A Preferred held by Flexpoint was reduced from $3.00 per share to $2.90 per share.
As a result of the settlement of the Direct Air Matter, see
Note 11. Commitments and Contingencies
, on March 23, 2017, the
conversion price of Series A Preferred was adjusted to $2.36 pursuant to the Series A Securities Purchase Agreement. Pursuant to
an agreement by and among the Company, Flexpoint and Sundara, the Series A Preferred conversion price may be adjusted upward upon
a successful recovery of funds in the Company’s lawsuit against Valley National Bank. The conversion price of the Series
A Preferred continues to be subject to downward adjustment upon the occurrence of certain events.
On October 18, 2016, the Company amended and restated the Series
A Purchase Agreement in part to facilitate the Company’s issuance and sale to Sundara of the 33,667 shares of Series A Preferred
that had not yet been purchased by Flexpoint (the “Remaining Shares”). Flexpoint’s right to acquire the Remaining
Shares was set to expire on October 11, 2016, but was extended until October 25, 2016 by an amendment to the Series A Purchase
Agreement, dated October 10, 2016, by and between the Company and Flexpoint. Pursuant to the A&R Purchase Agreement, the Company
and Flexpoint provided to Sundara the sole right to purchase the remaining 33,667 shares of Series A Preferred in a single transaction
consummated at the signing of the amended and restated Series A Purchase Agreement, for a purchase price of $10,100,100. This issuance
was completed on October 18, 2016.
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 common stock with respect to distributions of assets
upon the Company’s liquidation, dissolution or winding up. Holders of Series A Preferred have the right to request redemption
of any shares of Series A Preferred issued at least five (5) 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, subject to certain exceptions.
In addition to the foregoing, pursuant to a Securities Purchase
Agreement (the “Series A-1 Purchase Agreement”) with Wellington dated May 1, 2014, 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 $2.7 million. On May 5, 2014, the Company issued 2,565 shares of Series A-1 Preferred to Wellington
for an aggregate of $769,500, less certain agreed-upon reimbursable expenses of Wellington. Additionally, the Company issued to
Wellington 1,350 shares of Series A-1 Preferred on November 20, 2014 for $405,000; 2,250 shares of Series A-1 Preferred on December
31, 2014 for $675,000; and 2,835 shares of Series A-1 Preferred on April 13, 2017 for $850,500. The proceeds of the total
investment of $2.7 million by Wellington have been used for general corporate purposes.
Shares of Series A-1 Preferred are convertible into shares of the
Company’s common stock or, in certain circumstances, Series A-2 Convertible Preferred Stock, par value $0.001 per share.
Shares
of Series A-1 Preferred may 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 was $3.00. As
a result of the settlement of the Direct Air Matter, on March 23, 2017, the conversion price of Series A-1 Preferred was adjusted
to $2.45 pursuant to the Series A-1 Securities Purchase Agreement. Pursuant to an agreement by and among Wellington, the Series
A-1 Preferred conversion price may be adjusted upward upon a successful recovery of funds in the Company’s lawsuit against
Valley National Bank. The conversion price of the Series A-1 Preferred is subject to further downward adjustment upon the occurrence
of certain events as defined in the Series A-1 Purchase Agreement.
The Series A-1 Preferred has an initial liquidation preference of
$600 per share and ranks senior to the Company’s common stock and
pari passu
with the Series A Preferred
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 Series A-1 Purchase Agreement, the holders of a majority of the Series A-1 Preferred may demand immediate redemption
of all or a portion of the Series A-1 Preferred 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 its convertible
preferred stock instruments. 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 instruments; 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. Subject to certain exceptions applicable to Sundara, the shares of Series A Preferred and Series A-1 Preferred
are subject to redemption, at the option of the holder, on or after the fifth anniversary of their original purchase. Accordingly,
the convertible preferred stock has 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. An additional beneficial
conversion feature of $396,600 was recorded in August 2015 as a result of the change in conversion price per share from $3.00
to $2.90. Similarly, additional beneficial conversion features of $2.7 million and $2.2 million were recorded in March 2017 with
respect to the shares of Series A Preferred issued and sold to Flexpoint in 2013 and the shares of Series A Preferred issued and
sold to Sundara in 2016 as a result of the further change in conversion price per share of Series A Preferred from $2.90 to $2.36.
There was no beneficial conversion feature related to the 2014, 2015 or the 2016 issuances and sales of shares of Series A Preferred
to Flexpoint and shares of Series A-1 Preferred to Wellington as a result of the price of the Company’s common stock at
the dates of the closings being below the effective adjusted conversion price of the preferred stock. The Company accounts for
the beneficial conversion feature, the liquidation preference, and the issuance costs related to the Series A Preferred and Series
A-1 Preferred using the effective interest method by accreting such amounts to its Series A Preferred and 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 was $2.1 million and
$1.4 million for the three months ended March 31, 2017 and 2016, 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 shares of 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 Series A Purchase Agreement after the Initial Closing, and such breach has not been cured within 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 $5.0 million 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 the Prior HR & Payroll Services Credit Facility, and such
event of default has not been cured within thirty days after receipt of notice thereof.
Note 9. Stockholders’ Equity
Common Stock
On January 22, 2016, the Company sold 37,037 shares of common stock
to an additional investor at a purchase price of $2.70 per share for consideration of $100,000 prior to issuance costs of approximately
$36,000.
On June 29, 2016, the Board of Directors approved an amendment and
restatement of the JetPay Corporation 2013 Stock Incentive Plan, which was subsequently approved by the Company’s stockholders
at the Company’s 2016 Annual Meeting of Stockholders held on August 2, 2016. The Amended and Restated 2013 Stock Incentive
Plan (the “Amended and Restated 2013 Plan”) authorizes the availability of an additional 1,000,000 shares of common
stock available for the grant of awards under the 2013 Stock Incentive Plan, for a total of 3,000,000 shares of common stock total
available under the Plan.
On July 1, 2016, the Company issued 22,876 shares of common stock
under its Employee Stock Purchase Plan and an additional 51,480 shares on January 5, 2017.
Treasury Stock
On February 15, 2017, the Company bought back 2.2 million shares
of its common stock owned by WLES, which WLES had agreed to sell in connection with the Direct Air matter as part of the WLES Settlement
Agreement dated July 26, 2016. JetPay had previously paid off a $5.0 million Note due to Merrick Bank in January 2017, which WLES
had agreed to indemnify as part of the WLES Settlement Agreement by agreeing to sell the 2.2 million shares to satisfy JetPay’s
obligations in relation to the $5.0 million Note. As a result, no additional consideration was due to WLES in connection with the
stock buyback. Effective February 15, 2017 the 2.2 million shares of JetPay common stock were placed in treasury at a cost of $4.95
million and are available for issuance.
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 designations, rights and preferences as may be determined from time to time
by the Company’s Board of Directors.
As of March 31, 2017 and December 31, 2016, there were no shares
of preferred stock issued or outstanding other than the Series A Preferred issued to Flexpoint and Sundara and the 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.
The Amended and Restated 2013 Plan had available 678,752 shares
of common stock for the grant of awards as of March 31, 2017.
The Company granted options to purchase 75,000 and 0 shares of common
stock under the Amended and Restated 2013 Stock Incentive Plan during the three months ended March 31, 2017 and 2016, respectively,
all at an exercise price of $3.00 per share. The grant date fair value of the options granted during the three months ended March
31, 2017 and 2016 were determined to be approximately $89,000 and $0, respectively, using the Black-Scholes option pricing model.
Aggregated stock-based compensation expense for the three months ended March 31, 2017 and 2016 was $171,000 and $72,000, respectively.
Unrecognized compensation expense as of March 31, 2017 relating to non-vested common stock options was approximately $1.2 million
and is expected to be recognized through 2021. During the three months ended March 31, 2017, no options were exercised or forfeited.
The fair values of the Company’s options were estimated at
the dates of grant using a Black-Scholes option pricing model with the following weighted average assumptions:
|
|
For the Three Months Ended
March 31,
|
|
|
|
2017
|
|
|
2016
|
|
Expected term (years)
|
|
|
6.25
|
|
|
|
-
|
|
Risk-free interest rate
|
|
|
2.10
|
%
|
|
|
-
|
|
Volatility
|
|
|
62.3
|
%
|
|
|
-
|
|
Dividend yield
|
|
|
0
|
%
|
|
|
-
|
|
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 using a weighted average of both the Company’s stock price and 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 three months ended March
31, 2017 and the year ended December 31, 2016 are presented below:
|
|
Number of Options
|
|
|
Weighted Average
Exercise Price
|
|
Outstanding at December 31, 2015
|
|
|
1,717,082
|
|
|
$
|
3.02
|
|
Granted
|
|
|
905,000
|
|
|
|
2.70
|
|
Forfeited
|
|
|
(375,834
|
)
|
|
|
3.00
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Outstanding at December 31, 2016
|
|
|
2,246,248
|
|
|
$
|
3.02
|
|
Granted
|
|
|
75,000
|
|
|
|
3.00
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Outstanding at March 31, 2017
|
|
|
2,321,248
|
|
|
$
|
2.90
|
|
Exercisable at March 31, 2017
|
|
|
1,227,909
|
|
|
$
|
2.95
|
|
The weighted average remaining life of options outstanding at March
31, 2017 was 8.08 years. The aggregate intrinsic value of the exercisable options at March 31, 2017 was $0.
Employee Stock Purchase Plan
On June 29, 2015, the Board of Directors adopted the JetPay Corporation
Employee Stock Purchase Plan (the "Purchase Plan"), which was subsequently approved by the Company’s stockholders
at the Company’s 2015 Annual Meeting of Stockholders. The Purchase Plan allows employees to contribute a percentage of their
cash earnings, subject to certain maximum amounts, to be used to purchase shares of the Company’s common stock on each of
two (2) semi-annual purchase dates. The purchase price is equal to 90% of the market value per share on either: (a) the date of
grant of a purchase right under the Purchase Plan; or (b) the date on which such purchase right is deemed exercised, whichever
is lower.
As of March 31, 2017, an aggregate of 300,000 shares of common stock
were reserved for issuance under the Purchase Plan, of which 22,876 shares of common stock were issued on July 1, 2016 and 51,480
were issued on January 5, 2017.
Note 10. Income Taxes
The Company recorded income tax expense of $62,000 and $53,000
for the three months ended March 31, 2017 and 2016, respectively. Income tax expense reflects the recording of federal and state
income taxes. The effective tax rates were approximately (59.0)% and (5.6)% for the three months ended March 31, 2017 and 2016,
respectively. The effective rate differs from the federal statutory rate for each period, primarily due to state and local income
taxes and changes to the valuation allowance.
As of March 31, 2017, due to the acquisition of JetPay Payments,
FL and its related identifiable intangibles and the recording of an associated $1.86 million deferred tax liability, management
believed that it was more likely than not that the benefit of a portion of its federal net deferred tax assets would be realized
equal to the future source of taxable income created by the reversal of the book amortization of the JetPay Payments, FL fixed
assets and identifiable intangible assets. Accordingly, management believes recording a partial reduction of the valuation
allowance against its federal net deferred tax asset of $1.6 million is appropriate.
JetPay Payments, TX 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, 2016, the Company had U.S. federal net operating
loss carryovers (“NOLs”) of approximately $25.9 million available to offset future taxable income. These NOLs, if not
utilized, expire at various times through 2036. 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.
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 a total valuation allowance of approximately $8.9 million at March 31, 2017 is appropriate, representing
the amount of its deferred income tax assets in excess of certain of the Company’s deferred income tax liabilities. The deferred
tax liability related to goodwill that is amortizable for tax purposes (“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 or about March 13, 2012, a merchant of JetPay, LLC, Direct
Air, a charter travel company, abruptly ceased operations and filed for bankruptcy. Under United States 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 United States 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 United States Department of Transportation
escrow account 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 $31.0 million in the escrow account. Instead there was approximately $1.0 million. As a result, Merrick Bank Corporation (“Merrick”),
JetPay, LLC’s sponsor bank with respect to this particular merchant, incurred chargebacks in excess of $25.0 million. Merrick
maintained insurance through a Chartis Insurance Policy for chargeback losses that named Merrick as the primary insured. The policy
had a limit of $25.0 million and a deductible of $250,000. Merrick sued Chartis Insurance (“Chartis”) for payment under
the claim. Under an agreement between Merrick and JetPay, LLC, JetPay, LLC had certain obligations to indemnify Merrick for losses
realized from such chargebacks that Merrick was unable to recover from other parties. JetPay, LLC recorded a loss for all chargebacks
in excess of $25.0 million, the $250,000 deductible on the Chartis insurance policy and $487,000 of legal fees charged against
JetPay, LLC’s cash reserve account by Merrick, totaling $1.9 million in 2012, as well as an additional $597,000 in legal
fees charged against JetPay, LLC’s cash reserve account by Merrick through September 30, 2013. In December 2013, Merrick,
in addition to its suit against Chartis, also filed suit against Valley National Bank as escrow agent. In February 2015, JetPay
joined that suit, along with American Express. During 2012 and 2013, Merrick required JetPay, LLC to maintain increased cash reserves
in order to provide additional security for any obligations arising from the Direct Air situation. As of June 30, 2016, Merrick
held approximately $4.4 million of total reserves related to the Direct Air matter, which amount was released in full to Merrick
under the Merrick Settlement Agreement in July 2016, as more fully described below.
On August 7, 2013, JetPay Merchant Services, LLC (“JPMS”),
then a wholly owned subsidiary of JetPay, LLC and indirect wholly-owned subsidiary of the Company, together with WLES (collectively,
the “Plaintiffs”), filed suit in the United States 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 alleged
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 alleged 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 Services, LLC (“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
$4.7 million. The Company did not believe it had a responsibility to reimburse Merrick for these legal fees and disputed these
charges. Accordingly, the Company had not recorded an accrual for these legal fees as of June 30, 2016. These legal fees were eliminated
as part of the Merrick Settlement Agreement, as described below.
As partial protection against any potential losses related to
Direct Air, the Company required that, upon closing of the acquisition of JetPay, LLC, 3,333,333 shares of common stock that was
to be paid to WLES as part of the JetPay, LLC acquisition be placed into an escrow account with JP Morgan Chase as the trustee.
If JetPay, LLC suffered any liability as a result of the Direct Air matter, these shares would be used in partial payment for any
such liability, with any remaining shares delivered to WLES.
On July 26, 2016, we entered into two related settlement agreements:
(i) a Settlement Agreement and Release by and among Merrick, the Company, certain subsidiaries of the Company and WLES (the “Merrick
Settlement Agreement”) and (ii) a Settlement Agreement and Release by and among Trent Voigt, WLES and the Company (the “WLES
Settlement Agreement”). In connection with the parties’ entry into the Merrick Settlement Agreement, the District Court
for the District of Utah dismissed the Direct Air matter with prejudice on July 27, 2016.
As part of the Merrick Settlement Agreement, we agreed to release
all claims to the $4.4 million held in reserve at Merrick. In addition, pursuant to the Merrick Settlement Agreement, we issued
to Merrick the $3,850,000 note, bearing interest at a rate of 8% per annum, due December 28, 2017 (the “$3.85MM Note”)
and a $5,000,000 note, bearing interest at a rate of 12% per annum, due January 11, 2017 (the “$5MM Note” and, together
with the $3.85MM Note, the “Notes”) to Merrick. The Notes were secured by the 3,333,333 shares of JetPay’s common
stock issued in the name of WLES and held in escrow.
In connection with its entry into the Merrick Settlement Agreement,
JetPay executed three Stipulated and Confessed Judgments in favor of Merrick in the amounts of $32,500,000 (the “First Judgment”),
$28,650,000 (the “Second Judgment”) and $27,500,000 (the “Third Judgment” and, together with the First
Judgment and the Second Judgment, the “Judgments”), none of which would be of any effect unless and until JetPay failed
to make any payment when due under the Notes. If JetPay failed to make payment when due under the Notes, Merrick, after a five
(5) day cure period, would have been able to seek to obtain and/or enforce the applicable Judgments in the Federal District Court
for Utah or in any court of competent jurisdiction. On October 21, 2016, the Company paid in full the $3.85MM Note and on January
11, 2017, the Company paid in full the $5.0MM Note. As a result, no Judgments are available for Merrick’s relief.
Under the terms of the WLES Settlement
Agreement, WLES agreed to transfer the indebtedness represented by that certain promissory note, dated December 28, 2012 (the “WLES
Note”), in the original principal amount of $2,331,369 issued by JetPay in favor of WLES to Merrick. In addition, WLES agreed
to amend that certain promissory note, dated June 7, 2013, as amended, in the original principal amount of $491,693 issued by JetPay,
LLC in favor of Trent Voigt in order to (a) extend its maturity date from September 30, 2016 to September 30, 2017 and (b) waive
all interest payments for the period from September 30, 2016 to September 30, 2017. This note in favor of Mr. Voigt shall become
due and payable immediately should Mr. Voigt’s employment with JetPay be terminated other than for cause. In addition, pursuant
to the WLES Settlement Agreement, WLES authorized JetPay to arrange a private sale of that number of escrowed shares to the extent
necessary to satisfy JetPay’s obligations to Merrick under the $5.00MM Note (up to a total of 2,200,000 escrowed shares).
Upon consummation of the sale of more than 1,666,667 of the escrowed shares, JetPay agreed to issue to WLES fully vested and immediately
exercisable warrants with an expiration date of five (5) years from the date of the WLES Settlement Agreement to purchase that
number of shares of JetPay common stock equal to 50% of the difference between (a) the number of escrowed shares actually sold
by WLES and (b) 1,666,666 shares of JetPay common stock, at an exercise price per share equal to the amount per share paid for
the sold escrowed shares. The WLES Settlement Agreement also provides for the allocation of any recoveries by JPMS in connection
with the claims brought by JMPS in
American Express Travel Related Services and JetPay
Merchant Services, LLC v. Valley National Bank, Civil Action No. 2:14-cv-7827 (D. N.J.) between the Company and WLES. On February
15, 2017, 2,200,000 of the WLES escrowed shares were transferred to JetPay and placed into Treasury to satisfy WLES’ indemnification
under the Merrick and WLES Settlement Agreements.
The Company has recorded a Settlement of Legal Matter charge
of $6.19 million for the year ended December 31, 2016 based on the terms of the Merrick Settlement Agreement and the WLES Settlement
Agreement. The loss includes: (i) a charge of $4.4 million related to the Company’s release of all claims to the $4.4 million
held in reserve at Merrick; (ii) a charge of $1.4 million related to the Company’s issuance of the $3.85MM Note, less WLES’s
agreement to transfer the WLES Note (recorded at $2,036,511, net of an unamortized discount of $294,858) and accrued interest
on the WLES Note of $414,466; (iii) a charge of $50,000 representing the Company’s issuance of the $5.0MM Note less the
estimated value as of July 26, 2016 of the escrowed shares; and (iv) a charge for $373,334 representing the fair value of the
issuance of warrants to WLES as described in the WLES Settlement Agreement.
At the time of the acquisition of JetPay, LLC, the Company
entered into an Amendment, Guarantee, and Waiver Agreement (the “Agreement”) dated December 28, 2012 between the Company,
Ten Lords and Interactive Capital (“Ten Lords”) and JetPay Payments, TX. Under the Agreement, Ten Lords agreed to
extend payment of a $6.0 million note remaining outstanding at the date of acquisition for up to twelve months. The note was paid
in full in October 2013 using the proceeds from the initial purchase of Series A Preferred by Flexpoint. See
Note 8. Redeemable
Convertible Preferred Stock
. The terms of the Agreement required that the Company provide Ten Lords with a “true up”
payment, which was meant to put the holders of the note (Ten Lords) in the same after-tax economic position as they would have
been had the note been paid in full on December 28, 2012. JetPay calculated this true-up payment to Ten Lords at $222,310 and
paid such amount to Ten Lords in August 2015. Subsequent to the Company’s payment, the Company received notice on October
5, 2015 that Ten Lords had filed a lawsuit against JetPay, LLC disputing the amount determined and paid by the Company. On May
2, 2017, a trial took place in the District Court of Colin County, Texas during which the Court entered an indication in favor
of Ten Lords in the amount of $793,000 plus attorney’s fees, estimated at $115,000. JetPay intends to dispute the
amount of any request for judgement by Ten Lords. At this time, the Company cannot reasonably estimate the amount of any final
potential loss on this matter. Additionally, there is no certainty JetPay will prevail in its dispute of the amount of any judgement,
or the likelihood of success of any appeal, should JetPay decide to appeal a judgement once it is rendered. The Company estimates
that the range of loss on this matter is between $0 and $793,000, plus attorney’s fees estimated at $115,000.
In December 2015, Harmony Press Inc. (“Harmony”),
a customer of ADC and PTFS, filed a suit against an employee of Harmony for theft by that employee of over $628,000. JetPay, ADC,
and PTFS as well as several financial institution service providers to Harmony were also named in that suit for alleged negligence.
The Company believes that the allegations in the suit regarding JetPay, ADC, and PTFS are groundless and has turned the matter
over to the Company’s insurance carrier who is defending the suit. The Company is subject to a $50,000 deductible under its
insurance policy. The Company has not recorded an accrual for any potential loss related to this matter as of March 31, 2017.
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
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 former President of JetPay HR & Payroll Services. The rent is currently $45,163 per month. The office lease had an initial
10-year term which expired on May 31, 2016 and was extended for one year on June 1, 2016. Rent expense under this lease was $135,500
and $129,140 for the three months ended March 31, 2017 and 2016. The Company is currently evaluating its future space needs and
reviewing several alternatives, including a possible extension or amendment to the current lease.
JetPay Payments, TX retains a backup center in Sunnyvale, Texas
consisting of 1,600 square feet, rented from JT Holdings, an entity controlled by Trent Voigt, the previous Chief Executive Officer
of JetPay Payments, TX. The terms of the lease which expired on January 31, 2016 were commercial. Occupancy continues on a month-to-month
basis. Rent expense was $12,000 and $11,000 for the three months ended March 31, 2017 and 2016, respectively.
In connection with the closing of the Company’s acquisition
of JetPay Payments, TX, 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 issued a promissory note in the amount of $2,331,369 in favor of WLES. Interest accrued on amounts due under the note
at a rate of 5% per annum, and is payable quarterly. Interest expense was $0 and $29,000 for the three months ended March 31, 2017
and 2016, respectively. Under the terms of the WLES Settlement Agreement, WLES transferred the WLES Note and related accrued interest
to Merrick. See
Note 11. Commitments and Contingencies
.
On August 22, 2013, JetPay Payments, TX 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 revenue earned from JetPay Solutions,
LTD of $25,000 and $5,000 for the three months ended March 31, 2017 and 2016, respectively.
On June 7, 2013, the Company issued an unsecured promissory
note to Trent Voigt, the then Chief Executive Officer of JetPay Payments, TX, in the amount of $491,693. The note matures on September
30, 2017, as extended by the WLES Settlement Agreement dated July 26, 2016, see
Note 11. Commitments and Contingencies
,
and bears interest at an annual rate of 4% with interest expense of $4,850 recorded for the three months ended March 31, 2016.
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. See
Note 7. Long-Term Debt, Notes Payable and Capital Lease Obligations.
On May 6, 2015, the Company issued an unsecured promissory note
to C. Nicholas Antich, the then President of JetPay HR & Payroll Services, and Carol A. Antich in the amount of $350,000 to
satisfy the remaining balance of the $2.0 million deferred consideration. The promissory note bore interest at an annual rate of
4% and was scheduled to mature on May 6, 2017, payable in two equal installments of $175,000, with the first paid on May 6, 2016
and the second due on May 6, 2017. The promissory note was paid in full on December 31, 2016. Interest expense related to this
promissory note was $3,600 for the three months ended March 31, 2016. The promissory note was approved upon resolution and review
by the Company’s Audit Committee of the terms of the promissory 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.
On December 22, 2015, the Company entered into securities purchase
agreements (the “Insider Common Stock SPAs”) with each of certain investors, including Bipin C. Shah, its Chairman
and then Chief Executive Officer, Robert B. Palmer, Director and Chair of the Audit Committee, and Jonathan M. Lubert, Director.
Pursuant to the Insider Common Stock SPAs, Messrs. Shah, Palmer and Lubert each agreed to purchase 20,000 shares, or an aggregate
of 60,000 shares, of the Company’s common stock at a purchase price of $2.70 per share (a price greater than the closing
bid price of the common stock on December 21, 2015, which was the last closing bid price preceding the Company’s execution
of each of the Insider Common Stock SPAs), for aggregate consideration of $162,000, prior to issuance costs.
On January 15, 2016, the Company issued the Promissory Notes
in favor of each of Bipin C. Shah, Jonathan Lubert and Flexpoint. Amounts outstanding under the Promissory Notes accrued interest
at a rate of 12% per annum and carried a default interest rate upon the occurrence of certain events of default, including failure
to make payment under the applicable Promissory Note or a sale of the Company. Interest expense related to the Promissory Notes
was $177,000 for the year ended December 31, 2016. The maturity date of the Promissory Notes was extended to July 31, 2016 through
an extension executed on April 11, 2016. On July 26, 2016, Jonathan Lubert and Flexpoint agreed to further extend their Promissory
Notes to September 30, 2016 or the occurrence of an event of a default that is not properly cured or waived. Additionally, Flexpoint
increased the principal amount of its expiring Promissory Note from $1,000,000 to $1,400,000, the proceeds of which increase were
used to pay off the outstanding balance of the promissory note issued to Bipin C. Shah due on July 31, 2016. Finally, on September
30, 2016, Jonathan Lubert and Flexpoint agreed to further extend their Promissory Notes to October 31, 2016. The promissory notes
in favor of Mr. Lubert and Flexpoint were paid in full on October 21, 2016
.
Finally, on October 18, 2016, the Company entered into the amended
and restated Series A Purchase Agreement with Flexpoint and Sundara, a Delaware limited liability company wholly-owned by Laurence
Stone. Pursuant to the amended and restated Series A Purchase Agreement, Sundara acquired 33,667 shares of Series A Preferred for
$10.1 million. In connection with the Company’s entry into the amended and restated Series A Purchase Agreement, Mr. Stone
was appointed as a director of the Company by holders of Series A Preferred shares. In addition, on October 18, 2016, the Company
entered into a loan and security agreement with JetPay HR & Payroll Services and PTFS, as borrowers, the Company and JetPay
Payments, FL, as guarantors, and LHLJ, Inc., an entity wholly-owned by Laurence Stone, as lender. Pursuant to the loan and security
agreement, LHLJ, Inc., LHLJ, Inc. provided JetPay HR & Payroll Services and PTFS a term loan of $9.5 million. The loan carries
an interest rate of 8% and matures on October 18, 2021. Interest expense related to this promissory note was $186,000 for the three
months ended March 31, 2017. In connection with the parties’ entry into the loan and security agreement, the borrowers paid
LHLJ, Inc. a non-refundable closing fee of $190,000.
Note 13. Segments
The Company currently operates in two business segments, the
JetPay 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 JetPay HR and Payroll 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 JetPay Card Services was included
in JetPay HR and Payroll for the three months ended March 31, 2017 and in Corporate for the three months ended March 31, 2016 in
the tables below.
|
|
For the Three months ended March 31, 2017
|
|
|
|
JetPay Payment Services
|
|
|
JetPay HR & Payroll Services
|
|
|
General/ Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Processing revenues
|
|
$
|
14,304
|
|
|
$
|
4,638
|
|
|
$
|
-
|
|
|
$
|
18,942
|
|
Cost of processing revenues
|
|
|
10,342
|
|
|
|
2,243
|
|
|
|
-
|
|
|
|
12,585
|
|
Selling, general and administrative expenses
|
|
|
2,628
|
|
|
|
1,494
|
|
|
|
834
|
|
|
|
4,956
|
|
Change in fair value of contingent consideration liability
|
|
|
-
|
|
|
|
-
|
|
|
|
74
|
|
|
|
74
|
|
Amortization of intangibles and depreciation
|
|
|
783
|
|
|
|
321
|
|
|
|
1
|
|
|
|
1,105
|
|
Other expenses
|
|
|
91
|
|
|
|
214
|
|
|
|
22
|
|
|
|
327
|
|
Income (loss) before income taxes
|
|
$
|
460
|
|
|
$
|
366
|
|
|
$
|
(931
|
)
|
|
$
|
(105
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total property and equipment, net
|
|
$
|
1,714
|
|
|
$
|
528
|
|
|
$
|
31
|
|
|
$
|
2,273
|
|
Property and equipment additions
|
|
$
|
323
|
|
|
$
|
53
|
|
|
$
|
3
|
|
|
$
|
379
|
|
Intangible assets and goodwill
|
|
$
|
57,758
|
|
|
$
|
16,436
|
|
|
$
|
-
|
|
|
$
|
74,194
|
|
Total segment assets
|
|
$
|
124,554
|
|
|
$
|
86,853
|
|
|
$
|
2,617
|
|
|
$
|
214,024
|
|
|
|
For the Three months ended March 31, 2016
|
|
|
|
JetPay Payment Services
|
|
|
JetPay HR & Payroll Services
|
|
|
General/ Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Processing revenues
|
|
$
|
7,333
|
|
|
$
|
4,295
|
|
|
$
|
15
|
|
|
$
|
11,643
|
|
Cost of processing revenues
|
|
|
5,291
|
|
|
|
2,070
|
|
|
|
39
|
|
|
|
7,400
|
|
Selling, general and administrative expenses
|
|
|
1,703
|
|
|
|
1,319
|
|
|
|
785
|
|
|
|
3,807
|
|
Change in fair value of contingent consideration liability
|
|
|
-
|
|
|
|
-
|
|
|
|
46
|
|
|
|
46
|
|
Amortization of intangibles and depreciation
|
|
|
571
|
|
|
|
339
|
|
|
|
2
|
|
|
|
912
|
|
Other expenses
|
|
|
151
|
|
|
|
73
|
|
|
|
206
|
|
|
|
430
|
|
(Loss) income before income taxes
|
|
$
|
(383
|
)
|
|
$
|
494
|
|
|
$
|
(1,063
|
)
|
|
$
|
(952
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total property and equipment, net
|
|
$
|
1,398
|
|
|
$
|
512
|
|
|
$
|
33
|
|
|
$
|
1,943
|
|
Property and equipment additions
|
|
$
|
119
|
|
|
$
|
24
|
|
|
$
|
-
|
|
|
$
|
143
|
|
Intangible assets and goodwill
|
|
$
|
47,383
|
|
|
$
|
17,474
|
|
|
$
|
-
|
|
|
$
|
64,857
|
|
Total segment assets
|
|
$
|
78,250
|
|
|
$
|
90,252
|
|
|
$
|
1,017
|
|
|
$
|
169,519
|
|
Note 14. Subsequent Events
As previously disclosed on a Form 8-K filed with the SEC on
April 13, 2017, in connection with the purchase by Flexpoint of 8,333 shares of Series A Preferred on August 9, 2016 and the purchase
by Sundara of 33,667 shares of Series A Preferred on October 18, 2016, Wellington exercised its option to purchase the remaining
2,835 shares of Series A-1 Preferred available for purchase under the Series A-1 Purchase Agreement. The proceeds for the sale
were $850,500,which amount will be used for general working capital purposes. See
Note 8. Redeemable Convertible Preferred Stock
.
On May 2, 2017, a trial took place in the District Court of
Colin County, Texas during which the Court entered an indication in favor of Ten Lords in the amount of $793,000 plus attorney’s
fees, estimated at $115,000. JetPay intends to dispute the amount of any request for judgement by Ten Lords. At this time,
the Company cannot reasonably estimate the amount of any final potential loss on this matter. Additionally, there is no certainty
JetPay will prevail in its dispute of the amount of any judgement, or the likelihood of success of any appeal, should JetPay decide
to appeal a judgement once it is rendered. The Company estimates that the range of loss on this matter is between $0 and
$793,000, plus attorney’s fees estimated at $115,000.
As previously disclosed on a Form 8-K filed with the SEC on
May 11, 2017, Robert B. Palmer, a member of JetPay’s Board of Directors, passed away on May 7, 2017. Mr. Palmer joined the
Company’s Board as a founding director in February 2011. Mr. Palmer, an independent director, served as Chairman of the Audit
Committee and a member of the Compensation Committee and the Nominating Committee at the time of his passing. The Board of Directors
intends to identify candidates to replace Mr. Palmer on the Board of Directors of the Company and the Audit Committee.