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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2002

Commission file number 000-25959

Private Business, Inc.

(615) 221-8400

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

(1)   Yes   [x]   No [  ]

(2)   Yes   [x]   No [  ]

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

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PRIVATE BUSINESS, INC.

Form 10-Q

For Quarter Ended September 30, 2002

INDEX

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PRIVATE BUSINESS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS — UNAUDITED

The accompanying notes are an integral part of these consolidated financial statements.

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PRIVATE BUSINESS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS — UNAUDITED
For the Three Months Ended September 30, 2002 and 2001

The accompanying notes are an integral part of these consolidated financial statements.

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PRIVATE BUSINESS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS — UNAUDITED
For the Nine Months Ended September 30, 2002 and 2001

The accompanying notes are an integral part of these consolidated financial statements.

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PRIVATE BUSINESS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS — UNAUDITED
For the Nine Months Ended September 30, 2002 and 2001

The accompanying notes are an integral part of these consolidated financial statements.

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PRIVATE BUSINESS, INC.

Notes to Consolidated Financial Statements — Unaudited

A. Basis of Presentation

     The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and in accordance with Rule 10-01 of Regulation S-X.

     In the opinion of management, the unaudited interim financial statements contained in this report reflect all adjustments, consisting of only normal recurring accruals, which are necessary for a fair presentation of the financial position, and the results of operations for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year.

     These consolidated financial statements, footnote disclosures and other information should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2001.

B.  Summary of Significant Accounting Policies

Principles of Consolidation

     The accompanying financial statements include the accounts of Private Business, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

     Our other significant accounting policies include self-insurance reserves, income taxes, software development costs, acquisition accounting, intangible asset impairment evaluation, and revenue recognition. Please refer to our Annual Report on Form 10-K for the year ended December 31, 2001 for a more detailed description of these accounting policies.

C.  Acquisition of Access Retail Management

     On May 28, 2002, the Company entered into an asset purchase agreement to acquire certain operating assets of CAM Commerce’s (“CAM”) retail planning division, known as Access Retail Management, in exchange for cash consideration of $800,000. The acquisition has been recorded in accordance with SFAS No. 141, Business Combinations (“SFAS No. 141”), resulting in the operating results of the CAM division being included with those of the Company subsequent to the date of acquisition. The Company has completed its initial allocation of purchase price, resulting in identifiable intangible assets of approximately $220,000 and goodwill of approximately $570,000.

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D.  Sale of Company Headquarters and Other Properties

     During the quarter ended March 31, 2002, the Company sold its former headquarters building and consolidated its operations into the Technology and Business Center, which is adjacent to the former headquarters building. The net proceeds from the sale were approximately $2.2 million. During the third quarter of 2001, the Company recorded an impairment charge of $4.1 million to write down the headquarters building, land and fixtures to their estimated fair market value of approximately $2.0 million. Therefore the sale in March 2002 resulted in a net gain of approximately $200,000 being recorded in the first quarter of 2002, which is included in other operating expense, net in the accompanying consolidated statement of operations. During the quarter ended September 30, 2002, the Company sold the headquarters of its retail planning services division (“RMSA”) in Riverside, California, which had been acquired by the Company as part of the Towne acquisition. There was no gain or loss recorded from the sale, as the sales price of approximately $645,000, was equal to the recorded net book value of the property.

E.  Merger, Stock Split and Stock Options

     On August 9, 2001, the Company completed a merger of Towne Services, Inc. (“Towne”) into Private Business, which was accounted for as a purchase in accordance with SFAS No. 141. The merger was consummated by Towne shareholders exchanging all of their issued and outstanding common and preferred shares for Private Business common and preferred shares, respectively, at the conversion rate of .9087 shares of the Company’s common stock for one share of Towne common stock. The Company also assumed all stock option plans of Towne that existed as of the acquisition date using the same conversion rate noted above, resulting in the exchange of approximately 963,000 Private Business common stock options. The estimated value of these stock options, using the Black-Scholes option pricing model, of approximately $1.3 million has been recorded as a component of the purchase price. The assumptions used to value these options were; a risk-free interest rate range of 3.37% to 4.88%, an expected dividend yield of 0%, an expected volatility of 75% and an average expected life of 3.5 years. As a result of the merger, Private Business’ shareholders own 67% of the outstanding shares of the new combined entity. In conjunction with the merger agreement, a one for three reverse stock split of the Company’s common stock occurred before exchanging the Company’s common shares for the Towne common shares and common share equivalents. All shares and per share amounts in these consolidated condensed financial statements have been restated for the effect of the reverse stock split.

F.  Net Income (Loss) Per Share

     Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common and

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common equivalent shares outstanding during the period, which includes the additional dilution related to conversion of stock options as computed under the treasury stock method and the conversion of the preferred stock under the if-converted method for the quarter and nine months ended September 30, 2002.

     The following table represents information necessary to calculate earnings per share for the three and nine-month periods ended September 30, 2002 and 2001:

     For the nine months ended September 30, 2002 and 2001, approximately 2.4 million and 2.0 million employee stock options were excluded from diluted earnings (loss) per share calculations, as their effects were anti-dilutive.

G.  Comprehensive Income (Loss)

     Comprehensive income (loss) for the three and nine months ended September 30, 2002 and 2001 was comprised solely of net income (loss).

H.  Chief Executive Officer Change, Severance and Option Grants

     On February 1, 2001, the Company announced the departure of its then current Chief Executive Officer (“CEO”) and the hiring of a new CEO. The former CEO, as part of his employment and severance agreement, was entitled to a severance payment of $315,000, which was paid and expensed by the Company in February 2001. The former CEO served as a consultant for one year from the date of termination. As part of his consulting agreement, the former CEO was granted options to purchase 100,000 shares of the Company’s common stock at $3.75 per share, the fair market value as of that date. Options to purchase 66,667 of the shares vested ratably each month from February 2001 to January 2002, while the remaining 33,333 shares vested ratably each month from July 2001 to January 2002. The options expire 10 years from the date of the grant. The fair value of these options of approximately $288,000 has been calculated in accordance with SFAS No. 123, using a risk-free rate of 5.10%, an expected dividend yield of 0% and an expected volatility of 75%. This fair value was expensed to general and administrative expense over the vesting period ($264,000 in 2001 and $24,000 in 2002). Approximately $24,000 and $192,000 were expensed for the first nine months of 2002 and 2001, respectively.

     On August 13, 2001, the Company finalized an employment agreement with the new CEO, which included restricted stock in lieu of salary and stock options. According to the agreement, the CEO was awarded 43,608 shares of restricted common stock in lieu of

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of cash compensation for 2001. The shares vested 1/11th per month for 2001 and the related compensation expense was recorded as the shares vested. The CEO has opted for cash compensation in 2002. The CEO was also granted options to purchase 333,333 shares of the Company’s common stock. Options to purchase 166,667 shares vested immediately and are exercisable at $3.00 per share, while the remaining 166,666 shares vest ratably each month February 2001 to January 2005, of which 83,333 shares are exercisable at $12.00 per share and 83,333 shares are exercisable at $18.00 per share. The options expire 10 years from the date of the grant.

I.  Bank Covenants

     The Company’s credit facility is secured by a pledge of all Company assets and imposes financial covenants and requirements and contains limitations on the Company’s ability to sell material assets, redeem capital stock and pay dividends, among other actions. As of September 30, 2002, the Company was not in compliance with the Minimum EBITDA financial covenant contained in the credit agreement. On November 19, 2002, the Company obtained a waiver for this incidence of non-compliance and entered into an amendment dated September 30, 2002 to its credit facility to modify certain restrictive financial covenants for the fourth quarter of 2002 and all of 2003. The amendment also includes reductions in revolving credit availability and capital expenditure levels for future periods, as well as, an increase to the interest rate margin grid of 25 basis points on all outstanding debt obligations. In effect, the Company will pay higher interest rates on its outstanding debt until its leverage ratio declines to specified levels at which time the interest rate margin grid returns to the margins in effect prior to this latest amendment.

J.  Legal Proceedings

     As a result of the merger with Towne, we assumed certain outstanding litigation against Towne. Except for the lawsuits described below, we are not currently a party to, and none of our material properties is currently subject to, any material litigation.

	1.      As previously disclosed, Towne, two of its former officers and a current officer are defendants in a securities class action lawsuit filed in November 1999. No class has yet been certified. The complaints allege, among other things, that Towne should have disclosed in the prospectus used for its secondary public offering in June 1999 that it allegedly experienced serious problems with its network infrastructure and processing facilities during the move of its corporate headquarters in June 1999, and that these problems allegedly led to a higher than usual number of customers terminating their contracts during the second quarter. The Parties reached a Settlement Agreement on July 29, 2002 at informal settlement negotiations in Atlanta and anticipate filing a Memorandum of Understanding with the Court after final approval by the insurance carriers. The Settlement Agreement will also need final approval by the Court, and counsel for Defendants estimate it will take a minimum of twelve months for the Court to approve all substantive issues related to the class-action settlement.
	2.      Another lawsuit arises out of Towne’s acquisition of Banking Solutions, Inc. (“BSI”) through a stock purchase made by its subsidiary, BSI Acquisition Corp., in December 1998. Plaintiff Edward Sullivan, Jr. was employed by BSI. Sullivan alleges, among other things, that he had a buy-out agreement with BSI and certain BSI shareholders under which, in certain circumstances, Sullivan was to receive a commission based on the gross sales price paid by any purchaser of BSI. Sullivan

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	contends that BSI and the other shareholders allegedly fraudulently induced him to release them from the agreement by fraudulently misrepresenting the gross sales price paid by Towne Services’ subsidiary in the stock purchase. Sullivan contends that Towne Services is liable to him as the successor to BSI, and also for allegedly tortiously interfering with the agreement. Sullivan also contends Towne Services conspired with the other defendants to misrepresent the “gross purchase price.” We deny all allegations of the petition. Mr. Sullivan and his wife seek an unspecified amount of damages including a percentage of the gross sales price paid by Towne Services’ subsidiary for the acquisition of BSI, as well as punitive damages, attorneys’ fees, and pre-judgment and post-judgment interest. On July 15, 2002, the District Court of Collin County, Texas granted our motion for summary judgment on all claims. The Plaintiffs failed to exercise any right to appeal. We contend that we are entitled to indemnification from the BSI shareholders for our expenses in defending this action. Specifically, the BSI stock purchase agreement provides that the BSI shareholders will indemnify us against any claims, damages, liabilities, costs and expenses (including reasonable attorneys’ and accountants’ fees and expenses) we suffer that arise out of any breach of the representations made by BSI in the agreement, provided that the aggregate amount of all such claims, etc. exceeds $100,000. It is anticipated that legal action will ensue to enforce the provisions of the indemnification clause of the BSI stock purchase agreement.
	3.      Towne Services, Inc. has also sought relief in the U.S. District Court, Southern District of Mississippi in a companion case. Towne Services, Inc., and Banking Solutions, Inc. v. The Merchants Financial Services Group, LLC d/b/a Merchants Financial Services; AmFed Companies, LLC; Clipper Technologies, LLC; The Clipper Group, Inc.; and Prominent Technologies, LLC. This case was filed on July 24, 2001, and is an action for copyright infringement under the Copyright Act of 1976, 17 U.S.C. § 101, et seq., and related claims of misappropriation of trade secrets and tortuous interference with contractual relations. The suit alleges that former customers of Towne Services (a Mississippi bank and an affiliated insurance company) have developed and are using and marketing a software program, A/R Navigator, that is an improper copy of and a misappropriation of trade secrets in the Company’s Cash Flow Manager. It also alleges that several former employees of the Company (the Clipper Group) are marketing the copied service to banks including customers of the Company. Towne Services, Inc. has requested an independent comparison of the Cash Flow Manager software and the A/R Navigator software. At this point, it is anticipated that settlement negotiations between the parties will commence by December 31, 2002.

The Company is subject to various other legal proceedings, tax matters and other claims which arise in the ordinary course of business. In the opinion of management, the amount of any ultimate liability with respect to these actions will not materially affect the financial position or results of operations of the Company.

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K. Segment Information

     Prior to August 2001, the Company operated in one business segment, accounts receivable financing. As a result of the Company’s merger with Towne in August 2001, it now operates in a second business segment, retail inventory forecasting. The Company accounts for segment reporting under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. Since the Company operated in one business segment prior to 2001, prior year segment information is not presented. No corporate overhead costs or interest have been allocated to income (loss) before taxes and extraordinary item of the retail inventory forecasting segment, but are included in the accounts receivable financing segment costs.

The following table summarizes the financial information concerning the Company’s reportable segments from continuing operations for the three and nine months ended September 30, 2002 and 2001. The retail inventory forecasting segment only includes results subsequent to August 9, 2001, the merger date.

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L.  New Accounting Pronouncements

     On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). SFAS No. 142 supercedes Accounting Principles Board Opinion No. 17, Intangible Assets, and addresses how intangible assets and goodwill should be accounted for upon and after their acquisition. Specifically, goodwill and intangible assets with indefinite useful lives will not be amortized, but will be subject to impairment tests based on their estimated fair value. Upon adoption, the Company ceased amortization of goodwill totaling $4.1 million, which was previously being amortized over a 20-year period. For the nine months ended September 30, 2002, this resulted in a reduction of amortization expense of approximately $156,000.

The following table shows the results for the three and nine-month periods ended September 30, 2002 and 2001, as if the Company had followed SFAS No. 141 for all periods presented:

The recorded goodwill is subject to annual impairment evaluations by the Company, which could result in possible write-downs in future periods if impairments are determined. The Company completed its initial transitional goodwill impairment review in accordance with

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SFAS No. 142 during June of 2002. Based on the Company’s evaluation, there was no impairment of goodwill as of January 1, 2002.

     Also during the second quarter of 2002, the Company obtained an independent third-party appraisal to determine the estimated fair value of the intangible assets acquired in conjunction with the Towne acquisition. As a result, the Company recorded an adjustment to the opening balance sheet of Towne to record additional intangible assets of $1,480,000 and a corresponding reduction to goodwill. In accordance with SFAS No. 142 the Company also recorded amortization expense associated with these intangibles totaling approximately $230,000 during the second quarter, of which, approximately $161,000 relates to prior periods. Therefore, as of June 30, 2002, the net book value of the identified intangible assets of approximately $1,250,000 is stated as if the Company had recorded and amortized those intangible assets beginning August 9, 2001.

     In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This statement replaces SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (“SFAS No. 121”). However, it retains the fundamental provisions of SFAS No. 121 for recognition and measurement of the impairment of long-lived assets to be held and used and for measurement of long-lived assets to be disposed of by sale. This statement applies to all long-lived assets, including discontinued operations, and replaces the provisions of APB Opinion No. 30, Reporting Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, for the disposal of segments of a business. This statement requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. The Company was required to adopt this statement on January 1, 2002, which did not have any impact on its results of operations, financial position and cash flows.

     In August of 2002, the FASB issued SFAS No. 145, Recission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This statement rescinds Statement No. 4, which required all material gains and losses from extinguishment of debt to be classified as an extraordinary item, net of related income tax effects. Upon adoption of this statement, extinguishment gains and losses will be classified as ordinary gains and losses in the income statement. The statement is effective for fiscal years beginning after May 15, 2002, resulting in it being effective for the Company on January 1, 2003. The Company does not expect adoption of this statement to have any impact on its results of operations, financial position and cash flows, however, certain extinguishment losses reflected as extraordinary items in prior periods will be reclassified to ordinary expenses.

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PRIVATE BUSINESS, INC.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
Three and Nine Months Ended September 30, 2002 and 2001

Overview

     We are a leading provider of solutions that enable community banks to manage accounts receivable financing provided to their small business customers. Our solution is called Business Manager, and is based on software, marketing, and online electronic transaction processing services. One element of Business Manager is our proprietary software, which enables our network of client banks to purchase accounts receivable from their small business customers. The banks then process, bill and track those receivables on an ongoing basis. As a major component of our program, we work with client banks to design, implement and manage the sale of Business Manager accounts receivable financing services to their small business customers. We also give our client banks the option of outsourcing to us their application hosting and transaction processing in our Technology and Business Center. Through our subsidiary, Retail Merchandising Service Automation, (“RMSA”), we also provide merchandising forecasting information and consulting services to customers in the retail industry.

     On August 9, 2001, we completed a merger with Towne Services, Inc. (“Towne”) into Private Business. The merger was structured as a tax-free exchange of approximately 4.6 million shares of our common shares valued at approximately $13.2 million for all the issued and outstanding Towne common shares and common share equivalents and the issuance of approximately 963,000 common stock options valued at $1.3 million to replace all of the issued and outstanding Towne common stock options. Also, as a condition of the merger, on August 9, 2001, we issued 40,031 shares of Series B Convertible preferred stock valued at approximately $114,000 in exchange for all the issued and outstanding Towne Series B preferred stock. The merger was accounted for as a purchase in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations. As a result of the merger, Private Business’ shareholders own approximately 67% of the outstanding shares of the combined entity. In conjunction with the merger agreement, a one for three reverse stock split of our common stock occurred prior to the exchange of our common shares for the Towne common shares and common share equivalents.

     As a result of the merger, we began supporting Towne products, although from a business and operations standpoint our approach to the Towne merger has been to transition Towne banks and merchants to our Business Manager program. Historically, Towne provided services and products that process electronically sales and payment information and related financing transactions for businesses and banks in the United States. Towne delivers these services and products online via an electronic hub, or gateway, that links business and bank customers with the company and other providers of products

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and services that can benefit these customers. Revenues are generated through the deployment and use of three primary products: Towne Credit®, which processes consumer credit transactions for small and medium-sized businesses; Towne Finance® and Cash Flow Manager^SM, which process business-to-business credit transactions for commercial businesses; and RMSA® Merchandise Planning service, which processes sales and inventory transactions and provides merchandise forecasting information for specialty retail stores; and ancillary services related to these products. From an operations standpoint, RMSA has remained a distinct business unit since the merger in August 2001.

     We generate revenue from four main sources:

	•		participation fees earned on client bank purchases of small business accounts receivable.
	•		software license fees from new client banks.
	•		retail planning services.
	•		maintenance fees and other revenues, comprised primarily of fees received for insurance brokerage services, paper-based form sales, software maintenance, medical, leasing and processing services.

     There are two types of participation fees. The first type is earned upon the client bank’s initial purchase of a small business’ accounts receivable during the first 30 days in our program. The second type is an ongoing participation fee earned from subsequent period purchases. Both types of fees are based on a percentage of the receivables that a client bank purchases from its small business customers during each month. The second type of fee is a smaller percentage of the ongoing receivables purchased. Participation fees are recognized as earned.

     Software license fees for Business Manager consist of two components: the license fee and customer training and support fee. These are one-time fees that we receive upon the initial licensing of our Business Manager program to a community bank. Our license agreements are executed with terms ranging from three to five years, and are renewable for subsequent terms. Some agreements contain performance or deferred payment terms that must be met in order for us to receive payment and recognize revenue. We recognize revenues from the license fee once we have met the terms of the customer agreement. The customer training and support fee are recognized ratably over the twelve-month service period subsequent to the activation of the license agreement. Software license fees for Towne products include set-up fees for installation, implementation and training of bank and business customers. All revenues from Towne software license fees are recorded on a deferred basis over the estimated life of the contract term and for certain cancellation clauses and/or return guarantees until the guarantee period is expired. Software license fees for the Towne products charged to each bank vary depending on the asset size of the bank and the number of communities served. Set-up fees are also charged to business customers based either upon a flat rate or upon the expected transaction volume.

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     Retail planning services revenue is generated from fees charged primarily for providing inventory merchandising and forecasting information for specialty retail stores; and ancillary services related to these products. RMSA uses a proprietary software to process sales and inventory transactions and provide the merchandising forecasting information. During the second quarter of 2002, we completed a strategic acquisition of certain operating assets of CAM Commerce’s retail planning division, known as Access Retail Management, which operates in the same niche market as RMSA. We recognize revenues as the transactions occur and merchandising and forecasting services are performed.

     Maintenance fees and other revenues include several ancillary products and services we provide to client banks. Annual software maintenance fees are generated from our client banks starting on the first anniversary date of the Business Manager license agreement and annually thereafter. These revenues are recognized ratably over a twelve-month period beginning on the first anniversary date of the agreement. Additionally, since 1995, we have brokered, through our Private Business Insurance subsidiary, credit and fraud insurance products from a national insurance company. We earn fees based on a percentage of the premium that is paid to the insurance company. We also provide a standard set of forms that client banks may purchase and use in the normal course of administering the Business Manager program. Revenues related to these forms are recognized in the period that they are shipped to the client bank. We also offer processing services to our client banks for an additional fee, based on the volume of transactions processed through the system. We also have some industry-focused applications for the medical and dental markets. Monthly transaction processing fees include charges for electronic processing, statement rendering and mailing, settling payments, recording account changes and new accounts, leasing and selling point of sale terminals, telephone and software support services, rental fees and collecting debts.

     In previous filings we have discussed that part of our growth strategy is to acquire or develop new products or services. We are initiating development activities in two areas. One is a new program, similar to our Business Manager accounts receivable financing management product, that will eventually allow banks to offer commercial insurance products, including property, general liability and workers compensation, to their business customers in a very competitive and cost-effective manner. With over 350 large banking organizations having acquired insurance brokerage firms in recent years, we anticipate that this product will allow community banks to be more competitive. During the three months ended September 30, 2002, we executed two contracts with banks to participate in this program.

     Another project is the development of a software product called LineManager (“LM”), for commercial banks that would allow them to electronically monitor their conventional line of credit loans directly from their borrowers’ accounting system. The majority of commercial banks do not have the capability to routinely monitor their collateral for working capital lines of credit. This fact, along with credit officers and bank regulators expressing concern over the deteriorating credit conditions in the current

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economy, have led many of our banking clients to request a product of this type for their secured loans. Our system, which is currently in beta testing, should allow our client banks to monitor loans in a manner similar to the way large financial institutions monitor their asset based loans but on an ASP (Application Service Provider) basis with no additional labor impact for the bank. Currently, we have executed contracts with three banks to participate in the beta testing of this new product.

Results of Operations

     The following table sets forth, for the periods indicated, the percentage relationships of the identified consolidated statements of operations items to total revenue.