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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
|X|Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2002
OR
|_| Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Commission File No. 0-30152
BILLSERV, INC.
(Exact name of registrant as specified in its charter)
Nevada 98-0190072
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
211 North Loop 1604, Suite 200, San Antonio, Texas 78232
(Address of principal executive offices, including Zip Code)
(210) 402-5000
(Registrant's telephone number, including area code)
Securities registered pursuant to section 12(b) of the Act: None
Securities registered pursuant to section
12(g) of the Act:
Common Stock, par value $.001 per share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in part III of this Form 10-K or any amendment to this
Form 10-K. |_|
The aggregate market value of common stock held by non-affiliates of the
registrant as of March 17, 2003, was $3,212,012. As of March 17, 2003,
20,722,656 shares of the registrant's common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement for the Registrant's Annual Meeting
of Stockholders to be held May 29, 2003, or as soon as practicable thereafter,
are incorporated by reference in Part III of this Report.
BILLSERV, INC.
FORM 10-K
For the Year Ended December 31, 2002
INDEX
Page
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PART I
Item 1. Business ...................................................................... 3
Item 2. Properties ....................................................................11
Item 3. Legal Proceedings .............................................................11
Item 4. Submission of Matters to a Vote of Security Holders ...........................11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters .........12
Item 6. Selected Financial Data .......................................................13
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations .........................................................14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ....................26
Item 8. Financial Statements and Supplementary Data ...................................27
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure ..........................................................45
PART III
Item 10. Directors and Executive Officers of the Registrant ............................46
Item 11. Executive Compensation ........................................................46
Item 12. Security Ownership of Certain Beneficial Owners and Management ................46
Item 13. Certain Relationships and Related Transactions ................................46
Item 14. Controls and Procedures .......................................................47
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ..............48
Signatures ..............................................................................49
Certifications ..........................................................................50
FACTORS THAT MAY AFFECT FUTURE RESULTS
This Annual Report on Form 10-K and the documents incorporated herein by
reference contains certain forward-looking statements within the meaning of the
Federal Securities Laws. Specifically, all statements other than statements of
historical facts included in this Annual Report on Form 10-K regarding our
financial performance, business strategy and plans and objectives of management
for future operations are forward-looking statements and based on our beliefs
and assumptions. If used in this report, the words "anticipate," "believe,"
"estimate", "expect," "intend," and words or phrases of similar import are
intended to identify forward-looking statements. Such statements reflect the
current view of the Company with respect to future events and are subject to
certain risks, uncertainties, and assumptions, including but without limitation,
those risks and uncertainties contained in the Risk Factors section of Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, of this Annual Report on Form 10-K. Although we believe that our
expectations are reasonable, we can give no assurance that such expectations
will prove to be correct. Based upon changing conditions, any one or more of
these events described herein as anticipated, believed, estimated, expected or
intended may not occur. All prior and subsequent written and oral
forward-looking statements attributable to the Company or persons acting on its
behalf are expressly qualified in their entirety by this cautionary statement.
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PART I
ITEM 1. BUSINESS
All references to "we," "us," "our," "Billserv" or the "Company" in this Annual
Report on Form 10-K mean Billserv, Inc. and its consolidated subsidiaries. All
references to "billers", "billing customers" or "customers" in this Annual
Report on Form 10-K mean the companies that have contracted with us to receive
services from us. All references to "consumers" in this Annual Report on Form
10-K mean the persons that are receiving bills from companies, including the
companies that are billing customers of Billserv.
General
Billserv provides Electronic Bill Presentment and Payment ("EBPP") and related
services to companies that generate recurring paper-based bills. EBPP is the
process of sending bills to consumers securely through the Internet and
processing Internet payment of bills utilizing an electronic transfer of funds.
Our service offering allows companies to outsource their electronic billing
process, providing them a single point of contact for developing, implementing
and managing their EBPP process. Billserv offers services to consolidate billing
information and then securely deliver an electronic bill to the biller's own
Billserv-hosted payment Web site, the consumer's e-mail inbox and numerous
Internet bill consolidation Web sites, such as those sponsored by financial
institutions. Our EBPP services allow billers to establish an interactive,
online relationship with their consumers by integrating Internet customer care
and direct marketing with the electronic bill. We provide professional services
to assist with the implementation and maintenance of an electronic bill
offering. In addition, we offer consumer marketing support to assist billers in
encouraging their consumers to switch from paper to electronic billing.
Billserv generates revenue by charging volume-based fees fixed under long-term
contracts for transactions processed through its system, such as loading,
delivering, viewing and paying bills, customer care interactions, handling
payment returns and consolidating remittances. In certain instances, Billserv
receives a fixed amount per e-bill delivered and made available to consumers
regardless of whether they pay the e-bill using our services. Billserv also
typically receives an up-front fee from a customer to cover the initial basic
implementation of the contracted services. Billserv charges customers that
contract for professional consulting services on a time and materials basis and
charges license fees for the use of its proprietary gateway services technology
and the CheckFree iSolutions software that is resold by Billserv as an
authorized reseller in Australia only.
Our service offerings are supported by our systems infrastructure that
integrates certain proprietary components with third party hardware and software
platforms to offer our customers a scalable, branded and secure EBPP process.
Our systems infrastructure utilizes IBM Netfinity file servers for processing
and stores critical billing data on Network Appliance F760 external disk arrays.
The operating software architecture of our system combines Microsoft Windows NT
with IBM's DB2 database management system. We license software from CheckFree
iSolutions, Inc. that we use to parse the detail of our customers' billing data
print streams and create the electronic bill to be presented and also license
software from ACI Worldwide that allows us to securely deliver electronic bills
via e-mail. We have designed our systems infrastructure so that it is reliable,
flexible, and expandable to meet growth demands without significant cost or
changes. Our systems infrastructure allows us to work with our customers to
build a customized EBPP service offering tailored to their specific needs.
We currently market our services through both direct sales efforts and
organizations that resell our services to their customers and prospects. As of
December 31, 2002, we have signed 119 billers, of which 106 are in a full
production environment which means that the electronic billing services being
provided are available to their target consumers and 13 are in various stages of
implementation which means that the electronic billing product is still being
developed and is not yet ready for general release to the billers' consumers.
During 2002, 2001 and 2000, Billserv processed approximately 3,603,000,
2,045,000 and 448,000 electronic bill presentments, respectively, for its
billing customers. We processed our first transactions for billing customers
during the fourth quarter of 1999 so the number of transactions processed in
1999 was insignificant. Billserv's customers include companies operating in the
insurance, student loan financing, utilities, waste management,
telecommunications, media and cable industries. The Company was founded in July
1998 and is incorporated in the State of Nevada. Billserv operates primarily in
the United States as a single operating segment, although it also operates in
Australia and Canada on a limited basis. Foreign operations began in 2000;
however, the impact financially of expanding internationally is not significant
as of December 31, 2002.
Industry Background
As a paper-based process, bill presentment and payment are the most regular and
critical functions in which most businesses engage. For many companies,
particularly those generating recurring bills, the bill represents a critical
touch point for maintaining and improving customer loyalty, and a valuable
opportunity to increase revenues through up- and cross-selling. However, the
paper-based bill delivery and payment process is expensive and less efficient
for both businesses and consumers.
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Additionally, paper-based bills are limited in their functionality. The
potential for personalization is limited, and there are few opportunities for
companies to engage in interactive communication with their consumers through
the paper-based bill payment experience.
The majority of paper-based bills are recurring monthly or quarterly invoices
mailed to consumers by communications companies (such as telephone and cable
companies), utilities, newspapers and financial institutions such as banks and
other lenders. Paper bills are prepared either by the company itself or by an
outsourced bill fulfillment vendor. Creating and distributing a paper bill is a
costly, multiple-step process that includes extracting relevant data from the
internal accounts receivable system of the company, organizing the data into a
billing format, printing and separating the bills, inserting the bills into
envelopes, applying postage and mailing the bill to the consumer. Payments
mailed by the consumer must then be received and processed manually by the
biller or its lockbox provider in order to provide remittance information. This
paper bill and payment process is less efficient than electronic bill delivery
and payment, which eliminates or accelerates many of these steps.
Our Market Opportunity
Growth of the Internet and Electronic Commerce
The Internet has emerged as a significant global medium for communication,
information and commerce. Because of the Internet's increasing adoption rate,
businesses have a growing opportunity to conduct commerce and communicate with
their consumers and business partners over the Internet. One of the consequences
of the widespread growth and acceptance of Web use is that consumers are
embracing the ability to conduct financial and other personal business over the
Internet. Accordingly, we believe there is a substantial potential for growth in
EBPP and related services.
The growth in the use of the Internet has also transformed the competitive
landscape in many industries. To remain competitive, many companies are seeking
to leverage the Internet to provide operational efficiencies, create new revenue
opportunities and maximize the longevity and profitability of their customer
relationships. Many companies, particularly those generating recurring
paper-based bills, such as utilities and telecommunications providers, are
increasingly recognizing that an Internet-based offering to the bill presentment
and payment process can serve as the foundation for their broader Internet and
customer relationship management strategies.
These companies currently recognize the bill as the critical touch point for
maintaining and improving their customer relationships as well as providing the
opportunity to increase revenue streams. EBPP enables companies to enhance this
touch point by leveraging the capabilities of the Internet to promote customer
loyalty, provide enhanced customer service, increase control over the critical
billing process, enhance up- and cross-selling opportunities by utilizing the
direct marketing and interactive capabilities of the Internet and improve the
effectiveness of customer marketing by providing real-time market intelligence
on consumers. Companies can also realize significant cost savings by moving to
an electronic billing process from a paper-based system, especially given the
recent trend of steadily rising postal rates.
Challenges for Companies in Adopting EBPP
While companies may recognize the critical role that EBPP will play in their
mission critical Internet and customer relationship management strategies, they
face significant challenges in the development, implementation and management of
their EBPP offering. To execute a successful EBPP strategy, companies should
purchase, successfully implement and maintain:
o Software that enables the company to parse and decode bill data print
streams
o In-house servers that update and display bill content
o Automated clearinghouse software that enables the company to instruct its
bank to electronically debit consumer accounts
o Messaging software that enables the company to communicate with multiple
aggregators
o A dedicated interface with a major bank that enables the company to
receive funds and data through automated clearinghouse transactions
o Lockbox software that enables the company to update internal accounts
receivable files
o Customer support software and technical infrastructure that enables a
company to support the EBPP process with Internet- enabled customer care
In addition, if companies want to be able to provide their consumers with wider
access to their bills, they must make arrangements with multiple EBPP
aggregators, such as CheckFree, Metavante and Mastercard RPPS, or front ends,
such as Internet portals or financial institutions' Web sites that present bills
to consumers in a consolidated manner, and manage those multiple relationships
on an ongoing basis. EBPP aggregators are companies that have access to Web
sites that function as portals to allow multiple bills generated by different
billers to be delivered to and/or paid by consumers that access these sites.
Such aggregators enhance the convenience of payment and management of e-bills
via the Internet for consumers by giving them access to multiple bills at one
secure site versus having to visit multiple biller-specific Web sites to view or
pay each individual bill. Many companies lack the resources, expertise and/or
inclination to develop, implement and manage their own EBPP offering in a
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cost-effective manner. These issues are compounded by the current state of the
EBPP industry, which can be characterized by rapid technological change,
disparate standards and competing business models.
The Billserv Service Offering
Our services provide a comprehensive and cost-effective outsourced offering that
enables any company producing recurring paper-based bills to offer EBPP services
to their consumers and to utilize the electronic delivery and payment of bills
to enhance business and customer relationship management strategies. Our
offering allows our customers to provide EBPP services to their consumers,
support the EBPP process with Internet customer care, and utilize the electronic
delivery and payment of bills to reduce costs, create additional revenue
streams, increase branding opportunities, enhance customer service and provide
competitive differentiation. These service offerings are supported by our
systems infrastructure that integrates certain proprietary components with third
party hardware and software platforms to offer our customers a scalable, branded
and secure EBPP process. By outsourcing the development, implementation and
management of their entire EBPP process, our customers can realize the following
benefits:
o Single Point of Contact - Our services offers a one-stop, comprehensive
and cost-effective outsourced process for our customers' entire EBPP
offering. We become our customers' single point of contact for
implementing, developing and managing their entire EBPP offering.
o Speed to Market - Our services allows our customers to establish an EBPP
offering in as little as 90 days, without diverting critical time and
financial resources from their core competencies. The time-to-market of an
EBPP offering is important to our customers because it enables them to
rapidly address the opportunities presented by electronic delivery and
payment of bills.
o Reduced Capital Requirements and Technology Risk - Outsourcing the design,
development, installation and management of their entire EBPP process
reduces the costs and administrative burden on our customers by
eliminating the need to develop and manage an in-house system and by
capitalizing on our economies of scale and implementation expertise.
o Broad Distribution - Our relationships with multiple EBPP aggregators and
other front-ends enable our customers to publish their bills through
multiple presenters and our Direct Delivery product enables the
presentment of bills straight to the consumer's email inbox. These
distribution channels provide our customers with the ability to offer
their consumers numerous options of where and when to access and pay their
bills.
o Enhanced Customer Service - Our services provide Internet-enabled customer
support for the EBPP process and enables our customers to utilize the
electronic delivery and payment of bills to improve customer retention,
increase customer loyalty and enhance customer relationships.
o Open System Architecture - Our systems infrastructure supports all of the
data standards currently employed by aggregators and front-ends today,
including Open Financial eXchange (OFX), eXtensible Markup Language (XML),
Electronic Data Interchange (EDI) and others. This allows our customers to
present their bills to any Internet bill presenters, regardless of the
standard used.
o Scalability - We use IBM Netfinity line of servers that have the ability
to handle large volumes of transactions with an upward growth path and
clustering technology. Our current infrastructure has excess capacity to
support new billers and increasing transaction volumes.
o Increased Revenue Streams - We believe that our EBPP strategy provides our
customers with the potential for increased revenue opportunities by
leveraging the capabilities of the Internet to support direct marketing
and enable cross- and up-selling opportunities.
o Transparency - Our services are transparent to the consumer at all times,
allowing our customers to maintain and build upon their brand recognition.
o Security - Our services enable our customers to have total control over
their billing data at all times. In addition, we use digital certificates,
data encryption, NT authentication and firewalls to protect billing data.
o Transaction-Based Pricing - Our customers typically pay an up-front fee
that covers basic implementation of the contracted services. After the
customer is in production, we assess transaction-based fees based on the
number of electronic bills presented to and/or paid by their consumers,
depending on the specific services that have been contracted by the
customer. In virtually all cases, these transaction-based fees are
significantly less than the cost to our customers of processing
paper-based bills.
Our Strategy
Our goal is to be the leading outsourced service provider of EBPP and related
services. In order to achieve this goal, we are implementing a strategy
consisting of the following key elements:
Acquire Additional Billing Customers
We believe that establishing a large customer base that distributes a
significant number of recurring paper-based bills is critical to the long-term
success of our business. We intend to continue expanding our customer base,
targeting those companies with a high
5
likelihood of generating significant revenue. We are actively building
relationships with organizations that resell our services to their clients and
prospects. Our partners leverage relationships with existing and prospective
clients, using our EBPP capabilities as a means to retain or obtain new
accounts, as well as enhance profit margins. This strategy allows us to take
advantage of opportunities that arise from the sales activities of our resellers
while expending limited resources on our direct sales efforts.
We qualify potential resellers based on their market orientation, national
presence, account base, and sales capabilities. To date, we have signed
multi-year agreements with several companies that have a national presence to
resell our services on either a direct or referral basis. The reseller
agreements generally provide for either wholesale pricing or commissions based
on referred and qualified sales. If our services are resold on a direct basis,
the reseller receives wholesale pricing from us for our services and negotiates
terms with the biller directly. If our services are resold on a referral basis,
we negotiate terms with the biller directly and the reseller earns a specified
commission. These agreements vary in length from 5 to 7 years and the earliest
expiration of any of these agreements is February 2005. Our reselling partners
are generally leaders in their industries, with a strategic commitment to EBPP
and electronic commerce. We will continue to add select partners when
advantageous to us to expand horizontal and vertical coverage. Our direct sales
staff promotes business with our partners on both the corporate level and a
localized basis. Our direct sales development efforts are coordinated with
resellers to achieve comprehensive coverage of targeted markets.
Positively Influence Consumer Adoption Rates
We believe that the rate at which consumers begin utilizing EBPP services,
commonly referred to as the "consumer adoption rate," is a critical factor to
the long-term success of our business. A major component of our growth strategy
involves not only obtaining additional customers, but also actively assisting
contracted billers in developing a strategy designed to encourage the highest
possible acceptance of EBPP services by their consumers. This includes
incorporating our adoption-building Preferred Enrollment Program as part of a
customized EBPP offering purchased by our direct billing customers. This program
consists of process and service offerings that build adoption at the time of new
account acquisition and facilitate the accelerated conversion of existing
paper-based consumers to EBPP services. Program components include Auto
Enrollment of our customers' new customers, Online Demonstrations that walk
consumers through the client's bill presentment and payment site, Online
Enrollment Assistance to provide instant online help to consumers, and Instant
Activation that allows consumers immediate access to view and pay bills online
upon enrollment.
Additionally, we assign a dedicated Account Manager to each of our customers to
assist them in maximizing consumer adoption of their EBPP services and help them
realize a higher return on their investment. Our Account Managers work with
their customers to develop a tailored marketing strategy designed to increase
the EBPP adoption rate of their consumers. We assist our customers in carefully
planning and strategizing on all facets of the marketing process that are funded
by customers, including:
o Developing consumer enrollment materials, such as bill messages, bill
inserts, direct mail letters and enrollment feedback letters
o Developing public relations materials regarding their EBPP services
o Planning an effective advertising campaign regarding their EBPP services,
including broadcast and print advertisements
o Planning an Internet marketing campaign, including banner advertisements,
online promotional tactics and cost analysis
o Assisting in the customer launch process
o Assisting in the development of a regional marketing strategy
o Developing cross-marketing and co-marketing opportunities with other
billers, banks and bill payment Web sites
To date, we have seen positive results from marketing programs designed to
enhance adoption rates. Billers that are marketing aggressively to their
consumer base or have favorable consumer demographics, such as high Internet
usage, are experiencing adoption rates of between 3% and 30%. These adoption
rates are calculated by dividing the number of transactions for a given period
such as a month by the total population of a billing customer's bills that are
eligible for electronic presentment or payment during that same period. We do
not differentiate between initial customer transactions and repeat customer
transactions for purposes of calculating these adoption percentages and are
therefore unable to measure customer adoption or attrition rates over time.
Although an increase in the number of transactions does not necessarily mean
that more individual consumers are using the EBPP services that we provide
through our billing customers, it provides an indication of adoption growth
since a low percentage of consumers would be expected to make multiple
transactions during a month to pay a bill delivered monthly, for example. During
2002, we presented over 3.6 million electronic bills up from over 2 million in
2001 and 48,000 in 2000. New consumer enrollments rose to 504,000 for the year
2002 from 316,000 in 2001 and 101,000 in 2000.
Finally, connecting companies to customers through the widest array of Web sites
from which to receive, view, pay and manage bills is also an important step
towards realizing increased customer adoption. In this regard, the Company's
maintenance of distribution agreements with all of the major aggregators in the
EBPP industry demonstrates our commitment to proactively offer billers increased
opportunities for their consumers to pay and manage their bills via the
Internet. Our efforts to provide customers with distribution to all major
aggregators will be a continuing focus for the Company.
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Expand and Leverage Strategic Relationships and Partnerships
An important element of the Company's strategy is to strengthen and expand its
relationships with strategic allies and partners to increase the market
awareness, demand and acceptance of EBPP and value of Billserv's services. We
have formed strategic relationships and partnerships with key technology
providers and companies serving the EBPP industry to enable us to offer a high
quality of service to our customers. Our key partners and providers include:
o Technology providers, such as International Business Machines Corporation
("IBM"), CheckFree i-Solutions and ACI Worldwide, that provide various
hardware and software components of our service offering. We utilize IBM
servers and software in our system infrastructure. We have an electronic
billing services agreement with CheckFree licensing us to use their
CheckFree i-Solutions software and are also a certified reseller of this
software in Australia. CheckFree also owns approximately 5% of the Company
and holds warrants to purchase additional shares of the Company's common
stock. We have a license agreement with ACI for the use of their software
and a referral agent agreement with ACI qualifying them as an authorized
agent to earn commissions based on referring billers to us.
o Billing distribution partners, or aggregators, that provide the ability to
distribute electronic bills to various Internet sites where consumers can
receive, view, pay and manage bills as well as provide electronic payments
and remittance information back to our billing customers. We have
multi-year distribution agreements with all major EBPP aggregators
including CheckFree, Metavante (includes Spectrum and Paytrust) and
MasterCard RPPS that call for us to pay volume-based fees to the
aggregators for bills delivered through the aggregators' networks. The
terms of the distribution agreements vary from 2 years to 5 years. The
aggregators help us to generate revenue by allowing us to provide our
billing customers with access to a greater number of Web sites from which
their consumers can view, pay and manage their bills, thus making our
services more attractive and beneficial to billing customers. We charge
our billing customers a transaction fee for bills delivered to their
consumers through these aggregators.
o Payment processing partners, such as Bank One and Paymentech, Inc., that
allow us access to the ACH and credit card clearing network, respectively,
to facilitate the electronic transfer of funds between our billing
customers and their consumers who utilize a biller direct Web site.
Billserv has an agreement with Bank One to process ACH payments that has
an unspecified term and can be terminated upon 30-day written notice.
Billserv has an agreement with Paymentech, Inc. to process credit card
payments that automatically renews annually unless 60-day notice is given
prior to the end of the term. Through its contractual relationships with
Bank One and Paymentech, Billserv is able to process ACH and credit card
payment transactions on behalf of its billing customers. Billserv pays
volume-based fees for debit and credit transactions initiated through
these partners, and pays fees for other transactions such as returns,
notices of change to bank accounts, test debits, file transmission and
depository fees. Some of our billing customers do not rely exclusively on
our services to process their electronic payments.
o Reselling partners which resell our EBPP services to their billing
customer base under contractual agreements that provide for wholesale
pricing or commissions based on referred sales. Under these agreements,
these resellers are obligated to resell our EBPP services on a preferred
basis.
A strategic ally can also provide our customers with additional resources and
expertise, especially in vertical or geographic markets in which the partner has
expertise, to help meet our customers' system definition and application
development requirements. We intend to enhance the quality of our services by
continuing to pursue and enter into strategic relationships and partnerships
with companies that offer us the opportunity to benefit from the relationship.
Accelerate the Time to Market for our Customers
We believe that an important element of our service offering is our ability to
assist our customers in accelerating the time to market of their EBPP services,
thereby increasing the return on their investment. In order to help achieve this
objective, we assign a dedicated Account Manager and technical project team from
the beginning of the planning and implementation process for each customer to
ensure that the project implementation is completed effectively and on time. The
design of our service offering also contributes to an efficient and timely
deployment. Our core system consists of four major proprietary gateways:
financial, aggregator, biller and email, which support a variety of emerging
standards for data exchange and enable us to offer a quick implementation. These
interfaces give us the ability to integrate with our customers' legacy
applications, without disrupting or changing their internal systems, as well as
external software applications. The modular design and integrative features of
our products and services allows our customers to choose from a menu of
components and still have a system implemented in as little as 90 days. We
believe that our system design and approach utilizing a dedicated team has a
positive influence on the timing and effectiveness of the implementation of our
EBPP services for our customers.
Pursue International Market Opportunities
We believe our services can be adapted for international customers. Although we
have historically focused our marketing efforts in the United States, we also
market our services in Canada and Australia. We plan on continuing to market our
services outside the United States in the future. However, that expansion will
take place in a fashion that brings strength of local country partnerships and
minimizes the capital investment made by us to expand into these countries. For
example, during 2001, the
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Company acquired a 50% interest in a corporate joint venture operating in
Australia to provide EBPP services. The equal partner in this venture is Salmat,
a customer communications company in Australia specializing in document
management services, letterbox delivery, data solutions, teleservices,
fulfilment and customer targeting. The venture presented the first live
electronic bill through a banking Web site in Australia for payment through
BPAY, Australia's leading electronic bill payment service. We believe the demand
for EBPP services is developing in Australia and presents a viable market
opportunity through our partnership with Salmat.
Expand Service Utilization
Billserv is marketing a comprehensive offering that delivers a single,
outsourced capability for developing customer relationships utilizing the
electronic bill as a dynamic communication medium. By integrating our electronic
billing capabilities with Internet-enabled direct marketing and communication
("IDMC") services and online real-time customer care support provided by our
Internet Interaction Center ("IIC"), Billserv puts billers in direct,
interactive contact with their consumers. We refer to this as a "Customer
Communication Network". We are actively promoting our Customer Communication
Networks to qualified prospective billers as well as converting existing
customers to this enhanced service. In addition to the current components
integrated into our service offering, we intend to add enhanced products and
services that could further broaden the capabilities and revenue-generating
potential of our offering. These enhanced offerings will primarily be in the
areas of IDMC and customer relationship management services.
We believe that customer relationships can be enhanced through the effective use
of our comprehensive EBPP services. Specifically, each time a consumer receives
and pays a bill online or utilizes our customer care service, valuable data
about the interaction is obtained and stored in a database. Critical information
such as customer case histories, account balances and product configuration
details is presented or "popped" onto the service representative's screen at the
exact moment the consumer makes contact. As such, representatives are able to
provide better service more quickly, and consumers feel as though our customer
knows them individually and understands their particular needs. We are also able
to utilize this information to better anticipate the needs of a consumer in
advance of the next consumer contact. This information may also be used to
assist our customers in identifying specific consumer needs and possible
consumer segments that could be used to provide differentiated services such as
direct marketing or specific product offers.
Components of the Billserv Service Offering
One of the key advantages of our service offering is that we have integrated
certain proprietary components with third party software and hardware platforms
that cover a wide variety of services and functionality. This integration
enables us to be the single point of contact for all customer needs for
designing, developing, implementing and managing their entire EBPP process. Our
menu approach to offering our integrated products and services also allows us to
tailor our EBPP services to our customers' business and marketing objectives.
The components of our service offering, all of which are currently available to
customers and have generated revenue to date, include:
eServ
eServ is our flagship product and the foundation for our comprehensive EBPP
services. eServ provides our customers with a single offering for developing and
managing their entire EBPP capabilities. With eServ we manage, on behalf of our
customers, the multiple systems, delivery channels and relationships necessary
for a successful EBPP offering. Our eServ product provides outsourced creation
and management of presentment and payment processes for a biller direct site and
all aggregator sites, as well as payment processing and full reporting and
reconciliation capabilities. During the third quarter of 2002, we announced the
rebranding and reorganization of our product line under the eServ brand name,
which is a federally registered trademark owned by Billserv. This new
organization and branding was done in order to consolidate our products under
one identifiable and proprietary brand name, and distinguish our comprehensive
customizable EBPP offering marketed under the eServ Select product group from
our standard, parameter-driven EBPP offering marketed under the eServ Express
product group. Our eServ offering includes eServ Direct Delivery, which is a
delivery medium whereby the electronic bill is "pushed" directly to the
consumer's email inbox. This service gives consumers the opportunity to view
their bill and make payments directly from the email by clicking the "pay"
button found within. Also included in our offering is eServ Insert, our targeted
messaging and marketing tool that provides an interactive medium that can
dynamically present customized communication campaigns and deliver preemptive
customer care messages directly to consumers via the electronic bill statement.
eServ View and eServ Connect are our Internet-enabled customer care service
products supporting the EBPP process. eServ View is a proprietary,
multi-function, Web-based desktop browser product that provides access to the
consumer's bill detail stored on our servers. We provide a tool for our client's
customer service representatives ("CSRs") to deliver customer support to all
consumers, including those not using the Internet. eServ Connect provides
enhanced capabilities by utilizing licensed Internet collaboration software to
enable interaction with consumers over the Internet in a variety of ways, such
as email, Web collaboration (Web-chat) and voice-over Internet protocol
("VoIP"), and also provides capabilities for extended Customer Relationship
Management ("CRM") services. We have developed proprietary customer relationship
management software
8
applications that enable us to intelligently and efficiently analyze data
obtained through the EBPP process. eServ Connect Outsource is available through
our Internet Interaction Center ("IIC") to provide the client with essentially
the same functionality as eServ Connect, using our employees to perform customer
service on behalf of the client. This service can be a fully outsourced model in
which our client chooses not to provide direct in-house services. Alternatively,
this service model may be used as an after-hours support function that
supplements and extends our client's existing service center hours of operation.
eConsulting
eConsulting is Billserv's professional services group that offers electronic
billing, customer care, project management, and IT consulting services to both
existing billing customers and the EBPP industry in general. Billserv's
eConsulting group offers services ranging from project monitoring to complete
turnkey project development and implementation. In addition, customers can gain
access to Billserv's extensive and successful team to acquire data-centric
(Internet-based) customer care knowledge.
eServ Gateway
Billserv's eServ Gateway offers billers who are already participating in EBPP a
single distribution point to virtually all bill presentment and payment
locations across the World Wide Web. The Gateway is designed to improve a
biller's existing EBPP system, whether an in-house offering, biller direct site
or limited distribution channel, by expanding the range of distribution
partners. Billserv serves as the single point of contact to the numerous
distribution channels, which gives billers a cost-effective means to make bills
more accessible to consumers. Billserv's unique Gateway specifications may also
be embedded as an OEM (Original Equipment Manufacturer) component within
companies' software or service offerings, affording such vendors a
cost-effective, proven method to give their clients and consumers the ability to
make online payments, and view and pay bills through bank and internet payment
portals.
bills.com
Billserv operates a consumer Web site, or portal, focused on providing bill
presentment and payment services under the domain name www.bills.com. The
bills.com strategy is to provide the consumer with an efficient and secure
interface for viewing, paying and managing bills via the Internet. We also
market this portal service to online financial services providers looking to
provide EBPP capabilities as part of their service offering.
Product Development
Our total research and development expenses were $461,065, $760,082 and $767,751
for 2002, 2001 and 2000, respectively. We have created a proprietary technology
infrastructure to support all of the components of our service offering. Our
systems consist primarily of proprietary software applications that we have
integrated with third party hardware and software platforms. We have designed
our system so that it is reliable, flexible, and expandable to meet growth
demands without significant cost or change. The combination of Microsoft Windows
NT and IBM's DB2 database management system and use of redundant IBM Netfinity
file servers provides for a reliable environment which is further enhanced by
security measures taken such as the use of digital certificates, data
encryption, NT authentication and firewalls to protect billing data. The IBM
Netfinity line of servers have the ability to handle large volumes of
transactions with an upward growth path and clustering technology that readily
allows for expansion and scalability. Our support for open standards allows us
to integrate with any third party print-stream parser, as well as in-house EBPP
services. In addition, these widely used object oriented standards have provided
us with a highly reusable and flexible modular system. Because of this
reusability and flexibility, the business components can be constructed and
modified to adapt to the rapidly developing EBPP industry without affecting the
underlying software development.
The Company believes that its success will depend in part upon its ability to
enhance existing products to meet the needs of the rapidly evolving EBPP market.
The Company intends to continue to devote resources to enhancing its product
offerings and offering higher levels of integration among its products. We also
intend to continue to evaluate and enhance our systems as new technology is
developed to maintain a competitive advantage.
Sales and Marketing
Our sales strategy targets both direct and indirect sales. Leads for sales are
obtained through resellers, direct contact by our sales personnel, and our
marketing efforts to existing customers led by our Account Management team.
Billserv's direct sales effort is coordinated by a sales executive and supported
by other employees who function in limited sales capacities. We also market our
services through organizations that have exclusive reseller agreements with us
to sell our EBPP services. Reselling partners generate and qualify sales leads,
make initial contacts, assess client needs and recommend use of Billserv
services when appropriate, and introduce Billserv at high levels within the
customer organization.
9
Our marketing efforts are primarily EBPP adoption-focused. Our professional
staff of Account Managers actively assists our customers in creating programs to
encourage their consumers to utilize EBPP. The shared knowledge of our staff,
combined with the cumulative experience of our entire customer base, enables
them to provide valuable leadership as we work to build consumer adoption rates.
We also participate in limited corporate marketing that promotes the Billserv
brand.
Customers
Our primary market focus is on top-tier and middle-market companies generating
high volumes of recurring (usually monthly) paper-based bills. The Company
services billers in select vertical markets, such as utilities, telecom, cable,
media and financial services industries, as well as the higher education market.
All of our billing customers have signed long-term contracts, with generally
three to five year terms, that provide for set-up fees in certain cases and
volume-based transaction fees. The number of customers served by Billserv for
the three years ended December 31, 2002, including additions and attrition, was
as follows:
Number at beginning Number at end
of period Additions Attrition of period
------------------- --------- --------- -------------
Year ended December 31, 2000 14 36 1 49
Year ended December 31, 2001 49 53 1 101
Year ended December 31, 2002 101 34 16 119
The attrition in 2002 is primarily attributable to the loss of certain customers
serviced via resellers as a normal part of the resellers' account turnover and
the migration of certain customers to in-house EBPP offerings after their
billing agreements expired, such as Reliant Energy. EBPP services provided to
Reliant Energy accounted for approximately 16%, 23% and 40% of total
consolidated revenues for the years ended December 31, 2002, 2001 and 2000,
respectively. This customer began developing an in-house EBPP offering during
2002 utilizing Billserv's transition plan that allows a customer to move from an
outsourced offering provided by Billserv to an in-house offering of the
customer's choosing. The resulting loss of transaction revenues were mitigated
by fees generated from consulting services provided to Reliant Energy related to
the transition of their EBPP capabilities to an in-house offering as well as
transaction revenues for that portion of 2002 during which we provided this
customer transaction services. Total revenues generated by this customer in 2002
were approximately equal to those in 2001 for both consulting and transaction
services in the aggregate. We do not expect any significant revenues to be
generated by Reliant Energy in 2003 and beyond. Also, 27% of total consolidated
revenues for 2000 were attributable to a single customer for which we are no
longer providing services.
Competition
The market for EBPP services is highly competitive. We compete primarily with
companies that provide turnkey outsourced EBPP services for customers. These
companies include Metavante, Princeton eCom Corporation, KUBRA and DST Output
(formerly YourAccounts.com). In addition, we expect that other companies, such
as traditional information technology services companies and systems
integrators, may introduce services that compete with us. Remaining competitive
in the EBPP market will require a continued investment in new technologies,
marketing and a high level of customer service. We believe that the principal
competitive factors in our market include:
o System reliability and performance
o Ability to provide a CRM component
o Price and other financial terms
o Technological support and customer service
o Time-to-market of implemented services
o Strategic relationships with aggregators, front-ends and technology
providers
o Compliance with industry and technological standards
We also face potential competition from a number of other companies that compete
with us indirectly. These include aggregators, such as CheckFree Corporation;
EBPP front-ends, such as financial institutions and Internet portals; EBPP
software providers, such as CheckFree I-solutions, eDocs and Avolent; and
traditional bill printing companies, such as Electronic Data Systems
Corporation, CSG Interactive LLC, and Cable Data. In addition, several companies
are addressing the emergence of the Internet banking industry with service
bureau offerings, which could include electronic bill presentment. These
competitors have significant market presence and financial resources. If they
enter our market, we may not have sufficient resources to continue to make the
investments or achieve the technological advances necessary to compete
successfully.
10
Trademarks
We own federally registered trademarks of the following marks: Billserv, Inc.,
Billserv, Inc. and design, Bills.com, Bills.com and design, eServ, and Click
your bills goodbye. We have also secured the following domain name
registrations:
bills.com ebillepicenter.com
billserv.com mybillers.com
billserv.cc mypaymentbook.com
billserv.inc mypaymentbook.org
billserv.org mypaymentbook.net
billserv.law payb2bbill.com
billserv.tech securebills.com
billerregistry.com securebills.cc
b2bpayserv.com securebills.net
ebillcare.com
We rely on a combination of copyright, trademark and trade secret laws, employee
and third party nondisclosure agreements and other intellectual property
protection methods to protect our services and related products.
Employees
As of December 31, 2002, we had 48 employees. We are not a party to any
collective bargaining agreements. We believe that our relations with our
employees are good.
ITEM 2. PROPERTIES
As of December 31, 2002, our headquarters and operations were housed in
approximately 36,000 square feet of leased office space in San Antonio, Texas.
The Company believes its existing facilities will be adequate to meet its
anticipated needs for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
There is no material litigation currently pending. We are not aware of any
disputes that may lead to material litigation, except as follows:
Beginning in December 2000, the Company pledged certain funds held as money
market funds and certificates of deposit to collateralize certain margin loans
of three officers and an ex-officer of the Company. These funds are classified
as Cash pledged as collateral for related party obligations on the Company's
balance sheets at December 31, 2002 and 2001. The margin loans are from
institutional lenders and are secured by shares of the Company's common stock
held by these individuals. The Company's purpose in collateralizing the margin
loans was to prevent the sale of the Company's common stock held by these
officers while the Company was pursuing efforts to raise more capital through
private equity placements. The sale of the Company's common stock may have
hindered the Company's ability to raise capital in such a manner and compromised
the Company's continuing efforts to secure additional financing. The total
balance of the margin loans guaranteed by the Company was approximately $1.3
million at December 31, 2002. The Company believed it had the unrestricted legal
right to use the pledged funds for its operations if necessary based on (i) its
interpretation of the loan guarantee agreements, (ii) the market price of the
Company's stock at the time of the pledge, and (iii) assurances the Company
received from one of the institutional lenders that funds would be made
available if needed. The institutional lenders holding the funds as collateral
are disputing this claim, solely relying upon their strict interpretations of
the Loan guarantee agreements. Subsequent to December 31, 2002, the lenders
applied the pledged funds being held to satisfy the outstanding balances of the
loans. In light of this action, the Company recognized a loss on the guarantees
of $1,278,138 in the fourth quarter of 2002 and recorded a corresponding Payable
under related party guarantees on the Company's balance sheet at December 31,
2002. The Company may institute litigation or arbitration concerning these
matters, which may result in the assertion of claims by these officers under
their employee agreements. The ultimate outcome of this matter cannot presently
be determined.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the Company's stockholders during
the fourth quarter of fiscal year 2002.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Our common stock was traded on the National Association of Securities Dealers
("NASD") Over the Counter Bulletin Board ("OTC BB") through March 13, 2000 at
which time our common stock was approved for trading on the NASDAQ Small Cap
Market. Subsequently, our stock was approved for trading on the Nasdaq National
Market on July 31, 2000 under the symbol "BLLS." On February 4, 2003, the Nasdaq
National Market delisted our common stock because the Company did not meet the
requirements for continued listing on the Nasdaq National Market. The Company's
common shares were immediately eligible for quotation on the OTC BB effective at
open of business February 4, 2003. The Company kept the letters BLLS as its
ticker symbol.
The following table sets forth for the quarterly periods indicated the range of
high and low closing prices of the common stock as reported.
High Low
-------- --------
2002
-------------
First Quarter $ 1.25 $ 0.90
Second Quarter $ 1.70 $ 1.02
Third Quarter $ 1.25 $ 0.52
Fourth Quarter $ 0.70 $ 0.17
2001
-------------
First Quarter $ 5.38 $ 2.16
Second Quarter $ 3.05 $ 1.88
Third Quarter $ 2.20 $ 0.73
Fourth Quarter $ 1.55 $ 0.80
Holders
As of March 17, 2003, 20,722,656 shares of common stock are outstanding, $.001
par value. As of March 17, 2003, there were approximately 5,784 stockholders of
record of the common stock.
Dividend Policy
We have never declared or paid cash or stock dividends and have no present plan
to pay any such dividends in the foreseeable future, intending instead to
reinvest our earnings, if any.
12
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction
with the Consolidated Financial Statements and Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere in this Form 10-K.
Consolidated Statement Of Operations Data
From Inception
Year Ended Year Ended Year Ended Year Ended (July 30, 1998)
December 31, December 31, December 31, December 31, To December 31,
2002 2001 2000 1999 (1) 1998 (1)
------------------------------------------------------------------------------------
Revenues $ 4,206,554 $ 2,968,678 $ 650,023 $ 55,438 $ --
Cost of revenues 4,690,344 4,995,161 3,690,843 127,345 --
Operating expenses:
Research and development 461,065 760,082 767,751 906,532 --
Selling, general and
administrative 4,822,459 6,423,315 8,264,657 3,737,922 289,211
Depreciation and
amortization 1,658,886 1,555,626 940,995 270,908 559
Provision for impairment
of assets 855,117 -- -- -- --
Non-cash expense related
to the issuance of warrants -- -- 7,488,000 491,428 --
------------------------------------------------------------------------------------
Total operating expenses 7,797,527 8,739,023 17,461,403 5,406,790 289,770
Other income (expense), net (2,673,360) 359,800 546,173 5,749 --
Cumulative effect of a change
in accounting principle -- -- (52,273) -- --
------------------------------------------------------------------------------------
Net loss $(10,954,677) $(10,405,706) $(20,008,323) $ (5,472,948) $ (289,770)
====================================================================================
Per share information:
Net loss - basic and diluted $ (0.53) $ (0.58) $ (1.35) $ (0.50) $ (0.03)
Weighted average common shares
outstanding - basic and diluted 20,591,304 18,017,051 14,793,622 10,876,096 10,030,000
Consolidated Balance Sheet Data
-----------------------------------------------------------------------------
2002 2001 2000 1999 (1) 1998 (1)
-----------------------------------------------------------------------------
Working capital (deficit) $ (2,408,924) $ 5,750,354 $ 5,291,006 $ 6,293,217 $(303,926)
Current assets $ 2,514,973 $ 7,255,124 $ 8,848,543 $ 7,490,648 $ 387,980
Total assets $ 4,709,263 $ 11,415,136 $ 15,290,542 $ 9,398,168 $ 407,530
Long-term obligations,
net of current portion $ 39,168 $ -- $ 148,428 $ 259,694 $ --
Accumulated deficit $(47,136,060) $(36,181,383) $(25,775,677) $(5,767,354) $(294,406)
Total stockholders' equity (deficit) $ (345,270) $ 9,748,566 $ 11,011,410 $ 7,936,043 $(289,676)
(1) The accounting change related to SAB 101 has not been reflected in the
financials prior to its adoption on January 1, 2000.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and Notes thereto, and other financial
information included elsewhere in this Form 10-K. This report contains
forward-looking statements that involve risks and uncertainties. Actual results
in future periods may differ materially from those expressed or implied in such
forward-looking statements as a result of a number of factors, including, but
not limited to, the risks discussed under the heading "Risk Factors" and
elsewhere in this Form 10-K.
Overview
Billserv was a development stage enterprise through December 31, 2001 and so has
a limited operating history on which to base an evaluation of our businesses and
prospects. The Company's principal activities during development included
research and development, raising of capital and organizational activities. The
Company has recently focused its activities in the areas of obtaining billing
customers and implementing Electronic Bill Presentment and Payment ("EBPP")
capabilities for those billers. Our prospects must be considered in light of the
risks, expenses and difficulties frequently encountered by companies in their
early stages of development, particularly companies in new and rapidly evolving
markets such as electronic commerce. Such risks include, but are not limited to,
an evolving and unpredictable business model and our ability to manage growth.
To address these risks, we must, among other things, maintain and increase our
customer base; implement and successfully execute our business and marketing
strategy; continue to develop and upgrade our technology and
transaction-processing systems; provide superior customer service; respond to
competitive developments; attract, retain and motivate qualified personnel; and
respond to unforeseen industry developments and other factors. We cannot assure
you that we will be successful in addressing such risks, and the failure to do
so could have a material adverse effect on our business, prospects, financial
condition and results of operations.
Since inception, we have incurred operating losses each quarter, and as of
December 31, 2002, we have an accumulated deficit of $47.1 million. The Company
expects to continue to incur losses for the foreseeable future as efforts to
achieve profitability continue. We believe that our success will depend in large
part on our ability to (a) drive the consumer adoption rate of EBPP, (b)
continue to add quality billers to our significant client base, (c) meet
evolving customer requirements and (d) adapt to technological changes in an
emerging market. Accordingly, we intend to focus on activities that serve to
encourage EBPP adoption by consumers and billers in order to increase revenue.
In keeping with this strategy, our sales focus has shifted to a more
comprehensive offering that delivers a single, outsourced service offering for
developing customer relationships utilizing the electronic bill as a dynamic
communication medium. By integrating our electronic billing capabilities with
online real-time customer care support and Internet-enabled direct marketing and
communication, Billserv puts billers in direct, interactive contact with their
consumers. Our selling strategy is a targeted approach with an emphasis on
complementary marketing initiatives with our valued reseller and referral
partners in order to maximize our leverage in the marketplace and limit the
resources needed to obtain accounts through direct sales.
The Company also provides professional marketing consultations as a key element
of its account management group to actively assist billers in creating programs
to move their consumers to EBPP. Because growth of our revenues is dependent
upon consumer acceptance of EBPP, we work directly with a client's marketing
department to spur adoption rates and increase the number of EBPP transactions.
Since we have a significant amount of investment in infrastructure and a certain
level of fixed operating expenses, achieving profitability depends on the volume
of transactions we process and the revenue we generate from these transactions,
as well as other related services performed for our customers. During the third
quarter of 2002, we announced the rebranding and reorganization of our product
line under the eServ brand name, which is a federally registered trademark owned
by Billserv. This new organization and branding was done in order to consolidate
our products under one identifiable and proprietary brand name, and distinguish
our comprehensive customizable EBPP offering marketed under the eServ Select
brand name from our standard, parameter-driven EBPP offering marketed under the
eServ Express brand name. There were no significant changes made to any of our
service products as a result of this action. The components of our service
offering, all of which are currently available to customers and have generated
revenue to date, include:
o Internet billing services for EBPP through a Billserv-hosted payment
Web site, secure direct delivery to the consumer's email inbox, or
distribution via bill aggregators.
o Internet-enabled, interactive customer care services on an in-house
or outsourced basis.
o Professional consulting services for EBPP billers or software
vendors needing value-added resources to deliver customized EBPP
services, including payment gateway services that provide billers
who are already participating in EBPP using in-house software a
single distribution point to virtually any bill presentment and
payment location across the World Wide Web in addition to their
existing distribution points or biller direct site. Gateway
technology may also be embedded as an OEM (original equipment
manufacturer) component within vendors' software or service
offerings to provide a cost-effective, proven method to give their
clients and consumers the ability to make online payments, and view
and pay bills anytime, anywhere through bank and Internet payment
portals.
14
o Licensing of CheckFree e-billing software as an authorized reseller
in Australia only.
o Online bill payment and management services for consumers through
the bills.com Internet portal.
As a result of our limited operating history and the emerging nature of the
markets in which we compete, we are unable to precisely forecast our revenues.
Our current and future expense levels are based largely on our investment plans
and estimates of future revenues. Revenue and operating results will depend on
the volume of transactions processed and related services rendered. The timing
of such services and transactions and our ability to fulfill a customer's
demands are difficult to forecast. Although we systematically budget for planned
outlays and maintain tight controls on our expenditures, we may be unable to
adjust spending in a timely manner to compensate for any unexpected revenue
shortfall. Accordingly, any significant shortfall in revenues in relation to our
planned expenditures could have a material adverse effect on our business,
prospects, financial condition and results of operations. Further, we may make
certain pricing, service, marketing or acquisition decisions that could have a
material adverse effect on each or all of these areas.
Critical Accounting Policies
General
Billserv's discussion and analysis of its financial condition and results of
operations are based upon Billserv's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires
Billserv to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenue and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, Billserv evaluates its estimates,
including those related to the reported amounts of revenues and expenses, bad
debt, investments, intangible assets, income taxes, and contingencies and
litigation. Billserv bases its estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results could differ from these estimates under different
assumptions or conditions.
Revenue Recognition
Prior to December 31, 1999, we recognized revenue generated from up-front fees
upon completion of an implementation project. These up-front fees are charged
for the work involved in implementing the basic functionality required to
provide EBPP services to customers. These set-up procedures include tasks such
as establishing connectivity, design and construction of the hosted Web site,
and conversion of the paper bill print stream to an electronic format. In
December 1999, the SEC issued SAB 101, which requires that revenue generated
from up-front implementation fees that do not represent a separate earnings
process to be recognized over the term of the related service contract. We
adopted SAB 101 on January 1, 2000, and accordingly, revised our implementation
fee revenue recognition policy to defer this type of revenue, while the related
costs will be expensed as incurred. The cumulative effect of this accounting
change totaled $52,273 and was recognized as a non-cash after-tax charge during
the first quarter of 2000. The cumulative effect has been recorded as deferred
revenue to be recognized as revenue over the remaining contractual service
periods, which are primarily three to five years in length. At December 31,
2002, deferred revenue was $400,960. We anticipate that transaction fees and
other services will make up a larger percentage of total revenue in future
periods, which will further reduce the effect that deferring implementation fee
revenue has on our current operating results. However, the volume of
transactions and amount of related revenue we will generate in future periods is
dependent upon, among other things, the rate at which consumers utilize EBPP.
Bad Debt
Billserv maintains an allowance for doubtful accounts for estimated losses
resulting from the inability or failure of its customers to make required
payments. The Company recorded bad debt expense of $30,000, $21,000 and $10,000
for 2002, 2001 and 2000, respectively, and recorded bad debt write-offs of
$1,734 and $12,069 to its allowance for doubtful accounts in 2002 and 2001,
respectively. There were no write-offs recorded to the allowance for doubtful
accounts in 2000. At December 31, 2002 and 2001, the balance of the allowance
for doubtful accounts was $47,197 and $18,931, respectively. If the financial
condition of the Billserv's customers were to deteriorate, resulting in an
impairment of their ability to make contractual payments, additional allowances
may be required.
Valuation of Long-Lived and Intangible Assets
The Company assesses the impairment of long-lived and intangible assets whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. Factors considered important which could trigger an impairment
review include the following: significant underperformance relative to
historical or projected future cash flows; significant changes in the manner of
use of the assets or the strategy of the overall business; and significant
negative industry trends. When management determines that the carrying value of
long-lived and intangible assets may not be recoverable, impairment is measured
as the
15
excess of the assets' carrying value over the estimated fair value. An
impairment loss of $855,000 was recorded in 2002. No impairment losses were
recorded in 2001 or 2000.
Income Taxes
The Company accounts for income taxes using the liability method in accordance
with Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("FAS 109"). The liability method provides that the deferred tax assets
and liabilities are recorded based on the difference between the tax bases of
assets and liabilities and their carrying amount for financial reporting
purposes, as measured by the enacted tax rates and laws that will be in effect
when the differences are expected to reverse. Deferred tax assets are carried on
the balance sheet with the presumption that they will be realizable in future
periods when pre-taxable income is generated. Predicting the ability to realize
these assets in future periods requires a great deal of judgment by management.
It is our judgment that we cannot predict with reasonable certainty that the tax
assets carried on our balance sheet as of December 31, 2002 will be fully
realized in future periods. FAS 109 requires a valuation allowance to reduce the
deferred tax assets reported if, based on the weight of the evidence, it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. After consideration of all of the evidence, both positive and
negative, management determined that a valuation allowance at December 31, 2002
is necessary to reduce the deferred tax assets to the amount that will more
likely than not be realized. The change in valuation allowance for the current
year is a net increase of $3.7 million. At December 31, 2002, the Company has
available net operating loss carryforwards of approximately $34.8 million, which
expire beginning in the year 2020.
Results of Operations
Billserv's revenues are principally derived from fees for implementing EBPP
capabilities, processing EBPP transactions and providing related customer care,
and consulting services. Billserv also became a licensed reseller of CheckFree's
e-billing software in Australia during 2002. Revenues by type for the three
years in the period ended December 31, 2002, are as follows:
2002 2001 2000
---------- ---------- --------
Service revenues:
Implementation revenues $ 311,712 $ 502,753 $ 93,013
Transaction revenues 1,952,631 1,163,214 285,741
Consulting revenues 1,704,211 1,302,711 271,269
---------- ---------- --------
Total service revenues 3,968,554 2,968,678 650,023
Software license revenues 238,000 -- --
---------- ---------- --------
Total revenues $4,206,554 $2,968,678 $650,023
========== ========== ========
Total revenues increased 42% to $4,206,554 in 2002 from $2,968,678 in 2001. Of
the total increase from the prior year, 64% was attributable to the growth in
transaction fee revenue, while growth in consulting revenues, which includes
revenue from the licensing of the Company's gateway technology, accounted for
32% of the increase. These increases were due to an increase in the number of
implemented billers and volume of transactions. As of December 31, 2002, we had
119 billers under contract who were in various stages of development, including
106 billers that were in full production or pilot stages, as compared to 84
billers in full production or pilot stages at December 31, 2001. The Company's
first sale of a software license as a reseller of CheckFree's e-billing software
in Australia also contributed $238,000 to the increase in revenue from the prior
year. The sale was made to an Australian billing service provider that is also
an equal partner with the Company in a joint venture formed to provide EBPP
services to the Australian market. Total revenues increased 357% to $2,968,678
in 2001 from $650,023 in 2000. Of the increase from the prior year, 44% was
attributable to the addition of a full year of consulting revenue in 2001
(professional consulting services were first offered to customers in the fourth
quarter of 2000) with the remaining increase attributable to growth in
transaction and related implementation fee revenue due to an increase in the
number of implemented billers and volume of transactions. As of December 31,
2001, we had 101 billers under contract who were in various stages of
development, including 84 billers that were in full production or pilot stages,
as compared to 31 billers in full production or pilot stages at December 31,
2000.
During 2002, the Company entered into two separate nonmonetary transactions
whereby the Company licensed the use of its gateway technology to certain third
party software vendors to be used as an original equipment manufacturer ("OEM")
component of their product offering in exchange for software products from those
vendors. The Company accounted for these transactions in accordance with APB
Opinion No. 29, "Accounting for Nonmonetary Transactions". These exchanges were
determined to culminate the earning process because the technology exchanged by
the Company was held for sale in the ordinary course of business and the
products received by the Company were expected to be deployed and utilized as
productive assets. The Company recognized revenue related to these transactions
at the fair value of the software received, which was determined by reference to
vendor-specific objective evidence, because it was more clearly evident than the
value of the assets transferred. The value of the software received was
estimated by comparison to third party evidence including vendor-specific
established pricing lists and historical sales information and was more readily
determinable because the Company did not have a history of
16
comparable cash sales of its payment gateway technology. The Company recognized
$300,000 in a transaction where the Company's technology was exchanged for
customer relationship management software and concurrent seat licenses to use in
providing customer care services via the Internet or telephone. The Company also
recognized $300,000 in a transaction where the Company's technology was
exchanged for document archival and retrieval software to use in the storage of
electronic billing statements. The carrying value of the gateway technology
exchanged in both transactions was zero. The Company capitalized the software
received and at the time of acquisition and subsequently recognized a loss on
impairment of these assets which took the carrying amount of these assets to
zero.
One billing customer accounted for approximately 16%, 23% and 40% of total
consolidated revenues for the years ended December 31, 2002, 2001 and 2000,
respectively. This customer began developing an in-house EBPP offering during
2002 utilizing Billserv's transition plan that allows the customer to move from
an outsourced offering with Billserv to an in-house offering. The resulting loss
of transaction revenues were mitigated by fees generated from consulting
services provided to this customer related to transitioning their EBPP
capabilities to an in-house offering such that total revenues generated by this
customer in 2002 were approximately equal to those in 2001. We do not expect any
significant revenues to be generated by this customer in 2003 and beyond. In
addition, the Company recognized $173,000 of non-recurring revenue in 2000
attributable to a single customer for which we are no longer providing services.
Cost of revenues includes the cost of personnel dedicated to the design of
electronic bill templates, creation of connections to third-party aggregators
and payment processors, testing and quality assurance processes related to
implementation and presentment, as well as professional staff dedicated to
providing contracted services to EBPP customers under consulting arrangements.
Cost of revenues also includes fees paid for presentation of consumer bills on
Web sites powered by aggregators and processing of payments for EBPP
transactions by third party providers. We have multi-year distribution
agreements with all major EBPP aggregators, including CheckFree, Metavante
(includes Spectrum and Paytrust) and MasterCard RPPS, which call for
volume-based fees for bills delivered through the aggregators' networks. Through
its contractual relationships with its payment processors, Billserv is able to
process ACH and credit card payment transactions on behalf of its customers and
their consumers. Billserv pays volume-based fees for debit and credit
transactions initiated through these processors, and pays fees for other
transactions such as returns, notices of change to bank accounts, test debits,
file transmission and depository fees. Cost of revenues decreased 6% to
$4,690,344 in 2002 from $4,995,161 for 2001. The decrease from 2001 is primarily
due to cost reductions that were implemented in the second half of 2001, which
included a decrease in the number of personnel employed to provide
revenue-producing services from an average of 79 such employees for 2001 to 63
in 2002. The cost savings from the prior year period were partially offset by
the cost of the CheckFree software license that was resold in 2002, which was
$228,000. Cost of revenues increased 35% to $4,995,161 in 2001 from $3,690,843
for 2000. The increase from 2000 is primarily due to an increase in the number
of personnel employed to provide revenue-producing services from an average of
54 such employees for 2000 to 79 in 2001.
General and administrative expenses include costs for the Company's human
resources, finance, legal, facilities and executive management functions. These
expenses decreased to $3,948,684 in 2002 from $4,338,374 for 2001 and were
$3,677,834 in 2000. The decrease from 2001 to 2002 is attributable to cost
reductions resulting from the restructuring and realignment of our organization
during the latter half of 2001 to better position the Company for current
economic and market conditions. During the third quarter of 2001, the Company
downsized and realigned its organization to make more efficient use of its
resources and better match the Company's infrastructure to market conditions and
the current business environment since the overall growth of the economy and
rate of technology spending by businesses had slowed. This realignment included
the layoff of certain employees and reassignment of other employees to different
functions to reduce our cash outflows and allow us to utilize our limited
resources more prudently by eliminating functions that did not directly
contribute to our goal of profitability. It also involved reorganizing the
Company to promote better communication with customers and improve customer
service. The increase in general and administrative expenses from 2000 to 2001
was principally due to increased facilities costs resulting from our move to new
corporate headquarters. Total rent expense in 2000 was $681,000, and in 2001,
the aggregate rent expense was approximately $1.2 million.
Selling and marketing expenses consist primarily of payroll and related expenses
for personnel engaged in marketing and selling activities, as well as
advertising services. These expenses decreased to $873,775 in 2002 from
$2,084,941 for 2001 and $4,586,823 for 2000. The decrease in 2002 from 2001 was
primarily the result of reductions in our direct sales staff, which contributed
77% to the decrease from the prior year, as well as lower related travel
expenses and trade show participation, which contributed 18% to the decrease
from the prior year. As we have increased our focus throughout 2002 on using
strategic reseller partners to provide sales opportunities related to the
deployment and use of our EBPP services, we have experienced a decrease in the
amount of expenses related to our direct sales force. The decrease in selling
and marketing expenses in 2001 from 2000 was primarily the result of lower
advertising media costs related to promotion of the bills.com Web site as well
as lower corporate marketing expenses, which contributed 66% to the decrease,
and reductions in personnel and travel expenses, which contributed 27% to the
decline in expenses in total. During the second quarter of 2000, bills.com was
re-launched with a focus on making the Web site simpler and more secure for
consumers to view, pay and manage their bills online. As part of this re-launch,
we incurred approximately $1.2 million of expense in 2000 to develop and market
this consumer payment portal. The increase in selling and marketing expenses in
2000 from $1,750,615 in 1999 was the result of the development and expansion
initiatives of our sales and marketing departments as well as the advertising
media costs associated with our bills.com promotion. We will
17
continue to analyze our sales and marketing efforts in order to control costs,
increase the effectiveness of our sales force, and broaden our reach through
reseller initiatives and advantageous alliances.
Research and development expenses consist primarily of the cost of personnel
devoted to the design of new processes that will improve our electronic
presentment and payment abilities and capacities, integration of third-party
applications, new customer care services, additional business-to-consumer
applications, and services for direct marketing opportunities. These expenses
decreased to $461,065 in 2002 after remaining relatively flat in 2001 and 2000
at $760,082 and $767,751, respectively, due to a focus on our core competencies
in order to implement and service existing products. During the earlier stages
of our Company, we applied additional resources to design and develop our base
technology infrastructure and operating systems. All research and development
costs are expensed as incurred. We plan to minimize our research and development
activities in the foreseeable future, as we intend to concentrate our limited
resources on generating revenue and servicing existing customers.
Depreciation and amortization was $1,658,886, $1,555,626 and $940,995 for 2002,
2001 and 2000, respectively. The increase from 2001 was the result of writing
off $207,000 of leasehold improvements related to our corporate office facility
due to the cancellation of the related lease in March 2003. This increase was
partially offset by lower depreciation related to certain assets that became
fully depreciated during 2002. The increase from 2000 to 2001 reflected the
capital expenditures made in prior years for infrastructure and operating
systems in support of our growth strategy. We purchased approximately $402,000,
$723,000 and $3.7 million of property and equipment during 2002, 2001 and 2000,
respectively, but do not anticipate making significant capital expenditures in
2003.
During the fourth quarter of 2002, the Company performed an impairment review
because the uncertainty of the Company's ability to continue as a going concern
due to decreased liquidity indicated that the carrying value of certain
long-lived assets may not be recoverable. The Company determined that customer
relationship management software and document archival and retrieval software
with a carrying amount of $855,117 were no longer recoverable and recorded a
non-cash charge of $855,117, which is included as a component of operating
income in the accompanying consolidated statement of operations. Fair value was
based on the expected future cash flows to be generated by these assets, which
was zero because of the Company's inability to deploy and utilize the assets to
provide revenue-generating services, due to the Company's limited resources and
lack of liquidity.
Non-cash expense related to the issuance of warrants relates to expenses
recognized for warrants issued in consideration for services. In accordance with
accounting principles generally accepted in the United States, we expensed the
fair value of these warrant issuances, which was calculated using the
Black-Scholes option-pricing model, and recorded the related credit to paid-in
capital. During 2000, we recognized $7.5 million of expense associated with the
issuance of 1.3 million warrants to CheckFree as consideration for entering into
an extended biller service provider agreement. Under this agreement, which
expires in February 2005, CheckFree provides us with electronic bill presentment
services for volume-based fees. The related warrant expense was recognized
immediately instead of being deferred and recognized over the life of the
agreement because the warrants were fully vested at the date of grant and
CheckFree did not have to perform under the agreement to earn the warrants. We
may also recognize warrant costs in future periods based on CheckFree's ability
to earn incentive warrants on up to 2,801,903 additional shares, of which
1,000,000 are exercisable at $11.375 per share and 1,801,903 are exercisable at
$14.219 per share. The incentive warrants vest pro rata upon the achievement of
a target level of 200 referred billers, each generating approximately 500,000
paper-based bills per month, to the Company by CheckFree and will occur on the
first through fifth anniversaries of the agreement. All incentive warrants that
are not vested by the fifth anniversary will expire at that time. As of December
31, 2002, none of these incentive warrants were vested and management of the
Company is unable to assess the likelihood of whether or when any of these
incentive warrants will be earned by CheckFree and the related expenses
incurred.
Net other expense was $2,673,360 in 2002 compared to net other income of
$359,800 in 2001 and $546,173 in 2000. The increase in other expenses from 2001
to 2002 is primarily attributable to $1.4 million of interest and other expenses
related to the convertible debt issuance in 2002 and a $1.3 million loss on
related party loan guarantees as well as lower interest income earned in 2002 as
a result of lower invested balances and market interest rates. The decrease in
net other income from 2000 to 2001 is primarily attributable to lower interest
income earned in 2001 as a result of lower invested balances and market interest
rates.
The increase in net loss to $10,954,677 in 2002 from $10,405,706 in 2001 was
primarily due to non-operating expenses recognized in 2002, including $1.4
million of interest and other expenses related to the Laurus debt and a $1.3
million loss on related party loan guarantees. The decrease in net loss to
$10,405,706 in 2001 from $20,008,323 in 2000 was primarily due to $7.5 million
of expenses recognized in 2000 related to the issuance of warrants to CheckFree
as consideration for entering into an extended biller service provider
agreement. The increase in net loss in 2000 from $5,472,948 in 1999 was due to
the warrant expense in 2000 as well as an overall increase in expenses as a
result of employee growth from 50 employees at December 31, 1999 to 141 at
December 31, 2000 and expansion of the Company's operations.
18
Liquidity and Capital Resources
At December 31, 2002, the Company's principal source of liquidity consisted of
$286,000 of cash and cash equivalents, compared to $4.2 million of cash and cash
equivalents and $237,000 in short-term investments at December 31, 2001. The
Company has incurred substantial losses since inception and has experienced a
material shortfall from anticipated revenues, which has led to a significant
decrease in its cash position and a deficit in working capital. Also, the
Company defaulted under its convertible debt agreement during the fourth quarter
of 2002 and was unsuccessful in its attempt to access its funds held as
collateral to guarantee certain executive margin loans after attempting to
retrieve such funds during the fourth quarter of 2002. Consequently, the Company
believes that its current available cash and cash equivalents along with
anticipated revenues may be insufficient to meet its anticipated cash needs for
the foreseeable future. Accordingly, the Company reduced its workforce by 36
employees in November 2002 and is currently aggressively pursuing strategic
alternatives, including investment in or sale of the Company. The satisfactory
completion of a sale or additional investment in the Company is essential or the
Company has no other alternative that will provide sufficient cash flows to meet
current operating requirements. The sale of additional equity or convertible
debt securities would result in additional dilution to the Company's
stockholders, and debt financing, if available, may involve restrictive
covenants which could restrict operations or finances. There can be no assurance
that financing will be available in amounts or on terms acceptable to the
Company, if at all. If the Company cannot raise funds, on acceptable terms, or
achieve positive cash flow, it may not be able to continue to exist, conduct
operations, grow market share, take advantage of future opportunities or respond
to competitive pressures or unanticipated requirements, any of which would
negatively impact its business, operating results and financial condition.
Beginning in December 2000, the Company pledged certain funds held as money
market funds and certificates of deposit to collateralize certain margin loans
of three officers and an ex-officer of the Company. These funds are classified
as Cash pledged as collateral for related party obligations on the Company's
balance sheets at December 31, 2002 and 2001. The margin loans are from
institutional lenders and are secured by shares of the Company's common stock
held by these individuals. The Company's purpose in collateralizing the margin
loans was to prevent the sale of the Company's common stock held by these
officers while the Company was pursuing efforts to raise more capital through
private equity placements. The sale of the Company's common stock may have
hindered the Company's ability to raise capital in such a manner and compromised
the Company's continuing efforts to secure additional financing. The total
balance of the margin loans guaranteed by the Company was approximately $1.3
million at December 31, 2002. The Company believed it had the unrestricted legal
right to use the pledged funds for its operations if necessary based on (i) its
interpretation of the loan guarantee agreements, (ii) the market price of the
Company's stock at the time of the pledge, and (iii) assurances the Company
received from one of the institutional lenders that funds would be made
available if needed. The institutional lenders holding the funds as collateral
are disputing this claim, solely relying upon their strict interpretations of
the Loan guarantee agreements. Subsequent to December 31, 2002, the lenders
applied the pledged funds being held to satisfy the outstanding balances of the
loans. In light of this action, the Company recognized a loss on the guarantees
of $1,278,138 in the fourth quarter of 2002 and recorded a corresponding Payable
under related party guarantees on the Company's balance sheet at December 31,
2002. The Company may institute litigation or arbitration concerning these
matters, which may result in the assertion of claims by these officers under
their employee agreements. The ultimate outcome of this matter cannot presently
be determined.
Net cash used in operating activities was $5.6 million, $9.0 million and $11.0
million for 2002, 2001 and 2000, respectively. Net cash used in operating
activities was primarily attributable to operating net losses generated by
development stage activities and overhead costs. We plan to focus on expending
our resources prudently given our current state of liquidity and do not expect
to achieve positive cash flow from operations for 2003 as a result of lower than
anticipated revenue growth.
Net cash used in investing activities was $143,000 in 2002 and was primarily
used for purchases of computer equipment. Net cash provided by investing
activities for 2001 was $1.5 million and reflected sales and maturities of
marketable securities of $2.0 million and purchases of property and equipment of
$723,000. Net cash used in investing activities was $6.4 million in 2000 and was
primarily used for purchases of investments and equipment and to make deposits
for leases. We do not anticipate making significant capital expenditures during
2003.
Net cash provided by financing activities of $1.9 million for 2002 resulted
primarily from $1.5 million of borrowings under a convertible debt agreement and
the return of $707,000 that had been pledged as collateral for margin loans of
officers. Net cash provided by financing activities of $6.5 million for 2001
resulted from proceeds, net of issuance costs, of $9.2 million from the issuance
of common stock private placement offerings in March and November 2001. The $1.5
million repayment of the outstanding line of credit in January 2001 and
additional pledge of $1.0 million as collateral for margin loans of officers
reduced the amount of net cash provided by financing activities. Net cash
provided by financing activities of $15.6 million for 2000 resulted from
proceeds, net of issuance costs, of $9.5 million from the purchase of common
stock by CheckFree and $6.1 million from the exercise of warrants issued in the
October and December 1999 private equity placements. In addition, the Company
drew $1.5 million on its line of credit in 2000. The initial pledge of $1.0
million as collateral for margin loans of officers reduced the amount of net
cash provided by financing activities.
19
In June 2000, the Company executed a working capital line of credit agreement
with a bank in the amount of $1,500,000. Advances under the line of credit
accrued interest at the prime rate minus 0.25%, with repayment terms of monthly
interest-only payments and principal due in July 2001. The line of credit was
secured by certain investments of the Company. The Company borrowed $1,500,000
on this line of credit for the security deposit and leasehold improvements of
the Company's corporate headquarters and repaid the entire outstanding balance
plus accrued interest in January 2001. The line of credit expired in July 2001
and was not renewed. In March 2002, the Company executed a working capital line
of credit agreement with a bank in the amount of $700,000. The Company borrowed
$645,000 under this line of credit during the first six months of 2002. In
September 2002, the Company repaid the outstanding balance in full, including
accrued interest, and terminated the line of credit. Advances under the line of
credit accrued interest at the prime rate minus 0.25%, with repayment terms of
monthly interest-only payments and principal due in June 2003. As part of the
line of credit agreement, the Company had to maintain a minimum restricted cash
balance of $800,000 with the bank.
On July 25, 2002, the Company executed a financing agreement with Laurus Master
Fund, Ltd. ("Laurus") in exchange for a $1.5 million convertible note and a
four-year warrant to purchase 300,000 shares of the Company's common stock at
exercise prices of $0.936 for the first 150,000 shares, $0.975 for the next
50,000 shares, and $1.17 for the remaining 100,000 shares. Laurus may convert
the convertible note, which bears interest at 7% annually, at any time into
shares of the Company's common stock at a fixed conversion price of $0.78,
subject to certain restrictions in the purchase agreement.
The Company may pay the principal and interest on the convertible note, which
has a one-year term, in cash, shares of its common stock or a combination of
cash and stock. If common stock is used to pay the note, the conversion price
will be the lesser of (i) $0.78 or (ii) 88% of the average of the 7 lowest
closing prices during the 22 trading days prior to the date the Company gives
notice of payment. Accrued interest and one-ninth of the principal is due on the
first business day of each calendar month beginning on November 1, 2002 and
continuing until the maturity date of July 1, 2003. If the required principal
payment is made in cash, the principal amount paid will be 105% of the amount
due. The Company granted Laurus a security interest in all of its assets. As of
the date of this report, the Company has not made any principal payments to
Laurus and is in default under the note. A penalty of 20% of the outstanding
principal amount, or $300,000, has been assessed to the Company for being in
default, and is included in the balance of Short-term borrowings on the
Company's balance sheet at December 31, 2002.
The Company recorded a debt discount as a result of the issuance of the warrant
to Laurus of approximately $259,000, which was being charged to interest expense
over the term of the convertible note using the effective yield method. Upon the
Company's default under the note during the fourth quarter of 2002, the
remaining balance of the discount was charged to interest expense. Furthermore,
the Company recorded an additional debt discount as a result of the beneficial
conversion feature of approximately $283,000, which was charged to interest
expense at the date of issuance. The amount related to the beneficial conversion
feature was determined by dividing the note proceeds allocated to the
convertible security of approximately $1,241,000 by the number of shares into
which the note is convertible, or 1,923,077 shares based on the fixed conversion
price of $0.78 per common share. The resulting effective conversion price of
$0.65 per common share was then compared to the fair value of the Company's
stock, which was $0.93 per common share on the issuance date. The difference of
$0.28 per common share between the fair value of the stock and the effective
conversion price was then multiplied by 1,009,586, which was the number of
shares the note was convertible into at the date of issuance, taking into
account the limitation on the number of shares that Laurus could convert at that
time. The agreement stipulates that Laurus may not convert that amount of the
note that would result in beneficial ownership of more than 4.9% of the
outstanding common shares of the Company on the date of conversion. The
conversion limitation becomes null and void upon an event of default under the
note and may be raised if the Company chooses to redeem the outstanding
principal amount of the note in cash and Laurus elects to convert the note
instead. The limitation may also be raised if the Company were to issue
additional common shares for any reason, thus increasing the number of
outstanding shares. Due to the Company's default under the note during the
fourth quarter of 2002, the 4.9% limitation became null and void and additional
interest expense of approximately $256,000 was recognized at a rate of $0.28 per
common share for the 913,491 additional shares that the note became convertible
into upon default.
The Company agreed to file with the Securities and Exchange Commission,
and have declared effective by November 25, 2002, a registration statement
registering the resale of the shares of the Company's common stock issuable upon
conversion or payment of the note and exercise of the warrant. As of the date of
this report, the Company has filed a registration statement but it has not yet
been declared effective.
Effect of New Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"), which addresses the
recognition and measurement of other intangible assets acquired outside of a
business combination whether acquired individually or with a group of assets. In
accordance with FAS 142, goodwill and certain intangible assets are no longer
amortized, but are subject to at least an annual assessment of impairment. The
Company adopted this statement on January 1, 2002. The provisions of FAS 142 did
not have an impact on the Company's consolidated financial statements.
20
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("FAS 144"). FAS 144 clarifies the
accounting for the impairment of long-lived assets and for long-lived assets to
be disposed of, including the disposal of business segments and major lines of
business. FAS 144 became effective for the Company in the first quarter of 2002.
During the fourth quarter of 2002, the Company performed an impairment review
because the uncertainty of the Company's ability to continue as a going concern
due to decreased liquidity indicated that the carrying value of certain
long-lived assets may not be recoverable. The Company determined that customer
relationship management software and document archival and retrieval software
with a carrying amount of $855,000 were no longer recoverable and recorded a
non-cash charge of $855,000, which is included as a component of operating
income in the accompanying consolidated statement of operations. Fair value was
based on the expected future cash flows to be generated by these assets, which
was zero because of the Company's inability to deploy and utilize the assets to
provide revenue-generating services, due to the Company's limited resources and
lack of liquidity.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires that a liability be recorded
in the guarantor's balance sheet upon issuance of a guarantee. In addition, FIN
45 requires disclosures about the guarantees that an entity has issued. The
initial recognition and initial measurement provisions of FIN 45 are applicable
on a prospective basis to guarantees issued or modified after December 31, 2002,
irrespective of the guarantor's fiscal year-end. The initial recognition and
initial measurement provisions of FIN 45 are not expected to have a material
impact on the Company's consolidated financial statements. The disclosure
requirements of FIN 45 are effective for financial statements of interim or
annual periods ending after December 15, 2002; therefore, the Company has
included the disclosures herein as required.
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based
Compensation, Transition and Disclosure" ("FAS 148"). FAS 148 provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. FAS 148 also
requires that disclosures of the pro forma effect of using the fair value method
of accounting for stock-based employee compensation be displayed more
prominently and in a tabular format. Additionally, FAS 148 requires disclosure
of the pro forma effect in interim financial statements. The transition and
annual disclosure requirements of FAS 148 are effective for fiscal years ended
after December 15, 2002. The interim disclosure requirements of FAS 148 are
effective for interim periods beginning after December 15, 2002. The adoption of
the provisions of FAS 148 did not have an impact on the Company's consolidated
financial statements, however, the Company has modified its disclosures as
provided for in the new standard.
Risk Factors
There are many factors that affect the Company's business and the results of its
operations, some of which are beyond its control. The following is a description
of some of the important factors that may cause the actual results of the
Company's operations in future periods to differ materially from those currently
expected or desired.
Future Capital Needs; Uncertainty of Additional Financing
The Company currently plans to meet its capital requirements primarily through
issuance of equity securities or new borrowing arrangements, and in the longer
term, revenue from operations. Due to a material shortfall from anticipated
revenues and the inability to access its funds held as collateral to guarantee
certain executive margin loans, the Company believes that its current available
cash and cash equivalents and investment balances along with anticipated
revenues may be insufficient to meet its anticipated cash needs for the
foreseeable future. Accordingly, the Company reduced its workforce by 36
employees in November 2002 and is currently aggressively pursuing strategic
alternatives, including investment in or sale of the Company. The sale of
additional equity or convertible debt securities would result in additional
dilution to our shareholders, and debt financing, if available, may involve
restrictive covenants that could restrict our operations or finances. There can
be no assurance that financing will be available in amounts or on terms
acceptable to the Company, if at all. If the Company cannot raise funds on
acceptable terms, or achieve positive cash flow, it may not be able to continue
to exist, conduct operations, grow market share, take advantage of future
opportunities or respond to competitive pressures or unanticipated requirements,
any of which would negatively impact its business, operating results and
financial condition.
Lack of Profitability; Uncertainty of Future Profitability
The Company was organized in 1998 and began operations as a public company in
1999 offering electronic billing services to other companies. The Company has
not been profitable since inception and may never achieve profitability. As of
December 31, 2002, the Company's accumulated deficit was $47.1 million. Because
we have a relatively limited history in a rapidly evolving and dynamic market,
it is difficult to predict our future operating results. Therefore, all
historical information included herein may not necessarily be indicative of the
results of operations, financial position and cash flows of the Company in the
future.
21
Uncertain Reliability, Growth and Consumer Acceptance of the Internet, Internet
Technology, and Electronic Commerce
The electronic commerce market is a relatively new and growing service industry.
If the electronic commerce market fails to grow or grows slower than
anticipated, or if the Company, despite an investment of significant resources,
is unable to adapt to meet changing customer requirements or technological
changes in this emerging market, or if the Company's services and related
products do not maintain a proportionate degree of acceptance in this growing
market, the Company's business, operating results, and financial condition could
be materially adversely affected. Additionally, the security and privacy
concerns of existing and potential customers may inhibit the growth of the
electronic commerce market in general, and the Company's customer base and
revenues in particular. Similar to the emergence of the credit card and
automatic teller machine ("ATM") industries, the Company and other organizations
serving the electronic commerce market must educate users that electronic
transactions use encryption technology and other electronic security measures
that make electronic transactions more secure than paper-based transactions.
While the Company believes that it is utilizing proven applications designed for
premium data security and integrity to process electronic transactions, there
can be no assurance that the Company's use of such applications will be
sufficient to address the changing market conditions or the security and privacy
concerns of existing and potential customers. Adverse publicity raising concerns
about the safety or privacy of electronic transactions, or widely reported
breaches of the Company's or another provider's security, have the potential to
undermine consumer confidence in the technology and thereby have a materially
adverse effect on the Company's business. In addition, there can be no guarantee
that the Internet will continue to grow in acceptance or maintain its
reliability, or that new technologies will not supplant the Internet in part or
in whole.
Uncertain Growth of Proportion of Electronic Remittances
The Company's future financial performance will be materially affected by the
percentage of bill payments that can be cleared electronically. As compared with
making payment by paper check or by draft, the Company believes that electronic
payments: (i) cost much less to complete; (ii) give rise to fewer errors, which
are costly to resolve; and (iii) generate far fewer customer inquiries and
therefore consume fewer customer care resources. Accordingly, the Company's
inability to continue to decrease the percentage of remittances effected by
paper documents would result in flat or decreased margins, and a reversal of the
current trend toward a smaller proportion of paper-based payments would have a
material adverse effect upon the Company's business, operating results, and
financial condition.
Risk of Inability to Adapt to Rapid Technological Change; Risk of Delays
The Company's success is highly dependent on its ability to develop new and
enhanced services, and related products that meet changing customer
requirements. The market for the Company's services, however, is characterized
by rapidly changing technology, evolving industry standards, emerging
competition and frequent new and enhanced software, service and related product
introductions. In addition, the software market is subject to rapid and
substantial technological change. The Company, to remain successful, must be
responsive to new developments in hardware and semiconductor technology,
operating systems, programming technology and computer capabilities. In many
instances, the new and enhanced services, products, and technologies are in the
emerging stages of development and marketing, and are subject to the risks
inherent in the development and marketing of new software, services, and
products. The Company may not successfully identify new service opportunities,
and develop and bring new and enhanced services and related products to market
in a timely manner; there can be no assurance that any such services, products
or technologies will develop or will be commercially successful, that the
Company will benefit from such developments or that services, products or
technologies developed by others will not render the Company's services and
related products noncompetitive or obsolete. If the Company is unable, for
technological or other reasons, to develop and introduce new services and
products in a timely manner in response to changing market conditions or
customer requirements, or if new or enhanced software, services and related
products do not achieve a significant degree of market acceptance, the Company's
business, operating results and financial condition would be materially
adversely affected.
Changes in Regulation of Electronic Commerce and Related Financial Services
Management believes that the Company is not required to be licensed by the
Office of the Comptroller of the Currency, the Federal Reserve Board, or other
federal or state agencies that regulate or monitor banks or other types of
providers of electronic commerce services. There can be no assurance that a
federal or state agency will not attempt to regulate providers of electronic
commerce services, such as the Company, which could impede the Company's ability
to do business in the regulator's jurisdiction. The Company is subject to
various laws and regulations relating to commercial transactions generally, such
as the Uniform Commercial Code, and may be subject to the electronic funds
transfer rules embodied in Regulation E, promulgated by the Federal Reserve
Board. Given the expansion of the electronic commerce market, the Federal
Reserve Board might revise Regulation E or adopt new rules for electronic funds
transfer affecting users other than consumers. Because of growth in the
electronic commerce market, Congress has held hearings on whether to regulate
providers of services and transactions in the electronic commerce market, and it
is possible that Congress or individual states could enact laws regulating the
electronic commerce market. If enacted, such laws, rules and regulations could
be imposed on the Company's business and industry and could have a material
adverse effect on the Company's business, operating results and financial
condition.
22
Uncertainty of ACH Access
Billserv has a contractual relationship with Bank One, which is an Originating
Depository Financial Institution ("ODFI") in the Automated Clearinghouse (ACH)
Network. The ACH Network is a nationwide batch-oriented electronic funds
transfer system that provides for the interbank clearing of electronic payments
for participating financial institutions. An ODFI is a participating financial
institution that must abide by the provisions of the ACH Operating Rules and
Guidelines. Through its relationship with Bank One, Billserv is able to process
payment transactions on behalf of its customers and their consumers by
submitting payment instructions to Bank One in a prescribed ACH format. Billserv
pays volume-based fees to Bank One for debit and credit transactions processed
through Bank One each month, and pays fees for other transactions such as
returns, notices of change to bank accounts, test debits, file transmission and
depository fees. These fees are part of Billserv's cost structure. If the
Federal Reserve rules were to change to further restrict or modify access to the
ACH, the Company's business could be materially adversely affected.
Competition in Electronic Commerce and Related Financial Services
Portions of the electronic commerce market are becoming increasingly
competitive. The Company expects to face growing competition in certain areas of
the EBPP market. Although few companies have focused their efforts as service
bureau consolidators in the EBPP industry, new service bureau companies could
emerge and compete for billers of all sizes. The Company believes that software
providers, consumer front ends, banks and Internet portals may provide
increasingly competitive billing services for billers of all sizes. In addition,
a number of banks have developed, and others in the future may develop, home
banking services in-house. The Company believes that banks may also compete for
the EBPP business of billers. The Company expects competition to increase from
both established and emerging companies and that such increased competition
could materially adversely affect the Company's business, operating results and
financial condition. Moreover, the Company's current and potential competitors,
many of whom have greater financial, technical, marketing and other resources
than the Company, may respond more quickly than the Company to new or emerging
technologies or could expand to compete directly against the Company in any or
all of its target markets. Accordingly, it is possible that current or potential
competitors could rapidly acquire market share. There can be no assurance that
the Company will be able to compete against current or future competitors
successfully or that competitive pressures faced by the Company will not have a
material adverse effect on its business, operating results and financial
condition.
Dependence on Key Personnel
The Company's success depends to a significant degree upon the continued
contributions of its key management, marketing, service and related product
development and operational personnel, including its Chairman and Chief
Executive Officer, Michael R. Long; its President and Chief Operating Officer,
Louis A. Hoch; its Executive Vice President and Chief Financial Officer, Terri
A. Hunter; and its Senior Vice President of Sales and Marketing, Tony L.
Diamond. The Company's operations could be affected adversely if, for any
reason, any of these officers ceased to be active in the Company's management.
The Company maintains proprietary nondisclosure and non-compete agreements with
all of its key employees. The success of the Company depends to a large extent
upon its ability to retain and continue to attract highly skilled personnel.
Competition for employees in the electronic commerce industry is intense, and
there can be no assurance that the Company will be able to attract and retain
enough qualified employees. If the Company experiences significant growth, it
may become increasingly difficult to hire, train and assimilate the new
employees needed. The Company's potential inability to retain and attract key
employees could have a material adverse effect on the Company's business,
operating results and financial condition.
Potential Fluctuations in Quarterly Results
The Company's quarterly results of operations may fluctuate significantly as a
result of a number of factors, including changes in the Company's pricing
policies or those of its competitors, relative rates of acquisition of new
customers, delays in the introduction of new or enhanced services, software and
related products by the Company or by its competitors or market acceptance of
such services and products, other changes in operating expenses, personnel
changes and general economic conditions. These factors will impact the Company's
operating results. Fluctuations in operating results could result in volatility
in the price of the Company's common stock.
Risk of Product Defects
The software products utilized by the Company could contain errors or "bugs"
that could adversely affect the performance of services or damage a user's data.
In addition, as the Company increases its share of the electronic commerce
services market, software reliability and security demands will increase. The
Company attempts to limit its potential liability for warranty claims through
technical audits and limitation-of-liability provisions in its customer
agreements. There can be no assurance that the measures taken by the Company
will prove effective in limiting the Company's exposure to warranty claims.
Despite the existence of various security precautions, the Company's computer
infrastructure may also be vulnerable to viruses or similar disruptive problems
caused by its customers or third parties gaining access to the Company's
processing system.
23
Erosion of Revenue from Services
One of the Company's customers that accounted for approximately 16%, 23% and 40%
of total consolidated revenues for the years ended December 31, 2002, 2001 and
2000, respectively, began developing an in-house EBPP offering during 2002. To
the extent that this expected loss of revenue is not mitigated by fees generated
from consulting services provided to this customer related to the transition of
their EBPP capabilities to an in-house offering, the Company's revenues and
profits will be adversely affected. The profitability of the Company's business
depends, to a substantial degree, upon billers electing to continue to
periodically renew contracts and receive services under existing contracts. In
the event that a substantial number of these customers were to decline to renew
these contracts or choose to discontinue receiving services for any reason, the
Company's revenues and profits would be adversely affected. Sales of the
Company's services are dependent upon customer demand for the services, which is
affected by pricing decisions, the competition of similar products and services,
and reputation of the products and services for performance. Most of the
Company's services are likely to be sold within the utilities and financial
services industries, and poor performance by the Company in performing its
services would have the potential to undermine the Company's reputation and
affect future sales of other services. A substantial decrease in revenue from
services would have a material adverse effect upon the Company's business,
operating results and financial condition.
Risk of Loss from Returned Transactions, Merchant Fraud or Erroneous
Transmissions
The Company relies upon the Federal Reserve's ACH for electronic fund transfers
and conventional paper check and draft clearing systems for settlement of
payments by check or drafts. In its use of these established payment clearance
systems, the Company generally bears the same credit risks normally assumed by
other users of these systems arising from returned transactions caused by
insufficient funds, stop payment orders, closed accounts, frozen accounts,
unauthorized use, disputes, theft or fraud. In addition, the Company also
assumes the risk of merchant fraud and transmission errors when it is unable to
have erroneously transmitted funds returned by an unintended recipient. Merchant
fraud includes such actions as inputting false sales transactions or false
credits.
Risk of System Failure
The Company's operations are dependent on its ability to protect its computer
equipment against damage from fire, earthquake, power loss, telecommunications
failure or similar event. Any damage or failure that causes interruptions in the
Company's operations could have a material adverse effect on the Company's
business, operating results and financial condition. The Company's property and
business interruption insurance may not be adequate to compensate the Company
for all losses that may occur.
Limited Protection of Proprietary Services
The Company regards some of its services as proprietary and relies primarily on
a combination of trademark and trade secret laws, employee and third party
non-disclosure agreements, and other intellectual property protection methods to
protect its services. Existing intellectual property laws afford only limited
protection, and it may be possible for unauthorized third parties to copy the
Company's services and related products or to reverse engineer or obtain and use
information that the Company regards as proprietary. There can be no assurance
that the Company's competitors will not independently develop services and
related products that are substantially equivalent or superior to those of the
Company.
Volatility of Stock Price
The market price of the Company's common stock is subject to significant
fluctuations in response to variations in quarterly operating results, the
failure of the Company to achieve operating results consistent with securities
analysts' projections of the Company's performance, and other factors. The stock
market has experienced extreme price and volume fluctuations and volatility that
has particularly affected the market prices of many technology, emerging growth
and developmental stage companies. Such fluctuations and volatility have often
been unrelated or disproportionate to the operating performance of such
companies. Factors such as announcements of the introduction of new or enhanced
services or related products by the Company or its competitors, announcements of
joint development efforts or corporate partnerships in the electronic commerce
market, market conditions in the technology, banking, telecommunications and
other emerging growth sectors, and rumors relating to the Company or its
competitors may have a significant impact on the market price of the Company's
common stock.
Control by Principal Stockholders
As of December 31, 2002, the directors and officers of the Company and their
affiliates collectively own approximately 10% of the outstanding shares of the
Company's common stock. As a result, these stockholders are able to exercise
significant influence over matters requiring stockholder approval, including the
election of directors and approval of significant corporate transactions. Such
concentration of ownership may have the effect of delaying or preventing a
change in control of the Company.
24
Shares Eligible for Future Sale; Possible Adverse Effect on Market Price
As of December 31, 2002, the Company had 20,603,799 shares of common stock
outstanding. The Company anticipates that it may need future equity financing to
meet certain operational and strategic requirements. Such future equity
financing may have a significant dilutive effect on the Company's stock price.
Anti-Takeover Provisions; Certain Provisions of Nevada Law; Certificate of
Incorporation, Bylaws, and Stockholder Rights Plan
On October 4, 2000, the Company approved a stockholder rights plan to protect
stockholders in the event of an unsolicited attempt to acquire the Company in a
manner that would not be in the best interests of its stockholders. This
stockholder rights plan could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from attempting to
acquire, control of the Company. The Company's Board of Directors is also
classified into three classes of directors serving staggered three-year terms.
Such classification of the Board of Directors expands the time required to
change the composition of a majority of directors and may tend to discourage a
proxy contest or other takeover bid for the Company. The issuance of common
stock under a stockholder rights plan could decrease the amount of earnings and
assets available for distribution to the holders of the Company's common stock
or could adversely affect the rights and powers, including voting rights, of the
holders of the Company's common stock. In certain circumstances, such issuance
could have the effect of decreasing the market price of the Company's common
stock.
Difficulty in Management of Growth
The Company may experience a period of rapid growth that could place a
significant strain on its resources. The Company's ability to manage growth
successfully will require the Company to continue to improve its operational,
management and financial systems and controls as well as to expand its work
force. A significant increase in the Company's customer base would necessitate
the hiring of a significant number of additional customer care and technical
support personnel as well as computer software developers and technicians,
qualified candidates for which, at the time needed, may be in short supply. In
addition, the expansion and adaptation of the Company's computer and
administrative infrastructure will require substantial operational, management
and financial resources. Although the Company believes that its current
infrastructure is adequate to meet the needs of its customers in the foreseeable
future, there can be no assurance that the Company will be able to expand and
adapt its infrastructure to meet additional demand on a timely basis, at a
commercially reasonable cost, or at all. If the Company's management is unable
to manage growth effectively, hire needed personnel, expand and adapt its
computer infrastructure or improve its operational, management, and financial
systems and controls, the Company's business, operating results, and financial
condition could be materially adversely affected.
Acquisition-Related Risks
In the future, the Company may pursue acquisitions of complementary service or
product lines, technologies or businesses. Future acquisitions by the Company
could result in potentially dilutive issuance of equity securities, the
incurrence of debt and contingent liabilities, and amortization expenses related
to goodwill and other intangible assets, any of which could materially adversely
affect the Company's business, operating results and financial condition. In
addition, acquisitions involve numerous risks, including difficulties in the
assimilation of the operations, technologies, services and products of the
acquired companies, the diversion of management's attention from other business
concerns, risks of entering markets in which the Company has no or limited
direct prior experience, and the potential loss of key employees of the acquired
company. From time to time, the Company evaluates potential acquisitions of
businesses, services, products or technologies. The Company has no present
commitments or agreements with respect to any material acquisition of other
businesses, services, products or technologies. In the event that such an
acquisition were to occur, however, there can be no assurance that the Company's
business, operating results and financial condition would not be materially
adversely affected.
Unlikely Payment of Dividends
The Company has paid no cash dividends and has no present plan to pay cash
dividends, intending instead to reinvest its earnings, if any. However, payment
of future cash dividends will be determined from time to time by its Board of
Directors, based upon its future earnings, financial condition, capital
requirements and other factors. The Company is not presently subject to any
restriction on its present or future ability to pay such dividends.
Dependence Upon Contracts with Billers
The Company's business is dependent upon performing under the terms of
agreements with billers. Although the Company is unaware of any circumstance
that would prevent the operational ability to perform these agreements, there
can be no assurance that the Company might not be able to fully perform under
these agreements or that other factors may prevent billers from processing
billing information through the Company.
25
Dependence Upon Contracts with Trading Partners
The Company's business is dependent upon executing and maintaining agreements
with distribution and payment partners, such as CheckFree Services Corporation
and Paymentech, Inc., to provide dependable financial services for consumers of
billers. Such financial services include ACH processing through the client's
bank and delivery of good funds to the Company for remittance to the billers.
There can be no assurance that any of the distribution or payment partners will
be able to perform under these agreements in the future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's current investment portfolio. Certain of the
Company's marketable securities are designated as "available for sale" and
accordingly are presented at fair value on the balance sheets. The Company
generally invests its excess cash in high-quality short-term fixed income
securities. Fixed-rate securities may have their fair market value adversely
impacted by a rise in interest rates, and the Company may suffer losses in
principal if forced to sell securities that have declined in market value due to
changes in interest rates.
26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors .................................... 28
Consolidated Balance Sheets as of December 31, 2002 and 2001 ...... 29
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000 ................................ 30
Consolidated Statement of Changes in Shareholders' Equity (Deficit)
for the years ended December 31, 2002, 2001 and 2000 ............ 31
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000 ................................ 32
Notes to Consolidated Financial Statements ........................ 33
27
REPORT OF INDEPENDENT AUDITORS
To Board of Directors and Shareholders of Billserv, Inc.
We have audited the accompanying consolidated balance sheets of Billserv, Inc.
and subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of operations, changes in shareholders' equity, and cash flows for
the three years in the period ended December 31, 2002. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Billserv, Inc. and
subsidiaries at December 31, 2002 and 2001, and the consolidated results of
their operations and their cash flows for the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States.
The accompanying financial statements of Billserv, Inc. have been prepared
assuming that Billserv, Inc. will continue as a going concern. As more fully
described in Note 18, the Company has incurred substantial losses since
inception and has experienced a material shortfall in anticipated revenues,
which has led to a significant decrease in its cash position and a deficit in
working capital. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements of Billserv,
Inc. do no include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
ERNST & YOUNG LLP
San Antonio, Texas
April 1, 2003
28
BILLSERV, INC.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2002 2001
------------ -------------
Assets:
Cash and cash equivalents $ 286,105 $ 4,173,599
Cash pledged as collateral for related party obligations 1,311,984 2,018,951
Investments restricted as collateral for capital leases -- 236,948
Accounts receivable, net 659,074 437,677
Prepaid expenses and other 257,810 225,795
Related party notes receivable -- 162,154
------------ ------------
Total current assets 2,514,973 7,255,124
Property and equipment, net of accumulated
depreciation and amortization of $3,747,539
and $2,718,953 for 2002 and 2001, respectively 2,171,790 3,701,205
Intangible asset, net of accumulated amortization of
$52,500 and $37,500 for 2002 and 2001, respectively 22,500 37,500
Other assets -- 421,307
------------ ------------
Total assets $ 4,709,263 $ 11,415,136
============ ============
Liabilities and shareholders' equity (deficit):
Current liabilities:
Accounts payable $ 797,211 $ 201,513
Accrued expenses and other current liabilities 707,741 664,200
Payable under related party guarantees 1,278,138 --
Current portion of obligations under capital leases 31,315 148,228
Current portion of deferred revenue 309,492 490,829
Short-term borrowings 1,800,000 --
------------ ------------
Total current liabilities 4,923,897 1,504,770
Obligations under capital leases, less current portion 39,168 --
Deferred revenue, less current portion 91,468 161,800
Shareholders' equity (deficit):
Common stock, $.001 par value, 200,000,000 shares
authorized; 20,603,799 issued and outstanding
at December 31, 2002, 20,538,526 issued and
outstanding at December 31, 2001 20,604 20,539
Additional paid-in capital 46,770,186 45,909,410
Accumulated deficit (47,136,060) (36,181,383)
------------ ------------
Total shareholders' equity (deficit) (345,270) 9,748,566
------------ ------------
Total liabilities and shareholders' equity (deficit) $ 4,709,263 $ 11,415,136
============ ============
See notes to consolidated financial statements
29
BILLSERV, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended Year ended Year ended
December 31, December 31, December 31,
2002 2001 2000
------------ ------------ ------------
Service revenues $ 3,968,554 $ 2,968,678 $ 650,023
Software license revenues 238,000 -- --
------------ ------------ ------------
Total revenues 4,206,554 2,968,678 650,023
Cost of service revenues 4,462,344 4,995,161 3,690,843
Cost of software license revenues 228,000 -- --
------------ ------------ ------------
Total cost of revenues 4,690,344 4,995,161 3,690,843
------------ ------------ ------------
Gross margin (483,790) (2,026,483) (3,040,820)
Operating expenses:
General and administrative 3,948,684 4,338,374 3,677,834
Selling and marketing 873,775 2,084,941 4,586,823
Research and development 461,065 760,082 767,751
Depreciation and amortization 1,658,886 1,555,626 940,995
Provision for impairment of assets 855,117 -- --
Non-cash expense related to the
issuance of warrants -- -- 7,488,000
------------ ------------ ------------
Total operating expenses 7,797,527 8,739,023 17,461,403
------------ ------------ ------------
Operating loss (8,281,317) (10,765,506) (20,502,223)
Other income (expense), net:
Interest income 81,799 355,262 687,724
Interest expense (1,114,798) (40,079) (140,651)
Equity in earnings (loss) of
unconsolidated subsidiary (7,729) 7 ,676 --
Loss on related party guarantees (1,278,138) -- --
Other income (expense) (354,494) 36,941 (900)
------------ ------------ ------------
Total other income (expense), net (2,673,360) 359,800 546,173
Loss before income taxes and cumulative
effect of accounting change (10,954,677) (10,405,706) (19,956,050)
Income taxes -- -- --
------------ ------------ ------------
Net loss before cumulative effect of
accounting change (10,954,677) (10,405,706) (19,956,050)
Cumulative effect of a change in
accounting principle, net of taxes -- -- (52,273)
------------ ------------ ------------
Net loss $(10,954,677) $(10,405,706) $(20,008,323)
============ ============ ============
Net loss per common share before
cumulative effect of accounting change-
basic and diluted $ (0.53) $ (0.58) $ (1.35)
Cumulative effect of accounting change-
basic and diluted -- -- --
------------ ------------ ------------
Net loss per common share - basic and
diluted $ (0.53) $ (0.58) $ (1.35)
============ ============ ============
Weighted average common shares
outstanding - basic and diluted 20,591,304 18,017,051 14,793,622
============ ============ ============
See notes to consolidated financial statements.
30
BILLSERV, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
Common Stock Additional Other Total
--------------------- Paid - In Accumulated Comprehensive Shareholders'
Shares Amount Capital Deficit Income Equity (Deficit)
----------- -------- ----------- ------------- ------------- -----------------
Balance at December 31, 1999 13,113,065 $13,113 $13,695,584 $ (5,767,354) $ -- $ 7,941,343
Exercise of warrants 1,514,136 1,514 6,094,984 -- -- 6,096,498
Exercise of stock options 3,700 4 13,527 -- -- 13,531
Issuance of common stock, net
of issuance costs 896,969 897 9,466,355 -- -- 9,467,252
Value of common stock warrants
granted in connection with
issuance of common stock -- -- 7,488,000 -- -- 7,488,000
Comprehensive loss:
Unrealized gain on investments -- -- -- -- 13,109 13,109
Net loss for the year ended
December 31, 2000 -- -- -- (20,008,323) -- (20,008,323)
---------------
Comprehensive loss (19,995,214)
----------- -------- ----------- ------------- ------------- ---------------
Balance at December 31, 2000 15,527,870 15,528 36,758,450 (25,775,677) 13,109 11,011,410
Exercise of stock options 8,000 8 34,992 -- -- 35,000
Issuance of common stock, net
of issuance costs 5,002,656 5,003 9,115,968 -- -- 9,120,971
Comprehensive loss:
Unrealized gain on investments -- -- -- -- (13,109) (13,109)
Net loss for the year ended
December 31, 2001 -- -- -- (10,405,706) -- (10,405,706)
---------------
Comprehensive loss (10,418,815)
----------- -------- ----------- ------------- ------------- ---------------
Balance at December 31, 2001 20,538,526 20,539 45,909,410 (36,181,383) -- 9,748,566
Issuance of common stock 65,273 65 63,170 -- -- 63,235
Value of beneficial conversion
feature granted in connection
with issuance of debt -- -- 538,461 -- -- 538,461
Value of common stock warrants
granted in connection with
issuance of debt -- -- 259,145 -- -- 259,145
Comprehensive loss:
Net loss for the year ended
December 31, 2002 -- -- -- (10,954,677) -- (10,954,677)
----------- -------- ----------- ------------- ------------- ---------------
Balance at December 31, 2002 20,603,799 $20,604 $46,770,186 $(47,136,060) $ -- $ (345,270)
=========== ======== =========== ============= ============= ===============
See notes to consolidated financial statements.
31
BILLSERV, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
2002 2001 2000
------------- ------------- -------------
Cash flows from operating activities:
Net loss $(10,954,677) $(10,405,706) $(20,008,323)
Adjustments to reconcile net loss to net
cash used in operating activities:
Issuance of common stock warrants and convertible debt 797,606 -- 7,488,000
Amortization of financing costs 237,649 -- --
Depreciation and amortization 1,658,886 1,555,626 940,955
Loss on related party guarantees 1,278,138 -- --
Loss on impairment of assets 855,117 -- --
Non-cash exchange of assets (600,000) -- --
Loss on renegotiation of facilities leases 478,653 -- --
(Gain) loss on disposition 20,999 (36,070) --
Equity in (earnings) loss of unconsolidated subsidiary 7,729 (7,676) --
Cumulative effect of change in accounting principle -- -- 52,273
Changes in current assets and current liabilities:
(Increase) decrease in accounts receivable (221,397) 344,860 (772,310)
(Increase) decrease in related party notes receivable 162,154 121,584 (253,516)
Decrease in prepaid expenses and other 7,702 377,551 5,004
Increase (decrease) in accounts payable and
accrued expenses 893,818 (757,863) 735,458
Increase (decrease) in deferred revenue (251,669) (173,371) 768,727
------------- ------------- -------------
Net cash used in operating activities (5,629,292) (8,981,065) (11,043,732)
Cash flows from investing activities:
Purchases of property and equipment (401,904) (722,748) (3,652,712)
Purchase of investments -- -- (7,864,759)
Proceeds from sales and maturities of investments -- 2,028,680 5,863,048
Long-term deposits, net 255,503 218,641 (764,496)
Other investing activities 3,874 2,577 --
------------- ------------- -------------
Net cash provided by (used in) investing activities (142,527) 1,527,150 (6,418,919)
Cash flows from financing activities:
Proceeds from notes payable 2,145,000 -- 1,500,000
Principal payments for notes payable (645,000) (1,500,000) --
Financing costs, net (237,649) -- --
Principal payments for capital lease obligations (148,228) (181,328) (512,231)
Exercise of warrants -- -- 6,096,498
Cash pledged as collateral for related party obligations 706,967 (1,018,951) (1,000,000)
Issuance of common stock, net of issuance costs 63,235 9,155,971 9,480,783
------------- ------------- -------------
Net cash provided by financing activities 1,884,325 6,455,692 15,565,050
------------- ------------- -------------
Net decrease in cash and cash equivalents (3,887,494) (998,223) (897,601)
Cash and cash equivalents, beginning of period 4,173,599 5,171,822 7,069,423
------------- ------------- -------------
Cash and cash equivalents, end of period $ 286,105 $ 4,173,599 $ 5,171,822
============= ============= =============
Supplemental information:
Cash paid for interest $ 39,264 $ 52,027 $ 139,755
Non-cash investing and financing activities:
Purchases of equipment under capital leases $ 70,483 $ -- $ 278,080
See notes to consolidated financial statements.
32
BILLSERV, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2001 AND 2000
NOTE 1. Description of Business and Summary of Significant Accounting Policies
Description of Business
Billserv, Inc., formerly known as billserv.com, Inc., and its subsidiaries
(collectively, "Billserv" or "the Company"), provide electronic bill presentment
and payment ("EBPP") services to companies generating recurring bills, primarily
in the United States. The Company also provides related consulting and
Internet-based customer care interaction services. In addition, the Company
operates an Internet bill presentment and payment portal for consumers under the
domain name www.bills.com.
Basis of Presentation
The Company remained a development stage company through December 31, 2001, as
recurring revenue related to EBPP activity had not reached a significant level.
Based on revenue growth, the Company was no longer considered to be a
development stage enterprise in 2002.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year
presentation. These reclassifications had no impact on operating loss as
previously reported.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries, bills.com, Inc. and
billserv.com-canada, Inc. All significant intercompany accounts and transactions
have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with maturities of
three months or less to be cash equivalents.
Concentration of Credit Risk
Financial instruments that potentially expose the Company to credit risk consist
of cash and cash equivalents, investments and accounts receivable. The Company
is exposed to credit risk on its cash, cash equivalents and investments in the
event of default by the financial institutions or the issuers of these
investments to the extent of the amounts recorded on the balance sheet in excess
of amounts that are insured by the FDIC. Trade receivables potentially subject
the Company to concentrations of credit risk. The Company's customer base
operates in a variety of industries and is geographically dispersed, however,
the relatively small number of customers increases the risk. The Company closely
monitors extensions of credit and has not experienced significant credit losses
in the past. Credit losses have been provided for in the consolidated financial
statements and have been within management's expectations. The Company recorded
bad debt expense of $30,000, $21,000 and $10,000 for 2002, 2001 and 2000,
respectively, and recorded bad debt write-offs of $1,734 and $12,069 to its
allowance for doubtful accounts in 2002 and 2001, respectively. There were no
write-offs recorded to the allowance for doubtful accounts in 2000. At December
31, 2002 and 2001, the balance of the allowance for doubtful accounts was
$47,197 and $18,931, respectively.
One billing customer accounted for approximately 16%, 23% and 40% of total
consolidated revenues for the years ended December 31, 2002, 2001 and 2000,
respectively. This customer developed an in-house EBPP offering during 2002
utilizing Billserv's transition plan that allows the customer to move from an
outsourced offering with Billserv to an in-house offering. The resulting loss of
transaction revenues was mitigated by fees generated from consulting services
provided to this customer related to transitioning their EBPP capabilities to an
in-house offering. In addition, the Company recognized $173,000 of non-recurring
revenue in 2000 attributable to a single customer for which we are no longer
providing services.
33
Fair Value of Financial Instruments
Cash and cash equivalents, accounts receivable, accounts payable, accrued
liabilities and short-term borrowings are reflected in the accompanying
consolidated financial statements at cost, which approximates fair value because
of the short-term maturity of these instruments.
Investments
The Company's investments consist primarily of commercial paper, repurchase
agreements and investment-grade corporate bonds. The Company classifies these
investments as "available-for-sale," "trading" or "held-to-maturity" securities
in accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." The Company
has not had any investments classified as "trading" or "held-to-maturity"
securities. Investments classified as "available-for-sale" securities are
carried at fair value, with unrealized holding gains and losses reported as a
separate component of shareholders' equity (See Note 2). Realized gains and
losses on sales of available-for-sale securities are determined based on the
amortized cost of such securities using the specific identification method.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are
computed on a straight-line method over the estimated useful lives of the
related assets, ranging from three to seven years. Leasehold improvements are
amortized over the lesser of the estimated useful lives or remaining lease
period. Expenditures for maintenance and repairs are charged to expense as
incurred.
Impairment of Long-Lived Assets
The Company periodically reviews the carrying value of its long-lived assets,
including property, plant and equipment, whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. To the
extent fair value of a long-lived asset, determined based upon the estimated
future cash inflows attributable to the asset, less estimated future cash
outflows, are less than the carrying amount, an impairment loss is recognized.
Intangible Asset
The cost of the intangible asset is being amortized on a straight-line basis
over a five-year period.
Revenue Recognition
Revenue consists of implementation fees, hosting and transaction fees, fees for
consulting services and license revenue from the resale of third party software.
The Company typically receives an up-front fee for the work involved in
implementing the basic functionality required to provide electronic bill
presentment and payment services to a customer. Revenue from such implementation
fees is recognized over the term of the related service contract, generally
three to five years. Hosting and transaction fees are generated through the
electronic presentment of bills, processing of bill payments, and handling of
customer care interactions for billing customers and are recognized as revenue
as the related services are provided. Consulting fees are earned for
professional services provided to EBPP billers or vendors and are recognized as
services are rendered. Revenue from the resale of software licenses is
recognized when persuasive evidence of an agreement exists, delivery of the
product has occurred, the fee is fixed or determinable, and collection is
probable.
Research and Development Costs
Research and development costs are expensed as incurred.
Advertising Costs
The cost of advertising is expensed as incurred. The Company incurred $6,000,
$19,000 and $1,394,000 in advertising costs for the years ended December 31,
2002, 2001 and 2000, respectively.
Foreign Operations
Foreign operations began in 2000, however the impact financially of expanding
internationally is not material to the Company's financial position or results
of operations as of December 31, 2002. Australia and Canada are the only foreign
countries in which the Company is currently operating. The Company's Australia
operations include a 50% interest in a corporate joint venture to provide EBPP
services. The Company accounts for this investment under the equity method. At
December 31, 2002, the investment in this joint venture was zero. The Company
has no material additional contractual commitments to this joint venture
34
and no dividends have been received from this joint venture. Gains and losses
resulting from foreign currency transactions denominated in a currency other
than the functional currency are included in income and have not been
significant to the Company's consolidated operating results in any year.
Income Taxes
Income taxes are determined using the liability method (see Note 12). Under this
method, deferred tax assets and liabilities are recorded based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
Comprehensive Loss
The Company's comprehensive loss is comprised of net loss and unrealized gains
and losses on investments classified as available-for-sale.
Stock-Based Compensation
The Company applies the intrinsic value method in accounting for its stock
option and stock purchase plans. Accordingly, no compensation expense has been
recognized for options granted with an exercise price equal to market value at
the date of grant or in connection with the employee stock purchase plan. Had
compensation expense been recorded based on the fair value at the grant date for
2002, 2001 and 2000 stock option grants, net loss and net loss per share would
approximate the pro forma amounts below:
2002 2001 2000
---- ---- ----
Pro forma net loss $(12,539,041) $(13,188,701) $(23,778,759)
Pro forma net loss per common
share - basic and diluted $ (0.61) $ (0.73) $ (1.61)
The effects of applying SFAS 123 in this pro forma disclosure are not indicative
of future amounts. Additional awards in future years are anticipated.
Net Loss Per Share
Basic and diluted losses per common share are calculated by dividing net loss by
the weighted average number of common shares outstanding during the period.
Common stock equivalents, which consist of stock options and warrants and the
convertible debt, were excluded from the computation of the weighted average
number of common shares outstanding for purposes of calculating diluted loss per
common share because their effect was antidilutive. See Notes 10, 13 and 14 for
disclosure of securities that could potentially dilute basic EPS in the future
that were not included in the computation of diluted EPS because to do so would
have been antidilutive for the periods presented.
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"), which addresses the
recognition and measurement of other intangible assets acquired outside of a
business combination whether acquired individually or with a group of assets. In
accordance with FAS 142, goodwill and certain intangible assets are no longer
amortized, but are subject to at least an annual assessment of impairment. The
Company adopted this statement on January 1, 2002. The provisions of FAS 142 did
not have an impact on the Company's consolidated financial statements.
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("FAS 144"). FAS 144 clarifies the
accounting for the impairment of long-lived assets and for long-lived assets to
be disposed of, including the disposal of business segments and major lines of
business. FAS 144 became effective for the Company in the first quarter of 2002.
During the fourth quarter of 2002, the Company performed an impairment review
because the uncertainty of the Company's ability to continue as a going concern
due to decreased liquidity indicated that the carrying value of certain
long-lived assets may not be recoverable. The Company determined that customer
relationship management software and document archival and retrieval software
with a total carrying amount of $855,000 were no longer recoverable and recorded
a non-cash charge of $855,000, which is included as a component of operating
income in the accompanying consolidated statement of operations. Fair value was
based on the expected future cash flows to be generated by these assets, which
was zero because of the Company's inability to deploy and utilize the assets to
provide revenue-generating services, due to the Company's limited resources and
lack of liquidity.
35
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires that a liability be recorded
in the guarantor's balance sheet upon issuance of a guarantee. In addition, FIN
45 requires disclosures about the guarantees that an entity has issued. The
initial recognition and initial measurement provisions of FIN 45 are applicable
on a prospective basis to guarantees issued or modified after December 31, 2002,
irrespective of the guarantor's fiscal year-end. The initial recognition and
initial measurement provisions of FIN 45 are not expected to have a material
impact on the Company's consolidated financial statements. The disclosure
requirements of FIN 45 are effective for financial statements of interim or
annual periods ending after December 15, 2002; therefore, the Company has
included the disclosures herein as required.
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based
Compensation, Transition and Disclosure" ("FAS 148"). FAS 148 provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. FAS 148 also
requires that disclosures of the pro forma effect of using the fair value method
of accounting for stock-based employee compensation be displayed more
prominently and in a tabular format. Additionally, FAS 148 requires disclosure
of the pro forma effect in interim financial statements. The transition and
annual disclosure requirements of FAS 148 are effective for fiscal years ended
after December 15, 2002. The interim disclosure requirements of FAS 148 are
effective for interim periods beginning after December 15, 2002. The adoption of
the provisions of FAS 148 did not have an impact on the Company's consolidated
financial statements, however, the Company has modified its disclosures as
provided for in the new standard.
NOTE 2. Financial Instruments
There were no available-for-sale investments held at December 31, 2002. The
following is a summary of available-for-sale investments at December 31, 2001:
December 31, 2001
---------------------------------------
Gross
Amortized unrealized Fair
Cost gains value
--------- ---------- ----------
Time deposits $ 236,948 $ 0 $ 236,948
The securities included in the table above with fair values totaling $236,948 at
December 31, 2001 are classified as short-term investments restricted as
collateral for capital leases in the accompanying consolidated balance sheets
(see Note 8). All short-term investments mature within one year.
NOTE 3. Cumulative Effect of Accounting Change
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB 101"),
"Revenue Recognition in Financial Statements," which provides guidance on the
recognition, presentation and disclosure of revenue in financial statements. The
implementation of SAB 101 requires the Company's revenue generated from up-front
implementation fees that do not represent a separate earnings process to be
recognized over the term of the related service contract. Prior to December 31,
1999, the Company recognized revenue generated from such up-front fees upon
completion of an implementation project. The Company adopted SAB 101 as of
January 1, 2000, and accordingly, changed its revenue recognition policy for
up-front implementation fees. The cumulative effect of this accounting change
totaled $52,273. This amount was recognized as a non-cash after-tax charge
during the first quarter of 2000. The cumulative effect was recorded as deferred
revenue and is being recognized as revenue over the remaining contractual
service periods.
NOTE 4. Issuance of Capital Stock
Private Placements
In October 1999 and December 1999, the Company issued 1,404,637 and 732,000
shares of common stock, respectively, under a private placement offering (the
"1999 Offering"). The shares were issued at $3.25 and $5.50 per share,
respectively, which represented a discount upon the average reported closing
sale price of the common stock for the ten business days immediately preceding
the closing date. Net proceeds totaled approximately $7,907,000, net of offering
costs of $684,000, which included $526,000, or 6.5% of the 1999 Offering, paid
to the placement agent. Of the shares issued in October 1999, 153,846 were
issued in satisfaction of a $500,000 short-term note payable (See Note 10).
In accordance with the terms of the 1999 Offering, a registration statement on
Form SB-2 was filed with the SEC registering 3,782,360 shares of common stock.
This registration statement became effective on January 18, 2000. The registered
shares include the 2,136,637 shares issued in October and December 1999 and
1,645,723 shares which were issuable upon exercise of warrants to purchase
common stock issued to the holders of the shares issued in October and December
1999.
36
On June 2, 2000, the Company entered into an extended biller service provider
agreement with CheckFree Investment Corporation, CheckFree Services Corporation
and CheckFree Holdings Corporation ("CheckFree"). As part of this agreement,
CheckFree purchased 879,121 shares of the Company's common stock at $11.375 per
share totaling $10.0 million. Offering proceeds to the Company, net of issuance
costs, were approximately $9.5 million. In connection with this transaction, the
Company also issued warrants to purchase 2,179,121 shares of common stock, and
warrants to purchase up to an additional 2,801,903 shares if certain criteria
are met (See Note 14).
In March 2001, the Company issued 2,885,462 shares of common stock under a
private placement offering. The shares were issued at an undiscounted price of
$2.50 per share. Net proceeds totaled approximately $6.6 million, net of
offering costs of approximately $565,000, which included approximately $540,000,
or 7.5% of the Offering, paid to the placement agent. The Company subsequently
filed a registration statement with the SEC to register the shares issued in
this offering.
In November 2001, the Company issued 2,000,000 shares of common stock under a
private placement offering (the "2001 Offering"). The shares were issued at an
undiscounted price of $1.25 per share. Net proceeds totaled approximately $2.3
million, net of offering costs of approximately $211,000, which included
approximately $200,000, or 8% of the Offering, paid to the placement agent. The
Company subsequently filed a registration statement with the SEC to register the
shares issued in this offering. In connection with this transaction, the Company
also issued warrants to purchase 2,000,000 shares of common stock (See Note 14).
NOTE 5. Property and Equipment
The following is a summary of property and equipment at December 31, 2002 and
2001:
December 31, December 31,
2002 2001
------------ ------------
Furniture and fixtures $ 1,069,687 $ 1,285,440
Equipment 3,201,484 2,983,164
Software 1,612,707 1,613,759
Leasehold improvements 35,451 537,795
------------ ------------
5,919,329 6,420,158
Less: accumulated depreciation
and amortization (3,747,539) (2,718,953)
------------ ------------
Total property and equipment, net $ 2,171,790 $ 3,701,205
============ ============
For 2002, 2001 and 2000, the Company recorded $1,643,886, $1,540,626 and
$925,995, respectively, of depreciation expense related to fixed assets,
including amortization expense related to capital leases. Amortization expense
related to intangible assets in 2002, 2001 and 2000 was $15,000 each year.
NOTE 6. Other Assets
At December 31, 2001, other assets included a cash deposit of approximately
$413,000 related to the lease for the Company's corporate headquarters.
NOTE 7. Accrued Expenses
Accrued expenses consist of the following balances:
December 31, December 31,
2002 2001
----------- -----------
Accrued salaries $185,178 $257,843
Accrued vacation 80,517 122,501
Accrued property taxes 84,018 99,338
ESPP withholdings 6,710 40,745
Other accrued expenses 351,318 143,773
----------- -----------
Total $707,741 $664,200
=========== ===========
37
NOTE 8. Obligations Under Capital Leases
Property held under capital leases is stated at the present value of minimum
lease payments at the inception of the related leases. Property held under a
capital lease is amortized on a straight-line basis over the estimated useful
life of the assets. Amortization of property held under capital leases is
included with depreciation expense. At December 31, 2002 and 2001, there was
$70,483 and $498,946, respectively, of office and computer equipment held under
capital leases. All of the Company's capital leases at December 31, 2001 were
secured by certificates of deposit totaling approximately $237,000.
The following is a schedule of future minimum lease payments under capital
leases for the year ending December 31, 2003, together with the present value of
the minimum lease payments as of December 31, 2002:
Year ending December 31,
2003 $ 32,534
2004 21,062
2005 19,307
---------
Total minimum lease payments 72,903
Less: amount representing interest (2,420)
---------
70,483
Less: current portion (31,315)
---------
Obligations under capital leases $ 39,168
=========
NOTE 9. Operating Leases
In March 2000, the Company entered into a five-year operating lease for its
corporate headquarters at a rate of $98,000 per month. The lease required an
initial cash deposit of approximately $516,000. In May 2002, the lease agreement
for the office space the Company utilizes for its headquarters and operations
was amended. The amendment reduced the leased space to approximately 36,000
square feet and lowered the annual rent to approximately $677,000 from
$1,175,000. In return, the Company surrendered its prepaid rent, which was
included in other assets, to the lessor. Subsequent to December 31, 2002, the
lessor terminated this amended lease for nonpayment of rent and executed a
monthly lease with no renewal option for approximately 25,000 square feet with
the Company. Including the write-off of affected leasehold improvements, the
Company recognized total charges related to these lease amendments of $686,000
for the year ended December 31, 2002. Additionally, the Company leases office
equipment under non-cancelable operating leases. Rental expense under operating
leases for the year ended December 31, 2002, 2001 and 2000, was $998,000,
$1,245,000 and $681,000, respectively. Future minimum lease payments required
under operating leases, by year and in the aggregate, consist of the following
at December 31, 2002:
Year ending December 31,
2003 $ 214,407
2004 9,382
2005 1,940
---------
Total minimum lease payments $ 225,729
=========
NOTE 10. Debt
Line of Credit
In June 2000, the Company executed a working capital line of credit agreement
with a bank in the amount of $1,500,000. Advances under the line of credit
accrued interest at the prime rate minus 0.25%, with repayment terms of monthly
interest-only payments and principal due in July 2001. The line of credit was
secured by certain investments of the Company. The Company borrowed $1,500,000
on this line of credit for the security deposit and leasehold improvements of
the Company's corporate headquarters and repaid the entire outstanding balance
plus accrued interest in January 2001. The line of credit expired in July 2001
and was not renewed. In March 2002, the Company executed a working capital line
of credit agreement with a bank in the amount of $700,000. The Company borrowed
$645,000 under this line of credit during the first six months of 2002. In
September 2002, the Company repaid the outstanding balance in full, including
accrued interest, and terminated the line of credit. Advances under the line of
credit accrued interest at the prime rate minus 0.25%, with repayment terms of
monthly interest-only payments and principal due in June 2003. As part of the
line of credit agreement, the Company had to maintain a minimum restricted cash
balance of $800,000 with the bank.
38
Convertible Debt
On July 24, 2002, the Company executed a financing agreement with Laurus Master
Fund, Ltd. ("Laurus") in exchange for a $1.5 million convertible note and a
four-year warrant to purchase 300,000 shares of the Company's common stock at
exercise prices of $0.936 for the first 150,000 shares, $0.975 for the next
50,000 shares, and $1.17 for the remaining 100,000 shares. Laurus may convert
the convertible note, which bears interest at 7% annually, at any time into
shares of the Company's common stock at a fixed conversion price of $0.78,
subject to certain restrictions in the purchase agreement.
The Company may pay the principal and interest on the convertible note, which
has a one-year term, in cash, shares of its common stock or a combination of
cash and stock. If common stock is used to pay the note, the conversion price
will be the lesser of (i) $0.78 or (ii) 88% of the average of the 7 lowest
closing prices during the 22 trading days prior to the date the Company gives
notice of payment. Accrued interest and one-ninth of the principal is due on the
first business day of each calendar month beginning on November 1, 2002 and
continuing until the maturity date of July 1, 2003. If the required principal
payment is made in cash, the principal amount paid will be 105% of the amount
due. The Company granted Laurus a security interest in all of its assets.
Currently, the Company has not made any principal payments to Laurus and is in
default under the note. A penalty of 120% of the outstanding principal amount,
or $300,000, has been assessed to the Company for being in default, and is
included in the balance of short-term borrowings on the Company's balance sheet
at December 31, 2002.
The Company recorded a debt discount as a result of the issuance of the warrant
to Laurus of approximately $259,000, which was being charged to interest expense
over the term of the convertible note using the effective yield method. Upon the
Company's default under the note during the fourth quarter of 2002, the
remaining balance of the discount was charged to interest expense. Furthermore,
the Company recorded an additional debt discount as a result of the beneficial
conversion feature of approximately $283,000, which was charged to interest
expense at the date of issuance. The amount related to the beneficial conversion
feature was determined by dividing the note proceeds allocated to the
convertible security of approximately $1,241,000 by the number of shares into
which the note is convertible, or 1,923,077 shares based on the fixed conversion
price of $0.78 per common share. The resulting effective conversion price of
$0.65 per common share was then compared to the fair value of the Company's
stock, which was $0.93 per common share on the issuance date. The difference of
$0.28 per common share between the fair value of the stock and the effective
conversion price was then multiplied by 1,009,586, which was the number of
shares the note was convertible into at the date of issuance, taking into
account the limitation on the number of shares that Laurus could convert at that
time. The agreement stipulates that Laurus may not convert that amount of the
note that would result in beneficial ownership of more than 4.9% of the
outstanding common shares of the Company on the date of conversion. The
conversion limitation becomes null and void upon an event of default under the
note and may be raised if the Company chooses to redeem the outstanding
principal amount of the note in cash and Laurus elects to convert the note
instead. The limitation may also be raised if the Company were to issue
additional common shares for any reason, thus increasing the number of
outstanding shares. Due to the Company's default under the note during the
fourth quarter of 2002, the 4.9% limitation became null and void and additional
interest expense of approximately $256,000 was recognized at a rate of $0.28 per
common share for the 913,491 additional shares that the note became convertible
into upon default.
During 2002, the Company capitalized $238,000 in financing costs related to the
issuance of the Laurus debt that were being charged to interest expense over the
term of the convertible note using the effective yield method. Upon default
under the note in the fourth quarter of 2002, the remaining unamortized balance
was charged to interest expense.
The Company agreed to file with the Securities and Exchange Commission, and have
declared effective by November 25, 2002, a registration statement registering
the resale of the shares of the Company's common stock issuable upon conversion
or payment of the note and exercise of the warrant. Currently, the Company has
filed a registration statement but it has not yet been declared effective.
NOTE 11. Related Party Transactions and Guarantees
From time to time, the Company has made loans to certain officers of the
Company. These amounts are included in Related Party Notes Receivable. The
highest aggregate amount outstanding of loans due from officers (including an
ex-officer of the Company) was $162,000 during 2002 and $230,000 during 2001 and
2000.
On September 30, 1999, the Company loaned $25,000 to an officer of the Company.
The loan was repaid in full, including interest at 8% annually, during 2000.
In December 2000, an officer of the Company borrowed approximately $20,000 that
bears interest at a rate of 8% annually. The loan was repaid in full during
2001.
On August 16, 2000, an officer of the Company borrowed approximately $60,000
that bears interest at a rate of 8% annually. At December 31, 2001, $46,000 was
outstanding under this loan. In May 2002, this officer repaid the balance of
this loan in full,
39
including accrued interest. On December 21, 2000, the Company entered into a
30-day promissory note with the same officer for $125,000. The promissory note
was repaid in full in January 2001, including interest at a rate of 8% annually.
During 2000, an officer of the Company borrowed approximately $35,000, of which
$25,000 was outstanding at December 31, 2000. During 2001, the Company loaned an
additional $94,000 to this officer prior to his resignation from the Company. At
December 31, 2001, the Company had an aggregate of $115,000 in notes receivable
bearing interest at 8% annually from this ex-officer. In March 2002, this
ex-officer repaid the balance of these loans in full, including accrued
interest.
Beginning in December 2000, the Company pledged certain funds held as money
market funds and certificates of deposit to collateralize certain margin loans
of three officers and an ex-officer of the Company. These funds are classified
as cash pledged as collateral for related party obligations on the Company's
balance sheets at December 31, 2002 and 2001. The margin loans are from
institutional lenders and are secured by shares of the Company's common stock
held by these individuals. The Company's purpose in collateralizing the margin
loans was to prevent the sale of the Company's common stock held by these
officers while the Company was pursuing efforts to raise more capital through
private equity placements. The sale of the Company's common stock may have
hindered the Company's ability to raise capital in such a manner and compromised
the Company's continuing efforts to secure additional financing. The total
balance of the margin loans guaranteed by the Company was approximately $1.3
million at December 31, 2002. The Company believed it had the unrestricted legal
right to use the pledged funds for its operations if necessary based on (i) its
interpretation of the loan guarantee agreements, (ii) the market price of the
Company's stock at the time of the pledge, and (iii) assurances the Company
received from one of the institutional lenders that funds would be made
available if needed. The institutional lenders holding the funds as collateral
are disputing this claim, solely relying upon the strict interpretation of the
loan guarantee agreements. During the fourth quarter of 2002, the Company sought
partial release of the funds for operating purposes and was denied. Subsequent
to December 31, 2002, the lenders applied the pledged funds being held to
satisfy the outstanding balances of the loans. In light of this action, the
Company recognized a loss on the guarantees of $1,278,138 in the fourth quarter
of 2002 and recorded a corresponding payable under related party guarantees on
the Company's balance sheet at December 31, 2002. The Company may institute
litigation or arbitration concerning these matters, which may result in the
assertion of claims by these officers under their employee agreements. The
ultimate outcome of this matter cannot presently be determined.
NOTE 12. Income Taxes
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities as of December 31 are as
follows:
2002 2001
------------ -------------
Deferred Tax Assets:
--------------------
Warrant expense $ 3,166,992 $ 2,713,006
Deferred revenue 136,326 221,894
Start-up and organizational costs 90,632 167,042
Accrued expenses 36,481 42,748
Research credit 38,153 38,153
Amortization 12,325 8,925
Allowance for doubtful accounts 16,047 6,437
Trademark cost 583 636
Other 2,729 2,710
Impairment of assets 290,740 --
Loss on related party guarantees 434,567 --
Net operating loss 11,818,879 9,195,720
------------ -------------
16,044,454 12,397,271
Valuation allowance (15,921,467) (12,221,101)
------------ -------------
Total Deferred Tax Asset 122,987 176,170
Deferred Tax Liabilities:
-------------------------
Depreciation 30,835 104,773
Prepaid expenses 85,352 61,987
Equity in earnings of investee -- 2,610
Other 6,800 6,800
------------ -------------
Total Deferred Tax Liabilities 122,987 176,170
------------ -------------
Net Deferred Tax Asset (Liability) $ -- $ --
============ =============
40
For the years ended December 31, 2002, 2001 and 2000, the Company generated net
operating losses for tax purposes of approximately $7.7 million, $10.6 million,
and $12.0 million, respectively. The losses for the years ended December 31,
2002, 2001 and 2000 expire in 2023, 2022 and 2021, respectively. The Company
also has a research and development credit of approximately $38,000 that expires
in 2015. Legislation regarding the research and development tax credit extended
that utilization period. However, use of the credit is suspended during certain
periods. The Company intends to utilize the research and development credit
during the applicable periods. For financial reporting purposes, a valuation
allowance of approximately $15.9 million has been recognized to offset the
deferred tax assets related to various temporary differences at December 31,
2002.
For the period from inception (July 30, 1998) through December 31, 2002, the
Company has net operating loss carryforwards for tax purposes of approximately
$34.8 million that begin to expire in the year 2020. In October 1999, the
Company issued common stock pursuant to a private placement offering. As a
result, an ownership change occurred under Section 382 that limits the
utilization of pre-change net operating loss carryforwards. Approximately $3.5
million of the total net operating loss is subject to the Section 382
limitations.
The reconciliation of income tax computed at the U.S. federal statutory tax
rates to income tax expense is as follows:
2002 2001 2000
------------ ------------ ------------
Tax at US statutory rate -- 34% $(3,724,590) $(3,537,940) $(6,802,830)
Valuation allowance 3,700,366 3,421,050 6,809,538
Permanent and other differences 24,224 116,890 31,445
Research credit -- -- (38,153)
------------ ------------ ------------
Income tax expense $ -- $ -- $ --
============ ============ ============
NOTE 13. Employment Benefit Plans
Stock Option Plans
The Board of Directors and stockholders approved the 1999 Employee Comprehensive
Stock Plan ("Employee Plan") to provide qualified incentive stock options
("ISOs") and non-qualified stock options ("NQSOs") as well as restricted stock
to key employees. Under the terms of the Employee Plan, the exercise price of
incentive stock options must be equal to 100% of the fair market value on the
date of grant (or 110% of fair market value in the case of an ISO granted to a
10% stockholder/grantee). There is no price requirement for NQSOs, other than
that the option price must exceed the par value of the common stock. The Company
has reserved 5,000,000 shares of its common stock for issuance pursuant to the
Employee Plan.
The 1999 Non-Employee Director Plan ("Director Plan") was approved by the Board
of Directors and stockholders in 1999. Under the Director Plan, which is
administered by a committee of no less than two board members and two
disinterested persons, non-employee directors may be granted options to purchase
shares of common stock at 100% of fair market value on the date of grant. The
Company has reserved 1,000,000 shares of its common stock for issuance pursuant
to the Director Plan.
In May 2002, the Company tendered an offer to employees and non-employee
directors to cancel certain outstanding stock options under a stock option
exchange program. In return for voluntarily canceling certain stock options,
employees and non-employee directors were granted an equal number of stock
options promptly after six months and one day from the cancellation date. The
exercise price of the new options granted was equal to the fair market value of
the Company's common stock on the grant date. The program is not expected to
result in any additional compensation expense or variable plan accounting. In
connection with this offer, 754,925 options were canceled on June 11, 2002 and
513,150 options were granted on December 13, 2002 at an exercise price of $0.26
per share.
41
Activity under the Employee Plan and Director Plan for the three years in the
period ended December 31, 2002 is as follows:
Weighted Average
Number Of Shares Exercise Price
---------------- ----------------
Outstanding, December 31, 1999 1,064,300 $3.86
Granted 2,075,075 5.56
Cancelled (236,500) 5.42
Exercised (3,700) 3.66
---------------
Outstanding, December 31, 2000 2,899,175 4.95
Granted 2,045,162 0.97
Cancelled (646,032) 4.67
Exercised (8,000) 4.38
---------------
Outstanding, December 31, 2001 4,290,305 3.10
Granted 3,104,250 0.23
Cancelled (1,632,906) 5.09
Exercised -- --
---------------
Outstanding, December 31, 2002 5,761,649 $0.99
===============
There was an aggregate of 179,617 and 1,197,995 options to purchase the
Company's common stock available for future grants under the Employee and
Director Plans at December 31, 2002 and 2001, respectively. Exercisable stock
options amounted to 1,604,492 at a weighted average price of $2.33 and 1,089,059
at a weighted average price of $4.62 at December 31, 2002 and 2001,
respectively.
Summarized information about stock options outstanding at December 31, 2002 is
as follows:
Options Outstanding Options Exercisable
----------------------------------- -----------------------------
Weighted Average Weighted Weighted
Range of Exercise Options Remaining Average Number of Average
Prices Outstanding Contractual Life Exercise Price Options Exercise Price
- ----------------- ------------ ---------------- -------------- ---------- --------------
$0.18 - $0.52 2,945,750 9.99 $0.20 -- --
$0.81 - $1.02 1,514,200 8.85 $0.86 536,539 $0.86
$1.55 - $2.09 723,898 8.05 $2.03 507,852 $2.04
$2.75 - $3.81 393,267 6.19 $2.83 389,567 $2.83
$4.13 - $11.25 184,534 6.73 $6.73 170,534 $6.65
------------ ----------
5,761,649 9.08 $0.99 1,604,492 $2.33
============ ==========
The weighted average fair value of stock options at date of grant was $0.17,
$0.73 and $4.20 per option for options granted during fiscal years 2002, 2001,
and 2000, respectively. The fair value of each option granted was estimated
using the Black-Scholes option-pricing model, utilizing the following
assumptions:
2002 2001 2000
---- ---- ----
Dividend yield None None None
Expected volatility 128% 119% 118%
Risk-free interest rate 1.80% 3.40% 5.22%
Expected life 3.74 3.95 3.98
42
Employee Stock Purchase Plan
The Company established the 1999 Employee Stock Purchase Plan ("ESPP") under the
requirements of Section 423 of the Internal Revenue Code (the "Code") to allow
eligible employees to purchase the Company's common stock at regular intervals.
Participating employees may purchase common stock through voluntary payroll
deductions at the end of each participation period at a purchase price equal to
85% of the lower of the fair market value of the common stock at the beginning
or the end of the participation period. Common stock reserved for future
employee purchases under the plan aggregated 799,685 shares at December 31,
2002. The first offering period under the ESPP began January 1, 2000. A total of
65,273, 117,194 and 17,848 shares were issued under the ESPP in 2002, 2001 and
2000, respectively, at prices ranging from $0.92 per share to $6.56 per share.
401(k) Plan
In May 1999, the Company adopted a defined contribution plan (the "401(k) Plan")
pursuant to Section 401(k) of the Code. All eligible full and part-time
employees of the Company who meet certain age requirements may participate in
the 401(k) Plan. Participants may contribute between 1% and 15% of their pre-tax
compensation, but not in excess of the maximum allowable under the Code. The
401(k) Plan allows for discretionary and matching contributions by the Company.
The Company made no contributions during fiscal 2002, 2001 or 2000.
NOTE 14. Stock Warrants
On May 18, 1999, the Company contracted with an investment bank to provide
strategic and financial advisory services. In exchange for these advisory
services, a warrant to purchase 111,085 shares of the Company's common stock at
an exercise price of $6.75 per share (which represents the average closing price
of the stock over the twenty day period preceding May 18, 1999) was issued. The
warrant is exercisable for five years. This warrant was issued in accordance
with an exemption under Section 4(2) of the Securities Act of 1933, as amended,
because the transaction is by an issuer not involving a public offering. Using
the fair value-based method of accounting, the Company recorded $356,583 of
expense and a corresponding credit to additional paid-in capital related to the
issuance of this warrant.
As part of the August 1999 debt issuance, the Company issued a warrant to the
accredited investor for the purchase of 41,237 shares of the common stock at an
exercise price of $6.0625, which represents the average reported closing sale
price of the common stock for the ten business days immediately preceding the
loan agreement. The warrant is immediately exercisable and carries a term of
five years and piggyback registration rights. Using the fair value-based method
of accounting, the Company recorded $134,845 of expense and a corresponding
credit to paid-in-capital related to the issuance of this warrant.
In connection with the 1999 Offering (see Note 4), the Company issued warrants
to the twenty-one investors to purchase 1,404,637 shares of common stock at
$3.75 per share, or one warrant for each share issued. The warrants are
exercisable for three years from the date of issuance, or until October 14,
2002. The Company has the right to call the exercise of the warrants at any time
after six months after the date of the issuance and after the closing price of
the common stock exceeds $12.00 for a period of twenty consecutive trading days.
Upon such call notice, the holders of the warrants must exercise the warrants
within thirty days, after which time they may be redeemed for $.05 per warrant.
As part of the compensation for acting as placement agent for the 1999 Offering,
the Company issued warrants to the investment banker for the purchase of 36,924,
600, 18,900, 19,950, 8,890 and 3,500 shares of common stock. The warrants are
immediately exercisable, carry a five year term, exercise prices of $3.25,
$3.25, $8.00, $7.44, $7.41, and $7.31, respectively, piggyback registration
rights, and cashless exercise provision.
In connection with the CheckFree investment (see Note 4), the Company issued
CheckFree warrants to purchase 2,179,121 shares at $11.375 per share for
entering into the extended biller service provider agreement and investing $10.0
million. The Company recorded $7,488,000 of expense and a corresponding credit
to additional paid-in capital related to the estimated fair value of 1.3 million
of these warrants, which were issued as consideration for entering into the
extended biller service provider agreement. Under this agreement, which expires
in February 2005, CheckFree provides the Company with electronic bill
presentment services for volume-based fees. The related warrant expense was
recognized immediately instead of being deferred and recognized over the life of
the agreement because the warrants were fully vested at the date of grant and
CheckFree did not have to perform under the agreement to earn the warrants.
Also, CheckFree has the ability to earn incentive warrants on up to 2,801,903
additional shares, of which 1,000,000 are exercisable at $11.375 per share and
1,801,903 are exercisable at $14.219 per share. The incentive warrants vest upon
the achievement of certain target levels of referred billers to the Company by
CheckFree and will occur on the first through fifth anniversaries of the
agreement. All incentive warrants that are not vested by the fifth anniversary
will expire at that time. Assuming certain of these warrants vest, the Company
will record a charge for the fair value of the warrants based on a Black Scholes
valuation, which will take into consideration the market value of the Company's
stock, the strike price of the warrants, the volatility of the Company's stock
price and the applicable risk-free interest rate at the measurement date. As of
December 31, 2002, none of these incentive warrants have vested.
43
In connection with the 2001 Offering (see Note 4), the Company issued warrants
to the eighteen investors to purchase 2,000,000 shares of common stock at $1.80
per share, or one warrant for each share issued. The warrants are exercisable
for five years from the date of issuance, or until November 27, 2006. The
Company has the right to call the exercise of the warrants at any time after six
months after the date of the issuance and after the closing price of the common
stock exceeds $5.40 for a period of twenty consecutive trading days. Upon such
call notice, the holders of the warrants must exercise the warrants within
thirty days, after which time they may be redeemed for $.05 per warrant.
In connection with the July 2002 convertible debt issuance (see Note 10), the
Company issued a warrant to purchase 300,000 shares of the Company's common
stock at exercise prices of $0.936 for the first 150,000 shares, $0.975 for the
next 50,000 shares, and $1.17 for the remaining 100,000 shares. The warrant is
immediately exercisable and has a term of four years. Using the fair value-based
method of accounting, the Company recorded $259,000 of expense and a
corresponding credit to paid-in-capital during 2002 related to the issuance of
this warrant.
At December 31, 2002, the outstanding vested warrants to purchase common stock
are as follows:
Shares of Common Exercise Aggregate Exercise Expiration
Stock Price Price Date
-------------------------------------------------------------------
41,237 $ 6.06 $ 250,000 08/05/2004
250 3.25 813 10/14/2004
280 8.00 2,240 12/15/2004
8,890 7.41 65,875 12/20/2004
3,500 7.31 25,585 12/22/2004
2,179,121 11.38 24,798,397 06/02/2010
2,000,000 1.80 3,600,000 11/27/2006
150,000 0.936 140,400 07/24/2006
50,000 0.975 48,750 07/24/2006
100,000 1.17 117,000 07/24/2006
--------- ------------
4,533,278 $ 29,049,060
========= ============
NOTE 15. Common Stock Listing
Billserv common stock began trading on the OTC BB operated by the National
Association of Securities Dealers ("NASD") on December 3, 1998. The NASD adopted
eligibility rules in 1999, which required clearance of comments by the SEC on
all SEC filings. The Company filed its initial filing on Form 10 with the SEC on
June 10, 1999 but, as of October 7, 1999, the SEC had not cleared its comment
period. In accordance with the OTC BB's phase-in schedule for the new
eligibility rules, the listing on the OTC BB was terminated. The Company's
common stock was quoted in the National Quotation Board's Electronic Pink Sheets
until December 7, 1999, when the SEC cleared the comment period and the stock
was relisted and traded on the OTC BB through March 13, 2000 at which time the
stock was approved for trading on the NASDAQ Small Cap Market. Subsequently the
stock was approved for trading on the NASDAQ National Market on July 31, 2000,
under the symbol "BLLS". On February 4, 2003, the Nasdaq National Market ("NNM")
delisted the Company's common stock because the Company did not meet the
requirements for continued listing on the NNM. The Company's common shares were
immediately eligible for quotation on the OTC BB effective at open of business
February 4, 2003. The Company kept the letters BLLS as its ticker symbol.
NOTE 16. Nonmonetary Transactions
During 2002, the Company entered into two separate nonmonetary transactions
whereby the Company licensed the use of its Application Service Provider ("ASP")
payment gateway technology to certain third party software vendors to be used as
an original equipment manufacturer ("OEM") component of their product offering
in exchange for software products from those vendors. The Company accounted for
these transactions in accordance with APB Opinion No. 29, "Accounting for
Nonmonetary Transactions". These exchanges were determined to culminate the
earning process because the technology exchanged by the Company was held for
sale in the ordinary course of business and the products received by the Company
were expected to be deployed and utilized as productive assets. The Company
recognized revenue related to these transactions at the fair value of the
software received, which was determined by reference to vendor-specific
objective evidence, because it was more clearly evident than the value of the
assets transferred. The value of the software received was estimated by
comparison to third party evidence including vendor-specific established pricing
lists and historical sales information and was more readily determinable because
the Company did not have a history of comparable cash sales of its payment
gateway technology. The Company recognized $300,000 in a transaction where the
Company's technology was exchanged for customer relationship management software
and concurrent seat licenses to use in providing customer care services via the
Internet or telephone. The Company also recognized
44
$300,000 in a transaction where the Company's technology was exchanged for
document archival and retrieval software to use in the storage of electronic
billing statements. The carrying value of the gateway technology exchanged in
both transactions was zero. The Company capitalized the software received at the
time of acquisition and subsequently recognized a loss on impairment of these
assets which took the carrying amount of these assets to zero (see Note 1).
NOTE 17. Quarterly Financial Data (Unaudited)
Selected quarterly financial data for 2002 and 2001 is presented below.
2002
----------------------------------------------------------------
First Second Third Fourth
----------------------------------------------------------------
Revenue $ 1,129,672 $ 1,342,413 $ 827,736 $ 906,733
Gross margin (75,424) (109,647) (274,711) (24,008)
Net loss $ (1,892,630) $ (2,149,182) $ (2,275,705) $ (4,637,160)
Net loss per common share-
basic and diluted (a) $ (0.09) $ (0.10) $ (0.11) $ (0.23)
Weighted average shares 20,577,813 20,581,126 20,602,074 20,603,799
2001
----------------------------------------------------------------
First Second Third Fourth
----------------------------------------------------------------
Revenue $ 509,409 $ 690,062 $ 831,893 $ 937,314
Gross margin (722,907) (536,188) (474,507) (292,881)
Net loss $ (3,234,305) $ (2,576,973) $ (2,478,390) $ (2,116,038)
Net loss per common share-
basic and diluted (a) $ (0.21) $ (0.14) $ (0.13) $ (0.11)
Weighted average shares 15,697,051 18,490,631 18,535,923 19,299,313
(a) Earnings per common share are computed independently for each of the
quarters presented. Therefore, the sum of the quarterly loss per
common share information may not equal the annual loss per common
share.
NOTE 18. Going Concern
The Company has incurred substantial losses since inception and has experienced
a material shortfall from anticipated revenues, which has led to a significant
decrease in its cash position and a deficit in working capital. Also, the
Company defaulted under its convertible debt agreement during the fourth quarter
of 2002 (see Note 10) and was unsuccessful in its attempt to access its funds
held as collateral to guarantee certain executive margin loans (see Note 11)
after attempting to retrieve such funds during the fourth quarter of 2002.
Consequently, the Company believes that its current available cash along with
anticipated revenues may be insufficient to meet its anticipated cash needs for
the foreseeable future. Accordingly, the Company reduced expenditures for
operating requirements, including a reduction of 36 employees in its workforce
in November 2002, and is currently aggressively pursuing strategic alternatives,
including investment in or sale of the Company. The satisfactory completion of a
sale or additional investment in the Company is essential or the Company has no
other alternative that will provide sufficient cash flows to meet current
operating requirements. The sale of additional equity or convertible debt
securities would result in additional dilution to the Company's stockholders,
and debt financing, if available, may involve restrictive covenants which could
restrict operations or finances. There can be no assurance that financing will
be available in amounts or on terms acceptable to the Company, if at all. If the
Company cannot raise funds, on acceptable terms, or achieve positive cash flow,
it may not be able to continue to exist, conduct operations, grow market share,
take advantage of future opportunities or respond to competitive pressures or
unanticipated requirements, any of which would negatively impact its business,
operating results and financial condition.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
45
PART III
Certain information required by Part III is omitted from this Report in that we
will file our definitive Proxy Statement for our Annual Meeting of Stockholders
to be held May 29, 2003, or as soon as practicable thereafter, pursuant to
Regulation 14A of the Securities and Exchange Act of 1934 (the "Proxy
Statement") not later than 120 days after the end of the fiscal year covered by
this Report, and certain information included in the Proxy Statement is
incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
There is incorporated in this Item 10, by reference, that portion of the
Company's definitive proxy statement for the 2003 Annual Meeting of
Stockholders, which appears therein under the captions "Item 1: Election of
Directors," "Information Concerning Directors," and "Section 16(a) Beneficial
Ownership Reporting Compliance."
ITEM 11. EXECUTIVE COMPENSATION
There is incorporated in this Item 11, by reference, that portion of the
Company's definitive proxy statement for the 2003 Annual Meeting of
Stockholders, which appears under the caption "Compensation of Executive
Officers."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
There is incorporated in this Item 12, by reference, that portion of the
Company's definitive proxy statement for the 2003 Annual Meeting of
Stockholders, which appears under the caption "Beneficial Ownership of Certain
Stockholders, Directors and Executive Officers."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On June 2, 2000, the Company entered into an extended biller service provider
agreement with CheckFree Investment Corporation, CheckFree Services Corporation
and CheckFree Holdings Corporation ("CheckFree"). As part of this agreement,
CheckFree purchased 879,121 shares of the Company's common stock at $11.375 per
share totaling $10.0 million. Offering proceeds to the Company, net of issuance
costs, were approximately $9.5 million. In connection with the CheckFree
investment, the Company issued to CheckFree warrants to purchase 2,179,121
shares at $11.375 per share, thereby causing CheckFree to beneficially own more
than 5% of the Company's common stock. During 2001 and 2000, the Company paid
CheckFree approximately $175,000 and $100,000 for implementation and
distribution services related to the Company's provision of EBPP services to
billers.
On January 4, 2001, the Company retained PMG Capital to act as its placement
agent in connection with one or more private placement transactions, as well as
to perform other investment, strategic and financial advisory services for the
Company for a one-year term. As compensation for providing these services, the
Company paid PMG Capital a $50,000 initial retainer and a $5,000 monthly
retainer through August 2001. Under the agreement, the Company was obligated to
pay PMG Capital a fee equal to 7.5% of the total amount raised in a private
placement transaction.
Mr. Louis Hoch, President, Chief Operating Officer and a Director of the
Company, borrowed approximately $60,000 at a rate of 8% and entered into a
30-day promissory note for $125,000 at a rate of 8% on August 16, 2000 and
December 21, 2000, respectively. The largest amount owed to the Company by Mr.
Hoch during 2001 was approximately $184,000. Mr. Hoch used the proceeds of the
$60,000 loan for usual and customary living expenses. At December 31, 2001,
approximately $46,000 was outstanding under this loan. The $125,000 30-day
promissory note was incurred to allow Mr. Hoch to pay down a margin loan to an
institutional lender. This margin loan was secured by shares of the Company's
stock held by Mr. Hoch. The promissory note was repaid in full in January 2001,
including accrued interest.
Mr. David Jones, a former Executive Vice President and Director of the Company,
borrowed approximately $35,000 at a rate of 8% during 2000, of which $25,000 was
outstanding at December 31, 2000. During 2001, the Company loaned an additional
$94,000 at a rate of 8% to Mr. Jones prior to his resignation from the Company.
Mr. Jones used the proceeds of these loans for usual and customary living
expenses and to pay down a margin loan to an institutional lender. At December
31, 2001, the Company had an aggregate of $115,000 in notes receivable bearing
interest at 8%, which was the largest amount owed to the Company by Mr. Jones
during 2001. In March 2002, Mr. Jones repaid the balance of these loans in full,
including accrued interest.
46
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this Annual Report on Form 10-K,
an evaluation was performed under the supervision and with the participation of
the Company's management, including the Chief Executive Officer ("CEO") and
Chief Financial Officer ("CFO"), of the effectiveness of the design and
operation of the Company's disclosure controls and procedures (as defined in
Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934). Based on that
evaluation, the Company's CEO and CFO concluded that the Company's disclosure
controls and procedures were effective in ensuring that material information
relating to the Company with respect to the period covered by this report was
made known to them. Since the date of their evaluation, there have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect these controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
47
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents filed as a part of this Report
(1) Financial Statements
The financial statements listed in the index under Part II, Item 8
hereof are filed as part of this Report.
(2) Financial Statement Schedules
All financial statement schedules called for by Form 10-K are
omitted because they are inapplicable or the required information is
shown in the financial statements, or notes thereto, included
herein.
(3) Exhibits
The exhibits listed below are filed as part of or incorporated by
reference in this Report.
Exhibit Description
- ------- -----------
3.1 Articles of Incorporation, as amended (incorporated by reference to such
exhibit in the Registrant's Registration Statement on Form SB-2, filed
December 29, 1999)
3.2 By-laws, as amended (incorporated by reference to such exhibit in the
Registrant's Registration Statement on Form SB-2, filed December 29, 1999)
4.1 Rights Agreement, dated October 4, 2000 (incorporated by reference to such
exhibit in the Registrant's Registration Statement on Form 8-A, filed
October 11, 2000)
10.1 1999 Employee Comprehensive Stock Plan, as amended (incorporated by
reference to such exhibit in the Registrant's Registration Statement on
Form S-8, filed February 11, 2002)
10.2 1999 Non-Employee Director Plan (incorporated by reference to such exhibit
in the Registrant's Definitive Proxy Statement, filed November 22, 1999)
10.3 1999 Employee Stock Purchase Plan (incorporated by reference to such
exhibit in the Registrant's Definitive Proxy Statement, filed November 22,
1999)
10.4 Form of Employment Agreement dated May 31, 2001, between the Company and
Executive Officers of the Company (incorporated by reference to such
exhibit in the Registrant's Annual Report on Form 10-K, filed April 1,
2002)
21.1 Subsidiaries of the Registrant (incorporated by reference to such exhibit
in the Registrant's Annual Report on Form 10-K, filed April 1, 2002)
23.1 Consent of Ernst & Young LLP, Independent Auditors (filed herewith)
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter ended
December 31, 2002.
48
SIGNATURES
Pursuant to the requirements of Section 13 and 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized.
Billserv, Inc.
By: /s/ Michael R. Long
-------------------------------------
Michael R. Long
Chairman of the Board and
Chief Executive Officer
Date: April 15, 2003
Pursuant to the requirements of Section 13 and 15(d) of the Securities Exchange
Act of 1934, this report has been signed below by the following persons on
behalf of the registrant and in the capacities indicated on April 15, 2003.
By: /s/ Michael R. Long
-------------------------------------
Michael R. Long
Chairman of the Board and
Chief Executive Officer
(principal executive officer)
By: /s/ Louis A. Hoch
-------------------------------------
Louis A. Hoch
President, Chief Operating
Officer and Director
By: /s/ Terri A. Hunter
-------------------------------------
Terri A. Hunter
Executive Vice President,
Chief Financial Officer
(principal financial
and accounting officer)
and Director
By: /s/ Peter G. Kirby
-------------------------------------
Peter G. Kirby
Director
49
CERTIFICATIONS
I, Michael R. Long, certify that:
1. I have reviewed this annual report on Form 10-K of Billserv, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 15, 2003 /s/ Michael R. Long
----------------------------------------
Michael R. Long
Chief Executive Officer
50
I, Terri A. Hunter, certify that:
1. I have reviewed this annual report on Form 10-K of Billserv, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 15, 2003 /s/ Terri A. Hunter
----------------------------------------
Terri A. Hunter
Chief Financial Officer
51
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-3 Nos. 333-59042, 333-64508 and 333-75906) of Billserv, Inc.; (Form S-8
Nos. 333-30962 and 333-82530) pertaining to the 1999 Employee Comprehensive
Stock Plan of Billserv, Inc.; (Form S-8 No. 333-30960) pertaining to the 1999
Non-Employee Director Plan of Billserv, Inc.; and (Form S-8 No. 333-30958)
pertaining to the Employee Stock Purchase Plan of Billserv, Inc. of our report
dated April 1, 2003 with respect to the consolidated financial statements of
Billserv, Inc. included in the Annual Report (Form 10-K) for the year ended
December 31, 2002.
/s/ Ernst & Young LLP
----------------------------------------
Ernst & Young LLP
San Antonio, Texas
April 14, 2003
52
EXHIBIT 99.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Billserv, Inc. (the "Company") on Form
10-K for the period ending December 31, 2002 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), we, Michael R. Long,
Chief Executive Officer, and Terri A. Hunter, Chief Financial Officer, certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
Date: April 15, 2003 /s/ Michael R. Long
----------------------------------------
Michael R. Long
Chief Executive Officer
Date: April 15, 2003 /s/ Terri A. Hunter
----------------------------------------
Terri A. Hunter
Chief Financial Officer
53