UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017

or

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

SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM __ TO __

 

COMMISSION FILE NUMBER: 001-35170

JetPay Corporation

(Exact name of registrant as specified in its charter)

 

Delaware (State or other Jurisdiction of Incorporation or Organization)

90-0632274 (I.R.S. Employer Identification No.)

 

3939 West Drive, Center Valley, PA 18034

(Address of principal executive offices) (Zip code)

 

Registrant's Telephone Number, including area code: (610) 797-9500

 

(Former Name or Former Address, if Changed Since Last Report)

 

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	¨	Smaller reporting company	x
Non-accelerated filer	¨	Accelerated filer	¨
(Do not check if a smaller reporting company)		Emerging growth company	¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ 

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

 

As of November 6, 2017, there were 15,673,534 shares of the registrant’s common stock, par value $.001 per share, outstanding.

 

 

  

JetPay Corporation

Form 10-Q

Quarter Ended September 30, 2017

 

Table of Contents

 

		Page
PART I - FINANCIAL INFORMATION
Item 1 -	Financial Statements
	Consolidated Balance Sheets – September 30, 2017 (Unaudited) and December 31, 2016 (Audited)	1
	Consolidated Statements of Operations (Unaudited) for the three months ended September 30, 2017 and 2016	2
	Consolidated Statements of Operations (Unaudited) for the nine months ended September 30, 2017 and 2016	3
	Consolidated Statement of Changes in Stockholders’ Equity (Unaudited) for the nine months ended September 30, 2017	4
	Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2017 and 2016	5
	Notes to the Consolidated Financial Statements (Unaudited)	7
Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32
Item 3 -	Quantitative and Qualitative Disclosures about Market Risks	44
Item 4 -	Controls and Procedures	44
PART II - OTHER INFORMATION
Item 1 -	Legal Proceedings	45
Item 1A -	Risk Factors	45
Item 2 -	Unregistered Sales of Equity Securities	45
Item 3 -	Defaults Upon Senior Securities	45
Item 4 -	Mine Safety Disclosures	45
Item 5 -	Other Information	45
Item 6 -	Exhibits	46
Signatures		47

 

  

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

JetPay Corporation

Consolidated Balance Sheets

(In thousands, except share and par value information)

 

		September 30, 2017				December 31, 2016
		(Unaudited)				(Audited)
ASSETS
Current assets:
Cash and cash equivalents		$	7,207			$	12,584
Restricted cash			1,904				2,129
Accounts receivable, less allowance for doubtful accounts			4,037				4,677
Settlement processing assets and funds			38,257				35,240
Prepaid expenses and other current assets			1,475				5,849
Current assets before funds held for clients			52,880				60,479
Funds held for clients			44,968				49,154
Total current assets			97,848				109,633
Property and equipment, net			3,468				2,125
Goodwill			48,978				48,978
Identifiable intangible assets, net of accumulated amortization of $13,549 at September 30, 2017 and $10,926 at December 31, 2016			23,467				26,090
Other assets			393				384
Total assets		$	174,154			$	187,210
LIABILITIES
Current liabilities:
Current portion of long-term debt and capital lease obligations		$	2,862			$	8,074
Accounts payable and accrued expenses			10,583				10,821
Settlement processing liabilities			38,422				35,079
Deferred revenue			296				502
Other current liabilities			50				985
Current liabilities before client fund obligations			52,213				55,461
Client fund obligations			44,968				49,154
Total current liabilities			97,181				104,615
Long-term debt and capital lease obligations, net of current portion and unamortized discounts and financing costs of $426 and $339 at September 30, 2017 and December 31, 2016			12,872				13,794
Deferred income taxes			520				520
Other liabilities			980				1,228
Total liabilities			111,553				120,157
Commitments and Contingencies
Redeemable Convertible Preferred Stock;
Redeemable convertible Series A and Series A-1 preferred stock, $0.001 par value per share, 142,333 and 139,498 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively (liquidation preference of $85,400 at September 30, 2017)			56,817				53,324
Common Stock, subject to possible redemption (1,625,000 shares at September 30, 2017 and December 31, 2016)			3,520				3,520
Stockholders’ Equity
Preferred stock, $0.001 par value
Authorized 1,000,000 shares, none issued (which excludes 142,333 and 139,498 shares of Series A and Series A-1 redeemable convertible preferred stock at September 30, 2017 and December 31, 2016, respectively)			-				-
Common stock, $0.001 par value
Authorized 100,000,000 shares; 17,873,534 and 17,737,504 issued at September 30, 2017 and December 31, 2016, respectively (which includes 1,625,000 shares subject to possible redemption at September 30, 2017 and December 31, 2016) and 15,673,534 and 17,737,504 outstanding at September 30, 2017 and December 31, 2016, respectively			18				18
Additional paid-in capital			37,851				38,778
Treasury stock, 2,200,000 shares at cost			(4,950	)			-
Accumulated deficit			(30,655	)			(28,587	)
Total Stockholders’ Equity			2,264				10,209
Total Liabilities and Stockholders’ Equity		$	174,154			$	187,210

 

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

 

 

JetPay Corporation

Consolidated Statements of Operations

(Unaudited)

(In thousands, except share and per share information)

 

		For the Three Months Ended September 30,
		2017				2016
Processing revenues		$	18,440			$	15,214
Cost of processing revenues			12,855				10,199
Gross profit			5,585				5,015
Selling, general and administrative expenses			4,810				4,515
Settlement of legal matters			-				(20	)
Change in fair value of contingent consideration liability			(160	)			404
Amortization of intangibles			874				865
Depreciation			267				173
Operating loss			(206	)			(922	)
Other expenses (income)
Interest expense			281				301
Non-cash interest costs			39				11
Amortization of debt discounts			-				13
Other income			(7	)			(3	)
Loss before income taxes			(519	)			(1,244	)
Income tax expense			56				96
Net loss			(575	)			(1,340	)
Accretion of convertible preferred stock			(2,758	)			(1,557	)
Net loss applicable to common stockholders		$	(3,333	)		$	(2,897	)
Basic and diluted loss per share applicable to common stockholders		$	(0.21	)		$	(0.16	)
Weighted average shares outstanding:
Basic and diluted			15,660,540				17,682,903

 

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

 

 

JetPay Corporation

Consolidated Statements of Operations

(Unaudited)

(In thousands, except share and per share information)

 

		For the Nine Months Ended September 30,
		2017				2016
Processing revenues		$	56,159			$	39,069
Cost of processing revenues			38,489				25,905
Gross profit			17,670				13,164
Selling, general and administrative expenses			14,822				12,096
Settlement of legal matters			747				6,120
Change in fair value of contingent consideration liability			(343	)			234
Amortization of intangibles			2,623				2,377
Depreciation			746				540
Operating loss			(925	)			(8,203	)
Other expenses (income)
Interest expense			852				812
Non-cash interest costs			106				129
Amortization of debt discounts			-				151
Other income			(14	)			(6	)
Loss before income taxes			(1,869	)			(9,289	)
Income tax expense (benefit)			199				(1,378	)
Net loss			(2,068	)			(7,911	)
Accretion of convertible preferred stock			(7,533	)			(4,424	)
Net loss applicable to common stockholders		$	(9,601	)		$	(12,335	)
Basic and diluted loss per share applicable to common stockholders		$	(0.60	)		$	(0.78	)
Weighted average shares outstanding:
Basic and diluted			15,974,981				15,850,088

 

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

 

  

JetPay Corporation

Consolidated Statement of Changes in Stockholders’ Equity

(Unaudited)

(In thousands, except share information)

 

		Common Stock								Additional Paid-In Capital				Treasury Stock				Accumulated Deficit				Total Stockholders’ Equity
		Shares				Amount
Balance at December 31, 2016			17,737,504			$	18			$	38,778			$	-			$	(28,587	)		$	10,209
Common stock issued under employee stock purchase plan			91,790				-				181				-				-				181
Common shares issued as compensation			44,240				-				97				-				-				97
Common stock released from escrow to satisfy contingent consideration obligation			-				-				525				-				-				525
Repurchase of shares into treasury			-				-				-				(4,950	)			-				(4,950	)
Warrants issued for settlement of legal matter			-				-				373				-								373
Employee stock purchase plan expense			-				-				34				-				-				34
Stock-based compensation expense			-				-				531				-				-				531
Beneficial conversion feature on convertible preferred stock			-				-				4,865				-				-				4,865
Accretion of convertible preferred stock to redemption value			-				-				(7,533	)			-				-				(7,533	)
Net loss			-				-				-				-				(2,068	)			(2,068	)
Balance at September 30, 2017			17,873,534			$	18			$	37,851			$	(4,950	)		$	(30,655	)		$	2,264

 

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

 

  

JetPay Corporation

Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

		For the Nine Months Ended September 30,
		2017				2016
Operating Activities
Net loss		$	(2,068	)		$	(7,911	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation			746				540
Stock-based compensation			531				285
Common stock issued as compensation			97				-
Employee stock purchase plan expense			34				29
Amortization of intangibles			2,623				2,377
Non-cash interest costs			106				129
Amortization of debt discounts			-				151
Change in fair value of contingent consideration liability			(343	)			234
Loss on disposal of fixed assets			110				32
Deferred income taxes			-				(1,602	)
Recognition of note payable in connection with settlement of legal matter			-				1,851
Change in operating assets and liabilities:
Restricted cash			225				25
Accounts receivable			640				1,092
Settlement processing assets, funds and obligations, net			326				555
Prepaid expenses and other current assets			(576	)			(276	)
Other assets			(9	)			4,139
Deferred revenue			(206	)			(259	)
Accounts payable, accrued expenses and other liabilities			132				74
Net cash provided by operating activities			2,368				1,465
Investing Activities
Net decrease in restricted cash and cash equivalents held to satisfy client fund obligations			4,186				4,397
Cash acquired in acquisition			-				519
Purchase of property and equipment			(1,591	)			(615	)
Investment in acquired technology			-				(351	)
Proceeds on disposal of property and equipment			-				15
Net cash provided by investing activities			2,595				3,965
Financing Activities
Payments on long-term debt and capital lease obligations			(7,447	)			(2,392	)
Proceeds from issuance of common stock, net of issuance costs			-				64
Proceeds from issuance of common stock pursuant to employee stock purchase plan			181				47
Proceeds from notes payable			677				1,970
Proceeds from sale of preferred stock, net of issuance costs			825				2,500
Restricted cash reserve			-				(1,900	)
Payment of deferred financing fees associated with new borrowings			(76	)			(112	)
Payment of deferred and contingent acquisition consideration			(314	)			(1,386	)
Net decrease in client funds obligations			(4,186	)			(4,397	)
Net cash used in financing activities			(10,340	)			(5,606	)
Net decrease in cash and cash equivalents			(5,377	)			(176	)
Cash and cash equivalents, beginning			12,584				5,594
Cash and cash equivalents, ending		$	7,207			$	5,418

 

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

 

  

JetPay Corporation

Consolidated Statements of Cash Flows (continued)

(Unaudited)

(In thousands)

 

		For the Nine Months Ended September 30,
		2017				2016
Supplement disclosure of cash flow information:
Cash paid for interest		$	985			$	786
Cash paid for taxes		$	288			$	328
Supplemental disclosure of non-cash investing and financing activity:
Acquisition of equipment under capital lease		$	608			$	103
Promissory notes issued in connection with the settlement of legal matter		$	-			$	4,950
Treasury stock reclassification		$	4,950			$	-
Indemnification asset associated with settlement of legal matter		$	-			$	4,950
Issuance of warrants for settlement of legal matter		$	373			$	-
Beneficial conversion feature on convertible preferred stock		$	4,865			$	-
Accretion of convertible preferred stock		$	7,533			$	4,424
Release of common stock held in escrow		$	525			$	-
Summary of non-cash investing and financing activities:
Fair value of assets acquired		$	-			$	23,969
Fair value of company stock issued		$	-			$	(7,040	)
Fair value of contingent consideration		$	-			$	(1,975	)
Fair value of private stock purchase rights		$	-			$	(153	)
Fair value of deferred consideration		$	-			$	(143	)
Fair value of liabilities assumed		$	-			$	14,658

 

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

 

  

JetPay Corporation

Notes to Consolidated Financial Statements

(Unaudited)

 

Note 1.   Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, such statements include all adjustments (consisting only of normal recurring items) which are considered necessary for fair presentation of the consolidated financial statements of JetPay Corporation and its subsidiaries (collectively, the “Company” or “JetPay”) as of September 30, 2017. The results of operations for the three and nine months ended September 30, 2017 and 2016 are not necessarily indicative of the operating results for the full year. It is recommended that these consolidated financial statements be read in conjunction with the consolidated financial statements and related disclosures for the year ended December 31, 2016 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on March 24, 2017.

 

Note 2.   Organization and Business Operations

 

The Company was incorporated in Delaware on November 12, 2010 as Universal Business Payment Solutions Acquisition Corporation, a blank check company whose objective was to acquire, through a merger, share exchange, asset acquisition, stock purchase, plan of arrangement, recapitalization, reorganization or other similar business combination, one or more operating businesses. Until December 28, 2012, the Company’s efforts were limited to organizational activities, its initial public offering and the search for suitable business acquisition transactions.

 

Effective August 2, 2013, Universal Business Payment Solutions Acquisition Corporation changed its name to JetPay Corporation with the filing of its Amended and Restated Certificate of Incorporation. The Company’s ticker symbol on the Nasdaq Capital Market (“NASDAQ”) changed from “UBPS” to “JTPY” effective August 12, 2013.

 

The Company currently operates in two business segments: the Payment Services Segment and the HR & Payroll Services Segment. The Payment Services Segment is an end-to-end processor of credit and debit card and automated clearing house (“ACH”) payment transactions that focuses on processing omni-channel (internet, mobile, and point-of-sale) transactions and recurring billings for traditional retailers, government and utility, and service providers. The HR & Payroll Services Segment provides human capital management (“HCM”) services, including full-service payroll and related payroll tax payment processing, time and attendance, HCM services, low-cost money management and payment services to unbanked and underbanked employees through prepaid debit cards, and services under the Patient Protection and Affordable Care Act (the “Affordable Care Act”).

 

The Company entered the payment processing and the payroll processing businesses upon consummation of the acquisitions of JetPay Payment Services, TX, LLC (f/k/a JetPay, LLC) (“JetPay Payments, TX”) and JetPay HR & Payroll Services, Inc. (f/k/a A. D. Computer Corporation) (“JetPay HR & Payroll Services”) on December 28, 2012. Additionally, on November 7, 2014, the Company acquired JetPay Payment Services, PA, LLC (f/k/a ACI Merchant Systems, LLC) (“JetPay Payments, PA”), an independent sales organization specializing in relationships with banks, credit unions and other financial institutions. On June 2, 2016, the Company acquired JetPay Payment Services, FL, LLC (f/k/a CollectorSolutions, Inc.) (“JetPay Payments, FL”), a payment processor specializing in the processing of payments in the government and utilities channels.

 

The Company expects to fund its operating cash needs for the next fifteen months, including debt service requirements, capital expenditures and possible future acquisitions, with cash flow from its operating activities, sales of equity securities, including the recent sale of preferred stock, and current and future borrowings. The Company believes that the investments made in its technology, infrastructure, and sales staff will help generate cash flows in the future sufficient to cover its working capital needs.

 

In the past, the Company has been successful in obtaining loans and selling its equity securities. To fund the Company’s current debt service needs, expand its technology platforms for new business initiatives, and pursue possible future acquisitions, the Company may need to raise additional capital through loans or additional sales of equity securities. The Company continues to investigate the capital markets for sources of funding, which could take the form of additional debt, the restructuring of our current debt, or additional equity financing. The Company cannot provide any assurance that it will be successful in securing new financing or restructuring its current debt or that it will secure such future financing with commercially acceptable terms. If the Company is unable to raise additional capital, it may need to delay certain technology capital improvements, limit its planned level of capital expenditures and future growth plans or dispose of operating assets to generate cash to sustain operations and fund ongoing capital investments.

 

  

As disclosed in Note 8. Redeemable Convertible Preferred Stock, between October 11, 2013 and August 9, 2016, the Company sold 99,666 shares of Series A Convertible Preferred Stock, par value $0.001 per share (“Series A Preferred”), to Flexpoint Fund II, L.P. (“Flexpoint”) for an aggregate of $29.9 million, less certain costs. Additionally, on October 18, 2016, the Company sold 33,667 shares of Series A Preferred to Sundara Investment Partners, LLC (“Sundara”) for $10.1 million, less certain costs. In connection with the sale of shares of Series A Preferred to Sundara, the Company also entered into a Loan and Security Agreement with LHLJ, Inc., an affiliate of Sundara, for a term loan in the principal amount of $9.5 million, with $5.175 million of the proceeds used to simultaneously satisfy the remaining balances of a term loan and a revolving credit note payable to First National Bank of Pennsylvania (“FNB”) (the “Prior HR & Payroll Services Credit Facility”). See Note 7. Long-Term Debt, Note Payable and Capital Lease Obligations. These transactions provided approximately $14.0 million of net working capital, which the Company has used and expects to use for general working capital purposes, the payment of debt and for future capital needs, including a portion of the cost of potential future acquisitions. Finally, between May 5, 2014 and April 13, 2017, the Company sold 9,000 shares of Series A-1 Convertible Preferred Stock, par value $0.001 per share (“Series A-1 Preferred”), to an affiliate of Wellington Capital Management, LLP (“Wellington”) for an aggregate of $2.7 million.

 

The Company may from time to time determine that additional investments are prudent to maintain and increase stockholder value. In addition to funding ongoing working capital needs, the Company’s cash requirements for the next fifteen months ending December 31, 2018 include, but are not limited to, principal and interest payments on long-term debt and capital lease obligations of approximately $4.8 million and estimated capital expenditures of $4.4 million, $2.3 million of which the Company expects to fund with existing available credit facilities. Additionally, there are 133,334 shares of the Company’s Series A Preferred and 9,000 shares of the Company’s Series A-1 Preferred outstanding, with an aggregate redemption value of $85.4 million. On October 11, 2013, the Company issued the initial tranche of 33,333 shares of Series A Preferred to Flexpoint for an aggregate value of $10.0 million. On or after October 11, 2018, the fifth anniversary of the initial shares issuance, the holders of the shares of Series A Preferred issued in the initial tranche have the right to require the Company to repurchase any or all of such shares of Series A Preferred at the contractual redemption price of $600 per share or up to approximately $20.0 million. In addition, should the holders of the shares of the Series A Preferred exercise their redemption rights as described above, the holders of the Series A-1 Preferred may also redeem a proportionate amount of their shares outstanding up to an aggregate value of approximately $1.35 million. While these possible redemptions are not mandatory, it is outside the control of the Company and there can be no assurance that the Series A Preferred stockholders will not exercise their redemption rights on or after October 11, 2018. The Company would explore alternative financing opportunities with its Series A Preferred stockholders should they exercise their redemption rights, including exploring alternative equity or debt investors, or pursuing the possible sale of operating assets to generate sufficient liquidity. The Company believes that certain of its assets have sufficient value to meet this possible liquidity need and accordingly does not believe the potential liquidation event raises substantial doubt about the Company’s ability to continue as a going concern.

 

Note 3.   Business Acquisition

 

On June 2, 2016, JetPay completed its acquisition of CollectorSolutions, Inc. pursuant to the terms of the Agreement and Plan of Merger, dated February 22, 2016 (the “Merger Agreement”), by and among JetPay, CSI Acquisition Sub One, LLC, CSI Acquisition Sub Two, LLC, CollectorSolutions, Inc. and Gene M. Valentino, in his capacity as representative of the shareholders of CollectorSolutions, Inc. On October 21, 2016, the surviving entity of the merger changed its name to JetPay Payment Services, FL, LLC. The acquisition of JetPay Payments, FL provided the Company with additional expertise in selling debit and credit card processing services in the government and utilities channels through JetPay Payments, FL’s highly configurable payment gateway, added incremental debit, credit, and e-check processing volumes, and provided a base operation to sell the Company’s payroll, HCM, processing and prepaid card services to JetPay Payments, FL’s customer base. The consolidated financial statements include the accounts of JetPay Payments, FL since the acquisition date, June 2, 2016.

 

As consideration for the acquisition, the Company initially issued 3.25 million shares of its common stock to the stockholders of CollectorSolutions, Inc. and assumed approximately $1.0 million of CollectorSolutions, Inc.’s indebtedness. The 3.25 million shares of common stock issued in connection with closing, valued at $8.3 million at the date of acquisition, included: (i) 587,500 shares placed in escrow at closing as partial security for the indemnification obligations of the stockholders of CollectorSolutions, Inc. (the “Escrowed Shares”) and (ii) 500,000 shares placed in escrow at closing which would be released or cancelled if JetPay Payments, FL achieves certain gross profit performance targets in 2016 and 2017 (the “Earn-Out Shares”). In addition to the shares of its common stock issued at the date of acquisition, the Company issued an additional 54,601 shares on December 30, 2016 to the former stockholders of CollectorSolutions, Inc. in connection with a post-closing purchase price adjustment for working capital and debt levels as of the acquisition date pursuant to the Merger Agreement. JetPay Payments, FL’s former stockholders may also be entitled to receive warrants to purchase up to 500,000 shares of the Company’s common stock, each with a strike price of $4.00 per share and a 10-year term from its date of issuance, contingent upon JetPay Payments, FL achieving certain gross profit performance targets in 2018 and 2019. This contingent stock and warrant consideration, recorded as a liability, was valued at $1,975,000 at the date of acquisition utilizing a Monte Carlo simulation model. The fair value of the contingent consideration was $961,000 at September 30, 2017 (recorded within non-current other liabilities). See Note 4. Summary of Significant Accounting Policies.

 

  

Based upon the level of gross profit performance of JetPay Payments, FL in 2016, on June 28, 2017, the Company released 250,000 Earn-Out Shares from escrow to the former shareholders of CollectorSolutions, Inc. In addition, pursuant to the merger agreement, on June 28, 2017, the Company released 587,500 Escrowed Shares held for indemnification purposes from escrow to the former shareholders of CollectorSolutions, Inc.

 

In connection with the acquisition, certain executives of CollectorSolutions, Inc. were provided the right to purchase through a private placement, within twelve months after closing, up to 300,000 shares of common stock in the aggregate at a price equal to the higher of $3.00 per share and the volume-weighted average closing price of the stock of the Company for the twenty consecutive trading days ending three trading days prior to closing. This stock purchase right was valued at $152,000 utilizing a Black-Sholes option pricing model and was recorded as Additional Paid-In Capital at the date of acquisition. This purchase right was not exercised prior to its expiration on June 2, 2017.

 

In addition, the Company granted to each former stockholder of CollectorSolutions, Inc. a right to require the Company to repurchase up to 50% of the shares of common stock issued in connection with the acquisition and continuously held by such stockholder if Flexpoint exercises its right to redeem all of its shares of Series A Preferred. In a buyback of up to 50% of the shares issued to JetPay Payments, FL’s former shareholders, the Company would purchase each share of common stock issued as transaction consideration for $4.00 per share. The Company accounts for its common stock subject to possible redemption in accordance with the guidance in ASC 480 “Distinguishing Liabilities from Equity”. Conditionally redeemable common stock (including common stock that features redemption rights that are either within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within the Company’s control) is classified as temporary equity. At all other times, common stock is classified as stockholders’ equity. The common stock issued to JetPay Payments, FL’s previous shareholders features certain redemption rights that are considered to be outside of the Company’s control and subject to the occurrence of uncertain future events. Accordingly, at September 30, 2017, 50% of the estimated fair value of the common stock issued in connection with the acquisition, or $3.52 million, is presented as temporary equity, outside of the stockholders’ equity section of the Consolidated Balance Sheet.

 

The fair value of the identifiable assets acquired and liabilities assumed in the JetPay Payments, FL acquisition as of the acquisition date includes: (i) $520,000 of cash, (ii) $537,000 for accounts receivable; (iii) $113,000 for prepaid expenses and other assets; (iv) $10.6 million for settlement processing assets; (v) $93,000 for fixed assets; (vi) the assumption of $14.7 million of liabilities, including $9.95 million of settlement processing obligations and approximately $1.0 million of long term debt; and (vii) approximately $12.1 million allocated to goodwill and other identifiable intangible assets. Within the $12.1 million of acquired intangible assets, $7.2 million was assigned to goodwill, which is not subject to amortization under U.S. GAAP. The Company does not expect to deduct for tax purposes the goodwill related to the JetPay Payments, FL acquisition. The amount assigned to goodwill was deemed appropriate based on several factors, including: (i) the multiple paid by market participants for businesses in the merchant card processing business; (ii) levels of JetPay Payments, FL’s current and future projected cash flows; and (iii) the Company’s strategic business plan, which includes cross-marketing the Company’s payroll, HCM, processing and prepaid card services to JetPay Payments, FL’s customer base as well as offering merchant credit card processing services to the Company’s payroll and HCM customer base. The remaining intangible assets were assigned to customer relationships (for $4.1 million), software costs (for $710,000), and tradename (for $70,000). The Company determined that the fair value of non-compete agreements with certain employees of JetPay Payments, FL was immaterial. Customer relationships, software costs, and trade name were assigned a life of 12 years, 19 months, and 7 months, respectively.

 

Assets acquired and liabilities assumed in the JetPay Payments, FL acquisition were recorded on the Company’s Consolidated Balance Sheets as of the acquisition date based upon their estimated fair values at such date. The results of operations of the business acquired by the Company have been included in the Statements of Operations since the date of acquisition. The excess of the purchase price over the estimated fair values of the underlying identifiable assets acquired and liabilities assumed was allocated to goodwill.

 

  

The allocation of the JetPay Payments, FL purchase price and the estimated fair market values of the JetPay Payments, FL assets acquired and liabilities assumed are shown below (in thousands):

 

Cash		$	520
Accounts receivable			537
Settlement processing assets			10,587
Prepaid expenses and other assets			113
Property and equipment, net			93
Goodwill			7,218
Identifiable intangible assets			4,881
Total assets acquired			23,949
Accounts payable and accrued expenses			1,794
Settlement processing obligations			9,951
Long term debt			1,049
Long term deferred tax liability			1,864
Total liabilities assumed			14,658
Net assets acquired		$	9,291

 

Unaudited pro forma results of operations for the nine months ended September 30, 2016, as if the Company and JetPay Payments, FL had been combined on January 1, 2016, follow. The pro forma results include estimates and assumptions which management believes are reasonable. The pro forma results do not include any anticipated cost savings or other effects of the planned integration of these entities, and are not necessarily indicative of the results that would have occurred if the business combination had been in effect on the date indicated, or which may result in the future. The unaudited pro forma results of operations for the nine months ended September 30, 2016 are as follows (in thousands, except for shares information):

 

Revenues		$	46,743
Operating loss		$	(7,941	)
Net loss		$	(7,659	)
Net loss applicable to common stockholders		$	(12,083	)
Net loss per share applicable to common stockholders		$	(0.68	)

 

Note 4.   Summary of Significant Accounting Policies

 

Significant accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. The Company’s significant accounting policies are described below.

 

Use of Estimates, Presentation and Consolidation

 

The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and pursuant to the accounting and disclosure rules and regulations of the SEC. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the Company’s financial statements. Such estimates include, but are not limited to, the value of purchase consideration of acquisitions; valuation of accounts receivable, reserves for chargebacks, goodwill, intangible assets, and other long-lived assets; legal contingencies; the fair value of equity instruments classified as liabilities; and assumptions used in the calculation of stock-based compensation and in the calculation of income taxes. Actual results may differ from these estimates under different assumptions or conditions. These consolidated financial statements include our accounts and those of our wholly-owned subsidiaries and all intercompany balances and transactions have been eliminated in consolidation.

 

 

Revenue Recognition and Deferred Revenue

 

The Company recognizes revenue in general when the following criteria have been met: persuasive evidence of an arrangement exists, a customer contract or purchase order exists and the fees are fixed and determinable, no significant obligations remain and collection of the related receivable is reasonably assured. Allowances for chargebacks, discounts and other allowances are estimated and recorded concurrent with the recognition of revenue and are primarily based on historic rates.

 

Revenues from the Company’s credit and debit card processing operations are recognized in the period services are rendered as the Company processes credit and debit card transactions for its merchant customers or for merchant customers of its third party clients. Third party clients include Independent Sales Organizations (“ISOs”), Value Added Resellers (“VARs”), Independent Software Vendors (“ISVs”), and financial institutions. The majority of the Company’s revenue within its credit and debit card processing business is comprised of transaction-based fees, which typically constitute a percentage of dollar volume processed, or a fee per transaction processed. In the case where the Company is only the processor of transactions, it charges transaction fees only and records these fees as revenues. In the case of contracts pursuant to which the Company processes credit and debit card transactions for the third parties’ merchant customers, revenues are primarily comprised of fees charged to the merchant, as well as a percentage of the processed sale transaction. The Company’s contracts in most instances involve three parties: the Company, the merchant, and the sponsoring bank. Under certain of these sales arrangements, the Company’s sponsoring bank collects the gross revenue from the merchants, pays the interchange fees and assessments to the credit card associations, collects their fees and pays to the Company a net residual payment representing the Company’s fee for the services provided. Accordingly, under these arrangements, the Company records the revenue net of interchange, credit card association assessments and fees and the sponsoring bank’s fees. Under the majority of the Company’s sales arrangements, the Company is billed directly for certain fees by the credit card associations and the processing bank. In this instance, revenues and cost of revenues include the credit card association fees and assessments and the sponsoring bank’s fees which are billed to the Company and for which it assumes credit risk. In all of the above instances, the Company recognizes processing revenues net of interchange fees, which are assessed to its merchant and third party merchant customers on all processed transactions. Interchange rates and fees are not controlled by the Company. The Company effectively functions as a clearing house collecting and remitting interchange fee settlement on behalf of issuing banks, debit networks, credit card associations and their processing customers.

 

JetPay Payments, FL functions as the merchant of record and has the primary responsibility for providing end-to-end payment processing services for many of its clients. Clients contract with JetPay Payments, FL for all credit card processing services including transaction authorization, settlement, dispute resolution, security and risk management solutions, reporting and other value-added services. As such, JetPay Payments, FL is the principal obligor in these transactions and is solely responsible for all processing costs, including interchange fees. Further, JetPay Payments, FL sets prices as it deems reasonable for each merchant. The gross fees JetPay Payments, FL collects are intended to cover the interchange, assessments, and other processing fees and include JetPay Payments, FL’s margin on the transactions processed. For these reasons, JetPay Payments, FL is the principal obligor in the contractual relationship with its customers and therefore JetPay Payments, FL records its revenues, including interchange and assessments, on a gross basis. Revenues reported by JetPay Payments, FL include interchange fees of $2.43 million and $1.98 million for the three months ended September 30, 2017 and 2016, respectively and $7.73 million and $2.71 million for the nine months ended September 30, 2017 and 2016, respectively. Other fees assessed by JetPay Payments, FL to certain customers and remitted to partner entities for web and IVR supporting services provided by JetPay Payments, FL’s partner entities are presented on a net basis. The Company follows the guidance provided in ASC Topic 605-45, Revenue Recognition - Principal Agent Considerations. ASC 605-45 states that whether a company should recognize revenue based on the gross amount billed to a customer or the net amount retained is a matter of judgment that depends on the facts and circumstances of the arrangement and that certain factors are considered in the evaluation.

 

Additionally, the Company’s direct merchant customers have the liability for any charges properly reversed by the cardholder. In the event, however, that the Company is not able to collect such amount from the merchants due to merchant fraud, insolvency, bankruptcy or any other reason, it may be liable for any such reversed charges. The Company in some instances requires cash deposits, guarantees, letters of credit and other types of collateral from certain merchants to minimize any such contingent liability, and it also utilizes a number of systems and procedures to manage merchant risk.

 

  

Revenues from the Company’s JetPay HR & Payroll Services operations are recognized in the period services are rendered and earned under service arrangements with clients where service fees are fixed or determinable and collectability is reasonably assured. Certain processing services are provided under annual service arrangements with revenue recognized over the service period based on when the efforts and costs are expended. The Company’s service revenues are largely attributable to payroll-related processing services where the fees are based on a fixed amount per processing period or a fixed amount per processing period plus a fee per employee or transaction processed. The revenues earned from delivery service for the distribution of certain client payroll checks and reports is included in processing revenues, and the costs for delivery are included in selling, general, and administrative expenses on the Consolidated Statements of Operations.

 

Interest on funds held for clients is earned primarily on funds that are collected from clients before due dates for payroll tax administration services and for employee payment services, and invested until remittance to the applicable tax or regulatory agencies or client employee. These collections from clients are typically remitted between one (1) and thirty (30) days after receipt, with some items extending to ninety (90) days. The interest earned on these funds is included in total revenues on the Consolidated Statements of Operations because the collecting, holding, and remitting of these funds are critical components of providing these services.

 

Reserve for Chargeback Losses

 

Disputes between a cardholder and a merchant periodically arise as a result of, among other things, cardholder dissatisfaction with merchandise quality or merchant services. Such disputes may not be resolved in the merchant’s favor. In these cases, the transaction is “charged back” to the merchant, which means the purchase price is refunded to the customer through the merchant’s bank and charged to the merchant. If the merchant has inadequate funds, the Company must bear the credit risk for the full amount of the transaction. The Company evaluates the risk for such transactions and estimates the potential loss for chargebacks based primarily on historical experience and records a loss reserve accordingly. The Company believes its reserve for chargeback losses is adequate to cover both the known probable losses and the incurred but not yet reported losses at the balance sheet dates. Chargeback reserves totaling $349,000 and $436,000 were recorded as of September 30, 2017 and December 31, 2016, respectively.

 

Fair Value of Financial Instruments

 

The carrying amounts of financial instruments, including cash and cash equivalents, restricted cash, settlement processing assets and liabilities, accounts receivable, funds held for clients, accounts payable and client fund obligations, approximated fair value as of the balance sheet dates presented, because of the relatively short maturity dates on these instruments. The carrying amounts of the financing arrangements approximate fair value as of the balance sheet dates presented, because interest rates on these instruments approximate market interest rates after consideration of stated interest rates, anti-dilution protection and associated warrants.

 

Concentration of Credit Risk

 

Financial instruments that potentially expose the Company to concentration of credit risk consist primarily of cash and cash equivalents, accounts receivable, settlement processing assets and funds held for clients. The Company’s cash and cash equivalents are deposited with major financial institutions. At times, such deposits may be in excess of the Federal Deposit Insurance Corporation insurable amount.

 

Accounts Receivable

 

The Company’s accounts receivable are due from its merchant credit card and its payroll customers. Credit is extended based on the evaluation of customers’ financial condition and, generally, collateral is not required. Payment terms vary but are typically collected via Automated Clearing House (“ACH”) payments originated by us two (2) to three (3) days following month end. Amounts due from customers are stated in the financial statements net of an allowance for doubtful accounts. Accounts which are outstanding longer than the payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes off accounts receivables when they are deemed uncollectible.

 

Settlement Processing Assets and Funds and Obligations

 

Funds settlement refers to the process of transferring funds for sales and credits between card issuers and merchants. Depending on the type of transaction, either the credit card interchange system or the debit network is used to transfer the information and funds between the sponsoring bank and card issuing bank to complete the link between merchants and card issuers. In certain of our processing arrangements, merchant funding primarily occurs after the sponsoring bank receives the funds from the card issuer through the card networks, creating a net settlement obligation on the Company’s Consolidated Balance Sheet. In a limited number of other arrangements, the sponsoring bank funds the merchants before it receives the net settlement funds from the card networks, creating a net settlement asset on the Company’s Consolidated Balance Sheet. Additionally, certain of the Company’s sponsoring banks collect the gross revenue from the merchants, pay the interchange fees and assessments to the credit card associations, collect their fees for processing and pay the Company a net residual payment representing the Company’s fees for the services. In these instances, the Company does not reflect the related settlement processing assets and obligations in its Consolidated Balance Sheet.

 

  

Timing differences in processing credit and debit card and ACH transactions, as described above, interchange expense collection, merchant reserves, sponsoring bank reserves, and exception items result in settlement processing assets and obligations. Settlement processing assets consist primarily of our portion of settlement assets due from customers and receivable from merchants for the portion of the discount fee related to reimbursement of the interchange expense, our receivable from the processing bank for transactions we have funded merchants in advance of receipt of card association funding, merchant reserves held, sponsoring bank reserves and exception items, such as customer chargeback amounts receivable from merchants. Settlement processing obligations consist primarily of merchant reserves, our liability to the processing bank for transactions for which we have received funding from the members but have not funded merchants and exception items.

 

Settlement assets, funds and obligations resulting from JetPay Payments, FL’s processing services and associated settlement activities include settlement receivables due from credit card associations and debit networks and certain cash accounts to which JetPay Payments, FL does not have legal ownership but has the right to use the accounts to satisfy the related settlement obligations. JetPay Payments, FL’s corresponding settlement obligations are for amounts payable to customers, net of processing fees earned by JetPay Payments, FL. Settlement receivables and payables for credit and debit card transactions are recorded at the gross transaction amounts. The gross amounts are then processed through JetPay Payments, FL’s settlement accounts, and JetPay Payments, FL retains its fees for the transactions upon settlement. Settlement receivables for e-check transactions consist of only JetPay Payments, FL’s fees for the transactions. Settlement receivables are generally collected within four (4) business days. Settlement obligations are generally paid within three (3) business days, regardless of when the related settlement receivables are collected.

 

Property and Equipment

 

Property and equipment acquired in the Company’s business acquisitions have been recorded at estimated fair value. The Company records all other property and equipment acquired in the normal course of business at cost. Depreciation is recorded using the straight-line method over the estimated useful lives of the assets, which are generally as follows: leasehold improvements – shorter of economic life or initial term of the related lease; machinery and equipment – five (5) to fifteen (15) years; and furniture and fixtures – five (5) to ten (10) years. Significant additions or improvements extending assets’ useful lives are capitalized; normal maintenance and repair costs are expensed as incurred.

 

Goodwill

 

Goodwill represents the premium paid over the fair value of the net tangible and identifiable intangible assets acquired in the Company’s business combinations. The Company performs a goodwill impairment test on at least an annual basis. Application of the goodwill impairment test requires significant judgments, including estimation of future cash flows, which are dependent on internal forecasts, estimation of the long-term rate of growth for the businesses, the useful life over which cash flows will occur and determination of the Company’s weighted average cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and/or conclusions on goodwill impairment for each reporting unit. The Company conducts its annual goodwill impairment test as of December 31 of each year or more frequently if indicators of impairment exist. The Company periodically analyzes whether any such indicators of impairment exist. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include a sustained significant decline in our stock price and market capitalization, a significant adverse change in legal factors or in the business climate, unanticipated competition and/or slower expected growth rates, adverse actions or assessments by a regulator, among others. The Company compares the fair value of its reporting unit to its respective carrying value, including related goodwill. Future changes in the industry could impact the results of future annual impairment tests. The Company’s annual goodwill impairment testing indicated there was no impairment as of December 31, 2016. Additionally, no indicators of impairment occurred in the nine months ended September 30, 2017. There can be no assurance that future tests of goodwill impairment will not result in impairment charges.

 

  

Identifiable Intangible Assets

 

Identifiable intangible assets consist primarily of customer relationships, software costs, and tradenames. Certain tradenames are considered to have indefinite lives, and as such, are not subject to amortization. These assets are tested for impairment using undiscounted cash flow methodology annually and whenever there is an impairment indicator. Estimating future cash flows requires significant judgment and projections may vary from cash flows eventually realized. Several impairment indicators are beyond the Company’s control, and determining whether or not they will occur cannot be predicted with any certainty. Identifiable Intangible assets are amortized on a straight-line basis over their respective assigned estimated lives; customer relationships use eight (8) to fifteen (15) years; tradenames use one (1) to three (3) years; and software costs use one (1) to eight (8) years.

 

Impairment of Long–Lived Assets

 

The Company periodically reviews the carrying value of its long-lived assets held and used at least annually or when events and circumstances warrant such a review. If significant events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable, the Company performs a test of recoverability by comparing the carrying value of the asset or asset group to its undiscounted expected future cash flows. Cash flow projections are sometimes based on a group of assets, rather than a single asset. If cash flows cannot be separately and independently identified for a single asset, the Company determines whether impairment has occurred for the group of assets for which it can identify the projected cash flows. If the carrying values are in excess of undiscounted expected future cash flows, it measures any impairment by comparing the fair value of the asset group to its carrying value. If the fair value of an asset or asset group is determined to be less than the carrying amount of the asset or asset group, impairment in the amount of the difference is recorded. The Company’s annual testing indicated there was no impairment as of December 31, 2016. Additionally, no indicators of impairment occurred in the nine months ended September 30, 2017.

 

Convertible Preferred Stock

 

The Company accounts for the redemption premium, beneficial conversion feature and issuance costs on or of its convertible preferred stock using the effective interest method, accreting such amounts to its convertible preferred stock from the date of issuance to the earliest date of redemption.

 

Share-Based Compensation

 

The Company expenses employee share-based payments under ASC Topic 718, Compensation-Stock Compensation, which requires compensation cost for the grant-date fair value of share-based payments to be recognized over the requisite service period. The Company estimates the grant date fair value of the share-based awards issued in the form of options using the Black-Scholes option pricing model.

 

Loss Per Share

 

Basic loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during the period. The dilutive effect of the conversion option in the shares of Series A Preferred and shares of Series A-1 Preferred of 16,949,152 and 1,102,041 shares of common stock, respectively, at September 30, 2017, the effect of 1,469,570 exercisable stock options granted under the Company’s Amended and Restated 2013 Stock Incentive Plan (the “2013 Stock Incentive Plan”) at September 30, 2017 and the effect of 266,667 exercisable warrants issued in connection with the Company’s purchase of treasury shares in February 2017, have been excluded from the loss per share calculation for the three and nine months ended September 30, 2017 in that the assumed conversion of these options would be anti-dilutive. For the three and nine months ended September 30, 2016, the dilutive effect of the conversion option in the Series A Preferred and the Series A-1 Preferred of 10,310,276 and 616,500 shares of common stock, respectively, and the effect of 884,429 exercisable stock options granted under the Company’s 2013 Stock Incentive Plan at September 30, 2016 have been excluded from the loss per share calculation in that the assumed conversion of these options would be anti-dilutive.

 

Derivative Financial Instruments

 

The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. The Company does review the terms of debt instruments it enters into to determine whether there are embedded derivative instruments, including embedded conversion options, which are required to be bifurcated and accounted for separately as derivative financial instruments. In circumstances where the host instrument contains more than one embedded derivative instrument, including the conversion option, that is required to be bifurcated, the bifurcated derivative instruments are accounted for as a single compound derivative instrument.

 

  

Bifurcated embedded derivatives are initially recorded at fair value and are then revalued at each reporting date with changes in the fair value reported as non-operating income or expense. When the equity or convertible debt instruments contain embedded derivative instruments that are to be bifurcated and accounted for as liabilities, the total proceeds received are first allocated to the fair value of all the bifurcated derivative instruments. The remaining proceeds, if any, are then allocated to the host instruments themselves, usually resulting in those instruments being recorded at a discount from their face value. The discount from the face value of the convertible debt, together with the stated interest on the instrument, is amortized over the life of the instrument through periodic charges recorded within other expenses (income), using the effective interest method.

 

Fair Value Measurements

 

The Company accounts for fair value measurements in accordance with ASC Topic No. 820, Fair Value Measurements and Disclosures (“ASC Topic 820”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.

 

ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC Topic 820 are described below:

 

Level 1

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2

Applies to assets or liabilities for which there are inputs other than quoted prices included within Level 1 that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.

Level 3

Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).

 

The following table sets forth the Company’s financial assets and liabilities measured at fair value by level within the fair value hierarchy. As required by ASC Topic 820, assets and liabilities are classified in their entirety based on the level of input that is significant to the fair value measurement.

 

		Fair Value at September 30, 2017
		Total				Level 1				Level 2				Level 3
						(in thousands)
Contingent consideration		$	1,800			$	-			$	-			$	1,800

 

		Fair Value at December 31, 2016
		Total				Level 1				Level 2				Level 3
						(in thousands)
Contingent consideration		$	2,982			$	-			$	-			$	2,982

 

 

The following table sets forth a summary of the change in fair value of the Company’s Level 3 financial liabilities that are measured at fair value on a recurring basis (in thousands):

 

		For the Three Months Ended September 30,								For the Nine Months Ended September 30,
		2017				2016				2017				2016
Beginning balance		$	1,960			$	2,915			$	2,982			$	1,296
Addition of JetPay Payments, FL contingent consideration			-				-				-				1,975
JetPay Payments, FL contingent consideration shares released from escrow			-				-				(525	)			-
Change in fair value of JetPay Payments, TX contingent consideration			(4	)			36				(58	)			93
Change in fair value of JetPay Payments, PA contingent consideration			-				13				-				33
Change in fair value of JetPay Payments, FL contingent consideration			(156	)			355				(285	)			108
Payment of JetPay Payments, PA contingent consideration			-				-				(314	)			(186	)
Totals		$	1,800			$	3,319			$	1,800			$	3,319

 

Level 3 liabilities are valued using unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the financial instrument. For fair value measurements categorized within Level 3 of the fair value hierarchy, the Company’s accounting and finance department, which reports to the Chief Financial Officer, determines its valuation policies and procedures. The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s accounting and finance department with support from the Company’s outside consultants which are approved by the Chief Financial Officer. Level 3 financial liabilities for the relevant periods consist of contingent consideration related to the JetPay Payments, TX, JetPay Payments, PA and JetPay Payments, FL acquisitions for which there are no current markets such that the determination of fair value requires significant judgment or estimation. Changes in fair value measurements categorized within Level 3 of the fair value hierarchy will be analyzed each period based on changes in estimates or assumptions and recorded as appropriate.

 

In addition to the consideration paid upon closing of the JetPay Payments, TX acquisition, WLES, L.P. (“WLES”), through December 28, 2017, is entitled to receive 833,333 shares of common stock if the trading price of the common stock is at least $8.00 per share for any 20 trading days out of a 30 trading day period and $5.0 million in cash if the trading price of the common stock is at least $9.50 per share for any 20 trading days out of a 30 trading day period. This contingent consideration was valued at $1.54 million at the date of acquisition based on utilization of option pricing models and was recorded as a non-current other liability for $700,000 and as additional paid-in capital for $840,000 at December 31, 2012. The stock-based component value of $840,000 recorded at December 28, 2012 (the JetPay Payments, TX acquisition date), remains unchanged at September 30, 2017 as a result of this component being recorded as equity. The fair value at September 30, 2017 of the cash-based contingent consideration, valued at $0, recorded within other current liabilities, was determined using a binomial option pricing model. The following assumptions were utilized in the September 30, 2017 calculations: risk free interest rate: 1.06%; dividend yield: 0%; term of contingency of 0.24 years; and volatility: 74.1%.

 

The fair value of the common stock was derived from the per share price of the common stock at the valuation date. Management determined that the results of its valuation were reasonable. The expected life represents the remaining contractual term of the derivative. The volatility rate was developed based on analysis of the historical volatility rates of similarly situated companies (using a number of observations that was at least equal to or exceeded the number of observations in the life of the derivative financial instrument at issue). The risk free interest rates were obtained from publicly available U.S. Treasury yield curve rates. The dividend yield is zero because the Company has not paid dividends and does not expect to pay dividends in the foreseeable future.

 

In addition to the consideration paid upon closing of the JetPay Payments, PA acquisition, the previous unitholders were entitled to receive up to an additional $500,000 if certain net revenue goals were achieved through October 31, 2016. This contingent consideration was valued at $400,000 at the date of acquisition, $314,000 at December 31, 2016, and $0 at September 30, 2017, with $186,000 earned and paid to the previous unitholders of JetPay Payments, PA in February 2016 and the remaining $314,000 paid on January 17, 2017.

  

  

In addition to the consideration paid upon closing of the JetPay Payments, FL acquisition, the previous shareholders are entitled to receive up to an additional 500,000 shares of common stock upon JetPay Payments, FL achieving certain gross profit performance targets in 2016 and 2017 and up to 500,000 warrants to purchase shares of common stock, each with a strike price of $4.00 per share and a 10-year term from its date of issuance, upon JetPay Payments, FL achieving certain gross profit performance targets in 2018 and 2019. This contingent consideration was valued at $1,975,000 at the date of acquisition, $1,770,000 at December 31, 2016 ($563,000 recorded within other current liabilities and $1.2 million recorded within non-current other liabilities), and $961,000 at September 30, 2017 (recorded within non-current other liabilities), based on utilization of a Monte Carlo simulation to estimate the variance and relative risk of achieving future gross profit performance targets. Contingent consideration liability of $525,000 was reclassified to additional paid-in capital in June 2017 with 250,000 shares of common stock issued at the closing of the acquisition released from escrow as a result of the 2016 gross profit performance targets being achieved. The key assumptions in applying the Monte Carlo simulation included expected gross profit growth rates, the expected standard deviation and serial correlation of expected net revenue growth rates as well as a normal distribution assumption.

 

The Company uses either a binomial option-pricing model with a Monte Carlo simulation or the Black-Scholes option valuation model to value Level 3 financial liabilities at inception and on subsequent valuation dates. These models incorporate transaction details such as the Company’s stock price, contractual terms, maturity, risk free rates, as well as volatility. A significant decrease in the volatility or a significant decrease in the Company’s stock price, in isolation, would result in a significantly lower fair value measurement.

 

As of September 30, 2017, there were no transfers in or out of Level 3 from other levels in the fair value hierarchy.

 

In accordance with the provisions of ASC Topic 815, Derivatives and Hedging Activities, the Company presented its derivative liability at fair value on its Consolidated Balance Sheets, with the corresponding change in fair value recorded in the Company’s Consolidated Statement of Operations for the applicable reporting periods.

 

Income Taxes

 

The Company accounts for income taxes under ASC Topic 740, Income Taxes (“ASC Topic 740”). ASC Topic 740 requires the recognition of deferred tax assets and liabilities for both the expected impact of differences between the financial statements and tax basis of assets and liabilities and for the expected future tax benefit to be derived from tax loss and tax credit carryovers. Deferred income tax expense (benefit) represents the change during the period in the deferred income tax assets and deferred income tax liabilities. In establishing the provision for income taxes and determining deferred income tax assets and liabilities, the Company makes judgments and interpretations based on enacted laws, published tax guidance and estimates of future earnings. ASC Topic 740 additionally requires a valuation allowance to be established when, based on available evidence, it is more likely than not that some portion or the entire deferred income tax asset will not be realized.

 

ASC Topic 740 also clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. ASC Topic 740 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company is required to file income tax returns in the United States (federal) and in various state and local jurisdictions. Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company’s financial statements. The Company believes that its income tax positions and deductions would be sustained upon examination and does not anticipate any adjustments that would result in material changes to its financial position.

 

The Company’s policy for recording interest and penalties associated with unrecognized tax benefits is to record such interest and penalties as interest expense and as a component of selling, general and administrative expense, respectively. There were no amounts accrued for penalties or interest as of or during the three and nine months ended September 30, 2017 and 2016. Management does not expect any significant changes in its unrecognized tax benefits in the next year.

 

Subsequent Events

 

Management evaluates events that have occurred after the balance sheet date but before the financial statements are issued. Based upon the review, management did not identify any recognized or non-recognized subsequent events which would have required an adjustment or disclosure in the financial statements, except as described in Note 14. Subsequent Events.

 

  

Recently Adopted Accounting Standards

 

In November 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. The ASU simplifies the presentation of deferred income taxes under U.S. GAAP by requiring that all deferred tax assets and liabilities be classified as non-current. The guidance in ASU No. 2015-17 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company adopted this ASU and it did not have a material impact on the Company’s consolidated financial statements.

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This ASU makes targeted amendments to the accounting for employee share-based payments. This guidance is to be applied using various transition methods such as full retrospective, modified retrospective, and prospective based on the criteria for the specific amendments as outlined in the guidance. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The Company adopted this ASU and it did not have a material impact on the Company’s disclosures in the footnotes to its financial statements.

 

Recent Accounting Standards

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The ASU requires that a lessee recognize the assets and liabilities that arise from operating leases. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. This new guidance will be effective for annual reporting periods beginning after December 15, 2018, including interim periods within those annual reporting periods, and early adoption is permitted. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. JetPay has not yet determined the effect of the adoption of this standard on JetPay’s consolidated financial position and results of operations.

 

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). This ASU amends the principal versus agent guidance in ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which was issued in May 2014 (“ASU 2014-09”). Further, in April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. This ASU also amends ASU 2014-09 and is related to the identification of performance obligations and accounting for licenses. Most recently, in December 2016, the FASB issued ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. This amendment affects narrow aspects of the guidance issued in ASU 2014-09. The effective date and transition requirements for all of these amendments to ASU 2014-09 are the same as those of ASU 2014-09, which was deferred for one year by ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. That is, the guidance under these standards is to be applied using a full retrospective method or a modified retrospective method, as outlined in the guidance, and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted only for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The Company is currently evaluating the provisions of each of these standards and assessing their impact on the Company’s financial statements and disclosures.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 36): Measurement of Credit Losses on Financial Instruments, which provides guidance that will change the accounting for credit impairment. Under the new guidance, companies are required to measure all expected credit losses for financial instruments held at the reporting date based on historic experience, current conditions and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposure. This new guidance will be effective for annual reporting periods beginning after December 15, 2019, including interim periods within those annual reporting periods, and early adoption is permitted. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and disclosures.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Clarification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”), which eliminates the diversity in practice related to classification of certain cash receipts and payments in the statement of cash flows, by adding or clarifying guidance on eight specific cash flow issues. This new guidance will be effective for annual reporting periods beginning after December 15, 2017, and interim periods within those fiscal years and early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and disclosures.

 

  

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18), which provides guidance that will require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This new guidance will be effective for annual reporting periods beginning after December 15, 2017, and interim periods within those fiscal years and early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and disclosures.

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business.   This ASU clarifies the definition of a business when evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This new guidance will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within those periods. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and disclosures.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350). This ASU simplifies the subsequent measurement of goodwill by eliminating the second step of the goodwill impairment test, which required computing the implied fair value of goodwill. Under the amendments in this update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This new guidance will be effective January 1, 2020. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s consolidated financial statements and disclosures.

 

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. This ASU clarifies an entity’s ability to modify the terms or conditions of a share-based payment award presented. An entity should account for the effects of a modification unless all the following are met: the fair value of the modified award has not changed from the fair value on the date of issuance; the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; and, the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. This new guidance will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within those periods. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and disclosures.

 

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. This ASU clarifies the recognition, measurement, and effect on earnings per share of certain freestanding equity-classified financial instruments that include down round features affect entities that present earnings per share in accordance with the guidance in Topic 260, Earnings Per Share. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. This new guidance will be effective for annual reporting periods beginning after December 15, 2018, including interim periods within those periods. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and disclosures.

 

  

Note 5.   Property and Equipment, net of Accumulated Depreciation

 

		September 30, 2017				December 31, 2016
		(in thousands)
Leasehold improvements		$	423			$	417
Equipment			2,453				1,710
Furniture and fixtures			355				330
Computer software			1,242				1,230
Vehicles			245				245
Assets in progress			1,386				83
Total property and equipment			6,104				4,015
Less: accumulated depreciation			(2,636	)			(1,890	)
Property and equipment, net		$	3,468			$	2,125

 

Property and equipment included $702,887 and $422,167 of computer equipment as of September 30, 2017 and December 31, 2016, respectively, net of accumulated depreciation of $441,683 and $272,729 as of September 30, 2017 and December 31, 2016, respectively, that is subject to capital lease obligations.

 

Assets in progress consist primarily of computer software for internal use that will be placed into service upon completion.

 

Depreciation expense was $267,000 and $173,000 for the three months ended September 30, 2017 and 2016, respectively, and $746,000 and $540,000 for the nine months ended September 30, 2017 and 2016, respectively.

 

Note 6.    Accounts Payable and Accrued Expenses

 

Accounts payable and accrued expenses consist of the following

(in thousands):

 

		September 30, 2017				December 31, 2016
Trade accounts payable		$	2,888			$	3,438
ACH clearing liability			969				1,160
Accrued compensation			1,460				1,234
Accrued agent commissions			1,224				1,023
Related party payables			51				424
Other			3,991				3,542
Total		$	10,583			$	10,821

 

  

Note 7.   Long-Term Debt, Notes Payable and Capital Lease Obligations

 

Long-term debt, notes payable and capital lease obligations consist of the following:

 

		September 30, 2017				December 31, 2016
		(in thousands)
Term loan payable to LHLJ, Inc., interest rate of 8% payable in monthly payments of $128,677, including principal and interest, beginning on October 18, 2016, maturing on October 31, 2021, collateralized by the assets and equity interests of JetPay HR & Payroll Services and JetPay Payments, FL. See Note 12. Related Party Transactions.		$	8,765			$	9,371
Term loan payable to First National Bank of Pennsylvania (“FNB”), interest rate of 5.25% payable in monthly principal payments of $104,167 plus interest beginning on November 30, 2015, maturing November 6, 2021, collateralized by the assets and equity interests of JetPay Payments, PA.			5,104				6,042
Term note payable to Fifth Third Bank, interest rate of 4% payable in monthly payments of $27,317, including principal and interest, beginning on July 1, 2016, maturing November 30, 2019, collateralized by the assets and equity interests of JetPay Payments, FL.			705				925
Credit agreement payable to Fifth Third Bank providing for a 12-month draw period through June 22, 2018 for up to $1.6 million, converting into a 36 month amortizing term note maturing June 22, 2021. The credit agreement bears interest at LIBOR plus 3% (4.25% at September 30, 2017), collateralized by the assets and equity interests of JetPay Payments, FL.			657				-
Master equipment capital lease agreement payable to Fifth Third Bank for up to $1.5 million of lease financing to JetPay Payments, FL for a 12-month draw period through September 30, 2018. Interim draws will have a term of up to 48 months and will bear interest at LIBOR plus 3% (4.25% at September 30, 2017), until termed at a fixed rate set forth in the lease agreement, collateralized by equipment.			131				-
Amended and restated revolving promissory note payable to Fifth Third Bank, interest rate of LIBOR plus 2.00% (3.25% at September 30, 2017), maturing on June 1, 2018.			-				20
Promissory note payable to Merrick, interest rate of 12% beginning October 14, 2016 payable on the promissory note maturing on January 11, 2017, collateralized by the 3,333,333 shares of JetPay common stock issued to WLES and held in escrow. Paid in full on January 15, 2017.			-				5,000
Unsecured promissory note payable to stockholder, interest rate of 4% payable at maturity, note principal due September 30, 2017, as extended. See Note 12. Related Party Transactions.			59				492
Capital lease obligations related to computer equipment and software at JetPay Payments, TX, interest rates of 5.55% to 8.55%, due in monthly lease payments of $30,144 in the aggregate maturing from December 2017 through April 2020 collateralized by equipment.			623				357
			16,044				22,207
Less current portion			(2,862	)			(8,074	)
Less unamortized deferred financing costs			(310	)			(339	)
		$	12,872			$	13,794

 

The FNB term loan agreement requires the Company to provide FNB with annual financial statements within 120 days of the Company’s year-end and quarterly financial statements within 60 days after the end of each quarter. The FNB agreement also contains certain annual financial covenants with which the Company was in compliance as of September 30, 2017.

 

On June 2, 2016, in connection with the closing of the Company’s acquisition of JetPay Payments, FL, JetPay Payments, FL entered into a credit agreement with Fifth Third Bank to obtain a $1,068,960 term loan and a revolving line of credit facility of $500,000, in each case secured by all of JetPay Payments, FL’s assets. The term note issued to Fifth Third Bank matures on November 30, 2019 and bears interest at 4.00%. The revolving note issued to Fifth Third Bank matured on June 2, 2017 and was renewed to June 1, 2018 and bears interest at a rate of 2.00% plus the LIBOR Rate for the applicable interest period. The term note and the revolving note are guaranteed by the Company. The underlying credit agreement with Fifth Third Bank contains certain customary covenants, including a financial covenant related to JetPay Payments, FL’s fixed charge coverage ratio, with which the Company was in compliance as of September 30, 2017. The credit agreement was amended on June 22, 2017 as provided below.

 

  

On June 22, 2017, JetPay Payments, FL entered into a new Credit Agreement with Fifth Third Bank, which provides a $1.6 million Draw/Term Note to finance software integration costs; an Amended and Restated Revolving Promissory Note for $1.0 million (increasing the previous revolving promissory note for $500,000 and extending maturity to June 1, 2018); and a Second Modification of Credit Agreement. The Draw/Term Note provides for a 12 month draw period through June 22, 2018 (“the Conversion Date”), at which time the loan converts to a 36 month amortizing term loan which matures on June 22, 2021. The Draw/Term Note bears interest at the applicable LIBOR Rate plus 3%. The Draw/Term Note is payable in monthly installments beginning on the Conversion Date and can be prepaid without penalty or premium at any time. At September 30, 2017, $657,000 was outstanding against the $1.6 million Draw/Term Note.

 

The Amended and Restated Revolving Promissory Note replaced and superseded the prior $500,000 Revolving Promissory Note payable to Fifth Third Bank, extending its maturity to June 1, 2018. It bears interest at a rate of 2.00% plus the LIBOR rate for the applicable interest period and is expected to be used to extend temporary credit to cover JetPay Payments, FL’s customers’ processing return items.

 

The Second Modification amends and restates an original term loan to JetPay Payments, FL dated June 2, 2016 in the original amount of $1,068,960 to incorporate certain terms in the new Credit Agreement, including incorporating revised debt covenants, financial reporting requirements, collateral requirements, modifications to parent guarantees, and representations and warranties of JetPay Payments, FL.

 

Additionally, JetPay Payments, FL entered into a Master Equipment Lease Agreement and related Interim Lease Funding Schedule with Fifth Third Bank to provide up to $1.5 million of lease financing for point-of-sale equipment related to certain JetPay Payments, FL customer contracts and other computer equipment. The Interim Lease Funding Schedule provides the details of the allowable equipment to finance and provides for an interim draw periods through June 30, 2018. Upon completion of an interim draw, the leases under the Master Lease Agreement will have a term not exceeding 48 months at an interest rate of LIBOR Rate plus 3% until termed out on a schedule, at which time such leases will amortize and bear interest at a fixed rate set forth in the applicable schedule. At September 30, 2017, $131,000 was outstanding against the $1.5 million lease facility.

 

On July 26, 2016, as part of its settlement of litigation with Merrick, the Company issued two promissory notes in favor of Merrick in the amounts of $3,850,000 (the “$3.85MM Note”) and $5,000,000 (the “$5MM Note” and, together with the $3.85MM Note, the “Notes”) to settle legal proceedings involving Merrick Bank. The $3.85MM Note was paid in full on October 21, 2016 and the $5.00MM Note was paid in full on January 11, 2017.

 

Maturities of long-term debt and capital lease obligations, excluding unamortized financing costs, are as follows for the years ending September 30: 2018 – $2.9 million; 2019 – $2.9 million; 2020 – $2.7 million; 2021 – $2.6 million; 2022 – $5.0 million; and $0 thereafter.

 

Note 8.    Redeemable Convertible Preferred Stock

 

Under a Securities Purchase Agreement entered into on August 22, 2013 (as amended, the “Series A Purchase Agreement”), the Company agreed to sell to Flexpoint, and Flexpoint agreed to purchase, upon satisfaction of certain conditions, up to 133,333 shares of Series A Preferred for an aggregate purchase price of up to $40.0 million in three tranches.  The shares of Series A Preferred had a purchase price of $300 per share.

 

On October 11, 2013, the Company issued 33,333 shares of Series A Preferred to Flexpoint for an aggregate of $10.0 million less certain agreed-upon reimbursable expenses of Flexpoint pursuant to the Series A Purchase Agreement. Additionally, the Company issued 4,667 shares of Series A Preferred to Flexpoint on April 14, 2014 for an aggregate of $1.4 million; 20,000 shares on November 7, 2014 for $6.0 million; 33,333 shares on December 28, 2014 for $10.0 million; and 8,333 shares on August 9, 2016 for $2.5 million.

 

 

On October 18, 2016, the Company amended and restated the Series A Purchase Agreement in part to facilitate the Company’s issuance and sale to Sundara of the 33,667 shares of Series A Preferred that had not yet been purchased by Flexpoint (the “Remaining Shares”). Sundara purchased the remaining 33,667 shares of Series A Preferred in a single transaction for a purchase price of $10,100,100 on October 18, 2016.

  

The Series A Preferred is convertible into shares of common stock.  Any holder of Series A Preferred may at any time convert such holder’s shares of Series A Preferred into that number of shares of common stock equal to the number of shares of Series A Preferred being converted multiplied by $300 and divided by the then-applicable conversion price, which was initially $3.00. Under the Series A Purchase Agreement, Flexpoint and Sundara Investment Partners, LLC are provided with certain indemnification rights in the event of the incurrence of certain losses and expenses by the Company. In April 2015, Flexpoint tendered to the Company a claim letter regarding an indemnification claim with respect to a previously disclosed arbitration with EarlyBirdCapital. On August 6, 2015, in resolution of this claim, Flexpoint and the Company entered into a Letter Agreement, whereby the conversion price of any of the Series A Preferred held by Flexpoint was reduced from $3.00 per share to $2.90 per share. As a result of the previously disclosed settlement of the Direct Air matter, see Note 11. Commitments and Contingencies, on March 23, 2017, the conversion price of Series A Preferred was further adjusted to $2.36 pursuant to the Series A Securities Purchase Agreement. Pursuant to an agreement by and among the Company, Flexpoint and Sundara, the Series A Preferred conversion price may be adjusted upward upon a successful recovery of funds by the Company in the Company’s lawsuit against Valley National Bank. The conversion price of the Series A Preferred continues to be subject to downward adjustment upon the occurrence of certain events.

 

The Series A Preferred has an initial liquidation preference of $600 per share (subject to adjustment for any stock split, stock dividend or other similar proportionate reduction or increase of the authorized number of shares of common stock) and will rank senior to the common stock with respect to distributions of assets upon the Company’s liquidation, dissolution or winding up. Holders of Series A Preferred have the right to request redemption of any shares of Series A Preferred issued at least five (5) years prior to the date of such request by delivering written notice to the Company at the then applicable liquidation value per share, unless holders of a majority of the outstanding Series A Preferred elect to waive such redemption request on behalf of all holders of Series A Preferred, subject to certain exceptions. The five year anniversary of the Company’s initial issuance of 33,333 shares of Series A Preferred will occur on October 11, 2018.

 

In addition to the foregoing, pursuant to a Securities Purchase Agreement (the “Series A-1 Purchase Agreement”) with Wellington dated May 1, 2014, the Company agreed to sell to Wellington, upon the satisfaction of certain conditions, up to 9,000 shares of Series A-1 Preferred at a purchase price of $300 per share for an aggregate purchase price of up to $2.7 million. On May 5, 2014, the Company issued 2,565 shares of Series A-1 Preferred to Wellington for an aggregate of $769,500, less certain agreed-upon reimbursable expenses of Wellington. Additionally, the Company issued to Wellington 1,350 shares of Series A-1 Preferred on November 20, 2014 for $405,000; 2,250 shares of Series A-1 Preferred on December 31, 2014 for $675,000; and 2,835 shares of Series A-1 Preferred on April 13, 2017 for $850,500. The proceeds of the total investment of $2.7 million by Wellington have been used for general corporate purposes.

 

Shares of Series A-1 Preferred are convertible into shares of the Company’s common stock or, in certain circumstances, Series A-2 Convertible Preferred Stock, par value $0.001 per share. Shares of Series A-1 Preferred may be converted into that number of shares of common stock equal to the number of shares of Series A-1 Preferred being converted multiplied by $300 and divided by the then-applicable conversion price, which initially was $3.00. As a result of the settlement of the Direct Air matter, on March 23, 2017, the conversion price of Series A-1 Preferred was adjusted to $2.45 pursuant to the Series A-1 Securities Purchase Agreement. Pursuant to an agreement by and among Wellington, the Series A-1 Preferred conversion price may be adjusted upward upon a successful recovery of funds in the Company’s lawsuit against Valley National Bank. The conversion price of the Series A-1 Preferred is subject to further downward adjustment upon the occurrence of certain events as defined in the Series A-1 Purchase Agreement.

 

The Series A-1 Preferred has an initial liquidation preference of $600 per share and ranks senior to the Company’s common stock and pari passu with the Series A Preferred with respect to distributions of assets upon the Company’s liquidation, dissolution or winding up. Notwithstanding the above, no holder of the Series A-1 Preferred can convert if, as a result of such conversion, such holder would beneficially own 9.9% or more of the Company’s common stock. If at any time, no shares of Series A Preferred remain outstanding and shares of Series A-1 Preferred remain outstanding because of the limitation in the preceding sentence, all shares of Series A-1 Preferred shall automatically convert into shares of Series A-2 Preferred at a 1:1 ratio. Upon the occurrence of an Event of Noncompliance, as defined in the Series A-1 Purchase Agreement, the holders of a majority of the Series A-1 Preferred may demand immediate redemption of all or a portion of the Series A-1 Preferred at the then-applicable liquidation value.

 

The Company considered the guidance of ASC Topic 480, Distinguishing Liabilities from Equity, and ASC Topic 815, Derivatives, in determining the accounting treatment for its convertible preferred stock instruments. The Company considered the economic characteristics and the risks of the host contract based on the stated and implied substantive terms and features of the instruments; including, but not limited to, its redemption features, voting rights, and conversions rights; and determined that the terms of the preferred stock were more akin to an equity instrument than a debt instrument. Subject to certain exceptions applicable to Sundara, the shares of Series A Preferred and Series A-1 Preferred are subject to redemption, at the option of the holder, on or after the fifth anniversary of their original purchase. Accordingly, the convertible preferred stock has been classified as temporary equity in the Company’s Consolidated Balance Sheets.

 

  

Upon issuance of the 33,333 shares of the Series A Preferred, the Company recorded as a reduction to the Series A Preferred and as Additional Paid-In Capital a beneficial conversion feature of $1.5 million. The beneficial conversion feature represents the difference between the effective conversion price and the fair value of the Series A Preferred as of the commitment date. An additional beneficial conversion feature of $396,600 was recorded in August 2015 as a result of the change in conversion price per share from $3.00 to $2.90. Similarly, additional beneficial conversion features of $2.7 million and $2.2 million were recorded in March 2017 with respect to the shares of Series A Preferred issued and sold to Flexpoint in 2013 and the shares of Series A Preferred issued and sold to Sundara in 2016 as a result of the further change in conversion price per share of Series A Preferred from $2.90 to $2.36. There was no beneficial conversion feature related to the 2014, 2015 or the 2016 issuances and sales of shares of Series A Preferred to Flexpoint and shares of Series A-1 Preferred to Wellington as a result of the price of the Company’s common stock at the dates of the closings being below the effective adjusted conversion price of the preferred stock. The Company accounts for the beneficial conversion feature, the liquidation preference, and the issuance costs related to the Series A Preferred and Series A-1 Preferred using the effective interest method by accreting such amounts to its Series A Preferred and Series A-1 Preferred from the date of issuance to the earliest date of redemption as a reduction to its total permanent equity within the Company’s Consolidated Statement of Changes in Stockholders’ Equity as a charge to Additional Paid-In Capital. Any accretion recorded during the periods presented are also shown as a reduction to the income available to common stockholders in the Company’s Consolidated Statements of Operations when presenting basic and dilutive per share information. Accretion was $2.8 million and $1.6 million for the three months ended September 30, 2017 and 2016, respectively, and $7.5 million and $4.4 million for the nine months ended September 30, 2017 and 2016, respectively.

 

Upon the occurrence of an Event of Noncompliance, the holders of a majority of the Series A Preferred may demand immediate redemption of all or a portion of the shares of Series A Preferred at the then-applicable liquidation value.  Such holders may also exercise a right to have the holders of the Series A Preferred elect a majority of the Board by increasing the size of the Board and filling such vacancies.  Such right to control a minimum majority of the Board would exist for so long as the Event of Noncompliance continues. An “Event of Noncompliance” shall have occurred if: (i) the Company fails to make any required redemption payment with respect to the Series A Preferred; (ii) the Company breaches the Series A Purchase Agreement and such breach has not been cured within thirty days after receipt of notice thereof; (iii) the Company or any subsidiary makes an assignment for the benefit of creditors, admits its insolvency or is the subject of an order, judgment or decree adjudicating such entity as insolvent, among other similar actions; (iv) a final judgment in excess of $5.0 million is rendered against the Company or any subsidiary that is not discharged within 60 days thereafter; or (v) an event of default has occurred under the Prior HR & Payroll Services Credit Facility, and such event of default has not been cured within thirty days after receipt of notice thereof.

 

Note 9.    Stockholders’ Equity

 

Common Stock

 

On January 22, 2016, the Company sold 37,037 shares of common stock to an additional investor at a purchase price of $2.70 per share for consideration of $100,000 prior to issuance costs of approximately $36,000.

 

On July 1, 2016, the Company issued 22,876 shares of common stock under its Employee Stock Purchase Plan and an additional 51,480 and 40,310 shares on January 5, 2017 and July 12, 2017, respectively.

 

On August 3, 2017, the Company issued 44,240 shares of the Company’s common stock with a fair market value of approximately $97,000, as bonus compensation to the Chief Executive Officer.

 

Treasury Stock

 

On February 15, 2017, the Company repurchased 2.2 million shares of its common stock owned by WLES, which WLES had agreed to sell in connection with the Direct Air matter as part of the WLES Settlement Agreement dated July 26, 2016. JetPay had previously repaid the $5.0MM Note due to Merrick Bank in January 2017, which WLES had agreed to indemnify as part of the WLES Settlement Agreement by agreeing to sell the 2.2 million shares to satisfy JetPay’s obligations in relation to the $5.0MM Note. As a result, no additional consideration was due to WLES in connection with the stock buyback. Effective February 15, 2017, the 2.2 million shares of JetPay common stock were placed in treasury at a cost of $4.95 million and are available for issuance.

 

  

Preferred Stock

 

The Company is authorized to issue 1,000,000 shares of preferred stock with a par value of $0.001 per share with such designations, rights and preferences as may be determined from time to time by the Company’s Board of Directors.

 

As of September 30, 2017 and December 31, 2016, there were no shares of preferred stock issued or outstanding other than the Series A Preferred issued to Flexpoint and Sundara and the Series A-1 Preferred issued to Wellington described above.

 

Stock-Based Compensation

 

ASC Topic 718, Compensation-Stock Compensation, requires compensation expense for the grant-date fair value of share-based payments to be recognized over the requisite service period.

 

On July 5, 2017, the Board approved, subject to stockholder approval, the First Amendment to the Amended and Restated JetPay Corporation 2013 Stock Incentive Plan, to issue up to an additional 1,000,000 shares of its common stock as awards for a total of 4,000,000 shares of common stock available under the Plan. The First Amendment was subsequently approved by the Company’s stockholders at the Company’s 2017 Annual Meeting of Stockholders held on August 15, 2017. With the First Amendment to the Amended and Restated 2013 Plan, the Company had available 1,508,752 shares of common stock for the grant of awards as of September 30, 2017.

 

The Company granted options to purchase 340,000 and 505,000 shares of common stock under the Amended and Restated 2013 Stock Incentive Plan during the nine months ended September 30, 2017 and 2016, respectively, all at an exercise price of $3.00 per share except for 250,000 options granted at $2.48 per share in May 2016, the closing price of the Company’s common stock on the date of grant. The grant date fair value of the options granted during the nine months ended September 30, 2017 and 2016 were determined to be approximately $399,000 and $552,000, respectively, using the Black-Scholes option pricing model. Aggregated stock-based compensation expense was $170,000 and $121,000 for the three months ended September 30, 2017 and 2016, respectively, and $531,000 and $285,000 for the nine months ended September 30, 2017 and 2016, respectively. Unrecognized compensation expense as of September 30, 2017 relating to non-vested common stock options was approximately $1.0 million and is expected to be recognized through 2021. During the nine months ended September 30, 2017 and 2016, no options were exercised and 95,000 and 158,334 options, respectively, were forfeited.

 

The fair values of the Company’s options were estimated at the dates of grant using a Black-Scholes option pricing model with the following weighted average assumptions:

 

		For the Three Months Ended September 30,								For the Nine Months Ended September 30,
		2017				2016				2017				2016
Expected term (years)			-				6.25				6.25				5.75 to 6.25
Risk-free interest rate			-				1.27% to 1.31%				1.93% to 2.10%				1.27% to 1.50%
Volatility			-				59.9%				62.3% to 65.6%				58.1% to 59.9%
Dividend yield			-				0%				0%				0%

 

Expected term: The Company’s expected term is based on the period the options are expected to remain outstanding. The Company estimated this amount utilizing the “Simplified Method” in that the Company does not have sufficient historical experience to provide a reasonable basis to estimate an expected term.

 

Risk-free interest rate: The Company uses the risk-free interest rate of a U.S. Treasury Note with a similar term on the date of the grant.

 

Volatility: The Company calculates the volatility of the stock price based on historical value and corresponding volatility using a weighted average of both the Company’s stock price and the Company’s peer group stock price for a period consistent with the stock option expected term.

 

Dividend yield: The Company uses a 0% expected dividend yield as the Company has not paid dividends to date and does not anticipate declaring dividends in the near future.

 

  

A summary of stock option activity for the nine months ended September 30, 2017 and the year ended December 31, 2016 is presented below:

 

		Number of Options				Weighted Average Exercise Price
Outstanding at December 31, 2015			1,717,082			$	3.02
Granted			905,000				2.70
Forfeited			(375,834	)			3.00
Exercised			-				-
Outstanding at December 31, 2016			2,246,248			$	2.89
Granted			340,000				3.00
Forfeited			(95,000	)			3.00
Exercised			-				-
Outstanding at September 30, 2017			2,491,248			$	2.90
Exercisable at September 30, 2017			1,469,570			$	2.92

 

The weighted average remaining life of options outstanding at September 30, 2017 was 7.75 years. The aggregate intrinsic value of the exercisable options at September 30, 2017 was $0.

 

Employee Stock Purchase Plan

 

On June 29, 2015, the Board of Directors adopted the JetPay Corporation Employee Stock Purchase Plan (the "Purchase Plan"), which was subsequently approved by the Company’s stockholders at the Company’s 2015 Annual Meeting of Stockholders. The Purchase Plan allows employees to contribute a percentage of their cash earnings, subject to certain maximum amounts, to be used to purchase shares of the Company’s common stock on each of two (2) semi-annual purchase dates. The purchase price is equal to 90% of the market value per share on either: (a) the date of grant of a purchase right under the Purchase Plan; or (b) the date on which such purchase right is deemed exercised, whichever is lower.

 

As of September 30, 2017, an aggregate of 300,000 shares of common stock were reserved for issuance under the Purchase Plan, of which 22,876 shares of common stock were issued on July 1, 2016, 51,480 issued on January 5, 2017 and 40,310 shares on July 12, 2017.

 

Note 10.    Income Taxes

 

The Company recorded income tax expense (benefit) of $56,000 and $96,000 for the three months ended September 30, 2017 and 2016, respectively, and $199,000 and $(1.38) million for the nine months ended September 30, 2017 and 2016, respectively. Income tax expense (benefit) reflects the recording of federal and state income taxes. The effective tax rates were approximately (10.8)% and (7.7)% for the three months ended September 30, 2017 and 2016, respectively, and (10.7)% and 14.8% for the nine months ended September 30, 2017 and 2016, respectively. The effective rate differs from the federal statutory rate for each period, primarily due to state and local income taxes and changes to the valuation allowance.

 

As of September 30, 2016, due to the acquisition of JetPay Payments, FL and its related identifiable intangibles and the recording of an associated $1.86 million deferred tax liability, management believed that it was more likely than not that the benefit of a portion of its federal net deferred tax assets would be realized equal to the future source of taxable income created by the reversal of the book amortization of the JetPay Payments, FL fixed assets and identifiable intangible assets. Accordingly, management believes recording a partial reduction of the valuation allowance against its federal net deferred tax asset of $1.6 million is appropriate.

 

JetPay Payments, TX is subject to and pays the Texas Margin Tax which is considered to be an income tax in accordance with the provisions of the Income Taxes Topic in FASB, ASC and the associated interpretations. There are no significant temporary differences associated with the Texas Margin Tax.

 

As of December 31, 2016, the Company had U.S. federal net operating loss carryovers (“NOLs”) of approximately $25.9 million available to offset future taxable income. These NOLs, if not utilized, expire at various times through 2036. In accordance with Section 382 of the Internal Revenue Code, deductibility of the Company’s NOLs may be subject to an annual limitation in the event of a change in control.

 

  

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. After consideration of all of the information available, management believes that a total valuation allowance of approximately $9.6 million at September 30, 2017 is appropriate, representing the amount of its deferred income tax assets in excess of certain of the Company’s deferred income tax liabilities. The deferred tax liability related to goodwill that is amortizable for tax purposes (“Intangibles”) will not reverse until such time, if any, that the goodwill, which is considered to be an asset with an indefinite life for financial reporting purposes, becomes impaired or sold. Due to the uncertain timing of this reversal, the temporary difference cannot be considered as future taxable income for purposes of determining a valuation allowance. Therefore, the deferred tax liability related to tax deductible goodwill Intangibles cannot be considered when determining the ultimate realization of deferred tax assets.

 

Note 11.   Commitments and Contingencies

 

On or about March 13, 2012, a merchant of JetPay, LLC, Direct Air, a charter travel company, abruptly ceased operations and filed for bankruptcy. Under United States Department of Transportation requirements, all charter travel company customer charges for travel are to be deposited into an escrow account in a bank under a United States Department of Transportation escrow program, and not released to the charter travel company until the travel has been completed. In the case of Direct Air, such funds had historically been deposited into such United States Department of Transportation escrow account at Valley National Bank in New Jersey, and continued to be deposited through the date Direct Air ceased operations. At the time Direct Air ceased operations, according to Direct Air’s bankruptcy trustee, there should have been in excess of $31.0 million in the escrow account. Instead there was approximately $1.0 million. As a result, Merrick Bank Corporation (“Merrick”), JetPay, LLC’s sponsor bank with respect to this particular merchant, incurred chargebacks in excess of $25.0 million. Merrick maintained insurance through a Chartis Insurance Policy for chargeback losses that named Merrick as the primary insured. The policy had a limit of $25.0 million and a deductible of $250,000. Merrick sued Chartis Insurance (“Chartis”) for payment under the claim. Under an agreement between Merrick and JetPay, LLC, JetPay, LLC had certain obligations to indemnify Merrick for losses realized from such chargebacks that Merrick was unable to recover from other parties. JetPay, LLC recorded a loss for all chargebacks in excess of $25.0 million, the $250,000 deductible on the Chartis insurance policy and $487,000 of legal fees charged against JetPay, LLC’s cash reserve account by Merrick, totaling $1.9 million in 2012, as well as an additional $597,000 in legal fees charged against JetPay, LLC’s cash reserve account by Merrick through September 30, 2013. In December 2013, Merrick, in addition to its suit against Chartis, also filed suit against Valley National Bank as escrow agent. In February 2015, JetPay joined that suit, along with American Express. During 2012 and 2013, Merrick required JetPay, LLC to maintain increased cash reserves in order to provide additional security for any obligations arising from the Direct Air situation. As of September 30, 2016, Merrick held approximately $4.4 million of total reserves related to the Direct Air matter, which amount was released in full to Merrick under the Merrick Settlement Agreement in July 2016, as more fully described below.

 

On August 7, 2013, JetPay Merchant Services, LLC (“JPMS”), then a wholly owned subsidiary of JetPay, LLC and indirect wholly-owned subsidiary of the Company, together with WLES (collectively, the “Plaintiffs”), filed suit in the United States District Court for the Northern District of Texas, Dallas Division, against Merrick, Royal Group Services, LTD, LLC and Gregory Richmond (collectively, the “Defendants”). The suit alleged that Merrick and Gregory Richmond (an agent of Royal Group Services) represented to JPMS that insurance coverage was arranged through Chartis Specialty Insurance Company to provide coverage for JPMS against potential chargeback losses related to certain of JPMS’s merchant customers, including Southern Sky Air Tours, d/b/a Direct Air. The complaint alleged several other causes of action against the Defendants, including violation of state insurance codes, negligence, fraud, breach of duty and breach of contract. Also, in August 2013, JPMS, JetPay, LLC, and JetPay ISO Services, LLC (“JetPay ISO”) filed the second amendment to a previously filed complaint against Merrick in the United States District Court for the District of Utah, adding to its initial complaint several causes of action related to actions Merrick allegedly took during JetPay, LLC’s transition to a new sponsoring bank in June 2013. Additionally, subsequent to this transition, Merrick invoiced the Company for legal fees incurred by Merrick totaling approximately $4.7 million. The Company did not believe it had a responsibility to reimburse Merrick for these legal fees and disputed these charges. Accordingly, the Company had not recorded an accrual for these legal fees as of September 30, 2016. These legal fees were eliminated as part of the Merrick Settlement Agreement, as described below.

 

As partial protection against any potential losses related to Direct Air, the Company required that, upon closing of the acquisition of JetPay, LLC, 3,333,333 shares of common stock that was to be paid to WLES as part of the JetPay, LLC acquisition be placed into an escrow account with JP Morgan Chase as the trustee. If JetPay, LLC suffered any liability as a result of the Direct Air matter, these shares would be used in partial payment for any such liability, with any remaining shares delivered to WLES.

 

  

On July 26, 2016, we entered into two related settlement agreements: (i) a Settlement Agreement and Release by and among Merrick, the Company, certain subsidiaries of the Company and WLES (the “Merrick Settlement Agreement”) and (ii) a Settlement Agreement and Release by and among Trent Voigt, WLES and the Company (the “WLES Settlement Agreement”). In connection with the parties’ entry into the Merrick Settlement Agreement, the District Court for the District of Utah dismissed the Direct Air matter with prejudice on July 27, 2016.

 

As part of the Merrick Settlement Agreement, we agreed to release all claims to the $4.4 million held in reserve at Merrick. In addition, pursuant to the Merrick Settlement Agreement, we issued to Merrick a $3,850,000 note, bearing interest at a rate of 8% per annum, due December 28, 2017 (the “$3.85MM Note”) and a $5,000,000 note, bearing interest at a rate of 12% per annum, due January 11, 2017 (the “$5MM Note” and, together with the $3.85MM Note, the “Notes”) to Merrick. The Notes were secured by the 3,333,333 shares of JetPay’s common stock issued in the name of WLES and held in escrow.

 

In connection with its entry into the Merrick Settlement Agreement, JetPay executed three Stipulated and Confessed Judgments in favor of Merrick in the amounts of $32,500,000 (the “First Judgment”), $28,650,000 (the “Second Judgment”) and $27,500,000 (the “Third Judgment” and, together with the First Judgment and the Second Judgment, the “Judgments”), none of which would be of any effect unless and until JetPay failed to make any payment when due under the Notes. If JetPay failed to make payment when due under the Notes, Merrick, after a five (5) day cure period, would have been able to seek to obtain and/or enforce the applicable Judgments in the Federal District Court for Utah or in any court of competent jurisdiction. On October 21, 2016, the Company paid in full the $3.85MM Note and on January 11, 2017, the Company paid in full the $5.0MM Note. As a result, no Judgments are available for Merrick’s relief.

 

Under the terms of the WLES Settlement Agreement, WLES agreed to transfer the indebtedness represented by that certain promissory note, dated December 28, 2012 (the “WLES Note”), in the original principal amount of $2,331,369 issued by JetPay in favor of WLES to Merrick. In addition, WLES agreed to amend that certain promissory note, dated June 7, 2013, as amended, in the original principal amount of $491,693 issued by JetPay, LLC in favor of Trent Voigt in order to (a) extend its maturity date from September 30, 2016 to September 30, 2017 and (b) waive all interest payments for the period from September 30, 2016 to September 30, 2017. This note in favor of Mr. Voigt was paid down to $59,000 on August 30, 2017.

 

The WLES Settlement Agreement also provides for the allocation of any recoveries by JPMS in connection with the claims brought by JMPS in American Express Travel Related Services and JetPay Merchant Services, LLC v. Valley National Bank, Civil Action No. 2:14-cv-7827 (D. N.J.) between the Company and WLES. On February 15, 2017, 2,200,000 of the WLES escrowed shares were transferred to JetPay and placed into Treasury to satisfy WLES’ indemnification under the Merrick and WLES Settlement Agreements.

 

The Company has recorded a Settlement of Legal Matter charge of $6.19 million for the year ended December 31, 2016 based on the terms of the Merrick Settlement Agreement and the WLES Settlement Agreement. The loss includes: (i) a charge of $4.4 million related to the Company’s release of all claims to the $4.4 million held in reserve at Merrick; (ii) a charge of $1.4 million related to the Company’s issuance of the $3.85MM Note, less WLES’s agreement to transfer the WLES Note (recorded at $2,036,511, net of an unamortized discount of $294,858) and accrued interest on the WLES Note of $414,466; (iii) a charge of $50,000 representing the Company’s issuance of the $5.0MM Note less the estimated value as of July 26, 2016 of the escrowed shares; and (iv) a charge for $373,334 representing the fair value of the issuance of warrants to WLES as described in the WLES Settlement Agreement.

 

At the time of the acquisition of JetPay, LLC, the Company entered into an Amendment, Guarantee, and Waiver Agreement (the “Agreement”), dated December 28, 2012, between the Company, Ten Lords, Ltd. (“Ten Lords”) and JetPay, LLC (n/k/a JetPay Payment Services, TX, LLC). Under the Agreement, Ten Lords agreed to extend payment of a $6.0 million note remaining outstanding at the date of acquisition for up to twelve months. The terms of the Agreement required that the Company provide the owners of Ten Lords and Providence Interactive Capital, LLC (together with Ten Lords, the “Plaintiffs”) with a “true up” payment meant to put them in the same after-tax economic position as they would have been had the note been paid in full on December 28, 2012. The Company calculated this true-up payment to be $222,310 and paid such amount in August 2015. In addition to the $222,310 paid in 2015, the Company recorded an additional loss accrual of $125,500 relating to this matter. Subsequent to the Company’s payment, the Company received notice on October 5, 2015 that Plaintiffs filed a lawsuit (the “Lawsuit”) against JetPay, LLC and the Company disputing the true up payment. Since 2015, the Company and JetPay, LLC have been defendants in the Lawsuit in the 429th Judicial District Court of Collin County, Texas (the “Court”) styled Ten Lords, Ltd. and Providence Interactive Capital, LLC, Cause No. 429-04140-2015. The Lawsuit was tried in the Court on May 2, 2017 and the Court granted a judgment to Plaintiffs in the amount of $793,000 plus attorneys’ fees of $134,075, which judgment was entered by the Court on May 15, 2017 (the “Judgment”). On July 3, 2017, the Company and JetPay, LLC successfully settled the Lawsuit by entering into a Compromise Settlement Agreement and Mutual Release (the “Settlement Agreement”). Pursuant to the Settlement Agreement, the Company paid to Plaintiffs the sum of $872,500 on July 3, 2017 and the parties released one another and their respective affiliates from all claims arising out of the matters described in the Lawsuit and the Judgment. In connection with this settlement, the Company recorded an additional loss of $747,000 in the three months ended June 30, 2017.

 

  

In December 2015, Harmony Press Inc. (“Harmony”), a customer of ADC and PTFS, filed a suit against an employee of Harmony for theft by that employee of over $628,000. JetPay, ADC, and PTFS as well as several financial institution service providers to Harmony were also named in that suit for alleged negligence. The Company believes that the allegations in the suit regarding JetPay, ADC, and PTFS are groundless and has turned the matter over to the Company’s insurance carrier who is defending the suit. The Company is subject to a $50,000 deductible under its insurance policy. The Company has not recorded an accrual for any potential loss related to this matter as of September 30, 2017 and has incurred legal expense of $50,000 applied against its deductible, through September 30, 2017.

 

The Company is a party to various other legal proceedings related to its ordinary business activities. In the opinion of the Company’s management, none of these proceedings are material in relation to our results of operations, liquidity, cash flows, or financial condition.

 

Note 12.    Related Party Transactions

 

JetPay HR & Payroll Services’ headquarters are located in Center Valley, Pennsylvania and consist of approximately 22,500 square feet leased from C. Nicholas Antich and Carol A. Antich. Mr. Antich is the former President of JetPay HR & Payroll Services. The rent is currently $45,163 per month. The office lease had an initial 10-year term which expired on May 31, 2016 and was extended through January 31, 2018. Rent expense under this lease was $135,489 and $135,489 for the three months ended September 30, 2017 and 2016, respectively, and $406,467 and $395,882 for the nine months ended September 30, 2017 and 2016. On October 20, 2017, the Company entered into a new lease to replace the JetPay HR & Payroll Services’ headquarters lease in Center Valley upon its termination. See Note 14. Subsequent Events.

 

JetPay Payments, TX retains a backup center in Sunnyvale, Texas consisting of 1,600 square feet, rented from JT Holdings, an entity controlled by Trent Voigt, the previous Chief Executive Officer of JetPay Payments, TX. The prior lease expired on January 31, 2016. Rent expense was $18,000 and $30,000 for the three months ended September 30, 2017 and 2016, respectively, and $42,000 and $90,000 for the nine months ended September 30, 2017 and 2016, respectively. As a part of current negotiations with Mr. Voigt regarding the property and other related matters, the Company and JT Holdings entered into an agreement to extend the lease for twelve months beginning on July 1, 2017 at a monthly rate of $6,000 plus utilities and certain other costs.

 

In connection with the closing of the Company’s acquisition of JetPay Payments, TX, the Company entered into a Note and Indemnity Side Agreement with JP Merger Sub, LLC, WLES and Trent Voigt (the “Note and Indemnity Side Agreement”) dated as of December 28, 2012. Pursuant to the Note and Indemnity Side Agreement, the Company issued a promissory note in the amount of $2,331,369 in favor of WLES. Interest accrued on amounts due under the note at a rate of 5% per annum, and is payable quarterly. Interest expense was $8,100 and $67,000 for the three and nine months ended September 30, 2016, respectively. Under the terms of the WLES Settlement Agreement, WLES transferred the WLES Note and related accrued interest to Merrick. See Note 11. Commitments and Contingencies.

 

On August 22, 2013, JetPay Payments, TX entered into a Master Service Agreement with JetPay Solutions, LTD, a United Kingdom based entity 75% owned by WLES, an entity owned by Trent Voigt. The Company initiated transaction business under this agreement beginning in April 2014 with revenue earned from JetPay Solutions, LTD of $100 and $5,000 for the three months ended September 30, 2017 and 2016, respectively, and $41,700 and $16,000 for the nine months ended September 30, 2017 and 2016, respectively.

 

On June 7, 2013, the Company issued an unsecured promissory note to Trent Voigt, the then Chief Executive Officer of JetPay Payments, TX, in the amount of $491,693. The note matures on September 30, 2017, as extended by the WLES Settlement Agreement dated July 26, 2016, see Note 11. Commitments and Contingencies, and bore interest at an annual rate of 4% with interest expense of $4,900 and $14,700 recorded for the three and nine months ended September 30, 2016, respectively. The transaction was approved upon resolution and review by the Company’s Audit Committee of the terms of the note to ensure that such terms were no less favorable to the Company than those that would be available with respect to such transactions from unaffiliated third parties. This unsecured promissory note was paid down to $59,000 on August 30, 2017. See Note 7. Long-Term Debt, Notes Payable and Capital Lease Obligations.

 

 

Finally, on October 18, 2016, the Company entered into the amended and restated Series A Purchase Agreement with Flexpoint and Sundara, a Delaware limited liability company wholly-owned by Laurence L. Stone. Pursuant to the amended and restated Series A Purchase Agreement, Sundara acquired 33,667 shares of Series A Preferred for $10.1 million. In connection with the Company’s entry into the amended and restated Series A Purchase Agreement, Mr. Stone was appointed as a director of the Company by holders of Series A Preferred shares. In addition, on October 18, 2016, the Company entered into a loan and security agreement with JetPay HR & Payroll Services and PTFS, as borrowers, the Company and JetPay Payments, FL, as guarantors, and LHLJ, Inc., an entity controlled and majority-owned by Laurence L. Stone, as lender. Pursuant to the loan and security agreement, LHLJ, Inc., LHLJ, Inc. provided JetPay HR & Payroll Services and PTFS a term loan of $9.5 million. The loan carries an interest rate of 8% and matures on October 18, 2021. Interest expense related to this promissory note was $182,000 and $552,000 for the three and nine months ended September 30, 2017. In connection with the parties’ entry into the loan and security agreement, the borrowers paid LHLJ, Inc. a non-refundable closing fee of $190,000.

 

Note 13.    Segments

 

The Company currently operates in two business segments, the Payment Services Segment, which is an end-to-end processor of credit and debit card and ACH payment transactions to businesses with a focus on those processing internet transactions and recurring billings, and the HR & Payroll Services Segment, which is a full-service payroll and related payroll tax payment processor.

 

Segment operating results are presented below (in thousands). The results reflect revenues and expenses directly related to each segment. The activity within JetPay Card Services was included in the HR & Payroll Services for the three and nine months ended September 30, 2017, and in General/Corporate, for the three and nine months ended September 30, 2016 in the tables below.

 

		For the Three Months Ended September 30, 2017
		Payment Services				HR & Payroll Services				General/ Corporate				Total
Processing revenues		$	14,581			$	3,859			$	-			$	18,440
Cost of processing revenues			10,806				2,049				-				12,855
Selling, general and administrative expenses			2,722				1,446				642				4,810
Change in fair value of contingent consideration liability			-				-				(160	)			(160	)
Amortization of intangibles and depreciation			813				327				1				1,141
Other expenses			97				208				8				313
Income (loss) before income taxes		$	143			$	(171	)		$	(491	)		$	(519	)

 

		For the Three Months Ended September 30, 2016
		Payment Services				HR & Payroll Services				General/ Corporate				Total
Processing revenues		$	11,823			$	3,374			$	17			$	15,214
Cost of processing revenues			8,300				1,878				21				10,199
Selling, general and administrative expenses			2,894				1,377				244				4,515
Settlement of legal matter			(20	)			-				-				(20	)
Change in fair value of contingent consideration liability			-				-				404				404
Amortization of intangibles and depreciation			721				316				1				1,038
Other expenses			165				61				96				322
Loss before income taxes		$	(237	)		$	(258	)		$	(749	)		$	(1,244	)

 

  

		For the Nine Months Ended September 30, 2017
		Payment Services				HR & Payroll Services				General/ Corporate				Total
Processing revenues		$	43,873			$	12,286			$	-			$	56,159
Cost of processing revenues			32,022				6,467				-				38,489
Selling, general and administrative expenses			8,397				4,447				1,978				14,822
Settlement of legal matter			-				-				747				747
Change in fair value of contingent consideration liability			-				-				(343	)			(343	)
Amortization of intangibles and depreciation			2,391				975				3				3,369
Other expenses			276				634				34				944
Income (loss) before income taxes		$	787			$	(237	)		$	(2,419	)		$	(1,869	)
Total property and equipment, net		$	2,967			$	471			$	30			$	3,468
Property and equipment additions		$	2,064			$	132			$	3			$	2,199
Intangible assets and goodwill		$	56,528			$	15,917			$	-			$	72,445
Total segment assets		$	108,242			$	64,867			$	1,045			$	174,154

 

		For the Nine Months Ended September 30, 2016
		Payment Services				HR & Payroll Services				General/ Corporate				Total
Processing revenues		$	27,986			$	11,037			$	46			$	39,069
Cost of processing revenues			20,062				5,764				79				25,905
Selling, general and administrative expenses			6,722				3,907				1,467				12,096
Settlement of legal matter			6,120				-				-				6,120
Change in fair value of contingent consideration liability			-				-				234				234
Amortization of intangibles and depreciation			1,918				995				4				2,917
Other expenses			476				201				409				1,086
(Loss) income before income taxes		$	(7,312	)		$	170			$	(2,147	)		$	(9,289	)
Total property and equipment, net		$	1,626			$	547			$	31			$	2,204
Property and equipment additions		$	404			$	211			$	-			$	615
Intangible assets and goodwill		$	58,724			$	16,954			$	-			$	75,678
Total segment assets		$	91,742			$	64,485			$	6,600			$	162,827

 

Note 14.    Subsequent Events

 

On October 20, 2017, JetPay HR & Payroll Services, the Company’s wholly-owned subsidiary, entered into an office lease agreement (the “Lease”) with Brookwood Philadelphia I, LLC and Brookwood Philadelphia II, LLC to lease approximately 24,269 rentable square feet of a multi-tenant office building in Allentown, Pennsylvania (the Facility”). The Facility will house the Company’s HR & Payroll Services Segment operations. The Lease has an initial term of 10 years and 8 months from the date of occupancy planned for February 2018. Rent expense under the lease in year one is $40,448 per month with annual increases of 2.5% per annum with four months of abated rent in year one and three months of abated rent in year two of the Lease. JetPay HR & Payroll Services will not bear a prorated portion of the operating costs and taxes of the building in year one of the Lease but will be responsible for a portion of the increase in these costs over the base year amount in future years. The Lease also provides a tenant improvement allowance to cover all of the estimated leasehold improvement costs as well as a moving allowance.

 

Effective October 30, 2017, the board of directors (the “Board”) appointed Mr. Robert Frankfurt to fill a vacancy on the Board resulting from Fredrick S. Hammer’s resignation on August 2, 2016. Mr. Frankfurt was determined by the Board to be independent under the rules and regulations of the Nasdaq Stock Market (“NASDAQ”) and Securities and Exchange Commission (“SEC”). Mr. Frankfurt was also elected as a member and as chairman of the Audit Committee. The Board has determined that Mr. Frankfurt is an "audit committee financial expert," as such term is defined in Item 407(d)(5) of Regulation S-K, and that Mr. Frankfurt is “independent” under the rules and regulations of NASDAQ and the SEC. As a result of Mr. Frankfurt’s election to the Board and the Audit Committee, the Audit Committee now consists of three members, each of whom is independent, in compliance with Listing Rule 5605(c)(2)(A).

 

  

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion of the financial condition and results of operations should be read in conjunction with the financial statements and the notes thereto included in this Quarterly Report on Form 10-Q.

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

As used in this Quarterly Report on Form 10-Q, unless the context otherwise indicates, the references to “our company,” “the Company,” “JetPay,” “us,” “we” and “our” refer to JetPay Corporation.

 

This report and other written or oral statements made from time to time by us may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You can sometimes identify forward looking-statements by our use of the words “believes,” “anticipates,” “expects,” “intends,” “plans,” “forecast,” “guidance” and similar expressions. Some of the statements we use in this report contain forward-looking statements concerning our business operations, economic performance and financial condition, including in particular: our business strategy and means to implement the strategy; measures of future results of operations, such as revenue, expenses, operating margins, income tax rates, and earnings per share; other operating metrics such as shares outstanding and capital expenditures; our success and timing in developing and introducing new products or services and expanding our business; and the successful integration of future acquisitions.

 

Although we believe that the plans and expectations reflected in or suggested by our forward-looking statements are reasonable, those statements are based on a number of assumptions and estimates that are inherently subject to significant risks and uncertainties, many of which are beyond our control, cannot be foreseen and reflect future business decisions that are subject to change. Accordingly, we cannot guarantee you that our plans and expectations will be achieved. Our actual revenues, revenue growth rates and margins, other results of operations and shareholder values could differ materially from those anticipated in our forward-looking statements as a result of known and unknown factors, many of which are beyond our ability to predict or control. These factors include, but are not limited to, those set forth in Item 1A - Risk Factors of this report and in our Annual Report on Form 10-K, those set forth elsewhere in this report and those set forth in our press releases, reports and other filings made with the SEC. These cautionary statements qualify all of our forward-looking statements, and you are cautioned not to place undue reliance on these forward-looking statements.

 

Our forward-looking statements speak only as of the date they are made and should not be relied upon as representing our plans and expectations as of any subsequent date. While we may elect to update or revise forward-looking statements at some time in the future, we specifically disclaim any obligation to publicly release the results of any revisions to our forward-looking statements.

 

Overview

 

The Company entered the payment processing and the payroll processing businesses upon consummation of the acquisitions of JetPay Payment Services, TX, LLC (f/k/a JetPay, LLC) (“JetPay Payments, TX”) and JetPay HR & Payroll Services, Inc. (f/k/a A. D. Computer Corporation) (“JetPay HR & Payroll Services”) on December 28, 2012. Additionally, on November 7, 2014, the Company acquired JetPay Payment Services, PA, LLC (f/k/a ACI Merchant Systems, LLC) (“JetPay Payments, PA”), an independent sales organization specializing in relationships with banks, credit unions and other financial institutions. On June 2, 2016, the Company acquired JetPay Payment Services, FL, LLC (f/k/a CollectorSolutions, Inc.) (“JetPay Payments, FL”), a payment processor specializing in the processing of payments in the government and utilities channels.

 

We are a provider of debit and credit card processing, payroll and HCM services, and prepaid card services to businesses and their employees throughout the United States. We provide these services through four wholly-owned subsidiaries: JetPay Payments, TX, which provides debit and credit card processing and ACH payment services to businesses with a focus on processing omni-channel (internet, mobile, and point-of-sale) transactions and recurring billings; JetPay Payments, PA, an independent sales organization specializing in relationships with banks, credit unions, other financial institutions and strategic partners; JetPay Payments, FL, a debit and credit card processor specializing in providing services to government agencies and utilities; and JetPay HR & Payroll Services, which provides HCM services, including, payroll, tax filing, time and attendance, HR services, and Affordable Care Act and related services to small and medium-sized employers.  We also provide prepaid card services within our HR & Payroll Segment.

 

  

Our overall business strategy is to provide payment processing services to small to large-sized businesses with a high percentage of our revenues consisting of recurring revenues with strong margins and with relatively low capital requirements. Our corporate strategy is to increase our revenues through a combination of organic growth and acquisitions. Our organic growth strategy is focused on developing and increasing our current marketing and sales staff at JetPay Payment Services and JetPay HR & Payroll Services to penetrate new customer niches and geographic markets. Our organic growth strategy also includes cross marketing initiatives to sell credit and debit card processing services to JetPay HR & Payroll Services’ payroll customers and payroll processing services to JetPay Payment Services’ credit and debit card processing customers. Additionally, we will be seeking additional debt and/or equity capital to acquire additional credit and debit card processors, ISVs, ISOs and/or payroll processors to integrate into our JetPay Payment Services and JetPay HR & Payroll Services operations. Our acquisition strategy is focused on identifying small to medium-sized companies that either provide services similar to ours or services that expand our product and service offerings and/or our geographic reach.  Both our JetPay Payment Services and our JetPay HR & Payroll Services operations have significant under-utilized processing capacity, which can be leveraged to create additional processing revenues without significant cost increases.   Our overall strategy also includes looking for cost synergies as we continue to integrate the JetPay Payment Services and JetPay HR & Payroll Services operations in such areas as insurance costs, banking costs, employee benefit costs, and other selling, general and administrative cost as well as operating cost areas.

 

Payment Services Segment

 

Revenues

 

JetPay Payments, TX and JetPay Payments, PA’s revenues fall into two categories: transaction processing revenues and merchant discount revenues. As such, our two primary drivers are the number of transactions and merchant dollar volume. A third measure related to merchant dollar volume, for those merchants where we charge a percentage of the sale amount, is the average size of the transaction, as costs for processing the transaction tend to be fixed, so that the higher the average ticket, the more revenue we earn for a fixed cost. JetPay’s discount revenues are generally a fixed percentage of the merchant’s dollar volume, with interchange and other third-party fees passed through to the merchant without markup. Our billings to merchants primarily consist of these transaction fees and discount fees, as well as pass-through fees for other miscellaneous services, such as handling chargebacks. Interchange costs are set by the card networks, and are paid directly by the sponsoring bank to the credit card associations based upon a percentage of transaction amounts and/or a fixed price per transaction. JetPay Payment Services refers to the ratio of processing revenues to the dollar amount of card transactions processed as the “margin.” If margin increases, processing revenues will tend to increase accordingly. Further, both the number of merchants who process transactions, and the average dollar amount of transactions processed per merchant, will impact the total transaction volume and thus the total processing revenues. As such, growth in JetPay’s merchant count and/or growth in the same store transaction volume will also drive JetPay’s processing revenue growth.

 

JetPay Payments, FL generates substantially all of its revenues from transaction fees for processing payment transactions. For credit card transactions, our fee may be charged as a fixed fee or as a percentage of the dollars processed. As such, the two primary factors affecting our processing revenue from accepting and processing credit card payments are the number of transactions and the average dollar volume of the transaction. Accordingly, growth in JetPay Payments, FL’s client count and growth in the “same client” transaction dollar volume impact JetPay Payments FL’s processing revenue growth. In the case of e-check (ACH) payments, typically our fees are charged as a fixed fee per transaction regardless of the payment amount.

 

 Expenses

 

The most significant components of operating expenses are credit card association fees and assessments; residual payments to ISOs / VARs / ISVs, strategic partners, and financial institutions; and salaries and other employment costs. Salaries and other employment costs are largely fixed in nature, increasing slightly with the growth in numbers of customers, but tending to grow with inflation. Credit card fees and assessments and bank sponsorship costs are generally a percentage of card volume. Bank sponsorship costs and processing fees are largely based upon transaction counts and volumes. Selling, general and administrative expenses include stable costs such as occupancy and office costs, outside services, and depreciation and amortization expense, which is recognized on a straight-line basis over the estimated useful life of the assets. Cost of processing revenues also includes chargeback losses, which vary over the long term based upon transaction volume processed by JetPay’s merchants, but can vary from period to period depending upon specific events in that period. JetPay Payment Services has experienced higher than normal professional fees due to the Direct Air matter.

 

 

HR & Payroll Segment 

 

Revenues

 

The majority of revenues from HR & Payroll Services have traditionally been derived from its payroll processing operations, which includes the calculation, preparation, collection and delivery of employer payroll obligations and the production of internal accounting records and management reports, and from services provided for the preparation of federal, state, and local payroll tax returns, including the collection and remittance of clients’ payroll tax obligations.  In 2016, JetPay Payroll & HR Services placed a significant emphasis on providing additional human capital management services that complement the core payroll and tax filing businesses, including onboarding, time and attendance, compliance, and other services that are becoming increasingly important to employers with fifty (50) or more employees. JetPay anticipates that these revenues will become an increasingly important incremental source of revenues. JetPay HR & Payroll Services experiences increased revenues in the fourth and first calendar quarters due to additional employer annual tax filing requirements. Payroll Tax Filing Services (“PTFS”) trust account earnings represent the interest earned on the funds held for clients trust balance.  Trust fund earnings can fluctuate based on the amount held in the trust account as well as fluctuations in interest rates. Over the past two years, JetPay HR & Payroll Services has seen a significant increase in revenue from its human capital management, Affordable Care Act and time and attendance services.

 

Expenses

 

JetPay HR & Payroll Services’ most significant cost of processing revenues is its payroll and related expenses, costs of third party service providers, and facility overhead costs.  These costs are largely fixed in nature, increasing slightly with the growth in numbers of customers and payrolls processed, and except for payroll costs, tend to grow with inflation. JetPay HR & Payroll Services’ selling, general, and administrative expenses include the costs of the administrative and sales staff, payroll delivery costs, outside services, rent, office expense, insurance, sales and marketing costs and professional services costs.

 

Results of Operations for the Three Months Ended September 30, 2017 and 2016

 

The following tables represent a comparison of the results of our operations for the three month periods ended September 30, 2017 and September 30, 2016 (in thousands):

 

		For the Three Months Ended September 30, 2017
		Consolidated				General/ Corporate				HR & Payroll Services				Payment Services
Processing revenues		$	18,440			$	-			$	3,859			$	14,581
Cost of processing revenues			12,855				-				2,049				10,806
Gross profit			5,585				-				1,810				3,775
Selling, general, and administrative expenses			4,810				642				1,446				2,722
Settlement of legal matter			-				-				-				-
Change in fair value of contingent consideration liability			(160	)			(160	)			-				-
Amortization of intangibles			874				-				259				615
Depreciation			267				1				68				198
Operating (loss) income			(206	)			(483	)			37				240
Interest expense			281				2				182				97
Amortization of debt discounts and non-cash interest costs			39				6				26				7
Other income			(7	)			-				-				(7	)
(Loss) income before taxes			(519	)			(491	)			(171	)			143
Income tax expense			56				-				-				56
Net (loss) income			(575	)			(491	)			(171	)			87
Accretion of convertible preferred stock			(2,758	)			(2,758	)			-				-
Net (loss) income applicable to common stockholders		$	(3,333	)		$	(3,249	)		$	(171	)		$	87

 

  

		For the Three Months Ended September 30, 2016
		Consolidated				General/ Corporate				HR & Payroll Services				Payment Services
Processing revenues		$	15,214			$	17			$	3,374			$	11,823
Cost of processing revenues			10,199				21				1,878				8,300
Gross profit (loss)			5,015				(4	)			1,496				3,523
Selling, general, and administrative expenses			4,515				244				1,377				2,894
Settlement of legal matter			(20	)			-				-				(20	)
Change in fair value of contingent consideration liability			404				404				-				-
Amortization of intangibles			865				-				259				606
Depreciation			173				1				57				115
Operating loss			(922	)			(653	)			(197	)			(72	)
Interest expense			301				76				58				167
Amortization of debt discounts and non-cash interest costs			24				20				4				-
Other expense			(3	)			-				(1	)			(2	)
Loss before taxes			(1,244	)			(749	)			(258	)			(237	)
Income tax expense			96				-				11				85
Net loss			(1,340	)			(749	)			(269	)			(322	)
Accretion of convertible preferred stock			(1,557	)			(1,557	)			-				-
Net loss applicable to common stockholders		$	(2,897	)		$	(2,306	)		$	(269	)		$	(322	)

 

Revenues

 

Revenues were $18.4 million and $15.2 million for the three months ended September 30, 2017 and 2016, respectively. Overall revenues increased $3.2 million, or 21.2%, in 2017 as compared to 2016. Of the $18.4 million of revenues for the three months ended September 30, 2017, $3.9 million, or 20.9%, was generated from our HR & Payroll Segment and $14.6 million, or 79.1%, from our Payment Services Segment. Of the $15.2 million of revenues for the three months ended September 30, 2016, $3.4 million, or 22%, was generated from our HR & Payroll Segment and $11.8 million, or 78%, from our Payment Services Segment.

 

Payment Services Segment’s revenues increased $2.8 million, or 23.3%, for the three months ended September 30, 2017 as compared to 2016. This increase was attributable to net revenue growth in our Government and Utilities, e-Commerce, and ISO/ISV sectors, including growth in our Discount for Cash product. JetPay Payments, FL, our Government and Utilities payment operation acquired in June 2016, provided $5.3 million of revenues in 2017 as compared to $4.6 million for the same period in 2016.

 

HR & Payroll Segment’s revenues increased $485,000, or 14.4%, for the three months ended September 30, 2017 as compared to the same period in 2016. This increase was attributable to net growth in volume of payroll and related payroll taxes processed in addition to revenues generated from HCM services introduced in 2015.

 

Cost of Processing Revenues

 

Cost of revenues were $12.9 million, or 69.7% of revenues, and $10.2 million, or 67.0% of revenues, for the three months ended September 30, 2017 and 2016, respectively. Of the $12.9 million cost of revenues for the three months ended September 30, 2017, $2.1 million, or 15.9%, related to our HR & Payroll Segment, and $10.8 million, or 84.1%, related to our Payment Services Segment. Of the $10.2 million cost of revenues for the three months ended September 30, 2016, $1.9 million, or 18.5%, related to our HR & Payroll Segment and $8.3 million, or 81.5%, related to our Payment Services Segment.

 

The cost of processing revenues within the Payment Services Segment increased $2.5 million, or 30.2%, increasing from 70.2% of revenues in 2016 to 74.1% of revenues in 2017. The increase in cost of processing revenues was primarily related to the growth in our Payment Services Segment revenues, as well as stronger growth in lower-margin business including our Government and Utilities sector. Cost of processing revenues was also impacted by increased card association and other direct processing costs with an increase in back-end settlement volumes. Overall gross profit margin as reported within our Payment Services Segment decreased slightly from 29.8% in the three months ended September 30, 2016 to 25.9% for the same period in 2017 largely as a result of a larger increase in lower-margin third party ISO revenues, as well as by the impact of the lower margin Government and Utilities revenues (due to interchange being included in cost of goods sold for many of the JetPay Payment Services, FL merchants) and the continued investments made in technology professionals.

 

  

The cost of processing revenues within our HR & Payroll Segment increased $171,000, decreasing as a percentage of revenues from 55.7% in 2016 to 53.1% in 2017 principally due to the increase in HR related service revenues and the continued investment in technology, customer service professionals and new product management. The effect of this decrease in costs of processing revenues as a percentage of revenues was an increase in gross profit margin within our HR & Payroll Segment from 44.3% in the three months ended September 30, 2016 to 46.9% for the same period in 2017.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative (“SG&A”) expenses were $4.8 million, or 26.1% of revenues, for the three months ended September 30, 2017 as compared to $4.5 million, or 29.7% of revenues, for the same period in 2016.

 

SG&A expenses within the Payment Services Segment decreased from $2.9 million or 24.5% of revenues in 2016, to $2.7 million, or 18.7% of revenues in 2017. The decrease was largely the result of decrease in legal fees related to resolved legacy matters and controlling spending while increasing revenues at each divisional site within the segment.

 

SG&A expenses within our HR & Payroll Segment increased from $1.4 million in 2016 to $1.5 million in 2017, an increase of approximately $69,000, or 5.0%, while decreasing as a percentage of revenues from 40.8% in 2016 to 37.5% in 2017. The increase in expense is largely due to an increase in payroll costs as additional sales and technology professionals were added to help develop new products and services and execute our HCM revenue growth strategies.

 

Additionally, we incurred corporate SG&A expenses of $642,000 for the three months ended September 30, 2017, including the benefit of $450,000 of management fees received from the Company’s operating divisions as compared to corporate SG&A expenses of $244,000 in the same period of 2016, including the benefit of $630,000 of management fees received from the operating divisions. Corporate SG&A expenses include, but are not limited to, the salaries of our executive officers, outside professional fees, acquisition costs, investor relations and other public company costs, and general corporate operating expenses. Corporate SG&A expenses for the three months ended September 30, 2017 included non-cash stock-based compensation expense of $170,000 as compared to $121,000 for the same period in 2016.

 

Depreciation and Amortization

 

Depreciation and amortization totaled $1.1 million and $1.0 million for the three months ended September 30, 2017 and 2016, respectively. The increase in depreciation and amortization expense in 2017 as compared to 2016 was primarily related to increased depreciation expense on 2016 and 2017 capital expenditures and the amortization of JetPay Payments, FL’s intangible assets acquired on June 2, 2016.

 

Interest Expense

 

Interest expense for the three months ended September 30, 2017 and 2016 was $281,000 and $301,000, respectively. The decrease in interest expense in 2017 was primarily related to notes issued to Merrick on July 2016, being paid in full in previous quarters, partially offset by interest payments on the new financings with Fifth Third Bank in June 2017 for software development and equipment purchases and the refinancing of certain debt in October 2016 at higher interest rates.

 

Income Taxes

 

The Company recorded income tax (benefit) expense of $56,000 and $96,000 for the three months ended September 30, 2017 and 2016, respectively. Income tax expense reflects the recording of state income taxes. The effective tax rates were approximately (10.8)% and (7.7)% for the three months ended September 30, 2017 and 2016, respectively. The effective rate differs from the federal statutory rate for each year, primarily due to state and local income taxes and changes to the valuation allowance.

 

  

Results of Operations for the Nine Months Ended September 30, 2017 and 2016

 

The following tables represent a comparison of the results of our operations for the nine month periods ended September 30, 2017 and September 30, 2016 (in thousands):

 

		For the Nine Months Ended September 30, 2017
		Consolidated				General/ Corporate				HR & Payroll Services				Payment Services
Processing revenues		$	56,159			$	-			$	12,286			$	43,873
Cost of processing revenues			38,489				-				6,467				32,022
Gross profit			17,670				-				5,819				11,851
Selling, general, and administrative expenses			14,822				1,978				4,447				8,397
Settlement of a legal matter			747				747				-				-
Change in fair value of contingent consideration liability			(343	)			(343	)			-				-
Amortization of intangibles			2,623				-				778				1,845
Depreciation			746				3				197				546
Operating (loss) income			(925	)			(2,385	)			397				1,063
Interest expense			852				18				552				282
Amortization of debt discounts and non-cash interest costs			106				16				82				8
Other income			(14	)			-				-				(14	)
(Loss) income before taxes			(1,869	)			(2,419	)			(237	)			787
Income tax expense			199				-				8				191
Net (loss) income			(2,068	)			(2,419	)			(245	)			596
Accretion of convertible preferred stock			(7,533	)			(7,533	)			-				-
Net (loss) income applicable to common stockholders		$	(9,601	)		$	(9,952	)		$	(245	)		$	596

 

		For the Nine Months Ended September 30, 2016
		Consolidated				General/ Corporate				HR & Payroll Services				Payment Services
Processing revenues		$	39,069			$	46			$	11,037			$	27,986
Cost of processing revenues			25,905				79				5,764				20,062
Gross profit (loss)			13,164				(33	)			5,273				7,924
Selling, general, and administrative expenses			12,096				1,467				3,907				6,722
Settlement of legal matter			6,120				-				-				6,120
Change in fair value of contingent consideration liability			234				234				-				-
Amortization of intangibles			2,377				-				778				1,599
Depreciation			540				4				217				319
Operating (loss) income			(8,203	)			(1,738	)			371				(6,836	)
Interest expense			812				145				186				481
Amortization of debt discounts and non-cash interest costs			280				264				16				-
Other income			(6	)			-				(1	)			(5	)
(Loss) income before taxes			(9,289	)			(2,147	)			170				(7,312	)
Income tax (benefit) expense			(1,378	)			(1,602	)			34				190
Net (loss) income			(7,911	)			(545	)			136				(7,502	)
Accretion of convertible preferred stock			(4,424	)			(4,424	)			-				-
Net (loss) income applicable to common stockholders		$	(12,335	)		$	(4,969	)		$	136			$	(7,502	)

 

  

Revenues

 

Revenues were $56.2 million and $39.1 million for the nine months ended September 30, 2017 and 2016, respectively. Overall revenues increased $17.1 million, or 43.7%, in 2017 as compared to 2016. Of the $56.2 million of revenues for the nine months ended September 30, 2017, $12.3 million, or 21.9%, was generated from our HR & Payroll Segment and $43.9 million, or 78.1%, from our Payment Services Segment. Of the $39.1 million of revenues for the nine months ended September 30, 2016, $11.1 million, or 28.0%, was generated from our HR & Payroll Segment and $28.0 million, or 72.0%, from our Payment Services Segment.

 

Payment Services Segment’s revenues increased $15.9 million, or 56.8%, for the nine months ended September 30, 2017 as compared to 2016. This increase was attributable to net revenue growth in our Government and Utilities, e-Commerce, and ISO/ISV sectors, including growth in our Discount for Cash product. JetPay Payments, FL, our Government and Utilities payment operation acquired in June 2016, provided $16.6 million of revenues in 2017 as compared to $6.2 million the same period in 2016.

 

HR & Payroll Segment’s revenues increased $1.2 million, or 11.3%, for the nine months ended September 30, 2017 as compared to the same period in 2016. This increase was attributable to net growth in volume of payroll and related payroll taxes processed in addition to revenues generated from HCM services introduced in 2015.

 

Cost of Processing Revenues

 

Cost of revenues were $38.5 million, or 68.5% of revenues, and $25.9 million, or 66.3% of revenues, for the nine months ended September 30, 2017 and 2016, respectively. Of the $38.5 million cost of revenues for the nine months ended September 30, 2017, $6.5 million, or 16.8%, related to our HR & Payroll Segment, and $32.0 million, or 83.2%, related to our Payment Services Segment. Of the $25.9 million cost of revenues for the nine months ended September 30, 2016, $5.8 million, or 22.0%, related to our HR & Payroll Segment and $20.1 million, or 78.0%, related to our Payment Services Segment.

 

The cost of processing revenues within the Payment Services Segment increased $12.0 million, or 59.6%, increasing from 71.7% of revenues in 2016 to 73.0% of revenues in 2017. The increase in cost of processing revenues was primarily related to the growth in our Payment Services Segment revenues, including the acquisition of JetPay Payments, FL. Cost of processing revenues was also impacted by increased card association and other direct processing costs with an increase in back-end settlement volumes. Overall gross profit margin as reported within our Payment Services Segment decreased slightly from 28.3% in the nine months ended September 30, 2016 to 27.0% for the same period in 2017 largely as a result the impact of lower margin JetPay Payments, FL revenues and the continued investments made in technology professionals.

 

The cost of processing revenues within the HR & Payroll Segment increased $703,000, or 12.2%, increasing slightly as a percentage of revenues from 52.2% in 2016 to 52.6% in 2017 principally due to the increase in HR related service revenues and the continued investment in technology, customer service professionals and new product management. The effect of this increase in costs of processing revenues as a percentage of revenues was a slight decrease in gross profit margin within our HR & Payroll Segment from 47.8% in the nine months ended September 30, 2016 to 47.4% for the same period in 2017.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative (“SG&A”) expenses were $14.8 million, or 26.4% of revenues, for the nine months ended September 30, 2017 as compared to $12.1 million, or 31.0% of revenues, for the same period in 2016.

 

SG&A expenses within the Payment Services Segment increased from $6.7 million, or 24.0% of revenues in 2016, to $8.4 million, or 19.1% of revenues in 2017. This increase was largely the result of SG&A expenses related to JetPay Payments, FL of $2.7 million and the continued increase in sales staff and marketing costs to attract new business.

 

SG&A expenses within our HR & Payroll Segment increased from $3.9 million, or 35.4% of revenues in 2016 to $4.4 million, or 36.2% of revenues in 2017, an increase of approximately $540,000, or 13.8%, largely due to an increase in payroll costs as additional sales and technology professionals were added to help develop new products and services and execute our HCM revenue growth strategies.

 

Additionally, we incurred corporate SG&A expenses of $2.0 million for the nine months ended September 30, 2017, including $1.35 million of management fees received from the Company’s operating divisions, as compared to corporate SG&A expenses of $1.5 million in the same period of 2016, including $1.6 million of management fees received from the operating divisions. Corporate SG&A expenses include, but are not limited to, the salaries of our executive officers, outside professional fees, acquisition costs, investor relations and other public company costs, and general corporate operating expenses. Corporate SG&A expenses for the nine months ended September 30, 2017 included non-cash stock-based compensation expense of $531,000 as compared to $285,000 for the same period in 2016.

  

Settlement of Legal Matters

 

Settlement of Legal Matter charge in 2017 of $747,000 reflects the Company’s loss on the settlement of the Ten Lords matter, see Note 11. Commitments and Contingencies. On July 3, 2017, the Company and JetPay, LLC successfully settled a lawsuit with Ten Lords and Providence Interactive Capital (the “Plaintiffs”) by entering into a Compromise Settlement Agreement and Mutual Release (the “Settlement Agreement”). Pursuant to the Settlement Agreement, the Company paid to Plaintiffs the sum of $872,500 on July 3, 2017 and the parties released one another and their respective affiliates from all claims arising out of the matters related to the lawsuit. In connection with this settlement, the Company recorded a loss accrual of $747,000 at June 30, 2017 in addition to a previously recorded $125,500 loss reserve.

 

Settlement of Legal Matter charge in 2016 of $6.12 million reflects the Company’s loss based on the terms of the Merrick Settlement Agreement and the WLES Settlement Agreement. The loss includes: (i) a charge of $4.4 million related to the Company’s release of all claims to the $4.4 million held in reserve at Merrick; (ii) a charge of $1.4 million related to the Company’s issuance of the $3.85MM Note, less WLES’ agreement to transfer to Merrick the WLES Note (recorded at $2,036,511 at September 30, 2016 net of an unamortized discount of $294,858) and accrued interest on the WLES Note of $414,466; (iii) a charge of $50,000 representing the Company’s issuance of the $5.0MM Note, less the estimated value as of July 26, 2016 of the escrowed shares; and (iv) a charge for $300,000 representing the estimated value of the issuance of warrants to WLES on February 15, 2017 as described in the WLES Settlement Agreement.

 

Depreciation and Amortization

 

Depreciation and amortization totaled $3.4 million and $2.9 million for the nine months ended September 30, 2017 and 2016, respectively. The increase in depreciation and amortization expense in 2017 as compared to 2016 was primarily related to increased depreciation expense on 2016 and 2017 capital expenditures and the amortization of JetPay Payments, FL’s intangible assets acquired on June 2, 2016.

 

Interest Expense

 

Interest expense for the nine months ended September 30, 2017 and 2016 was $852,000 and $812,000, respectively. The increase in interest expense in 2017 was primarily related to interest payments on the Fifth Third Bank term note issued on June 2, 2016 in connection with our acquisition of JetPay Payments, FL, notes issued to Merrick on July 26, 2016, and the refinancing of certain debt in October 2016 at higher interest rates.

 

Income Taxes

 

The Company recorded income tax (benefit) expense of $199,000 and $(1.38) million for the nine months ended September 30, 2017 and 2016, respectively. Income tax (benefit) expense reflects the recording of state income taxes. The effective tax rates were approximately (10.7)% and 14.8% for the nine months ended September 30, 2017 and 2016, respectively. The effective rate differs from the federal statutory rate for each year, primarily due to state and local income taxes and changes to the valuation allowance.

 

  

Liquidity and Capital Resources

 

Cash and cash equivalents were $7.2 million at September 30, 2017, excluding $1.9 million of cash deposited into restricted cash accounts. The ratio of our total debt to total capitalization, which consists of total debt, convertible preferred stock, and stockholders’ equity, was 20% and 25% at September 30, 2017 and December 31, 2016, respectively. As of September 30, 2017, we had working capital, excluding funds held for clients and client funds obligations, of $667,000.

 

The Company expects to fund its operating cash needs for the next fifteen months, including debt service requirements, capital expenditures and possible future acquisitions, with cash flow from its operating activities, sales of equity securities, including the recent sale of preferred stock, and current and future borrowings. The Company believes that the investments made in its technology, infrastructure, and sales staff will help generate cash flows in the future sufficient to cover its working capital needs.

 

In the past, the Company has been successful in obtaining loans and selling its equity securities. To fund the Company’s current debt service needs, expand its technology platforms for new business initiatives, and pursue possible future acquisitions, the Company may need to raise additional capital through loans or additional sales of equity securities. The Company continues to investigate the capital markets for sources of funding, which could take the form of additional debt, the restructuring of our current debt, or additional equity financing. The Company cannot provide any assurance that it will be successful in securing new financing or restructuring its current debt or that it will secure such future financing with commercially acceptable terms. If the Company is unable to raise additional capital, it may need to delay certain technology capital improvements, limit its planned level of capital expenditures and future growth plans or dispose of operating assets to generate cash to sustain operations and fund ongoing capital investments.

 

As disclosed in Note 8. Redeemable Convertible Preferred Stock, from October 11, 2013 to August 9, 2016, we sold 99,666 shares of Series A Convertible Preferred Stock, par value $0.001 per share (“Series A Preferred”), to Flexpoint for an aggregate of $29.9 million, less certain costs. Additionally, on October 18, 2016, we sold 33,667 shares of Series A Preferred to Sundara for $10.1 million, less certain costs. In connection with the sale of shares of Series A Preferred to Sundara, we also entered into a Loan and Security Agreement with LHLJ, Inc., an affiliate of Sundara, for a term loan in the principal amount of $9.5 million, with $5.175 million of the proceeds used to simultaneously satisfy the remaining balances of a term loan and a revolving credit note payable to First National Bank of Pennsylvania (f/k/a Metro Bank) (“FNB”) (the “Prior JetPay HR & Payroll Services Credit Facility”). See Note 7. Long-Term debt, Note Payable and Capital Lease Obligations. Both Sundara and LHLJ are owned and controlled by Laurence L. Stone, who was appointed as a director of the Company by the holders of the Series A Preferred shares in October 18, 2016. These two transactions provided approximately $14.0 million of net working capital that we used and expect to use for general working capital needs, the payment of other debt instruments, and for future capital needs, including a portion of the cost of potential future acquisitions. Finally, from May 5, 2014 to April 13, 2017, we sold 9,000 shares of Series A-1 Convertible Preferred Stock, par value $0.001 per share (“Series A-1 Preferred”), to an affiliate of Wellington Capital Management, LLP (“Wellington”) for an aggregate of $2.7 million. Additionally, as disclosed in Note 9. Stockholders’ Equity, from December 22, 2015 to January 22, 2016, we sold to certain accredited investors, including Bipin C. Shah, Robert B. Palmer, and Jonathan M. Lubert, an aggregate of 517,037 shares of the Company’s common stock at a purchase price of $2.70 per share for aggregate consideration of $1,396,000, prior to issuance costs.

 

Capital expenditures, including equipment financed through capital leases, were $877,000 and $310,000 for the three months ended September 30, 2017 and 2016, respectively, and $2.2 million and $718,000 for the nine months ended September 30 2017, and 2016, respectively. We currently estimate capital expenditures, including equipment potentially financed through capital leases, for all of our ongoing operations, including the Payment Services Segment and HR & Payroll Services Segment, at approximately $800,000 to $1.2 million for the remainder of 2017, principally related to technology improvements and the implementation of major new customer contracts. Our capital requirements include working capital for daily operations, including expenditures to maintain and upgrade our technology platforms and to purchase point-of-sale equipment as required under certain customer contracts. Our operations currently generate sufficient cash flow to satisfy our current operating needs and our routine debt service requirements.

 

  

The Company may from time to time determine that additional investments are prudent to maintain and increase stockholder value. In addition to funding ongoing working capital needs, the Company’s cash requirements for the next fifteen months ending December 31, 2018 include, but are not limited to, principal and interest payments on long-term debt and capital lease obligations of approximately $4.8 million and estimated capital expenditures of $4.4 million, $2.3 million of which the Company expects to fund with existing available credit facilities. Additionally, there are 133,334 shares of the Company’s Series A Preferred and 9,000 shares of the Company’s Series A-1 Preferred outstanding, with an aggregate redemption value of $85.4 million. On October 11, 2013, the Company issued the initial tranche of 33,333 shares of Series A Preferred to Flexpoint for an aggregate value of $10.0 million. On or after October 11, 2018, the fifth anniversary of the initial shares issuance, the holders of the shares of Series A Preferred issued in the initial tranche have the right to require the Company to repurchase any or all of such shares of Series A Preferred at the contractual redemption price of $600 per share or up to approximately $20.0 million. In addition, should the holders of the shares of the Series A Preferred exercise their redemption rights as described above, the holders of the Series A-1 Preferred may also redeem a proportionate amount of their shares outstanding up to an aggregate value of approximately $1.35 million. While these possible redemptions are not mandatory, it is outside the control of the Company and there can be no assurance that the Series A Preferred stockholders will not exercise their redemption rights on or after October 11, 2018. The Company would explore alternative financing opportunities with its Series A Preferred stockholders should they exercise their redemption rights, including exploring alternative equity or debt investors, or pursuing the possible sale of operating assets to generate sufficient liquidity. The Company believes that certain of its assets have sufficient value to meet this possible liquidity need and accordingly does not believe the potential liquidation event raises substantial doubt about the Company’s ability to continue as a going concern.

 

Debt Capitalization and Other Financing Arrangements

 

At September 30, 2017, we had borrowings of approximately $15.7 million net of unamortized deferred financing costs of $310,000.

 

In connection with the closing of our acquisitions of JetPay Payments, TX and JetPay HR & Payroll Services, we entered into a Note and Indemnity Side Agreement. Pursuant to the Note and Indemnity Side Agreement, we agreed to issue the WLES Note in the original principal amount of $2,331,369. Interest accrued on amounts due under the WLES Note at a rate of 5% per annum. Under the terms of the WLES Settlement Agreement, WLES transferred the WLES Note to Merrick on July 26, 2016. See Note 11. Commitments and Contingencies.

 

JetPay Payments, PA, as borrower, and the Company, as guarantor, entered into a Loan and Security Agreement on November 7, 2014 with FNB (as amended, the “JetPay Payments, PA Credit Facility”) and obtained a term loan with a principal amount of $7.5 million. Amounts outstanding under the loan accrue interest at a rate of 5.25% per annum. The loan matures on November 6, 2021 and amortizes in equal monthly installments of $104,167. The principal balance of this term loan was $5.1 million at September 30, 2017. Additional principal payments may be required at the end of each fiscal year based on a free cash flow calculation set forth in the Loan and Security Agreement.

 

On June 2, 2016, in connection with the closing of the JetPay Payments, FL acquisition, JetPay Payments, FL and the Company entered into a credit agreement with Fifth Third Bank. In connection with the credit agreement, JetPay Payments, FL issued in favor of Fifth Third Bank a term note with a principal amount of $1,068,960 and a $500,000 revolving note to refinance certain credit arrangements of JetPay Payments, FL in place at another financial institution prior to the closing of the transaction. The term note matures on November 30, 2019 and bears interest at 4.00%. The revolving note as amended on June 22, 2017 (as described below), matures on June 2, 2018, and the bears interest at a rate of 2.00% plus the LIBOR Rate for the applicable interest period. The term note and the revolving note are secured by the assets of JetPay Payments, FL and guaranteed by JetPay. On March 23, 2016 and June 22, 2017, the Company entered into a Modification of Credit Agreement and Other Loan Documents that amended the definition of “fixed charge coverage ratio” to account for expected capital expenditures with respect to the Company’s “Magic Platform.” The credit agreement contains certain customary covenants, including a financial covenant related to JetPay Payments, FL’s fixed charge coverage ratio, which the Company was in compliance as of September 30, 2017.

 

On June 22, 2017, JetPay Payments, FL entered into another credit agreement (the “Credit Agreement”) with Fifth Third Bank, which provides a $1,600,000 Draw/Term Note to finance software integration costs, an Amended and Restated Revolving Promissory Note for $1,000,000 (increased from a previous revolving promissory note for $500,000), and a Second Modification of Credit Agreement. At September 30, 2017, $657,000 was outstanding against the $1.6 million Draw/Term Note.

 

The Draw/Term Note provides for a twelve (12) month draw period through June 22, 2018 (“the Conversion Date”), at which time the loan converts to a 36 month amortizing term loan, which matures on June 22, 2021. The Draw/Term Note bears interest at the applicable LIBOR Rate plus 3%. The Draw/Term Note is payable in monthly installments beginning on the Conversion Date and can be prepaid without penalty or premium at any time.

 

The $1,000,000 Amended and Restated Revolving Promissory Note renews, amends, replaces and supersedes the original $500,000 Revolving Promissory Note, extending maturity to June 1, 2018 and bears interest at a rate of 2.00% plus the LIBOR Rate for the Interest Period. The Amended and Restate Revolving Promissory Note is expected to be used to extend temporary credit to cover JetPay Payments, FL’s customers’ processing return items.

 

  

The Second Modification amends and restates the original term loan to JetPay Payments, FL dated June 2, 2016 in the original principal amount of $1,068,960 to incorporate certain terms in the new Credit Agreement, including incorporating revised debt covenants, financial reporting requirements, collateral requirements, modifications to parent guarantees, and representations and warranties of Borrower. Additionally, JetPay Payments, FL entered into a Master Equipment Lease Agreement and related Interim Lease Funding Schedule with the Lender to provide up to $1.5 million of lease financing for certain point-of-sale equipment related to certain JetPay Payments, FL customer contracts and other computer equipment. The Interim Lease Funding Schedule provides the details of the allowable equipment to finance and provides for an interim draw periods through June 30, 2018. Upon completion of an interim draw, the leases under Master Lease Agreement will have a term not exceeding 48 months at an interest rate of LIBOR Rate plus 3% until termed out on a schedule, at which time such leases will amortize and bear interest at a fixed rate set forth in the applicable schedule. At September 30, 2017, $131,000 was outstanding against the $1.5 million lease facility. The Term Notes, the Revolving Note and the Master Lease Agreement are guaranteed by JetPay Corporation pursuant to a guaranty dated June 22, 2017, by and between JetPay Corporation and Fifth Third Bank in respect of the Term Notes and Master Lease Agreement and the guaranty, dated June 22, 2017, by and between the JetPay Corporation and Lender in respect of the Revolving Note (collectively, the “Guaranty Agreements”). The Guaranty Agreement requires that the Company maintain a $2,000,000 minimum liquidity level while there outstanding amounts owed under the various credit arrangements.

 

On October 18, 2016, JetPay HR & Payroll Services and PTFS, as borrowers, entered into a Loan and Security Agreement (the “Loan Agreement”) with LHLJ, Inc., a Delaware corporation controlled by Laurence L. Stone, as lender, for a term loan in the principal amount of $9.5 million (the “LHLJ Debt Investment”). The underlying promissory note bears interest at 8%. The loan matures on October 18, 2021 and is payable in equal monthly installments of principal and interest of $128,677 with a final payment of $4.75 million at maturity. The obligations of the borrowers under the Loan Agreement are guaranteed by the Company and JetPay Payments, FL, and are secured by all of the assets of JetPay HR & Payroll Services, PTFS and JetPay Payments, FL, as well as a pledge by the Company of its ownership interests in JetPay HR & Payroll Services and PTFS. The Loan Agreement contains affirmative and negative covenants, including limitations on the incurrence of indebtedness, liens, transactions with affiliates and other customary restrictions for loans of this type and size. The borrowers are also subject to financial covenants relating to their debt coverage ratio and total leverage ratio during the term of the loan. The Company was in compliance with these covenants as of December 31, 2016. The principal balance of this term loan was $8.77 million at September 30, 2017.

 

A portion of the proceeds of the LHLJ Debt Investment was used to simultaneously satisfy the remaining balance of $4.175 million outstanding under the Prior JetPay HR & Payroll Services Credit Facility. In connection with the satisfaction of the Borrowers’ obligations under the Prior JetPay HR & Payroll Services Credit Facility, JetPay Payments, PA, JetPay HR & Payroll Services, the Company and FNB entered into an amendment to the JetPay Payments, PA Credit Facility to release JetPay HR & Payroll Services’ guaranty of the obligations of JetPay Payments, PA under the JetPay Payments, PA Credit Facility and to eliminate provisions relating to the cross-collateralization.

 

Our ongoing ability to comply with the debt covenants under our credit arrangements and to refinance our debt depends largely on the achievement of adequate levels of cash flow. If our future cash flows are less than expected or our debt service, including interest expense, increases more than expected, causing us to default on any of the loan covenants in the future, we will need to obtain amendments or waivers from the applicable lender. In the event that non-compliance with the debt covenants should occur in the future, we would pursue various alternatives in an attempt to successfully resolve the non-compliance, which might include, among other things, seeking additional debt covenant waivers or amendments or refinancing debt with other financial institutions. There can be no assurance that debt covenant waivers or amendments would be obtained, if needed, or that the debt could be refinanced with other financial institutions on favorable terms.

 

Additionally, in connection with the December 2012 $9.0 million term loan, the November 2014 $7.5 million term loan, and the May 2015 Revolving Note, all payable to FNB, we incurred $23,000, $76,000, and $40,000 of deferred financing costs, respectively. Finally, we incurred (i) $95,000 of deferred financing fees related to the issuance of the promissory notes and (ii) $16,600 of deferred financing fees related to JetPay Payments, FL’s term note and revolving note, each in favor of Fifth Third Bank, and $310,000 of deferred financing fees related to the LHLJ, Inc. Loan Agreement. Unamortized deferred financing costs were $310,000 at September 30, 2017.

 

Off-Balance Sheet Arrangements

 

Off-balance sheet arrangements as of September 30, 2017 consisted of an outstanding letter of credit in the amount of $100,000, which represents collateral with respect to a front-end processing relationship with a credit card company.

 

  

Contractual Obligations

 

We are obligated under various operating leases, primarily for office space and certain equipment related to our operations. Certain of these leases contain purchase options, renewal provisions, and contingent rentals for our proportionate share of taxes, utilities, insurance, and annual cost of living increases.

 

The following are summaries of our contractual obligations and other commercial commitments at September 30, 2017, excluding fair value and conversion option debt discounts and the effect of the refinancing subsequent to September 30, 2017 (in thousands):

 

		Payments Due By Period
		Total				Less than One Year				One to Three Years				Three to Five Years				More than 5 years
Contractual obligations (1)
Long-term debt and capital lease obligations (1)		$	16,044			$	2,862			$	5,648			$	7,534			$	-
Minimum operating lease payments (2)			496				459				37				-				-
Total		$	16,540			$	3,321			$	5,685			$	7,534			$	-

 

		Amounts Expiring Per Period
		Total				Less than One Year				One to Three Years				Three to Five Years				More than 5 years
Other Commercial Commitments
Standby letters of credit (3)		$	100			$	100			$	-			$	-			$	-

 

(1)

Related interest obligations have been excluded from this maturity schedule. Our interest payments for the next twelve-month period, based on current market rates, are expected to be approximately $1.0 million.

(2)

Minimum operating lease payments excludes contractual obligation related to a lease entered into on October 20, 2017 for approximately 24,269 square feet of space to replace the current HR & Payroll Services’ Center Valley, PA facility. Contractual obligations related to this new lease are as follows for the years ending September 30: 2018 –$121,000; 2019 – $368,000; 2020 – $505,000; 2021 – $517,000; 2022 – $530,000; and $3.5 million thereafter.

(3)

Outstanding letter of credit of $100,000, which represents collateral for a front-end processing relationship with a credit card company.

 

Cash Flow

 

Operating Activities. Net cash provided by operating activities totaled $2.37 million for the nine months ended September 30, 2017. Cash used in operating activities in this period was primarily due to a net loss of $2.1 million, an increase in prepaid expenses and other current assets of $576,000, an increase in deferred revenue of $206,000, and a change in fair value of contingent consideration liability of $343,000, all offset by non-cash depreciation and amortization relating to fixed assets, intangible assets, non-cash interest costs and loss on the disposal of fixed assets of $3.6 million, stock based compensation expenses of $565,000, common stock issued as compensation of $97,000, a decrease in accounts receivable of $640,000, a net decrease in settlement processing assets and liabilities of $326,000, and an increase of $216,000 in restricted cash and other assets.

 

Net cash provided by operating activities totaled $1.5 million for the nine months ended September 30, 2016. Cash used in operating activities in this period was primarily due to a net loss of $7.9 million, an increase in prepaid expenses and other assets of $276,000, an increase in deferred income tax liability of $1.6 million, and a decrease in deferred revenue of $259,000, all offset by non-cash depreciation and amortization relating to fixed assets, intangible assets, deferred financing fees and debt discounts and conversion options of $3.2 million, a change in fair value of contingent consideration liability of $234,000, stock based compensation expenses of $285,000, recognition of a note payable in connection with the settlement of a legal matter of $1.85 million, a decrease in other assets of $4.1 million, a decrease in accounts receivable of $1.1 million, a net decrease in settlement processing assets and liabilities of $555,000, and an increase in accounts payable, accrued expenses, and other liabilities of $74,000.

 

  

Investing Activities. Cash provided by investing activities totaled $2.6 million for the nine months ended September 30, 2017, including a decrease of $4.2 million in restricted cash and equivalents held to satisfy client obligations, partially offset by the purchases of property and equipment of $1.6 million.

 

Cash provided by investing activities totaled $4.0 million for the nine months ended September 30, 2016, including a decrease of $4.4 million in restricted cash and equivalents held to satisfy client obligations and cash acquired in the JetPay Payments, FL acquisition of $519,000, all partially offset by the purchase of property and equipment of $615,000 and an investment in acquired JetPay Payments, FL technology of $351,000.

 

Financing Activities. Cash used in financing activities totaled $10.3 million for the nine months ended September 30, 2017, which included a decrease of $4.1 million in client fund obligations, $7.4 million of cash used for payments on long-term debt, and payment of deferred and contingent acquisition consideration of $314,000, partially offset by proceeds from notes payable of $677,000, and issuance of common stock and sale of preferred stock of $1.0 million.

 

Cash used in financing activities totaled $5.6 million for the nine months ended September 30, 2016, which included proceeds from issuance of promissory notes of $2.0 million, proceeds from the sale of preferred stock, net of issuance costs, of $2.5 million, proceeds from the issuance of common stock under the Employee Stock Purchase Plan of $47,000, and proceeds from issuance of common stock, net of issuance costs, of $64,000, all offset by a decrease of $4.4 million in client fund obligations, $2.4 million of cash used for routine payments on long-term debt, an increase in restricted cash reserves of $1.9 million, payment of deferred and contingent acquisition consideration of $1.4 million, and payment of deferred financing fees associated with new borrowings of $112,000.

 

Seasonality

 

The Payment Services segment has generally experienced increased revenues during the first and second quarters due to seasonal volumes of certain merchants, including vacation, travel, and government and utility clients and their billing cycles, with the government and utilities also providing some seasonality with increased revenues in the fourth quarter.

 

HR & Payroll Services Segment’s revenues are recognized in the period services are rendered and earned. The HR & Payroll Services Segment’s experiences increased revenues during the first and fourth quarters due to the processing of additional year-end tax filing requirements. Accordingly, revenues and earnings are greater in the first and fourth quarter than in the second and third quarters.

 

Effects of Inflation

 

The Payment Services Segment’s and HR & Payroll Services Segment’s monetary assets, consisting primarily of cash and receivables, are not significantly affected by inflation. Non-monetary assets, consisting primarily of property and equipment, are not affected by inflation. We believe that replacement costs of equipment, furniture and leasehold improvements will not materially affect our operations. However, the rate of inflation affects our expenses, such as those for employee compensation and other operating expenses, which may not be readily recoverable in the price of services offered by us. The rate of inflation can also affect our revenues by affecting our client’s payroll processing volumes and our merchant charge volume and corresponding changes to processing revenues. While these can be positive or negative, since a portion of Payment Services Segment’s revenues are derived as a percentage of dollar volume processed, Payment Services Segment’s revenues will generally rise when inflation rises. Additionally, the HR & Payroll Services Segment’s revenues include the interest earned on the funds held for clients’ investment trust account balance.  Trust fund earnings can fluctuate based on the amount held in the trust account as well as fluctuations in interest rates.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risks

 

We are a smaller reporting company. As a result, we are not required to report the information required by Item 305 of Regulation S-K.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our Chief Executive Officer, or CEO, and our Chief Financial Officer, or CFO, we completed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the CEO and the CFO concluded that the Company’s disclosure controls and procedures, including the accumulation and communication of disclosures to the Company’s CEO and CFO as appropriate to allow timely decisions regarding required disclosure, were effective as of September 30, 2017 to provide reasonable assurance that information that is required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.

 

Changes in Internal Control

 

There has been no change in our internal controls over financial reporting as defined in Rule 13a-15(f) under the Exchange Act identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during our quarter ended September 30, 2017 that are reasonably likely to materially affect our internal control over financial reporting.

 

  

PART II

OTHER INFORMATION

 

Item 1. Legal Proceedings

 

See Note 11. Commitments and Contingencies to our consolidated financial statements in Part I, Item 1 of this report.

 

Item 1A. Risk Factors

 

There have been no material changes in our risk factors disclosed in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Mine Safety Disclosures

 

None.

 

Item 5. Other Information

 

None.

 

 

Item 6. Exhibits

 

Exhibits:

 

10.1**		Lease, dated October 20, 2017, by and between Brookwood Philadelphia I, LLC, Brookwood Philadelphia II, LLC and JetPay HR & Payroll Services, Inc.
31.1**		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2**		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**		Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2**		Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**		XBRL Instance Document.
101.SCH**		XBRL Taxonomy Extension Schema Document.
101.CAL**		XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB**		XBRL Taxonomy Extension Label Linkbase Document.
101.PRE**		XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF**		XBRL Taxonomy Extension Definition Linkbase Document.
		** Filed herewith

 

  

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	JetPay Corporation
	By:	/s/ Diane (Vogt) Faro
	Diane (Vogt) Faro, Chief Executive Officer
	(Principal Executive Officer)
	By:	/s/ Gregory M. Krzemien
	Gregory M. Krzemien, Chief Financial Officer
	and Chief Accounting Officer
	(Principal Financial Officer)

 

DATE:

November 9, 2017

 

  

EXHIBIT INDEX

 

 

Exhibit No.		Description
10.1**		Lease, dated October 20, 2017, by and between Brookwood Philadelphia I, LLC, Brookwood Philadelphia II, LLC and JetPay HR & Payroll Services, Inc.
31.1**		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2**		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**		Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2**		Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**		XBRL Instance Document.
101.SCH**		XBRL Taxonomy Extension Schema Document.
101.CAL**		XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB**		XBRL Taxonomy Extension Label Linkbase Document.
101.PRE**		XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF**		XBRL Taxonomy Extension Definition Linkbase Document.
		** Filed herewith