Heyu Biological Technology Corp - Annual Report: 2012 (Form 10-K)

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Our Business

Since January 1999 our business operations have been focused on providing internet application services to small to mid-sized businesses to establish a business presence on the internet.  In 2011 the Company’s management decided to expand operations to also include an investment and business consulting arm to seek expansion opportunities into synergistic industries or businesses.

Pacific WebWorks’ Web Site Business

Pacific WebWorks is an application service provider and software development firm that develops business software technologies and services for business merchants and organizations using Internet and other technologies. We specialize in turnkey applications allowing small- to medium-sized businesses to expand over the Internet.  Our product family provides tools for web site creation, management and maintenance, electronic business storefront hosting and Internet payment systems for the small- to medium-sized business and organization.  Additionally, we have integrated our product with many of the popular online auction/sales portals enabling our customers to easily sell their products at these portals using our Visual WebTools product.

We initially focused our business entirely on virtual retailing software solutions, meaning merchants that do not have a physical store location and would exist only on the Internet.  Due to requests in the marketplace, we expanded our technologies to include features for small to medium-sized physical “brick and mortar” entities, in addition to our virtual merchants. This is expected to give these businesses and other organizations a complete solution for all physical store and Internet concerns and at the same time reduce the costs of operations and introduce new profit centers for them.

Our Products

Even though small business, including small office/home office, typically understands how traditional brick and mortar businesses operate, we believe they need assistance in order to replicate business processes effectively and economically using the Internet.  Pacific WebWorks assists small businesses in succeeding online through our Visual WebTools™ software; including our eBay submission tool, the Intellipay payment systems and our hosting services.

We provide a comprehensive one-stop solution that incorporates our integrated suite of e-commerce software tools, plus hosting, site management, and web design services.  By leveraging a shared commerce platform across many customers, we bring economies of scale to our customers.  We believe this structure allows our customers to focus on their business instead of technology, enabling them to achieve a much faster return on investments made in technology and to experience more success on the Internet.

While we enjoyed great success marketing our WebTools product over the internet, we also experienced considerable difficulties in a number of areas as a result of our inability to control the misleading messages conveyed by many affiliates and networks on the internet in an effort to drive traffic to our product offerings. As a result of these issues we have discontinued marketing our WebTools product over the internet. This has resulted, and will continue to result, in a decrease in the revenues we will generate from that product until we are able to re-launch the product with acceptable marketing techniques, which we are actively working to develop.

Consistent with the above we believe that our new investment and consulting operation, Headlamp Ventures, can provide valuable capital and management to a variety of companies both within our industry and elsewhere.  We also believe there is opportunity to grow our product set through an acquisition strategy.

Pacific WebWorks Product Characteristics

Visual WebTools^TM Version 5 is a suite of software programs that fit together to perform the basic business functions we believe are the most effective on the Internet.  The following products are included as part of this

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suite.

WebWizard is an easy-to-use web page design program that possesses a simple user interface and templates for the novice, yet has very powerful additional functionalities for web design professionals.  In February 2010 we released WebWizard 5 which incorporates sophisticated site components like tables, frames, flash and other multimedia capabilities in a straightforward, menu driven process.  No complicated programming skills are required to use the WebWizard tool.  Our customers can easily manage their sites’ layout, colors, content, tables and graphics. WebWizard includes a library of hundreds of graphics that are readily accessible by our customers. WebWizard allows our customers to quickly and easily create, update, modify and enhance their web sites.  It also integrates with social media outlets such as Twitter, Facebook and MySpace.  Changes can be uploaded to our servers within minutes, 24 hours a day, 7 days a week from any Internet-connected Microsoft Windows® computer.

ClipOn Commerce™ is an e-storefront and product management system, complete with shopping cart technology.  ClipOn Commerce allows our customers to build an Internet storefront.  They can create a complete product catalog, organize and search products by unlimited categories, and import/export to and from their database. ClipOn Commerce is designed to function with a third party merchant account and is integrated with our Intellipay payment system which allows our clients to accept all major credit cards online.  ClipOn Commerce has support for QuickBooks® accounting software enabling our customers to update between their accounting records and their Internet storefront.  ClipOn Commerce also features UPS shipping integration.

WebContacts is a contact management program.  Companies that use our system can utilize WebContacts to organize information about all the entities they do business with including customers, suppliers, distributors, potential customers, etc.  WebContacts also enables customers to capture information about people that visit their web site, if those visitors elect to supply contact information at the site, enabling our customers to be more effective when using the web as a marketing and communications tool.

WebChannels is an e-mail distribution program that enables our customers to send customized e-mails in either plaintext or HTML format to their WebContacts database of visitors.  Since email is the most popular activity on the web, and one of the most effective forms of Internet marketing, WebChannels provides our customers with a practical tool with which to promote their businesses.  For example, by using WebChannels, a client could easily send out a weekly newsletter, coupons or special offers to an entire customer base, certain visitor types or to a segment of their customers.

Web Profiling Tool is a form and survey creation tool that helps capture feedback and valuable demographic information from customers and web site visitors.  Our clients can create customizable forms, surveys and interactive questionnaires. The web profiling tool includes a catalog of pre-designed questions such as education level, hobbies, satisfaction level, etc.  The profiling forms may also be custom created by our customers.

WebStats enables our customers to analyze visitor activities on their web sites in order to track pages viewed, hits, time of access, etc.  WebStats is a statistics program that provides detailed reports and graphs related to referring pages, geographic location of visitors, browsers and the operating systems web site visitors are using, which web pages generate hits, and which pages are the most popular.  WebStats can produce reports of business information, including year-long trends and the effectiveness of the clients’ sites.

Auction Connection is a module that allows Visual WebTools users to list inventory items with eBay at the click of a button.

Increase My Margin is a tool that allows eBay users to quickly and effectively analyze information and data related to the sale of products sold on eBay over a period of time.  

Intellipay Product Characteristics

Intellipay™ Payment System - This group of products offers payment technologies for business-to-business and

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business-to-customer uses on the Internet and in physical store locations.  These products allow our customers to accept real time credit card payments from their web site, Internet appliances, kiosks, remote locations through their Nextel cell phone or at the physical point of sale.  The Intellipay products use the same standards as all major commerce sites, including industry standard security components and methods.  The product has been tested under strict banking network procedures.  Once customers enter the necessary data in a secure form, Intellipay quickly processes the transaction in real-time (2 to 5 seconds) and returns the customer back to the business site.  Intellipay also provides methods for enterprise-level businesses to link Intellipay products, services and features into their ecommerce web sites and transmit transactional data for use in back-office systems.  Intellipay is entirely compliant with PCI 2.0, which is a combined security regulation for VISA and Mastercard.  As part of our new strategy we expect to pursue additional ways in which we can market and implement our Intellipay product.

ePayment System supports all major card types including Visa, MasterCard, American Express, Discover, Diners Club and JCB.  Also, support is provided for Visa and MasterCard debit (check) cards and Level Two corporate/commercial cards through various bank networks.  Transaction types include industry standard transactions such as normal authorizations, pre-authorizations intended for delayed settlement, the so-called “force” allowing a transaction authorized offline (such as a voice authorization) to be settled and credits for refunds. Intellipay’s innovative address verification system allows merchants to retrieve a score and verify account validity.

This Intellipay product allows our customers to control transaction level behavior depending on AVS scores, duplicate transaction attempt detection, and more.  Intellipay also automatically settles merchant batches nightly so our customers are freed from forcing settlement via manual or programmatic methods, which also helps reduce our customer’s costs by settling within the 24-hour window mandated by most merchant accounts.  The Intellipay system is fully transportable; meaning that a customer can switch web site hosting companies, move between most e-commerce software programs or change to or from many merchant account providers.  Our products can grow and change with our customer at little or no additional charge, and with minimal technology issues.

ExpertLink™ is Intellipay's proprietary connection protocol for high-volume Internet businesses requiring reliable, high velocity real-time transaction authorizations linked to their own secure web site and/or back office systems. ExpertLink is a standards-based secure communications method allowing web and application developers to build in ePayment processing and features like batch management commands, duplicate transaction detection and management, and more.  Our customers usually purchase ExpertLink or LinkSmart, and both come with Smart Terminal and the Secure Account Management System.

LinkSmart™ gives our online customers ePayment features with minimal technical installation required. With LinkSmart, our customer does not need to pay for installation and maintenance of expensive secure servers since LinkSmart serves the secure, customizable payment pages for them.  LinkSmart offloads many expensive mission-critical e-commerce tasks from the merchant.

Smart Terminal™ allows our customers to securely log into their Intellipay account from any Internet browser and authorize manual transactions and orders they have received through offline methods.  Smart Terminal supports industry-standard transactions including normal authorizations, authorization-only for delayed settlement, settlement for non-Intellipay authorized transactions, credits, partial credits and more. Most clients receive Smart Terminal along with LinkSmart or ExpertLink, but Smart Terminal can also be purchased as a stand-alone product.

Secure Account Management System (“SAMS”) allows Intellipay customers to securely log into Intellipay's Secure Account Management System from any web browser to configure and control various Intellipay components and behaviors. Customers can manage current day authorized transaction batches, control passwords, enforce transaction data components, control features such as our duplicate transaction detection and management system, control email transaction receipts, access Smart Terminal, control LinkSmart payment page contents, target returning live data streams, configure Visa-required invoice numbering, and more.  Customers can also view transaction histories for any day in the trailing 180 day period.

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IntelliPay Desktop Terminal (“IDT”) brings all of the functionality of a Virtual Terminal application to your desktop while supporting hardware such as a card reader and receipt printer.  This allows merchants to receive a qualified discount rate on their transactions and reduce equipment and processing fee costs.  They can also take advantage of sharing printers on their network by allowing several terminals to print to the same receipt printer in order to reduce hardware requirements.

IntelliPay Wireless Terminal (“IWT”) submits wireless transactions with retail qualifications using Nextel data service.  This allows a merchant to accept either swiped or keyed transactions with a Nextel Cellular / Data phone using a card reader. The merchant has all of the benefits of retail rates with the added value of visual batch management and settlement process.  IntelliPay Wireless Terminal is an attractive solution for all mobile merchants that also use a cellular phone.

Other Services and Products

Technical Support is offered via online chat or e-mail from 8 a.m. to 5 p.m. (MST), or by phone from 8 a.m. to 5 p.m. (MST).

Our PCI compliant hosting infrastructure allows us to host our customers’ web sites, therefore eliminating the cost of hardware investment and maintenance for them.

Domain Names are offered to customers online at retail prices.  These include “.com,” “.org,” “.biz,” “.net,” “.us” and “.info.”

Additionally, we have several complimentary product offers including:

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Amazing WebStores – allows users to set up a store to sell Amazon products directly from their web site.

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“eSuccess2U.com” – our proprietary e-mail marketing system.

These products continue to receive enthusiastic reception amongst our customer base and are a positive component of our virtual product portfolio.

Sales and Marketing

We have marketed and sold our products primarily through a variety of online marketing partners and programs. Due to the difficulty of controlling the marketing message delivered through this manner of marketing we are constantly seeking improvements to the methods of distribution for our products. This may, at times, limit the speed with which we are able to increase revenues moving forward, however, we believe it will result in a more satisfied customer who will remain with our service for a more extended period of time. We believe the ease and versatility of our products, which allows small businesses to participate in Internet commerce by creating and managing their own Internet web sites and storefronts at a reasonable cost, will continue to be a major selling point.

We do not believe that our competitors are effectively targeting our market niche: A totally Internet based, end-to-end business solution for small- and medium-sized businesses.  We believe that our products will allow businesses to generate leads, sell products, run sales promotions, capture demographic information about web site visitors, communicate with web site visitors, and obtain intelligent information about who is visiting their web sites and what they are doing while they are there.  Our products allow our customers to stay in complete control of their web sites and provide tools that can facilitate a successful Internet experience for them.

Competition

Our market is quickly evolving, is very competitive and subject to rapid technological change.  We expect competition to persist, increase, and intensify in the future as the markets for our products and services continue to

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develop and as additional companies enter our markets.  Many companies are now providing Internet services to small businesses.  Our success in our target market will depend upon our ability to establish successful ongoing marketing programs, build name brand recognition and to provide quality, cost-effective products and services to our customers.  

In our estimation, few major competitors currently offer products comparable to the Visual WebTools™ product family.  We believe that our product provides a comparable service for a lower price than that provided by our competitors.  In addition, because we have focused our efforts on small businesses, including providing Internet tools which allow businesses to develop their own web sites, we believe that we are better able to address our customer’s web site development needs.

Our Intellipay payment system competes with AuthorizeNet products and certain VeriSign products, along with other companies that provide e-commerce solutions.  Our ability to successfully compete will depend upon a number of factors, including:

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our ability to successfully maintain and sell existing products;

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our ability to conceive, develop, improve, and market new products;

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our ability to identify and take advantage of emerging technological trends within our target markets;

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our ability to respond effectively to technological changes or new product announcements by competitors;

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our ability to carve out “niche” markets in combination with our technologies;

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our ability to recruit resellers who can market and sell our products and services in significant volumes to the market;

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our ability to maintain satisfactory relationships with our online marketing partners; and

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our ability to manage and maintain our merchant accounts.  

We believe that we will need to make significant expenditures for research and development and marketing in the future to compete effectively.

The rapidly increasing competitive landscape along with the difficulties we have incurred in affiliate marketing has played a significant role in our decision to expand our horizons to include other investment opportunities and to add other potential product offerings to our operations.

Major Customers

Our client base includes approximately 4,000 active customer accounts.  We rely on the efforts of our internal marketing staff and on third party resellers, including our wholly-owned reseller, TradeWorks Marketing, to add accounts to our customer base.  Prior to 2010 a significant portion of our customer accounts were provided by previous Pacific WebWorks and Intellipay resellers who no longer resell our products and services.  We are now primarily dependent upon our internal marketing staff and our online marketing partners for our product sales.

We also note that a significant portion of Intellipay sales are with Fundtech Corporation (formerly Bankserv) whom we view as a major customer.  During the year ended December 31, 2012, the Company recorded revenues of $227,745 related to the Fundtech Corporation account.

Trademark, Licenses and Intellectual Property

We own trademarks for Visual WebTools™ (United States Patent and Trademark Office Serial No. 567,136) that we acquired and became responsible for upon our merger with Utah WebWorks.  In addition we have trademarks for Pacific WebWorks™ and ClipOn Commerce™.  

On August 2, 2007 we received notice of acceptance and acknowledgment from the U.S. Department of Commerce Patent and Trademark Office validating our registration of a trademark for “Intellipay.”  The mark has been renewed for 10 years subject to constructive notice by July 24, 2013 of our claim to exclusive ownership.

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On August 30, 2007 we received notice of acceptance and acknowledgment from the U.S. Department of Commerce Patent and Trademark Office validating our registration of a trademark for “Increase My Margin.”  The mark has been registered for 10 years subject to constructive notice of our claim to exclusive ownership by August 13, 2013.

Our success will depend, in part, on our ability to obtain and protect our trademark and trade secrets and operate without infringing upon the proprietary rights of others in the United States and other countries.  If we were to become involved in a dispute regarding our intellectual property, it may become necessary for us to participate in interference proceedings before the United States Patent and Trademark Office to determine whether we have a valid claim to the rights involved.  We could also be forced to seek a judicial determination concerning the rights in question.  These proceedings could be costly and time consuming, even if we were to eventually prevail.  Should we not prevail, we could be forced to pay significant damages, obtain a license to the technology in question, or stop marketing one or more of our products.  

The majority of our core technology was developed internally by either our engineers or by the engineers of Utah WebWorks and Intellipay.  Other than Internet connectivity and other information technology infrastructure, the performance of our products does not significantly rely on any third party technology, although we continue to support as many third party technologies as possible.

We also rely upon trade secrets, proprietary know-how, and confidentiality provisions in agreements with employees, consultants, and resellers to protect our intellectual property rights.  There are risks that these other parties may not comply with the terms of their agreements with us, and that we may not be able to adequately enforce our rights against these parties.  We have adopted a policy of requiring our employees and resellers to execute confidentiality agreements when they commence employment with us or resell our products.  These agreements generally provide that all confidential information developed or made known to the employees or resellers during the course of their relationship with us is to be kept confidential and not disclosed to third parties, except under certain specific circumstances.  In the case of employees, the agreements also provide that all inventions conceived by the employees in the course of their employment will be the Company’s exclusive property.

Research and Development

We continue to improve our existing products and release new related products.  During the year ended December 31, 2012, we recorded research and development expense of $231,275 and during the year ended December 31, 2011, we recorded research and development expense of $235,348 primarily related to the maintenance of our technologies and the development of our new offerings.  

Investments and Business Consulting

During the year ended December 31, 2011, the Company’s management decided to expand operations to include an investment and business consulting arm which seeks expansion opportunities into synergistic industries or businesses.  Our subsidiaries’ search for business opportunities to invest in and this search will not be limited to any particular geographical area or industry.  Our subsidiaries’ management has unrestricted discretion in seeking a business opportunity, subject to the availability of such opportunities, economic conditions and other factors. Business opportunity participation is governed by the parent company management and board of directors.  In addition, the selection of a business opportunity in which to participate is complex and extremely risky and will be made by the subsidiary’s management in the exercise of its business judgment and due diligence including valuation and return on investment estimates.  We cannot be assured that the subsidiaries will be able to identify only business opportunities which will ultimately prove to be beneficial to the Company and our stockholders.  The following transactions occurred during 2011 and 2012.  

On August 2, 2011, Pacific WebWorks acquired Thrifty Seeker, LLC, (“Thrifty Seeker”), a company that

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competes in the “daily deals” space on the Internet, for $18,000.  Thrifty Seeker partners with various suppliers to offer short term discounts to generate sales through the Thrifty Seeker web site.  Thrifty Seeker primarily targets female Internet shoppers, especially those seeking deals on home crafts type products.  Thrifty Seeker pays suppliers a percentage of sales generated by Thrifty Seeker and the suppliers manage order fulfillment.  The most significant competitors in this space are Groupon and Living Social; however, Thrifty Seeker competes directly with various smaller daily deal sites.  

On April 21, 2011, Pacific WebWorks invested $250,000 in common units of Middlebury Ventures II, LLC, a Delaware limited liability company formed for the purpose of participating in the Fisker Holdings, Inc. Series C-1 and subsequent rounds of financing.  On December 27, 2011, the Company invested an additional $93,280 in common units of Middlebury Ventures II, LLC.  On March 28, 2012, the Company invested an additional $25,000 in common units of Middlebury Ventures II, LLC.  The funds are to be used by Middlebury Ventures II, LLC for the acquisition of Fisker Holdings, Inc. Series D-1 Shares pursuant to the Fisker Series D-1 transaction documents.  Fisker Holdings, Inc. is an automotive company competing in the luxury hybrid-electric vehicle market. During August, 2012, Middlebury Ventures II, LLC changed its name to Ridgemaker Ventures II, LLC.  On December 31, 2012, the Company recognized a $285,749 unrealized loss on its investment to impair its carrying value to the current estimated market value.

Headlamp Ventures, LLC:  Pacific WebWorks formed Headlamp Ventures, LLC (“Headlamp Ventures”) in June 2011 to pursue investment opportunities.   Headlamp Ventures has invested funds in six business opportunities. (See Item 7, “Liquidity and Capital Resources” for more information).  Headlamp Ventures holds a 51% ownership interest in one of those businesses, Asher, LLC.  Asher’s business operations include the design and production of golf gloves which it sells to retail outlets, distributors and direct to consumers through its website.

World Commerce Network, LLC:  Pacific WebWorks activated World Commerce Network, LLC (“World Commerce”) in July 2011 to pursue investment opportunities. On August 3, 2011, World Commerce issued a promissory note in the amount of $250,000 to Bryan Development, LLC, a Utah limited liability company, for use as working capital in its business investment activities.  

Competition

The market for high-quality business investments is fairly competitive.  While we see strong demand for investment capital, high-quality opportunities to invest in startup and early-stage companies often require investors to evidence their ability to provide synergistic value in addition to capital investment.  Our success in participating in high-quality investment opportunities depends upon our ability to bring synergistic value and sufficient capital into the company seeking investment.

Employees

As of the date of this filing, Pacific WebWorks has a total of seven full time employees.  We have two employees in administration, two development engineers, one web designer, one business manager and one customer service employee.  Our employees are not presently covered by any collective bargaining agreement.  We have not experienced any work stoppages and believe that our relations with our employees are good.

ITEM 1A.  RISK FACTORS

Factors Affecting Future Performance

We may pursue investments in, or acquisitions of, complementary service product lines, technologies or business opportunity through our subsidiaries which may interfere with our operations and negatively affect our financial position.

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We intend to expand our services and product offerings and anticipate evaluating potential acquisitions of or investments in businesses, services, products, or technologies.  These investments or acquisitions may result in the incurrence of debt and contingent liabilities, goodwill impairment charges and amortization of expenses related to other intangible assets.  In addition, acquisitions and investments involve numerous risks, including difficulties in the assimilation of the operations, technologies, services, and products of acquired companies; the diversion of management’s attention from other business concerns; risks of entering markets in which we have no or limited direct prior experience; and, the potential loss of key employees of an acquired company.  As of the date of this filing, other than those items detailed herein, we have no present commitment or agreement with respect to any material acquisition of other businesses, services, products, or technologies.

We cannot be assured that the subsidiaries will be able to identify only business opportunities which will ultimately prove to be beneficial to the Company and our stockholders.  

Our subsidiaries’ search for business opportunities to invest in and this search will not be limited to any particular geographical area or industry.  Our subsidiaries’ management has unrestricted discretion in seeking a business opportunity, subject to the availability of such opportunities, economic conditions and other factors.  Business opportunity participation is governed by the parent company management and board of directors.  In addition, the selection of a business opportunity in which to participate is complex and extremely risky and will be made by the subsidiary’s management in the exercise of its business judgment.  We cannot be assured that the subsidiaries will be able to identify only business opportunities which will ultimately prove to be beneficial to the Company and our stockholders.  

We may experience difficulty maintaining sufficient credit card processing capabilities to keep up with our transaction volume.

We rely upon our credit card merchant accounts to collect our monthly hosting payments and many of the limitations imposed upon us by the credit card associations, in the opinion of management, are unreasonable and unnecessarily confining.  In the past, these merchant account limitations have forced management to restrict our business growth and this restriction of growth continues to impact our earnings in a negative manner.   

We may need additional external capital and may be unable to raise it.

Our success will depend upon our ability to generate future cash flows and, if needed in the future, the ability to access equity capital markets and borrow on terms that are financially advantageous to us.  Also, we may not be able to obtain additional funds on acceptable terms.  If we are unable to obtain additional capital, then we may not have sufficient working capital to develop products, finance acquisitions, or pursue business opportunities.  If we borrow funds, then we could be forced to use a large portion of our cash reserves to repay principal and interest on those funds.  If we issue our securities for capital, then the interests of investors and shareholders could be diluted.

We are subject to intense competition from large and small companies that limits our ability to obtain market share and may force our prices down.

We face competition in the overall Internet software market, as well as in the business opportunity market.  Our ability to earn significant revenues from our Visual WebTools™ or IntelliPay payment system will depend in part on their acceptance by a substantial number of online businesses.  Broad acceptance of our products and services and their use in large numbers is critical to our success because a large portion of our revenues are derived from one-time and recurring fees we charge to customers buying our products and services.  Our success in obtaining market share will depend upon our ability to build name brand recognition and to provide cost-effective products and services to our customers.  We have developed our products to meet the needs of small businesses and we believe the generality of our competitors’ services may be inadequately addressing the small business owner’s needs. We expect competition to persist, increase, and intensify in the future as the markets for our products and services continue to develop and as additional competitors enter our market.  In addition, many of our current or potential competitors have broad distribution channels that they may use to bundle competing products directly to

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end-users or purchasers.  If these competitors were to bundle competing products for their customers, it could adversely affect our ability to obtain market share and may force our prices down.

We may be unable to achieve market acceptance because technological standards for payment processing are not established.

One obstacle to widespread market acceptance for the IntelliPay payment system is that widely adopted technological standards for accepting and processing payments over the Internet have not yet emerged.  As a result, merchants and financial institutions have been slow to select which service to use.  Until one or more dominant standards emerge, we must design, develop, test, introduce and support new services to meet changing customer needs and respond to other technological developments.  To be successful, we must obtain widespread acceptance of our technologies, or modify our products and services to meet whatever industry standards do ultimately develop. It is not certain that we will be able to do either.

We depend upon our proprietary rights, none of which can be completely safeguarded against infringement.

Our ability to compete effectively will depend, in part, upon our ability to protect our proprietary source codes for Visual WebTools™ and the IntelliPay payment system through a combination of licenses and trade secrets.  These agreements and procedures may not effectively prevent disclosure of our confidential information and may not provide us with an adequate remedy in the event of unauthorized disclosure of such information.  Intellectual property rights, by their nature, are uncertain and involve complex legal and factual questions.  We rely upon trade secrets with respect to our source code and functionalities and other unpatented proprietary information in our product development activities.  We seek to protect trade secrets and proprietary knowledge in part through confidentiality agreements with our employees, resellers, and collaborators.

If employees or collaborators develop products independently that may be applicable to our products under development, disputes may arise about ownership of proprietary rights to those products or services.  Protracted and costly litigation could be necessary to enforce and determine the scope of our proprietary rights and it would be impossible to predict whether litigation might be successful.

We rely in part on third party technology licenses which we cannot guarantee will be available to us in the future.

We rely on certain technology which we license from third parties, including software which is integrated with internally developed software and used in our software to perform key functions.  Our inability to maintain any of these technology licenses could result in delays in distribution of our services or increased costs of our products and services.  We cannot be assured that third party technology licenses will continue to be available to us on commercially reasonable terms, or at all.

We must update our products and services and may experience increased costs and delays which could reduce operating profit.

The electronic commerce, web hosting and merchant processing markets in which we compete are characterized by technological change, new product introductions, evolving industry standards and changing customer needs.  In order to remain competitive, we may be required to engage in a number of research and development projects, which carries the risks associated with any research and development effort, including cost overruns, delays in delivery and performance problems.  Any delay in the delivery of new products or services could render them less desirable by our customers, or possibly even obsolete.  Any performance problem with a new product or service may require significant funds to correct the problem.  As a result of these factors, our research and development efforts could result in increased costs that could reduce our operating profit, a loss of revenue if promised new products are not timely delivered to our customers, or a loss of revenue or possible claims for damages if new products and services do not perform as anticipated.

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We may experience software defects which may damage customer relations.

Despite rigorous testing, our software may nevertheless contain undetected bugs, errors or experience failures when introduced, or when the volume of services provided increases.  Any material errors could damage the reputation of our service or software, as well as damage our customer relations. We have detected errors, defects, and bugs in the past and have corrected them as quickly as possible.  Correcting any defects or bugs we may discover in the future may require us to make significant expenditures of capital and other resources.  We believe that we follow industry-standard practices relating to the identification and resolution of errors, defects, or bugs encountered in the development of new software and in the enhancement of existing features in our products.  As of the date of this filing we have not experienced any material adverse effect by reason of an error, defect, or bug.

We may experience breakdowns in our hosting services, infrastructure or payment processing systems, which may expose us to liabilities and cause customers to abandon our products and services.

We would be unable to deliver our payment processing services or hosting services if our system infrastructures break down or are otherwise interrupted.  Events that could cause system interruptions are:

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fire

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earthquake,

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power loss,

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terrorist attacks,

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harmful software programs,

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telecommunications failure, and

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unauthorized entry or other events.

Although we regularly back up data from operations, and take other measures to protect against loss of data, there is still some risk of such losses.  Despite the security measures we maintain, our infrastructure may be vulnerable to computer viruses, hackers, rouge employees or similar sources of disruption.  Any problem of this nature could result in significant liability to customers or financial institutions and also may deter potential customers from using our services.  We attempt to limit this sort of liability through back-up systems, contractual provisions, insurance and other security measures.  However, we cannot be assured that these contractual limitations on liability would be enforceable, or that our insurance coverage would be adequate to cover any liabilities we might sustain.

Also, a breach of our e-commerce security measures could reduce demand for our services.  The e-commerce industry is intensely focused on the need for Internet security, particularly with respect to the transmission and storage of confidential personal and financial data.  Any compromise or elimination of our security could erode customer confidence in our systems and could result in lower demand for our services or possible litigation.

We are dependent upon license renewal which cannot be assured to occur.

We derive revenues from user licenses and license renewals on a month-to-month arrangement.  We also intend to increase the brand recognition of our products among users through these types of relationships.  If a substantial number of our customers were to decline to renew their contracts for any reason, then we could experience a substantial drop in revenues. Our success in establishing our products as a recognized brand name and achieving their acceptance in the market will depend in part on our ability to continually engineer and deliver new product technologies and superior customer service, so that customers renew their licenses month to month.

We may not be able to adapt as the Internet market changes, including changing marketing strategies and the associated risks.

Our failure to respond in a timely manner to changing market conditions or client requirements could have a material adverse effect on our business, prospects, financial condition, and results of operations.  The Internet is characterized by:

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rapid technological change;

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changes in advertiser and user requirements and preferences;

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frequent new product and service introductions embodying new technologies; and

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the emergence of new industry standards and practices that could render our existing service offerings, technology, and hardware and software infrastructure obsolete.

In order to compete successfully in the future, we must:

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enhance our existing products and develop new services and technology that address the increasingly sophisticated and varied needs of our prospective or current customers;

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license, develop or acquire technologies useful in our business on a timely basis;

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respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis; and

*

continue to find acceptable means through which to market our products.

Our industry is experiencing increased legal actions related to Internet marketing strategies and our financial condition may be at risk due to such legal actions.

We experienced increased legal actions from 2009 until 2012 related to our marketing strategies and these legal actions required our cash flows to be directed to our legal defense.  Our marketing strategies had relied upon resellers and affiliate marketers and these third parties may lack sufficient knowledge regarding proper marketing activities.  As a result, we have been included in litigation alleging violations of consumer protection and federal RICO laws, fraud and use of deceptive trade practices.  These contingent liabilities may increase our cost of doing business.  

Regulation of the Internet and Internet-based services may decrease the demand for our services and/or increase our cost of doing business.

Due to the increasing popularity and use of the Internet and online services, federal, state, local, and foreign governments may adopt laws and regulations, or amend existing laws and regulations, with respect to the Internet and other online services.  These laws and regulations may affect issues such as user privacy, pricing, content, taxation, copyrights, distribution, and quality of products and services.  Any new legislation could hinder the growth in use of the Internet generally or in our industry and could impose additional burdens on companies conducting business online, which could, in turn, decrease the demand for our services and increase our cost of doing business. The laws governing the Internet remain largely unsettled, even in areas where legislation has been enacted.  It may take years to determine whether and how existing laws, such as those governing intellectual property, privacy, libel, and taxation, apply to the Internet.  In addition, the growth and development of the market for electronic commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on companies conducting business via the Internet.

ITEM 2.  PROPERTIES

Our principal offices, including our main office and data center, are located in Salt Lake City, Utah.  We own two commercial buildings on approximately 0.82 acres of land located in the “central business district” of Salt Lake City, Utah.  We currently occupy a portion of the available 16,000 square feet of our office building located at 230 West 400 South.  The second commercial building adjoins the first on property located at 244 West 400 South. This 3,000 square foot retail commercial building, which is currently unoccupied, may provide additional space for our future growth.  We are actively seeking tenants to whom we can lease unoccupied portions of our office buildings.

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ITEM 3.  LEGAL PROCEEDINGS

Class Action Lawsuits

During the years ended December 31, 2011 and 2012, the Company was involved in five class action law suits.  All plaintiffs in these cases were represented by the same legal firm and each complaint sought class action certification.  The complaints alleged that Pacific WebWorks violated consumer protection laws, committed fraud and used deceptive trade practices in relation to the manner in which Pacific WebWorks charged for purchases of its products.  Each action sought compensatory and punitive damages, plus reasonable costs and attorney fees.  The actions are as follows:

*

On November 9, 2009, Barbara Ford filed an action in the Circuit Court of Cook County, Illinois, Chancery Division.  On December 18, 2009, this matter was removed to the United States District Court for the Northern District of Illinois.  

*

A second action was filed on November 12, 2009, by Deanna Pelletier in the Superior Court of the State of California, County of Solano.  On December 18, 2009, this matter was removed to the United States District Court for the Eastern District of California.  

*

A third action was filed by Lisa Rasmussen on November 20, 2009, in the Superior Court of Washington, Snohomish County.  On December 23, 2009, this matter was removed to the United States District Court for the Western District of Washington.  

*

On July 10, 2010, Thomas Aikens filed an action in the Circuit Court of Jackson County, Missouri, which matter was removed to the United States District Court for the Western District of Missouri.  

*

On September 19, 2011, Lynette Booth filed an action in the Circuit Court of Cook County, Illinois, Chancery Division alleging violations of consumer protection laws by Pacific WebWorks.  This case was removed to the United States District Court for the Northern District of Illinois on December 1, 2011.  Damages are unspecified in this action.  Pacific WebWorks answered the complaint and denied liability, and intends to defend against all such claims.

In response to these actions, Pacific WebWorks retained legal counsel to vigorously defend the Company in these lawsuits.  Discovery began on the class certification phase in the Illinois, Washington and California lawsuits.  Our legal counsel opposed class certification and filed motions to dismiss all claims in the Illinois and Washington actions, which motions were granted in part and denied in part.  Pacific WebWorks renewed its motion to dismiss in the Illinois action.  In addition, Pacific Webworks brought motions to dismiss the Pelletier, Guffey and Aikens actions.

On May 24, 2012, the Company entered into a Stipulation of Class Action Settlement relating to its outstanding class action lawsuits.  The settlement agreement required the Company to contribute a maximum of $400,000 to the settlement fund, class counsel and claims administration fees.  The Company’s entry into the settlement agreement was intended to reduce its overall litigation expense by putting an end to the significant legal fees continually incurred to defend against the actions.  As of December 31, 2011 and 2012, the Company had recorded a liability of $400,000 in contemplation of reaching settlement on its outstanding class action lawsuits.  As a part of the settlement agreement, the Company agreed to establish an escrow account and deposit the amount of their maximum contribution into the escrow account to be held there during the settlement approval process.  The escrow account was established and fully funded by the Company with the appropriate $400,000 maximum contribution on July 2, 2012.

On November 28, 2012, the Class Action Settlement received final approval in the Circuit Court of Cook County, Illinois.  On January 10, 2013, the $400,000 held in escrow was contributed to the settlement fund, class counsel and claims administration fees.  The Company considers this matter to be closed.

As a result of the above class actions suits, Blooksy Interactive, LLC had threatened claims of indemnification against Pacific WebWorks.  We denied that we had any duty to defend or indemnify Blooksy Interactive, LLC.  On May 18, 2012, the Company entered into a settlement agreement with Bloosky Interactive, LLC in which the

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parties agreed to waive any and all indemnification claims against one another.  The Company considers this matter to be closed.

Other Actions

On February 3, 2010, a suit was brought against Pacific WebWorks by Tommy Tompkins in the Circuit Court of Jefferson County, Alabama.  The complaint in that case alleged that Pacific WebWorks violated the Telephone Consumer Protection Act by calling Mr. Tompkins’ cellular telephone to make a sales solicitation.  Pacific WebWorks has denied that it ever improperly called Mr. Tompkins, or that it otherwise violated the Telephone Consumer Protection Act.  In response to this action, Pacific WebWorks retained the law firm of Snell & Wilmer as legal counsel to vigorously defend the Company.  The plaintiffs, along with other parties and the Company have come to resolution as to a settlement of this dispute with a Settlement Agreement being fully executed on March 29, 2012.  Under the terms of this Settlement Agreement, the Company paid $15,000 to the client trust account of Henninger Garrison Davis, LLC to be allocated and distributed at the discretion of the plaintiffs and their counsel.

On November 1, 2011, the Company was named in a suit brought by Adrian O. Alegria in the District Court of the Central District of California.  The complaint in that case alleged breach of contract and fraud.  Pacific WebWorks retained Hirschi, Steele & Baer, PLLC and Single Oak Law Offices, APC as legal counsel to defend the Company. On April 24, 2012 the Company’s motion to dismiss was granted by the Court and this matter is considered to be closed.

We are involved in various other disputes and claims arising in the normal course of our business.  In the opinion of management, any resulting litigation from these disputes and claims will not have a material effect on our financial position and results of operations.

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable to our operations.

PART II

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock is listed to trade on the OTC Bulletin Board under the symbol “PWEB.”  In May 2011 our listing was moved to the OTC Markets Pink and it returned to the OTC Bulletin Board in May 2012.  The following table presents the range of the high and low trading prices of our common stock for each quarter of the years ended December 31, 2012 and 2011 as reported by the OTC Markets and OTC Bulletin Board.  Bid and ask  quotations represent prices between dealers and may not include retail markups, markdowns, or commissions and may not necessarily represent actual transactions.

Our shares are subject to Section 15(g) and Rule 15g-9 of the Securities and Exchange Act, commonly referred to

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as the “penny stock” rule.  The rule defines penny stock to be any equity security that has a market price less than $5.00 per share, subject to certain exceptions.  These rules may restrict the ability of broker-dealers to trade or maintain a market in our common stock and may affect the ability of shareholders to sell their shares.  Broker-dealers who sell penny stocks to persons other than established customers and accredited investors must make a special suitability determination for the purchase of the security.  Accredited investors, in general, include individuals with assets in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together with their spouse, and certain institutional investors.  The rules require the broker-dealer to receive the purchaser’s written consent to the transaction prior to the purchase and require the broker-dealer to deliver a risk disclosure document relating to the penny stock prior to the first transaction.  A broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, and current quotations for the security.  Finally, monthly statements must be sent to customers disclosing recent price information for the penny stocks.

Holders   

As of April 1, 2013 we had 409 stockholders of record of our common stock, which does not include shareholders who hold shares in “street accounts” of securities brokers.

Dividends   

We have not paid cash or stock dividends and have no present plan to pay any dividends.  Instead, we intend to retain any earnings to finance the operation and expansion of our business.  We are not presently subject to any restriction on our present or future ability to pay any dividends, but the payment of any cash dividends on our common stock is unlikely.

Recent Sales of Unregistered Securities

None.

Issuer Purchase of Securities

None.

ITEM 6.  SELECTED FINANCIAL DATA

Not applicable to smaller reporting companies.

ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Executive Overview

Pacific WebWorks enjoyed dramatic growth during 2009 and this growth was related largely to the upgrading of our marketing channels and the migration of our marketing towards a greater emphasis on the viability of our software products as a revenue generating tool, including the ability to use our tools in connection with the major retail sites. However, due to legal matters that the Company encountered in 2010, 2011 and 2012, Management determined that it was prudent to stop marketing the Company’s products while the legal matters were addressed.  This has, and will continue to result in a significant decline in our revenues.  Consistent with this reduction in revenues, management has taken steps to reduce our overhead expense.  

The year ended December 31, 2012 was primarily devoted to addressing items related to our ongoing legal and

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reporting issues as well as retooling the Company’s internet technology infrastructure and products. As announced, the Company has been developing alternative means to market our Visual WebTools™ product while at the same time expanding its internet technology suite and establishing an international framework for taking its products to market.

Over the last two years we trimmed our staffing significantly and identified and hired the personnel necessary to address our legal and reporting issues and move the business forward.  One of our goals has been to find synergistic opportunities that help to diversify the Company’s operations.  We formed Headlamp Ventures, LLC and activated World Commerce Network, LLC and funded these subsidiaries for the purpose of seeking out investment opportunities in other businesses.  As of December 31, 2012, the Company, directly or through our subsidiaries, has invested an aggregate of $710,780 in other businesses and has been issued an aggregate of $3,450,000 in notes receivable by other businesses (See “Liquidity and Capital Resources,” below).

During 2012 the Company continued to expend time and money to defend itself in the legal actions brought against the Company during the past three years.  In an effort to end the litigation, motions to dismiss the legal actions in the various jurisdictions have been filed and we have entered into a stipulated class action settlement agreement (See Part I, Item 3, above).  

Competition throughout the internet software industry continues to intensify.  In particular, competition for the small office/home office business is intensifying with greater attention being directed to this market from a larger variety of product and service providers using new and more aggressive means to market to this industry.  We believe Pacific WebWorks has great potential in the marketplace, but we constantly need more capital and greater processing resources.  We also have the challenge of identifying and effectively implementing our products into new product distribution channels, responding to economic changes generally, continuing to gain marketplace acceptance and we must address shifting public appetites for technology products.  These challenges could pose a threat to our success.  

Liquidity and Capital Resources

We have relied primarily on revenues and loans to fund operations for the past two years.  We expect to generate positive cash flows through further development of our business and distribution channels and investments in other businesses.  We plan to address only the liabilities of our operating subsidiaries with our current cash balances and cash inflows.  Of course cash outflows can exceed monthly cash inflows based on timing differences between marketing campaigns and sales and returns on investment.

Our net revenues for 2012 decreased as compared to 2011 due to continued customer attrition as our marketing was stopped due to legal issues that were ongoing in 2012.  Cash and cash equivalents for 2012 increased as compared to 2011 due to the repayment and return on certain notes receivable.  During 2011 we assumed a $30,000 promissory note as part of the Asher, LLC acquisition and in July and August, 2012, we issued a total of $150,000 in promissory notes payable.   The promissory notes are discussed in more detail below (See “Commitments and Contingent Liabilities”).  We intend to use our cash for operating capital and we believe that we will be able to fund our operations with our revenues and available cash and assets for the next twelve months.

Maintaining sufficient merchant account processing capabilities will continue to be a factor in our overall performance as an Internet application service provider.  We work diligently with our existing merchant account providers and continually search for new merchant account providers in order to manage this risk.

Historically we have relied upon equity offerings to pay for additional services and funding and we anticipate that we will likely use private placements of our common stock in the future.  However, we currently have only 286,105 authorized common shares remaining and we will need to increase our authorized common stock to conduct any future offerings.   Accordingly, management anticipates that the Company will conduct a stockholder’s meeting within the next twelve months to amend the Company’s articles of incorporation to increase the authorized common stock.   In any future offering, the purchasers and manner of issuance will be determined

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according to our financial needs and the available exemptions.  We likely will rely upon exemptions from the registration requirements provided by federal and state securities laws.  We also note that if we issue more shares of our common stock our stockholders may experience dilution in the value per share of their common stock.  

We believe that we will be able to sustain our operations with existing cash and assets and future cash flows during the next twelve to twenty-four months and possibly beyond.  Should we need to raise money in the future we believe funding may be obtained through additional debt arrangements in addition to our internally generated cash flows.  However, if we are unable to obtain additional funds on acceptable terms, then we might be forced to delay or abandon some or all of our product development, marketing or business plans, and growth could be slowed, which may result in declines in our operating results and common stock market price.  

Investments and Notes Receivable  

During the years ended December 31, 2011 and 2012, in addition to our web site business the Company, directly or through our subsidiaries, has invested in other businesses and was issued notes receivable by other businesses.  The Company expects to see returns on these investments and financial arrangements as they continue to mature.  

On April 21, 2011, Pacific WebWorks invested $250,000 in common units of Middlebury Ventures II, LLC, a Delaware limited liability company formed for the purpose of participating in the Fisker Holdings, Inc. Series C-1 and subsequent rounds of financing.  On December 27, 2011, the Company invested an additional $93,280 in common units of Middlebury Ventures II, LLC.  On March 28, 2012, the Company invested an additional $25,000 in common units of Middlebury Ventures II, LLC.  The funds are to be used by Middlebury Ventures II, LLC for the acquisition of Fisker Holdings, Inc. Series D-1 Shares pursuant to the Fisker Series D-1 transaction documents. Fisker Holdings, Inc. is an automotive company competing in the luxury hybrid-electric vehicle market. During August, 2012, Middlebury Ventures II, LLC changed its name to Ridgemaker Ventures II, LLC.  On December 31, 2012, the Company recognized a $285,749 unrealized loss on its investment to impair its carrying value to the current estimated market value.

On August 2, 2011, the Company acquired Thrifty Seeker, LLC, a Utah limited liability company, for $18,000. Thrifty Seeker, LLC competes in the daily deals space.  We foresee opportunity in the daily deals space and believe that Thrifty Seeker can be grown into a strong competitor by leveraging our connections and experience in internet marketing, without incurring the risks previously experienced in Internet marketing.

On July 28, 2011, the Company, through its Headlamp Ventures, LLC subsidiary, established a revolving line of credit facility and issued an initial $400,000 promissory note to Bsquare Red, LLC, a Utah limited liability company, to be used as working capital in their internet marketing business.  The note carries a 15% effective annual rate of interest.  On October 3, 2011, the principal amount of the promissory note was increased to $500,000.  On July 31, 2012, the maturity date of the promissory note was extended to August 1, 2013 (See Item 13, below.)  We are pleased with the rate of return on this financial instrument and have also ensured that there are satisfactory provisions securing the note.

On August 15, 2011, Headlamp Ventures established a revolving line of credit facility and issued an initial $400,000 promissory note to Grupo Zapata Arce, a division of Metales y Minerales S.A. De C.V., a corporation organized under the laws of Mexico, for use in its iron ore exporting business.  Interest shall be charged on amounts outstanding in the form of a fee of $3.00 per metric ton of iron ore purchased with proceeds of the note.  On September 20, 2011, Grupo Zapata Arce Division Metales y Minerals S.A. de C.V., LLC was added as a party to the revolving line of credit and promissory note originally established on August 15, 2011 for Grupo Zapata Arce. Grupo Zapata Arce is positioned in an industry experiencing resurgent demand that is especially driven by emerging markets around the world.  We believe that as the company continues to establish its operations it will produce growth and income.

On August 3, 2011, World Commerce Network issued a promissory note in the amount of $250,000 to Bryan Development, LLC for use as working capital in its business investment activities.  The note carries a 5% annual

19

interest rate and can be converted, in whole or in part at the election of the Company, into common stock shares owned or held by Bryan Development, LLC.  On December 31, 2012, the maturity date of the promissory note was extended to December 31, 2013.  We are optimistic about the conversion possibilities associated with this note and continue to work with the borrower to identify promising investment opportunities.

On October 19, 2011, the Company’s Board of Directors resolved to authorize the investment of up to $1,200,000 in Rsignia, Inc.  Rsignia, Inc. is a leading provider of cyber security solutions and services including detection, mitigation, countermeasures and forensics.  The Company, through its Headlamp Ventures, LLC subsidiary, subsequently issued a promissory note in the amount of $1,200,000 to Rsignia, Inc. for use as working capital.  The note carries a 2% annual interest rate and can be converted, in whole or in part at the election of the Company, into common stock shares in an amount equal to 10% of the total outstanding shares at the time of conversion.  The note’s original maturity date of December 31, 2011 was amended to April 15, 2012.  On April 16, 2012, the $1,200,000 Promissory Note previously extended to Rsignia, Inc., went into default.  The Company subsequently provided Rsignia, Inc. with notice of default and a demand for repayment of all outstanding principal and accrued interest.  After ten days in default, the interest rate on the note increased an additional two percent per annum, to four percent per the terms of the note.  On November 26, 2012, the promissory note was repaid in full.

On November 11, 2011, the Company, through its Headlamp Ventures, LLC subsidiary, invested a total of $250,000 in Payroll Innovations, LLC and PickYourPayday.com, LLC, sister companies having common ownership and management and providing payroll debit card and online payroll advance service to small and mid-sized employers. For value received, the Company holds a 25% ownership position in Payroll Innovations, LLC and PickYourPayday.com, LLC.  On May 30, 2012, the Company invested an additional total of $30,000 in Payroll Innovations, LLC and PickYourPayday.com, LLC to meet a capital call approved by the members.  During September, October and November, 2012, the Company invested an additional total of $34,500 in Payroll Innovations, LLC and PickYourPayday.com, LLC to meet a capital call approved by the members.  For the year ended December 31, 2011 the Company recognized a $21,186 loss on its equity investment and for the year ended December 31, 2012 the Company recognized an $84,597 loss on its equity investment.

On December 2, 2011, the Company, through its Headlamp Ventures, LLC subsidiary, invested $10,000 in Asher, LLC, a business specializing in design and production of gloves and apparel sold in the athletics industry.  For value received, Headlamp Ventures holds a 51% ownership position in Asher, LLC.

On January 18, 2012, the Company, through its World Commerce Network, LLC subsidiary, issued a short term $300,000 promissory note to Bsquare Red, LLC, a Utah limited liability company and related party, to be used as working capital in their Internet marketing business.  The note has a maturity date of February, 15, 2012, carries a 15% effective annual rate of interest and a one-time fee equal to one percent of the total loan amount.  The note, along with all accrued interest and fees, was paid in full at maturity.  

On February 9, 2012, the Company, through its Headlamp Ventures, LLC subsidiary, established a new revolving line of credit facility and issued an initial $500,000 promissory note to Bsquare Red, LLC to be used as working capital in their internet marketing business.  The note carries an 18% effective annual rate of interest.  On September 27, 2012, the promissory note was repaid in full.

On November 15, 2012, the Company, through its Headlamp Ventures, LLC subsidiary, issued a $300,000 promissory note to Bsquare Red, LLC to be used as working capital in their internet marketing business.  The note carries an 18% effective annual rate of interest.  On December 20, 2012, the promissory note was repaid in full.

Commitments and Contingencies

Current Liabilities: Our total current liabilities at December 31, 2012 included accounts payable and accrued liabilities.  Accounts payable of $80,638 was related to operating costs such as marketing and advertising expenses and professional fees.  Our accrued liabilities of $632,582 were primarily the result of payroll related liabilities, income tax payable and legal liabilities, offset by estimated refunds and receivables.   

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The Company was involved in several legal actions and as of December 31, 2011 and 2012 management has recorded a contingent liability of $400,000 in contemplation of the settlement of a number of litigation matters.  The Company was also required to pay $19,000 for costs, attorneys’ fees and future monitoring by the State of Florida Department of Legal Affairs Revolving Trust Fund in the State of Florida Settlement Agreement executed on July 11, 2011, and $15,000 into the client trust account of Henninger Garrison Davis, LLC as part of the Settlement Agreement in the matter of Tompkins et al. v. Pacific WebWorks, Inc. et al. entered into on March 29, 2012.

Also included in current liabilities at December 31, 2012 is $11,195 in deferred revenue primarily related to hosting services and $209,328 in accrued interest payable related to the Company’s notes payable.

Promissory Notes:  On January 27, 2010, the Company executed a Promissory Note Secured by a Deed of Trust with Assignment of Rents in the principal amount of $1,000,000.  The holder of the note, Principal Development, LLC, is entitled to receive the entire principal amount with all accrued interest, at 7% interest per annum, payable on or before January 27, 2012.  On January 25, 2012, the maturity date of the note was extended to January 27, 2015.

On July 10, 2012, the Company executed a Promissory Note Secured by a Deed of Trust with Assignment of Rents in the principal amount of $100,000.  Principal Development, LLC is entitled to receive the entire principal amount with all accrued interest, at 7% interest per annum, payable on or before December 31, 2012.  On November 2, 2012, the maturity date of the note was extended to January 10, 2014.

On August 31, 2012, the Company executed a Promissory Note Secured by a Deed of Trust with Assignment of Rents in the principal amount of $50,000.  Principal Development, LLC is entitled to receive the entire principal amount with all accrued interest, at 7% interest per annum, payable on or before December 31, 2012.  On November 2, 2012, the maturity date of the note was extended to January 10, 2014.

The January 27, 2010, July 10, 2012 and August 31, 2012 Promissory Notes are secured by a deed of trust with assignment of rents on the Company’s principal office building and a second commercial building the Company owns in Salt Lake City, Utah.  Principal Development, LLC, the note holder, is entitled to collect rents and lease amounts, if any, from the buildings upon any default and may at its option elect to foreclose on the properties.  The Company may make payments prior to the due date and any payment will be applied first to the reduction of interest and the balance to the outstanding principal.   In the event that the Company fails to pay any amount when due, then the amount owing will become immediately due and a default interest rate of 15% shall apply to the principal amount. Management intends to use the proceeds from the notes for operational expenses.  Accrued interest related to the notes was $134,822 and $209,328 as of December 31, 2011 and 2012, respectively.

On December 2, 2011, the Company assumed a Promissory Note in the principal amount of $30,000 as part of its acquisition of Asher, LLC.  The holder of the note, Scott Johansen, is entitled to receive the entire principal amount with all accrued interest, at 5% interest per annum, on or before January 1, 2014.  As of December 31, 2012, the outstanding balance on this note was $16,627.

Results of Operations

The following discussions are based on the consolidated financial statements of Pacific WebWorks and its subsidiaries.

The following chart is a summary of our financial statements for the years ended December 31, 2011 and 2012 and should be read in conjunction with the financial statements, and notes thereto, included with this report at Part II, Item 8, below.

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Total assets decreased at December 31, 2012 as compared to December 31, 2011 primarily as a result of a the impairment of certain investment assets, the use of cash for operating activities and decreases in receivables related to the Visual WebTools business.

At December 31, 2012 total current liabilities decreased compared to 2011 primarily as a result of a decrease in accounts payable, deferred revenue and accrued liabilities.  Long-term liabilities increased due to new promissory notes assumed in 2012.  Our accumulated deficit increased at December 31, 2012 as a result of posting a net loss for the year.

We receive revenue for hosting, gateway, and maintenance fees, software access and licensing fees and product sales. Revenues from up-front fees are deferred and recognized over the period in which services are performed, ranging from one month to one year.  Fees for the set-up of merchant accounts are deferred and recognized as services are completed (which is generally two months).  Revenues from monthly hosting, maintenance, transaction and processing fees are recorded when earned. Operating lease revenues for merchant accounts and

22

software are recorded when earned.  Revenues for product sales are recorded when order fulfillment is complete.

Our net revenues decreased for 2012 compared to 2011 resulting from customer attrition and a lack of new customer acquisition as the Company did not market its software products and services due to ongoing legal issues. Management anticipated that revenues would continue to decline as we developed lower risk methods for marketing our software products and services and worked toward returns on the Company’s acquisitions and investments.  

Cost of sales includes costs related to fulfillment, customer service, certain royalties and commissions, amortization of purchased customer portfolios, service personnel, telecommunications and data center costs.  Cost of sales was 20.6% of net revenues for 2012 as compared to 10.02% of net revenues for 2011.  Cost of sales as a percentage of sales was higher in the 2012 periods due to a decline in hosting sales against certain fixed costs and an increase in hard goods and fulfillment costs related to the Asher, LLC line of business.  Management anticipates that cost of sales will remain higher as a percentage of sales in the short term as new revenue streams are developed and matured.

Total operating expenses decreased for 2012 compared to 2011 primarily due to decreases in employee benefit and payroll related expenses, professional fees and merchant fees.  Professional fees include legal, accounting and investor relations fees.  Merchant fees include transaction fees, discount rate fees and customer chargeback fees.

General and administrative expenses include personnel expenses for executive, finance, and internal support personnel.  In addition, general and administrative expenses include fees for bad debt costs, professional legal and accounting services, insurance, office space, banking and merchant fees, and other overhead-related costs.  General and administrative expenses decreased for 2012 compared to 2011 due to decreases in employee benefit and payroll related expenses, professional fees, merchant fees and other overhead-related costs.

Other income of $13,700 recorded in 2012 was primarily related to rent income.  Interest expense of $75,621 was recognized in 2012 related to notes payable, and interest income of $190,211 was recognized in 2012 primarily related to notes receivable.

As a result of the above changes in our operations, we recorded net losses for 2011 and 2012.

Off-balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources and would be considered material to investors.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes.  Estimates of particular significance in our financial statements include trade receivables and collections, goodwill, contingent liabilities, and valuing stock option compensation.

Trade receivables and collections - We apply a range of collection techniques to manage delinquent accounts. Management reviews accounts receivable monthly and records an estimate of receivables determined to be uncollectible due to allowance for doubtful accounts and bad debt.  Accounts receivable and the corresponding allowance for doubtful accounts are reviewed for collectability by management quarterly and uncollectible accounts receivable are written off.

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Revenue Recognition - The Company recognizes revenue in accordance with the Securities and Exchange Commission, Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements” and its revisions in SAB No. 104.  SAB 101 and 104 clarify application of generally accepted accounting principles related to revenue transactions.

We receive revenue for hosting, gateway, and maintenance fees, software access and licensing fees and product sales. Revenues from up-front fees are deferred and recognized over the period in which services are performed, ranging from one month to one year.  Fees for the set-up of merchant accounts are deferred and recognized as services are completed (which is generally two months).  Revenues from monthly hosting, maintenance, transaction and processing fees are recorded when earned. Operating lease revenues for merchant accounts and software are recorded when earned.  Revenues for product sales are recorded when order fulfillment is complete.

The Company recognizes revenues when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery of products and services has occurred, (3) the fee is fixed or determinable and (4) collectibility is reasonably assured.

Goodwill - Goodwill related to Intellipay is assessed annually for impairment by comparing the fair value of Intellipay to its carrying amount, including goodwill.  In testing for a potential impairment of goodwill, the estimated fair value of Intellipay is compared with book value, including goodwill.  If the estimated fair value exceeds book value, goodwill is considered not to be impaired and no additional steps are necessary.  If, however, the fair value of Intellipay is less than book value, then an impairment loss is recognized equal to the excess of book value to estimated fair value. The impairment test for 2011 and 2012 also resulted in an estimated fair value in excess of the book value of goodwill and no impairment was required.

The estimate of implied fair value of goodwill may require independent valuations of certain internally generated and unrecognized intangible assets such as our paying monthly gateway portfolio, software and technology and trademarks.  If the carrying amount of our goodwill exceeds the implied fair value of that goodwill, an impairment loss would be recognized in an amount equal to the excess.  The fair value of Intellipay is estimated using both cash flow information from internal budgets and multiples of revenue.  In the event that an impairment indicator arises prior to our annual impairment test of goodwill, we will provide a full test relative to the indicator in the period that the indicator is present.  

Contingent liabilities - Material estimates for contingent liabilities include approximately $400,000 for our operating companies related to the outcome of certain litigation matters.  From a liquidity standpoint, any settlement or judgment received by the Company from pending or threatened litigation may have a direct effect on our cash balances at December 31, 2012.  Management believes that all amounts estimated and recorded as contingent liabilities approximate the amount of liabilities that could be owed to parties in the form of settlement or in a judgment.  Any settlements that might occur below amounts accrued would result in a favorable impact to our earnings and working capital (See Item 3, “Legal Proceedings” for more information.)

Valuing stock options - We measure and record compensation cost relative to performance stock option costs in accordance with FASB ASC 480-10, which requires the Company to use the Black-Scholes pricing model to estimate the fair value of options at the option date of grant.  The fair value of the option grant is established at the date of grant using the Black-Scholes option pricing model based on assumptions related to the five year risk free interest rate, dividend yield, volatility, and average expected term (years to exercise).

Fair Value Measurements - We adopted ASC Topic 820 (originally issued as SFAS 157, “Fair Value Measurements”) as of January 1, 2008 for financial instruments measured at fair value on a recurring basis.  ASC Topic 820 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States and expands disclosures about fair value measurements.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC Topic 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to

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unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements).  These tiers include:

·

Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;

·

Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and

·

Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

Fair Value of Other Financial Instruments - The carrying amounts of our accounts receivable, accounts payable and accrued liabilities approximate their fair values due to their immediate or short-term maturities.  The aggregate carrying amount of the notes payable approximates fair value as the individual notes bear interest at market interest rates and there hasn’t been a significant change in our operations and risk profile.

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ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

PACIFIC WEBWORKS, INC.

CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012 and 2011

INDEX

Report of Independent Registered Public Accounting Firm

27

Consolidated Balance Sheets

28

Consolidated Statements of Operations

29

Consolidated Statements of Stockholders’ Equity

30

Consolidated Statements of Cash Flows

31

Notes to the Consolidated Financial Statements

32

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Report of Independent Registered Public Accounting Firm

To the Board of Directors

Pacific WebWorks, Inc.

Salt Lake City, Utah

We have audited the accompanying consolidated balance sheets of Pacific WebWorks, Inc. and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pacific WebWorks, Inc. and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

/s/HJ & Associates, LLC

HJ & Associates, LLC

Salt Lake City, Utah

April 1, 2013

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