Paysign, Inc. - Quarter Report: 2020 September (Form 10-Q)

Table of Contents

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, 2020

or

o 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 001-38623

PAYSIGN, INC.

(Exact name of registrant as specified in its charter)

2615 St. Rose Parkway,

Henderson, Nevada 89052

(Address of principal executive offices)

(702) 453-2221

(Registrant’s telephone number, including area code)

                    N/A                    

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

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 o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.

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 o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 49,844,457 shares as of November 12, 2020.

PAYSIGN, INC.

FORM 10-Q REPORT

INDEX

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PAYSIGN, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to unaudited condensed consolidated financial statements.

PAYSIGN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements.

PAYSIGN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(UNAUDITED)

PAYSIGN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (continued)

(UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements.

PAYSIGN, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements.

PAYSIGN, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.     BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT POLICIES

The foregoing unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions for Form 10-Q and Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”). Accordingly, these financial statements do not include all of the disclosures required by GAAP for complete financial statements. These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited financial statements and the notes thereto included on Form 10-K for the year ended December 31, 2019. In the opinion of management, the unaudited interim condensed consolidated financial statements furnished herein include all adjustments, all of which are of a normal recurring nature, necessary for a fair statement of the results for the interim period presented.

The preparation of financial statements in accordance with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and the reported amounts of revenues and expenses during the reporting period. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of the Company’s financial statements; accordingly, it is possible that the actual results could differ from these estimates and assumptions that could have a material effect on the reported amounts of the Company’s financial position and results of operations.

Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.

Impact of COVID-19 Pandemic

The outbreak of a novel coronavirus and the incidence of the related disease (COVID-19) starting in late 2019 has continued, spreading throughout the United States and much of the world beginning in the first quarter of 2020. In March 2020, the World Health Organization declared the outbreak as a pandemic. While the disruption is currently expected to be temporary, there is uncertainty around the duration. The COVID-19 outbreak has had and will continue to have an adverse effect on the Company's results of operations. Given the uncertainty around the extent and timing of the potential future spread or mitigation of COVID-19 and around the imposition or relaxation of protective measures, management cannot reasonably estimate the impact to the Company's future results of operations, cash flows, or financial condition.

On March 27, 2020, President Trump signed into a law a stimulus package, the Coronavirus Aid, Relief and Economic Security ("CARES") Act, which contains several tax provisions. The new provisions did not have a material impact on the Company’s condensed consolidated financial statements.

About Paysign, Inc.

Paysign, Inc. (the “Company,” “Paysign,” or “we,” formerly known as 3PEA International, Inc.) is a vertically integrated provider of prepaid card products and processing services for corporate, consumer and government applications. The Company markets prepaid card solutions under our PaySign^® brand. As we are a payment processor and prepaid card program manager, we derive revenue from all stages of the prepaid card lifecycle. We provide a card processing platform consisting of proprietary systems and software applications based on the unique needs of our programs. We have extended our processing business capabilities through our proprietary PaySign platform. We design and process prepaid programs that run on the platform through which customers can define the services they wish to offer cardholders. Through the PaySign platform, we provide a variety of services including transaction processing, cardholder enrollment, value loading, cardholder account management, reporting, and customer service.

The PaySign brand offers prepaid card based solutions or “card products” for corporate incentive rewards and corporate expense, per diem and travel payments, healthcare reimbursement payments, pharmaceutical co-pay assistance, donor compensation and clinical trials. We plan to expand our product offering to include payroll cards, general purpose re-loadable cards, and others. Our cards are offered to end users through our relationships with bank issuers.

Our proprietary PaySign platform was built on modern cross-platform architecture and designed to be highly flexible, scalable and customizable. The platform allows us to expand our operational capabilities by facilitating entry into new markets within the payments space through its flexibility and ease of customization. The PaySign platform delivers cost benefits and revenue building opportunities to our partners.

We manage all aspects of the debit card lifecycle, from managing the card design and approval processes with partners and networks, to production, packaging, distribution, and personalization. We oversee inventory and security controls, renewals, lost and stolen card management and replacement. We deploy a fully staffed, in-house customer service department which utilizes bilingual customer service agents, Interactive Voice Response (IVR), and two-way short message service (SMS) messaging and text alerts.

Principles of Consolidation – The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated.

Use of Estimates – The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and (iii) the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Restricted Cash – At September 30, 2020 and December 31, 2019, restricted cash consisted of funds held specifically for our card product programs that are contractually restricted to use. The Company includes changes in restricted cash balances with cash and cash equivalents when reconciling the beginning and ending total amounts in our condensed consolidated statements of cash flows.

Fixed Assets – Fixed assets are stated at cost less accumulated depreciation. Depreciation is principally recorded on the straight-line method over the estimated useful lives of the assets, which are generally 3 to 10 years. The cost of repairs and maintenance is charged to expense as incurred. Leasehold improvements are capitalized and depreciated over the shorter of the remaining lease term or the estimated useful life of the improvements. Expenditures for property betterments and renewals are capitalized. Upon sale or other disposition of a depreciable asset, cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in other income (expense).

The Company periodically evaluates whether events and circumstances have occurred that may warrant revision of the estimated useful life of fixed assets or whether the remaining balance of fixed assets should be evaluated for possible impairment. The Company uses an estimate of the related undiscounted cash flows over the remaining life of the fixed assets in measuring their recoverability.

Intangible Assets – For intangible assets, we recognize an impairment loss if the carrying amount of the intangible asset is not recoverable and exceeds fair value. The carrying amount of the intangible asset is considered not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset.

Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives.

Internally Developed Software Costs - Computer software development costs are expensed as incurred, except for internal use software or website development costs that qualify for capitalization as described below, and include compensation and related expenses, costs of hardware and software, and costs incurred in developing features and functionality.

For computer software developed or obtained for internal use, costs that are incurred in the preliminary project and post implementation stages of software development are expensed as incurred. Costs incurred during the application and development stage are capitalized. Capitalized costs are amortized using the straight-line method over a three to five year estimated useful life, beginning in the period in which the software is available for use.

Earnings Per Share – Basic earnings per share exclude any dilutive effects of options, warrants and convertible securities. Basic earnings per share is computed using the weighted-average number of common shares outstanding during the applicable period. Diluted earnings per share is computed using the weighted average number of common and common stock equivalent shares outstanding during the period, using the treasury stock method. Common stock equivalent shares are excluded from the computation if their effect is antidilutive.

Revenue and Expense Recognition – In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers (ASC Topic 606), guidance on recognizing revenue from contracts with customers. The guidance outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the model is that an entity recognizes revenue to portray the transfer of goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also expands disclosure requirements regarding revenue recognition. We adopted this guidance as of January 1, 2018 using the modified retrospective transition method. The adoption of the guidance did not have a material impact on our financial condition and results of operations. The standard also requires new, expanded disclosures regarding revenue recognition.

The Company recognizes revenue when goods or services are transferred to customers in an amount that reflects the consideration which it expects to receive in exchange for those goods or services. In determining when and how revenue is recognized from contracts with customers, the Company performs the following five-step analysis: (i) identification of contracts with customers; (ii) determination of performance obligations; (iii) measurement of the transaction price; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation.

The Company generates revenue for the Plasma industry through fees generated from cardholder transactions, interchange and card program management fees. For the Pharma industry, the Company generates revenue from interchange, program management fees and settlement income. Revenue from cardholder transactions, interchange and card program management is recorded when the performance obligation is fulfilled. Previously, settlement income from breakage on Pharma programs was recognized and recorded ratably throughout the program lifecycle based on the Company’s estimate of the unspent balances to be remaining on the card at program expiration. During the quarter ended September 30, 2020, the Company changed its estimate of breakage for recognizing settlement income for Pharma programs resulting in the Company constraining revenue on all Pharma programs in accordance with ASC 606 by changing the estimate of breakage to the remote method of revenue recognition for settlement income whereby the unspent balances will be recognized as revenue at the expiration of the cards and the respective program. See Note 11. The Company records all revenue on a gross basis since it is the primary obligor and establishes the price in the contract arrangement with its customers. The Company is currently under no obligation for refunding any fees, and the Company does not currently have any obligations for disputed claim settlements. Given the nature of the Company’s services and contracts, it has no contract assets.

Cost of revenues is comprised of transaction processing fees, data connectivity and data center expenses, network fees, bank fees, card production costs, customer service, program management, application integration setup, and sales and commission expense.

Stock-Based Compensation – The Company recognizes compensation expense for all restricted stock and stock option awards. The fair value of restricted stock is measured using the grant date trading price of our stock. The fair value of stock option awards is estimated at the grant date using the Black-Scholes option-pricing model, and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period. We have elected to recognize compensation expense for all options with graded vesting on a straight-line basis over the vesting period of the entire option. The determination of fair value using the Black-Scholes pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility and the risk-free interest rate.

New Accounting Pronouncements - In December 2019, the FASB issued ASU No. 2019-12, Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which intends to simplify the guidance by removing certain exceptions to the general principles and clarifying or amending existing guidance. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Company is currently evaluating the impact of the adoption of ASU 2019-12 on its consolidated financial statements.

2.     FIXED ASSETS, NET

Fixed assets consist of the following:

Depreciation expense for the three months ended September 30, 2020 and 2019 was $115,778 and $91,635, respectively. Depreciation expense for the nine months ended September 30, 2020 and 2019 was $311,039 and $230,411, respectively. During the nine months ended September 30, 2020 the Company relocated its corporate headquarters and recognized a $42,898 loss on abandonment of assets primarily related to leasehold improvements.

3.     INTANGIBLE ASSETS, NET

Intangible assets consist of the following:

Intangible assets are amortized over their useful lives ranging from periods of 3 to 5 years. Amortization expense for the three months ended September 30, 2020 and 2019 was $422,014 and $226,873, respectively. Amortization expense for the nine months ended September 30, 2020 and 2019 was $1,235,606 and $817,369, respectively.

During the three months ended September 30, 2020 the Company reviewed the carrying value of acquisition costs related to a business license and determined that there was an impairment necessary as the efforts to acquire the license had been suspended. As the impairment was deemed other than temporary, the impairment of $382,414 was recorded during the third quarter of 2020.

4.     LEASE

The Company entered into an operating lease for an office space which became effective in June 2020 when the construction was complete and we were given access to occupy the space. The lease term is 10 years from the effective date and allows for two optional extensions of five years each. The two optional extensions are not recognized as part of the right-of-use asset or lease liability since it is not reasonably certain that the Company will extend this lease. As of September 30, 2020, the remaining lease term was 10 years and the discount rate was 6%. The lease for our previous office space was accounted for as a short-term lease.

Operating lease cost included in selling, general and administrative expenses was $218,412 and $278,302 for the three and nine months ended September 30, 2020. Short-term lease cost included in selling, general and administrative expense was $57,309 for the three months ended September 30, 2019. Short-term lease cost included in selling, general and administrative expense was $94,906 and $166,538 for the nine months ended September 30, 2020 and 2019, respectively.

The following is the lease maturity analysis of our operating lease as of September 30, 2020:

Twelve months ending September 30,

5.     CUSTOMER CARD FUNDING LIABILITY

The Company issues prepaid cards with various provisions for transaction fees, inactivity fees, or expiration. Revenue generated from cardholder transactions and interchange are recognized when a card transaction occurs and the Company's performance obligation is fulfilled. Unspent balances left on the cards will be recognized as settlement income at the expiration of the cards and the program. Contract liabilities related to prepaid cards represent funds on card and client funds held to be loaded to card before the amounts are ultimately spent by the cardholders or recognized as revenue by the Company. Contract liabilities related to prepaid cards are reported as Customer card funding liability on the consolidated balance sheet.

The opening and closing balances of the Company's contract liabilities are as follows:

The amount of revenue recognized during the nine months ended September 30, 2020 and 2019 that was included in the opening contract liability for prepaid cards was $844,514 and $818,889, respectively.

6.     COMMON STOCK

At September 30, 2020, the Company's authorized capital stock was 150,000,000 shares of common stock, par value $0.001 per share, and 25,000,000 shares of preferred stock, par value $0.001 per share. On that date, the Company had 49,888,907 shares of common stock issued, and no shares of preferred stock outstanding.

Stock-based compensation expense related to Company grants for the three and nine months ended September 30, 2020 was $798,849 and $2,123,807, respectively. Stock-based compensation expense for the three and nine months ended September 30, 2019 was $651,267 and $1,865,887, respectively.

2020 Transactions: During the three and nine months ended September 30, 2020, the Company issued -0- and 500,000 stock options, respectively, valued at $2.86 per share that will vest over four years. The assumptions used in the Black Scholes option-pricing model for the 2020 options was a risk-free interest rate of 0.38%, expected volatility of 100%, dividend yield of -0- and a weighted-average expected life of 5 years. During the three and nine months ended September 30, 2020 the Company also issued 515,200 and 1,291,195 shares of common stock, respectively, for restricted stock awards previously granted, earned and vested, and for the exercise of vested stock options and received proceeds of $139,680 and $163,680, respectively. In addition, for the nine months ended September 30, 2020, the Company issued 20,000 shares of common stock related to the acquisition of customer lists and contracts valued at $8.86 per share.

2019 Transactions: During the three and nine months ended September 30, 2019, the Company issued 538,280 and 1,654,427 shares, respectively, of common stock for restricted stock awards previously granted, earned and vested and for the exercise of vested stock options and received proceeds of $252,813 for the three and nine months ended September 30, 2019.

7.        BASIC AND FULLY DILUTED NET INCOME (LOSS) PER COMMON SHARE

The following table sets forth the computation of basic and fully diluted net income (loss) per common share.

Due to the net losses for the three and nine months ended September 30, 2020, the effect of all potential common share equivalents was anti-dilutive, and therefore, all such shares were excluded from the computation of diluted weighted average shares outstanding for both periods. The amount of potential common share equivalents excluded were 5,005,985 and 5,452,382 for the three and nine months ended September 30, 2020, respectively.

8.        COMMITMENTS AND CONTINGENCIES

The Company has been named as a defendant in three complaints filed in the United States District Court for the District of Nevada: Yilan Shi v. Paysign, Inc. et. al., filed on March 19, 2020, Lorna Chase v. Paysign, Inc. et. al., filed on March 25, 2020, and Smith & Duvall v. Paysign, Inc. et. al., filed on April 2, 2020 (collectively, the “Complaints” or the “Securities Class Action”). Smith & Duvall v. Paysign, Inc. et. al. was voluntarily dismissed on May 21, 2020. On May 18, 2020, the plaintiffs in Yilan Shi v. Paysign, Inc., Lorna Chase v. Paysign, Inc., and another entity called the Paysign Investor Group, each filed a motion to consolidate the remaining Shi and Chase actions, and the Paysign Investor Group filed a motion to be appointed lead plaintiff. The Complaints are putative class actions filed on behalf of a class of persons who acquired the Company’s common stock from March 12, 2020 through March 15, 2020, inclusive. The Complaints generally allege that the Company, Mark R. Newcomer, and Mark Attinger violated Section 10(b) of the Exchange Act, and that Messrs. Newcomer and Attinger violated Section 20(a) of the Exchange Act, by making materially false or misleading statements, or failing to disclose material facts, regarding the Company’s internal control over financial reporting and its financial statements. The Complaints seek class action certification, compensatory damages, and attorney’s fees and costs. The motion to consolidate, and the motion to appoint lead plaintiff, are pending before the court. The parties have entered into a court approved stipulation specifying a timetable for lead plaintiff to file an amended complaint. As of the date of this filing Paysign cannot give any meaningful probability of outcome or damages.

The Company has also been named as a nominal defendant in a stockholder derivative action in the U.S. District Court for the District of Nevada: Andrzej Toczek, derivatively on behalf of Paysign, Inc. v. Mark, R. Newcomer, et. al., filed on September 17, 2020. This action alleges violations of Section 14(a) of the Exchange Act, breach of fiduciary duty, unjust enrichment, and waste, largely in connection with the failure to correct information technology controls over financial reporting alleged in the Securities Class Action, thereby causing the Company to face exposure in the Securities Class Action. The derivative complaint also alleges insider trading, violations against certain individual defendants. As of the date of this filing, Paysign cannot give any meaningful probability of outcome or damages.

9.        RELATED PARTY

A member of our Board of Directors is also a partner in a law firm that the Company engages for services to review regulatory filings and various legal matters. The Company incurred legal expense of $429,380 and $544,868 during the three and nine months ended September 30, 2020, respectively, with the related party law firm. During each of the three and nine months ended September 30, 2019 the Company incurred legal expense of $4,862 and $29,029 with the related party law firm.

10.        INCOME TAX BENEFIT

The effective tax rate (income tax benefit as a percentage of income (loss) before income tax benefit) was 26.9% and 36.5% for the three and nine months ended September 30, 2020, as compared to (23.5%) and (11.1%) for the three and nine months ended September 30, 2019. The effective tax rates vary, primarily related to the deferred benefit for stock-based compensation.

11.        CHANGE IN ACCOUNTING ESTIMATE

The Company generates settlement income from breakage on Pharma industry programs which was previously recognized and recorded ratably throughout the account and program lifecycle based on expected dollar loads, spending patterns and historical experience. The Company accumulated data trends on over 100 Pharma programs over the last 10 years and has historically realized settlement income from breakage at an average rate of approximately 23.5%, calculated as unspent balances as a percentage of dollars loaded to card. The most recent completed programs in the prior year performed consistent with our historical breakage estimates. During the three and nine months ended September 30, 2020, the Company changed its estimate of breakage for recognizing settlement income for Pharma programs based on substantially different performance indicators observed, current trends in the industry regarding program management by third parties, and new information available in dollar loads and spending patterns compared to historical experience. Given these triggering events based on the new information observed, this change in accounting estimate resulted in the Company constraining revenue on all Pharma programs in accordance with ASC 606 by changing the estimate of breakage to the remote method of revenue recognition for settlement income whereby the unspent balances will be recognized as revenue at the expiration of the cards and the respective program. This has resulted in the reversal of all previously recognized settlement income for all current Pharma programs. The adjustment was a $6,293,203 reduction in Pharma revenue and an increase in net loss after the impact of income taxes of $4,971,630 or $(0.10) per basic and diluted share for the three and nine months ended September 30, 2020.

Item 2. Management’s discussion and analysis of financial condition and results of operations.

Disclosure Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (“Forward-Looking Statements”). All statements other than statements of historical fact included in this report are Forward-Looking Statements. In the normal course of our business, we, in an effort to help keep our stockholders and the public informed about our operations, may from time-to-time issue certain statements, either in writing or orally, that contain, or may contain, Forward-Looking Statements. Although we believe that the expectations reflected in such Forward-Looking Statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Generally, these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of such plans or strategies, possible future of acquisitions and projected or anticipated benefits from acquisitions made by or to be made by us, or projections involving anticipated revenues, earnings, levels of capital expenditures or other aspects of operating results. All phases of our operations are subject to a number of uncertainties, risks and other influences, many of which are outside of our control and any one of which, or a combination of which, could materially affect the results of our operations and whether Forward-Looking Statements made by us ultimately prove to be accurate. Such important factors (“Important Factors”) and other factors could cause actual results to differ materially from our expectations are disclosed in this report, including those factors discussed in “Part II - Item 1A. Risk Factors.” All prior and subsequent written and oral Forward-Looking Statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the Important Factors described below that could cause actual results to differ materially from our expectations as set forth in any Forward-Looking Statement made by or on behalf of us.

Overview

We are a vertically integrated provider of prepaid card programs and processing services for corporate, consumer and government applications. Our payment solutions are utilized by our corporate customers as a means to increase customer loyalty, increase patient adherence rates, reduce administration costs and streamline operations. Public sector organizations can utilize our payment solutions to disburse public benefits or for internal payments. We market our prepaid card solutions under our PaySign brand. As we are a payment processor and prepaid card program manager, we derive our revenue from all stages of the prepaid card lifecycle. We provide a card processing platform consisting of proprietary systems and software applications based on the unique needs of our clients. We have extended our processing business capabilities through our proprietary PaySign platform. Through the PaySign platform, we provide a variety of services including transaction processing, cardholder enrollment, value loading, cardholder account management, reporting, and customer service. The PaySign platform was built on modern cross-platform architecture and designed to be highly flexible, scalable and customizable. The platform has allowed the Company to significantly expand its operational capabilities by facilitating our entry into new markets within the payments space through its flexibility and ease of customization. The PaySign platform delivers cost benefits and revenue building opportunities to our partners.

We have developed prepaid card programs for corporate incentive and rewards including, but not limited to, consumer rebates and rewards, donor compensation, healthcare reimbursement payments and pharmaceutical payment assistance. We have expanded our product offerings to include additional corporate incentive products and demand deposit accounts accessible with a debit card. In the future we expect to further expand our product offerings into payroll cards, travel cards, and expense reimbursement cards. Our cards are sponsored by our issuing bank partners.

Our revenues include fees generated from cardholder transactions, interchange, card program management fees and settlement income. Revenue from cardholder transactions, interchange and card program management fees is recorded when the performance obligation is fulfilled. Settlement income is recorded ratably throughout the program lifecycle.

We have two categories for our prepaid debit cards: (1) corporate and consumer reloadable, and (2) non-reloadable cards.

Reloadable Cards: These types of cards are generally classified as payroll or considered general purpose reloadable (“GPR”) cards. Payroll cards are issued by an employer to an employee in order to allow the employee to access payroll amounts that are deposited into an account linked to their card. GPR cards can also be issued to a consumer at a retail location or mailed to a consumer after completing an on-line application. GPR cards can be reloaded multiple times with a consumer’s payroll, government benefit, a federal or state tax refund or through cash reload networks located at retail locations. Reloadable cards are generally open loop cards as described below.

Non-Reloadable Cards: These are generally one-time use cards that are only active until the funds initially loaded to the card are spent. These types of cards are generally used as gift or incentive cards. Normally these types of cards are used for purchase of goods or services at retail locations and cannot be used to receive cash.

Both reloadable and non-reloadable cards may be open loop, closed loop or semi-closed loop. Open loop cards can be used to receive cash at ATM locations by PIN; or purchase goods or services by PIN or signature at retail locations virtually anywhere that the network brand (American Express, Discover, MasterCard, Visa, etc.) is accepted. Closed loop cards can only be used at a specific merchant. Semi-closed loop cards can be used at several merchants, such as all merchants at a specific shopping mall.

The prepaid card market is one of the fastest growing segments of the payments industry in the U.S. This market has experienced significant growth in recent years due to consumers and merchants embracing improved technology, greater convenience, more product choices and greater flexibility. Prepaid cards have also proven to be an attractive alternative to traditional bank accounts for certain segments of the population, particularly those without, or who could not qualify for, a checking or savings account.

We manage all aspects of the debit card lifecycle, from managing the card design and approval processes with partners and networks, to production, packaging, distribution, and personalization. We also oversee inventory and security controls, renewals, lost and stolen card management and replacement. We deploy a fully staffed, in-house customer service department which utilizes bilingual customer service representatives, Interactive Voice Response (“IVR”), and two-way short message service (“SMS”) messaging and text alerts.

Currently, we are focusing our marketing efforts on corporate incentive and expense prepaid card products in various market verticals including but not limited to general corporate expense, healthcare related markets including co-pay assistance, clinical trials and donor compensation, loyalty rewards and incentive cards.

As part of our continuing platform expansion process, we evaluate current and emerging technologies for applicability to our existing and future software platform. To this end, we engage with various hardware and software vendors in evaluation of various infrastructure components. Where appropriate, we use third-party technology components in the development of our software applications and service offerings. Third-party software may be used for highly specialized business functions, which we may not be able to develop internally within time and budget constraints. Our principal target markets for processing services include prepaid card issuers, retail and private-label issuers, small third-party processors, and small and mid-size financial institutions in the United States and in emerging international markets.

We have devoted more extensive resources to sales and marketing activities as we have added essential personnel to our marketing and sales team. We sell our products directly to customers in the U.S. but may work with a small number of resellers and third parties in international markets to identify, sell and support targeted opportunities. We have also identified opportunities in the European Union and are pursuing those opportunities.

In 2020, we plan to continue to invest additional funds in technology improvements, sales and marketing, customer service, and regulatory compliance. From time to time, we evaluate raising capital as we continue to explore merger and acquisition opportunities and seek to further diversify into new industry verticals. If we do not raise new capital, we believe that we will still be able to expand into new markets using internally generated funds.

Key Performance Indicators and Non-GAAP Measures

Management reviews a number of metrics to help us monitor the performance of and identify trends affecting our business. We believe the following measures are the primary indicators of our quarterly and annual revenues:

Gross Dollar Volume Loaded on Cards – Represents the total dollar volume of funds loaded to all of our prepaid card programs. Our gross dollar volume was $721,000,000 and $630,000,000 for the nine months ended September 30, 2020 and 2019, respectively. We use this metric to analyze the total amount of money moving into our prepaid card programs.

Conversion Rates on Gross Dollar Volume Loaded on Cards – Comprised of revenues, gross profit and net profit conversion rates of gross dollar volume loaded on cards. Our revenue conversion rates for the three months ended September 30, 2020 and 2019 were (0.07%) or (7) basis points (“bps”), and 4.29% or 429 bps, respectively, of gross dollar volume loaded on cards. Our gross profit conversion rates for the three months ended September 30, 2020 and 2019 were (1.62%) or (162) bps, and 2.55% or 255 bps, respectively, of gross dollar volume loaded on cards. Our net profit conversion rates for the three months ended September 30, 2020 and 2019 were (2.90%) or (290) bps, and 1.41% or 141 bps, respectively, of gross dollar volume loaded on cards. Our revenue conversion rates for the nine months ended September 30, 2020 and 2019 were 2.34% or 234 bps, and 3.95% or 395 bps, respectively, of gross dollar volume loaded on cards. Our gross profit conversion rates for the nine months ended September 30, 2020 and 2019 were 0.78% or 78 bps, and 2.25% or 225 bps, respectively, of gross dollar volume loaded on cards. Our net profit conversion rates for the nine months ended September 30, 2020 and 2019 were (0.67%) or (67) bps, and 0.88% or 88 bps, respectively, of gross dollar volume loaded on cards.

Management also reviews key performance indicators, such as revenues, gross profit, operational expenses as a percent of revenues, and cardholder participation. In addition, we consider certain non-GAAP (or "adjusted") measures to be useful to management and investors evaluating our operating performance for the periods presented, and provide a tool for evaluating our ongoing operations, liquidity and management of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment and investment in new card programs. These adjusted metrics are consistent with how management views our business and are used to make financial, operating and planning decisions. These metrics, however, are not measures of financial performance under GAAP and should not be considered a substitute for revenue, operating income (loss), net income (loss), earnings (loss) per share (basic and diluted) or net cash from operating activities as determined in accordance with GAAP. We consider the following non-GAAP measures, which may not be comparable to similarly titled measures reported by other companies, to be key performance indicators:

“EBITDA” is defined as earnings before interest, income taxes, and depreciation and amortization expense and "Adjusted EBITDA" reflects the adjustment to EBITDA to exclude stock-based compensation expense, impairment of intangible asset and loss on abandonment of assets.

Results of Operations

Three Months Ended September 30, 2020 and 2019

The following table summarizes our consolidated financial results:

The decrease in total revenues of $9,160,658 compared to the same period in the prior year consisted of a 25.2% reduction in Plasma revenue and a $7,454,938 reduction in Pharma revenue. The decrease in Plasma revenue was primarily due to a decrease in plasma donations and dollars loaded to card and a reduction in card load fees. The Pharma revenue decrease included a $6,293,203 adjustment for a change in accounting estimate of breakage for recognizing settlement income for Pharma programs based on substantially different performance indicators observed, current trends in the industry regarding program management by third parties, and new information available in dollar loads and spending patterns compared to historical experience. This change in accounting estimate resulted in the Company constraining revenue on all Pharma programs in accordance with ASC 606 by changing the estimate of breakage to the remote method of revenue recognition for settlement income whereby the unspent balances will be recognized as revenue at the expiration of the cards and the respective program. This has resulted in the reversal of all previously recognized settlement income for all current Pharma programs. In addition, both industries were impacted by a novel coronavirus and the incidence of the related disease COVID-19.

Cost of revenues for the three months ended September 30, 2020 decreased $359,707 compared to the same period in the prior year. Cost of revenues is comprised of transaction processing fees, data connectivity and data center expenses, network fees, bank fees, card production costs, customer service, program management, application integration setup, and sales and commission expense. There was a favorable volume variance of $3,703,260 due to the decrease in transactions, offset by an unfavorable rate variance of $3,343,553 resulting from a decrease in higher margin revenue business.

Gross profit for the three months ended September 30, 2020 decreased $8,800,951 compared to the same period in the prior year resulting from the reduction in revenue described above, and the disproportionate decrease in cost of sales. The decrease in gross margin resulted from the lower revenue conversion rate and an unfavorable cost of revenue rate variance.

Selling, general and administrative expenses (“SG&A”) for the three months ended September 30, 2020 increased $1,304,250 or 47% compared to the same period in the prior year and consisted primarily of an increase in staffing and compensation of $420,000, professional services for tax, audit and consultants of $524,000, stock-based compensation of $148,000, technologies and telecom of $87,000, and rent of $171,000 related to a new office lease entered into in June 2020; offset by a decrease in travel of $47,000.

For the three months ended September 30, 2020, we reviewed the carrying value of acquisition costs related to a business license and determined that there was an impairment necessary as the efforts to acquire the license had been suspended. An impairment of intangible asset of $382,414 was recorded.

Depreciation and amortization expense for the three months ended September 30, 2020 increased $219,284 compared to the same period in the prior year. The increase in depreciation and amortization expense was primarily due to continued capitalization of new technologies and enhancements to our platform.

For the three months ended September 30, 2020, we recorded a loss from operations representing a net decrease in income from operations of $10,706,899 related to the aforementioned factors.

Other income for the three months ended September 30, 2020 decreased $101,483 related to a decrease in interest income resulting primarily from the reduction beginning in the first quarter of 2020 to a near 0% federal funds rate.

The effective tax rate was 26.9% and (23.5%) for the three months ended September 30, 2020 and 2019. The effective tax rates vary, primarily as a result of the tax benefit related to our stock-based compensation and a pretax loss in the current year period.

The net income (loss) attributable to Paysign, Inc. for the three months ended September 30, 2020 decreased $9,112,213. The overall change in net income (loss) attributable to Paysign, Inc. relates to the aforementioned factors.

Nine Months Ended September 30, 2020 and 2019

The following table summarizes our consolidated financial results:

Total revenues for the nine months ended September 30, 2020 decreased $8,034,681 compared to the same period in the prior year. The 32.3% decrease in total revenues was primarily due to the effects of COVID-19 in the second and third quarter, offset by an increase of approximately 20% in new card programs year over year, contributing to a strong first quarter. In addition, The Pharma revenue decrease included a $6,293,203 adjustment for a change in accounting estimate of breakage for recognizing settlement income for Pharma programs based on substantially different performance indicators observed, current trends in the industry regarding program management by third parties, and new information available in dollar loads and spending patterns compared to historical experience. This change in accounting estimate resulted in the Company constraining revenue on all Pharma programs in accordance with ASC 606 by changing the estimate of breakage to the remote method of revenue recognition for settlement income whereby the unspent balances will be recognized as revenue at the expiration of the cards and the respective program. This has resulted in the reversal of all previously recognized settlement income for all current Pharma programs.

Cost of revenues for the nine months ended September 30, 2020 increased $553,889 compared to the same period in the prior year. Cost of revenues constituted approximately 66.9% and 43.1% of total revenues for the nine months ended September 30, 2020 and 2019, respectively. Cost of revenues is comprised of transaction processing fees, data connectivity and data center expenses, network fees, bank fees, card production costs, customer service, program management, application integration setup, and sales and commission expense. Our cost of revenues as a percentage of revenues increased due to a mix change towards lower gross margin non-Pharma business, partially offset by lower transaction volumes in non-Pharma lines of business.

Gross profit for the nine months ended September 30, 2020 decreased $8,588,670 compared to the same period in the prior year. Our overall gross margins were 33.1% and 56.9% during the nine months ended September 30, 2020 and 2019, respectively, a decrease of 2,379 bps with reasons consistent with the change in cost of revenues as a percent of revenues.

Selling, general and administrative expenses for the nine months ended September 30, 2020 increased $2,815,154 or 33% compared to the same period in the prior year. The increase in SG&A consisted primarily of an increase in staffing and wages of $1,199,000, professional services for tax, audit and consultants of $776,000, technologies and telecom of $334,000, stock-based compensation of $258,000 and rent of $260,000 related to a new office lease entered into in June 2020.

For the nine months ended September 30, 2020, we reviewed the carrying value of acquisition costs related to a business license and determined that there was an impairment necessary as the efforts to acquire the license had been suspended. An impairment of intangible asset of $382,414 was recorded.

During the nine months ended September 30, 2020 we relocated our corporate headquarters and recognized a $42,898 loss on abandonment of assets primarily related to leasehold improvements.

Depreciation and amortization expense for the nine months ended September 30, 2020 increased $498,866 compared to the same period in the prior year. The increase in depreciation and amortization expense was primarily due to continued capitalization of new technologies and enhancements to our platform, which we expect to continue as the company continues to grow.

For the nine months ended September 30, 2020, income (loss) from operations decreased $12,328,002 related to the aforementioned factors.

Other income for the nine months ended September 30, 2020 decreased $287,177 related to a decrease in interest income primarily resulting from the reduction beginning in the first quarter of 2020 to a near 0% federal funds rate.

The effective tax rate was 36.5% and (11.1%) for the nine months ended September 30, 2020 and 2019. The effective tax rates vary, primarily as a result of the tax benefit related to our stock-based compensation and a pretax loss in the current year period.

Net income (loss) attributable to Paysign, Inc. for the nine months ended September 30, 2020 decreased $10,400,944. The overall change in net income (loss) attributable to Paysign, Inc. relates to the aforementioned factors.

Liquidity and Capital Resources

The following table sets forth the major sources and uses of cash:

Comparison of Nine Months Ended September 30, 2020 and 2019

During the nine months ended September 30, 2020 and 2019, we financed our operations through internally generated funds.

Cash provided by operating activities increased $1,780,691 in the nine months ended September 30, 2020, as compared to the same period in the prior year. The increase is primarily due to the increase in the customer card funding liability offset by the decrease in net income (loss) and deferred income taxes. The increase in the card funding liability is partially related to the change in estimate and reversal of previously recognized settlement income on Pharma programs.

Cash used in investing activities increased $1,060,212 in the nine months ended September 30, 2020, as compared to the same period in 2019, with the difference primarily attributed to an increase in fixed assets during the current period and enhancements to our processing platform.

Cash used in financing activities was $81,745 in the nine months ended September 30, 2020 as compared to cash provided by financing activities of $252,813 for the nine months ended September 30, 2019. The change between years primarily consists of shares withheld to cover taxes as well as the cash received from exercises of stock options.

Sources of Liquidity

We believe that our available cash on hand, excluding restricted cash, at September 30, 2020 of $7,497,579, along with our forecast for revenues and cash flows for the remainder of the year and for 2021, will be sufficient to sustain our operations for the next twelve months.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that 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 that are material to investors.

Critical Accounting Policies and Estimates

Our significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements and our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Our estimates are based on our experience and our interpretation of economic, political, regulatory, and other factors that affect our business prospects. Actual results may differ significantly from our estimates.

Revenue and Expense Recognition – The Company recognizes revenue when goods or services are transferred to customers in an amount that reflects the consideration which it expects to receive in exchange for those goods or services. In determining when and how revenue is recognized from contracts with customers, the Company performs the following five-step analysis: (i) identification of contracts with customers; (ii) determination of performance obligations; (iii) measurement of the transaction price; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation.

The Company generates revenue for the Plasma industry through fees generated from cardholder transactions, interchange and card program management fees. For the Pharma industry, the Company generates revenue from interchange, program management fees and settlement income. Revenue from cardholder transactions, interchange and card program management is recorded when the performance obligation is fulfilled. Previously, settlement income from breakage on Pharma programs was recognized and recorded ratably throughout the program lifecycle based on the Company’s estimate of the unspent balances to be remaining on the card at program expiration. During the quarter ended September 30, 2020, the Company changed its estimate of breakage for recognizing the settlement income for Pharma programs resulting in the Company constraining revenue on all Pharma programs in accordance with ASC 606 by changing the estimate of breakage to the remote method of revenue recognition for settlement income whereby the unspent balances will be recognized as revenue at the expiration of the cards and the respective program. The Company records all revenue on a gross basis since it is the primary obligor and establishes the price in the contract arrangement with its customers. The Company is currently under no obligation for refunding any fees, and the Company does not currently have any obligations for disputed claim settlements. Given the nature of the Company’s services and contracts, it has no contract assets.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Because the Company is a smaller reporting company, it is not required to provide the information called for by this Item.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures.

We have evaluated, under the supervision of our chief executive officer and chief financial officer and with the participation of other members of management, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of September 30, 2020. Management necessarily applies its judgment in assessing the costs and benefits of those controls and procedures, which by their nature, can provide only reasonable assurance about management’s control objectives. You should note that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. Based on that evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were not effective due to previously reported material weaknesses in internal control over financial reporting, which were described in Part II, Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (the “2019 10-K”).

Remediation of Material Weakness

We are committed to maintaining a strong internal control environment and implementing measures designed to help ensure that control deficiencies contributing to the material weakness are remediated as soon as possible. We continue to implement our remediation plan for the previously reported material weaknesses in internal control over financial reporting, described in Part II, Item 9A of our 2019 10-K, which includes taking steps to improve the design and methods for testing internal controls, adding resources to carry out such practices, and instituting new procedures for managing system user access and change control. The material weaknesses will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.

Changes in Internal Control over Financial Reporting

Other than the changes related to our remediation efforts described above, we made no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.

The Company has been named as a defendant in three complaints filed in the United States District Court for the District of Nevada: Yilan Shi v. Paysign, Inc. et. al., filed on March 19, 2020, Lorna Chase v. Paysign, Inc. et. al., filed on March 25, 2020, and Smith & Duvall v. Paysign, Inc. et. al., filed on April 2, 2020 (collectively, the “Complaints” or “Securities Class Action”). Smith & Duvall v. Paysign, Inc. et. al. was voluntarily dismissed on May 21, 2020. On May 18, 2020, the plaintiffs in Yilan Shi v. Paysign, Inc., Lorna Chase v. Paysign, Inc., and another entity called the Paysign Investor Group, each filed a motion to consolidate the remaining Shi and Chase actions, and the Paysign Investor Group filed a motion to be appointed lead plaintiff. The Complaints are putative class actions filed on behalf of a class of persons who acquired the Company’s common stock from March 12, 2020 through March 15, 2020, inclusive. The Complaints generally allege that the Company, Mark R. Newcomer, and Mark Attinger violated Section 10(b) of the Exchange Act, and that Messrs. Newcomer and Attinger violated Section 20(a) of the Exchange Act, by making materially false or misleading statements, or failing to disclose material facts, regarding the Company’s internal control over financial reporting and its financial statements. The Complaints seek class action certification, compensatory damages, and attorney’s fees and costs. The motion to consolidate and the motion to appoint lead plaintiff are pending before the court. The parties have entered into a court approved stipulation specifying a timetable for lead plaintiff to file an amended complaint. As of the date of this filing, Paysign cannot give any meaningful probability of outcome or damages.

The Company has also been named as a nominal defendant in a stockholder derivative action in the U.S. District Court for the District of Nevada: Andrzej Toczek, derivatively on behalf of Paysign, Inc. v. Mark, R. Newcomer, et. al., filed on September 17, 2020. This action alleges violations of Section 14(a) of the Exchange Act, breach of fiduciary duty, unjust enrichment, and waste, largely in connection with the failure to correct information technology controls over financial reporting alleged in the Securities Class Action, thereby causing the Company to face exposure in the Securities Class Action. The derivative complaint also alleges insider trading, violations against certain individual defendants. As of the date of this filing, Paysign cannot give any meaningful probability of outcome or damages. 

Item 1A. Risk Factors.

There have been no material changes with respect to the risk factors disclosed in Part I, Item 1A of our annual report on Form 10-K for the year ended December 31, 2019.

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

During the quarter ended September 30, 2020, we issued, pursuant to an exemption from registration provided by Section 4(2) of the Securities Act of 1933, a total of 457,000 shares of common stock for restricted stock shares previously earned and vested as well as 58,200 shares of common stock for stock options exercised.

Item 6. Exhibits.

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.