Usio, Inc. 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. FORWARD-LOOKING STATEMENTS DISCLAIMER This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. If used in this report, the words "anticipate," "believe," "estimate," "intend," and other words or phrases of similar import are intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described in our annual report on Form 10-K and other reports we file with the Securities and Exchange Commission. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made. We do not intend to update any of the forward-looking statements after the date of this report to conform these statements to actual results or to changes in our expectations, except as required by law. This discussion and analysis should be read in conjunction with the unaudited interim condensed consolidated financial statements and the notes thereto included in this report, and our annual report on Form 10-K for the fiscal year ended December 31, 2019 , filed on March 30, 2020, including the audited consolidated financial statements and the notes contained therein. Name Change Effective on June 26, 2019 we changed our corporate name from Payment Data Systems, Inc. to Usio, Inc. Overview We provide integrated electronic payment processing services to merchants and businesses, including all types of Automated Clearing House, or ACH processing, credit card, PINless debit, prepaid card and debit card-based processing services. Through Akimbo, under the domain name www.akimbocard.com, we offer MasterCard prepaid cards to consumers for use as a tool to stay on budget, to manage allowances, and to share money with family and friends. We have further developed our Akimbo platform to include Akimbo Now for businesses, Akimbo Gift for consumers and support for Apple Pay®, Android Pay™ and Samsung Pay™. During the third quarter of 2020 , the volume of credit card transactions processed increased by 81% versus the third quarter of 2019 . The amount of credit card dollars processed during the third quarter of 2020 increased by 15% compared to the same time period in 2019. Both credit card transactions processed and dollars processed were the highest in our history. Both metrics were achieved despite widespread third quarter industry weakness related to COVID-19 impacts. The continued growth in credit card metrics was primarily attributable to our card processing growth initiatives with the Integrated Payments (Payment Facilitation) segment due to increased penetration of multiple industries including healthcare and legal. In April, we experienced a decline of nearly $10 million of credit card processing volume in the Singular portfolio primarily attributable to mandated closures to dental and veterinary practices in the portfolio. Revenues of these merchants increased in May and June 2020 and throughout the third quarter returning to pre-COVID-19 revenue levels as these merchants have reopened. 11 ACH (eCheck) transaction volumes during the third quarter of 2020 decreased by 18% compared to the third quarter of 2019 . Returned check transactions processed during the third quarter of 2020 decreased by 39% compared to the third quarter of 2019 . The decreases in eCheck transactions and returned check transactions were primarily attributable to lower volumes experienced by our non-bank consumer lending merchants as a result of COVID-19 impacts. While we experienced sequential growth in both transactions and returned checks processed in the third quarter as compared to the second quarter, we expect COVID-19 to continue to hamper growth in our ACH business in the fourth quarter due to the increases in unemployment and the effects on the consumer credit ratings. We have a high degree of confidence the ACH business will recover once unemployment decreases and as consumer government assistance programs are curtailed. Prepaid card load volume during the third quarter of 2020 increased by 329% compared to the third quarter of 2019 . Prepaid card transaction volumes during the third quarter of 2020 increased by 170% compared to the third quarter of 2019 . These increases occurred primarily due to the implementation and sales of many newly created prepaid government assistance programs including organizations such as the Mayors Fund to Advance New York City, Greater Washington Community Foundation (Washington DC Program), United Way of Central and Northeastern Connecticut, Mayor's Fund for Los Angeles, New York Immigration Coalition, One Fair Wage, Inc. and Dorcas International of RI. Total dollars processed for the third quarter of 2020 were $852 million compared to $915 million in the third quarter of 2019 . Critical Accounting Policies Our management’s discussion and analysis of our financial condition and results of operations is based upon our interim condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to the reported amounts of revenues and expenses, bad debt, investments, intangible assets, income taxes, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions or conditions. We consider the accounting policies described in Note 1 to the Notes to the Interim Condensed Consolidated Financial Statements to be critical because the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change or because the impact of the estimates and assumptions on financial condition or operating performance is material. For a summary of Critical Accounting Policies, please refer to the Notes to Interim Condensed Consolidated Financial Statements, Note 1, Basis of Presentation. 12 Results of Operations Revenues Our revenues are principally derived from providing integrated electronic payment services to merchants and businesses, including credit and debit card-based processing services and transaction processing via the Automated Clearing House, or ACH, network and the program management and processing of prepaid debit cards. Three Months Ended September 30, 2020 2019 $ Change % Change ACH and complementary service revenue $ 2,063,458 $ 2,313,742 $ (250,284 ) (10.8 )% Credit card revenue 5,076,591 4,467,189 609,402 13.6 % Prepaid card services revenue 997,028 306,801 690,227 225.0 % Total Revenue $ 8,137,077 $ 7,087,732 $ 1,049,345 14.8 % Nine Months Ended September 30, 2020 2019 $ Change % Change ACH and complementary service revenue $ 6,080,449 $ 7,029,953 $ (949,504 ) (13.5 )% Credit card revenue 14,647,448 12,795,058 1,852,390 14.5 % Prepaid card services revenue 2,141,412 1,008,132 1,133,280 112.4 % Total Revenue $ 22,869,309 $ 20,833,143 $ 2,036,166 9.8 % Revenues for the quarter ended September 30, 2020 increased by 14.8% to $8.1 million, as compared to $7.1 million for the quarter ended September 30, 2019 . The revenue increase resulted primarily from revenue growth in our prepaid and credit card portfolios offset by declines in our consumer lending portfolios within our ACH business. Revenues for the nine months ended September 30, 2020 increased 9.8% to $22.9 million, as compared to $20.8 million for the nine months ended September 30, 2019 . The revenue increase resulted from growth in our credit card and prepaid growth initiative programs offset by declines in our consumer lending portfolios within our ACH business. Cost of Services Cost of services includes the cost of personnel dedicated to the creation and maintenance of connections to third-party payment processors and the fees paid to such third-party providers for electronic payment processing services. Through our contractual relationships with our payment processors and sponsoring banks, we process ACH and debit, credit or prepaid card transactions on behalf of our customers and their consumers. We pay volume-based fees for debit, credit, ACH and prepaid transactions initiated through these processors or sponsoring banks, and pay fees for other transactions such as returns, notices of change to bank accounts and file transmission. Cost of service fees also include fees paid to referral agents and partners. Cost of services increased by 16% to $6.4 million for the quarter ended September 30, 2020 , as compared to $5.5 million for the same period in the prior year. Cost of services increased by 9% to $17.9 million for the nine months ended September 30, 2020 , as compared to $16.4 million for the same period in the prior year. The increases in the quarter and nine -month period ended September 30, 2020 , as compared to the same period in the prior year, were primarily due to the increased credit card and prepaid transaction costs associated with higher revenues. 13 Table of Contents Gross Profit Gross profit is the net profit existing after the cost of services. Gross profits increased by 11% to $1.7 million for the quarter ended September 30, 2020 , as compared to $1.5 million for the same period in the prior year. The increase in gross profit for the quarter ended September 30, 2020 , as compared to the same period in the prior year, was primarily a result of higher profits in our prepaid and credit card businesses offset by lower ACH profits from our consumer lending merchants. Gross profits for the nine months ended September 30, 2020 increased by 11% to $4.9 million as compared to $4.4 million for the same period in the prior year primarily as a result of strong revenue and gross profit growth in our prepaid and credit card portfolios offset by lower profits from our consumer lending merchants. Stock-based Compensation Stock-based compensation expenses decreased to $267,223 as a result of one-time cancellations of previously recorded stock compensation expenses for the quarter ended September 30, 2020 as compared to $315,259 for the quarter ended September 30, 2019 . Stock-based compensation expenses for the nine months ended September 30, 2020 and 2019 , were $903,326 and $954,770 respectively. Other Selling, General and Administrative Expenses Other selling, general and administrative expenses (SG&A) were flat at $2.0 million for the quarters ended September 30, 2020 . Other SG&A expenses for the nine months ended September 30, 2020 increased by 6% to $6.0 million compared to $5.6 for the nine months ended September 30, 2019 . The other SG&A increase reflects our continued investment in our prepaid and PayFac growth initiatives. Depreciation and Amortization Depreciation and amortization totaled $0.4 million and $0.5 million for the quarters ended September 30, 2020 and September 30, 2019 , respectively, and $1.2 million and $1.5 for the nine months ended September 30, 2020 and September 30, 2019 , respectively. Other Income (Expense) Other income was $10,343 for the quarter ended September 30, 2020 compared to other income of $21,389 for the quarter ended September 30, 2019 . For the nine months ended September 30, 2020 and September 30, 2019 , other income was $23,712 and $66,660 , respectively. Lower interest-bearing merchant reserves and lower interest rates drove the lower other income. Net Loss We reported a net loss of $0.9 million for the quarter ended September 30, 2020 , as compared to a net loss of $1.2 million for the same period in the prior year. We reported a net loss of $3.1 million for the nine months ended September 30, 2020 , as compared to a net loss of $3.6 million for the same period in the prior year. We may incur future operating losses. To regain and sustain profitability, we must, among other things, incrementally grow and maintain our customer base, sell our ACH, credit card and prepaid product offerings to existing and new customers, implement successful marketing strategies, maintain and upgrade our technology and transaction-processing systems, provide superior customer service, respond to competitive developments, attract, retain and motivate personnel, and respond to unforeseen industry developments among other factors. We believe that our success will depend in large part on our ability to (a) grow revenues, (b) manage our operating expenses, (c) add quality customers to our client base, (d) meet evolving customer requirements, (e) adapt to technological changes in an emerging market, and (f) assimilate current and future acquisitions of companies and customer portfolios. We continue to invest in our sales force and technology platforms to drive revenue growth. In particular, we are focused on growing our ACH merchants, adding new software integrators and providing incremental services to existing merchants. In addition to our near-term growth opportunities, we are focused on leveraging and optimizing the infrastructure of the organization allowing expansion of our payment processing capabilities without significantly increasing our operating costs. Liquidity and Capital Resources At September 30, 2020 , we had $11.4 million of cash and cash equivalents, as compared to $2.1 million of cash and cash equivalents at December 31, 2019 . We received funding under the Paycheck Protection Program, or PPP, as part of the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, administered by the U.S. Small Business Administration. Under the terms of the Note, we received total proceeds of $813,500 bearing interest at a rate of 1% per annum with a maturity date of April 15, 2022. In addition, principal and interest payments will be deferred for the first ten months of the loan. The loan is subject to the terms and conditions applicable to loans administered by the U.S. Small Business Administration under the CARES Act. We used the proceeds for payroll costs and other permitted expenses. Under the terms of the PPP Loan, the principal may be forgiven if the loan proceeds are used for qualifying expenses as described in the CARES act, such as payroll costs, benefits, rent and utilities. We filed the loan forgiveness documentation with the Small Business Administration. How much of the loan, if any, may be subject to forgiveness will be determined by the Small Business Administration. On July 1, 2020, Topline Capital Partners, LP purchased 1,796,407 unregistered shares of common stock at an offering price of $1.67 per share in a private offering. The gross proceeds to us from the private offering were $3.0 million. On September 25, 2020, we entered into a placement agency agreement with Ladenburg Thalmann & Company Inc. for the issuance and sale of an aggregate of 4,705,883 shares of common stock at an offering price of $1.70 per share in a public offering. We agreed to pay Ladenburg a cash fee of equal to $0.12325 per share of common stock sold in the offering as well as legal fees and expenses of up to $100,000. The net proceeds to the Company from the public offering were $7.4 million, after deducting the offering expenses and fees payable by the Company. Cash Flows We reported a net loss of $0.9 million for the quarter ended September 30, 2020 and a net loss of $3.1 million for the nine months ended September 30, 2020 . At September 30, 2020 , we had an accumulated deficit of $65.2 million. Additionally, we had working capital of $10.4 million and $1.3 million at September 30, 2020 and December 31, 2019 , respectively. Net cash provided by operating activities, including merchant reserve funds, prepaid card load assets and net lease assets was $4.6 million and net cash used by operating activities of $3.0 million for the nine months ended September 30, 2020 and September 30, 2019 , respectively. Excluding merchant reserves, prepaid card load assets and lease right-of-use assets and liabilities, our cash used by operating activities was $1.0 million and $0.9 million for the nine months ended September 30, 2020 and September 30, 2019 , respectively. We continue to invest resources and infrastructure in our prepaid and PayFac integrated payments growth initiatives to achieve scale in these business lines. Net cash used by investing activities was $582,347 and $536,405 for the nine months ended September 30, 2020 and September 30, 2019 , respectively. The primary drivers of the capital expenditures were development costs associated with internal use software capitalization. 14 Table of Contents Net cash provided from financing activities for the nine months ended September 30, 2020 and September 30, 2019 was $10.9 million and $1.7 million, respectively. The 2020 cash provided from financing activities was as a result of the $813,500 proceeds from the PPP loan in April, 2020 plus the July proceeds of $3.0 million from Topline Capital Partners, LP and net proceeds of $7.4 million from a public offering in September, 2020. The 2019 net cash provided by financing activities was a result of the February 2019 public offering which raised $1.8 million in net proceeds. Material Trends and Uncertainties In March 2020, the outbreak of COVID-19 was recognized as a pandemic by the World Health Organization, and the outbreak has spread to all parts of the United States, including in the markets in which we operate. The ongoing COVID-19 outbreaks have had a notable impact on general economic conditions, including but not limited to the temporary closures of many businesses, “shelter in place” and other governmental regulations, reduced consumer spending due to both job losses and other effects attributable to the COVID-19. There remain many uncertainties as a result of the pandemic. As a result of the spread of COVID-19, economic uncertainties could continue to impact our operations. Any potential incremental financial impact is unknown at this time. While we have seen a limited impact to our operations and results in the third quarter of 2020 , we cannot determine the long-term impact on our business going forward. We experienced a decline in our ACH consumer lending businesses during the second and third quarter. We also experienced an April decline our Singular credit card portfolio primarily attributable to mandated closures to dental practices in the portfolio. Revenues from these merchants increased in starting in May and June 2020 and have returned to pre-COVID-19 levels as these merchants have reopened. The COVID-19 pandemic has caused various business disruptions through mandated and voluntary closings. While the closures were temporary, there is considerable uncertainty whether new closures will occur in hot spot areas. We are implementing actions as prescribed by government health officials. All of our offices are currently open and we continue to monitor the impact of the COVID-19 outbreak closely. We have limited exposure to retail, or face-to-face processing and our non-face-to-face processing can continue should we have to operate remotely. We saw an increase in remote payment processing and our credit card processing. We expect this trend to continue in the remainder of the year. Off-Balance Sheet Arrangements We currently have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. As a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item. 15 Table of Contents