10-Q 1 digitalcourier10q.txt 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 December 31, 2001 ----------------- [ ] 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 0-20771 DIGITAL COURIER TECHNOLOGIES, INC. ------------------------------------------------------ (exact name of registrant as specified in its charter) Delaware 87-0461856 ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 348 East 6400 South, Suite 220 Salt Lake City, Utah 84107 (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) (801) 266-5390 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 13 and 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 No X -------------- --------------- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. The Registrant has Common Stock with $.0001 par value, of which 43,614,448 shares were issued and outstanding as of February 14, 2002. PART I. FINANCIAL INFORMATION ITEM 1. Condensed Consolidated Financial Statements (unaudited)
DIGITAL COURIER TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS ASSETS ------ December 31, 2001 June 30, (unaudited) 2001 ------------ ------------ CURRENT ASSETS: Cash $ 204,870 $ 712,264 Restricted cash 18,441,908 31,008,230 Deposit with payment processor -- 2,067,148 Receivable from payment processors 247,339 1,154,607 Current portion of prepaid software license 2,247,684 2,247,684 Prepaid expenses and other current assets 107,037 170,262 ------------ ------------ Total current assets 21,248,838 37,360,195 ------------ ------------ PROPERTY AND EQUIPMENT: Computer and office equipment 8,365,139 8,353,347 Furniture, fixtures and leasehold improvements 593,416 593,416 ------------ ------------ 8,958,555 8,946,763 Less accumulated depreciation and amortization (7,031,465) (5,999,889) ------------ ------------ Net property and equipment 1,927,090 2,946,874 GOODWILL AND OTHER INTANGIBLE ASSETS, net of accumulated amortization of $57,004,248 and $54,472,885 respectively 13,401,064 15,932,427 PREPAID SOFTWARE LICENSE, net of current portion 2,809,605 3,933,447 ------------ ------------ $ 39,386,597 $ 60,172,943 ============ ============
See accompanying notes to condensed consolidated financial statements. 2
DIGITIAL COURIER TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Continued) LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ December 31, 2001 June 30, (unaudited) 2001 ------------- ------------- CURRENT LIABILITIES: Notes payable $ 957,365 $ 1,656,655 Current portion of capital lease obligations 41,109 43,342 Accounts payable 1,107,184 723,067 Merchant reserves 17,616,999 28,074,138 Accrued merchant payable 1,026,889 2,920,085 Settlements due to merchants 202,101 741,057 Accrued chargebacks 1,950,684 1,727,637 Due to processor 17,000 2,484,107 Deferred revenue 324,776 486,776 Other accrued liabilities 2,222,903 2,689,339 ------------- ------------- Total current liabilities 25,467,010 41,546,203 ------------- ------------- CAPITAL LEASE OBLIGATIONS, net of current portion 28,471 49,839 ------------- ------------- COMMITMENTS AND CONTINGENCIES: Convertible Preferred Stock, 2,500,000 shares authorized, Series A - $10,000 par value 360 shares outstanding (liquidation preference of $3,600,000) Series B par value $0.0001- 4 and 0 shares outstanding respectively 3,600,000 3,600,000 ------------- ------------- STOCKHOLDERS' EQUITY: Common stock, $.0001 par value; 75,000,000 shares authorized, 43,614,444 and 40,044,444 shares issued and outstanding respectively 4,361 4,004 Additional paid-in capital 279,705,487 279,355,836 Warrants outstanding 1,363,100 1,363,100 Subscriptions receivable (12,000) (12,000) Accumulated deficit (270,769,832) (265,734,039) ------------- ------------- Total stockholders' equity 10,291,116 14,976,901 ------------- ------------- $ 39,386,597 $ 60,172,943 ============= =============
See accompanying notes to condensed consolidated financial statements. 3
DIGITAL COURIER TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000 (Unaudited) 2001 2000 ------------- ------------- REVENUE $ 4,668,676 $ 9,137,924 COST OF REVENUE 2,958,635 6,198,506 ------------- ------------- Gross margin 1,710,041 2,939,418 ------------- ------------- OPERATING EXPENSES: Depreciation and amortization 2,323,146 13,489,448 Impairment writedown of goodwill -- 142,000,000 Selling, general and administrative 1,480,840 3,373,014 Research and development 119,491 513,257 Chargebacks -- 249,000 ------------- ------------- Total operating expenses 3,923,477 159,624,719 ------------- ------------- OPERATING LOSS (2,213,436) (156,685,301) ------------- ------------- OTHER INCOME (EXPENSE): Gain on return of common shares -- 3,109,544 Interest and other income 1,387 91,726 Interest and other expense (44,492) (34,749) ------------- ------------- Net other income (expense) (43,105) 3,166,521 ------------- ------------- LOSS BEFORE INCOME TAXES (2,256,541) (153,518,780) INCOME TAX -- -- ------------- ------------- NET LOSS $ (2,256,541) $(153,518,780) ------------- ------------- NET LOSS PER COMMON SHARE: Basic and Diluted $ (0.05) $ (3.64) ============= ============= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: Basic and Diluted 42,993,574 42,164,840 ============= =============
See accompanying notes to condensed consolidated financial statements. 4
DIGITAL COURIER TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE SIX MONTHS ENDED DECEMBER 31, 2001 AND 2000 (Unaudited) 2001 2000 ------------- ------------- REVENUE $ 9,311,571 $ 18,633,834 COST OF REVENUE 5,954,840 12,352,131 ------------- ------------- Gross margin 3,356,731 6,281,703 OPERATING EXPENSES: Depreciation and amortization 4,686,781 26,935,446 Impairment writedown of goodwill -- 142,000,000 Selling, general and administrative (includes $0 and ($285,346), respectively of non-cash, stock-based expense) 3,089,465 5,742,239 Research and development (includes $0 and ($363,954), respectively of non-cash, stock-based expense) 252,882 594,251 Chargebacks 250,000 249,000 Visa and Mastercard Fines 60,000 -- ------------- ------------- Total operating expenses 8,339,128 175,520,936 ------------- ------------- OPERATING LOSS (4,982,397) (169,239,233) ------------- ------------- OTHER INCOME (EXPENSE): Gain on return of common shares -- 3,109,544 Interest and other income 42,984 174,188 Net loss on sale of assets -- (15,383) Interest and other expense (96,380) (60,904) ------------- ------------- Net other income (expense) (53,396) 3,207,445 ------------- ------------- LOSS BEFORE INCOME TAXES (5,035,793) (166,031,788) INCOME TAX -- -- ------------- ------------- NET LOSS $ (5,035,793) $(166,031,788) ------------- ------------- NET LOSS PER COMMON SHARE: Basic and Diluted $ (0.12) $ (3.67) ============= ============= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: Basic and Diluted 41,519,009 45,282,149 ============= =============
See accompanying notes to condensed consolidated financial statements. 5
DIGITAL COURIER TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED DECEMBER 31, 2001 AND 2000 (Unaudited) Increase (Decrease) in Cash 2001 2000 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (5,035,793) $(166,031,788) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 4,686,781 26,935,446 Loss from impairment writedown of goodwill -- 142,000,000 Gain on return of common shares -- (3,109,544) Compensation (income) related to cashless exercise feature of stock options -- (649,300) Loss on disposition of equipment -- 15,383 Changes in operating assets and liabilities Restricted cash 12,566,322 (14,088,458) Trade accounts receivable -- (1,150,998) Deposit with payment processor 2,067,148 -- Receivable from payment services processor 907,268 3,892,717 Other receivables -- 477,935 Deferred revenue (162,000) 570,000 Prepaid expenses and other current assets 63,225 (531,695) Other assets -- 329,356 Accounts payable 384,117 (1,665,621) Settlements due to merchants (2,432,152) 2,462,489 Merchant reserves (10,457,139) 2,211,510 Due to payment processor (2,467,107) 1,322,798 Accrued chargebacks 223,047 (572,476) Accrued liabilities (116,428) (2,887,684) ------------- ------------- Net cash provided by (used in) operating activities $ 227,289 $ (10,469,930) ------------- -------------
See accompanying notes to condensed consolidated financial statements. 6
DIGITAL COURIER TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED DECEMBER 31, 2001 AND 2000 (Continued) (Unaudited) Increase (Decrease) in Cash 2001 2000 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (11,792) (855,802) Proceeds from sale of equipment -- 2,543 ----------- ----------- Net cash provided by (used in) investing activities (11,792) (853,259) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuance of common stock upon exercise of warrants -- 5,200,000 Principal payments on capital lease obligations (23,601) (315,525) Principal payments on borrowings (699,290) -- ----------- ----------- Net cash provided by (used in) financing activities (722,891) 4,884,475 ----------- ----------- NET DECREASE IN CASH (507,394) (6,438,714) CASH AT BEGINNING OF PERIOD 712,264 7,382,773 ----------- ----------- CASH AT END OF PERIOD $ 204,870 $ 944,059 ----------- =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest $ 103,455 $ 76,287
NONCASH FINANCING AND INVESTING ACTIVITIES: The company issued 3,570,000 shares of stock in October 2001 to settle a legal obligation discussed in Note 4 to the financial statements. See accompanying notes to condensed consolidated financial statements. 7 DIGITAL COURIER TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1 - INTERIM CONDENSED FINANCIAL STATEMENTS The accompanying interim condensed consolidated financial statements as of December 31, 2001 and for the three and six months ended December 31, 2001 and 2000 are unaudited. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation have been included. The financial statements are condensed and, therefore, do not include all disclosures normally required by generally accepted accounting principles. These financial statements should be read in conjunction with the Company's annual financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2001. The results of operations for the three and six months ended December 31, 2001 are not necessarily indicative of the results to be expected for the entire fiscal year ending June 30, 2002. Certain previously reported amounts have been reclassified to conform to the current period presentation. These reclassifications had no affect on the previously reported net loss. During the three months ended December 31, 2001 the Company's operations were basically break even after excluding non-cash expenses for amortization and depreciation. During the six months ended December 31, 2001 the Company's operations generated a loss from operations of $295,616 (unaudited), after excluding non-cash expenses for amortization and depreciation. Since its inception, our business has incurred significant losses, and as of December 31, 2001 had negative working capital of $4,218,172. As a result, there is uncertainty about the Company's ability to continue as a going concern, which was stated in our auditor's report on the Company's financial statement for the 2001 fiscal year. While management projects improved cash flows from operating activities, there can be no assurance that management's projections will be achieved. Management may also be required to pursue sources of additional funding to meet marketing and expansion objectives. There can be no assurance that additional funding will be available or, if available, that it will be available on acceptable terms or in required amounts. NOTE 2 - ACQUISITIONS AND DISPOSITIONS DataBank International, Ltd. As approved by the shareholders of the Company at a Special Shareholders Meeting on October 5, 1999, the Company acquired all of the outstanding stock of DataBank, a credit card processing company organized under the laws of St. Kitts. On that date the shareholders of DataBank were issued 16,600,000 shares of the Company's common stock valued at $88,195,800 (based on the quoted market price of the Company's common stock on the date the Company and DataBank entered into the merger agreement). If DataBank met certain performance criteria, as defined in the acquisition documents, the Company would be required to issue up to an additional 13,060,000 shares of common stock to the former shareholders of DataBank. The acquisition of DataBank has been accounted for as a purchase and 8 the results of operations of DataBank are included in the accompanying consolidated financial statements since the date of acquisition. The tangible assets acquired included $515,674 of cash, $411,313 of receivables, and $185,000 of equipment. Expenses incurred in connection with the acquisition were $87,577. Liabilities assumed consisted of $1,820,096 of accounts payable and accrued liabilities. The excess of the purchase price over the estimated fair market value of the acquired net assets on October 5, 1999 of $88,991,486 was recorded as goodwill and was being amortized over a period of 5 years. On January 13, 2000, the Board of Directors of the Company elected to issue the 13,060,000 contingent shares, in light of the achievement of performance criteria, with an approximate 12.5% discount in the number of shares to the former shareholders of DataBank. Therefore, the Company issued an additional 11,427,500 shares of the Company's common stock valued at $108,561,250 (based on the quoted market price of the Company's common stock on the date of the Board of Directors meeting). This additional amount was recorded as goodwill and was being written off over 57 months beginning January 2000. Subsequent to the acquisition of DataBank, the Company became aware of an additional $581,000 of liabilities related to DataBank's operations prior to the acquisition. This additional amount was recorded as an adjustment to goodwill and was being amortized over the remainder of the five-year period. During the quarter ended December 31, 2000, the Company assessed the realizability of the recorded goodwill and $134,228,591 was written off as impaired. At June 30,2001, the Company assessed the realizability of the remaining goodwill under current business conditions and recorded an additional writedown of $6,494,142. MasterCoin In April, 2000, the Company entered into agreements to purchase certain software, a merchant portfolio, and certain equipment from various entities referred to jointly as MasterCoin. The Company's Board of Directors approved a total purchase price of $2.9 million for all of the assets to be acquired with the assumption that Mr. James Egide, the then CEO and Chairman of the Company, would negotiate the acquisition and allocate the total price among the assets acquired. The software, which will allow the Company to address the "Server Wallet" market opportunity, was acquired through a Software Purchase and Sales Agreement with MasterCoin, International, Inc. ("MCII") in exchange for $1,000,000 in cash. The Company acquired all rights to MCII's e-commerce and e-cash software. The owners of MCII included Don Marshall, who was then President and a Director of the Company. Mr. Marshall did not accept any remuneration from the Company as a result of the transaction. Since the acquisition, the Company has invested an additional $165,000, accounted for as research and development expense, to complete the development of the software. Management believes the potential market for the software is significant and intends to begin marketing the software during fiscal 2002. The cost of the software and additional development costs will be amortized over the life of the software that is estimated to be three years. 9 The merchant portfolio was acquired through a Portfolio Purchase and Sale Agreement with the sellers who had developed and acquired the merchant portfolio of MasterCoin of Nevis, Inc. and MasterCoin Inc. in exchange for $700,000 in cash. The Company acquired all rights, title and interests in and to the portfolio. The Company paid $400,000 at closing with the remaining $300,000 payable subject to the performance of the portfolio. The portfolio is currently generating revenues for the Company. The Sellers included Don Marshall, the then President and Director of DCTI, and a person who was hired by the Company in July 2000. Mr. Marshall did not accept any remuneration from the Company as a result of the transaction. The cost of the portfolio was amortized over twelve months, the estimated average service period for the merchants acquired. The equipment was acquired through an Asset Purchase and Sale Agreement with MasterCoin, Inc., a Nevada corporation (MC) in exchange for $1,200,000 in cash. The Company acquired title to equipment located in St. Kitts, British West Indies consisting of computers, a satellite system, phone systems and leasehold improvements which the Company anticipated would be useful in exploiting the Server Wallet market opportunity referred to above. At the date of the transaction, Mr. James Egide, the former CEO and Chairman of the Company, was a shareholder in MC. In the course of closing fiscal 2000, the Company reviewed the value of the equipment and determined that through age and non-use the book value of the assets was impaired. Upon assessing a current realizable value of $300,000, the Company wrote off the difference of $900,000 to expense. The remaining balance is being depreciated over three years. CaribCommerce, Ltd. Effective January 1, 2000, the Company acquired all of the outstanding stock of CaribCommerce, a sales and marketing organization. The shareholders of CaribCommerce were issued 600,000 shares of the Company's common stock valued at $4,837,800 (based on the quoted market price of the Company's common stock on the date of the acquisition) and $150,000 in cash. The acquisition of CaribCommerce has been accounted for as a purchase and the results of operations of CaribCommerce are included in the accompanying financial statements since the date of acquisition. The Company did not receive any tangible assets and assumed no liabilities. The Company has employed two former shareholders of CaribCommerce without employment agreements. The Company was assigned a service agreement with a bank as a result of the acquisition. The term of the agreement is four years dating from August 1999. The purchase price of $4,987,800 was recorded as an intangible asset and was being amortized over a period of 44 months, the remaining term of the service agreement. The service agreement allows the Company to develop a processing program with the bank. During the quarter ended March 31, 2001, the Company evaluated the potential benefits associated with the service agreement and concluded that it would not be in the best interests of the Company to pursue a relationship with the bank. Upon this determination, the Company assessed the 10 realizability of the remaining unamortized goodwill associated with the acquisition and having determined it to be impaired, wrote off the full amount of $3,429,113. Digital Courier International, Inc. Effective March 17, 1998, the Company entered into a Stock Exchange Agreement (the "Exchange Agreement") with DCII. Pursuant to the Exchange Agreement, the Company agreed to issue 4,659,080 shares of its common stock valued at $14,027,338 to the shareholders of DCII. The issuance of the common shares was recorded at the quoted market price on the date of acquisition. The acquisition was approved by the shareholders of the Company on September 16, 1998 and was accounted for as a purchase. During the quarter ended December 31, 2000, the Company assessed the realizability of the goodwill associated with this and other acquisitions. As a result of that analysis, unamortized goodwill of $6,539,338 associated with DCII was written off as impaired. Access Services, Inc. Effective April 1, 1999, the Company acquired all of the outstanding stock of Access Services, a credit card processing company. The shareholders of Access Services were issued 300,000 shares of the Company's common stock valued at $1,631,400 (based on the quoted market price of the Company's common stock on the date of the acquisition), $75,000 in cash and warrants to purchase 100,000 shares of the Company's common stock at $5.50 per share valued at $440,000. The acquisition of Access Services has been accounted for as a purchase and the results of operations of Access Services are included in the accompanying consolidated financial statements since the date of acquisition. The excess of the purchase price over the estimated fair market value of the acquired net assets of $2,327,866 was recorded as goodwill and was being amortized over a period of 5 years. During the quarter ended December 31, 2000 the Company assessed the realizability of the goodwill associated with this and other acquisitions. As a result of that analysis, unamortized goodwill of $1,412,071 associated with Access Services was written off as impaired. SB.com, Inc. Effective June 1, 1999, the Company acquired all of the outstanding stock of SB.com, a credit card transaction processing company. The shareholders of SB.com were issued 2,840,000 shares of the Company's common stock valued at $17,838,040 (based on the quoted market price of the Company's common stock on the date of the acquisition). The acquisition of SB.com has been accounted for as a purchase and the results of operations of SB.com are included in the accompanying consolidated financial statements since the date of acquisition. The former shareholders of SB.com retained all tangible assets and liabilities existing at the date of acquisition. Accordingly, the purchase price of $17,838,040 has been recorded as goodwill and is being amortized over a period of 5 years. At June 30, 2001, the Company assessed the realizability of the remaining goodwill under current business conditions and recorded an additional writedown of $4,199,858. 11 In connection with the acquisition of SB.com, the Company loaned $500,000 to each of four of SB.com's prior shareholders. The notes receivable bear interest at 6 percent, are unsecured, and were due at the earlier of June 30, 2001 or from the proceeds from the sale of DCTI common stock held by the individuals. Since the stated interest rate on the notes of 6 percent was less than the current market interest rate at the inception of the notes, the notes have been discounted using a 10 percent interest rate. The notes remain outstanding at December 31, 2001 pending resolution of registration rights claims made by the Noteholders as discussed further in Note 4. Management will aggressively pursue collection of the notes, however, it was considered prudent to fully reserve the amounts due in the quarter ended June 30, 2001. A reserve of $2,197,596 was recorded at that time. In addition, the Company has stopped making payments on a severance agreement with one of the prior SB.com shareholders pending resolution of these matters. Books Now, Inc. In January 1998, the Company acquired all of the outstanding stock of Books Now, a seller of books through advertisements in magazines and over the Internet. The shareholders of Books Now received 100,000 shares of the Company's common stock valued at $312,500 and an earn-out of up to 262,500 additional common shares. The issuance of the common shares was recorded at the quoted market price on the date of acquisition. The acquisition was accounted for as a purchase and the results of operations of Books Now are included in the accompanying consolidated financial statements since the date of acquisition. The excess of the purchase price over the estimated fair market value of the acquired assets of $616,764 was recorded as goodwill and was being amortized over a period of 5 years. Effective May 28, 1999, the Company entered into an Asset Purchase Agreement with ClickSmart, a new corporation formed for the purpose of combining the assets acquired from the Company with certain assets contributed by Video Direct Inc. Pursuant to the agreement, the Company exchanged certain assets for 19.9 % of the common stock of ClickSmart.com. The assets exchanged by the Company primarily related to the operations of Books Now and Videos Now and consisted of $57,183 of equipment, $52,204 of prepaid advertising and certain intangibles represented by goodwill of $442,020. ClickSmart did not assume any existing liabilities related to Books Now and Videos Now. The operations of Books Now and Videos Now were not generating positive cash flows prior to the exchange and the operations of Video Direct did not have any history of profitability. Due to these uncertainties with respect to the future cash flows and profitability of ClickSmart.com, at the time of the exchange management determined that the Company's investment in ClickSmart.com of $551,407 should be written off. Prior to the exchange, management was considering the termination of the Books Now and Videos Now operations. In connection with the exchange the Company loaned ClickSmart.com $300,000 under a promissory note bearing interest at 8 percent and due in May of 2000. In May 2000, Clicksmart.com was sold to Ubrandit.com ("UBI") for 300,000 shares of UBI, of which the Company received 100,000 shares. The UBI shares are available for resale as of May 2001. The Company has not recorded an asset relative to the shares as their value remains uncertain. The Company sold 20,000 shares of the stock during the quarter ended September 30, 2001, recording a gain of $1,286. 12 Sale of Certain Assets Related to WorldNow On July 15, 1998, the Company signed an agreement to sell a portion of its assets related to the Company's Internet-related business branded under the "WorldNow" and "WorldNow Online Network" marks to Gannaway Web Holdings, LLC ("Gannaway"). The assets primarily related to the national Internet-based network of local television stations. Pursuant to the asset purchase agreement, Gannaway agreed to pay $487,172 (less certain amounts as defined) in installments over a one-year period from the date of closing and agreed to pay earn-out amounts of up to $500,000. The earn-out amounts are calculated as ten percent of monthly revenues actually received by Gannaway in excess of $100,000 and are to be paid quarterly. Subsequent to the sale through December 31, 2001, the Company has not received any earn-out payments. NOTE 3 - NET LOSS PER COMMON SHARE Basic net loss per common share ("Basic EPS") excludes dilution and is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share ("Diluted EPS") reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock. The computation of Diluted EPS does not assume exercise or conversion of securities that would have an antidilutive effect on net loss per common share. Options to purchase 4,247,049 and 4,047,691 shares of common stock at weighted average exercise prices of $0.82 and $5.75 per share as of December 31, 2001 and 2000, respectively, warrants to purchase 1,990,000 shares of common stock at weighted average exercise prices of $7.20 per share as of December 31, 2001 and 2000, and 360 shares of Series A preferred stock convertible to 800,000 shares of common stock at $4.50 per share at December 31, 2001 and 2000 were not included in the computation of Diluted EPS. The inclusion of the options, warrants and preferred stock would have been antidilutive, thereby decreasing net loss per common share. NOTE 4 - COMMITMENTS AND CONTINGENCIES Purchase Commitment On November 28, 1996, the Company entered into an agreement with Sprint Communications Company L.P. ("Sprint") to establish special prices and minimum purchase commitments in connection with the use of communication products and services. This agreement was terminated and superceded by an agreement effective July 15, 1997. This agreement was amended further on February 28, 2000, reducing the commitment for the first two years of the agreement to actual expenditures and establishing the Company's commitment for the third and final year to a minimum usage of at least $240,000. The agreement expires in February 2003. 13 Bank Commitment On June 6, 2000, the Company entered into an agreement with the St. Kitts Nevis Anguilla National Bank Limited ("SKNANB") whereby the Company would provide SKNANB with services relating to credit card processing. These services include fraud screening, pre- and post- authorization, fraud and loss prevention, technical services and the right to refer merchants to be considered by SKNANB for inclusion in their processing program. The Company is required to maintain a security deposit with SKNANB in the amount of $6,400,000. SKNANB collects 80 basis points for all credit card settlements processed through SKNANB. This payment for basis points shall not be less than $100,000 per month. Legal Matters ePayment Solutions ("EPS") was a processing client of DataBank. Unbeknownst to present management of the Company, various non-EPS owned merchants were sending credit card payments to EPS, who in turn processed the transactions with the Company under the EPS name. EPS in turn was supposed to take its settlement funds and disburse them to its various merchants. When the present management began reviewing its merchants for risk assessment purposes, it discovered that EPS was indeed factoring, a violation of Visa/MasterCard regulations. It also began seeing large chargebacks in EPS's account and therefore larger reserves were withheld in the EPS account to cover expected chargebacks and in preparation for merchant termination should EPS be unwilling to sign the merchants directly with DCTI/SKNANB. As of December 31, 2001, funds held for EPS totaled approximately $1.3 million. The Company believes that adequate reserves are being held for all remaining chargebacks and fines. The Company has been served with injunctions issued by the High Court of Justice, Federation of St. Christopher and Nevis on behalf of several merchants which were doing business with EPS prohibiting the Company from disbursing the funds held for EPS's account until further court order. The Company is complying with these injunctions. During the quarter ended March 31, 2001 certain shareholders made claims against the Company that the Company should have filed registration statement with the Securities and Exchange Commission at various times during fiscal 2000 to allow specific shareholders to market their otherwise restricted common shares in the Company. The Company is continuing to work to resolve the various claims. In addition, other shareholders have made claims against the Company alleging in part that the delisting of the Company's stock from Nasdaq violated certain provisions of their investment agreements with the Company. Also, the Company has stopped making payments on a severance agreement with one of the prior SB.com shareholders pending resolution of these matters. On October 16, 2001, the Company entered into a settlement with a shareholder regarding the Company's alleged failure to register restricted shares of the Company's common stock, as well as certain other alleged breaches of his contract rights. The shareholder received the shares in the course of the Company's acquisition of DataBank in October, 1999. The shareholder had claimed that the Company was obligated to periodically register a portion of those restricted shares with the SEC following the DataBank transaction and subsequently failed to do so. In July 2001, the shareholder filed a lawsuit against the Company in federal court in Salt Lake City, Utah. The shareholder's complaint sought damages of $10,500,000. The Company negotiated a settlement with the shareholder whereby the shareholder was issued 3,500,000 shares of the 14 Company's restricted common stock. As part of the settlement, the shareholder granted the Company's current Chairman an irrevocable proxy to vote these shares for a period of up to three years. In addition, the shareholder received a promissory note from the Company for $800,000 to be paid in quarterly installments, beginning with the quarter ending December 31, 2001.The Company's quarterly payments will be based upon a percentage of the Company's earnings before taxes, depreciation, and amortization, if any, during each quarter, but the note will have a final maturity date in October 2004. Interest of 15% per annum will not begin accruing on the note until 2003. To assure payment under the note, the Company also executed a confession of judgment, which may not be entered absent a default, in an amount substantially in excess of the principal amount of the note. Finally, as part of the settlement, the Company and the shareholder agreed to modify a prior severance agreement between them. The shareholder has fully released the Company from all claims stated in the complaint. The total amount of the settlement of $1,447,500 was recorded at June 30, 2001 as an expense and an accrued liability on the balance sheet. The value of the shares issued was recorded at the price of the Company's common stock on October 16, 2001. Additionally, as part of the settlement, the shareholder was allowed to keep 70,000 shares previously promised to be returned to the Company. The Company processed a limited number of transactions through the Bank of Nevis, located in the British West Indies ("the Bank") during fiscal 2000. DataBank, acquired by the Company in October 1999, processed through the Bank prior to the acquisition. In February 2000, the Bank informed the Company that unspecified amounts were due the Bank for periods before and after the DataBank acquisition due to processing errors. The Company responded that, in fact, it believes the Bank owes the Company certain amounts that were never settled after the Company ceased processing. The Bank engaged an audit firm to analyze the matter and the results of that audit are being discussed with the Bank today. The Bank claims the Company owes it $581,000 for the period prior to the DataBank acquisition and $500,000 for the period after the acquisition. The Company believes that the $581,000 was incorrectly overpaid by the Bank to various merchants and that it is the obligation of the Bank to recover these amounts from those merchants. The Company is liable for any unrecovered overpayments as DataBank's liabilities were assumed by the Company in the acquisition. During fiscal 2000 the Company increased the liabilities assumed in the DataBank transaction by $581,000 and increased acquired goodwill by the same amount. The Company believes that the Bank's claim regarding the $500,000 amount is erroneous as it includes one merchant that was never a client of DataBank or the Company and another merchant whose payments to the Bank have not been considered in the audit. The Company wrote off a receivable due from the Bank of $255,531 in fiscal 2000. Management will continue to work with the Bank and their auditors and believes the issues with the Bank will be settled during fiscal 2002 and that no material adverse impact will result. In November 2000 a plaintiff filed suit against the Company and a former President and director of the Company alleging that the plaintiff is the assignee of several persons and entities, which owned interests in DataBank which the Company acquired in October 1999. The plaintiff alleges that its assignors were not paid their alleged share of the purchase price by the former 15 President and director and is suing, therefore, for breach of contract. The plaintiff has recently added as a defendant a former Chief Executive Officer and Chairman of the Company. The Company has filed several motions to dismiss the complaint, certain of which the court has granted, including one without leave to amend. The Company anticipates moving to dismiss the recent amendment to the complaint and anticipates that motion will be heard by the court in April 2002. While the Company intends to vigorously defend this action, no assurance can be given as to the ultimate outcome or resolution of this action. During fiscal 2000, the Company received information indicating that its Chief Executive Officer and Chairman at the time, Mr. James Egide, may have had a conflicting, undisclosed, interest in DataBank at the time the Company acquired it. Specifically, there were two general allegations. First, it was alleged that he had been a part of a group that had acquired 75% of the stock of DataBank (the "Group DataBank Transaction") approximately 2 months before the Company entered into a letter of intent to acquire it. That earlier purchase was for 75% of DataBank at a purchase price of $6.2 million, while the Company's subsequent acquisition, deemed fair and equitable at the time, was priced at 28,027,500 shares of the Company's common stock. Second, it was alleged that Mr. Egide did not adequately disclose to the Company his ownership position in DataBank at or prior to the time of the Company's acquisition of DataBank. The Company's Board of Directors formed a special committee of directors, each of whom had no involvement in the transaction themselves, to investigate these allegations; as finally constituted, that committee consisted of Mr. Ken Woolley and Mr. Greg Duman (the "Special Committee"). The Special Committee, in turn, retained Munger, Tolles & Olson LLP, as outside counsel to conduct an investigation into this matter (the "Internal Investigation"). During this period, Mr. Egide resigned first as Chief Executive Officer and, later, as a director and as Chairman of the Board of Directors. Additionally, some DataBank shareholders who had received shares of the Company pursuant to the DataBank acquisition returned some or all of the DCTI shares they had received, although they did not present the Company with any signed agreement or otherwise document any right of the Company to take action with respect to the returned shares. (Approximately 7.7 million DCTI shares were received by the Company in this fashion.) All of these facts were promptly disclosed by the Company in press releases as they occurred. The investigation was conducted between August and October of 2000. In the process of conducting its investigation, the Special Committee's counsel retained private investigators, reviewed all relevant documents in the Company's possession and conducted interviews of some 11 individuals. On October 25, 2000, they released the "Summary and Conclusions" of their final report. (The Summary and Conclusions were released while the remainder of the report was in technical preparation and review in order to facilitate certain corporate plans, including consummation of settlement negotiations with certain individuals, and to permit the preparation of annual financial statements for submission to the Company's independent auditors, both of which were dependent to some degree upon the results of the report.) The results of the investigation were inconclusive. Conflicting testimony was received as to the ownership of certain offshore entities, and dispositive evidence was not found. As to certain other factual questions, more subtle 16 differences of interpretation were identified that could have had legal significance. For example, there were conflicting views as to whether the initial purchase of DataBank shares was made available to the Company. Moreover, there were significant uncertainties as to the legal effect of the different possible factual interpretations. In the view of counsel to the Special Committee, it was not fairly predictable what version of the facts a court would find credible. Also, it was not clear what legal conclusions a court would reach, or what remedies it would find to be available and appropriate, even if the factual questions were not in dispute. At approximately the time that the investigation was being completed, Mr. Woolley entered into discussions with certain of the stockholders who received DCTI shares in the DataBank acquisition. Ultimately, 7 stockholders agreed to return to the Company 8,637,622 DCTI shares in settlement of any claims by the Company of impropriety against them in connection with the transaction. These shares included the DCTI shares that had earlier been returned to the Company, but this time the Company's right to accept and cancel the shares was made clear. Also included in the returned shares were 1,120,000 shares returned by Mr. Don Marshall, the Company's President, and a former controlling shareholder of DataBank (before the Group DataBank Transaction). The Special Committee agreed that Mr. Marshall had no responsibility or liability with respect to any of the alleged improprieties, but he also agreed that, as the Company's President, and a former DataBank stockholder, he should not benefit through an increased percentage ownership in the Company from the return of stock by others from the DataBank transaction. Accordingly, his return of shares was designed to preserve, after the return of all the shares involved, his percentage interest in the Company at a level equal to what it was immediately before any such share returns. In the view of counsel to the Special Committee who had conducted the investigation, the settlement of claims in exchange for the return of shares was a favorable settlement for the Company in comparison to the certain expenses, and uncertain recoveries, that would have attended any litigation of the matter. After careful consideration of the final report of the Special Committee's counsel, the Company's Board of Directors continues to believe that the Company paid a fair price for DataBank. The shares returned to the Company were accounted for as a settlement of claims and credited to income at the time of settlement. Accordingly, during the quarter ended December 31, 2000 the Company recorded a gain from settlement of $3,109,544 based on the quoted market price of the Company's common stock at the time trading was allowed to resume on the OTC. In January 2002, the Company filed a lawsuit in Federal Court in San Francisco in response to the "Consent Statement" which was earlier filed by a group of shareholders led by Mr. James Egide (the Egide group), the Company's onetime Chairman and CEO. The Company is asking the Court to rule that the Egide group's Consent Statement is false and misleading and that it violates the SEC Act of 1934. The Company is requesting injunctive relief such that shareholders are not allowed to vote until the Egide group files a truthful Proxy. The Company believes that the Consent Statement filed by the Egide group contains numerous false and misleading statements, that it omits important information the shareholders should know about and that Mr. Egide and certain members of his group were officers, employees and Board Members during the time that gave rise to the losses which the Company has endured as it has written down the value of various acquisitions and expensed the costs of uncollectible chargebacks and credit card association fines. 17 In addition to the above, the Company is the subject of certain legal matters, which it considers incidental to its business activities. It is the opinion of management, after consultation with independent legal counsel, that the ultimate disposition of these legal matters will not individually or in the aggregate have a material adverse effect on the consolidated financial position, liquidity or results of operations of the Company. These claims, if determined adversely to the Company, could have a material adverse effect on the Company's financial position, liquidity and results of operations. NOTE 5 - CAPITAL TRANSACTIONS. Preferred Stock The Company is authorized to issue up to 2,500,000 shares of its $10,000 par value preferred stock. The Company's Board of Directors is authorized, without shareholder approval, to fix the rights, preferences, privileges and restrictions of one or more series of the authorized shares of preferred stock. As of September 30, 2001 and 2000, 360 shares were designated as Series A convertible preferred stock and 720 shares were designated as Series B convertible preferred stock. The Company issued the 360 shares of Series A during the year ended June 30, 1999. The Series A and Series B preferred shares are identical and rank pari passu with regard to liquidation, and other preferential rights, except that the conversion price for the Series A is $4.50 per share of common stock and the conversion price for the Series B is $7.00 per share of common stock. The Series A and B preferred shares are senior in right of payment, whether upon liquidation, dissolution, change of control or otherwise, to any other class of equity securities of the Company. On December 31, 2001, the Company issued one share of Series B Preferred Stock to each current member of the Board of Directors. The issuance of the Series B Preferred Stock was intended to create a mechanism whereby the Company's shareholders are assured a fair process for electing members to the Company's Board, including an opportunity to review accurate and fair proxy solicitations. The terms of the Series B Preferred Stock allow the holders, voting as one class, to elect 4 directors at each annual or special meeting at which directors are elected, or pursuant to any election of directors by written consent of the shareholders. A Series B director may be removed by a majority of the then serving directors with or without cause. The Series B Preferred Stock rights may be amended or repealed by any of the following: a vote of at least 70% of the Company's shareholders voting at a meeting with a record date on or prior to February 15, 2002, a vote of at least 60% of the Company's shareholders voting at a meeting with a record date after February 15, 2002, approval of at least 80% of shareholders of the Company acting by written consent, or unanimous approval (by vote or written consent) of the Series B Preferred shareholders voting as one class. The voting rights of the Series B Preferred Stock terminate automatically on June 30, 2003. On January 15, 2002 the Series B Preferred shares outstanding were converted to common stock, see discussion in Note 7, subsequent events. 18 Common Stock Issuances and Other Transactions During the year ended June 30, 2000, the Company issued 28,027,500 and 600,000 shares of common stock to acquire DataBank and CaribCommerce, respectively. During the year ended June 30, 2001, the Company issued 1,000,000 shares to Transaction Systems Architect, Inc. in connection with the exercise of warrants. Also, 8,637,622 shares were returned to the Company in connection with the settlement of the investigation into the DataBank acquisition as described in Note 4. On October 16, 2001 the Company issued 3,500,000 shares to a shareholder in settlement claims of regarding the Company's alleged failure to register restricted shares of the Company's common stock, as well as certain other alleged breaches of his contract rights as described in Note 4. Additionally, as part of the settlement, the shareholder was allowed to keep 70,000 shares previously promised to be returned to the Company. Stock Purchase Agreements with the Brown Simpson Strategic Growth Funds On November 24, 1998, the Company raised $1,800,000 by selling its common stock and warrants to purchase common stock to The Brown Simpson Strategic Growth Funds (the "Purchasers") pursuant to a Securities Purchase Agreement between the Company and the Purchasers (the "Purchase Agreement"). On December 2, 1998, the Company sold an additional $1,800,000 of common stock to the Purchasers and amended the Purchase Agreement and related documents (the "Amended Agreements"). Pursuant to the Purchase Agreement and Amended Agreements, the Purchasers acquired 800,000 shares of the Company's common stock and five-year warrants to purchase 800,000 additional shares ("Tranche A"). The exercise price for 400,000 of the warrants is $5.53 per share and the exercise price of the remaining 400,000 warrants is $9.49 per share. The exercise price of the warrants is subject by the Company if for 15 consecutive trading days, the closing bid price of the Company's stock is at least two times the then-current exercise price. Because the shares acquired by the purchasers were priced at a 10% discount from the quoted market price no value has been allocated to the warrants. The Amended Agreements also required the Company to sell to the Purchasers, and the Purchasers to purchase from the Company, an additional tranche of 800,000 units, each unit consisting of one share of the Company's common stock and a warrant to purchase one share of common stock (the "Tranche B Units"), if certain conditions are met. A condition to the sale of the Tranche B Units, among others, is that the closing bid price of the Company's common stock be more than $7 per share for 15 consecutive trading days. The price for the Tranche B Units is $7 per Unit and the exercise price of the warrants contained in the Tranche B Unit will be equal to 110% of the closing bid price of the Company's stock on the day of the sale of the Tranche B Units. The commitment to purchase the Tranche B Units was subsequently terminated (see discussion below). On March 3, 1999, the Company raised an additional $3,600,000 through the sale of Series A Convertible Preferred Stock (the "Preferred Stock") and warrants to purchase common stock to the Purchasers pursuant to a Securities Purchase Agreement between the Company and the Purchasers (the "March Purchase Agreement"). Pursuant to the March Purchase Agreement, the Purchasers acquired 360 shares of Series A Preferred Stock convertible into 800,000 shares of common stock and five-year warrants to purchase an additional 800,000 shares of common stock. The 19 Preferred Stock is convertible into common stock at a price of $4.50 per share of common stock. The initial exercise price for the warrants is $5.23 per share, subject to adjustment on the six month anniversary of the closing, to the lesser of the initial exercise price and the average price of the Company's common stock during any five consecutive business days during the 22 business days ending on such anniversary of the closing. The warrants are callable by the Company if for 30 consecutive trading days, the closing bid price of the Company's common stock is at least two times the then-current exercise price. The quoted market price of the Company's common stock on March 3, 1999 was $4.75 per share, which is greater than the $4.50 per share conversion price. The intrinsic value of the beneficial conversion feature of $200,000 was reflected in the accompanying consolidated financial statements as a preferred stock dividend. The March Purchase Agreement also requires the Company to sell to the Purchasers, and the Purchasers to purchase from the Company, an additional tranche of 1,600,000 units, each unit consisting of Series B Convertible Preferred Stock convertible into one share of the Company's common stock and a five-year warrant to purchase one share of common stock (the "Tranche D Units"), if certain conditions are met. A condition to the sale of the Tranche D Units, among others, is that the closing bid price of the Company's common stock be more than $7 per share for 130 consecutive trading days. The price for the Tranche D Units is $7 per Unit and the exercise price of the warrants contained in the Tranche D Unit will be $7.70. The March Purchase Agreement terminates the commitment for Tranche B Units previously disclosed. Subsequent to the end of the period, the Company reached a settlement with Brown Simpson. See Note 7 - Subsequent Events. Issuance of Common Stock to Transaction Systems Architects, Inc. On June 14, 1999, TSAI purchased 1,250,000 shares of the Company common stock and five- year warrants to purchase an additional 1,000,000 shares of the Company's common stock in exchange for $6,500,000. The exercise price of the warrants is the lower of $5.20 per share or the average per share market value for the five consecutive trading days with the lowest per share market value during the 22 trading days prior to December 14, 1999. On July 7, 2000 TSAI exercised their warrants and purchased 1,000,000 shares of the Company's common stock for $5.20 per share. In May 2001, the various agreements with ACI were amended. The distribution agreement was modified such that an exclusivity clause granted ACI was cancelled, the rate at which the Company earns fees was reduced to 10% of the amounts received by ACI and the remaining future payments of $4,800,000 were cancelled. Additionally, a consulting agreement requiring payment of $2,000,000 to ACI was cancelled, a service agreement with various guaranteed payments due ACI was cancelled and other amounts due ACI were consolidated into a Note for $667,406. The Note is payable in monthly installments over twelve months from April 1, 2001 and earns interest at Prime. No payments have been made since June 2001. NOTE 6 - STOCK-BASED COMPENSATION The Company has elected to continue to apply Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans as they relate to employees and directors. Historically, the 20 Company's stock options have been accounted for using fixed plan accounting. The option grants permit various exercise alternatives, including certain cashless exercise provisions. Through fiscal 1999, the Company's experience indicated that substantially all cashless exercises could have been effected through the use of mature shares and therefore fixed plan accounting was appropriate. Due to the Company's recent acquisitions and growth, options have been granted to more employees who do not hold mature shares of the Company's common stock and therefore the Company has determined that these options should be accounted for using variable plan accounting. Under variable plan accounting, changes, either increases or decreases, in the market price of the Company's common stock results in a change in the measurement of compensation. Compensation is measured as the difference between the market price and the option exercise price and is amortized to expense over the vesting period. During the year ended June 30, 2000, the Company recorded $649,300 of compensation expense related to these variable awards. During the year ended June 30, 2001, as a result of a decrease in the Company's stock price, the $649,300 recorded during the year ended June 30, 2000 was reversed. In February 2001, the Company repriced approximately 1,069,000 employee options from an exercise price of $2.91 to $0.49. These options were already accounted for using variable plan accounting. During fiscal 2001 the Company granted the then Chairman of the Board of Directors 300,000 options with an exercise price of $4.50, which was the market price of the stock on the date of the grant. Since this grant exceeded the typical grant for other Board members, the Company has recorded compensation expense determined using the Black Scholes Method. Accordingly a non-cash expense in the amount of $895,776 was recorded during fiscal 2001. On October 16, 2001, the Company's board of directors agreed to reprice all outstanding stock options for current employees and directors at the closing market price on that date of $0.096 cents per share. The total number of options affected was 2,724,952. NOTE 7 - SUBSEQUENT EVENTS - BROWN SIMPSON SETTLEMENT, CONVERSION OF SERIES B PREFERRED On January 22, 2002, the Company entered into an agreement with Brown Simpson Partners I, Ltd. whereby, in exchange for 360 shares of Series D Preferred Stock, Brown Simpson agreed to surrender all Series A Preferred Stock of the Company, all warrants to purchase shares of capital stock of the Company, and all registration, anti-dilution or participation rights Brown Simpson may have with respect to the Company's capital stock previously issued to Brown Simpson. In addition, Brown Simpson agreed to release the Company from any liability arising from claims it has asserted against the Company in connection with the acquisition of DataBank International Ltd. and the delisting of the Company's stock by Nasdaq. Each share of Series D Preferred Stock issued to Brown Simpson has a stated value of $10,000, and is presently convertible into 33,333 shares of common stock of the Company, although Brown Simpson cannot exercise any conversion right until May 31, 2002. On January 15, 2002, the Company converted all outstanding shares of Series B Preferred Stock, issued on December 31, 2001 to each current member of the Board of Directors, to a total of 4 shares of common stock. The Company had authorized 21 the issuance of the Series B Preferred Stock as a short-term mechanism to protect the shareholders against the Egide Group's Consent Statement (which the Company believes is false), referred to under legal matters in Note 4, in the event the Egide Group was permitted, over the Holidays, to commence soliciting shareholders before the Company had an opportunity to respond. Since December 31, 2001, the Company has taken several actions to ensure a fair election process. The Company has filed a letter to shareholders with the SEC and has taken other steps to inform the shareholders of key facts, including the fact that Egide was Chairman of the Board and CEO when certain acquisitions were consummated for which the Company has had to report more than $188 million in write downs and that Egide was Chairman and CEO when various merchants were allowed to process with the Company without proper authorization, which has cost the Company over $7 million in uncollectible chargebacks and fines. NOTE 8 - NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board finalized FASB Statements No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that the Company recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS 141 applies to all business combinations initiated after June 30, 2001 and for purchase business combinations completed on or after July 1, 2001. It also requires, upon adoption of SFAS 142, that the Company reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141. SFAS 142 requires, among other things, that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires that the Company identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized. SFAS 142 requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS 142. The Company's previous business combinations were accounted for using the purchase method. As of December 31, 2001, the net carrying amount of goodwill is $13,401,064 and other intangible assets is $5,057,289. Amortization expense during the three and six months ended December 31, 2001 was $1,827,602 and $3,655,204 respectively. Currently, the Company is assessing but has not yet determined how the adoption of SFAS 141 and SFAS 142 will impact its financial position and results of operations. SFAS 143, Accounting for Asset Retirement Obligations, was issued in June 2001 and is effective for fiscal years beginning after June 15, 2002. SFAS 143 requires that any legal obligation related to the retirement of long-lived assets be quantified and recorded as a liability with the associated asset retirement cost capitalized on the balance sheet in the period it is incurred when a reasonable estimate of the fair value of the liability can be made. 22 SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, was issued in August 2001 and is effective for fiscal years beginning after December 15, 2001. SFAS 144 provides a single, comprehensive accounting model for impairment and disposal of long-lived assets and discontinued operations. SFAS 143 and SFAS 144 will be adopted on their effective dates, Currently, the Company is assessing but has not yet determined how the adoption will impact its financial position and results of operations. 23 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Digital Courier Technologies, Inc. (referred to herein as "DCTI" or the "Company"; the Company is also referred to in the first person, using terms like "we", "our" and "us") is a leading provider of advanced e-payment services for businesses, merchants, and financial institutions. In fiscal 2001, our revenues were primarily derived from processing payments for the internet gaming and e-tailing industries. Over 90% of our revenues are earned from customers located outside the U.S. The Company's services have introduced to the marketplace a secure and cost-effective system for credit card processing and merchant account management. By integrating services under one provider, DCTI can offer to customers an outsource solution for merchant account set-up, an Internet Payment Gateway, payment processing, fraud control technology, and Web-based reporting. The Company, a Delaware corporation, was originally incorporated May 16, 1985. DCTI and its predecessor have acquired and sold several companies during the last four fiscal years. On January 8, 1997, the Company acquired the stock of Sisna, Inc. ("Sisna"). During fiscal 1998, the Company acquired the stock of DCTI, Books Now, Inc. ("Books Now") and the stock of WeatherLabs Technologies, Inc. ("WeatherLabs"). During fiscal 1999, the Company acquired the stock of Access Services, Inc. ("Access Services"), the stock of SB.com, Inc. ("SB.com") and acquired the stock of Digital Courier International, Inc. ("DCII"). During fiscal 2000, the Company acquired the stock of DataBank International, Ltd. ("DataBank"), the stock of CaribCommerce, Ltd. ("CaribCommerce") and the assets of various entities referred to jointly as "MasterCoin". These acquisitions have been accounted for as purchases with the results of operations of the acquired entities being included in the accompanying consolidated financial statements from the dates of the acquisitions. In fiscal 1998, the Company sold its direct mail advertising operations to Focus Direct, Inc. ("Focus Direct") and sold the stock of Sisna acquired in January 1997 back to Sisna's former major shareholder. In fiscal 2000, the Company sold its WeatherLabs operations to Landmark Communications, Inc. DCTI, DCII, Access Services, SB.com, DataBank and CaribCommerce are collectively referred to herein as the "Company". All significant intercompany accounts and transactions have been eliminated in consolidation. Results of Operations Three months ended December 31, 2001 compared with three months ended December 31, 2000, and six months ended December 31, 2001 compared with six months ended December 31, 2000 Revenue Revenue for the three months ended December 31, 2001 was $4,668,676 as compared to $9,137,924 for the three months ended December 31, 2000. During the three months ended December 31, 2001, revenues were primarily derived from payment 24 processing activities, including $222,685 of revenues related to fees earned on the processing of chargebacks. In addition, $162,000 of revenues were earned under a software distribution agreement. During the three months ended December 31, 2000, payment processing revenues were $8,822,924 and revenues earned under a software distribution agreement were $315,000. Additionally, during the three months ended December 31, 2000, the Company recorded $643,410 of revenues related to fees earned on the processing of chargebacks. The decrease in revenues is primarily due to the loss of a significant merchant, which provided 18% of revenues during fiscal 2001, as well as, the decrease in the volume of transaction from merchants utilizing the Company's processing services. Revenue for the six months ended December 31, 2001 was $9,311,571 as compared to $18,633,834 for the six months ended December 31, 2000. During the six months ended December 31, 2001, revenues were primarily derived from payment processing activities, including $700,578 of revenues related to fees earned on the processing of chargebacks. In addition, $162,000 of revenues were earned under a software distribution agreement. During the six months ended December 31, 2000, payment processing revenues were $18,003,924 and revenues earned under a software distribution agreement were $630,000. Additionally, during the six months ended December 31, 2000, the Company recorded $1,353,030 of revenues related to fees earned on the processing of chargebacks. The decrease in revenues is primarily due to the loss of a significant merchant, which provided 18% of revenues during fiscal 2001, as well as, the decrease in the volume of transaction from merchants utilizing the Company's processing services. Cost of Revenue Cost of revenue includes amounts paid to banks and processors. For the three months ended December 31, 2001 cost of revenue was $2,958,635 or 63.4% of revenue. Cost of revenue for the three months ended December 31, 2000 were $6,198,506 or 67.8% of revenue. The decrease in cost of revenues as a percentage of sales is primarily due to the decrease in lower margin, domestic processing as a percentage of total revenues. For the six months ended December 31, 2001 cost of revenue was $5,954,840 or 63.9% of revenue. Cost of revenue for the six months ended December 31, 2000 were $12,352,131 or 66.3% of revenue. The decrease in cost of revenues as a percentage of sales is primarily due to the decrease in lower margin, domestic processing as a percentage of total revenues. Operating Expenses Depreciation and amortization expense decreased 82.8% to $2,323,146 during the three months ended December 31, 2001 from $13,489,448 during the three months ended December 31, 2000. The decrease in depreciation and amortization expense was due to the decrease in amortization of goodwill as a result of the $156,123,113 of goodwill impairment write-down during fiscal 2001. Depreciation and amortization expense decreased 82.6% to $4,686,781 during the six months ended December 31, 2001 from $26,935,446 during the six months ended December 31, 2000. The decrease in depreciation and amortization expense was due to the decrease in amortization of goodwill as a result of the $156,123,113 of goodwill impairment write-down during fiscal 2001. 25 Selling, general and administrative expense decreased 56.1% to $1,480,840 during the three months ended December 31, 2001 from $3,373,014 during the three months ended December 31, 2000. The decrease in selling, general and administrative expense was due to the reductions in work force and closing of offices during fiscal 2001. Selling, general and administrative expense net of non-cash, stock based expense decreased 48.7% to $3,089,465 during the six months ended December 31, 2001 from $6,027,585 during the six months ended December 31, 2000. The decrease in selling, general and administrative expense was due to the reductions in work force and closing of offices during fiscal 2001. Research and development decreased 76.7% to $119,491 during the three months ended December 31, 2001 from $513,257 during the three months ended December 31, 2000. The decrease in research and development expense was due to the reductions in work force and closing of offices during fiscal 2001. Research and development expense net of non-cash, stock based expense decreased 73.6% to $252,882 during the six months ended December 31, 2001 from $958,205 during the six months ended December 31, 2000. The decrease in research and development expense was due to the reductions in work force and closing of offices during fiscal 2001. The Company's variable option plan did not create any non-cash compensation adjustments during the three or six month periods ended December 31, 2001 as all outstanding options were priced in excess of the quoted stock price as of the end of these periods. During the six months ended December 31, 2000 the non-cash compensation adjustment associated with the Company's variable option plan generated a credit of $649,300 as all outstanding options had exercise prices greater than the quoted stock price on December 31, 2000. Our income tax benefit is zero as we fully provide for our deferred tax assets as realization of these benefits is not deemed to be more likely than not. Liquidity and Capital Resources In October 1997, the Company entered into a sale and three-year capital leaseback agreement related to $3,000,000 of the Company's computer equipment. The agreement provided that $250,000 of the proceeds be placed in escrow upon signing the agreement. The Company sold its equipment at book value resulting in no deferred gain or loss on the transaction. This capital lease obligation was settled in full in July 2000. On November 24, 1998, the Company raised $1.8 million by selling its common stock and warrants to purchase common stock to The Brown Simpson Strategic Growth Funds (the "Purchasers") pursuant to a Securities Purchase Agreement between the Company and the Purchasers (the "Purchase Agreement"). On December 2, 1998, the Company sold an additional $1.8 million of common stock to the 26 Purchasers and amended the Purchase Agreement and related documents (the "Amended Agreements"). Pursuant to the Purchase Agreement and Amended Agreements, the Purchasers acquired 800,000 shares of the Company's common stock and five-year warrants to purchase 800,000 additional shares ("Tranche A"). The exercise price for 400,000 of the warrants is $5.53 per share and the exercise price of the remaining 400,000 warrants is $9.49 per share. The warrants are callable by the Company if for 130 consecutive trading days, the closing bid price of the Company's stock is at least two times the then-current exercise price. Because the shares acquired by the purchasers were priced at a 10% discount from the quoted market price no value was allocated to the warrants. On March 3, 1999, the Company raised an additional $3.6 million through the sale of Series A Convertible Preferred Stock (the "Preferred Stock") and warrants to purchase common stock to the Purchasers pursuant to a Securities Purchase Agreement between the Company and the Purchasers (the "March Purchase Agreement"). Pursuant to the March Purchase Agreement, the Purchasers acquired 360 shares of Preferred Stock convertible into 800,000 shares of common stock and five-year warrants to purchase an additional 800,000 shares of common stock. The Preferred Stock is convertible into common stock at a price of $4.50 per share of common stock. The exercise price for the warrants is $5.23 per share. The warrants are callable by the Company if for 130 consecutive trading days, the closing bid price of the Company's common stock is at least two times the then-current exercise price. The March Purchase Agreement also requires the Company to sell to the Purchasers, and the Purchasers to purchase from the Company, an additional tranche of 1,600,000 units, each unit consisting of Series B Convertible Preferred Stock convertible into one share of the Company's common stock and a five-year warrant to purchase one share of common stock (the "Tranche D Units"), if certain conditions are met. A condition to the sale of the Tranche D Units, among others, is that the closing bid price of the Company's common stock be more than $7 per share for 130 consecutive trading days. The price for the Tranche D Units is $7 per Unit and the exercise price of the warrants contained in the Tranche D Unit will be $7.70. On March 25, 1999, the Company entered into a 60 month software license agreement with ACI Worldwide, Inc. ("ACI") for ACI's BASE24(R) software which is being used to enhance the Company's Internet-based platforms that offer secure payments processing for business-to-consumer electronic commerce. Pursuant to the agreement, the Company agreed to pay ACI $5,941,218 during the life of the contract. The Company made a payment upon signing the contract of $591,218 and was scheduled to make equal payments at the beginning of each quarter totaling $1,000,000 for calendar year 2000, $1,200,000 for calendar year 2001, $1,400,000 for calendar year 2002, $1,400,000 for calendar year 2003 and a final payment of $350,000 on January 1, 2004. On June 14, 1999, Transactions Systems Architects, Inc. ("TSAI"), the parent of ACI, purchased 1,250,000 shares of the Company's common stock and warrants to purchase an additional 1,000,000 shares of the Company's common stock in exchange for $6,500,000. As part of the securities purchase agreement, the Company agreed to immediately pay ACI the discounted future payments under the original agreement, which amounted to $3,888,453. The amounts paid under the agreement have been recorded as prepaid software license in the accompanying 27 condensed consolidated financial statements and are being expensed ratably over the term of the agreement. In July, 2000, TSAI exercised all of its warrants for a total exercise price of $5,200,000. On March 31, 2000, the software license agreement was modified to grant the Company a non-transferable and non-exclusive license to use ACI's Base24(R) software in all international markets, as well as the United States, which was granted in the original contract. In exchange for this agreement the Company paid ACI $2,500,000 on April 15, 2000 and made a final payment of $2,500,000 on September 30, 2000. On June 3, 1999, the Company entered into a three-year agreement with ACI to distribute the Company's e-commerce products. As consideration for this agreement, ACI paid the Company a non-refundable deposit of $700,000. ACI will pay the Company license fees of 40% of the fee paid ACI until the Company receives $800,000, 35% of the fees paid ACI until; the Company receives $1,500,000 and 30% of the fees paid ACI thereafter. On April 1, 2000 the distribution agreement was amended extending the term to six years and providing a guarantee to the Company of an additional $6,000,000 payable in installments of $1,200,000 on September 1, 2000 through September 1, 2004. In May 2001, the various agreements with ACI were amended. The distribution agreement was modified such that an exclusivity clause granted ACI was cancelled; the rate at which the Company earns fees was reduced to 10% of the amounts received by ACI and the remaining future payments of $4,800,000 were cancelled. Additionally, a consulting agreement requiring payment of $2,000,000 to ACI was cancelled, a service agreement with various guaranteed payments due ACI was cancelled and other amounts due ACI were consolidated into a Note for $667,406. The Note is payable in monthly installments over twelve months from April 1, 2001 and earns interest at Prime. No payments have been made since June 2001. Additionally the extension of the agreement to six years was cancelled. Accordingly the agreement terminates in June 2002. During the quarter ended December 31, 2001 management determined that the remaining deferred revenue from the Agreement should be recognized ratably over 9 months beginning October 2001. As a result, $162,000 has been recognized during the quarter. During the six months ended December 31, 2001, operating activities provided cash of $227,289. The net loss of $5,035,793 was mostly offset by non-cash depreciation and amortization expense of $4,686,781. Additionally, cash provided by a decrease in restricted cash was offset by a decrease in merchant reserve and merchant settlement liabilities. These decreases are consistent with the decrease in revenues. Also, reducing the liability to payment processor offset cash provided by the liquidation of our deposit with payment processor. Other changes in current asset and liabilities accounts accounted for the remaining net cash used in operating activities during the period. During the six months ended December 31, 2000, operating activities used cash of $10,469,930. The net loss of $166,031,788 was more than offset by non-cash depreciation and amortization expense and impairment write-down of goodwill of $168,935,446. The decrease in cash was due to an increase in restricted cash of approximately $14.1 million along with decreases of accruals and accounts 28 payable. These uses of cash were partially offset by the conversion of a receivable from payment processor to cash and increases to cash balances from increased amounts payable to merchants and payment processors. The Company used $11,792 of cash for investing activities during the six months ended December 31, 2001 related to the purchase of computer equipment. During the six months ended December 31, 2000 net cash used in investing activities was $853,259 as the Company upgraded and built redundancy in its computer facilities. The Company used $772,891 of cash during for financing activities during the six months ended December 31, 2001. The cash was used to make repayments of principal amounts owed on borrowings and under capital lease agreements. The Company generated $4,884,475 in cash from financing activities in the six months ended December 31, 2000, as TSAI exercised its option to purchase 1,000,000 shares of the Company's common stock at $5.20 and the Company paid $315,525 under capital lease obligations. During the three months ended December 31, 2001 the Company's operations were basically break even after excluding non-cash expenses for amortization and depreciation. During the six months ended December 31, 2001 the Company's operations generated a loss from operations of $295,616 (unaudited), after excluding non-cash expenses for amortization and depreciation. Since its inception, our business has incurred significant losses, and as of December 31, 2001 had negative working capital of $4,218,172. As a result, there is uncertainty about the Company's ability to continue as a going concern, which was stated in our auditor's report on the Company's financial statement for the 2001 fiscal year. While management projects improved cash flows from operating activities, there can be no assurance that management's projections will be achieved. Management may also be required to pursue sources of additional funding to meet marketing and expansion objectives. There can be no assurance that additional funding will be available or, if available, that it will be available on acceptable terms or in required amounts. Forward-Looking Information Statements regarding the Company's expectations as to future revenue from its business strategy, and certain other statements presented herein, constitute forward-looking information within the meaning of the Private Securities Litigation Reform Act of 1995. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from expectations. In addition to matters affecting the Company's industry generally, factors which could cause actual results to differ from expectations include, but are not limited to risks relating to the Company's continued ability to create or acquire products and services that customers will find attractive and the potential for increased competition which could affect pricing and profitability. Additional information on factors that may affect the business and financial results of the Company can 29 be found in filings of the Company with the Securities and Exchange Commission, including the Company's annual report on form 10K. The Company does not undertake, and specifically disclaims any obligation, to update any forward looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. PART II Item 1 LEGAL PROCEEDINGS On October 16, 2001, the Company entered into a settlement with a shareholder regarding the Company's alleged failure to register restricted shares of the Company's common stock, as well as certain other alleged breaches of his contract rights. The shareholder received the shares in the course of the Company's acquisition of DataBank in October, 1999. The shareholder had claimed that the Company was obligated to periodically register a portion of those restricted shares with the SEC following the DataBank transaction and subsequently failed to do so. In July 2001, the shareholder filed a lawsuit against the Company in federal court in Salt Lake City, Utah. The shareholder's complaint sought damages of $10,500,000. The Company negotiated a settlement with the shareholder whereby the shareholder was issued 3,500,000 shares of the Company's restricted common stock. As part of the settlement, the shareholder granted the Company's current Chairman an irrevocable proxy to vote these shares for a period of up to three years. In addition, the shareholder received a promissory note from the Company for $800,000 to be paid in quarterly installments, beginning with the quarter ending December 31, 2001.The Company's quarterly payments will be based upon a percentage of the Company's earnings before taxes, depreciation, and amortization, if any, during each quarter, but the note will have a final maturity date in October 2004. Interest of 15% per annum will not begin accruing on the note until 2003. To assure payment under the note, the Company also executed a confession of judgment, which may not be entered absent a default, in an amount substantially in excess of the principal amount of the note. Finally, as part of the settlement, the Company and the shareholder agreed to modify a prior severance agreement between them. The shareholder has fully released the Company from all claims stated in the complaint. The total amount of the settlement of $1,447,500 was recorded at June 30, 2001 as an expense and an accrued liability on the balance sheet. The value of the shares issued was recorded at the price of the Company's common stock on October 16, 2001. Additionally, as part of the settlement, the shareholder was allowed to keep 70,000 shares previously promised to be returned to the Company. In November 2000 a plaintiff filed suit against the Company and a former President and director of the Company alleging that the plaintiff is the assignee of several persons and entities, which owned interests in DataBank which the Company acquired in October 1999. The plaintiff alleges that its assignors were not paid their alleged share of the purchase price by the former President and director and is suing, therefore, for breach of contract. The plaintiff has recently added as a defendant a former Chief Executive Officer and Chairman of the Company. The Company has filed several motions to dismiss the complaint, certain of which the court has granted, including one without leave to amend. The Company anticipates moving to dismiss the recent amendment to the complaint and anticipates that motion will be heard by the court in April 2002. While the Company intends to vigorously defend this action, no assurance can be given as to the ultimate outcome or resolution of this action. 30 In January 2002, the Company filed a lawsuit in Federal Court in San Francisco in response to the "Consent Statement" which was earlier filed by a group of shareholders led by Mr. James Egide (the Egide group), the Company's onetime Chairman and CEO. The Company is asking the Court to rule that the Egide group's Consent Statement is false and misleading and that it violates the SEC Act of 1934. The Company is requesting injunctive relief such that shareholders are not allowed to vote until the Egide group files a truthful Proxy. The Company believes that the Consent Statement filed by the Egide group contains numerous false and misleading statements, that it omits important information the shareholders should know about and that Mr. Egide and certain members of his group were officers, employees and Board Members during the time that gave rise to the losses which the Company has endured as it has written down the value of various acquisitions and expensed the costs of uncollectible chargebacks and credit card association fines. Item 2 CHANGES IN SECURITIES AND USE OF PROCEEDS On January 15, 2002, the Company converted all outstanding shares of Series B Preferred Stock, issued on December 31, 2001 to each current member of the Board of Directors, to a total of 4 shares of common stock. The Company had authorized the issuance of the Series B Preferred Stock as a short-term mechanism to protect the shareholders against the Egide Group's Consent Statement (which the Company believes is false), referred to under legal matters in Note 4, in the event the Egide Group was permitted, over the Holidays, to commence soliciting shareholders before the Company had an opportunity to respond. Since December 31, 2001, the Company has taken several actions to ensure a fair election process. The Company has filed a letter to shareholders with the SEC and has taken other steps to inform the shareholders of key facts, including the fact that Egide was Chairman of the Board and CEO when certain acquisitions were consummated for which the Company has had to report more than $188 million in write downs and that Egide was Chairman and CEO when various merchants were allowed to process with the Company without proper authorization, which has cost the Company over $7 million in uncollectible chargebacks and fines. Item 3 DEFAULTS UPON SENIOR SECURITIES None Item 4 SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS None 31 Item 5 OTHER INFORMATION None Item 6 EXHIBITS AND REPORTS ON FORM 8-K None 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. DIGITAL COURIER TECHNOLOGIES, INC. Date: February 14, 2002 By /s/ John J. Hanlon ------------------------------------- John J. Hanlon President and Chief Financial Officer 32