PAYS Paysign Inc

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

Disclosure Regarding Forward Looking Statements

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

Overview

On March 4, 2019, our board of directors and stockholders holding a majority of our outstanding common stock agreed to amend our articles of incorporation to change our name from 3PEA International, Inc. to Paysign, Inc. As a result, we amended our articles of incorporation on April 23, 2019 for such name change. Additionally, we changed our trading symbol on the Nasdaq Capital Market to “PAYS”.

We are a vertically integrated provider of innovative prepaid card products and processing services for corporate, consumer and government applications. Our payment solutions are utilized by our corporate customers as a means to increase customer loyalty, increase patient adherence rates, reduce administration costs and streamline operations. Public sector organizations can utilize our payment solutions to disburse public benefits or for internal payments. We market our prepaid card solutions under our Paysign brand. As we are a payment processor and prepaid card program manager, we derive our revenue from all stages of the prepaid card lifecycle. We provide a card processing platform consisting of proprietary systems and innovative software applications based on the specific needs of our clients. We have extended our processing business capabilities through our proprietary Paysign platform. Through the Paysign platform, we provide a variety of services including transaction processing, cardholder enrollment, value loading, cardholder account management, reporting, and customer service.

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

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

Our revenues include fees generated from cardholder transactions, interchange and card program management fees. Revenue from cardholder transactions, interchange and card program management fees is recorded when the performance obligation is fulfilled. We provide an in-house customer service center which includes live bi-lingual phone operators staffed 24/7/365, for incoming calls. We also provide in house Interactive Voice Response and two-way SMS messaging platforms.

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

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

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

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

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

We have developed prepaid card products for healthcare reimbursement payments, pharmaceutical assistance, donor compensation, corporate and incentive rewards and expense reimbursement cards. We plan to expand our product offering to include payroll cards, general purpose re-loadable cards and travel cards. Our cards are offered to end users through our relationships with bank issuers.

Our products and services are aimed at capitalizing on the growing demand for stored value and reloadable ATM/prepaid card financial products in a variety of market niches. Our proprietary platform is scalable and customizable, delivering cost benefits and revenue building opportunities to partners. We manage all aspects of the debit card lifecycle, from managing the card design and approval processes with banking partners and card networks, to production, packaging, distribution, and personalization. We also oversee inventory and security controls, renewals, lost and stolen card management and replacement.

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

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

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

During 2019, we will continue to invest additional funds in technology improvements, sales and marketing, customer service, and regulatory compliance. We are considering raising capital to enable us to diversify into new market verticals. If we do not raise new capital, we believe that we will still be able to expand into new markets using internally generated funds, but our expansion will not be as rapid.

Key Performance Indicators and Non-GAAP Measures

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

Gross Dollar Volume Loaded on Cards – Represents the total dollar volume of funds loaded to all of our prepaid card programs. Our gross dollar volume was $210 million and $172 million for the three months ended September 30, 2019 and 2018, respectively. Our gross dollar volume was $607 million and $449 million for the nine months ended September 30, 2019 and 2018, respectively. We use this metric to analyze the total amount of money moving into our prepaid card programs.

Conversion Rate on Gross Dollar Volume Loaded on Cards – Comprised of revenues, gross profit and net profit conversion rates of gross dollar volume loaded on cards. Our revenue conversion rate for the three months ended September 30, 2019 and 2018 were 4.29% or 429 basis points (“bps”), and 3.72% or 372 bps, respectively, of gross dollar volume loaded on cards. Our gross profit conversion rate for the three months ended September 30, 2019 and 2018 were 2.55% or 255 bps, and 1.77% or 177 bps, respectively, of gross dollar volume loaded on cards. Our net profit conversion rate for the three months ended September 30, 2019 and 2018 were 1.41% or 142 bps, and 0.46% or 46 bps, respectively, of gross dollar volume loaded on cards. Our revenue conversion rate for the nine months ended September 30, 2019 and 2018 were 4.10% or 410 basis points (“bps”), and 3.69% or 369 bps, respectively, of gross dollar volume loaded on cards. Our gross profit conversion rate for the nine months ended September 30, 2019 and 2018 were 2.34% or 234 bps, and 1.76% or 176 bps, respectively, of gross dollar volume loaded on cards. Our net profit conversion rate for the nine months ended September 30, 2019 and 2018 were 0.92% or 92 bps, and 0.43% or 43 bps, respectively, of gross dollar volume loaded on cards.

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

“EBITDA” defined as earnings before interest, income taxes, depreciation and amortization expense and "Adjusted EBITDA" reflects the adjustment to EBITDA to exclude stock-based compensation expense.

Results of Operations

Three Months ended September 30, 2019 and 2018

Revenues for the three months ended September 30, 2019 were $9,008,117, an increase of $2,586,721 compared to the same period in the prior year, when revenues were $6,421,396. The increase in revenue approximating 40% was primarily due to an increase in new clients, new industry verticals and new card programs with existing clients. We believe with the addition of the new card programs added September 30^th, the fourth quarter will experience a comparable or better rate of growth in comparison to the prior year.

Cost of revenues (excluding depreciation and amortization) for the three months ended September 30, 2019 were $3,641,595, an increase of $264,842 compared to the same period in the prior year, when cost of revenues were $3,376,753. Cost of revenues constituted approximately 40% and 53% of total revenues for the three months ended September 30, 2019 and 2018, respectively. Cost of revenues is comprised of transaction processing fees, data connectivity and data center expenses, network fees, bank fees, card production costs, customer service and program management expenses, application integration setup, and sales and commission expense. Our cost of revenues (excluding depreciation and amortization) as a percentage of revenues decreased due to improved network interchange margins and a favorable client mix.

Gross profit for the three months ended September 30, 2019 was $5,366,522, an increase of $2,321,879 compared to the same period in the prior year, when gross profit was $3,044,643. Our overall gross margins were 60% and 47% during the three months ended September 30, 2019 and 2018, respectively, and an improvement of 1216 bps resulting from favorable client industry mix.

Depreciation and amortization for the three months ended September 30, 2019 were $318,508, an increase of $34,384 compared to the same period in the prior year, when depreciation and amortization were $284,124. The increase in depreciation and amortization was primarily due to continued capitalized enhancements to our platform which we expect to continue. Additionally, investments in fixed assets and software licensing contributed to the variance.

Selling, general and administrative expenses (“SG&A”) for the three months ended September 30, 2019 were, $2,765,961 an increase of $769,004 or 39% compared to the same period in the prior year, when SG&A were $1,996,957. The increase in SG&A was primarily due to increased investments in infrastructure, staffing and stock-based compensation.

In the three months ended September 30, 2019, we recorded operating income of $2,282,053 as compared to operating income of $763,562 in the three months ended September 30, 2018, an increase of $1,518,491 or 199%.

Other income, net for the three months ended September 30, 2019 was $113,667, as compared to other income, net of $36,683 in three months ended September 30, 2018, which represents an increase in net other income, net of $76,984. The increase in our other income, net is attributable to increased interest earnings on our cash balances.

Our income tax benefit for the three months September 30, 2019 was $563,864, while there was none for the three months ended September 30, 2018. The increase from prior year is a result of the tax benefit related to our stock-based compensation.

Our net income attributable to Paysign, Inc. for the three months ended September 30, 2019 was $2,960,078 as compared to net income of $800,862 in the three months ended September 30, 2018, which represents an increase in net income of $2,159,216 or 270%. The overall change in net income is attributable to the aforementioned factors.

Nine Months ended September 30, 2019 and 2018

Revenues for the nine months ended September 30, 2019 were $24,901,678, an increase of $8,343,240 compared to the same period in the prior year, when revenues were $16,558,438. The increase in revenue approximating 50% was primarily due to the addition of new prepaid card industry verticals, new clients and new prepaid card programs for existing clients. We believe we will continue to experience a strong rate of growth rate for the remainder of 2019 and into 2020.

Cost of revenues (excluding depreciation and amortization) for the nine months ended September 30, 2019 were $10,721,769, an increase of $2,070,930 compared to the same period in the prior year, when cost of revenues was $8,650,839. Cost of revenues constituted approximately 43% and 52% of total revenues for the nine months ended September 30, 2019 and 2018, respectively. Cost of revenues is comprised of transaction processing fees, data connectivity and data center expenses, network fees, bank fees, card production costs, customer service and program management expenses, application integration setup, and sales and commission expense. Our cost of revenues (excluding depreciation and amortization) as a percentage of revenues has decreased due to improved network interchange margins and a favorable client mix.

Gross profit for the nine months ended September 30, 2019 was $14,179,909, an increase of $6,272,310 compared to the same period in the prior year, when gross profit was $7,907,599. Our overall gross margins were 57% and 48% during the nine months ended September 30, 2019 and 2018 which for the current year has run slightly better than management’s projections, and has improved 919 bps, resulting from favorable client industry mix. Given expectations about new business and the effect of seasonality on industry mix, management expects that gross margins are likely to maintain this trend, or slightly lower, in the next quarter.

Depreciation and amortization for the nine months ended September 30, 2019 were $1,047,779, an increase of $267,576 compared to the same period in the prior year, when depreciation and amortization were $780,203. The increase in depreciation and amortization was primarily due to continued capitalized enhancements to our platform which we expect to continue.

SG&A for the nine months ended September 30, 2019 were, $8,483,882 an increase of $3,239,604 compared to the same period in the prior year, when SG&A were $5,244,278. The increase in SG&A was primarily due to investments in infrastructure, increased staffing, and increased stock based compensation expense.

In the nine months ended September 30, 2019, we recorded operating income of $4,648,248 as compared to operating income of $1,883,118 in the nine months ended September 30, 2018, an increase of $2,765,130 or 147%.

Other income, net for the nine months ended September 30, 2019 was $364,652, as compared to other income, net of $59,173 in nine months ended September 30, 2018, which represents an increase in net other income, net of $305,479. The increase in our other income, net is attributable to increased interest earnings on our cash balances, which we expect to continue in future periods.

Our income tax benefit for the nine months September 30, 2019 was $556,068, while there was none for the nine months ended September 30, 2018. The increase from prior year is a result of the tax benefit related to our stock-based compensation.

Our net income attributable to Paysign, Inc. for the nine months ended September 30, 2019 was $5,570,540 as compared to net income of $1,945,425 in the nine months ended September 30, 2018, which represents an increase in net income of $3,625,115 or 186%. The overall change in net income is attributable to the aforementioned factors.

Comparison of nine months ended September 30, 2019 and 2018

During the nine months ended September 30, 2019 and 2018, we financed our operations primarily through internally generated funds.

Cash provided by operating activities increased $2,147,892 in the nine months ended September 30, 2019, as compared to the same period in the prior year. The increase is primarily related to a $3,625,115 increase in net income and a $1,110,384 increase in stock based compensation for the period partially offset by a $2,415,872 decrease in customer card funding as compared to the prior year period.

Cash used in investing activities increased $317,935 in the nine months ended September 30, 2019, as compared to the same period in 2018, with the difference primarily attributed to an increase in enhancements to our processing platform and investments in our telephone and equipment infrastructure during the current year.

Cash provided by financing activities was $252,813 in the nine months ended September 30, 2019 as compared to $100,000 for the nine months ended September 30, 2018. In 2019, financing activities consisted of cash provided from exercises of stock options. In 2018, financing activities consisted of $100,000 in cash provided from an exercise of a stock warrant.

Sources of Financing

We believe that our available cash on hand, excluding restricted cash, at September 30, 2019 of $7,988,803, combined with revenues and operating earnings anticipated for the remainder of 2019 will be sufficient to sustain our operations for the next twelve months.

Off-Balance Sheet Arrangements

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

Critical Accounting Estimates

Our significant accounting policies are described in Note 1 of the Notes to Financial Statements and our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Any estimates we make will be based on our experience and our interpretation of economic, political, regulatory, and other factors that affect our business prospects. Actual results may differ significantly from our estimates.