Item 1 of this Form 10-K entitled "Business" and Item 7 of this Form 10-K entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are inherently uncertain and actual results could differ materially from those expressed or implied by the forward-looking statements. These forward-looking statements should be considered in the context of the business risks set forth below in Item 1A, "Risk Factors."
PART I
ITEM 1. BUSINESS
Affinity Technology Group, Inc. (the "Company") was formed to develop and market technologies that enable financial institutions and other businesses to provide consumer financial services electronically with reduced or no human intervention. Products and services previously offered by the Company include its DeciSys/RT(R) loan processing system, which automated the processing and consummation of consumer financial services transactions; the Affinity Automated Loan Machine (the ALM), which allowed an applicant to apply for and, if approved, obtain a loan in as little as ten minutes; the Mortgage ALM, which allowed an applicant to apply for a mortgage loan; E-xpertLender(R), which permitted a financial institution to make automated lending decisions through its call centers and branches; iDEAL, which permitted automobile lenders to make automobile lending decisions for loan applications originated at automobile dealers; and rtDS, which permitted lenders to deliver credit decisions to applicants over the Internet. Due to capital constraints, the Company has suspended all efforts to further develop, market and operate these products and services. The Company's last processing contract terminated in late 2002, and the Company has no plans in the near term to engage in further sales or other activities related to its products or services, other than to attempt to license certain of the patents that it owns. Currently, the Company's business activities consist exclusively of attempting to enter into license agreements with third parties to license the Company's rights under certain of its patents.
In conjunction with its product development activities, the Company applied for and obtained three patents. The Company has been granted two patents covering its fully-automated loan processing systems (U. S. Patents No. 5,870,721 and 5,940,811). In August 2000, the U.S. Patent and Trademark Office issued to the Company a patent covering the fully-automated establishment of a financial account, including credit accounts (U. S. Patent No. 6,105,007). In addition, in 1997 the Company acquired a patent that covers the automated processing of an insurance binder through a kiosk (U. S. Patent No. 5,537,315).
Both of the Company's patents covering fully automated loan processing systems have been subject to reexamination by the U.S. Patent and Trademark Office (the "PTO") as a result of challenges to such patents by third parties. On January 28, 2003, the Company received a Reexamination Certificate (U. S. Patent No. 5,870,721 C1) from the PTO which formally concluded the reexamination of U. S. Patent No. 5,870,721. On December 20, 2005, the Company received a Reexamination Certificate (U.S. Patent No. 5,940,811 C1) from the PTO which formally concluded the reexamination of U.S. Patent No. 5,940,811.
On March 26, 2004, the Company was notified by Federated Department Stores, Inc. ("Federated") and Ameritrade Holding Corporation ("Ameritrade") that they had jointly filed a request with the PTO to reexamine U. S. Patent No. 6,105,007. On June 23, 2004, the Company received notification that the PTO had granted the request for reexamination. The Company has lawsuits pending against Federated and Ameritrade in the Columbia Division of the United States District Court for the State of South Carolina (the "Columbia Federal Court") in which it claims that both Federated and Ameritrade infringe U. S. Patent No. 6,105,007. The Company has similar litigation pending against Household International, Inc. ("Household"), in which it claims that Household infringes U.S. Patent No. 5,870,721 C1, No. 5,940,811 C1 and No. 6,105,007. The Company has jointly, with Federated, Ameritrade and Household, requested the Columbia Federal Court to stay the lawsuits against Federated, Ameritrade and Household pending resolution of the reexamination of U. S. Patent No. 6,105,007. On March 30, 2006 the Company was notified that the PTO has concluded the reexamination of U.S. Patent No. 6,105,007 and has issued a "Notice of Intent to Issue Ex Parte Reexamination Certificate" (the "Notice"). The Notice indicates that the reexamination resulted in the full allowance of all the claims of the Company's U.S. Patent No. 6,105,007. The Company expects to request that the stay of the lawsuits against Federated, Ameritrade and Household be lifted so that the lawsuits may proceed in the Columbia Federal Court. It may take an extended period of time to complete the litigation with Federated, Ameritrade and Household. Moreover, protracted litigation with Federated, Ameritrade and Household may have a material adverse effect on the Company's patent licensing program and impede its ability to attract additional capital resources in order to continue its operations.
It is possible that third parties may bring additional actions to contest all or some of the Company's patents. The Company can make no assurances that it will not lose all or some of the claims covered by its existing patents.
To date, the Company has generated substantial operating losses and has been required to use a substantial amount of cash resources to fund its operations. At December 31, 2005, the Company had cash and cash equivalents of $13,776. As of March 31, 2006, the Company had almost completely exhausted its remaining cash resources. Unless it secures additional capital immediately, the Company may have to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection. Moreover, the Company currently does not have the resources to repay the principal and accrued interest outstanding under its convertible secured notes (the "notes"), which have become due and payable in full as discussed below. If any of the holders of these notes takes action to collect the amounts owed by the Company under these notes, the Company will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
Since 2002, the Company has issued an aggregate of $1,425,336 principal amount of convertible secured notes to certain investors as part of its efforts to raise additional capital. These notes bear interest at 8%, are convertible into the Company's common stock at a conversion rate of $.20 per share, and are secured by the Company's equity interest in decisioning.com, Inc., which owns the Company's patent portfolio. The outstanding notes include a note in the principal amount of $125,000 acquired on June 3, 2002 by the Company's Chief Executive Officer and a note in the principal amount of $100,000 acquired on November 5, 2003 by a subsidiary of The South Financial Group, which at that time owned approximately 12% of the Company's outstanding capital stock. Principal and interest under these notes generally becomes payable in full on the second anniversary of the date on which these notes were issued. However, under the terms of the notes, the full amount of principal and interest under all notes becomes immediately due and payable in certain events, including bankruptcy or similar proceedings involving the Company, a default in the payment of principal and interest under any note, or a change in control of the Company.
To date, notes with a principal amount of $1,206,336 have become due and payable in accordance with their contractual two-year maturity dates. The Company has had discussions with the holders of these notes regarding the extension of the maturity date of these notes. However, the Company has not been successful in reaching an agreement with all of the holders of these notes regarding an extension of their maturity date. Because the Company is currently in default regarding payment of principal and interest due under certain of the notes, the full amount of principal and interest outstanding under all notes has become due and payable. Accordingly, the full amount of principal and accrued interest under all of these notes is shown as a current liability of the Company as of December 31, 2005. As of December 31, 2005, and December 31, 2004, the amount of principal and accrued interest outstanding under all of the notes was $1,595,906 and $1,383,149, respectively.
To remain viable, the Company must generate working capital through the sale of patent licenses or by raising additional capital. To date, the Company generally has been unable to enter into licensing agreements with potential licensees upon terms that are acceptable to the Company. As discussed above, the Company has been forced to become involved in litigation with alleged infringers. The Company believes that these lawsuits may take an extended period of time to complete, and no assurance can be given that the Company will have the resources necessary to complete these lawsuits or that it will be successful in obtaining a favorable outcome. Accordingly, to remain viable it is critical that the Company raise additional capital immediately. The uncertainties of these litigation matters and other factors affecting the Company's short and long-term liquidity discussed above has impeded and will likely continue to impede the Company's ability to raise additional capital. To maintain the minimal resources necessary to support its current operations and execute a patent licensing strategy, the Company does not believe that substantial additional reductions in its operating expenses are feasible. No assurances can be given that the Company will be able to raise additional capital or generate working capital from its patent licensing business.
The Company has been a defendant in a lawsuit brought by Temple Ligon, who claims that the Company breached an agreement to give him a 1% equity interest in the Company in consideration of services he claims to have performed in 1993 and 1994 in conjunction with the formation of the Company. In January 2004, this litigation resulted in a jury verdict against the Company of $382,148. In connection with the litigation and the resulting jury verdict, the Company filed post-trial motions with the trial court in which, among other things, it claimed that the jury verdict should be set aside. On July 23, 2004, the trial judge granted the Company's motions, set aside the jury verdict, and ordered entry of a judgment in favor of the Company. The plaintiff has appealed the trial judge's ruling to the South Carolina Court of Appeals. If the Company becomes obligated to pay more than an insignificant amount of damages in connection with this litigation, it will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
The Company maintains an Internet site at HTTP://WWW.AFFI.NET, although the contents of such web site are not incorporated into this report. The Company has made its annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K and any amendments to these reports available through its web site free of charge through a link to the SEC's web site.
The Company was incorporated as a Delaware corporation in 1994. Its principal executive offices are located at 8807-A Two Notch Road, Columbia, South Carolina 29223, and its telephone number is (803) 758-2511.
PATENT LICENSING AGENT
On May 27, 2003, decisioning.com entered into a legal representation agreement with Withrow & Terranova, PLLC, pursuant to which decisioning.com appointed Withrow & Terranova, PLLC as its exclusive representative for the solicitation and negotiation of agreements to license decisioning.com's patents. (This arrangement replaced the former patent licensing agent agreement between decisioning.com and Information Ventures LLC d/b/a LPS Group, which was terminated on April 30, 2003.) Under the agreement, Withrow & Terranova, PLLC has agreed to promote, market, solicit, and negotiate the licensing of patents with third parties and to represent decisioning.com as legal counsel in connection with any patent litigation associated with the enforcement of the patents. As compensation for its services under the agreement, Withrow & Terranova will receive 25% of all revenues received by decisioning.com under any patent agreements and 25% of all amounts paid in settlement of any patent litigation commenced by the Company. The term of the agreement is for the life of the patents, subject to either party's right to terminate the agreement for "cause," as specified in the agreement, and without cause following the third anniversary of the agreement. If the agreement is terminated by decisioning.com, Withrow & Terranova, PLLC will be entitled to continue to receive compensation attributable to patent agreements negotiated prior to termination and, if such termination is without cause, compensation for certain future patent agreements.
COMPETITION
The market for technologies that enable electronic commerce is highly competitive and is subject to rapid innovation and technological change, shifting consumer preferences, new product introductions and competition from traditional methods having all or some of the same features as technologies enabling electronic commerce. Competitors in this market have frequently taken different strategic approaches and have launched substantially different products or services in order to exploit the same perceived market opportunity. Until the market actually validates a strategy through widespread acceptance of a product or service, it is difficult to identify all current or potential market participants. There can be no assurance that the technologies covered by the Company's patents will be competitive technologically or otherwise.
Electronic commerce technologies in general, including the methods covered by the Company's patents, compete with traditional methods for processing financial transactions. The success of the Company's patent licensing efforts will depend in part on consumer acceptance of electronic commerce and industry use of systems that are covered by the Company's patents.
INTELLECTUAL PROPERTY
The Company was issued two patents in 1999 covering systems and methods for real-time loan processing over a computer network without human intervention ("System and Method for Real-time Loan Approval", U.S. Patent No. 5,870,721, and "Closed-loop Financial Transaction Method and Apparatus," U.S. Patent No. 5,940,811). Both of the Company's patents covering fully automated loan processing systems expire in 2013 and have been subject to reexamination by the PTO at the request of third parties who have challenged the validity of the patents. On January 28, 2003, the Company received a Reexamination Certificate relating to the completion of the PTO's reexamination of U. S. Patent No. 5,870,721. On December 20, 2005, the Company received a Reexamination Certificate relating to the completion of the PTO's reexamination of U.S. Patent No. 5,940,811.
In August 2000, the Company was issued a patent covering the automated establishment of a financial account without human intervention ("Automatic Financial Account Processing System", U.S. Patent No. 6,105,007). The patent expires in 2013. On June 23, 2004, the Company was notified by the PTO that it had granted a reexamination request previously filed by Federated Department Stores, Inc. ("Federated") and Ameritrade Holding Corporation ("Ameritrade") to reexamine U. S. Patent No. 6,105,007. The Company has lawsuits pending against Federated and Ameritrade in the Columbia Division of the United States District Court for the State of South Carolina (the "Court") in which it claims that both Federated and Ameritrade infringe U. S. Patent No. 6,105,007. The Company has similar litigation pending against Household International, Inc. ("Household"), in which it claims that Household infringes U.S. Patent No. 5,870,721 C1, No. 5,940,811 C1 and No. 6,105,007. The Company has jointly, with Federated, Ameritrade and Household, requested the Columbia Federal Court to stay the lawsuits against Federated, Ameritrade and Household pending resolution of the reexamination of U. S. Patent No. 6,105,007. On March 30, 2006 the Company was notified by the PTO that the reexamination had been concluded and that all of the claims of U.S. Patent No. 6,105,007 had been allowed. The Company expects to request that the stay of the lawsuits against Federated, Ameritrade and Household be lifted so that the lawsuits may proceed in the Columbia Federal Court. It may take an extended period of time to complete the litigation with Federated, Ameritrade and Household.
Other parties may take actions to challenge the Company's patents. The Company can make no assurances that it will not lose all or some of the claims covered by its existing patents.
The Company also holds a patent, which expires in 2014, covering the issuance of insurance products automatically through a kiosk ("Method and Apparatus for Issuing Insurance from a Kiosk", U.S. Patent No. 5,537,315).
"DeciSys/RT", and "E-xpertLender" are registered trademarks of the Company and "Affinity Technologies," "iDEAL," "rtDS," and "Affinity enabled" are registered service marks of the Company.
The Company's success is completely dependent upon its ability to defend and license its patents. There can be no assurance that the Company will be able to protect its intellectual property. Moreover, there can be no assurance that new technological innovations will not be developed and widely accepted by the market which will render obsolete the types of systems and methods over which the Company believes it has proprietary intellectual property rights.
EMPLOYEES
At December 31, 2005, the Company employed 1 full-time employee and one part-time employee, compared to 3 full-time employees at December 31, 2004. The Company has no collective bargaining agreements.
ITEM 1A.
ITEM 1A. RISK FACTORS
In addition to the other information in this report, readers should carefully consider the following important factors, among others, that in some cases have affected, and in the future could affect, the Company's actual results and could cause the Company's future results to differ materially from those expressed in any forward looking statements made by, or on behalf of, the Company.
LIMITED CAPITAL RESOURCES; OPERATING LOSSES
The Company has generated net losses of $69,244,419 since its inception and has financed its operations primarily through net proceeds from its initial public offering in May 1996 and cash generated from operations and other financing transactions. Net proceeds from the Company's initial public offering were $60,088,516.
To date, the Company has generated substantial operating losses and has been required to use a substantial amount of cash resources to fund its operations. At December 31, 2005, the Company had cash and cash equivalents of $13,776. As of March 31, 2006, the Company had almost completely exhausted its remaining cash resources. Unless it secures additional capital immediately, the Company may have to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection. Moreover, the Company currently does not have the resources to repay the principal and accrued interest outstanding under its convertible secured notes (the "notes"), which have become due and payable in full as discussed below. If any of the holders of these notes takes action to collect the amounts owed by the Company under these notes, the Company will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
Since 2002, the Company has issued an aggregate of $1,425,336 principal amount of convertible secured notes to certain investors as part of its efforts to raise additional capital. These notes bear interest at 8%, are convertible into the Company's common stock at a conversion rate of $.20 per share, and are secured by the Company's equity interest in decisioning.com, Inc., which owns the Company's patent portfolio. The outstanding notes include a note in the principal amount of $125,000 acquired on June 3, 2002 by the Company's Chief Executive Officer and a note in the principal amount of $100,000 acquired on November 5, 2003 by a subsidiary of The South Financial Group, which at that time owned approximately 12% of the Company's outstanding capital stock. Principal and interest under these notes generally becomes payable in full on the second anniversary of the date on which these notes were issued. However, under the terms of the notes, the full amount of principal and interest under all notes becomes immediately due and payable in certain events, including bankruptcy or similar proceedings involving the Company, a default in the payment of principal and interest under any note, or a change in control of the Company.
To date, notes with a principal amount of $1,206,336 have become due and payable in accordance with their contractual two-year maturity dates. The Company has had discussions with the holders of these notes regarding the extension of the maturity date of these notes. However, the Company has not been successful in reaching an agreement with all of the holders of these notes regarding an extension of their maturity date. Because the Company is currently in default regarding payment of principal and interest due under certain of the notes, the full amount of principal and interest outstanding under all notes has become due and payable. Accordingly, the full amount of principal and accrued interest under all of these notes is shown as a current liability of the Company as of December 31, 2005. As of December 31, 2005, and December 31, 2004, the amount of principal and accrued interest outstanding under all of the notes was $1,595,906 and $1,383,149, respectively.
To remain viable, the Company must generate working capital through the sale of patent licenses or by raising additional capital. To date, the Company generally has been unable to enter into licensing agreements with potential licensees upon terms that are acceptable to the Company. As discussed above, the Company has been forced to become involved in litigation with alleged infringers. The Company believes that these lawsuits may take an extended period of time to complete, and no assurance can be given that the Company will have the resources necessary to complete these lawsuits or that it will be successful in obtaining a favorable outcome. Accordingly, to remain viable it is critical that the Company raise additional capital immediately. The uncertainties of these litigation matters and other factors affecting the Company's short and long-term liquidity discussed above has impeded and will likely continue to impede the Company's ability to raise additional capital. To maintain the minimal resources necessary to support its current operations and execute a patent licensing strategy, the Company does not believe that substantial additional reductions in its operating expenses are feasible. No assurances can be given that the Company will be able to raise additional capital or generate working capital from its patent licensing business.
The Company has been a defendant in a lawsuit brought by Temple Ligon, who claims that the Company breached an agreement to give him a 1% equity interest in the Company in consideration of services he claims to have performed in 1993 and 1994 in conjunction with the formation of the Company. In January 2004, this litigation resulted in a jury verdict against the Company of $382,148. In connection with the litigation and the resulting jury verdict, the Company filed post-trial motions with the trial court in which, among other things, it claimed that the jury verdict should be set aside. On July 23, 2004, the trial judge granted the Company's motions, set aside the jury verdict, and ordered entry of a judgment in favor of the Company. The plaintiff has appealed the trial judge's ruling to the South Carolina Court of Appeals. If the Company becomes obligated to pay more than an insignificant amount of damages in connection with this litigation, it will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
In order to fund its operations, the Company may need to raise additional funds through the issuance of additional convertible debt or equity securities, in which case the percentage ownership of the stockholders of the Company may be reduced, stockholders may experience additional dilution, and such securities may have rights, preferences or privileges senior to common stock. There can be no assurance that additional financing will be available on terms acceptable to the Company or at all. If adequate funds are not available or not available on acceptable terms, the Company may be unable to continue operations.
DEPENDENCE ON PATENT LICENSING PROGRAM
Due to capital constraints, the Company has suspended efforts to deploy its loan processing products and services. The Company's business activities currently consist exclusively of attempting to license certain of its patents. The Company's prospects are dependent on its ability to finance and execute a sustainable patent licensing program. Even though the Company believes there are companies that may be using systems, processes and methods covered by the Company's patents, it is not known whether the Company will be able to enter into any new licensing agreements. Moreover, the Company may not have the resources to sustain its patent licensing program, enforce its patent rights, finance any related litigation, or successfully negotiate patent licenses on terms that will generate meaningful future revenues.
The Company is further subject to the risk that negotiations to license its patents may be lengthy and that it may be necessary for the Company to become involved in litigation to assert and protect its intellectual property rights. To date, the Company generally has been unable to enter into licensing agreements with potential licensees upon terms that are acceptable to the Company. As a result, the Company has been forced to become involved in litigation with alleged infringers. Currently, the Company is involved in three patent litigation actions. The Company believes that these lawsuits may take an extended period of time to complete. No assurance can be given that the Company will have the resources necessary to complete these lawsuits or that it will be successful in obtaining a favorable outcome. Prolonged patent litigation could have a material adverse effect on the Company's business, operating results and financial position.
CHALLENGES TO PATENTS
Both of the Company's patents covering fully-automated loan processing systems have been subject to reexamination by the PTO as a result of requests by third parties who have challenged the validity of the patents. On January 28, 2003, the Company received a Reexamination Certificate relating to the completion of the PTO's reexamination of U. S. Patent No. 5,870,721. On December 20, 2005, the Company received a Reexamination Certificate relating to the completion of the PTO's reexamination of U.S. Patent No. 5,940,811.
On March 26, 2004, the Company was notified by Federated Department Stores, Inc. ("Federated") and Ameritrade Holding Corporation ("Ameritrade") that they had jointly filed a request with the PTO to reexamine U. S. Patent No. 6,105,007. On June 23, 2004, the Company received notification that the PTO had granted the request for reexamination. The Company has lawsuits pending against Federated and Ameritrade in the Columbia Division of the United States District Court for the State of South Carolina (the "Columbia Federal Court") in which it claims that both Federated and Ameritrade infringe U. S. Patent No. 6,105,007. The Company has similar litigation pending against Household International, Inc. ("Household"), in which it claims that Household infringes U.S. Patent No. 5,870,721 C1, No. 5,940,811 C1 and No. 6,105,007. The Company has jointly, with Federated, Ameritrade and Household, requested the Columbia Federal Court to stay the lawsuits against Federated, Ameritrade and Household pending resolution of the reexamination of U. S. Patent No. 6,105,007. On March 30, 2006 the Company was notified that the PTO has concluded the reexamination of U.S. Patent No. 6,105,007 and has issued a "Notice of Intent to Issue Ex Parte Reexamination Certificate" (the "Notice"). The Notice indicates that the reexamination resulted in the full allowance of all the claims of the Company's U.S. Patent No. 6,105,007. The Company expects to request that the stay of the lawsuits against Federated, Ameritrade and Household be lifted so that the lawsuits may proceed in the Columbia Federal Court. It may take an extended period of time to complete the litigation with Federated, Ameritrade and Household. Moreover, protracted litigation with Federated, Ameritrade and Household may have a material adverse effect on the Company's patent licensing program and impede its ability to attract additional capital resources in order to continue its operations.
It is possible that third parties may bring additional actions to contest all or some of the Company's patents. The Company may lose all or some of the claims covered by its existing patents as a result of existing or future challenges. The loss of all or some of its claims or a significant limitation of such claims could have a material adverse effect on the Company's ability to execute a successful patent licensing program. Moreover, if other parties request reexaminations of or otherwise challenge the Company's patents in the future, the Company is subject to the risk that such proceeding may not be resolved to the Company's satisfaction on a timely basis, if at all. Any such proceeding may have a material adverse effect on the Company's business, operating results and financial position. Moreover, in the event a challenge to the Company's patents results in a significant loss of all or some of its claims, the Company's only remedy may be to contest the decision, which would likely be a lengthy process. Due to the Company's limited capital resources, it is unlikely that the Company could successfully contest the decision without additional cash resources. Accordingly, a decision by the PTO to limit all or some of the Company's patent claims could have a material adverse effect on the Company's business, operating results and financial position.
DEPENDENCE ON E-COMMERCE TECHNOLOGIES
The Company's patents are specific to the e-commerce businesses of the financial services industry and generally cover the automated establishment of loans, financial accounts and credit accounts using specific e-commerce related systems, processes and methods. The market for products and services that enable e-commerce is subject to change and technological development, shifting consumer preferences, new product introductions and competition from traditional products and services having all or some of the same features as products and services which enable e-commerce. It is possible that new products or technologies may be developed that may render obsolete the systems, processes and methods over which the Company believes it has intellectual property rights. Moreover, the delivery of products and services through e-commerce channels is not fully developed, and competition from traditional channels to deliver these same products and services is intense. Any wide-scale rejection of e-commerce channels by consumers will have a material adverse effect on the Company's business, operating results and financial position.
DEPENDENCE ON THIRD PARTIES
Patent licensing is a highly technical and specialized business which requires the Company to rely on the services of third parties. In May 2003, the Company appointed Withrow & Terranova, PLLC as its exclusive patent licensing agent. Under the terms of the agreement, Withrow & Terranova, PLLC has agreed, among other things, to perform market research, initiate the sales of patent license agreements, negotiate patent licensing arrangements with third parties, and represent the Company as legal counsel in connection with the enforcement of its patents. Accordingly, the Company is dependent on Withrow & Terranova, PLLC to successfully execute its patent licensing program. Additionally, the agreement requires Withrow & Terranova, PLLC to coordinate the engagement of experts, on terms satisfactory to the Company, if litigation becomes necessary to enforce the Company's patent rights. The success of the Company's patent licensing program and enforcement of its patents may depend on the satisfactory retention and efforts of experts. Moreover, experts frequently request and charge significant fees.
POTENTIAL FOR FLUCTUATION IN QUARTERLY RESULTS
Since its inception, the Company's quarterly results have fluctuated and have not been susceptible to meaningful period-to-period comparisons. The Company believes that it may continue to experience significant fluctuations in its quarterly operating results in the foreseeable future. The Company anticipates that its period-to-period revenue and operating results will depend on numerous factors including the ability of the Company to successfully negotiate and enter into patent licensing agreements and the timing, terms and the pricing attributes of any such agreements.
The Company believes that period-to-period comparisons of its operating results are not meaningful and should not be relied upon as an indication of future performance. The uncertainty regarding the extent and timing of revenues coupled with the risk of substantial fluctuations in its quarterly operating results may have a material adverse effect on the price of the Company's Common Stock in the future.
DEPENDENCE ON KEY EMPLOYEES
The Company is highly dependent on the services of its Chairman, President and Chief Executive Officer, Joseph A. Boyle. The Company does not have an employment agreement with Mr. Boyle or "key man" insurance on his life. The complete loss of the services of Mr. Boyle could have a material adverse effect upon the Company's business, operating results and financial condition. In addition, the Company's financial condition would likely adversely affect the Company's ability to retain or recruit employees and executives.
RISK OF SUBSTANTIAL DILUTION
The Company has issued convertible notes that are convertible into common stock at $0.20 per share, which could be substantially less than the market price of the common stock at the time of conversion. The issuance of stock at a price that is less than the market price could have an immediate adverse effect on the market price of the Company's common stock. In addition, the Company has issued options and warrants to acquire shares of its common stock, and the Company may issue additional convertible notes or warrants in connection with financing arrangements and may grant additional stock options under its stock option plan that may further dilute the Company's common stock. The exercise of such securities would have a dilutive effect on the Company's common stock. Also, to the extent that persons who acquire shares under all the foregoing agreements sell those shares in the market, the price of the Company's shares may decrease due to additional shares in the market.
VOLATILITY OF STOCK PRICE AND RISK OF LITIGATION
The Company's common stock price has been volatile and has experienced substantial and sudden fluctuations in response to a number of events and factors. In addition, the stock market has experienced significant price and volume fluctuations that have especially affected the market prices of equity securities of many companies directly and indirectly involved in the technology sector, and that often have been unrelated to the operating performance of such companies. These broad market fluctuations have adversely affected and may continue to adversely affect the market price of the Company's common stock. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against such a company. Such litigation could result in substantial costs and a diversion of management's attention and resources, which would have a material adverse effect on the Company's business, operating results and financial condition.
ANTI-TAKEOVER PROVISIONS
Certain provisions of Delaware law and the Company's Certificate of Incorporation and bylaws could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. Such provisions could limit the price that certain investors might be willing to pay in the future for shares of the Company's common stock. These provisions of Delaware law and the Company's Certificate of Incorporation and bylaws may also have the effect of discouraging or preventing certain types of transactions involving an actual or threatened change of control of the Company (including unsolicited takeover attempts), even though such a transaction may offer the Company's stockholders the opportunity to sell their stock at a price above the prevailing market price. Certain of these provisions allow the Company to issue preferred stock with rights senior to those of the common stock and other rights that could adversely affect the interests of holders of common stock without any further vote or action by the stockholders. The issuance of preferred stock, for example, could decrease the amount of earnings or assets available for distribution to the holders of common stock or could adversely affect the rights and powers, including voting rights, of the holders of the common stock. In certain circumstances, such issuance could have the effect of decreasing the market price of the common stock, as well as having the anti-takeover effects discussed above.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
The Company's principal executive offices are located at 8807-A Two Notch Road in Columbia, South Carolina. Such office space encompasses approximately 300 square feet and is currently under a month-to-month lease. The Company also leases warehouse space located in Columbia, South Carolina, which encompasses approximately 4,000 square feet. Such space is under a month-to-month lease.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company and its founder, Jeff Norris, are defendants in a lawsuit filed by Temple Ligon on November 30, 1996 in the Court of Common Pleas for the County of Richland in Columbia, South Carolina. Mr. Ligon claims, among other things, that the Company and Mr. Norris breached an agreement to give him a 1% equity interest in the Company in consideration of services Mr. Ligon claims to have performed in 1993 and 1994 in conjunction with the formation of the Company, and seeks monetary damages of $5,463,000. This lawsuit initially resulted in a jury verdict against the Company of $68,000. However, Mr. Ligon subsequently requested and was granted a new trial. In January 2004, this lawsuit resulted in another jury verdict against the Company of $382,148. In connection with the litigation and the resulting jury verdict, the Company filed post-trial motions with the trial court in which, among other things, it claimed that the jury verdict should be set aside. On July 23, 2004, the trial judge granted the Company's motions, set aside the jury verdict, and ordered entry of a judgment in favor of the Company. The plaintiff has appealed the trial judge's ruling to the South Carolina Court of Appeals. If the Company becomes obligated to pay more than an insignificant amount of damages in connection with this litigation, it will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
In June 2003, the Company filed a lawsuit against Federated Department Stores, Inc., and certain of its subsidiaries alleging that Federated has infringed one of the Company's patents (U. S. Patent No. 6,105,007). In September 2003, the Company filed a similar lawsuit against Ameritrade Holding Corporation and its subsidiary, Ameritrade, Inc. (collectively "Ameritrade"), alleging infringement of the same patent. Both lawsuits were filed in the United States District Court in Columbia, South Carolina (the "Columbia Federal Court"), and both seek unspecified damages. On March 26, 2004, the Company was notified by Federated and Ameritrade that they had jointly filed a request with the PTO to reexamine U. S. Patent No. 6,105,007. On June 23, 2004, the Company received notification that the PTO had granted the request for reexamination. The Company has jointly, with Federated and Ameritrade, requested the Columbia Federal Court to stay the lawsuits against Federated and Ameritrade pending resolution of the reexamination of U. S. Patent No. 6,105,007. On March 30, 2006 the Company was notified that the PTO has concluded the reexamination of U.S. Patent No. 6,105,007 and has issued a "Notice of Intent to Issue Ex Parte Reexamination Certificate" (the "Notice"). The Notice indicates that the reexamination resulted in the full allowance of all the claims of the Company's U.S. Patent No. 6,105,007. The Company expects to request that the stay of the lawsuits against Federated and Ameritrade be lifted so that the lawsuits may proceed in the Columbia Federal Court. It may take an extended period of time to complete the litigation with Federated, Ameritrade and Household.
In November 2003, Household International, Inc. ("Household") filed a declaratory judgment action against the Company in the United States District Court in Wilmington, Delaware (the "Delaware Federal Court"). In its complaint Household requested the Delaware Federal Court to rule that Household was not infringing any of the claims of the Company's patents (U.S. Patent No. 5,870,721 C1, No. 5,940,811 C1, and No. 6,105,007) and that the patents were not valid. The Company filed counterclaims against Household claiming that Household infringes U. S. Patent No. 5,870,721 C1, No. 5,940,811 C1 and No. 6,105,007. The Company also filed a motion with the Delaware Federal Court to transfer the case to the Columbia Federal Court. In April 2004, the Delaware Federal Court granted the Company's motion to transfer the case to Columbia Federal Court. The Company has jointly, with Household, requested and received a stay of the Household action from the Columbia Federal Court pending the resolution of the PTO's reexamination of U.S. Patent No. 6,105,007. As discussed above, the PTO has concluded the reexamination of U.S. Patent No. 6,105,007. Accordingly, the Company expects to request that the stay of the lawsuit against Household be lifted so that the lawsuit may proceed in the Columbia Federal Court.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
NAME AGE POSITION WITH THE COMPANY - ----------------- --- ------------------------- Joseph A. Boyle 52 Chairman, President, Chief Executive Officer, and Chief Financial Officer S. Sean Douglas 37 Executive Vice President and Chief Operating Officer
JOSEPH A. BOYLE became President and Chief Executive Officer of the Company in January 2000 and Chairman in March 2001. Mr. Boyle has also served as Chief Financial Officer of the Company since September 1996. Mr. Boyle also held the title of Senior Vice President from September 1996 to January 2000. Mr. Boyle has previously served as Secretary and Treasurer of the Company. To conserve the Company's limited financial resources, Mr. Boyle has from time to time reduced his time commitment to and compensation received from the Company. Since January 3, 2005, Mr. Boyle has performed consulting services for a local financial institution. From April 2003 to August 2004, Mr. Boyle also was a partner of Elliott Davis, LLC, a South Carolina public accounting firm. Prior to joining the Company, Mr. Boyle served as Price Waterhouse, LLP's engagement partner for most of its Kansas City, Missouri, financial services clients and was a member of the firm's Mortgage Banking Group. Mr. Boyle was employed by Price Waterhouse, LLP from June 1982 to August 1996.
S. SEAN DOUGLAS became Executive Vice President and Chief Operating Officer of the Company in March 2003. Mr. Douglas also held the title of Senior Vice President of Finance, Operations and Administration of the Company from March 2002 to March 2003. From January 2000 to March 2002, Mr. Douglas held the title of Vice President and Controller of the Company. From November 1995 to January 2000 Mr. Douglas was the Company's accounting manager.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
(a) Since February 12, 2001, the Company's common stock has traded on the OTC Bulletin Board under the symbol "AFFI." The Company's common stock traded on the Nasdaq SmallCap Market from March 27, 2000 to February 12, 2001. Prior to March 27, 2000, the Company's common stock was traded on the Nasdaq National Market. The following table presents the high and low sales prices of the Company's Common Stock for the periods indicated during 2005 and 2004 as reported by the OTC Bulletin Board. As of March 6, 2006, there were 443 stockholders of record of the Common Stock.
SALES PRICE PER SHARE --------------------- HIGH LOW ------ ----- First Quarter 0.19 0.05 Second Quarter 0.15 0.06 Third Quarter 0.10 0.06 Fourth Quarter 0.10 0.05 First Quarter 0.17 0.09 Second Quarter 0.12 0.06 Third Quarter 0.07 0.04 Fourth Quarter 0.09 0.04
The Company has never paid dividends on its capital stock. The Company intends to retain earnings, if any, for use in its business and does not anticipate paying any cash dividends in the foreseeable future.
On December 13, 2005, the Company issued $25,000 principal amount of its convertible secured notes to an accredited investor for cash in a transaction exempt from registration pursuant to Rule 506 of Regulation D and Section 4(2) of the Securities Act of 1933. These notes are convertible into shares of common stock of the Company at a price of $0.20 per share.
(b) Not applicable
(c) Not applicable
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data of the Company for the periods indicated. The following financial data should be read in conjunction with the information set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Company's Consolidated Financial Statements and Notes thereto and other information included elsewhere in this report.
- ------------------------------------------
(1) Amounts outstanding under the convertible debenture as of December 31, 2001, were classified as a current liability and, accordingly, are included in the working capital of the Company at December 31, 2001, set forth above.
(2) $756,336 of the amount outstanding under the convertible notes as of December 31, 2003, was classified as a current liability and, accordingly, is included in the working capital of the Company at December 31, 2003, set forth above.
(3) All amounts outstanding under the convertible notes as of December 31, 2004, were classified as a current liability and, accordingly, are included in the working capital of the Company at December 31, 2004, set forth above.
(4) All amounts outstanding under the convertible notes as of December 31, 2005, were classified as a current liability and, accordingly, are included in the working capital of the Company at December 31, 2005, set forth above.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company was formed in 1994 to develop and market technologies that enable financial institutions and other businesses to provide consumer financial services electronically with reduced or no human intervention. Due to capital constraints, the Company has suspended efforts to deploy products and services that use its loan processing system, DeciSys/RT, in order to focus its efforts exclusively on attempting to license certain of its patents.
In conjunction with its product development activities, the Company applied for and obtained three patents. The Company has been granted two patents covering its fully-automated loan processing systems (U. S. Patent No. 5,870,721 and No. 5,940,811). In August 2000, the U.S. Patent and Trademark Office issued to the Company a patent covering the fully-automated establishment of a financial account, including credit accounts (U. S. Patent No. 6,105,007). In addition, in 1997 the Company acquired a patent that covers the automated processing of an insurance binder through a kiosk (U. S. Patent No. 5,537,315).
Both of the Company's patents covering fully automated loan processing systems have been subject to reexamination by the U.S. Patent and Trademark Office (the "PTO") as a result of challenges to such patents by third parties. On January 28, 2003, the Company received a Reexamination Certificate (U. S. Patent No. 5,870,721 C1) from the PTO which formally concluded the reexamination of U. S. Patent No. 5,870,721. On December 20, 2005, the Company received a Reexamination Certificate (U.S. Patent No. 5,940,811 C1) from the PTO which formally concluded the reexamination of U.S. Patent No. 5,940,811.
On March 26, 2004, the Company was notified by Federated Department Stores, Inc. ("Federated") and Ameritrade Holding Corporation ("Ameritrade") that they had jointly filed a request with the PTO to reexamine U. S. Patent No. 6,105,007. On June 23, 2004, the Company received notification that the PTO had granted the request for reexamination. The Company has lawsuits pending against Federated and Ameritrade in the Columbia Division of the United States District Court for the State of South Carolina (the "Columbia Federal Court") in which it claims that both Federated and Ameritrade infringe U. S. Patent No. 6,105,007. The Company has similar litigation pending against Household International, Inc. ("Household"), in which it claims that Household infringes U.S. Patent No. 5,870,721 C1, No. 5,940,811 C1 and No. 6,105,007. The Company has jointly, with Federated, Ameritrade and Household, requested the Columbia Federal Court to stay the lawsuits against Federated, Ameritrade and Household pending resolution of the reexamination of U. S. Patent No. 6,105,007. On March 30, 2006 the Company was notified that the PTO has concluded the reexamination of U.S. Patent No. 6,105,007 and has issued a "Notice of Intent to Issue Ex Parte Reexamination Certificate" (the "Notice"). The Notice indicates that the reexamination resulted in the full allowance of all the claims of the Company's U.S. Patent No. 6,105,007. The Company expects to request that the stay of the lawsuits against Federated, Ameritrade and Household be lifted so that the lawsuits may proceed in the Columbia Federal Court. It may take an extended period of time to complete the litigation with Federated, Ameritrade and Household. Moreover, protracted litigation with Federated, Ameritrade and Household may have a material adverse effect on the Company's patent licensing program and impede its ability to attract additional capital resources in order to continue its operations.
It is possible that third parties may bring additional actions to contest all or some of the Company's patents. The Company can make no assurances that it will not lose all or some of the claims covered by its existing patents.
To date, the Company has generated substantial operating losses and has been required to use a substantial amount of cash resources to fund its operations. At December 31, 2005, the Company had cash and cash equivalents of $13,776. As of March 31, 2006, the Company had almost completely exhausted its remaining cash resources. Unless it secures additional capital immediately, the Company may have to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection. Moreover, the Company currently does not have the resources to repay the principal and accrued interest outstanding under its convertible secured notes (the "notes"), which have become due and payable in full as discussed below. If any of the holders of these notes takes action to collect the amounts owed by the Company under these notes, the Company will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
Since 2002, the Company has issued an aggregate of $1,425,336 principal amount of convertible secured notes to certain investors as part of its efforts to raise additional capital. These notes bear interest at 8%, are convertible into the Company's common stock at a conversion rate of $.20 per share, and are secured by the Company's equity interest in decisioning.com, Inc., which owns the Company's patent portfolio. The outstanding notes include a note in the principal amount of $125,000 acquired on June 3, 2002 by the Company's Chief Executive Officer and a note in the principal amount of $100,000 acquired on November 5, 2003 by a subsidiary of The South Financial Group, which at that time owned approximately 12% of the Company's outstanding capital stock. Principal and interest under these notes generally becomes payable in full on the second anniversary of the date on which these notes were issued. However, under the terms of the notes, the full amount of principal and interest under all notes becomes immediately due and payable in certain events, including bankruptcy or similar proceedings involving the Company, a default in the payment of principal and interest under any note, or a change in control of the Company.
To date, notes with a principal amount of $1,206,336 have become due and payable in accordance with their contractual two-year maturity dates. The Company has had discussions with the holders of these notes regarding the extension of the maturity date of these notes. However, the Company has not been successful in reaching an agreement with all of the holders of these notes regarding an extension of their maturity date. Because the Company is currently in default regarding payment of principal and interest due under certain of the notes, the full amount of principal and interest outstanding under all notes has become due and payable. Accordingly, the full amount of principal and accrued interest under all of these notes is shown as a current liability of the Company as of December 31, 2005. As of December 31, 2005, and December 31, 2004, the amount of principal and accrued interest outstanding under all of the notes was $1,595,906 and $1,383,149, respectively.
To remain viable, the Company must generate working capital through the sale of patent licenses or by raising additional capital. To date, the Company generally has been unable to enter into licensing agreements with potential licensees upon terms that are acceptable to the Company. As discussed above, the Company has been forced to become involved in litigation with alleged infringers. The Company believes that these lawsuits may take an extended period of time to complete, and no assurance can be given that the Company will have the resources necessary to complete these lawsuits or that it will be successful in obtaining a favorable outcome. Accordingly, to remain viable it is critical that the Company raise additional capital immediately. The uncertainties of these litigation matters and other factors affecting the Company's short and long-term liquidity discussed above has impeded and will likely continue to impede the Company's ability to raise additional capital. To maintain the minimal resources necessary to support its current operations and execute a patent licensing strategy, the Company does not believe that substantial additional reductions in its operating expenses are feasible. No assurances can be given that the Company will be able to raise additional capital or generate working capital from its patent licensing business.
The Company has been a defendant in a lawsuit brought by Temple Ligon, who claims that the Company breached an agreement to give him a 1% equity interest in the Company in consideration of services he claims to have performed in 1993 and 1994 in conjunction with the formation of the Company. In January 2004, this litigation resulted in a jury verdict against the Company of $382,148. In connection with the litigation and the resulting jury verdict, the Company filed post-trial motions with the trial court in which, among other things, it claimed that the jury verdict should be set aside. On July 23, 2004, the trial judge granted the Company's motions, set aside the jury verdict, and ordered entry of a judgment in favor of the Company. The plaintiff has appealed the trial judge's ruling to the South Carolina Court of Appeals. If the Company becomes obligated to pay more than an insignificant amount of damages in connection with this litigation, it will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
CRITICAL ACCOUNTING POLICIES
The Company applies certain accounting policies which are important in understanding the Company's results of operations and the information presented in the consolidated financial statements. The Company considers critical accounting policies to be those that require more significant judgments and estimates in the preparation of its financial statements and include the valuation reserve on net deferred tax assets. The Company records a valuation allowance to reduce its deferred tax assets to the amount that it estimates is more likely than not to be realized. As of December 31, 2005, the Company recorded a valuation allowance that reduced its deferred tax assets to zero
RESULTS OF OPERATIONS
REVENUES. The Company's revenues from continuing operations were $20,261, $287,298 and $517,647 for the years ended December 31, 2005, 2004, and 2003, respectively. The types of revenue recognized by the Company are as follows:
PATENT LICENSE REVENUE. The Company recognized patent licensing revenue of $20,261, $267,467 and $17,647 in 2005, 2004 and 2003, respectively. In 2005, 2004 and 2003, the Company recognized patent licensing revenue associated with the annual fee from one patent license agreement executed in 1999. Of the total amount recognized in 2004, $250,000 was related to a settlement agreement with an institution that formerly maintained a system that permitted consumers to apply for credit cards over the Internet and is non-recurring.
OTHER INCOME. In 2005, the Company recognized no amounts classified as other income. In 2004, other income consisted exclusively of non-recurring miscellaneous income items primarily associated with the sale of equipment no longer needed in the operation of the Company's business. In 2003, other income of $500,000 related exclusively to amounts received by the Company as a result of the settlement of a lawsuit.
COSTS AND EXPENSES
COSTS OF REVENUES. Costs of revenues from continuing operations for the years ended December 31, 2005, 2004, and 2003 were $2,026, $64,265 and $1,765, respectively. Cost of revenues consists of commissions paid to the Company's patent licensing agents.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative ("G&A") expenses for the year ended December 31, 2005, were $486,607, compared to $732,285 and $996,711 for the years ended December 31, 2004 and 2003, respectively.
G&A expenses during 2005 consisted primarily of personnel expense of approximately $248,000; professional fees of approximately $139,000; depreciation and amortization expense of approximately $6,000; rent expense of approximately $26,000; and insurance and taxes of approximately $56,000.
G&A expenses during 2004 consisted primarily of personnel expense of approximately $272,000; professional fees of approximately $321,000; depreciation and amortization expense of approximately $8,000; rent expense of approximately $41,000; and insurance and taxes of approximately $61,000.
G&A expenses during 2003 consisted primarily of personnel expense of approximately $266,000; professional fees of approximately $269,000; depreciation and amortization expense of approximately $15,000; rent expense of approximately $54,000; insurance and taxes of approximately $72,000; and litigation accruals of approximately $318,000.
The decrease in G&A in 2005 compared to 2004 and 2004 compared to 2003 is due the continued reduction of the Company's activities over the past three years and curtailment of other expenses. G&A expenses were lower in all material categories in 2005 compared to 2004. G&A expenses were lower in all material categories in 2004 compared to 2003, except for personnel expense and professional fees. The approximately $6,000 increase in personnel expense in 2004 compared to 2003 was attributable to the full-time employment of the Company's President and CEO for four months in 2004 compared to three months in 2003. The approximately $52,000 increase in professional fees in 2004 compared to 2003 was primarily attributable to legal expenses incurred with respect to the Temple Ligon trial.
INTEREST INCOME
Interest income was $182, $1,967 and $694 during 2005, 2004, and 2003, respectively, and primarily reflects interest income attributable to cash balances.
INTEREST EXPENSE
Interest expense was $98,197, $95,990 and $80,373 in 2005, 2004, and 2003, respectively. Interest expense is primarily associated with the interest on $1,425,336 aggregate principal amount of convertible notes issued in installments in June 2002 ($830,336), March 2003 ($200,000), August 2003 ($25,000), November 2003 ($150,000), December 2003 ($50,000), January 2004 ($25,000), May 2005 ($75,000), August 2005 ($45,000) and December 2005 ($25,000). The increase in interest expense in 2005 compared to 2004 and 2004 compared to 2003 is attributable to the increase in the average amounts of the convertible notes outstanding.
LITIGATION ACCRUAL REVERSAL
The Company has been a defendant in a lawsuit which resulted in a jury verdict against the Company in January 2004. The Company had recorded a reserve for the estimated loss in this litigation of $386,148 as a result of the jury verdict. In July 2004 the trial judge ruled on post-trial motions submitted by the Company and set aside the jury verdict, and accordingly, in the third quarter of 2004, the Company reversed the $386,148 accrual and recognized a like amount as other income.
INCOME TAXES
The Company has recorded a valuation allowance for the full amount of its net deferred income tax assets as of December 31, 2005, 2004, and 2003, based on management's evaluation of the recognition criteria as set forth in Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes."
LIQUIDITY AND CAPITAL RESOURCES
The Company has generated net losses of $69,244,419 since its inception and has financed its operations primarily through net proceeds from its initial public offering in May 1996 and cash generated from operations and other financing transactions. Net proceeds from the Company's initial public offering were $60,088,516.
To date, the Company has generated substantial operating losses and has been required to use a substantial amount of cash resources to fund its operations. At December 31, 2005, the Company had cash and cash equivalents of $13,776. As of March 31, 2006, the Company had almost completely exhausted its remaining cash resources. Unless it secures additional capital immediately, the Company may have to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection. Moreover, the Company currently does not have the resources to repay the principal and accrued interest outstanding under its convertible secured notes (the "notes"), which have become due and payable in full as discussed below. If any of the holders of these notes takes action to collect the amounts owed by the Company under these notes, the Company will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
Since 2002, the Company has issued an aggregate of $1,425,336 principal amount of convertible secured notes to certain investors as part of its efforts to raise additional capital. These notes bear interest at 8%, are convertible into the Company's common stock at a conversion rate of $.20 per share, and are secured by the Company's equity interest in decisioning.com, Inc., which owns the Company's patent portfolio. The outstanding notes include a note in the principal amount of $125,000 acquired on June 3, 2002 by the Company's Chief Executive Officer and a note in the principal amount of $100,000 acquired on November 5, 2003 by a subsidiary of The South Financial Group, which at that time owned approximately 12% of the Company's outstanding capital stock. Principal and interest under these notes generally becomes payable in full on the second anniversary of the date on which these notes were issued. However, under the terms of the notes, the full amount of principal and interest under all notes becomes immediately due and payable in certain events, including bankruptcy or similar proceedings involving the Company, a default in the payment of principal and interest under any note, or a change in control of the Company.
To date, notes with a principal amount of $1,206,336 have become due and payable in accordance with their contractual two-year maturity dates. The Company has had discussions with the holders of these notes regarding the extension of the maturity date of these notes. However, the Company has not been successful in reaching an agreement with all of the holders of these notes regarding an extension of their maturity date. Because the Company is currently in default regarding payment of principal and interest due under certain of the notes, the full amount of principal and interest outstanding under all notes has become due and payable. Accordingly, the full amount of principal and accrued interest under all of these notes is shown as a current liability of the Company as of December 31, 2005. As of December 31, 2005, and December 31, 2004, the amount of principal and accrued interest outstanding under all of the notes was $1,595,906 and $1,383,149, respectively.
To remain viable, the Company must generate working capital through the sale of patent licenses or by raising additional capital. To date, the Company generally has been unable to enter into licensing agreements with potential licensees upon terms that are acceptable to the Company. As discussed above, the Company has been forced to become involved in litigation with alleged infringers. The Company believes that these lawsuits may take an extended period of time to complete, and no assurance can be given that the Company will have the resources necessary to complete these lawsuits or that it will be successful in obtaining a favorable outcome. Accordingly, to remain viable it is critical that the Company raise additional capital immediately. The uncertainties of these litigation matters and other factors affecting the Company's short and long-term liquidity discussed above has impeded and will likely continue to impede the Company's ability to raise additional capital. To maintain the minimal resources necessary to support its current operations and execute a patent licensing strategy, the Company does not believe that substantial additional reductions in its operating expenses are feasible. No assurances can be given that the Company will be able to raise additional capital or generate working capital from its patent licensing business.
The Company has been a defendant in a lawsuit brought by Temple Ligon, who claims that the Company breached an agreement to give him a 1% equity interest in the Company in consideration of services he claims to have performed in 1993 and 1994 in conjunction with the formation of the Company. In January 2004, this litigation resulted in a jury verdict against the Company of $382,148. In connection with the litigation and the resulting jury verdict, the Company filed post-trial motions with the trial court in which, among other things, it claimed that the jury verdict should be set aside. On July 23, 2004, the trial judge granted the Company's motions, set aside the jury verdict, and ordered entry of a judgment in favor of the Company. The plaintiff has appealed the trial judge's ruling to the South Carolina Court of Appeals. If the Company becomes obligated to pay more than an insignificant amount of damages in connection with this litigation, it will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
Net cash used during the year ended December 31, 2005, to fund operations was approximately $194,000, compared to approximately $558,000 and $44,000 for 2004 and 2003, respectively. The decrease in cash used to fund operations during 2005 as compared to 2004 primarily reflects lower operating expenses in 2005, an increase in the deferral of the payment of certain operating expenses in 2005, which is reflected as an increase in accounts payable, accrued expenses, and accrued compensation and related benefits on the December 31, 2005 balance sheet compared to December 31, 2004 balances, and a reduction in prepaid expenses in 2005. In 2003, the Company received $500,000 in conjunction with the settlement of a lawsuit which significantly reduced cash used to fund its operations. At December 31, 2005, 2004, and 2003, cash and liquid investments were $13,776, $62,756 and $578,398, respectively, and working capital was ($1,992,056), ($1,524,772) and ($909,356), respectively. For purposes of determining working capital at December 31, 2005 and 2004, $1,595,906 and $1,383,149, respectively, of principal and accrued interest under the Company's convertible notes are included as current liabilities.
CONTRACTUAL OBLIGATIONS
The following table sets forth the Company's long-term debt and other obligations at December 31, 2005.
(1) Convertible notes consist of the Company's convertible notes, including accrued interest, which have become immediately due and payable.
ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The report of Independent Registered Public Accounting Firm and consolidated financial statements are set forth below (see item 15(a) for list of financial statements and financial statement schedules):
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders Affinity Technology Group, Inc. Columbia, South Carolina
We have audited the accompanying consolidated balance sheets of Affinity Technology Group, Inc. and subsidiaries (collectively, the "Company") as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in stockholders' equity (deficiency), and cash flows for each of the years in the three-year period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has incurred recurring operating losses, has an accumulated deficit, and has certain convertible notes in default. These matters raise substantial doubt about the ability of the Company to continue as a going concern. Management's plans in regard to these matters are also discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ SCOTT McELVEEN, L.L.P.
Columbia, South Carolina March 13, 2006, except for Note 1 which is as of March 30, 2006
AFFINITY TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AFFINITY TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AFFINITY TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
AFFINITY TECHNOLOGY GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
AFFINITY TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY - GOING CONCERN
The Company was formed to develop and market technologies that enable financial institutions and other businesses to provide consumer financial services electronically with reduced or no human intervention. Products and services previously offered by the Company include its DeciSys/RT(R) loan processing system, which automated the processing and consummation of consumer financial services transactions; the Affinity Automated Loan Machine (the ALM), which allowed an applicant to apply for and, if approved, obtain a loan in as little as ten minutes; the Mortgage ALM, which allowed an applicant to apply for a mortgage loan; E-xpertLender(R), which permitted a financial institution to make automated lending decisions through its call centers and branches; iDEAL, which permitted automobile lenders to make automobile lending decisions for loan applications originated at automobile dealers; and rtDS, which permitted lenders to deliver credit decisions to applicants over the Internet. Due to capital constraints, the Company has suspended all efforts to further develop, market and operate these products and services. The Company's last processing contract terminated in late 2002, and the Company has no plans to engage in further sales or other activities related to its products or services, other than to attempt to license certain of the patents that it owns. Currently, the Company's business activities consist exclusively of attempting to enter into license agreements with third parties to license the Company's rights under certain of its patents.
In conjunction with its product development activities, the Company applied for and obtained three patents. The Company has been granted two patents covering its fully-automated loan processing systems (U. S. Patents No. 5,870,721 and 5,940,811). In August 2000, the U.S. Patent and Trademark Office issued to the Company a patent covering the fully-automated establishment of a financial account, including credit accounts (U. S. Patent No. 6,105,007). In addition, in 1997 the Company acquired a patent that covers the automated processing of an insurance binder through a kiosk (U. S. Patent No. 5,537,315).
Both of the Company's patents covering fully automated loan processing systems have been subject to reexamination by the U.S. Patent and Trademark Office (the "PTO") as a result of challenges to such patents by third parties. On January 28, 2003, the Company received a Reexamination Certificate (U. S. Patent No. 5,870,721 C1) from the PTO which formally concluded the reexamination of U. S. Patent No. 5,870,721. On December 20, 2005, the Company received a Reexamination Certificate (U.S. Patent No. 5,940,811 C1) from the PTO which formally concluded the reexamination of U.S. Patent No. 5,940,811.
On March 26, 2004, the Company was notified by Federated Department Stores, Inc. ("Federated") and Ameritrade Holding Corporation ("Ameritrade") that they had jointly filed a request with the PTO to reexamine U. S. Patent No. 6,105,007. On June 23, 2004, the Company received notification that the PTO had granted the request for reexamination. The Company has lawsuits pending against Federated and Ameritrade in the Columbia Division of the United States District Court for the State of South Carolina (the "Columbia Federal Court") in which it claims that both Federated and Ameritrade infringe U. S. Patent No. 6,105,007. The Company has similar litigation pending against Household International, Inc. ("Household"), in which it claims that Household infringes U.S. Patent No. 5,870,721 C1, No. 5,940,811 C1 and No. 6,105,007. The Company has jointly, with Federated, Ameritrade and Household, requested the Columbia Federal Court to stay the lawsuits against Federated, Ameritrade and Household pending resolution of the reexamination of U. S. Patent No. 6,105,007. On March 30, 2006 the Company was notified that the PTO has concluded the reexamination of U.S. Patent No. 6,105,007 and has issued a "Notice of Intent to Issue Ex Parte Reexamination Certificate" (the "Notice"). The Notice indicates that the reexamination resulted in the full allowance of all the claims of the Company's U.S. Patent No. 6,105,007. The Company expects to request that the stay of the lawsuits against Federated, Ameritrade and Household be lifted so that the lawsuits may proceed in the Columbia Federal Court. It may take an extended period of time to complete the litigation with Federated, Ameritrade and Household. Moreover, protracted litigation with Federated, Ameritrade and Household may have a material adverse effect on the Company's patent licensing program and impede its ability to attract additional capital resources in order to continue its operations.
It is possible that third parties may bring additional actions to contest all or some of the Company's patents. The Company can make no assurances that it will not lose all or some of the claims covered by its existing patents.
To date, the Company has generated substantial operating losses and has been required to use a substantial amount of cash resources to fund its operations. At December 31, 2005, the Company had cash and cash equivalents of $13,776. As of March 31, 2006, the Company had almost completely exhausted its remaining cash resources. Unless it secures additional capital immediately, the Company may have to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection. Moreover, the Company currently does not have the resources to repay the principal and accrued interest outstanding under its convertible secured notes (the "notes"), which have become due and payable in full as discussed below. If any of the holders of these notes takes action to collect the amounts owed by the Company under these notes, the Company will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
Since 2002, the Company has issued an aggregate of $1,425,336 principal amount of convertible secured notes to certain investors as part of its efforts to raise additional capital. These notes bear interest at 8%, are convertible into the Company's common stock at a conversion rate of $.20 per share, and are secured by the Company's equity interest in decisioning.com, Inc., which owns the Company's patent portfolio. The outstanding notes include a note in the principal amount of $125,000 acquired on June 3, 2002 by the Company's Chief Executive Officer and a note in the principal amount of $100,000 acquired on November 5, 2003 by a subsidiary of The South Financial Group, which at that time owned approximately 12% of the Company's outstanding capital stock. Principal and interest under these notes generally becomes payable in full on the second anniversary of the date on which these notes were issued. However, under the terms of the notes, the full amount of principal and interest under all notes becomes immediately due and payable in certain events, including bankruptcy or similar proceedings involving the Company, a default in the payment of principal and interest under any note, or a change in control of the Company.
To date, notes with a principal amount of $1,206,336 have become due and payable in accordance with their contractual two-year maturity dates. The Company has had discussions with the holders of these notes regarding the extension of the maturity date of these notes. However, the Company has not been successful in reaching an agreement with all of the holders of these notes regarding an extension of their maturity date. Because the Company is currently in default regarding payment of principal and interest due under certain of the notes, the full amount of principal and interest outstanding under all notes has become due and payable. Accordingly, the full amount of principal and accrued interest under all of these notes is shown as a current liability of the Company as of December 31, 2005. As of December 31, 2005, and December 31, 2004, the amount of principal and accrued interest outstanding under all of the notes was $1,595,906 and $1,383,149, respectively.
To remain viable, the Company must generate working capital through the sale of patent licenses or by raising additional capital. To date, the Company generally has been unable to enter into licensing agreements with potential licensees upon terms that are acceptable to the Company. As discussed above, the Company has been forced to become involved in litigation with alleged infringers. The Company believes that these lawsuits may take an extended period of time to complete, and no assurance can be given that the Company will have the resources necessary to complete these lawsuits or that it will be successful in obtaining a favorable outcome. Accordingly, to remain viable it is critical that the Company raise additional capital immediately. The uncertainties of these litigation matters and other factors affecting the Company's short and long-term liquidity discussed above has impeded and will likely continue to impede the Company's ability to raise additional capital. To maintain the minimal resources necessary to support its current operations and execute a patent licensing strategy, the Company does not believe that substantial additional reductions in its operating expenses are feasible. No assurances can be given that the Company will be able to raise additional capital or generate working capital from its patent licensing business.
The Company has been a defendant in a lawsuit brought by Temple Ligon, who claims that the Company breached an agreement to give him a 1% equity interest in the Company in consideration of services he claims to have performed in 1993 and 1994 in conjunction with the formation of the Company. In January 2004, this litigation resulted in a jury verdict against the Company of $382,148. In connection with the litigation and the resulting jury verdict, the Company filed post-trial motions with the trial court in which, among other things, it claimed that the jury verdict should be set aside. On July 23, 2004, the trial judge granted the Company's motions, set aside the jury verdict, and ordered entry of a judgment in favor of the Company. The plaintiff has appealed the trial judge's ruling to the South Carolina Court of Appeals. If the Company becomes obligated to pay more than an insignificant amount of damages in connection with this litigation, it will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
In order to fund its operations, the Company may need to raise additional funds through the issuance of additional convertible debt or equity securities, in which case the percentage ownership of the stockholders of the Company may be reduced, stockholders may experience additional dilution, and such securities may have rights, preferences or privileges senior to common stock. There can be no assurance that additional financing will be available on terms acceptable to the Company or at all. If adequate funds are not available or not available on acceptable terms, the Company may be unable to continue operations. The Company is evaluating alternatives to continue its business activities through 2006 and beyond.
There is substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or amounts and classification of liabilities that may result from this uncertainty. However, management believes that any adjustments to reflect the possible future effects on the recoverability and classification of assets and amounts of liabilities would not materially change the Company's financial position.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Affinity Technology Group, Inc. and its subsidiaries, Affinity Bank Technology Corporation, Affinity Clearinghouse Corporation, Affinity Credit Corporation, Affinity Processing Corporation, Affinity Mortgage Technology, Inc., decisioning.com, Inc. ("decisioning.com"), and Multi Financial Services, Inc. All significant inter-company balances and transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reported in the balance sheet for cash and cash equivalents, accounts payable and notes payable approximate their fair values.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. Estimated useful lives range from five to ten years for office furniture and fixtures and three to five years for all other depreciable assets. Depreciation expense was approximately $6,000, $7,000 and $13,000 during 2005, 2004, and 2003, respectively.
SOFTWARE DEVELOPMENT COSTS
Costs incurred in the development of software, which formerly was incorporated as part of the Company's products or sold separately, are capitalized after a product's technological feasibility has been established. Capitalization of such costs is discontinued when a product is available for general release to customers. Software development costs are capitalized at the lower of cost or net realizable value and amortized using the greater of the revenue curve method or the straight-line method over the estimated economic life of the related product. Amortization begins when a product is ready for general release to customers. The net realizable value of unamortized capitalized costs is periodically evaluated and, to the extent such costs exceed the net realizable value, unamortized amounts are reduced to net realizable value. The Company had no amortization of capitalized software in 2003, 2004 and 2005.
REVENUE RECOGNITION
PATENT LICENSING - The Company recognizes revenue from patent licensing activities pursuant to the provisions of each license agreement which specify the periods to which the related license and corresponding revenue applies.
DEFERRED REVENUES - Deferred revenues relate to unearned revenue associated with cash received for patent licenses. Such revenue is recognized in the period the patent license entitles the licensee to use technology covered by the Company's patents.
COST OF REVENUES
Cost of revenues consists solely of commissions paid to the Company's patent licensing agents. Commissions paid or accrued by the Company totaled $2,026, $64,265 and $1,765 for the years ended December 31, 2005, 2004, and 2003, respectively.
STOCK BASED COMPENSATION
The Company accounts for stock options in accordance with APB Opinion No.25, "Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, no compensation expense is recognized for stock or stock options issued to employees at fair value. For stock options granted at exercise prices below the estimated fair value, the Company records deferred compensation expense for the difference between the exercise price of the shares and the estimated fair value. The deferred compensation expense is amortized ratably over the vesting period of the individual options.
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS 123") as amended by FASB Statement No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure" ("SFAS 148"), provides an alternative to APB 25 in accounting for stock based compensation issued to employees. SFAS 123 provides for a fair value based method of accounting for employee stock options and similar equity instruments. However, for companies that continue to account for stock based compensation arrangements under APB 25, SFAS 123 requires disclosure of the pro forma effect on net income and earnings per share as if the fair value based method prescribed by SFAS 123 had been applied. The Company accounts for stock based compensation arrangements under APB No. 25 and has adopted the pro forma disclosure requirements of SFAS 123. Equity instruments issued to consultants, directors and employees in lieu of cash payments for services are recorded at the fair value of the equity instrument on the date the equity instrument is granted and the related expense is recognized over the period the services are performed. In 2005, 2004 and 2003, the Company recognized $1,100, $3,500 and $57,200, respectively, of stock based compensation related to the issuance of equity instruments.
Had compensation cost for options granted under the Company's stock-based compensation plans been determined based on the fair value at the grant dates consistent with SFAS 123, the Company's net income and earnings per share would have changed to the pro forma amounts listed below:
2005 2004 2003 ------------------------------------ Net loss: As reported $(566,387) $(217,127) $(560,508)
Add: stock-based compensation expense included in reported net income - - - ----------------------------------- Deduct: stock-based compensation expense determined under the fair value based method for all awards (6,543) (22,887) (47,941) ----------------------------------- Pro forma net loss $(572,930) $(240,014) $(608,449) =================================== Net loss per common share: As reported: Basic and diluted $ (0.01) $ (0.01) $ (0.01) =================================== Pro forma: Basic and diluted $ (0.01) $ (0.01) $ (0.01) ===================================
See Note 5 for more information regarding the Company's stock compensation plans and the assumptions used to prepare the pro forma information presented above.
NET LOSS PER SHARE OF COMMON STOCK
All net loss per share of Common Stock amounts presented have been computed based on the weighted average number of shares of Common Stock outstanding in accordance with SFAS 128. Stock warrants and stock options are not included in the calculation of dilutive loss per common share because the Company has experienced operating losses in all periods presented and, therefore, the effect would be antidilutive.
NEW ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payments (SFAS 123R). This accounting standard, which is effective for interim and annual periods beginning after January 1, 2006, requires the recognition of compensation expense related to stock options under SFAS 123. The United States Securities and Exchange Commission (SEC) announced on April 14, 2005 that it approved a phased-in implementation process for SFAS 123R. Under the new SEC implementation process, the Company's effective date for adopting SFAS 123R was extended six months. The Company plans to adopt SFAS 123R prospectively in the first quarter of 2006 with an anticipated impact to earnings per share of less than $0.01 per share in 2006.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (SFAS 154), "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3". SFAS 154 requires, unless impracticable, retrospective application to prior periods' financial statements of changes in accounting principle. SFAS 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle should be recognized in the period of the accounting change. The new standard is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company will adopt the provisions of SFAS 154, as applicable, beginning in fiscal 2006 and does not anticipate that the adoption of this standard will have a material effect on the Company's consolidated results of operations, financial position, or cash flows.
INCOME TAXES
Deferred income taxes are calculated using the liability method prescribed by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109").
CONCENTRATIONS OF CREDIT RISK
The Company is not exposed to any concentration of credit risk.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
RECLASSIFICATION
Certain amounts in 2003 and 2004 have been reclassified to conform to 2005 presentations for comparability. These reclassifications have no effect on previously reported stockholders' equity (deficiency) or net loss.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31, 2005 2004 -------------------- Data processing equipment $ 32,109 $ 32,109 Office furniture and fixtures 37,161 37,161 Automobiles and industrial equipment 11,038 11,038 Purchased software 3,770 3,770 -------------------- 84,078 84,078 Less accumulated depreciation and amortization (79,282) (72,829) --------------------- $ 4,796 $ 11,249 =====================
4. CONVERTIBLE NOTES
In June 2002, the Company issued convertible secured notes (the "notes") to certain investors as part of its capital raising initiatives. The principal amount of notes issued totaled $830,336 and included the issuance of a note in the principal amount of $125,000 to the Company's Chief Executive Officer and the issuance of a note in the principal amount of $205,336 to AMRO International, S.A. ("AMRO") in satisfaction of the principal and accrued interest outstanding under AMRO's convertible debenture previously acquired by AMRO. The notes bear interest at 8% and principal and accrued interest were due in June 2004. In 2005, 2004 and 2003, the Company issued additional convertible notes in the aggregate amount of $145,000, $25,000 and $425,000, respectively. Such notes also bear interest at 8% and mature at various dates in 2007, 2006 and 2005. Included in the aggregate $425,000 principal amount of convertible notes issued by the Company in 2003 is a $100,000 convertible note issued to a subsidiary of The South Financial Group, which at that time owned approximately 12% of the Company's outstanding common stock. All notes are collateralized by the stock of the Company's wholly-owned subsidiary, decisioning.com. decisioning.com is the Company's patent licensing subsidiary and owns the Company's patent portfolio. The notes are convertible into the Company's common stock at a conversion rate of $.20 per share.
AMRO has converted principal and accrued interest related to its $205,336 convertible note purchased in June 2002 into shares of the Company's common stock at the rate of $0.20 per share as detailed in the table below:
Conversion Date Principal Interest Shares of Common Stock - --------------------------------------------------------------------------- October 2003 $ 74,000 $ 7,959 409,796 October 2004 25,000 4,683 148,417 February 2005 25,000 5,439 152,194 --------------- -------------- ----------------- $ 124,000 $ 18,081 710,407 =============== ============== =================
As more fully explained in Note 1, all the convertible notes are in default and are classified as current liabilities. The contractual maturities of the principal outstanding under the Company's 8% convertible notes are as follows:
December 31, Contractual Maturity Date 2005 2004 ------------------------------------------------------------------- June 2004 $ 706,336 $ 731,336 March 2005 200,000 200,000 August 2005 25,000 25,000 November 2005 150,000 150,000 December 2005 50,000 50,000 January 2006 25,000 25,000 May 2007 75,000 - August 2007 45,000 - December 2007 25,000 - ------------------------------- 1,301,336 1,181,336 Less: current portion (1,301,336) (1,181,336) -------------- -------------- Long-term portion $ - $ - ============== ==============
On February 22, 2005, AMRO International, S.A. converted $25,000 principal amount and $5,439 of accrued interest under an 8% convertible note issued by the Company to AMRO into an aggregate of 152,194 shares of the Company's common stock. Under the terms of the note, principal and interest converted into shares of common stock at $.20 per share. Such shares were issued by the Company in reliance on an exemption from registration set forth in Section 3(a)(9)of the Securities Act of 1933.
5. STOCKHOLDERS' DEFICIENCY
PREFERRED STOCK
Pursuant to the Company's Certificate of Incorporation, the Board of Directors has the authority, without further action by the stockholders, to issue up to 5,000,000 shares of preferred stock in one or more series and to fix the designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations, or restrictions thereof, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights of the common stock. At December 31, 2005 and 2004 there are no shares of preferred stock issued or outstanding.
STOCK OPTION PLANS
During 1995, the Company adopted the 1995 Stock Option Plan under which incentive stock options and nonqualified stock options may be granted to employees, directors, consultants or independent contractors. At December 31, 2005, 3,180 options were outstanding under the 1995 Stock Option Plan, all of which are exercisable. At December 31, 2005, the weighted average exercise price was $0.44 and the weighted average remaining contractual life was 0.2 years. This plan closed during April 1996.
In April 1996, the Company adopted the 1996 Incentive Stock Option Plan. Under the terms of the plan, incentive options may be issued at an exercise price not less than the estimated fair market value on the date of grant. Generally, options granted vest ratably over a 60 month term.
In addition, the 1996 Incentive Stock Option Plan was amended and restated effective May 28, 1999, to increase the number of shares of common stock available for issuance from 1,900,000 to 2,900,000 and to permit non-employee directors to participate in the 1996 Stock Option Plan. Under the Company's director compensation program in effect from April 1999 to March 2002, non-employee directors received options under the 1996 Incentive Stock Option Plan to purchase 5,000 shares of common stock of the Company on the 5th business day after each annual shareholder meeting. In March 2002, the Company adopted a new director compensation program as a component of the 1996 Incentive Stock Option Plan under which all non-employee directors received a one-time grant of options to purchase 100,000 shares of the Company's stock at the closing sales price of the Company's common stock on the business day immediately prior to the date of grant. Such options vest ratably over a two-year period. Under the program, all non-employee directors on the Board were granted options to purchase 100,000 shares on March 20, 2002. Any new non-employee directors appointed to the Board will be granted options to purchase 100,000 shares at the time of his or her election to the Board.
A summary of activity under the 1995 and 1996 Option Plans is as follows:
A summary of stock options exercisable and stock options outstanding under the 1996 Incentive Stock Option Plan is as follows:
The pro forma disclosures required by SFAS 123 regarding net loss and net loss per share are stated as if the Company had accounted for stock options using fair values. Using the Black-Scholes option-pricing model the fair value at the date of grant for these options was estimated using the following assumptions:
------------------ Dividend yield - Expected volatility 132% Risk-free rate of return 1.99% Expected option life, years 3
The weighted average fair value for options granted under the Option Plans during 2003 was $0.14. No options were granted by the Company in 2004 or 2005.
The Black-Scholes and other option pricing models were developed for use in estimating fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions. The Company's employee stock options have characteristics significantly different than those of traded options, and changes in the subjective assumptions can materially affect the fair value estimate. Accordingly, in management's opinion, these existing models may not necessarily provide a reliable single measure of the fair value of employee stock options.
STOCK WARRANTS
In September 2000, the Company entered into a convertible debenture and warrants purchase agreement with an investor and, in connection therewith, issued to the broker representing the investor in this transaction a five-year warrant to acquire 35,000 shares of the Company's common stock at $0.47 per share. These warrants expired unexercised in 2005.
6. EMPLOYEE BENEFIT PLANS
The Company has an employee savings plan (the Savings Plan) that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Savings Plan, participating employees may defer a portion of their pretax earnings, up to the Internal Revenue Service annual contribution limit.
7. LEASES
The Company has non-cancelable operating leases for the rental of its offices and warehouse. Future minimum lease payments under these leases at December 31, 2005 are approximately $1,700, all of which is payable in 2006.
In 2005, 2004, and 2003 the Company incurred rent expense, including rent associated with cancelable rental agreements, of approximately $24,000, $32,000 and $47,000, respectively.
8. INCOME TAXES
As of December 31, 2005, the Company had federal and state tax net operating loss carryforwards of approximately $67,299,000. The net operating loss carryforwards will begin to expire in 2009, if not utilized.
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities consist of the following:
December 31, 2005 2004 ---------------------------- Deferred tax assets: Net operating loss carryforwards $ 25,102,000 $ 24,891,000 Accrued expenses 19,000 18,000 Other - 6,000 ---------------------------- Total deferred tax assets 25,121,000 24,915,000 ---------------------------- Deferred tax liabilities: Other - - ---------------------------- Total deferred tax liabilities - - ---------------------------- Less: Valuation allowance (25,121,000) (24,915,000) ---------------------------- Total net deferred taxes $ - $ - ============================
The Company has recorded a valuation allowance for the full amount of its net deferred tax assets as of December 31, 2005 and 2004, based on management's evaluation of the evidential recognition requirements under the criteria of SFAS 109. The main component of the evidential recognition requirements was the Company's cumulative pretax losses since inception. The provision for income taxes at the Company's effective rate did not differ from the provision for income taxes at the statutory rate for 2005, 2004, and 2003.
9. SEGMENT INFORMATION
The Company conducts its business within one industry segment - financial services technology. To date, all revenues generated have been from transactions with North American customers. Single entities accounted for 100%, 87% and 97% of revenues in 2005, 2004, and 2003, respectively.
10. RELATED PARTY TRANSACTIONS
In December 2003, the Company sold a convertible note in the principal amount of $100,000 to a subsidiary of The South Financial Group, which at that time owned approximately 12% of the Company's outstanding common stock.
In July 2003, the Company relocated and executed a month-to-month lease with a holder of one of its convertible notes. The rent expense for the office for the twelve month period ended December 31, 2004 and six month period ended December 31, 2003, was approximately $18,000 and $7,500, respectively. In April 2005, the Company again relocated and executed a month-to-month lease with the same holder of one of its convertible notes. The rent expense for the office for the twelve month period ended December 31, 2005 was approximately $9,250.
In January 2003, the Company issued 283,334 shares of common stock to two board members in lieu of cash compensation owed to them by the Company.
In June 2002, the Company sold a convertible secured note to its Chairman, President and Chief Executive Officer in the principal amount of $125,000. The note bears interest at 8%, and principal and accrued interest were due in June 2004.
In June 2002, the Company issued 70,000 shares of Company stock to a member of its Board of Directors as a finder's fee for capital raising services.
11. COMMITMENTS AND CONTINGENT LIABILITIES
The Company and its founder, Jeff Norris, have been defendants in a lawsuit filed by Temple Ligon on November 30, 1996 in the Court of Common Pleas for the County of Richland in Columbia, South Carolina. Mr. Ligon claims, among other things, that the Company and Mr. Norris breached an agreement to give him a 1% equity interest in the Company in consideration of services Mr. Ligon claims to have performed in 1993 and 1994 in conjunction with the formation of the Company, and seeks monetary damages of $5,463,000. This lawsuit initially resulted in a jury verdict against the Company of $68,000. However, Mr. Ligon subsequently requested and was granted a new trial. In January 2004, this lawsuit resulted in another jury verdict against the Company of $382,148. In connection with the litigation and the resulting jury verdict, the Company filed post-trial motions with the trial court in which, among other things, it claimed that the jury verdict should be set aside. On July 23, 2004, the trial judge granted the Company's motions, set aside the jury verdict, and ordered entry of a judgment in favor of the Company. The plaintiff has appealed the trial judge's ruling to the South Carolina Court of Appeals. If the Company becomes obligated to pay more than an insignificant amount of damages in connection with this litigation, it will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.
12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
First Second Third Fourth Quarter Quarter Quarter Quarter ------------------------------------------------------ YEAR ENDED DECEMBER 31, 2005
Revenue $ 4,412 $ 4,412 $ 4,411 $ 7,026 Gross profit 3,971 3,971 3,969 6,324 Net (loss) income (129,625) (165,330) (134,976) (136,456)
Net loss per share - basic and diluted (0.00) (0.00) (0.00) (0.00)
YEAR ENDED DECEMBER 31, 2004
Revenue $ 254,412 $ 4,412 $ 23,011 $ 5,463 Gross profit 191,471 3,971 22,569 5,022 Net (loss) income (122,990) (185,575) 242,351 (150,913)
Net loss per share - basic and diluted (0.00) (0.00) 0.01 (0.00)
The sum of certain net loss per share amounts differs from the annual reported total due to rounding.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
The Company has carried out an evaluation, under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as defined in Rule 13a-15 of the Securities Exchange Act of 1934 (the "Exchange Act"). Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2005, in recording, processing, summarizing and reporting information required to be disclosed by the Company (including consolidated subsidiaries) in the Company's Exchange Act filings.
There were no changes in the Company's internal controls over financial reporting that occurred during the Company's most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this Item will be contained in the Registrant's definitive proxy statement relating to its 2006 Annual Meeting of Stockholders under the captions "Board of Directors - Code of Ethics," "Board of Directors - Audit Committee Financial Expert," "Board of Directors--Nominees for Director," and "Section 16(a) Beneficial Ownership Reporting Compliance," which are incorporated by reference herein.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this Item will be contained in the Registrant's definitive proxy statement relating to its 2006 Annual Meeting of Stockholders under the captions "Executive Compensation" and "Board of Directors--Compensation of Directors", which are incorporated by reference herein.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Certain information required by this Item will be contained in the Registrant's definitive proxy statement relating to its 2006 Annual Meeting of Stockholders under the caption "Security Ownership of Management and Certain Beneficial Owners," which is incorporated by reference herein.
The table set forth above does not include any information with respect to shares of common stock that may be issued upon the conversion of convertible notes that have been issued by the Company. At December 31, 2005, there was $1,595,906 of principal and accrued interest outstanding under these notes, which could be converted into an aggregate of 7,979,530 shares of the Company's common stock at a conversion price of $0.20 per share.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
If applicable, information required by this Item will be contained in the Registrant's definitive proxy statement relating to its 2006 Annual Meeting of Stockholders under the caption "Certain Transactions," which is incorporated by reference herein.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information required by this item will be contained in the Registrant's definitive proxy statement relating to its 2006 Annual Meeting of Stockholders, under the caption "Accounting Fees."
ITEM 15.
ITEM 15. EXHIBITS
(a) (1) The following consolidated financial statements of Affinity Technology Group, Inc. and subsidiaries included in this Annual Report on Form 10-K are included in Item 8.
i. Consolidated Balance Sheets as of December 31, 2005 and 2004.
ii. Consolidated Statements of Operations for the years ended December 31, 2005, 2004, and 2003.
iii. Consolidated Statements of Stockholders' Equity (Deficiency) for the years ended December 31, 2005, 2004, and 2003.
iv. Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004, and 2003.
v. Notes to Consolidated Financial Statements.
(2) Exhibits:
Documents incorporated by reference to exhibits that have been filed with the Company's reports or proxy statements under the Securities Exchange Act of 1934 are available to the public over the Internet from the SEC's web site at HTTP://WWW.SEC.GOV. You may also read and copy any such document at the SEC's public reference room located at 100 F Street, N.E., Room 1580, Washington, D.C. 20549 under the Company's SEC file number (0-28152).
EXHIBIT NUMBER DESCRIPTION - --------------------- ---------------------------------------------------------
3.1 Certificate of Incorporation of Affinity Technology Group, Inc., which is hereby incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-1 of Affinity Technology Group, Inc. (File No. 333-1170).
3.2 Bylaws of Affinity Technology Group, Inc., which is hereby incorporated by reference to Exhibit 3.2 to the Registration Statement on Form S-1 of Affinity Technology Group, Inc. (File No. 333-1170).
4.1 Specimen Certificate of Common Stock, which is hereby incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-1 of Affinity Technology Group, Inc. (File No. 333-1170).
4.2 Sections 4, 7 and 8 of the Certificate of Incorporation of Affinity Technology Group, Inc., as amended, and Article II, Sections 3, 9 and 10 of the Bylaws of Affinity Technology Group, Inc., as amended, which are incorporated by reference to Exhibits 3.1 and 3.2, respectively, to the Registration Statement on Form S-1 of Affinity Technology Group, Inc. (File No. 333- 1170).
4.3 Convertible Note Purchase Agreement, dated June 3, 2002, between Affinity Technology Group, Inc., and certain investors, which is incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the Quarter ended June 30, 2002.
10.1* Form of Stock Option Agreement (1995 Stock Option Plan), which is hereby incorporated by reference to Exhibit 10.7 to the Registration Statement on Form S-1 of Affinity Technology Group, Inc. (File No. 333-1170).
10.2* Form of Stock Option Agreement (1996 Stock Option Plan), which is hereby incorporated by reference to Exhibit 10.8 to the Registration Statement on Form S-1 of Affinity Technology Group, Inc. (File No. 333-1170).
10.3* Form of Stock Option Agreement (Directors' Stock Option Plan), which is hereby incorporated by reference to Exhibit 10.9 to the Registration Statement on Form S-1 of Affinity Technology Group, Inc. (File No. 333-1170).
10.4* 1995 Stock Option Plan of Affinity Technology Group, Inc., which is hereby incorporated by reference to Exhibit 10.10 to the Registration Statement on Form S-1 of Affinity Technology Group, Inc. (File No. 333-1170).
10.5* Amended and Restated 1996 Stock Option Plan of Affinity Technology Group, Inc., which is hereby incorporated by reference to Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999.
10.6* Non-Employee Directors' Stock Option Plan of Affinity Technology Group, Inc., which is hereby incorporated by reference to Exhibit 10.12 to the Registration Statement on Form S-1 of Affinity Technology Group, Inc. (File No. 333-1170).
10.7 Stock Rights Agreement, dated October 20, 1995, between Affinity Technology Group, Inc., and certain investors, which is hereby incorporated by reference to Exhibit 10.15 to the Registration Statement on Form S-1 of Affinity Technology Group, Inc. (File No. 333-1170).
10.8* Declaration of First Amendment to 1996 Stock Option Plan of Affinity Technology Group, Inc., and 1995 Stock Option Plan of Affinity Technology Group, Inc., which is incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998.
10.9* Restricted Stock Agreement between Affinity Technology Group, Inc., and Joseph A. Boyle, which is incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002.
10.10* Stock Agreement between Affinity Technology Group, Inc., and Wade H. Britt, III, which is incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002.
10.13 Legal Representation Agreement, dated May 27, 2003, between decisioning.com, Inc., and Withrow & Terranova, PLLC, which is incorporated by reference to Exhibit 10.1 of the Quarterly Report on Form 10-Q for the quarter ended June 30, 2003.
14 Code of Ethics, which is incorporated by reference to Exhibit 14 of the Company's Annual Report on Form 10-K for the year ended December 31, 2003.
21 Subsidiaries of Affinity Technology Group, Inc.
23.1 Consent of Scott McElveen, L.L.P.
31 Rule 13a-14(a)/15d-14(a) Certification.
32 Section 1350 Certification.
* Denotes a management contract or compensatory plan or arrangement.
(b) Exhibits
The exhibits required by Item 601 of Regulation S-K are filed herewith and incorporated by reference herein. The response to this portion of Item 15 is submitted under Item 15(a) (3).
(c) Financial Statement Schedules
The response to this portion of Item 15 is submitted under Item 15(a) (2).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
AFFINITY TECHNOLOGY GROUP, INC.
Date: March 31, 2006 By: /S/ JOSEPH A. BOYLE ------------------------------------- Joseph A. Boyle President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ---------------- -------------------------------------------------------------- 21 Subsidiaries of Affinity Technology Group, Inc. 23.1 Consent of Independent Registered Public Accounting Firm 31 Rule 13a-14(a)/15d-14(a) Certifications 32 Section 1350 Certifications