UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
(Mark One)
 
þ ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2011.
 
o TRANSITION REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to ________
 
Commission File No. 000-30152
 
PAYMENT DATA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
 
Nevada   98-0190072
(State or other jurisdiction of incorporation or organization)     (I.R.S. Employer Identification No.)
 
12500 San Pedro, Ste. 120, San Antonio, TX       78216
(Address of principal executive offices)    (Zip Code)
 
Registrant’s telephone number, including area code (210) 249-4100
 
Securities registered pursuant to Section 12(b) of the Act:  
None.
     
Securities registered pursuant to Section 12(g) of the Act:  
Common stock, par value $0.001 per share.
(Title of class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o   Yes  þ   No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  o   Yes   þ   No
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  þ Yes   o   No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  þ   Yes   o   No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o Accelerated filer  o
Non-accelerated filer o Smaller reporting company  þ
(Do not check if a smaller reporting company)      
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o  Yes   þ   No
 
The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2011 the last business day of the registrant's second fiscal quarter, was approximately $1,758,432 based on 67,372,902 shares of the registrant’s common stock held by non-affiliates on June 30, 2011 at the closing price of $0.0261 per share.  For purposes of this computation, all officers, directors and 10% beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed an admission that such officers, directors or 10% beneficial owners are, in fact, affiliates of the registrant.
 
As of March 29, 2012, the number of outstanding shares of the registrant's common stock was 142,721,077.
 
 
 
 
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Not applicable.
 
 
 
 
 
 
 
 
 
 
 
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PAYMENT DATA SYSTEMS, INC.

FORM 10-K
For the Year Ended December 31, 2011
 
INDEX
 
     
Page
 
PART I
         
Item 1.
Business.
    5  
Item 1A.
Risk Factors.
    10  
Item 1B.
Unresolved Staff Comments (Not applicable).
    17  
Item 2.
Properties.
    18  
Item 3.
Legal Proceedings.
    18  
Item 4.
Mine Safety Disclosures (Not applicable).
    18  
           
PART II
           
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
    19  
Item 6.
Selected Financial Data.
    20  
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
    20  
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
    24  
Item 8.
Financial Statements and Supplementary Data.
    25  
Item 9.
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.
    40  
Item 9A
Controls and Procedures.
    40  
Item 9B.
Other Information.
    40  
           
PART III
           
Item 10.
Directors, Executive Officers and Corporate Governance.
    41  
Item 11.
Executive Compensation.
    44  
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
    49  
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
    50  
Item 14.
Principal Accounting Fees and Services.
    51  
           
PART IV
           
Item 15.
Exhibits, Financial Statement Schedules.
    52  
 
 
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FACTORS THAT MAY AFFECT FUTURE RESULTS

This Annual Report on Form 10-K and the documents incorporated herein by reference contain certain forward-looking statements as defined under the federal securities laws. Specifically, all statements other than statements of historical facts included in this Annual Report on Form 10-K regarding our financial performance, business strategy and plans and objectives of management for future operations and any other future events are forward-looking statements and based on our beliefs and assumptions. If used in this report, the words "anticipate," "believe," "estimate", "expect," "intend," and words or phrases of similar import are intended to identify forward-looking statements. Such statements reflect our current view with respect to future events and are subject to certain risks, uncertainties, and assumptions, including, but without limitation, those risks and uncertainties contained in the Risk Factors section of this Annual Report on Form 10-K and our other filings made with the SEC. Although we believe that our expectations are reasonable, we can give no assurance that such expectations will prove to be correct. Based upon changing conditions, any one or more of these events described herein as anticipated, believed, estimated, expected or intended may not occur. All prior and subsequent written and oral forward-looking statements attributable to our Company or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement. We do not intend to update any of the forward-looking statements after the date of this Annual Report to conform these statements to actual results or to changes in our expectations, except as required by law.
 
 
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PART I


ITEM 1.            BUSINESS.

General

We were founded in July 1998 and incorporated in the State of Nevada. Our primary operations consist of functioning as a processor of electronic payments for other companies. We provide integrated electronic payment processing services to merchants and businesses, including all types of Automated Clearing House (ACH) processing and credit and debit card-based processing services. The ACH network is a nationwide electronic funds transfer system that is regulated by the Federal Reserve and NACHA – The Electronic Payments Association and provides for the clearing of electronic payments between participating financial institutions. Our ACH processing services enable merchants or businesses to both disburse and collect funds electronically using e-checks to transfer funds instead of traditional paper checks. An e-check is an electronic debit to a bank checking account that is initiated at the point-of-sale, on the Internet, over the telephone or via a bill payment sent through the mail and is processed using the ACH network. Our card-based processing services enable merchants to process both traditional card-present, or "swipe," transactions, as well as card-not-present transactions. A traditional card-present transaction occurs whenever a cardholder physically presents a credit or debit card to a merchant at the point-of-sale. A card-not-present transaction occurs whenever the customer does not physically present a payment card at the point-of-sale and may occur over the Internet, mail, fax or telephone. Our electronic payment processing may take place in a variety of forms and situations. For example, our capabilities allow merchants to convert a paper check to an e-check or receive card authorization at the point-of-sale, have their customer service representatives take e-check or card payments from their consumers by telephone, and enable their consumers to make e-check or card payments directly through the use of a web site or by calling an Interactive Voice Response telephone system. We also operate an online payment processing service for consumers under the domain name www.billx.com through which consumers can pay anyone. We also provide prepaid card processing services for merchants and consumers through our wholly owned subsidiary FiCentive, Inc. We offer MasterCard prepaid cards branded with corporations’ brands. The prepaid cards can be used for various applications including payroll, corporate incentives, employee incentives, and general use.  Some card programs can be reloaded with funds and others cannot.  In some cases, the cards can be used at Automatic Teller Machines to withdrawal cash.

We generate revenues by charging fees for the electronic processing of payment transactions and related services. We charge certain merchants for these processing services at a bundled rate based on a percentage of the dollar amount of each transaction and, in some instances, additional fees are charged for each transaction. We charge other merchant customers a flat fee per transaction, and may also charge miscellaneous fees to our customers, including fees for returns, monthly minimums, and other miscellaneous services. We charge consumers that use our billx.com online payment service a flat monthly fee that allows them to make a certain number of payments in a month. We also charge these consumers an additional fee for each payment that exceeds the allowed number of payments in a given month. We operate solely in the United States as a single operating segment.

Our website is www.paymentdata.com. Information contained in our website does not constitute part of this annual report.

Industry Background

In the United States, the use of non-paper based forms of payment, such as credit and debit cards, has risen steadily over the past several years. According to a 2010 Federal Reserve Payments study, the estimated number of non-cash payments totaled $108.9 Billion in 2009, with a value of $72.3 Trillion. From 2006 to 2009, ACH, debit cards and prepaid cards grew at a compound annual growth rate of 9.3%, 14.8% and 21.5%, respectively, while credit card growth remained relatively flat (down 0.2%) and use of paper checks declined by 7.2%. Electronic payments, including payments made with cards and ACH, now collectively exceed three-quarters of all non-cash payments. Banking and financial institutions enable their account holders to use more check image deposit services which is also referred to as “remote deposit capture.” As a result, traditional paper trails are being replaced by speedier, more cost-effective and eco-friendly image exchanges.

The growth of electronic commerce has made the acceptance of card-based and other electronic forms of payment a necessity for businesses, both large and small, in order to remain competitive. We believe that the electronic payment processing industry will continue to benefit from the following trends:
 
 
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Favorable Demographics

As consumers age, we expect that they will continue to use the payment technology to which they have grown accustomed. More consumers are beginning to use card-based and other electronic payment methods for purchases at an earlier age. As these consumers, a demographic whom have witnessed the wide adoption of card products, technology innovations such as mobile phone payment applications, and widespread adoption of the Internet, comprise a greater percentage of the population and increasingly enter the work force, we expect purchases using electronic payment methods will comprise an increasing percentage of total consumer spending. Because of the increasing adoption rate of the Internet, businesses have a growing opportunity to conduct commerce with their consumers and business partners over the Internet. We believe this opportunity is equally true as it relates to the foreseeable increased usage of smartphones as an instrument of payment.

Increased Electronic Payment Acceptance by Small Businesses

Small businesses are a vital component of the U.S. economy and are expected to contribute to the increased use of electronic payment methods. The lower costs associated with electronic payment methods are making these services more affordable to a larger segment of the small business market. In addition, we believe these businesses are experiencing increased pressure to accept electronic payment methods in order to remain competitive and to meet consumer expectations. As a result, many of these small businesses are seeking to provide customers with the ability to pay for merchandise and services using electronic payment methods, including those in industries have historically accepted cash and checks as the only forms of payment for their merchandise and services.

Growth in Online Transactions

Market researchers expect continued growth in card-not-present transactions due to the steady growth of the Internet and electronic commerce. According to the U.S. Census Bureau, estimated retail e-commerce sales for 2011 were $194.3 billion, an increase of 17.5% from $165.4 billion in 2010. We believe the prevalence of the Internet makes having an online presence a basic and necessary consideration for those operating a business today.

The growth of electronic commerce also has made the acceptance of card-based and other electronic forms of payment a necessity for today's business. Forrester Research expects that e-commerce sales in the U.S. will keep growing at a 10% compound annual growth rate through 2014, translating to online retail sales of $250 billion, up from $194 billion in 2011. Companies, both large and small, continue to leverage the Internet in order to remain competitive, improve operational efficiencies, create new revenue streams and maximize the longevity and profitability of their customer relationships.

Products and Services

Our service offerings are supported by our systems’ infrastructure that integrates certain proprietary components with processing systems outsourced to third-party providers to offer our customers a flexible and secure payment process. We utilize a secure sockets layer architecture so that connections and information are secure from outside inspection. We also use 128-bit encryption for all electronic transactions that we process to make information unreadable as it passes over the Internet. Our systems’ infrastructure allows us to work with our customers to build a customized electronic payment service offering tailored to their specific needs. We have designed and implemented our integrated payment systems to function as gateways between our customers and our third-party processing providers. Our systems provide for interfaces with our customers through which payment data is captured electronically and transferred through the connections we have with our processing providers. Our systems also provide a data warehousing capability so that all of a customers’ payment data can be stored in one place to facilitate efficient data retrieval and analysis.  All data stored within and without the data warehouse is fully encrypted.  We outsource our ACH transaction processing and card-based transaction processing to third-party providers. Our card-based processing system is capable of connecting with all of the major card-based processors in the United States.

The components of our service offering include all forms of ACH transaction processing, such as Re-presented Check (RCK), which is a consumer non-sufficient funds check that is re-presented for payment electronically rather than through the paper check collection system, and Accounts Receivable Check Conversion, which is a consumer paper check payment that is converted into an e-check. Our customers can initiate ACH transactions directly using an online terminal accessible through a web site or we can initiate ACH transactions on their behalf. Our service offering also includes merchant account services for the processing of card-based transactions through the VISA and MasterCard, American Express, Discover, JCB networks, including online terminal services accessed through a web site or retail services accessed via a physical terminal. We offer a proprietary web-based customer service application that combines both ACH and card processing capabilities that allows companies to process one-time and recurring payments via e-checks or credit cards at the request of their consumers. In addition, we offer an Interactive Voice Response telephone system to companies that accept payments directly from consumers over the telephone using e-checks or credit cards.
 
 
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In addition to these electronic payment services, we are a prepaid card program manager and prepaid card processor.  We develop and manage prepaid card programs on behalf of corporate clients whom have customers that have a need for prepaid cards that are branded with the entity’s unique logo. We previously held a bank sponsorship agreement with Metabank to assist in this product offering, but our agreement terminated with the bank on December 31, 2011. Now, we hold a bank sponsorship agreement with University National Bank for our prepaid card program and started issuing cards in conjunction with the bank in October 2011. We also have the ability to issue Discover, American Express, Visa, and MasterCards. We primarily create, manage and process prepaid card programs for corporate clients that wish to provide an incentive the cards to their customer base or employees as a form of a rebate, commission, or other incentive.  We also issue general purpose reloadable, or GPR, cards to consumers as an alternative to a traditional bank account. Our product offering is competitive due to our proprietary systems and the ability to implement corporate-branded card programs in a shorter time frame than most of our competitors.  We believe our six years of experience in processing and managing prepaid card programs is a competitive advantage over many of our competitors due to the industry being relatively new.

Based on the changes in 2010 through federal legislation specifically related to closed-loop prepaid gift cards, we have decided to no longer develop or offer this type of program.  This decision has no material effect on our consolidated financial statements or business model, due to the very small amount of revenue contribution historically generated by these gift cards.  Furthermore, this segment does not affect in any way our ability to continue to issue prepaid cards for general purpose reloadable or corporate incentive cards.  We can also do third party gift cards if requested.

We also operate a consumer web site focused on providing bill payment services under the domain name www.billx.com and manage all of the related back-end processing through our own proprietary processing engine. Consumers subscribe to the payment service and are allowed to make a certain number of payments each month for a flat monthly fee and are assessed a separate fee for any additional payments made over the limit. Our online payment processing service seeks to provide consumers with an efficient and secure interface for paying and managing bills via the Internet. We also sell this payment portal service as a private label solution to online financial services providers looking to provide online bill payment capabilities as part of their service offering to consumers. We also offer this service to other debit card issuers, as we are able to utilize the bill payment component of this service for payments made via debit cards, a patented process for which we own a perpetual license.

Relationships with Sponsors and Processors

We have agreements with several processors to provide to us, on a non-exclusive basis, transaction processing and transmittal, transaction authorization and data capture, and access to various reporting tools. In order to provide payment processing services for ACH transactions, we must maintain a relationship with an Originating Depository Financial Institution (ODFI) in the Automated Clearing House network because we are not a bank and therefore not eligible to be an Originating Depository Financial Institution. For the ODFI portion of our ACH business we use Fifth Third Bank. Similarly, in order to provide payment-processing services for Visa, MasterCard and Discover transactions, we must be sponsored by a financial institution that is a principal member of the respective Visa, MasterCard and Discover card associations. Both Merrick Bank and HSBC Bank have sponsored us with the card associations under the designations Third Party Processor (TPP) and Independent Sales Organization (ISO) with Visa, and Third Party Servicer (TPS) and Merchant Service Provider (MSP) with MasterCard. We have an agreement with TriSource Solutions, LLC and an agreement with Global Payments, Inc. through which their member banks (Merrick Bank and HSBC) sponsor us for membership in the Visa and MasterCard, American Express, and Discover card associations and settle card transactions for our merchants. These agreements may be terminated by the processor if we materially breach the agreements and we do not cure the breach within 30 days, or if we enter bankruptcy or file for bankruptcy. We also maintain a bank sponsorship agreement with University National Bank for our prepaid card programs. We are liable for any card-associated losses for cards that we issue that might incur a negative balance and we are liable for card association fines, fees and chargebacks.

Under our processing agreement with TriSource Solutions, we are financially liable for all fees, fines, chargebacks and losses related to our card processing merchant customers. Under our processing agreement with Global Payments, Inc., we are not financially liable for all fees, chargebacks and losses related to our card processing merchant customers, but we are liable for potential card association fines. If, due to insolvency or bankruptcy of our merchant customers, or for another reason, we are unable to collect from them amounts that have been refunded to the cardholders because the cardholders properly initiated a chargeback transaction to reverse the credit card charges, we must bear the credit risk for the full amount of the cardholder transaction. We utilize a number of systems and procedures to evaluate and manage merchant risk, such as obtaining approval of prospective merchants from our processor and sponsor bank, setting transaction limits and monitoring account activity. We may also require cash deposits and other types of collateral from certain merchants to mitigate any such risk. We maintain a reserve for losses resulting from card processing and related chargebacks. We estimate our potential loss for chargebacks by performing a historical analysis of our chargeback loss experience with similar merchants and considering other factors that could affect that experience in the future, such as the types of card transactions processed and nature of the merchant relationship with their consumers.
 
 
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We maintain a separate allowance for estimated losses resulting from the inability or failure of our merchant customers to make required payments for fees charged by us. Amounts due from customers may be deemed uncollectible because of merchant disputes, fraud, insolvency or bankruptcy. We determine the allowance based on an account-by-account review, taking into consideration such factors as the age of the outstanding receivable, historical pattern of collections and financial condition of the customer. We closely monitor extensions of credit and if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make contractual payments, additional allowances may be required.

Sales and Marketing

We market and sell our products and services through direct contact by our sales personnel, as well as through non-exclusive resellers that act as an external sales force, with minimal direct investment in sales infrastructure and management. Our direct sales effort is coordinated by a sales executive and supported by other employees who function in sales capacities. Our primary market focus is on companies generating high volumes of electronic payment transactions. We tailor our sales efforts to reach this market by pre-qualifying prospective sales leads through direct contact or market research. Our sales personnel typically initiate contact with prospective customers that we identify as meeting our target profile. We also plan to market and sell our prepaid card program directly to corporations and to consumers through the internet.  We intend to continue to analyze our sales and marketing efforts in order to control costs, increase the effectiveness of our sales force, and broaden our reach through reseller initiatives and advantageous alliances.

Customers

Our primary customers are merchants and businesses that use our Automated Clearing House and/or card-based processing services in order to provide their consumers with the ability to pay for goods and services without having to use cash or a paper check. These merchant customers operate in a variety of retail industries and are under contract with us to exclusively use the services that we provide to them. Most of our merchant customers have signed long-term contracts, generally with three-year terms, that provide for volume-based transaction fees. Our merchant accounts increased to   675 customers at December 31, 2011 from 599 customers at December 31, 2010.

We had one customer that accounted for 44% of our 2011 revenue.  This customer is a reseller and represents a collection of merchants.  No other customer accounted for more than 10% of revenues in 2011.

All of our customers, including those utilizing our billx.com Internet bill payment service on a recurring monthly basis to pay household bills, are consumers geographically dispersed throughout the United States. The service relationship between our billx.com customers and us is not contractual and the fee we charge for the service is not negotiable. We seek to retain customers by providing high service levels. Customers also have incentive to continue using the service once activated due to their investment of time in setting up the service with their personal banking and payment information. The monthly average number of billx.com customers using our online payment service increased to 2,962 in 2011 from 2,269 in 2010.

Competition

The payment processing industry is highly competitive. Many small and large companies compete with us in providing payment processing services and related services to a wide range of merchants. There are a number of large transaction processors, including First Data Merchant Services Corporation, National Processing Company, and Global Payments Inc. that serve a broad market spectrum from large to small merchants and provide banking, automatic teller machine, and other payment-related services and systems in addition to card-based payment processing. There are also a large number of smaller transaction processors that provide various services to small and medium-sized merchants. Many of our competitors have substantially greater capital resources than us and operate as subsidiaries of financial or bank holding companies, which may allow them on a consolidated basis to own and conduct depository and other banking activities that we do not have the regulatory authority to own or conduct. We believe that the principal competitive factors in our market include:

●   
quality of service;
●
reliability of service;
●   
ability to evaluate, undertake and manage risk;
●
speed in implementing payment processes;
●   
price and other financial terms; and
●   
multi-channel payment capability.

 
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We believe that our specific focus on providing integrated payment processing solutions to merchants, in addition to our understanding of the needs and risks associated with providing payment processing services electronically, gives us a competitive advantage over other competitors, which have a narrower market perspective, and over competitors of a similar or smaller size that may lack our experience in the electronic payments industry. Furthermore, we believe we present a competitive distinction through the use of our internal technology to provide a single integrated payment storage or warehouse that consolidates, processes, tracks and reports all payments regardless of payment source or channel.

Our prepaid card offering is competitive due to our proprietary systems and the ability to bring corporate branded card programs in a shorter time frame than most of our competitors.  We also believe our six years of experience in processing and managing prepaid card programs is a competitive advantage over many of our competitors due to the industry being relatively new.

Trademarks

We own federally registered trademarks on the mark “Payment Data Systems, Inc.” and its respective design. We have also secured, among others, domain name registrations for:

●   
billx.com;
●   
billxpress.com;
●   
billhelp.com;
●   
debitservice.com;
●   
ficenitve.com;
●   
iremotepay.com;
●   
iremotepay.net;
●   
merchandisemastercard.com;
●   
nataliecard.com;
●   
nataliegiftcard.com;
●   
nataliegulbismastercard.com;
●   
nataliegulbiscard.com;
●   
paymentdatasystems.com;
●   
paymentdata.org;
●   
paymentdata.com;
●   
paymentrecovery.com;
●   
paymentrecoverysystems.com;
●   
parishiltoncard.com;
●   
gogreenmastercard.com;
●   
mipromesa.com;
●   
pdsnetwork.com;
●   
prepaidload.com;
●   
primacard.com;
●   
securepds.com;
●   
stardebit.com;
●   
viewbill.com; and
●   
zbill.com
 
 
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We rely on a combination of copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements, and other intellectual property protection methods to protect our services and related products.

Patents

In April 2006, we were awarded Patent Number 7,021,530 from the U.S. Patent Office for the technology and method for managing and processing bill payment via a stored-value debit card, check card, signature debit card, PIN-based card or ATM card from a variety of access points. The debit card technology for which we received patent protection allows a cardholder to use their debit or ATM card to pay local, national, or international bills with the card from their electronic balance. Because it does not require linkage to a traditional checking or savings account, this new debit technology is unique in that it allows for use by “unbanked” consumers.

On January 11, 2008, we signed an agreement to sell selected patents and patent applications to PCT Software Data, LLC, including U.S. Patent Number 7,021,530. On January 17, 2008, we completed the sale of selected patents and patent applications to PCT Software Data, LLC for net proceeds of approximately $750,000. The patents and patent applications sold relate to bill payments made with debit and stored value cards. We retained a worldwide, non-exclusive license under the patents for use with all current and future customers.

Employees

As of December 31, 2011, we had   7 full-time employees and   1 part-time employees. We are not a party to any collective bargaining agreements. We believe that our relations with our employees are very good.
ITEM 1A.          RISK FACTORS.

An investment in our common stock involves a high degree of risk. You should carefully consider the following risk factors and other information included in this annual report on Form 10-K. If any of the following risks actually occur, our business, financial condition or results of operations could be materially and adversely affected and you may lose some or all of your investment.

RISKS RELATED TO OUR BUSINESS

We have generated significant losses in the past years and have only been profitable since the third quarter of 2011.

We organized in 1998 and began operations as a public company in 1999 by offering electronic billing services to other companies. After the sale of our primary business in July 2003, we have concentrated on building our electronic payments services operations. As of December 31, 2011, our accumulated deficit was $54,339,799.

If our security applications are not sufficient to address changing market conditions and customer concerns, we may incur significant losses and be unable to sell our services.

Our use of applications designed for premium data security and integrity to process electronic transactions may not be sufficient to address changing market conditions or the security and privacy concerns of existing and potential customers. If our security applications are breached and sensitive data is lost or stolen, we could incur significant costs to not only assess and repair any damage to our systems, but also to reimburse customers for losses that occur from the fraudulent use of the data. We may also be subject to fines and penalties from the credit card associations in the event of the loss of confidential card information. Adverse publicity raising concerns about the safety or privacy of electronic transactions, or widely reported breaches of our or another provider's security, have the potential to undermine consumer confidence in the technology and could have a materially adverse effect on our business.

If we do not adapt to rapid technological change, our business may fail.

Our success depends on our ability to develop new and enhanced services and related products that meet changing customer needs. The market for our services, however, is characterized by rapidly changing technology, evolving industry standards, emerging competition and frequent new and enhanced software, service and related product introductions. In addition, the software market is subject to rapid and substantial technological change. To remain successful, we must respond to new developments in hardware and semiconductor technology, operating systems, programming technology and computer capabilities. In many instances, new and enhanced services, products and technologies are in the emerging stages of development and marketing, and are subject to the risks inherent in the development and marketing of new software, services and products. We may not successfully identify new service opportunities, and develop and bring new and enhanced services and related products to market in a timely manner. Even if we do bring such services, products or technologies to market, they may not become commercially successful. Additionally, services, products or technologies developed by others may render our services and related products noncompetitive or obsolete. If we are unable, for technological or other reasons, to develop and introduce new services and products in a timely manner in response to changing market conditions or customer requirements, our business may fail.
 
 
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We rely on our relationship with the Automated Clearing House network and if the Federal Reserve rules were to change, our business could be adversely affected.

We have a contractual relationship with Fifth Third Bank, which is an Originating Depository Financial Institution in the Automated Clearing House network. The ACH network is a nationwide batch-oriented electronic funds transfer system that provides for the interbank clearing of electronic payments for participating financial institutions. An Originating Depository Financial Institution is a participating financial institution that must abide by the provisions of the ACH Operating Rules and Guidelines. Through our relationship with this third-party provider, we are able to process payment transactions on behalf of our customers and their consumers by submitting payment instructions in a prescribed ACH format. We pay volume-based fees to the third-party provider for debit and credit transactions processed each month, and pay fees for other transactions such as returns and notices of change to bank accounts. These fees are part of our cost structure. If the Federal Reserve rules were to change to introduce restrictions or modify access to the Automated Clearing House, our business could be materially adversely affected.  We are pursuing multiple contractual relationships with additional banks to serve as Originating Depository Financial Institutions.

If our third-party card processing providers or our bank sponsors fail to comply with the applicable requirements of Visa and MasterCard credit card associations, we may have to find a new third-party processing provider, which could increase our costs.

Substantially all of the card-based transactions we process involve Visa or MasterCard. If our third-party processing provider, TriSource Solutions, LLC, or our bank sponsors, Merrick Bank or HSBC Bank, fail to comply with the applicable requirements of the Visa and MasterCard credit card associations, Visa or MasterCard could suspend or terminate their registration. Also, our contract with these third parties is subject to cancellation upon limited notice by either party. The cancellation of our contract, termination of their registration or any changes in the Visa or MasterCard rules that would impair their registration could require us to stop providing such payment processing services if we are unable to obtain another provider or sponsor at similar costs. Additionally, changing our bank sponsor could adversely affect our relationship with our merchants if the new sponsor provides inferior service or charges higher costs.

Our prepaid card revenues from the sale of services to merchants that accept MasterCard cards are dependent upon our continued MasterCard registration and financial institution sponsorship and, in some cases, continued participation in certain payment networks.
 
In order to provide our MasterCard transaction processing services, we must be either a member of a payment network or be registered as a merchant processor of MasterCard. Registration as a merchant processor is dependent upon our being sponsored by member clearing banks of both organizations. If our sponsor banks should stop providing sponsorship for us, we would need to find another financial institution to provide those services or we would need to be a member, either of which could prove to be difficult and/or more expensive. If we are unable to find a replacement financial institution to provide sponsorship or become a member we may no longer be able to provide processing services to the affected customers which would negatively impact our revenues and earnings.

If we fail to comply with the applicable requirements of the card networks, they could seek to fine us, suspend us or terminate our registrations. If our merchants or ISOs incur fines or penalties that we cannot collect from them, we could end up bearing cost of fines or penalties.

In order to provide our transaction processing services, we are registered with Visa and MasterCard as service providers and transaction processors for member institutions and with other networks. As such, we are subject to card association and network rules that could subject us to a variety of fines or penalties that may be levied by the card networks for certain acts or omissions. The rules of the card networks are set by their boards, which may be influenced by banks that own their stock and, in the case of Discover by the card issuers, and some of those banks and issuers are our competitors with respect to these processing services. The termination of our registrations or our status as a service provider or transaction processor, or any changes in card association or other network rules or standards, including interpretation and implementation of the rules or standards, that increase the cost of doing business or limit our ability to provide transaction processing services to our customers, could have a material adverse effect on our business, operating results and financial condition. If a merchant or one of our resellers fails to comply with the applicable requirements of the card associations and networks, it could be subject to a variety of fines or penalties that may be levied by the card associations or networks. If we cannot collect such amounts from the applicable merchant or one of our resellers, we could end up bearing such fines or penalties, resulting in lower earnings for us.
 
 
11
 

We are subject to extensive and complex federal and state regulation and new regulations and/or changes to existing regulations could adversely affect our business.

As an agent of, and third-party service provider to, our issuing banks, we are subject to indirect regulation and direct audit and examination by the Office of Thrift Supervision, or the OTS, the Office of the Comptroller of the Currency, or the OCC, the Board of Governors of the Federal Reserve System, or the FRB, and the Federal Deposit Insurance Corporation, or the FDIC.
 
On March 23, 2010, the FRB issued a final rule implementing Title IV of the Credit Card Accountability, Responsibility, and Disclosure Act of 2009, or CARD Act, which imposes requirements relating to disclosures, fees and expiration dates that are generally applicable to gift certificates, store gift cards and general-use prepaid cards. We believe that our general purpose reloadable prepaid cards, and the maintenance fees charged on our general purpose reloadable cards, are exempt from the requirements under this rule, as they fall within an express exclusion for cards which are reloadable and not marketed or labeled as a gift card or gift certificate. However, this exclusion is not available if the issuer, the retailer selling the card to a consumer or the program manager, promotes, even if occasionally, the use of the card as a gift card or gift certificate. As a result, we provide retailers with instructions and policies regarding the display and promotion of our general purpose reloadable cards. It is possible, however, that despite our instructions and policies to the contrary, a retailer engaged in offering our general purpose reloadable cards to consumers could take an action with respect to one or more of the cards that would cause each similar card to be viewed as being marketed or labeled as a gift card, such as by placing our general purpose reloadable cards on a display which prominently features the availability of gift cards and does not separate or otherwise distinguish our general purpose reloadable cards from the gift cards. In such event, it is possible that such general purpose reloadable cards would lose their eligibility for such exclusion to the CARD Act and its requirements, and therefore could be deemed to be in violation of the CARD Act and the rule, which could result in the imposition of fines, the suspension of our ability to offer our general purpose reloadable cards, civil liability, criminal liability, and the inability of our issuing banks to apply certain fees to our general purpose reloadable cards, each of which would likely have a material adverse impact on our revenues.
As the laws applicable to our business, and those of our distributors and issuing banks, change frequently, are often unclear and may differ or conflict between jurisdictions, ensuring compliance has become more difficult and costly. Any failure, or perceived failure, by us, our issuing banks or our distributors to comply with all applicable statutes and regulations could result in fines, penalties, regulatory enforcement actions, civil liability, criminal liability, and/or limitations on our ability to operate our business, each of which could significantly harm our reputation and have a material adverse impact on our business, results of operations and financial condition.

Our card programs are subject to strict regulation under federal law regarding anti-money laundering and anti-terrorist financing. Failure to comply with such laws, or abuse of our card programs for purposes of money laundering or terrorist financing, could have a material adverse impact on our business.

Provisions of the USA PATRIOT Act, the Bank Secrecy Act and other federal law impose substantial regulation of financial institutions designed to prevent use of financial services for purposes of money laundering or terrorist financing. Increasing regulatory scrutiny of our industry with respect to money laundering and terrorist financing matters could result in more aggressive enforcement of such laws or more onerous regulation, which could have a material adverse impact on our business. In addition, abuse of our prepaid card programs for purposes of money laundering or terrorist financing, notwithstanding our efforts to prevent such abuse through our regulatory compliance and risk management programs, could cause reputational or other harm that would have a material adverse impact on our business.

On June 21, 2010, the Financial Crimes Enforcement Network of the U.S. Department of the Treasury, or FinCEN, issued a notice of proposed rulemaking regarding the applicability of the Bank Secrecy Act's anti-money laundering provisions to prepaid products and other matters related to the regulation of money services businesses. This rulemaking would create additional obligations for entities, including our distributors, engaged in the provision and sale of certain prepaid products, including our prepaid debit cards, such as the obligation for sellers of prepaid debit cards to obtain identification information from the purchaser at the point-of-sale. Compliance with these obligations may result in increased compliance costs for us, our issuing banks and our distributors, and may therefore have a negative impact on the profitability of our business. Additionally, the imposition of such obligations upon sellers of prepaid debit cards may cause some of our distributors to determine that they do not wish to continue offering our prepaid debit cards for sale or reload, which could also have a significant negative impact on our business. However, as the proposed rulemaking is subject to further comment and revision, it is difficult to determine with any certainty what obligations the final rulemaking might impose or what impact they might have on our business or that of our issuing banks or distributors.

Unauthorized disclosure of cardholder data, whether through breach of our computer systems or otherwise, could expose us to liability and protracted and costly litigation.

We collect and store personal identifiable information about our cardholders, including names, addresses, social security numbers, driver's license numbers and account numbers, and maintain a database of cardholder data relating to specific transactions, including account numbers, in order to process transactions and prevent fraud. As a result, we are required to comply with the privacy provisions of the Gramm-Leach-Bliley Act, various other federal and state privacy statutes and regulations, and the Payment Card Industry Data Security Standard, each of which is subject to change at any time. Compliance with these requirements is often difficult and costly, and our failure, or our distributors' failure, to comply may result in significant fines or civil penalties, regulatory enforcement action, liability to our issuing banks and termination of our agreements with one or more of our issuing banks, each of which could have a material adverse effect on our financial position and/or operations. In addition, a significant breach could result in our being prohibited from processing transactions for any of the relevant card associations or network organizations, including Visa, MasterCard, American Express, Discover or regional debit networks, which would also have a significant material adverse impact on our financial position and/or operations.
 
 
12
 

Furthermore, if our computer systems are breached by unauthorized users, we may be subject to liability, including claims for unauthorized purchases with misappropriated bank card information, impersonation or similar fraud claims. We could also be subject to liability for claims relating to misuse of personal information, such as unauthorized marketing purposes, or failure to comply with laws governing notification of such breaches. These claims also could result in protracted and costly litigation. In addition, we could be subject to penalties or sanctions from the relevant card associations or network organizations.

We depend on Michael R. Long and Louis A. Hoch, and if these officers ceased to be active in our management, our business may not be successful.

Our success depends to a significant degree upon the continued contributions of our key management, marketing, service and related product development and operational personnel, including our Chairman, Chief Executive Officer and Chief Financial Officer, Michael R. Long, and our President and Chief Operating Officer, Louis A. Hoch. We signed employment agreements with Mr. Long and Mr. Hoch in February 2007 which prohibits them from competing with us for a period of two years upon termination of their employment. Our business may not be successful if, for any reason, either of these officers ceased to be active in our management.

If our software fails, and we need to repair or replace it, or we become subject to warranty claims, our costs could increase.

Our software products could contain errors or "bugs" that could adversely affect the performance of services or damage a user's data. We attempt to limit our potential liability for warranty claims through technical audits and limitation-of-liability provisions in our customer agreements. However, these measures may not be effective in limiting our exposure to warranty claims. We have not experienced a significant increase in software errors or warranty claims. Despite the existence of various security precautions, our computer infrastructure may also be vulnerable to viruses or similar disruptive problems caused by our customers or third parties gaining access to our processing system. If our software fails, and we need to replace or repair it, or we become subject to warranty claims, our costs could significantly increase.

We depend on the efficient and uninterrupted operation of our computer network systems, software, data center and telecommunications networks, as well as the systems and services of third parties. Our systems and operations or those of our third-party providers could be exposed to damage or interruption from, among other things, fire, natural disaster, power loss, telecommunications failure, terrorist acts, war, unauthorized entry, human error, and computer viruses or other defects. Defects in our systems or those of third parties, errors or delays in the processing of payment transactions, telecommunications failures or other difficulties could result in loss of revenue, loss of merchants, loss of merchant and cardholder data, harm to our business or reputation, exposure to fraud losses or other liabilities, negative publicity, additional operating and development costs, and/or diversion of technical and other resources. We perform the vast majority of disaster recovery operations ourselves, though we utilize select third parties for some aspects of recovery. To the extent we outsource our disaster recovery, we are at risk of the vendor’s unresponsiveness in the event of breakdowns in our systems.

Loss of key resellers could reduce our revenue growth.
 
Our reseller sales channel, which purchases and resells our end-to-end services to its own portfolio of merchant customers, is a strong contributor to our revenue growth. If an reseller switches to another transaction processor, shuts down, becomes insolvent, or enters the processing business themselves, we may no longer receive new merchant referrals from the reseller, and we risk losing existing merchants that were originally enrolled by the reseller, all of which could negatively affect our revenues and earnings.

Risks associated with reduced levels of consumer spending could adversely affect our revenues and earnings.
 
Significant portions of our revenue and earnings are derived from fees from processing consumer ACH, prepaid, credit card and debit card transactions. We are exposed to general economic conditions that affect consumer confidence, consumer spending, consumer discretionary income or changes in consumer purchasing habits. A general reduction in consumer spending in the United States or any other country where we do business could adversely affect our revenues and earnings. A further weakening in the economy could also force retailers to close resulting in exposure to potential credit losses and future transaction declines. Additionally, credit card issuers have been reducing credit limits and closing accounts, and are overall more selective with respect to whom they issue credit cards.
 
 
13
 

Fraud by merchants or others could have an adverse effect on our operating results and financial condition.
 
We have potential liability for fraudulent bankcard, ACH and prepaid card transactions or credits initiated by merchants or others. Examples of merchant fraud include when a merchant knowingly uses a stolen or counterfeit bankcard or card number to record a false sales transaction, processes an invalid bankcard, or intentionally fails to deliver the merchandise or services sold in an otherwise valid transaction. Criminals are using increasingly sophisticated methods to engage in illegal activities such as counterfeit and fraud. While we have systems and procedures designed to detect and reduce the impact of fraud, we cannot assure the effectiveness of these measures. It is possible that incidents of fraud could increase in the future. Failure to effectively manage risk and prevent fraud would increase our chargeback liability or cause us to incur other liabilities. Increases in chargebacks or other liabilities could have an adverse effect on our operating results and financial condition.

Increases in credit card network fees may result in the loss of customers or a reduction in our earnings.
 
From time to time, the card networks, including Discover, Visa and MasterCard, increase the fees (interchange and assessment fees) that they charge processors such as us. We may attempt to pass these increases along to our merchant customers, but this strategy might result in the loss of those customers to our competitors who do not pass along the increases. If competitive practices prevent our passing along such increased fees to our merchant customers in the future, we may have to absorb all or a portion of such increases thereby increasing our operating costs and reducing our earnings.

We are subject to risks and write-offs resulting from fraudulent activities and losses from overdrawn cardholder accounts that could adversely impact our financial performance and results of operations.

Our prepaid cards expose us to threats involving the misuse of such cards, collusion, fraud, identity theft and systemic attacks on our systems. Although a large portion of fraudulent activity is addressed through the chargeback systems and procedures maintained by the card association networks, we are often responsible for other losses due to merchant and cardholder fraud. No system or procedures established to detect and reduce the impact of fraud are entirely effective and we recorded minimal losses due to fraud in 2011. Although we actively devote efforts to effectively manage risk and prevent fraud, we could nevertheless experience an increase in fraud losses over our historical experience.

Our cardholders can in some circumstances incur charges in excess of the funds available in their accounts and are liable for the resulting overdrawn account balance. Although we generally decline authorization attempts for amounts that exceed the available balance in a cardholder's account, the application of the card association networks' rules and regulations, the timing of the settlement of transactions and the assessment of subscription, maintenance or other fees can, among other things, result in overdrawn card accounts. As of December 31, 2011, our cardholders' overdrawn account balances totaled less than $250.

Although we maintain reserves for fraud and other losses, our exposure to these types of risks may exceed our reserve levels for a variety of reasons, including our failure to predict the actual recovery rate, failure to effectively manage risk and failure to prevent fraud. Accordingly, our business, results of operations and financial condition could be materially and adversely affected to the extent that we incur losses resulting from overdrawn cardholder accounts and fraudulent activity that exceed our designated reserves or if we determine that it is necessary to increase our reserves substantially in order to address any increased recovery risk.

Our business strategy includes identifying businesses and assets to acquire, and if we cannot integrate acquisitions into our company successfully, we may have limited growth.

Our success partially depends upon our ability to identify and acquire undervalued businesses and merchant portfolios within our industry. Although we believe that there are companies and portfolios available for potential acquisition that might offer attractive business opportunities, we may not be able to make any acquisitions, and if we do make acquisitions, they may not be profitable. As a result, our business may not grow or sustain profitability.

If we do not manage our growth or sustain profitability.

We may experience a period of rapid growth that could place a significant strain on our resources. In order to manage our growth successfully, we will have to continue to improve our operational, management and financial systems and expand our work force. A significant increase in our customer base may necessitate the hiring of a significant number of additional personnel, qualified candidates for which, at the time needed, may be in short supply. In addition, the expansion and adaptation of our computer and administrative infrastructure will require substantial operational, management and financial resources. Although we believe that our current infrastructure is adequate to meet the needs of our customers in the foreseeable future, we may not be able to expand and adapt our infrastructure to meet additional demand on a timely basis, at a commercially reasonable cost, or at all. If our management is unable to manage growth effectively, hire needed personnel, expand and adapt our computer infrastructure and improve our operational, management, and financial systems and controls, we may not sustain profitability.
 
 
14
 

If we do not manage our credit risks related to our merchant accounts, we may incur significant losses.

We rely on the Federal Reserve's Automated Clearing House system for electronic fund transfers and the Visa and MasterCard associations for settlement of payments by credit or debit card on behalf of our merchant customers. In our use of these established payment clearance systems, we generally bear the credit risks arising from returned transactions caused by insufficient funds, stop payment orders, closed accounts, frozen accounts, unauthorized use, disputes, customer charge backs, theft or fraud. Consequently, we assume the credit risk of merchant disputes, fraud, insolvency or bankruptcy in the event we attempt to recover funds related to such transactions from our customers. We have not experienced a significant increase in the rate of returned transactions or incurred any losses with respect to such transactions. We utilize a number of systems and procedures to manage and limit credit risks, but if these actions are not successful in managing such risks, we may incur significant losses.

Current economic conditions could have a materially adverse effect on our business.

Our operations and performance depend to some degree on economic conditions and their impact on levels of consumer spending, which have recently deteriorated significantly in many countries and regions, including the regions in which we operate, and may remain depressed for the foreseeable future. For example, some of the factors that could influence the levels of consumer spending include continuing increases in fuel and other energy costs, conditions in the residential real estate and mortgage markets, labor and healthcare costs, access to credit, consumer confidence and other macroeconomic factors affecting consumer spending behavior. These and other economic factors could have a material adverse effect on demand for our products and on our financial condition and operating results.

Any new or changes made to laws, regulations, card network rules or other industry standards affecting our business may require significant development efforts or have an unfavorable impact to our financial results.

For example, in the United States, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) on July 21, 2010, which is intended to make significant structural reforms to the financial services industry.  The law regulates the fees charged or received by issuers for processing debit transactions and the transaction routing options available to merchants. On June 29, 2011, the Federal Reserve Board adopted the final rule implementing the interchange fee and routing provisions in the Dodd-Frank Act. The Dodd-Frank Act, when implemented in September of 2011, caused interchange fees to be lowered on large bank issued debit cards.  The lowered interchange had a mild negative impact on our revenues, but increased our earnings due to the fact that we were able to keep our prices constant with our merchants.  If our competitors start to pass the extra margin into savings to their merchants, we may be forced to follow their actions and become exposed to lower earnings on the debit card transactions for large banks.  Our prepaid cards, while they process some transactions on debit networks, are currently exempt from the Dodd-Frank Act.
 
 
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  RISKS RELATED TO OUR INDUSTRY

The electronic commerce market is relatively new and if it does not grow, we may not be able to sell sufficient services to make our business viable.

The electronic commerce market is a relatively new and growing service industry. If the electronic commerce market fails to grow or grows slower than anticipated, or if we, despite an investment of significant resources, are unable to adapt to meet changing customer requirements or technological changes in this emerging market, or if our services and related products do not maintain a proportionate degree of acceptance in this growing market, our business may not grow and could even fail. Additionally, the security and privacy concerns of existing and potential customers may inhibit the growth of the electronic commerce market in general, and our customer base and revenues, in particular. Similar to the emergence of the credit card and automatic teller machine industries, we and other organizations serving the electronic commerce market must educate users that electronic transactions use encryption technology and other electronic security measures that make electronic transactions more secure than paper-based transactions.

Changes in regulation of electronic commerce and related financial services industries could increase our costs and limit our business opportunities.

We believe that we are not required to be licensed by the Office of the Comptroller of the Currency, the Federal Reserve Board, or other federal or state agencies that regulate or monitor banks or other types of providers of electronic commerce services. It is possible that a federal or state agency will attempt to regulate providers of electronic commerce services, which could impede our ability to do business in the regulator's jurisdiction. Our business has also been affected by anti-terrorism legislation, such as the USA PATRIOT Act. Banking related provisions of the USA PATRIOT Act have been implemented as additions to the banking rules regarding monetary instrument sales record keeping requirements and tracking of cash movements. In our capacity as an agent for University National Bank, the issuing bank for our prepaid card programs, we are required to comply with these rules. We are also required to implement a Customer Identification Program and establish an Anti-Money Laundering program and to report any suspected money laundering to the appropriate agencies. Our compliance with such regulations increases our responsibilities and costs associated with the administration of our debit card programs. We are also subject to various laws and regulations relating to commercial transactions, such as the Uniform Commercial Code, and may be subject to the electronic funds transfer rules embodied in Regulation E, promulgated by the Federal Reserve Board. Given the expansion of the electronic commerce market, the Federal Reserve Board might revise Regulation E or adopt new rules for electronic funds transfer affecting users other than consumers. Because of growth in the electronic commerce market, Congress has held hearings on whether to regulate providers of services and transactions in the electronic commerce market. It is possible that Congress or individual states could enact laws regulating the electronic commerce market. If enacted, such laws, rules and regulations could be imposed on our business and industry and could increase our costs or limit our business opportunities.

If we cannot compete successfully in our industry, we could lose market share and our costs could increase.

Portions of the electronic commerce market are becoming increasingly competitive. We expect to face growing competition in all areas of the electronic payment processing market. New companies could emerge and compete for merchants of all sizes. We expect competition to increase from both established and emerging companies and that such increased competition could lower our market share and increase our costs. Moreover, our current and potential competitors, many of whom have greater financial, technical, marketing and other resources than us, may respond more quickly than us to new or emerging technologies or could expand to compete directly against us in any or all of our target markets. Accordingly, it is possible that current or potential competitors could rapidly acquire market share. We may not be able to compete against current or future competitors successfully. Additionally, competitive pressures may increase our costs, which could lower our earnings, if any.
 
 
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RISKS RELATED TO OUR COMMON STOCK

Our stock price is volatile and you may not be able to sell your shares at a price higher than what you paid.

The market for our common stock is highly volatile. In 2011, our closing stock price fluctuated between $0.02 and $0.13. The trading price of our common stock could be subject to wide fluctuations in response to, among other things, quarterly variations in operating and financial results, announcements of technological innovations or new products by our competitors or us, changes in prices of our products and services or our competitors' products and services, changes in product mix, or changes in our revenue and revenue growth rates.

Existing stockholders may experience significant dilution from the sale of securities pursuant to our Investment Agreement with Dutchess.

Should we exercise the Investment Agreement with Dutchess, the sale of shares pursuant to that Agreement may have a dilutive impact on our stockholders. As a result, our net income per share could decrease in future periods and the market price of our common stock could decline. In addition, the lower our stock price is at the time we exercise our put option, the more shares we will have to issue to Dutchess to draw down on the full equity line with Dutchess. If our stock price decreases, then our existing stockholders would experience greater dilution.

Dutchess will pay less than the then-prevailing market price of our common stock, which could cause the price of our common stock to decline.

Our common stock to be issued under our Investment Agreement with Dutchess will be purchased at a 5% discount to the lowest closing best bid price during the five days immediately following our notice to Dutchess of our election to exercise our put right. Dutchess has a financial incentive to sell our common stock immediately upon receiving the shares to realize the profit between the discounted price and the market price. If Dutchess sells our shares, the price of our stock could decrease. If our stock price decreases, Dutchess may have a further incentive to sell the shares of our common stock that it holds. The discounted sales under our Investment Agreement with Dutchess could cause the price of our common stock to decline.

“Penny stock” rules may make buying or selling our securities difficult which may make our stock less liquid and make it harder for investors to buy and sell our shares.

Trading in our securities is subject to the SEC's "penny stock" rules and it is anticipated that trading in our securities will continue to be subject to the penny stock rules for the foreseeable future. The SEC has adopted regulations that generally define a penny stock to be any equity security that has a market price of less than $5.00 per share, subject to certain exceptions. These rules require that any broker-dealer who recommends our securities to persons other than prior customers and accredited investors must, prior to the sale, make a special written suitability determination for the purchaser and receive the purchaser's written agreement to execute the transaction. Unless an exception is available, the regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the risks associated with trading in the penny stock market. In addition, broker-dealers must disclose commissions payable to both the broker-dealer and the registered representative and current quotations for the securities they offer. The additional burdens imposed upon broker-dealers by these requirements may discourage broker-dealers from recommending transactions in our securities, which could severely limit the liquidity of our securities and consequently adversely affect the market price for our securities.

We have adopted certain measures that may make it more difficult for a third party to acquire control of our company.

Our Board of Directors is classified into three classes of directors serving staggered three-year terms. Such classification of the Board of Directors expands the time required to change the composition of a majority of directors and may tend to discourage a proxy contest or other takeover bid for our company. We have also instituted a stockholders rights plan that serves to help prevent a hostile takeover of our company.

ITEM 1B.          UNRESOLVED STAFF COMMENTS.

Not applicable.
 
 
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ITEM 2.             PROPERTIES.

Our headquarters and operations are housed in approximately 4,500 square feet of leased office space in San Antonio, Texas.  Rental expense under the operating lease was approximately $84,000 and $81,000 for the years ended December 31, 2011 and 2010, respectively. On October 7, 2009, we executed a second amendment to this lease agreement. The amendment extended the lease agreement for a period of three years and requires future minimum lease payments of $86,000 for 2012 through the termination of the lease.  We expect to renew this lease or enter into a new lease with similar terms and rates later this year. If we are unable to renew this lease, we believe we will be able to obtain additional space prior to the lease expiration, if needed, and that upon expiration of the lease, we will be able to renew, extend or obtain additional space, as needed, on commercially reasonable terms.

ITEM 3.             LEGAL PROCEEDINGS.

As previously disclosed, in 2002 we recognized a loss on margin loans it guaranteed for Michael R. Long, then Chairman of the Board of Directors and Chief Executive Officer, and current Chief Executive Officer and Chief Financial Officer; and Louis A. Hoch, our President and Chief Operating Officer, in the amounts of $535,302 and $449,371, respectively. In February 2007, we signed employment agreements with Mr. Long and Mr. Hoch that required each to repay his respective obligation to us in four equal annual payments of cash or stock or any combination thereof. In December 2007, we accepted common stock and stock options valued at $133,826 and $112,343 from Mr. Long and Mr. Hoch, respectively, in satisfaction of their annual payments for 2007 as provided for under their respective employment agreements.

In December 2008, Mr. Long and Mr. Hoch did not pay us the second annual installment pursuant to their respective employment agreements. They each withheld payment of the installment due because we had deferred payment of their salary increases for 2008 called for under their respective employment agreements. At December 31, 2008, we owed Mr. Long and Mr. Hoch deferred salary of $110,000 and $100,000, respectively, and Mr. Long and Mr. Hoch owed us $133,825 and $112,343, respectively, for the second installment due by December 31, 2008. The total amount owed to us for the second installment was $246,168. On March 30, 2009, we accepted 680,715 shares of our common stock valued at $23,825 and 352,658 shares of our common stock valued at $12,343 from Mr. Long and Mr. Hoch, respectively, in partial satisfaction of their payments due to us for 2008 as provided for under their employment agreements. The partial payments of $23,825 and $12,343 made to us by Mr. Long and Mr. Hoch, respectively, equaled the difference between the amount each owed to us for the second installment and the amount that we owed to each for deferred salary. The common stock accepted from Mr. Long and Mr. Hoch was valued at $0.035 per share, which was the closing price of the common stock on March 30, 2009.

In December 2009, Mr. Long and Mr. Hoch did not pay us the third annual installment pursuant to their respective employment agreements. They each withheld payment of the installment due because we had partially deferred payment of their salary for 2009 called for under their respective employment agreements. At December 31, 2009, we owed Mr. Long and Mr. Hoch deferred salary for 2009 of $162,385 and $141,808, respectively, and Mr. Long and Mr. Hoch owed us $133,825 and $112,343, respectively, for the third installment due by December 31, 2009.

In December 2010, Mr. Long and Mr. Hoch did not pay us the fourth and final annual installment pursuant to their respective employment agreements. They each withheld payment of the installment due because we continued to be unable to pay deferred salaries that were called for under their respective employment agreements. At December 31, 2010, we owed Mr. Long and Mr. Hoch deferred salaries of $147,368 and $126,915, respectively in regards to their 2009 deferred salary balances.  As of December 31, 2010, Mr. Long and Mr. Hoch owed us $133,825 and $112,343, respectively, for the fourth and final installment due by December 31, 2010.

As of December 31, 2011, Mr. Long owed us $377,651 and Mr. Hoch owed us $324,686.  At December 31, 2011, we owed Mr. Long and Mr. Hoch deferred salaries of $23,473 and $3,300, respectively in regards to their 2010 deferred salary balances.  No payments were made in 2011 by either Mr. Long or Mr. Hoch related to the repayment of their respective obligations to us, as each of their salaries were respectively reduced to $24,000 for the fiscal year ended December 31, 2011 to ensure we maintained positive cash flow fiscal year 2011 and profitability for the third and fourth quarters of 2011.

ITEM 4.             MINE SAFETY DISCLOSURES.

Not applicable.

 
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PART II
ITEM 5.             MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our common stock is quoted on the OTCQB, the OTC market tier for companies that are reporting with the SEC, and on the OTC Bulletin Board, or OTCBB, under the ticker symbol “PYDS.”

The following table sets forth the high and low closing prices for our common stock for each quarter during the last two fiscal years. The prices reported below reflect inter-dealer prices and are without adjustments for retail markups, markdowns or commissions, and may not necessarily represent actual transactions.

   
High
   
Low
 
2011
           
First Quarter
  $ 0.035     $ 0.002  
                 
Second Quarter
  $ 0.029     $ 0.015  
                 
Third Quarter
  $ 0.090     $ 0.012  
                 
Fourth Quarter
  $ 0.130     $ 0.052  
                 
2010
               
First Quarter
  $ 0.032     $ 0.020  
                 
Second Quarter
  $ 0.059     $ 0.020  
                 
Third Quarter
  $ 0.055     $ 0.035  
                 
Fourth Quarter
  $ 0.050     $ 0.020  

Holders

As of March 29, 2012, 142,721,077 shares of our common stock are issued and outstanding. As of March 29, 2012, there were approximately 3,000 stockholders of record of our common stock.

Dividends

We have never declared or paid cash or stock dividends and have no plans to pay any such dividends in the foreseeable future, instead, we intend to reinvest our earnings, if any.
 
 
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Securities Authorized for Issuance under Equity Compensation Plans
 
The following table provides information as of December 31, 2011 with respect to compensation plans (including individual compensation arrangements) under which equity securities of the registrant are authorized for issuance:
 
    
Number of securities to be
issued upon exercise of
outstanding options
   
Weighted-average
exercise price
of outstanding
options
   
Number of securities
remaining available for
future issuance under
compensation plan
 
Employee Comprehensive Stock Plan approved by stockholders
    2,398,921     $ 0.11       14,259,747  
                         
Non-Employee Director Plan approved by stockholders
    600,000     $ 0.18       780,000  
                         
Total
    2,998,921               15,039,747  
 
Recent Sales of Unregistered Securities
 
During the quarter ended December 31, 2011, we did not sell any unregistered securities.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

We did not repurchase any of our common stock during the fourth quarter of 2011.

ITEM 6.             SELECTED FINANCIAL DATA.

Not applicable.

ITEM 7.             MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto, and other financial information included elsewhere in this Form 10-K. This report contains forward-looking statements that involve risks and uncertainties. Actual results in future periods may differ materially from those expressed or implied in such forward-looking statements as a result of a number of factors, including, but not limited to, the risks discussed under the heading "Risk Factors" and elsewhere in this Form 10-K.
 
 
20
 
 
Overview

We provide integrated electronic payment processing services to merchants and businesses, including credit and debit card-based processing services and transaction processing via the Automated Clearing House network. We also operate an online payment processing service for consumers under the domain name www.billx.com through which consumers can pay anyone. Since inception we have incurred operating losses each quarter through June 30, 2011.  However, we have reported net income in the third and fourth quarter of 2011 due primarily to our expanded customer base.  At December 31, 2011, we have an accumulated deficit of approximately $54.3 million. To maintain profitability  we must, among other things, grow and maintain our customer base, implement a successful marketing strategy, continue to maintain and upgrade our technology and transaction-processing systems, provide superior customer service, respond to competitive developments, attract, retain and motivate qualified personnel, and respond to unforeseen industry developments and other factors. We believe that our success will depend in large part on our ability to (a) manage our operating expenses, (b) add quality customers to our client base, (c) meet evolving customer requirements and (d) adapt to technological changes in an emerging market. Accordingly, we intend to focus on customer acquisition activities and outsource some of our processing services to third parties to allow us to maintain an efficient operating infrastructure and expand our operations without significantly increasing our fixed operating expenses.

Critical Accounting Policies

General

Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to the reported amounts of revenues and expenses, bad debt, investments, intangible assets, income taxes, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions or conditions. We consider the following accounting policies to be critical because the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change or because the impact of the estimates and assumptions on financial condition or operating performance is material.

Revenue Recognition

Revenue consists primarily of fees generated through the electronic processing of payment transactions and related services, and are recognized as revenue in the period the transactions are processed or when the related services are performed. Merchants may be charged for these processing services at a bundled rate based on a percentage of the dollar amount of each transaction and, in some instances, additional fees are charged for each transaction. Certain merchant customers are charged a flat fee per transaction, while others may also be charged miscellaneous fees, including fees for chargebacks or returns, monthly minimums, and other miscellaneous services. Revenues derived from electronic processing of credit and debit card transactions that are authorized and captured through third-party networks are reported gross of amounts paid to sponsor banks as well as interchange and assessments paid to credit card associations (Discover, MasterCard and Visa). Revenue also includes any up-front fees for the work involved in implementing the basic functionality required to provide electronic payment processing services to a customer. Revenue from such implementation fees is recognized over the term of the related service contract. Sales taxes billed are reported directly as a liability to the taxing authority, and are not included in revenue.
 
 
21
 

Reserve for Losses on Merchant Accounts

If, due to insolvency or bankruptcy of the merchant, or for another reason, we are not able to collect amounts from our card processing merchant customers that have been properly "charged back" by the cardholders, we must bear the credit risk for the full amount of the cardholder transaction. We may require cash deposits and other types of collateral from certain merchants to minimize any such risk. In addition, we utilize a number of systems and procedures to manage merchant risk. Card merchant processing loss reserves are primarily determined by performing a historical analysis of our chargeback loss experience and considering other factors that could affect that experience in the future, such as the types of card transactions processed and nature of the merchant relationship with their consumers. This reserve amount is subject to risk that actual losses may be greater than our estimates. We have not incurred any significant chargeback losses to date. Our estimate for chargeback losses is likely to increase in the future as our volume of card-based transactions processed increases.

Bad Debts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability or failure of our customers to make required payments. We determine the allowance for doubtful accounts based on an account-by-account review, taking into consideration such factors as the age of the outstanding balance, historical pattern of collections and financial condition of the customer. Past losses incurred by us due to bad debts have been within our expectations. If the financial conditions of our customers were to deteriorate, resulting in an impairment of their ability to make contractual payments, additional allowances may be required. Our estimate for bad debt losses is likely to increase in the future as our volume of transactions processed increases.

Marketable Securities

We classify our marketable security investment portfolio as either held to maturity, available-for-sale, or trading. At December 31, 2011, all our marketable securities were trading. Securities classified as trading are carried at fair value with unrealized gains and losses included in the consolidated statement of operations. Classification as current or non-current is based primarily on whether there is an active public market for such security.  Gains or losses from the sale or redemption of the marketable securities are determined using the specific identification method.

Valuation of Long-Lived and Intangible Assets

We assess the impairment of long-lived and intangible assets at least annually, and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important, which could trigger an impairment review, include the following: significant underperformance relative to historical or projected future cash flows; significant changes in the manner of use of the assets or the strategy of the overall business; and significant negative industry trends. When management determines that the carrying value of long-lived and intangible assets may not be recoverable, impairment is measured as the excess of the assets’ carrying value over the estimated fair value. No impairment losses were recorded in 2011 or 2010.
 
Income Taxes

Deferred tax assets and liabilities are recorded based on the difference between the tax bases of assets and liabilities and their carrying amount for financial reporting purposes, as measured by the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets are computed with the presumption that they will be realizable in future periods when taxable income is generated. Predicting the ability to realize these assets in future periods requires a great deal of judgment by management. It is our judgment that we cannot predict with reasonable certainty that the deferred tax assets as of December 31, 2011 will be realized in future periods. Accordingly, a valuation allowance has been provided to reduce the net deferred tax assets to $0.

We recognize income tax benefits only when it meets the “more likely than not” recognition threshold.  We have not recorded any unrecognized income tax benefits at December 31, 2011.
 
 
22
 
 
Results of Operations

Our revenues are principally derived from providing integrated electronic payment services to merchants and businesses, including credit and debit card-based processing services and transaction processing via the Automated Clearing House network and the program management and processing of prepaid debit cards. We also operate an online payment processing service for consumers under the domain name www.billx.com and sell this service as a private-label application to resellers. Total revenues for 2011 increased 84% to $4,813,257 from $2,618,864 for 2010.  The increase is primarily related to higher transaction volumes and an increase in the number of our customers.  We increased our merchant account users to 675 customers at December 31, 2011 from 599 customers at December 31, 2010. In addition, the monthly average number of consumers using our billx.com online payment service increased to 2,962 in 2011 from 2,269 in 2010. We expect this trend for our online payment service to continue as we have introduced and established enhanced value by offering the service to other prepaid card issuing companies in the prepaid card industry.

Cost of services includes the cost of personnel dedicated to the creation and maintenance of connections to third-party payment processors and fees paid to such third-party providers for electronic payment processing services. Through our contractual relationships with our payment processors and sponsoring banks, we are able to process ACH and debit or credit card transactions on behalf of our customers and their consumers. We pay volume-based fees for debit and credit transactions initiated through these processors, and pay fees for other transactions such as returns, notices of change to bank accounts and file transmission. Cost of services was $3,093,891 and $2,019,602 for 2011 and 2010, respectively. The increase in cost of services for 2011 was due to an increase in transaction volume.

Stock-based compensation expenses decreased to $348,768 for 2011 from $534,600 for 2010 due to less compensation being paid through stock issuance in 2011.

Other selling, general and administrative expenses increased to $993,877 for 2011, from $650,879 for 2010. The increase from the prior year was principally due to higher salary expenses.

Depreciation and amortization was $3,722 and $23,514 for 2011 and 2010, respectively. The decrease from the prior year was due to lower depreciation expense related to certain assets that became fully depreciated during 2011. We capitalized $4,880 in expenditures during 2011 and $993 in 2010.

Other income (expense) was $(2,782) and $160,000 in 2011 and 2010, respectively and is primarily attributable to a decrease in the value of the common stock we hold in Commerce Planet.

Income taxes of $18,369 and $14,437 in 2011 and 2010, respectively, represent the amounts incurred under the Texas margin tax.  We did not incur any federal income tax in 2011 or 2010.

Net income for 2011 was $351,848 compared to a net loss of $(464,168) in 2010, as a result of the items discussed above.

Liquidity and Capital Resources

At December 31, 2011, we had $3,678,688 of cash and cash equivalents, compared to $978,699 of cash and cash equivalents at December 31, 2010. We have incurred substantial losses since inception through June 30, 2011.  However, we recorded net income in the third and fourth quarters of 2011. Our working capital deficit has decreased from $979,354 at December 31, 2010 to $211,744 at December 31, 2011. We believe that our current available cash and cash equivalents along with anticipated revenues may be insufficient to meet our anticipated cash needs for the foreseeable future.
 
 
23
 

On June 11, 2007, we entered into an agreement for an equity line of credit with Dutchess Private Equities Fund, LP. Under the terms of the agreement, we may elect to receive as much as $10 million from common stock purchases by Dutchess through August 23, 2012. Through December 31, 2009, we sold 1,535,263 shares of our common stock pursuant to the equity line of credit and received total proceeds, net of issuance costs, of $75,064.  From January 1, 2010 through December 31, 2011, we did not sell any shares under the agreement.

On November 4, 2010, Michael Long, Chief Executive Officer and Chief Financial Officer, and Louis Hoch, President and Chief Operating Officer, were each granted 5,400,000 shares of restricted common stock by us as an annual bonus valued at $216,000 pursuant to the terms of their respective employment agreements. The number of shares granted to each officer was based on the closing price of the common stock on October 15, 2010, which was $0.04 per share.  We elected to make the bonus payments entirely in common stock in order to conserve our cash and to further incent our executive officers to increase shareholder value by raising their ownership stake. On November 13, 2011, Michael Long, Chief Executive Officer and Chief Financial Officer, and Louis Hoch, President and Chief Operating Officer were each granted a cash bonus of $216,000 by us pursuant to the terms of their respective employment agreements.

Net cash provided by operating activities was $2,404,869 for 2011 and $413,814 for 2010. Net cash provided by operating activities in 2011 and 2010 was primarily attributable to the increase in customer deposits payable, which consists of cash held in transit that we collected on behalf of our merchants via the ACH system. We plan to focus on expending our resources prudently given our current state of liquidity.

Net cash used by investing activities was $4,880 for 2011 and was $712 for 2010 which primarily related to acquisitions of equipment.

Net cash provided by financing activities was $300,000 in 2011 and $0 in 2010 which relates to the proceeds from debt.

Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

ITEM 7A.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

As a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item.
 
 
24
 
ITEM 8.             FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
Report of Independent Registered Public Accounting Firm
    26  
         
Consolidated Balance Sheets as of December 31, 2011 and 2010
    27  
 
       
Consolidated Statements of Operations for the years ended   December 31, 2011 and 2010
    28  
         
Consolidated Statement of Changes in Stockholders’ Equity (Deficit) for the years ended   December 31, 2011 and 2010
    29  
         
Consolidated Statements of Cash Flows for the years ended   December 31, 2011 and 2010
    30  
         
Notes to Consolidated Financial Statements
    31  
 
 
25
 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
The Board of Directors and Stockholders
Payment Data Systems, Inc. and Subsidiaries
San Antonio, Texas

We have audited the accompanying consolidated balance sheets of Payment Data Systems, Inc. and its Subsidiaries (collectively referred to as the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in stockholders' equity (deficit) and cash flows for the years then ended. 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2011 and 2010, and the consolidated results of their operations and cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
 
         
/s/ Akin, Doherty, Klein & Feuge, P.C.
       
Akin, Doherty, Klein & Feuge, P.C.
       
San Antonio, Texas
   
 
 
         
April 2, 2012        
 
 
26
 
 
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
 
   
December 31,
2011
   
December 31,
2010
 
ASSETS
                 
Cash and cash equivalents
  $ 3,678,688     $ 978,699  
Accounts receivable, net
    376,070       137,957  
Prepaid expenses and other
    32,164       22,130  
                  Total current assets
    4,086,922       1,138,786  
                 
Property and equipment, net
    4,234       3,076  
                 
Other assets:
               
           Related party receivable
    702,337       703,060  
           Marketable securities
    74,787       99,716  
           Other assets
    41,693       39,193  
                  Total other assets
    818,817       841,969  
                 
Total Assets
  $ 4,909,973     $ 1,983,831  
                 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
               
           Accounts payable
  $ 43,375     $ 70,725  
           Accrued expenses
    521,808       1,040,721  
           Customer deposits payable
    3,429,135       983,713  
           Line of credit
    300,000       -  
           Deferred revenue
    4,348       22,981  
                  Total current liabilities
    4,298,666       2,118,140  
                 
Stockholders' Equity:
               
           Common stock, $0.001 par value, 200,000,000 shares authorized; 142,721,077 and  141,073,691 issued and 137,725,833 and 136,078,447 outstanding
    142,721       141,074  
           Additional paid-in capital
    56,328,423       56,285,070  
           Treasury stock, at cost; 4,995,244 and 4,995,244 shares
    (238,158 )     (238,158 )
           Deferred compensation
    (1,281,880 )     (1,630,648 )
           Accumulated deficit
    (54,339,799 )     (54,691,647 )
                  Total stockholders' equity (deficit)
    611,307       (134,309 )
                 
Total Liabilities and Stockholders' Equity
  $ 4,909,973     $ 1,983,831  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
27
 
 
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
 
   
Year ended
December 31,
2011
   
Year ended
December 31,
2010
 
             
Revenues
  $ 4,813,257     $ 2,618,864  
                 
Operating expenses:
               
Cost of services
    3,093,891       2,019,602  
Selling, general and administrative:
               
Stock-based compensation
    348,768       534,600  
Other expenses
    993,877       650,879  
Depreciation
    3,722       23,514  
Total operating expenses
    4,440,258       3,228,595  
                 
Operating income (loss)
    372,999       (609,731 )
                 
Other income:
               
Other income (expense)
    (2,782 )     160,000  
Other income, net
    (2,782 )     160,000  
                 
Income (loss) before income taxes
    370,217       (449,731 )
Income taxes
    18,369       14,437  
                 
Net Income (Loss)
  $ 351,848     $ (464,168 )
                 
Earnings (Loss) Per Share
               
Basic and diluted earnings (loss) per common share:
  $ 0.00     $ (0.00 )
Weighted average common shares outstanding
               
Basic
    137,148,311       121,508,634  
    Diluted
    137,391,675       121,508,634  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
28
 
 
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
 
                Additional Paid - In Capital                      
Total
Stockholders' Equity (Deficit)
 
   
Common Stock
       
Treasury
Stock
   
Deferred
Compensation
   
Accumulated
Deficit
     
   
Shares
   
Amount
                     
                                           
Balance at December 31, 2009
    115,773,691     $ 115,774     $ 55,444,770     $ (238,155 )   $ (1,979,416 )   $ (54,227,479 )   $ (884,506 )
                                                         
Purchase of treasury stock
    -       -       -       (3 )     -       -       (3 )
Issuance of common stock
    25,300,000       25,300       840,300       -       -       -       865,600  
Deferred compensation
    -       -       -       -       348,768       -       348,768  
Net loss for the year
    -       -       -       -       -       (464,168 )     (464,168 )
                                                         
Balance at December 31, 2010
    141,073,691     $ 141,074     $ 56,285,070     $ (238,158 )   $ (1,630,648 )   $ (54,691,647 )   $ (134,309 )
Issuance of common stock
    1,647,386       1,647       43,353       -       -       -       45,000  
Deferred compensation
    -       -       -       -       348,768       -       348,768  
Net income for the year
    -       -       -       -       -       351,848       351,848  
                                                         
Balance at December 31, 2011
    142,721,077     $ 142,721     $ 56,328,423     $ (238,158 )   $ (1,281,880 )   $ (54,339,799 )   $ 611,307  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
29
 
 
PAYMENT DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Year Ended
December 31, 2011
   
Year Ended
December 31, 2010
 
Operating Activities
           
Net income (loss)
  $ 351,848     $ (464,168 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation
    3,722       23,514  
Deferred compensation
    348,768       348,768  
Bad debt
    -       17,989  
Marketable securities received in litigation settlement
    -       (100,000 )
Unrealized loss on investments
    24,929       -  
Non-cash issuance of common stock
    45,000       432,000  
Changes in current assets and current liabilities:
               
Accounts receivable
    (238,113 )     (63,401 )
Prepaid expenses and other
    (10,034 )     (5,861 )
Other assets
    (2,500 )     (32,500 )
Related party receivable
    723       (246,892 )
Accounts payable and accrued expenses
    (546,263 )     (35,621 )
Customer deposits payable
    2,445,422       534,341  
Deferred revenue
    (18,633 )     5,645  
Net cash provided by operating activities
    2,404,869       413,814  
                 
Investing Activities
               
Purchase of treasury stock
    -       (3 )
Proceeds from sales of investments
    -       284  
Purchases of property and equipment
    (4,880 )     (993 )
Net cash used by investing activities
    (4,880 )     (712 )
                 
Financing Activities
               
Proceeds from debt
    400,000       -  
Payments on debt
    (100,000 )     -  
Net cash provided by financing activities
    300,000       -  
                 
Change in cash and cash equivalents
    2,699,989       413,102  
Cash and cash equivalents, beginning of year
    978,699       565,597  
                 
Cash and Cash Equivalents, End of Year
  $ 3,678,688     $ 978,699  
                 
Supplemental Disclosures
               
Cash paid for interest
  $ 395     $ -  
Cash paid for income taxes
  $ 18,369     $ 13,227  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
30
 
 
PAYMENT DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011 AND 2010
Note 1. Description of Business and Summary of Significant Accounting Policies

Organization: Payment Data Systems, Inc. along with its subsidiaries, Ficentive, Inc., a Nevada corporation, Zbill, Inc., a Nevada corporation and billserv.com-Canada, Inc., a Nevada corporation, provides integrated electronic payment services, including credit and debit card-based processing services and transaction processing via the Automated Clearing House (“ACH”) network to billers and retailers. In addition, the Company operates an Internet electronic payment processing service for consumers under the domain name www.billx.com.

Principles of Consolidation and Basis of Presentation: The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

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

Revenue Recognition: Revenue consists primarily of fees generated through the electronic processing of payment transactions and related services, and are recognized as revenue in the period the transactions are processed or when the related services are performed. Merchants may be charged for these processing services at a bundled rate based on a percentage of the dollar amount of each transaction and, in some instances, additional fees are charged for each transaction. Certain merchant customers are charged a flat fee per transaction, while others may also be charged miscellaneous fees, including fees for chargebacks or returns, monthly minimums, and other miscellaneous services. Revenues derived from electronic processing of credit and debit card transactions that are authorized and captured through third-party networks are reported gross of amounts paid to sponsor banks as well as interchange and assessments paid to credit card associations (MasterCard and Visa). Revenue also includes any up-front fees for the work involved in implementing the basic functionality required to provide electronic payment processing services to a customer. Revenue from such implementation fees is recognized over the term of the related service contract. Sales taxes billed are reported directly as a liability to the taxing authority, and are not included in revenue.

Cash and Cash Equivalents : The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

Accounts Receivable: Accounts receivables are reported at outstanding principal net of an allowance for doubtful accounts of $103,052 and $51,442 at December 31, 2011 and 2010, respectively. The allowance is generally determined based on historical trends and an account-by-account review. Accounts are charged off when collection efforts have failed and the account is deemed uncollectible. The Company normally does not charge interest on accounts receivable.

Marketable Securities : The Company classifies its marketable security investment portfolio as either held to maturity, available-for-sale, or trading. At December 31, 2011 and 2010, all of the Company’s marketable securities were trading. Securities classified as trading are carried at fair value with unrealized gains and losses included in the consolidated statement of operations. Classification as current or non-current is based primarily on whether there is an active public market for such security. Gains or losses from the sale or redemption of the marketable securities are determined using the specific identification method.
 
 
31
 

Property and Equipment : Property and equipment are stated at cost. Depreciation and amortization are computed on a straight-line method over the estimated useful lives of the related assets, ranging from three to seven years. Leasehold improvements are amortized over the lesser of the estimated useful lives or remaining lease period. Expenditures for maintenance and repairs are charged to expense as incurred.

Concentration of Credit Risk: Financial instruments that potentially expose the Company to credit risk consist of cash and cash equivalents, and accounts receivable. The Company is exposed to credit risk on its cash and cash equivalents in the event of default by the financial institutions to the extent of balances in excess of amounts that are insured by the FDIC ($250,000). Trade receivables potentially subject the Company to concentrations of credit risk. The Company’s customer base operates in a variety of industries and is geographically dispersed, however, the relatively small number of customers increases the risk. The Company closely monitors extensions of credit and credit losses have been provided for in the consolidated financial statements and have been within management's expectations. For the year ended December 31, 2011, 44% of total revenues were from sales to one customer. This customer is a reseller and represents a collection of merchants. No other customer accounted for more than 10% of total revenues during 2011. For the year ended December 31, 2010 no single customer accounted for 10% of total revenues,

Fair Value of Financial Instruments: Cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities and short-term borrowings are reflected in the accompanying consolidated financial statements at cost, which approximates fair value because of the short-term maturity of these instruments.

Impairment of Long-Lived Assets : The Company periodically reviews, on at least an annual basis, the carrying value of its long-lived assets, including property, plant and equipment, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. To the extent fair value of a long-lived asset, determined based upon the estimated future cash inflows attributable to the asset, less estimated future cash outflows, is less than the carrying amount, an impairment loss is recognized.

Reserve for Losses on Merchant Accounts: Disputes between a cardholder and a merchant periodically arise as a result of, among other things, cardholder dissatisfaction with merchandise quality or merchant services. Such disputes may not be resolved in the merchant’s favor. In these cases, the transaction is “charged back” to the merchant and the purchase price is refunded to the customer through the merchant’s acquiring bank, and charged to the merchant. If the merchant has inadequate funds, the Company must bear the credit risk for the full amount of the transaction. The Company evaluates its risk for such transactions and estimates its potential loss for chargebacks based primarily on historical experience and other relevant factors.

Advertising Costs: Advertising is expensed as incurred. The Company incurred approximately $2,500 and $1,000 in advertising costs in 2011 and 2010, respectively.

Income Taxes: Deferred tax assets and liabilities are recorded based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. As with all businesses, the Company’s tax returns are subject to periodic examination.  The Company’s federal returns for the past four years remain open to examination.  The Company is subject to the Texas margin tax.

Stock-Based Compensation : The Company recognizes as compensation expense all share-based payment awards made to employees and directors, including grants of stock options and warrants, based on estimated fair values. Fair value is generally determined based on the closing price of the Company’s common stock on the date of grant.

Earnings (Loss) Per Share : Basic and diluted earnings (loss) per common share are calculated by dividing earnings (loss) by the weighted average number of common shares outstanding during the period. Common stock equivalents, which consist of stock options, were excluded from the computation of the weighted average number of common shares outstanding for purposes of calculating diluted loss per common share because their effect was antidilutive.
 
 
32
 

Reclassification: Certain reclassifications, all insignificant in amount, have been made to the prior year’s financial statements in order to conform to the current presentation .

Note 2. Stock-Based Compensation

On November 4, 2010, Mr. Long and Mr. Hoch were each granted 5,400,000 shares of restricted common stock by the Company as an annual bonus valued at $216,000 pursuant to the terms of their respective employment agreements. The number of shares granted to each officer was based on the closing price of the common stock on October 15, 2010, which was $0.04 per share.

Compensation cost related to non-vested common stock awards will be recognized in future years as follows:
 
Year ending December 31,
     
2012
    238,000  
2013
    238,000  
2014
    238,000  
2015
    238,000  
2016
    202,000  
2017
    127,648  
         
Total deferred compensation
  $ 1,281,648  
 
Note 3. Equity Line of Credit

On June 11, 2007, the Company entered into an agreement for an equity line of credit with Dutchess Private Equities Fund, LP (“Dutchess”). Under the terms of the agreement, at its election, the Company may receive as much as $10 million in common stock purchases by Dutchess over a period of five years. The Company agreed to file with the Securities and Exchange Commission (“SEC”), and have declared effective before any funds may be received under the agreement, a registration statement registering the resale of the shares of the Company’s common stock to be issued to Dutchess. The Company filed a registration statement on Form SB-2 with the SEC on August 23, 2007 to register the resale of these shares. On September 10, 2007, the SEC declared the registration statement effective. The Company did not sell any shares of its common stock pursuant to the equity line of credit during 2011 or 2010.  Management does not currently expect to renew the agreement upon its termination on August 23, 2012.

Note 4.  Line of Credit:

The Company has secured a line of credit that provides a maximum borrowing of $500,000 which matures on November 16, 2012.  The credit line bears interest at 2.25% and is collateralized by a $500,000 certificate of deposit.  The Company had borrowed $300,000 on the line of credit at December 31, 2011.
 
 
33
 

Note 5. Fair Value Measurements

ASC Topic 820 established a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements).

The three levels of the fair value hierarchy defined by the standard are as follows:
 
●   
Level 1: Quoted prices are available in active markets for identical assets or liabilities;
●   
Level 2: Quoted prices in active markets for similar assets and liabilities that are observable for the asset or liability; or
●   
Level 3: Unobservable pricing inputs that are generally less observable from objective sources, such as discounted cash flow models or valuations.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. The following table sets forth by level within the fair value hierarchy the Company’s financial assets and liabilities that are accounted for at fair value.
 
         
December 31, 2011
       
Recurring Fair Value Measures Assets:
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Marketable securities
  $ 74,787       -       -     $ 74,787  
                                 
Liabilities:
                               
None
    -       -       -       -  
                                 
           
December 31, 2010
         
Recurring Fair Value Measures Assets:
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Marketable securities
  $ 99,716       -       -     $ 99,716  
                                 
Liabilities:
                               
None
    -       -       -       -  
 
The Company’s financial instruments relate to its trading marketable securities, which are valued using quoted market prices. Adjustments to fair value are recorded in the consolidated statement of operations.
 
 
34
 
 
Note 6. Property and Equipment

The following is a summary of property and equipment at December 31:
 
2011
   
2010
 
Furniture and fixtures
  $ 175,856     $ 175,856  
Equipment
    506,457       501,577  
Software
    326,315       326,315  
Leasehold improvements
    15,992       15,992  
Total property and equipment
    1,024,620       1,019,740  
Less: accumulated depreciation
    (1,020,386 )     (1,016,664 )
                 
Net property and equipment
  $ 4,234     $ 3,076  

Note 7.  Valuation Accounts:

Valuation and allowance accounts include the following at December 31:

   
Balance Beginning
of Year
   
Net Charged to Costs and Expenses
   
Transfers
   
Net
Write-Off
   
Balance End
of Year
 
2011
                             
                               
Allowance for doubtful accounts
  $ 51,442     $ -     $ 75,000     $ (23,400 )   $ 103,042  
                                         
Reserve for merchant losses
    205,400       1,144       (75,000 )     -       131,544  
                                         
2010
                                       
                                         
Allowance for doubtful accounts
  $ 42,359     $ 17,989     $ -     $ (8,906 )   $ 51,442  
                                         
Reserve for merchant losses
    205,400       -       -       -       205,400  
 
Note 8. Accrued Expenses

Accrued expenses consist of the following balances at December 31:

 
 
2011
   
2010
 
Accrued salaries
  $ 135,768     $ 686,982  
Reserve for merchant losses
    131,544       205,400  
Accrued commissions
    132,798       55,891  
Accrued taxes
    40,319       38,117  
Other accrued expenses
    81,379       54,331  
                 
Total accrued expenses
  $ 521,808     $ 1,040,721  

 
35
 

Note 9. Operating Leases

The Company has a lease for approximately 4,500 square feet that houses its headquarters and operations. Rental expense under the operating lease was approximately $84,000 and $81,000 for the years ended December 31, 2011 and 2010, respectively. On October 7, 2009, the Company executed a second amendment to this lease agreement. The amendment extended the lease agreement for a period of three years and requires future minimum lease payments of $63,000 through its expiration in October 2012.

Note 10. Related Party Transactions and Guarantees

As previously disclosed, in 2002 the Company recognized a loss on margin loans it guaranteed for Michael R. Long, then Chairman of the Board of Directors and Chief Executive Officer, and current Chief Executive Officer and Chief Financial Officer; and Louis A. Hoch, the Company’s President and Chief Operating Officer, in the amounts of $535,302 and $449,371, respectively. In February 2007, the Company signed employment agreements with Mr. Long and Mr. Hoch that required each to repay his respective obligation to the Company in four equal annual payments of cash or stock or any combination thereof. In December 2007, the Company accepted common stock and stock options valued at $133,826 and $112,343 from Mr. Long and Mr. Hoch, respectively, in satisfaction of their annual payments for 2007 as provided for under their respective employment agreements.

In December 2008, Mr. Long and Mr. Hoch did not pay the Company the second annual installment pursuant to their respective employment agreements. They each withheld payment of the installment due because the Company had deferred payment of their salary increases for 2008 called for under their respective employment agreements. At December 31, 2008, the Company owed Mr. Long and Mr. Hoch deferred salary of $110,000 and $100,000, respectively, and Mr. Long and Mr. Hoch owed the Company $133,825 and $112,343, respectively, for the second installment due by December 31, 2008. The total amount owed to the Company for the second installment was $246,168 and is classified as “Related Party Receivable” on the Company’s balance sheet at December 31, 2008. On March 30, 2009, the Company accepted 680,715 shares of the Company’s common stock valued at $23,825 and 352,658 shares of the Company’s common stock valued at $12,343 from Mr. Long and Mr. Hoch, respectively, in partial satisfaction of their annual payments due to the Company for 2008 as provided for under their employment agreements. The partial payments of $23,825 and $12,343 made to the Company by Mr. Long and Mr. Hoch, respectively, equaled the difference between the amount each owed to the Company for the second installment and the amount the Company owed to each for deferred salary. The common stock accepted from Mr. Long and Mr. Hoch was valued at $0.035 per share, which was the closing price of the common stock on March 30, 2009. The common stock accepted from Mr. Long and Mr. Hoch was recorded as treasury stock with a total cost of $36,168.

In December 2009, Mr. Long and Mr. Hoch did not pay the Company the third annual installment pursuant to their respective employment agreements. They each withheld payment of the installment due because the Company had partially deferred payment of their salary for 2009 called for under their respective employment agreements. At December 31, 2009, the Company owed Mr. Long and Mr. Hoch deferred salary for 2009 of $162,385 and $141,808, respectively, and Mr. Long and Mr. Hoch owed the Company $133,825 and $112,343, respectively, for the third installment due by December 31, 2009.

On November 12, 2009, the Company executed amendments to its employment agreements with Mr. Long, Chief Executive Officer and Chief Financial Officer, and Mr. Hoch, President and Chief Operating Officer. Under the terms of their respective amended employment agreements, Mr. Long and Mr. Hoch agreed to reduce their annual base salaries for 2009 to $190,000 and $175,000, respectively, from $375,000 and $350,000, respectively.

On April 12, 2010, the Company executed amendments to its employment agreements with Mr. Long, Chief Executive Officer and Chief Financial Officer, and Mr. Hoch, President and Chief Operating Officer. Under the terms of their respective amended employment agreements, Mr. Long and Mr. Hoch agreed to reduce their annual base salaries for 2010 to $24,000 each from $375,000 and $350,000, respectively, and change the annual bonus limit from 100% of current salary to 100% of the highest salary received in any year of the agreement.

In December 2010, Mr. Long and Mr. Hoch did not pay the Company the fourth and final annual installment pursuant to their respective employment agreements. They each withheld payment of the installment due because the Company continued to be unable to pay deferred salaries that were called for under their respective employment agreements. At December 31, 2010, the Company owed Mr. Long and Mr. Hoch deferred salaries of $147,368 and $126,915, respectively, in regards to their 2009 deferred salary balance. As of December 31, 2010, Mr. Long and Mr. Hoch owed the Company $133,825 and $112,343, respectively, for the fourth and final installment due by December 31, 2010.
 
 
36
 

The total amount owed to the Company for the unpaid installments is classified as “Related Party Receivable” on the Company’s balance sheet and was $702,337 and $703,060 at December 31, 2011 and 2010, respectively.  At December 31, 2011, we owed Mr. Long and Mr. Hoch deferred salaries of $23,473 and $3,300, respectively in regards to their 2010 deferred salary balances.

During the years ended December 31, 2011 and 2010, the Company respectively paid Herb Authier $30,000 for consulting services related to network engineering and administration that he provided to the Company. Mr. Authier is the father-in-law of Louis Hoch, the Company’s President and Chief Operating Officer.

Note 11. Income Taxes

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 are as follows at December 31:
 
   
2011
   
2010
 
             
Gross deferred tax assets:
           
Warrant expense
  $ -     $ 3,228,000  
Loss on related party guarantees
    435,000       435,000  
Net operating loss carryforwards
    15,100,000       14,388,000  
Depreciation and other items
    70,000       91,000  
Total deferred tax assets
    15,605,000       18,142,000  
                 
Gross deferred tax liabilities:
               
Other items
    (2,000 )     (14,000 )
Total deferred tax liabilities
    (2,000 )     (14,000 )
                 
Net deferred tax asset
    15,603,000       18,128,000  
Less: valuation allowance
    (15,603,000 )     (18,128,000 )
                 
Net deferred tax asset recorded
  $ -     $ -  

Management has reviewed its net deferred asset position, and due to the history of operating losses has determined that the application of a full valuation allowance at December 31, 2011 and December 31, 2010 is warranted. If applicable, the Company would recognize interest expense and penalties related to uncertain tax positions in interest expense. As of December 31, 2011, the Company had not accrued any interest or penalties related to uncertain tax provisions.

The Company has net operating loss carryforwards for tax purposes of approximately $44 million that begin to expire in the year 2020. Approximately $3.5 million of the total net operating loss is subject to an IRS Section 382 limitation from 1999.

The reconciliation of federal income tax computed at the U.S. federal statutory tax rates to total income tax expense is as follows for the year ended December 31:

   
2011
   
2010
 
Tax (benefit) at statutory rate -- 34%
  $ 138,000     $ (158,000 )
Change in valuation allowance
    (2,525,000 )     158,000  
Permanent and other differences
    2,387,000       -  
                 
Income tax expense
  $ -     $ -  
 
 
37
 
 
Note 12. Stock Option and Incentive Plans

Stock Option Plans : The Board of Directors and stockholders approved the 1999 Employee Comprehensive Stock Plan ("Employee Plan") to provide qualified incentive stock options (“ISOs”) and non-qualified stock options (“NQSOs”) as well as restricted stock grants to key employees. Under the terms of the Employee Plan, the exercise price of ISOs must be equal to 100% of the fair market value on the date of grant (or 110% of fair market value in the case of an ISO granted to a 10% stockholder/grantee). There is no price requirement for NQSOs, other than that the option price must exceed the par value of the common stock. The Company reserved 30,000,000 shares of its common stock for issuance pursuant to the Employee Plan. This Employee Plan terminated in 2010, subject to its terms which stated it would terminate ten years from its effective date.

The 1999 Non-Employee Director Plan ("Director Plan") was approved by the Board of Directors and stockholders to provide non-employee directors options to purchase shares of common stock at 100% of fair market value on the date of grant. The Company reserved 1,500,000 shares of its common stock for issuance pursuant to the Director Plan.  This plan terminated in 2010, ten years following its inception.

The Company currently has no active stock option or incentive plan under which options or shares may be issued. Options issued under the now terminated Plans remain in effect through their stated termination date, and will terminate according to the terms set on the day each option was respectively issued. Option activity under the terminated Employee Plan and Director Plans are as follows:

   
Number
of Shares
   
Weighted Average Exercise Price
 
             
Outstanding, December 31, 2009
    3,619,503     $ 0.27  
   Granted
    -       -  
   Canceled
    (104,834 )   $ 4.55  
   Exercised
    -       -  
                 
Outstanding, December 31, 2010
    3,514,669     $ 0.15  
   Granted
    -       -  
   Canceled
    (515,748 )   $ 0.36  
   Exercised
    -       -  
                 
Outstanding, December 31, 2011
    2,998,921     $ 0.11  

There was an aggregate of 15,039,747 options to purchase the Company’s common stock available for future grants under the Employee and Director Plans at December 31, 2011. There were no stock options granted during 2011 or 2010.

Summarized information about stock options outstanding is as follows at December 31, 2011:

         
Options Outstanding
   
Options Exercisable
 
Range of
Exercise Prices
   
Options
Outstanding
 
Weighted Average Remaining Contractual Life
 
Weighted Average
Exercise Price
   
Number
of Options
   
Weighted Average
Exercise Price
 
$ 0.08 - $0.14       2,884,421  
2.9 years
  $ 0.11       2,884,421     $ 0.11  
$ 0.18 - $0.26       114,500  
1.0 years
  $ 0.18       114,500     $ 0.18  
                                       
          2,998,921  
2.9 years
  $ 0.15       2,998,921     $ 0.11  
 
 
38
 
 
Employee Stock Purchase Plan : The Company established the 1999 Employee Stock Purchase Plan ("ESPP") under the requirements of Section 423 of the Internal Revenue Code (the "Code") to allow eligible employees to purchase the Company’s common stock at regular intervals. Participating employees may purchase common stock through voluntary payroll deductions at the end of each participation period at a purchase price equal to 85% of the lower of the fair market value of the common stock at the beginning or the end of the participation period. Common stock reserved for future employee purchases under the plan aggregated 755,828 shares at December 31, 2011. No shares were issued pursuant to the ESPP in 2011 or 2010.

401(k) Plan: The Company has a defined contribution plan (the "401(k) Plan") pursuant to Section 401(k) of the Code. All eligible full and part-time employees of the Company who meet certain age requirements may participate in the 401(k) Plan. Participants may contribute between 1% and 15% of their pre-tax compensation, but not in excess of the maximum allowable under the Code. The 401(k) Plan allows for discretionary and matching contributions by the Company. The Company did not make any contributions in 2011 or 2010.

Note 13.  Earnings per Share:

Basic earnings per share (EPS) were computed by dividing net income by the weighted average number of shares of common stock outstanding during the period.  Diluted EPS differs from basic EPS due to the assumed conversion of potentially dilutive options that were outstanding during the period.  The following is a reconciliation of the numerators and the denominators of the basic and diluted per share computations for net income.
 
    2011     2010  
Numerator            
Numerator for basic and diluted earnings per share, net income available to common shareholders   $ 351,848     $ (464,168 )
                 
Denominator                
Denominator for basic earnings per share, weighted average shares outstanding     137,148,311       121,508,634  
                 
Effect of dilutive securities Stock options     243,364       -  
                 
Denominator for diluted earnings per share, adjusted weighted average shares and assumed conversion     137,391,675       121,508,634  
                 
Basic earnings (loss) per common share   $ 0.00     $ (0.00 )
                 
Diluted earnings (loss) per common share and common share equivalent   $ 0.00     $ (0.00 )
 
Options to purchase shares of common stock that were outstanding December 31, 2010 were not included in the computation of diluted earnings (loss) per share because the effect would have been antidilutive, are as follows:
 
    2011     2010  
             
Total options and antidilutive securities     3,514,688       1,349,500  
                       
Note 14. Stock Warrants

There were no outstanding warrants as of December 31, 2011 or December 31, 2010.
 
Note 15. Legal Proceeding

The Company was not involved in or aware of any legal proceedings at December 31, 2011 or through the date of the report of the independent registered public accounting firm.

 
39
 

ITEM 9.             CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

ITEM 9A.          CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

Our management evaluated, with the participation of our Chief Executive Officer / Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, our Chief Executive Officer / Chief Financial Officer concluded that our disclosure controls and procedures as of December 31, 2011 are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer / Chief Financial Officer, as appropriate, to allow timely decisions regarding required reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures include components of our internal control over financial reporting. Management's assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance that the control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system's objectives will be met.

Management’s Annual Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for our Company. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our management conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2011 based on criteria established in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, our management concluded that, as of December 31, 2011, our internal control over financial reporting was effective.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B.          OTHER INFORMATION.

None.

 
40
 

PART III

ITEM 10.           DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

Set forth below is certain information with respect to the individuals who are our executive officers and/or directors as of December 31, 2011:

Michael R. Long, age 67 - Chief Executive Officer, Chief Financial Officer and Chairman of the Board

Mr. Long has been our Chief Executive Officer and Chairman of the Board since July 1998. In addition, Mr. Long served as our Chief Financial Officer since September 2003. Mr. Long has more than thirty years of senior executive management and systems development experience in six publicly traded companies, as well as experience operating a systems consulting business. Before assuming the highest position with our Company, Mr. Long was Vice President of Information Technology at Billing Concepts, Inc., the largest third party billing clearinghouse for the telecommunications industry. Mr. Long's career experience also includes financial services industry business development for Anderson Consulting and several executive positions in publicly traded telecommunications and financial services companies. Mr. Long is a valuable member of our Board due to his depth of operating, strategic, systems development, transactional, and senior management experience in our industry. Additionally, Mr. Long has held positions of increasing responsibility at our Company and holds an intimate knowledge of our Company due to his longevity in the industry and with us.

Louis A. Hoch, age 46 - President, Chief Operating Officer and Vice Chairman of the Board

Mr. Hoch has been our President, Chief Operating Officer, and Director since July 1998 and also serves as Vice Chairman of our Board and Chief Executive Officer of our wholly owned subsidiary FiCentive, Inc. Mr. Hoch is a valuable member of our Board as he has over twenty years of management experience, sixteen years of which were at a senior executive level in large systems development, and he is an expert in payment processing, call center operations and service bureau operations. He holds inventor status on U.S. Patent 7,021,530 (“System and method for managing and processing stored-value cards and bill payment therefrom.”).   Mr. Hoch has held various key management positions with U.S. Long Distance, Billing Concepts, Inc. and Anderson Consulting. Mr. Hoch holds a BBA in Computer Information Systems and an MBA in International Business Management, both from Our Lady of the Lake University Business School.

Ken Keller, age 46 - Vice President, Chief Technology Officer

Mr. Keller joined Payment Data Systems in June 2003 and has served as our Vice President, Chief Technology Officer since January 2008. Mr. Keller has over eighteen years of experience in the development and delivery of specialized high volume transaction-based systems. Prior to joining our Company in 2003, he served in a variety of key leadership and executive technical roles at Billserv, Inc. Prior to Billserv, Inc., Mr. Keller was employed in the telecommunications industry with companies such as US Long Distance, LCI International, Qwest Communications and Broadwing, specializing in enterprise wide database development and implementation. Mr. Keller earned a BBA in Information Technology from the University of Texas - San Antonio.

Larry Morrison, age 52 - Vice President, Sales and Marketing Officer

Mr. Morrison has been our Vice President, Sales and Marketing Officer since July 2003. Mr. Morrison has over twenty-five years of experience in all aspects of sales and sales management. Before joining our Company to oversee all sales and marketing functions, Mr. Morrison served as a major accounts executive for a tier one telecommunications provider and vice president of sales and operations for a major two-way communications firm. His background also includes management and implementation of large government communication systems installations both domestic and abroad.

Peter G. Kirby, Ph.D. SPHR CM, age 72 - Director

Dr. Kirby has served a director of our Company since June 2001. Dr. Kirby distinguished himself in professional and community activities in a career that spanned over thirty-five years. He is an accomplished public speaker and has provided consulting services to Fortune 100 firms. Dr. Kirby has published numerous works in the fields of management, decision-making and human resources. He has been a director on many university advisory councils and boards and has served on many charitable committees and foundations. Dr. Kirby retired in 2006 as a tenured professor of management at Our Lady of the Lake University in San Antonio, Texas, where he taught for seventeen years. Dr. Kirby served as Chair of the QFN Economic Development Corporation, a Canadian corporation, from April 2007 to May 2008. Dr. Kirby is a valuable member of our Board due to his depth of strategic and management experience.
 
 
41
 
 
OTHER INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS

None of our directors or executive officers have been involved in any bankruptcy  or criminal proceedings, nor have there been any judgments or injunctions brought against any of our directors or executive officers during the last ten years that we consider material to the evaluation of the ability and integrity of any director or executive officer.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Under federal securities laws, directors, officers and beneficial owners of more than 10% of our common stock must report their initial ownership of the common stock, and any changes in that ownership, to the Securities and Exchange Commission, or SEC. The SEC has designated specific due dates for these reports. Directors, officers and greater-than-10% beneficial owners are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. To our knowledge, based solely on a review of copies of such reports furnished to us, we believe all Section 16(a) filing requirements applicable to our directors, officers and greater-than-10% beneficial owners were complied with during our fiscal year ended December 31, 2011.
 
CODE OF ETHICS

We have adopted a Code of Ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions. Our code of ethics is filed as Exhibit 14.1 to our annual report on Form 10-K for the year ended December 31, 2003. We will provide a copy of our code of ethics to any person without charge, upon request. Requests should be addressed to: Payment Data Systems, Inc., Attn: Investor Relations Department, 12500 San Pedro, Suite 120, San Antonio, Texas 78216.

PROCEDURE FOR NOMINATING DIRECTORS

We have not made any material changes to the procedures by which security holders may recommend nominees to our Board of Directors.

We consider recommendations for Director candidates from our Directors, officers, employees, stockholders, customers and vendors. Stockholders wishing to nominate individuals to serve as directors may submit such nominations, along with a nominee's qualifications, to our Board of Directors at Payment Data Systems, Inc., 12500 San Pedro, Suite 120, San Antonio, Texas, 78216, and the Board of Directors will consider such nominee. The Board of Directors selects the Director candidates slated for election. We do not have a Nominating Committee in light of resource allocations made by the Board of Directors in its business judgment.

AUDIT COMMITTEE

The Audit Committee, established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended, is currently comprised of our sole independent director, Dr. Peter Kirby. It operates under a written charter adopted by our Board of Directors. The Board has determined Dr. Kirby was our sole independent board member as determined as defined by Rule 5605(a)(2) of the NASDAQ Listing Rules. The composition of the Audit Committee, the attributes of its members and the responsibilities of the Committee, as reflected in its charter, are intended to be in accordance with applicable requirements for corporate audit committees. The Committee reviews and assesses the adequacy of its charter on an annual basis.
 
 
42
 

As set forth in more detail in its charter, the Audit Committee’s purpose is to assist the Board of Directors in its general oversight of our financial reporting, internal control and audit functions. Management is responsible for the preparation, presentation and integrity of our financial statements, accounting and financial reporting principles and internal controls and procedures designed to ensure compliance with accounting standards, applicable laws and regulations. Akin, Doherty, Klein & Feuge, P.C., our independent auditing firm, is responsible for performing an independent audit of the consolidated financial statements in accordance with standards of the Public Company Accounting Oversight Board.
 
The Audit Committee members are generally not professional accountants or auditors, and their functions are not intended to duplicate or to certify the activities of management and the independent auditor, nor can the Audit Committee certify that the independent auditor is “independent” under applicable rules. The Audit Committee serves a board-level oversight role, in which it provides advice, counsel and direction to management and the auditors on the basis of the information it receives, discussions with management and the auditors and the experience of the Audit Committee’s members in business, financial and accounting matters.

Among other matters, the Audit Committee monitors the activities and performance of our internal and external auditors, including the audit scope, external audit fees, auditor independence matters and the extent to which the independent auditor may be retained to perform non-audit services. The Audit Committee and the Board of Directors have ultimate authority and responsibility to select, evaluate and, when appropriate, replace our independent auditor. The Audit Committee also reviews the results of the internal and external audit work with regard to the adequacy and appropriateness of our financial, accounting and internal controls. Management and independent auditor presentations to and discussions with the Audit Committee also cover various topics and events that may have significant financial impact or are the subject of discussions between management and the independent auditor. In addition, the Audit Committee generally oversees our internal compliance programs.

In overseeing the preparation of our financial statements, the Audit Committee has had access to our management to review and discuss all financial statements prior to their issuance and to discuss significant accounting issues. Management advised the Audit Committee that all financial statements were prepared in accordance with U.S. generally accepted accounting principles. The Audit Committee has met with our independent auditors with regard to our audited financial statements for the year ended December 31, 2011. For the year ended December 31, 2011, the Audit Committee received the independent auditor’s letter and written disclosures required by the Rule 3526 of the Public Company Accounting Oversight Board, Communications with Audit Committee Concerning Independence .

The Audit Committee met four times during the year ended December 31, 2011. We do not have an audit committee financial expert serving on our Audit Committee because we have been unable to replace the independent director serving as the audit committee financial expert after his resignation. We are still seeking an independent director to serve as the audit committee financial expert.
 
 
43
 

ITEM 11.           EXECUTIVE COMPENSATION.

SUMMARY COMPENSATION

The following table shows the compensation earned during the fiscal years ended December 31, 2011 and 2010 by (i) our Principal Executive Officer, or PEO; and (ii) our two most highly compensated executive officers, other than our PEO.  We refer to the individuals included below as our “named executive officers.”

Summary Compensation Table for the Fiscal Years Ended December 31, 2011 and 2010

 
 
 
Name and Principal Position
(a)
 
Year
Ended
Dec. 31,
(b)
 
 
 
 
Salary
($)(5)
(c)
   
 
 
 
Bonus
($)(1)
(d)
   
 
 
Stock
Awards
($)(2)
(e)
   
 
 
Option
Awards
($)(3)
(f)
   
 
Nonequity Incentive Plan Compensation
($)
(g)
   
Nonqualified Deferred Compensation Earnings
($)
(h)
   
 
 
All Other Compensation
($)(4)
(i)
   
 
 
 
Total
($)
(j)
 
                                                   
Michael R. Long
                                                 
Chairman, Chief
2011
    24,000       216,000       131,592       -       -       -       12,117       383,709  
Executive Officer
2010
    24,000       216,000       131,592       -       -       -       12,117       383,709  
and Chief Financial Officer
                                                                 
                                                                   
Louis A. Hoch
                                                                 
Vice Chairman,
2011
    24,000       216,000       151,776       -       -       -       2,520       394,296  
President and
2010
    24,000       216,000       151,776       -       -       -       2,520       394,296  
Chief Operating Officer
                                                                 
                                                                   
Larry Morrison
                                                                 
Vice President,
2011
    45,500       20,000       -       -       -       -       1,008       66,508  
Sales and Marketing
2010
    24,000       -       -       -       -       -       1,008       25,008  
Officer
                                                                 

(1)  
On November 4, 2010, Michael Long, Chief Executive Officer and Chief Financial Officer, and Louis Hoch, President and Chief Operating Officer, were each granted 5,400,000 shares of restricted common stock by us as an annual bonus valued at $216,000 pursuant to the terms of their respective employment agreements. On November 13, 2011, Michael Long, Chief Executive Officer and Chief Financial Officer, and Louis Hoch, President and Chief Operating Officer, were each granted a cash bonus of $216,000 by us pursuant to the terms of their respective employment agreements.
 
 
44
 
 
(2)  
Amount recognized for financial statement reporting purposes. On February 27, 2007, we executed employment agreements with Mr. Long and Mr. Hoch and subsequently issued 500,000 shares of common stock to each under the terms of their respective employment agreements. We also issued 2,500,000 shares of common stock to each as a long-term incentive under the terms of their respective employment agreements. The incentive stock is restricted and vests annually over five years in increments of 500,000 shares beginning on February 28, 2009. The grant date fair value of the stock award was calculated in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718. See Note 12 of the Notes to our Financial Statements contained elsewhere in this Form 10-K for a discussion of all assumptions made by us in determining values of our stock awards.
 
(3)  
There were no stock options granted to any of our named executive officers during fiscal year 2011 or 2010.
 
(4)  
Reflects premiums paid for term life insurance coverage.
 
(5)  
On November 12, 2009, we executed amendments to our employment agreements with Michael Long, Chief Executive Officer and Chief Financial Officer, and Louis Hoch, President and Chief Operating Officer. Under the terms of their respective amended employment agreements, Mr. Long and Mr. Hoch agreed to reduce their annual base salaries for 2009 to $190,000 and $175,000, respectively, from $375,000 and $350,000, respectively. On April 12, 2010, we executed a second amendment to our employment agreements with Michael Long, Chief Executive Officer and Chief Financial Officer, and Louis Hoch, President and Chief Operating Officer. Under the terms of the second amendment to their respective employment agreements, Mr. Long and Mr. Hoch agreed to reduce their annual base salaries for 2010 to $24,000 and $24,000, respectively, from $375,000 and $350,000, respectively, and change the annual bonus limit from 100% of current salary to 100% of the highest salary received in any year of the agreement. On January 14, 2011, we executed a third amendment to our employment agreements with Michael Long, Chief Executive Officer and Chief Financial Officer, and Louis Hoch, President and Chief Operating Officer. Under the terms of the third amendment to their respective employment agreements, Mr. Long and Mr. Hoch agreed to reduce their annual base salaries for 2011 to $24,000 and $24,000, respectively, from $375,000 and $350,000, respectively.

Narrative to Summary Compensation Table

Named Executive Officer Employment Agreements

We entered into an employment agreement with Michael R. Long effective February 27, 2007. Under the agreement, Mr. Long serves as our Chairman of the Board, Chief Executive Officer and Chief Financial Officer. The agreement provides for base annual salaries of $190,000 for 2007, $300,000 for 2008 and $375,000 for the years 2009, 2010 and 2011. In addition, Mr. Long will receive an additional annual bonus of $216,000 during the term of the agreement to be paid in cash or stock at our sole discretion. Upon execution of the agreement, Mr. Long received cash of $15,000, 500,000 shares of common stock from our Employee Stock Plan, and 2,500,000 shares of restricted common stock that vest annually in increments of 500,000 shares beginning on February 28, 2009. On November 12, 2009, we executed an amendment to our employment agreement with Mr. Long. Under the terms of the amended employment agreement, Mr. Long agreed to reduce his annual base salary for 2009 to $190,000 from $375,000. On April 12, 2010, we executed a second amendment to our employment agreement with Mr. Long. Under the terms of the amended employment agreement, Mr. Long agreed to reduce his annual base salary for 2010 to $24,000 from $375,000, and to change the annual bonus limit from 100% of current salary to 100% of the highest salary received in any year of the agreement. On January 14, 2011, we executed a third amendment to our employment agreement with Mr. Long. Under the terms of the amended employment agreement, Mr. Long agreed to reduce his annual base salary for 2011 to $24,000 from $375,000.

We entered into an employment agreement with Louis A. Hoch effective February 27, 2007. Under the agreement, Mr. Hoch serves as our Vice Chairman of the Board, President and Chief Operating Officer. The agreement provides for base annual salaries of $175,000 for 2007, $275,000 for 2008 and $350,000 for the years 2009, 2010 and 2011. In addition, Mr. Hoch will receive an additional annual bonus of $216,000 during the term of the agreement to be paid in cash or stock at our sole discretion. Upon execution of the agreement, Mr. Hoch received cash of $15,000, 500,000 shares of common stock from our Employee Stock Plan, and 2,500,000 shares of restricted common stock that vest annually in increments of 500,000 shares beginning on February 28, 2009. On November 12, 2009, we executed an amendment to our employment agreement with Mr. Hoch. Under the terms of the amended employment agreement, Mr. Hoch agreed to reduce his annual base salary for 2009 to $175,000 from $350,000. On April 12, 2010, we executed a second amendment to our employment agreement with Mr. Hoch. Under the terms of the amended employment agreement, Mr. Hoch agreed to reduce his annual base salary for 2010 to $24,000 from $350,000, and to change the annual bonus limit from 100% of current salary to 100% of the highest salary received in any year of the agreement. On January 14, 2011, we executed a third amendment to our employment agreement with Mr. Hoch. Under the terms of the amended employment agreement, Mr. Hoch agreed to reduce his annual base salary for 2011 to $24,000 from $350,000.
 
 
45
 

We do not have an employment agreement with Mr. Morrison.

Risk Considerations in our Compensation Programs

The Board is responsible for reviewing and evaluating the risks related to our compensation programs, policies and practices. The risk assessment included, among other things, a review of program documentation, practices and controls, meetings with employees involved with the creation and administration of compensation programs, and reviews of policies and practices that are relevant to our compensation programs and practices. We believe our approach to goal setting and evaluation of performance results assist in mitigating excessive risk-taking that could harm our value or reward poor judgment by our executives. Several features of our program reflect sound risk management practices. We believe we have allocated our compensation among base salary and short and long-term compensation target opportunities in such a way as to not encourage excessive risk-taking.

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END

The following table shows grants of unexercised stock options and unvested stock by grant date outstanding on December 31, 2011, the last day of our fiscal year, to each of the named executive officers included in the Summary Compensation Table.

Outstanding Equity Awards at Fiscal Year-End Table for the Fiscal Year Ended December 31, 2011

   
Option awards (1)
   
Stock awards (1)
 
Name
(a)
 
Number of securities underlying unexercised options (#) exercisable
(b)
   
Number of securities underlying unexercised options (#) unexercisable
(c)
   
Option
exercise price
($)
(e)
   
Option
expiration date
(f)
   
Number of shares or units of stock that have not vested
(#)(2)
(g)
   
Market value of shares or units of stock that have not vested
($)(3)
(h)
 
Michael R. Long
                                   
12/30/2003
    400,000       -       0.14    
12/30/2013
      -       -  
12/29/2005
    381,833       -       0.082    
12/29/2015
      1,355,972       131,529  
12/27/2006
    -       -       -       -       2,500,611       242,559  
2/27/2007
    -       -       -       -       2,500,000       242,500  
1/09/2008
    -       -       -       -       7,750,000       751,750  
                                                 
Louis A. Hoch
                                               
12/30/2003
    425,000       -       0.14    
12/30/2013
      -       -  
12/29/2005
    586,147       -       0.082    
12/29/2015
      2,081,536       201,908  
12/27/2006
    -       -       -       -       4,083,333       396,083  
2/27/2007
    -       -       -       -       2,500,000       242,500  
1/09/2008
    -       -       -       -       7,750,000       751,750  
                                                 
Larry Morrison
                                               
12/29/2005
    -       -       -       -       95,156       9,230  
12/27/2006
    -       -       -       -       1,000,000       97,000  
1/09/2008
    -       -       -       -       700.000       67,900  
 
(1)  
We do not have any equity incentive plan awards.
 
 
46
 
 
(2)  
Unvested common stock granted on December 29, 2005 vests on December 29, 2015, unvested common stock granted on December 27, 2006 vests on December 27, 2016 and unvested common stock granted on January 9, 2008 vests on January 9, 2018. Unvested common stock granted on February 27, 2007 vests annually over five years in increments of 500,000 shares beginning on February 28, 2009. Mr. Long and Mr. Hoch each chose to defer vesting of the increment of 500,000 shares that was granted to each of them on February 27, 2007 and was scheduled to vest on February 28, 2009, 2010 and 2011.
 
(3)  
Calculated using the OTC Bulletin Board, or OTCBB, closing price of $0.097 per share of our common stock on December 30, 2011.
 
Narrative to Outstanding Equity Awards at Fiscal Year-End Table

Retirement Benefits

We do not have any qualified or non-qualified defined benefit plans. We do have a tax-qualified defined contribution plan pursuant to Section 401(k) of the Internal Revenue Code. All of our eligible full and part-time employees who meet certain age requirements may participate in this 401(k) plan. Participants may contribute between 1% and 15% of their pre-tax compensation. The 401(k) plan allows for us to make discretionary and matching contributions. We made no such contributions during 2011 or 2010.

Non-qualified Deferred Compensation

We do not have any non-qualified defined contribution plans or other deferred compensation plans.

Potential Payments Upon Termination or Change of Control

Our employment agreements with Mr. Long and Mr. Hoch each provide that upon termination of his employment with us due to death or disability, involuntary termination without cause, termination for good reason or default by us, termination due to non-renewal of the agreement, or change of control, he is entitled to deferred compensation. This deferred compensation shall be the amount which is calculated as the greater of the base salary payments that each would have received had his employment continued for the remaining term of the agreement (including yearly increases calculated at the maximum increase for the prior two years), or an amount equal to 2.95 times the higher annual compensation earned by him in the past two years. In addition to this compensation, each shall be entitled to all of the benefits otherwise provided in his agreement during that period of time which is the greater of the remaining term of the agreement, or one year, and an amount equal to the pro rata portion of his bonus compensation for the year in which his employment is terminated. In addition, all stock options and restricted stock granted to each executive become fully vested upon his termination for any of these reasons. Also, in consideration of the executive’s obligations for a period of two years after the termination of his employment under a non-competition clause in the employment agreement, he shall be paid an amount equal to 2 times the base salary paid to him in the year prior to the expiration of the agreement.
 
DIRECTOR COMPENSATION
 
The following table sets forth information concerning the compensation provided to each person who served as a non-employee member of our Board of Directors during the fiscal year ended December 31, 2011.  Directors who are also employees are included in the Summary Compensation Table above.
 
 
47
 

Director Compensation Table for the Fiscal Year Ended December 31, 2011
 
Name
(a)
 
Fees earned or
paid in cash
($)
(b)
   
Stock
awards
($)(1)
(c)
   
Option
awards
($)(2)
(d)
   
Non-equity incentive plan compensation
($)
(e)
   
Non-qualified deferred compensation earnings
($)
(f)
   
All other
compensation
($)
(g)
   
Total
($)
(h)
 
                                                         
Peter G. Kirby
    -       6,348       -       -       -       -       6,348  
 
(1)  
Amount recognized for financial statement reporting purposes. At December 31, 2009, Dr. Kirby had outstanding 500,000 shares of common stock with a grant date fair value of $27,500 granted on January 9, 2008 that vest on January 9, 2018, 400,000 shares of common stock with a grant date fair value of $36,000 granted on December 27, 2006 that vest on December 27, 2016 and 300,000 shares of common stock with a grant date fair value of $60,000 granted on March 28, 2005 that vested one-third on each of March 28, 2006, March 28, 2007 and March 28, 2008. The grant date fair value of the stock award was calculated in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718. See Note 12 of the Notes to our Financial Statements contained elsewhere in this Form 10-K for a discussion of all assumptions made by us in determining values of our stock awards.
 
(2)  
At December 31, 2011, Dr. Kirby had outstanding options to purchase 618,000 shares of our common stock.

Narrative to Director Compensation Table

We do not have an agreement with our independent director, Dr. Peter G. Kirby, to compensate him for his service on our Board of Directors. Mr. Long and Mr. Hoch receive no compensation for serving on our Board of Directors due to their status as officers of our Company.
 
 
48
 
 
ITEM 12.           SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth, to our knowledge, certain information concerning the beneficial ownership of our common stock as of December 31, 2011 by each stockholder known by us to be (i) the beneficial owner of more than 5% of the outstanding shares of our common stock, (ii) each current director, (iii) each of the named executive officers included in the Summary Compensation Table, and (iv) all of our directors and current executive officers as a group:

Name and address of beneficial owner
 
Amount and Nature of
Beneficial Ownership
 
Percent of Shares Beneficially Owned (1)
5% Stockholder
               
Robert Evans, P.O. Box 56, Williamsville, IL 62693
   
14,020,000
(2)
   
9.8
%
                 
Named Executive Officers and Directors
               
Louis A. Hoch
   
37,093,163
(3)
   
25.8
%
Michael R. Long
   
33,510,461
(4)
   
23.4
%
Larry Morrison
   
  2,187,490(5)
 
   
1.5
%
Peter G. Kirby
   
1,818,500
(6)
   
1.3
%
All executive officers and directors as a group (5 people)
   
78,019,596
(7)
   
53.6
%

(1)  
Based on a total of 142,721,077 shares of common stock issued and outstanding on December 31, 2011.

(2)  
We relied on the Form 4 filed by Robert Evans with the SEC on June 9, 2011 for this information.

(3)  
Includes 1,011,147 shares that Mr. Hoch has the right to acquire upon the exercise of stock options.

(4)  
Includes 781,833 shares that Mr. Long has the right to acquire upon the exercise of stock options.

(5)  
Includes 226,795 shares that Mr. Morrison has the right to acquire upon the exercise of stock options.

(6)  
Includes 618,000 shares that Dr. Kirby has the right to acquire upon the exercise of stock options.

(7)  
The address of all individual directors and executive officers is c/o Payment Data Systems, Inc., 12500 San Pedro, Suite 120, San Antonio, Texas 78216.
 
 
49
 
 
ITEM 13.           CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

TRANSACTIONS WITH RELATED PERSONS

In December 2002, we recognized losses of $535,302 and $449,371 under loan guarantees we made to collateralize margin loans for Michael R. Long, then Chairman of the Board of Directors and Chief Executive Officer, and Louis A. Hoch, then President and Chief Operating Officer, respectively, for which they were obliged to repay us. In February 2007, we entered into employment agreements with Mr. Long, our Chairman of the Board, Chief Executive Officer and Chief Financial Officer, and Mr. Hoch, our President and Chief Operating Officer, that require each executive officer to repay his respective obligation to us in four equal annual payments of cash or stock or any combination thereof. On December 29, 2007, we accepted common stock and stock options valued at $133,826 and $112,343 from Mr. Long and Mr. Hoch, respectively, in satisfaction of their annual payments for 2007 as provided for under their employment agreements. Mr. Long’s payment consisted of 1,285,714 shares of our common stock valued at $96,429 and options to purchase a total of 898,334 shares of our common stock at exercise prices ranging from $0.18 to $2.81 per share. These options were valued at $37,397. Mr. Hoch’s payment consisted of 1,061,041 shares of our common stock valued at $79,623 and options to purchase a total of 765,000 shares of our common stock at exercise prices ranging from $0.18 to $2.81 per share. These options were valued at $32,720. The common stock accepted from Mr. Long and Mr. Hoch was valued at $0.075 per share, which was the closing price of our common stock on December 19, 2007. We recorded the common stock accepted from Mr. Long and Mr. Hoch as treasury stock with a total cost of $176,052. We determined the fair value of each stock option accepted from Mr. Long and Mr. Hoch using the Black-Scholes option-pricing model. We canceled the options accepted from Mr. Long and Mr. Hoch on December 29, 2007 and recorded a total direct charge to equity of $70,117. In December 2008, Mr. Long and Mr. Hoch did not pay us the second annual installment pursuant to their respective employment agreements. They each withheld payment of the installment due because we had deferred payment of their salary increases for 2008 called for under their respective employment agreements. At December 31, 2008, we owed Mr. Long and Mr. Hoch deferred salary of $110,000 and $100,000, respectively, and Mr. Long and Mr. Hoch owed us $133,825 and $112,343, respectively, for the second installment due by December 31, 2008. The total amount owed to us for the second installment was $246,168 and is classified as “Related Party Receivable” on our balance sheet at December 31, 2008. On March 30, 2009, we accepted 680,715 shares of our common stock valued at $23,825 and 352,658 shares of our common stock valued at $12,343 from Mr. Long and Mr. Hoch, respectively, in satisfaction of a portion of their annual payments for 2008 as provided for under their employment agreements. The common stock accepted from Mr. Long and Mr. Hoch was valued at $0.035 per share, which was the closing price of the common stock on March 30, 2009.

In December 2009, Mr. Long and Mr. Hoch did not pay us the third annual installment pursuant to their respective employment agreements. They each withheld payment of the installment due because we had partially deferred payments of their salary for 2009 called for under their respective employment agreements. At December 31, 2009, we owed Mr. Long and Mr. Hoch deferred salary of $162,385 and $141,808, respectively, and Mr. Long and Mr. Hoch owed us $133,825 and $112,343, respectively, for the third installment due by December 31, 2009.

In December 2010, Mr. Long and Mr. Hoch did not pay us the fourth and final annual installment pursuant to their respective employment agreements. They each withheld payment of the installment due because we continued to be unable to pay deferred salaries that were called for under their respective employment agreements. At December 31, 2010, we owed Mr. Long and Mr. Hoch deferred salary $147,368 and $126,915, respectively, in regards to their 2009 deferred salary balances.

As of December 31, 2011, Mr. Long owed us $377,651 and Mr. Hoch owed us $324,685. These amounts, totaling $702,337, are classified as “Related Party Receivables” on our balance sheet as of December 31, 2011. At December 31, 2011, we owed Mr. Long and Mr. Hoch deferred salaries of $23,473 and $3,300, respectively in regards to their 2010 deferred salary balances. No payments were made in 2011 by either Mr. Long or Mr. Hoch related to the repayment of their respective obligations to us, as each of their salaries were respectively reduced to $24,000 for the fiscal year ended December 31, 2011 to ensure we maintained positive cash flow for fiscal year 2011 and profitability in the third and fourth quarters of 2011.

During the years ended December 31, 2011 and 2010, the Company paid Herb Authier a total of $30,000 and $30,000 in cash, respectively, for consulting services related to network engineering and administration that he provided to us. Mr. Authier is the father-in-law of Louis Hoch, our President and Chief Operating Officer.

DIRECTOR INDEPENDENCE

During the fiscal year ended December 31, 2011, Michael R. Long, Louis A. Hoch, and Peter G. Kirby served on our Board of Directors. The Board has determined Dr. Kirby was our sole independent board member as determined as defined by Rule 5605(a)(2) of the NASDAQ Listing Rules.

 
50
 

ITEM 14.           PRINCIPAL ACCOUNTING FEES AND SERVICES.

Fees Paid to the Independent Accountants

The aggregate fees billed to us for professional accounting services, including the audit of our annual consolidated financial statements by our principal accountant for the fiscal years ended December 31, 2011 and 2010 included in our Form 10-K, are set forth in the table below.
 
    2011     2010  
 Audit fees   $ 38,100     $ 37,500  
 Tax fees     2,500       2,500  
                 
 Total fees   $ 40,600     $ 40,000  
 
For purposes of the preceding table, the professional fees are classified as follows:

●  Audit Fees—These are fees for professional services billed for the audit of the consolidated financial statements included in our Form 10-K filings, the review of consolidated financial statements included in our Form 10-Q filings, comfort letters, consents and assistance with and review of documents filed with the SEC. The fees in the 2011 column include amounts billed to us through March 30, 2012 for the year ended December 31, 2011 and the fees in the 2010 column include amounts billed to us through April 15, 2010 for the years ended December 31, 2010.

●  Tax Fees—These are fees for professional services rendered by our independent accountant for tax compliance, tax planning and tax advice. Tax compliance involves preparation of original and amended tax returns. Tax planning and tax advice encompass a diverse range of subjects, including assistance with tax audits and appeals, tax advice related to dispositions, and requests for rulings or technical advice from taxing authorities.

Audit Committee’s Pre-Approval Policies and Procedures

We may not engage our independent accountant to render any audit or non-audit service unless our Audit Committee approves the service in advance. 100% of the services performed by our independent accountant described above were approved in advance by our Audit Committee.
 
 
51
 
 
PART IV

ITEM 15.           EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
 
(a)(1) Consolidated Financial Statements.
 
The following documents are filed in Part II, Item 8 of this annual report on Form 10-K:
 
Report of Independent Registered Public Accounting Firm
 
Consolidated Balance Sheets as of December 31, 2011 and 2010
 
Consolidated Statements of Operations for the years ended December 31, 2011 and 2010
 
Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the years ended December 31, 2011 and 2010
 
Consolidated Statements of Cash Flows for the years ended December 31, 2011 and 2010
 
Notes to Consolidated Financial Statements
 
(a)(2) Financial Statement Schedules.
 
All financial statement schedules have been omitted as they are not required, not applicable, or the required information is otherwise included.
 
(a)(3) Exhibits.
 
Exhibit  Number
 
Description
     
3.1  
Amended and Restated Articles of Incorporation (included as exhibit 3.1 to the Form 10-KSB filed March 31, 2006, and incorporated herein by reference).
     
3.2  
Amended and Restated By-laws (included as exhibit 3.2 to the Form 10-KSB filed March 31, 2006, and incorporated herein by reference).
     
3.3  
Articles of Amendment to the Amended and Restated By-laws (included as exhibit A to the Schedule 14C filed April 18, 2007, and incorporated herein by reference).
     
4.1  
Amended and Restated 1999 Employee Comprehensive Stock Plan (included as exhibit 4.1 to the Form S-8 filed May 25, 2006, and incorporated herein by reference).
 
 
52
 
 
4.2  
Amended and Restated 1999 Non-Employee Director Plan (included as exhibit 10.2 to the Form 8-K filed January 3, 2006, and incorporated herein by reference).
     
4.3  
Employee Stock Purchase Plan (included as exhibit 4.3 to the Form S-8, File No. 333-30958, filed February 23, 2000, and incorporated herein by reference).
     
4.4  
Registration Rights Agreement between the Company and Dutchess Private Equities Fund, L.P., dated June 4, 2004 (included as exhibit 10.9 to the Form SB-2 filed June 18, 2004, and incorporated herein by reference).
     
4.5  
Rights Agreement between the Company and American Stock Transfer & Trust Company, dated February 28, 2007 (included as exhibit 4.1 to the Form 8-K filed March 5, 2007, and incorporated herein by reference).
     
10.1  
Lease Agreement between the Company and Frost National Bank, Trustee for a Designated Trust, dated August 22, 2003 (included as exhibit 10.3 to the Form 10-Q filed November 14, 2003, and incorporated herein by reference).
     
10.2  
Employment Agreement between the Company and Michael R. Long, dated February 27, 2007 (included as exhibit 10.1 to the Form 8-K filed March 2, 2007, and incorporated herein by reference).
     
10.3  
Employment Agreement between the Company and Louis A. Hoch, dated February 27, 2007 (included as exhibit 10.2 to the Form 8-K filed March 2, 2007, and incorporated herein by reference).
     
10.4  
Investment Agreement between the Company and Dutchess Private Equities Fund, L.P., dated June 4, 2004 (included as exhibit 10.8 to the Form SB-2 filed June 18, 2004, and incorporated herein by reference).
     
10.5  
Placement Agent Agreement between the Company, Charleston Capital Corporation, and Dutchess Private Equities Fund, L.P., dated June 4, 2004 (included as exhibit 10.10 to the Form SB-2 filed June 18, 2004, and incorporated herein by reference).
     
10.6  
Affiliate Office Agreement between the Company and Network 1 Financial, Inc. (included as exhibit 10.11 to the Form SB-2 filed April 28, 2004, and incorporated herein by reference).
     
10.7  
Warrant Agreement between the Company and Kubra Data Transfer Ltd., dated as of September 30, 2004 (included as exhibit 10.1 to the Form 8-K filed October 6, 2004, and incorporated herein by reference).
     
10.8  
Promissory Note between the Company and Dutchess Private Equities Fund, II, LP, dated August 21, 2006 (included as exhibit 10.1 to the Form 8-K filed August 25, 2006, and incorporated herein by reference).
     
10.9  
Stock Purchase Agreement between the Company and Robert D. Evans, dated January 18, 2007 (included as exhibit 10.1 to the Form 8-K filed January 23, 2007, and incorporated herein by reference).
     
10.1  
Stock Purchase Agreement between the Company and Robert D. Evans, dated March 1, 2007 (included as exhibit 10.1 to the Form 8-K filed March 5, 2007, and incorporated herein by reference).
     
10.11  
Amended Investment Agreement between the Company and Dutchess Private Equities Fund, Ltd., dated August 21, 2007 (included as exhibit 10.16 to the Form SB-2 filed August 23, 2007, and incorporated herein by reference).
     
10.12  
Amended Registration Rights Agreement between the Company and Dutchess Private Equities Fund, Ltd., dated August 21, 2007 (included as exhibit 10.17 to the Form SB-2 filed August 23, 2007, and incorporated herein by reference).
     
10.13  
Trademark and Domain Name Purchase Agreement between the Company and Alivio Holdings, LLC, dated November 14, 2005 (included as exhibit 10.1 to the Form 8-K filed November 17, 2005, and incorporated herein by reference).
     
10.14  
First Amendment to Employment Agreement between the Company and Michael R. Long, dated November 12, 2009 (included as exhibit 10.15 to the Form 10-Q filed November 16, 2009, and incorporated herein by reference).
 
 
53
 
 
10.15  
First Amendment to Employment Agreement between the Company and Louis A. Hoch, dated November 12, 2009 (included as exhibit 10.16 to the Form 10-Q filed November 16, 2009, and incorporated herein by reference).
     
10.16  
Second Amendment to Employment Agreement between the Company and Michael R. Long, dated April 12, 2010 (included as exhibit 10.16 to the Form 10-K filed April 15, 2010, and incorporated herein by reference).
     
10.17  
Second Amendment to Employment Agreement between the Company and Louis A. Hoch, dated April 12, 2010 (included as exhibit 10.17 to the Form 10-K filed April 15, 2010, and incorporated herein by reference).
     
10.18  
Bank Sponsorship Agreement between the Company and University National Bank, dated August 29, 2011 (filed herewith).
     
10.19  
Third Amendment to Employment Agreement between the Company and Michael R. Long, dated January 14, 2011 (filed herewith).
     
10.20  
Third Amendment to Employment Agreement between the Company and Louis A. Hoch, dated January 14, 2011 (filed herewith).
     
14.1  
Code of Ethics (included as exhibit 14.1 to the Form 10-K filed March 30, 2004, and incorporated herein by reference).
     
16.1  
Letter from Ernst and Young LLP to the Securities and Exchange Commission dated February 10, 2004 (included as exhibit 16 to the Form 8-K filed February 11, 2004, and incorporated herein by reference).
     
21.1  
Subsidiaries of the Company (included as exhibit 21.1 to the Form 10-K filed March 31, 2008, and incorporated herein by reference).
     
23.1  
Consent of Akin Doherty Klein & Feuge, P.C. (filed herewith).
     
31.1  
Certification of the Chief Executive Officer/Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
     
32.1  
Certification of the Chief Executive Officer/Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
     
101.INS
 
XBRL Instance Document (filed herewith).
     
101.SCH
 
XBRL Taxonomy Extension Schema Document (filed herewith).
     
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document (filed herewith).
     
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document (filed herewith).
     
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document (filed herewith).
     
101.PRE
 
XBRL Taxonomy Presentation Linkbase Document (filed herewith).
 
 
54
 
 
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.
 
  Payment Data Systems, Inc.  
       
Date: April 2, 2012
By:
 /s/ Michael R. Long  
    Michael R. Long  
    Chairman of the Board, Chief Executive Officer, and Chief Financial Officer  
    (Principal Executive Officer and Principal Financial and Accounting Officer)  

Pursuant to the requirements of Section 13 or 15(d) 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.
 
Date: April 2, 2012
By:
/s/ Michael R. Long  
    Michael R. Long  
    Chairman of the Board, Chief Executive Officer, and Chief Financial Officer  
    (Principal Executive Officer and Principal Financial and Accounting Officer)  
 
Date: April 2, 2012
By:
/s/ Louis A. Hoch  
    Louis A. Hoch  
    President, Chief Operating Officer, and Director  
 
Date: April 2, 2012
By:
/s/ Peter G. Kirby  
    Peter G. Kirby  
    Director  
 
 
55
EXHIBIT 10.18
 
Prepaid Card Program Agreement
 
This PREPAID CARD PROGRAM AGREEMENT (the “Agreement”) dated this 29 day of August, 2011 (“Effective Date”) is by and between FICENTIVE, INC. (“Company”), a Nevada Corporation, whose principal office is located at 12500 San Pedro, Suite 120, San Antonio, TX 78216 and UNIVERSITY NATIONAL BANK ,   a federally-chartered bank having its principal offices at 200 University Avenue West, St. Paul, Minnesota 55103 (“Bank”). Company and Bank are collectively referred to the “Parties” and are individually referred to as a “Party.”
 
RECITALS
 
(a)   Bank is a member of Visa, MasterCard, Discover and various other card associations and electronic payment networks, and, among other things, issues prepaid cards and establishes settlement accounts for the settlement of card transactions;
 
(b)   Company is a program manager in connection with prepaid card programs and a marketer of prepaid cards through various outlets as set forth herein, and desires to market and distribute Cards issued by Bank;
 
(c) Company has entered into an Agreement For Services dated February 21, 2011, with TransCard, L.L.C. (“TransCard”) for the electronic transaction processing of prepaid cards established pursuant to this Agreement (the “Agreement For Services”); and
 
(d) Bank and TransCard have entered into a Prepaid Card Sponsorship and Processing Agreement dated September 15, 2009 (the “Sponsorship Agreement”) and a Supplement to Prepaid Card Sponsorship and Processing Agreement dated __________ ___, 2011; and
 
(e)   Bank and Company desire to collaborate in developing, marketing and distributing Cards issued by Bank under the Card Programs contemplated herein;
 
(f)   Bank desires to (i) retain Company to provide certain marketing and program management services; (ii) have Company market Bank’s Programs in accordance with this Agreement; and (iii) grant to Company sponsorship into the Network (as defined below) and the privileges that relate to said sponsorship for the purposes of marketing Bank-issued prepaid Card to Company’s customers;
 
(g)   Company desires to (i) provide its marketing services to Bank; (ii) serve as the Bank’s limited agent solely for the purposes of marketing Bank’s Programs to Company’s customers in accordance herewith; (iii) remit to Bank such Load Amounts as Company receives from any third party retailers and sellers; and (iv) enter into an agreement with TransCard to provide for all necessary Processing Services provided in connection with the Programs.
 
TERMS OF AGREEMENT
 
NOW, THEREFORE , in consideration of the mutual covenants and conditions hereinafter set forth, the Parties hereto, intending to be legally bound, agree as follows:
 
UNB / FiCentive Prepaid Card Program Agreement
Rev. August 2011
© 2010 University National Bank, St. Paul, Minnesota
\\Houston\l_hoch_data\PayData\Contracts\UNB Bank\Prepaid Card Program Agr  FINAL.docx
 
 
 
 
1.
CERTAIN DEFINITIONS.
 
Except as otherwise specifically indicated, the following terms shall have the following meanings in this Agreement (such meanings to be equally applicable to both the singular and plural forms of the terms defined):
 
(a) “Activity Account” means the account maintained by Bank used for Settlement of all Transactions initiated by use of a Card by or on behalf of a Cardholder.
 
(b) “Applicable Law” means any applicable international, federal, state, or local law or regulation or rule promulgated by any Regulatory Authority, any order issued by a court having jurisdiction over a Party, or any applicable rule or requirement of any Network related to the issuance, sale, authorization or usage of the Cards or services to be provided under this Agreement.
 
(c) “Card” means a pre-paid card that is issued by Bank utilizing a unique card number and sold by Company to a Cardholder pursuant to this Agreement and used for the purchase of goods and services by accessing the available balance in a Cardholder Account through a Network. Card may include prepaid cards of any type acceptable by a Network as further described in any Card Program Addendum.
 
(d) “Cardholder” means (i) a person to whom a Card is issued, or (ii) a person who activates or otherwise uses a Card to originate a Transaction.
 
(e) “Cardholder Account” means the prepaid account which is associated with a Card, and includes the record of debits and credits with respect to Transactions originated by a Cardholder.
 
(f) “Card Account Income” means all revenue received from a Cardholder including but not limited to interest income, interchange income, quarterly and yearly ATM income from Networks, foreign exchange fee income, Transaction fees, balance inquiry fees, and other fees as specified in the Cardholder Agreement from time to time.
 
(g) “Cardholder Agreement” means the agreement between Bank and a Cardholder governing the terms and use of a Card.
 
(h) “Card Pack” means a retail packet that includes an un-activated Card or a direct mail packet that includes a Card together with the Cardholder Agreement and that is produced by or on behalf of Company for display and use with respect to a Card Program.
 
(i) “Float” means the average daily balance of funds in the Activity Account for a given month multiplied by the Federal Funds rate as reported on the last business day of the month.
 
(j) “Funding Account” means those accounts maintained at Bank which are used to hold the funds that have not yet been attributed to the Activity Account for purposes of the daily Settlement of Card Transactions as further described and depicted in the Program Addendum.
 
(k) “Graphic Standards” means all standards, policies, and other requirements adopted by a Network or Bank from time to time with respect to use of its Marks.
 
(l) “Interchange” or “Interchange Fee” means the fee paid to the issuer of a Card by an acquiring financial institution for a Transaction, as established by a Network.
 
(m) “Load” means the loading of funds or value to a Card at the time such Card is activated, or subsequent thereto.
 
(n) “Load Amount” means the amount a Cardholder Loads onto a Card.
 
2
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
(o)   “Load Failure” means the inability of any Load to be effectively credited to the Activity Account, for any reason, including but not limited to a Load reject or ACH reject, but excluding a Load failure due to the action or inaction of Bank or the Network.
 
(p)   “Mark” means the service marks and trademarks of a Network, Bank and Company, including but not limited to, the names and other distinctive marks or logos, which identify a Network and Bank.
 
(q)   “Membership” means the membership in a Network and licensing rights thereto obtained by Bank.
 
(r)   “Network” means MasterCard, VISA, Cirrus, Plus, and/or any other network over which Transactions and Settlements are processed.
 
(s)   “Processing Services” means those services, which are necessary to issue a Card and process a Transaction in accordance with the Rules of any Network and Regulatory Authority. Such services shall include but not be limited to: set-up and maintenance of the Cardholder Account, Transaction authorization, processing, clearing and Settlement, Network access, Cardholder dispute resolution, Network compliance, regulatory compliance, security and fraud control, customer service, and activity reporting, all as further set forth in this Agreement.
 
(t)   “Processor” means a third party provider of payment processing or recordkeeping services relied upon by Company and Bank in connection with any Programs contemplated by this Agreement.
 
(u)   “Program” means the marketing, evaluation, processing, administration, supervision, servicing, and maintenance of the Cards and Cardholder Accounts established under this Agreement.
 
(v)   “Program Addendum” means an addendum to this Agreement, executed by Bank and Company, in which Bank authorizes the implementation of a Program and which sets forth the general features of the Program, specific additional responsibilities or obligations of each Party, funding flow, and terms and conditions of a specific Program marketing effort.
 
(w)   “Program Revenues” means all Card Account Income derived from quarterly and yearly ATM income from Networks, foreign exchange fee income and Interchange Fee revenues generated by or accruing under a Program.
 
(x)   “Regulation E” means (i) the regulations, all amendments thereto and official interpretations thereof (12 C.F.R. Part 205) issued by the Board of Governors of the Federal Reserve Network implementing Title IX (Electronic Fund Transfer Act) of the Consumer Credit Protection Act as amended (15 U.S.C. 1693 et. seq.), and (ii) the Electronic Fund Transfer Act and any amendments thereto.
 
(y)   “Regulatory Authority” means, as the context requires, any Network; the Office of the Comptroller of the Currency; the Federal Deposit Insurance Corporation; the Federal Reserve Board; the Federal Trade Commission, and any other Federal or state regulator or agency having jurisdiction over Bank or Company.
 
(z)   “Rules” means the by-laws and operating rules of any Network, the published regulations of any Regulatory Authority, any Federal or State statutes, and the published policies and procedures of Bank, as promulgated by Bank’s Board of Directors in good faith to ensure the continued safety and soundness of Bank.
 
(aa)   “Settlement” means the movement of funds between Bank and Network members in accordance with the Rules.
 
(bb)   “Solicitation Material” means the advertisements, brochures, applications, marketing materials, telemarketing scripts and any other materials relating to a Program, including point of purchase displays, television advertisements, radio advertisements, electronic web pages, electronic web links, and any other type of advertisement, marketing material, or interactive media related to the Program or any other materials sent to, or viewed by, a Cardholder or prospective Cardholder from time to time.
 
(cc)   “Transaction” means a Card transaction that is processed through the Network and its members or through Processor, Bank and Company, including deposits, purchases, cash withdrawals, disputes and refunds.
 
3
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
2.
GENERAL DESCRIPTION OF PROGRAM
 
2.1   Purpose . The purpose of any Program initiated pursuant to this Agreement is to offer Cards, issued by Bank and marketed by Company, as an alternative to traditional payment mechanisms. Cards may be used by Cardholders to pay for purchases, obtain cash advances or other uses as allowed by law all as further set forth in the applicable Program Addendum.
 
2.2   Cardholder Approval . Prior to Card activation, and as may be required by Applicable Law, Cardholders shall be approved and qualified for purposes of receiving a Card, which may include, but is not limited to the collection of Cardholder and Cardholder identity verification. Bank reserves the right to deny Cardholder approval in accordance with Applicable Law or Rule, and Company agrees to cooperate with Bank in the Cardholder approval or denial process.
 
2.3   Cardholder Solicitation and Distribution . Company will market to prospective Cardholders and distribute Cards in accordance with the terms of this Agreement and the Rules, and subject to the terms and conditions of any Program Addendum. Cards may be distributed in custom packaging, which shall include such additional materials as the Parties may determine including, but not limited to, a Cardholder Agreement describing the Program and Card use.
 
2.4   Card Activation . Cards for approved Cardholders may be activated by a Cardholder by calling an Interactive Voice Response Unit, accessing an approved Internet application, or by customer service representative, or as otherwise described in the applicable Program Addendum.
 
2.5   Establishment of Activity Account . Bank shall set up and maintain a Bank owned and Bank controlled Activity Account, or such other accounts as it may deem appropriate under the applicable Program Addendum, for purposes of applying Cardholder value Loads and the payment of Settlement Transactions to the Network.
 
2.6   Card Value Loads and Delivery of Cardholder Payments . All mechanisms for Card Loading will be as set forth in this Agreement or the applicable Program Addendum. No Loading mechanism may be utilized unless approved by Bank in writing. All payments collected from Cardholders shall be collected by Bank. To the extent Company receives such sums, Company or Company’s agent shall forward the same to Bank immediately via wire, ACH transfer or as otherwise specified in the applicable Program Addendum.
 
2.7   Program Modification . In the event that Bank and/or Company determines that Applicable Law requires a modification to any Card Program contemplated by this Agreement, including, without limitation, a determination that Applicable Laws have been modified or passed in a jurisdiction that prohibit or place restrictions on the sale or distribution of Cards in the manner agreed, then the determining Party shall provide the other Party with written notice of such determination, and each Party shall cause itself and its agents, vendors, and/or third party service providers to take reasonable steps to avoid violating such Applicable Law, which the Parties acknowledge and agree may require suspending or terminating sales of the Cards in certain jurisdictions, and the actual out-of-pocket costs of taking such reasonable steps shall be borne solely by Company.
 
2.8   Program Preservation . Unless otherwise prohibited by Applicable Law or Rule, in the event of any Program modifications contemplated by Section 2.7 or otherwise, the Parties agree to use commercially reasonable efforts to exhaust any inventory of current Cards, Cardholder Agreements, and Solicitation Materials as applicable.
 
2.9   Holder of Funds . Unless otherwise agreed or operationally determined between the Parties, Bank shall be the holder of funds for purposes of any state unclaimed property laws.
 
4
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
3.
DUTIES OF COMPANY
 
3.1   Marketing . Company shall, from time to time, promote and market Cards to prospective customers, subject to Applicable Law, all Rules, and in accordance with this Agreement and any Program Addendum.
 
(a)   Except as may be agreed by the Parties from time to time during the term of this Agreement, Company shall be responsible for its own costs and expenses associated with the marketing of any Card or Program under this Agreement and shall further be responsible to ensure that all Solicitation Material, Cardholder Agreements, marketing methods, marketing-related activities in any jurisdiction in which Company operates, and Card Loading processes and procedures are in compliance with Applicable law.
 
(b)   Bank shall use its best efforts to assure Company obtains all required Network approvals in timely manner, as Bank or such Network may require. Company shall be responsible for costs related to such approval, including, but not limited to, any costs relating to any Independent Sales Organization (“ISO”) involved in the Program. It is expressly understood that approval by any Network is a condition precedent to the commencement of any Card Program and the execution of a Program Addendum.
 
(c)   Bank grants to Company a nonexclusive, royalty free, nontransferable right and license to use certain Marks (owned by Bank or its licensors). The use of the Marks by Company without the prior written consent of the Bank is prohibited.
 
(d)   Company will submit all proposed Solicitation Material and any proposed Cardholder Agreements relating to a Card or Program to the Bank for review and written approval prior to its release or use in the marketplace. Bank shall not intentionally delay or unreasonably withhold its review and approval of proposed Solicitation Material and Cardholder Agreement. It is expressly understood that Bank’s review and approval shall be for Bank’s independent purposes, but such approval shall not constitute a certification to Company or operate to relieve Company of its independent and exclusive obligation to ensure that such materials comply with Applicable Law.
 
3.2   Program Development and Implementation . Company will develop Card marketing efforts for the marketing and distribution of Cards in various markets, subject to terms and conditions as set forth in a Program Addendum (substantially in the form of Exhibit A ) and any related attachments, and such other documents as Bank may reasonably require in connection with any Program. Bank reserves the right, in its sole discretion, to refuse approval of any Card marketing proposal that, in its opinion presents excessive financial or reputational risk, is deemed by Bank to be non-viable or not in keeping with any Rule, or may deemed to be in violation of Applicable Law.
 
3.3   Cards and Cardholder Agreements .
 
(a)   Company shall be responsible for the manufacturing and printing of all Cards and the applicable Cardholder Agreement as approved by Bank from time to time. All such Cards and Cardholder Agreements shall identify Bank (or its designee) as the issuer and shall include such other names and Marks as may be required to conform to Graphic Standards, Regulatory Authority and Rules. Any design for a co-branded Card and Cardholder Agreement shall be subject to Bank’s prior approval, which shall not be unreasonably withheld or delayed.
 
(b)   In the event that the Card and/or Cardholder Agreement do not comply with any Applicable Law at any time after delivery thereof to a Cardholder, Company shall use commercially reasonable efforts to deliver to such Cardholder an amended Cardholder Agreement that complies with Applicable Law.
 
(c)   Bank shall have the right, in its sole discretion, from time to time upon sixty (60) days’ prior written notice to Company (or such shorter notice period as Company may agree, or with no advance notice in the event of a change that is required in order to comply with Applicable Law), to change, alter or amend the Card or Cardholder Agreement, all in accordance with Applicable Law and the provisions of Section 2.8.
 
5
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
(d)   Distribution of Cards . Company shall be responsible for the distribution of Cards (or Retail Card Pack), as further described in any Program Addendum. Company shall ensure that any and all Cards are handled, shipped and distributed in accordance with any and all Rules, including the Network Rules provided to Company upon execution of this Agreement, and as the same may be amended and provided to Company annually th ereafter in associati on with Company’s ISO registration renewal. In accordance with the Rules, Company agrees that it shall implement inventory management controls for any and all Cards that are maintained in its possession and cause, through contractual agreement, any third party in possession of such Cards to implement inventory management controls which comply with the Rules as may be communicated by Bank to Company from time to time. Company agrees that it will provide Bank with online access to all Card inventory information maintained on Company’s system. Company shall further send inventory reports to the Bank upon request. Monthly inventory reports shall include at a minimum, the following data:  prior month’s beginning on hand inventory, new inventory received, month’s usage (new issues and reissues), miscellaneous usage (damaged, physical adjustments, etc.), and prior month’s ending inventory.
 
3.4   Termination of Cards . Company acknowledges that Cards are the property of Bank, and shall be subject to cancellation at any time by Bank, in accordance with this Agreement, the Cardholder Agreement or as required by Applicable Law, or, on a case-by-case basis, where the Bank believes a Cardholder is using the Card for fraudulent or illegal purposes. Upon receipt of such notice from Bank or upon Termination of this Agreement for any reason, Company shall, at its sole expense (i) immediately return such cancelled Cards in its possession or under its control to Bank or destroy cards per Rules, and (ii) notify any other party or agent of Company, including any third party service providers to return all such cancelled Cards in their possession to Bank or destroy cards per Rules, or (iii) provide written certification of destruction of any unused Cards, under dual control, by a third party approved by the Bank all in keeping with the Rules as set forth by the applicable Network as it pertains to the shipping and destruction of Cards.
 
3.5   Distribution of Cardholder Agreements . Company shall be responsible for the distribution of Cardholder Agreements (or Retail Card Pack), as further described in any Program Addendum. In the event that Bank, in its sole discretion, determines that the Cardholder Agreement does not comply with any Applicable Law, Company shall immediately cease delivery of such Cardholder Agreements as directed by Bank. The Parties shall reasonably cooperate with one another to promptly include any amended Cardholder Agreements in the Retail Card Packs or replace such Retail Card Packs with Retail Card Packs that include such amended Cardholder Agreement. All costs and expenses associated herewith shall be borne solely by Company.
 
3.6   Customer Service . Company shall be responsible for such customer service standards as may be set forth in the applicable Program Addendum. Company may not engage a third party service provider in connection with the performance of customer service activities without Bank’s prior approval. Company specifically acknowledges and agrees that the customer service provided to Cardholders in connection with the Program, whether provided by Company or through a third party processor or servicer, shall be subject to a service level agreement requiring the performance of the servicing in accordance with those specific standards as set forth in the Program Addendum and such other commercially reasonable industry standards and shall provide for appropriate monitoring, monthly reporting, and penalties for performance outside of parameters specified by Bank. Company agrees that in the event it or any third party processor or servicer receives any oral or written notice of “error” as defined by 12 CFR 205.11(a) of Regulation E, Company will respond to such errors in accordance with the terms of the Cardholder Agreement, or Regulation E, as applicable. Company shall retain all error-related information and shall provide the same to Bank as it may reasonably request from time to time. To the extent Bank responds to any such errors, Company shall use reasonable efforts to cooperate with Bank in the reasonable resolution of any customer or Cardholder-reported error, all in accordance with Applicable Law.
 
3.7   Establishment of Funding Account . As Bank may direct, Company shall set up and maintain a Funding Account at Bank for purposes of receiving funds from Card issuance and Cardholder Load Transactions from sales attributable to Company marketing performed directly or through any agent of Company. Company shall ensure at all times adequate funds are available for Load Transactions.
 
3.8   Payment Load Mechanisms and Locations . Any Load mechanism or location with respect to any Card Program shall be as set forth in the Program Addendum or as may otherwise be approved by Bank in writing. No Load mechanisms, including Load locations, Networks or other features may be used in connection with any Program unless pre-approved by Bank. Other than to the extent of Bank’s approval of the same, Company shall be responsible for ensuring that any Load mechanism or Load location, including the involvement of third parties in connection with the same are in compliance with Applicable Law.
 
6
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
3.9   Liability for Load Problems . With the exception of Loads to the Cards to be transferred by TransCard, Company shall be responsible for all Load Failures, without regard to causation except those caused by the Bank or the Networks. Initially, Company shall be responsible for all Loads save and except MasterCard re-Power Loads and direct deposit Loads conveyed by TransCard. In the event of a Load Failure in connection with any Card Program, not caused by the Bank, Network, or TransCard error, Company shall, within one (1) business day after receiving notice of such Load Failure, fully fund any shortfall in the Funding Account. To the extent not covered by any reserve account, a monetary assessment of 2% times the amount of the Load Failure shall be assessed each calendar day that any Load Failure is outstanding after the date of funding.
 
3.10   Reserve Account Requirement . Bank may, subject to the conditions stated in this Section 3.11, require Company to establish a Reserve Account (“Reserve Account”) for purposes of mitigating and managing any identified financial or operational risks to Bank under this Agreement. Bank may require Company to establish a Reserve Account (i) in the event of a Load failure; (ii) in the event of Company’s failure to pay any of its monetary obligations to Bank under this Agreement; or (iii) in response to Bank’s reasonable determination that Company’s financial position is deemed materially adverse to the Bank . The required balance in such Reserve Account shall be as Bank may in its discretion reasonably require, but shall in no event be greater than the average of the seven (7) largest days of Card Loads from the same month of the prior year, plus ten percent (10%) multiplied by five (5).
 
3.11   Transfer of Load Amounts and Payments . For all Programs Company shall be responsible for the collection and transfer of Load Amounts to the Bank, all as further described herein and in the applicable Program Addendum. It is expressly understood that any Load Amounts coming into the possession of Company or any agent or service provider of Company shall be deemed to be held in trust for the Bank (i.e. statutory trust) and for the benefit of the applicable Cardholder, and no part of such Load Amounts shall be deemed the property of, or an asset of, Company at any time.
 
3.12   Processing Services; TransCard Agreement for Services . Company shall retain the services of a Processor to perform Processing Services in connection with the Program. The Processor shall be subject to Bank’s prior review and approval. Unless otherwise agreed, Company shall initially retain the services of TransCard under the Agreement For Services for purposes of processing Cardholder Transactions. The Agreement For Services shall specifically provide that Bank shall be entitled to rely upon and enforce as a third party beneficiary the provisions of the Agreement For Services related to Processing Services and general servicing of the Cardholder Accounts. Unless otherwise agreed, the Agreement For Services shall include or make provision for Cardholder identification, and additional compliance with anti-money laundering laws and other applicable laws, including confidentiality and data privacy; providing Cardholder service support; authorizing Cardholder transactions and adjusting Cardholder Account balances per transaction; and providing reporting of Cardholder Account activity and risk management. Such Agreement For Services shall entitle Bank to all those reports provided by Processor to Company as well as any additional reports that the Bank may reasonably request from time to time. To the extent TransCard will be providing customer service, the Agreement For Services shall include a service level agreement requiring that the servicing be provided in a professional manner in accordance with industry standards and, further, providing for appropriate monitoring, monthly reporting, and penalties for performance outside of parameters specified by Bank and as further set forth in any program addendum. In no event may Company materially alter, change, amend, or otherwise terminate the Agreement For Services with TransCard without prior written consent of Bank.
 
3.13   Cardholder Fraud and Fraud Recovery . Company agrees that it shall be responsible for and liable to Bank for all expenses associated with and any losses from over limit processing, negative Cardholder Account balances, Cardholder or value Load fraud, under floor limit processing, or Bank’s efforts at fraud or unauthorized Transaction recovery under Applicable Law. Company shall cooperate fully with Bank in its efforts, and engage in any commercially reasonable efforts to locate, and prosecute the perpetrator of any such unauthorized activity or fraud.
 
3.14   Establishment of Negative Balance Reserve Account . For purposes of retaining adequate reserves to off-set any outstanding balances and fraud losses as described in Section 3.14, Bank shall set up and maintain for each Program, as applicable, a Bank-owned and Bank-controlled reserve account known as the “Negative Balance Reserve Account” in an amount commensurate with any actual negative balances as of the last day of the previous calendar month. At the end of each calendar month, Card Account Income will be disbursed net of any outstanding negative balance accounts. Any negative balance reserves maintained by Bank will be net of unposted chargeback funds on deposit in the applicable Program accounts.
 
3.15   Cardholder Refunds . Company shall be responsible for any refunds paid to Cardholder (beyond any actual remaining balances in the Cardholder Account from Loads transferred to Bank) necessitated by any Cardholder complaint or otherwise, unless said refunds are necessitated in whole or in part Bank, including but not limited to, any fees charged by the retailer or marketer in connection with the sale of the Cards as well as all Card Account Income.
 
7
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
3.16   Bank Secrecy Act Compliance . Upon execution of this Agreement, or at any time during its performance, Bank may require that Company cooperate with Bank in the implementation of Bank’s anti-money laundering (AML) and anti-terrorism financing (ATF) compliance program in accordance with Applicable Law, including the implementation of such commercially reasonable policies and procedures as Bank may require. Upon Bank’s direction and as may be required by Applicable Law, Company shall implement measures to allow Bank to verify the identity of all Cardholders and prospective Cardholders consistent with the Rules, including the development of an appropriate customer identification program as approved by Bank. Upon Bank’s written consent, the duties specified in this section may be provided by TransCard on Company’s behalf.
 
3.17   Program and Compliance Training . Company shall permit Bank to train, or shall otherwise be responsible to provide such Program training to those employees of Company who are involved in the marketing, promotion, or implementation of the Card Program, as further set forth in any Program Addendum. Unless otherwise agreed, the costs of such training shall be borne by Company.
 
3.18   Recordkeeping; Reporting; and Audit Rights .
 
(a)   Unless otherwise agreed, for each applicable Card Program and to the extent such records are maintained or in its possession, Company will keep complete records reflecting (i) the identity of each Cardholder and the steps taken to verify such identity,  if required; (ii) an inventory of each Card sold and/or activated by such Cardholder and all Loads on such Cards, (iii) the remaining value on each Card, and (iv) all charges, Transaction and fees that have been made or charged to each Card or Cardholder, and other information as may be required by Applicable Law or Bank, from time to time (“Required Records”). With respect to each Card, Company shall retain all Required Records for the time period required by Applicable Law, and in any event, for no less than five (5) years after the termination of any Cardholder Agreement or Card Program, whichever is later.
 
(b)   Company shall, within a reasonable time after Bank’s request, and to the extent it has such information under in its possession or under its control (directly or through the Processor or other third party), provide Bank with the following reports with respect to any Card Program:  (i) reports detailing the number and nature of complaints and customer service calls that Company receives in connection with any Card on a monthly basis; (ii) detailed reports of any unusual, unauthorized or suspicious activity or Transactions involving the Cards, on a monthly basis; (iii) the number of new Cards sold or issued, summarized on a weekly basis; (iv) the average account balance per Card, average number of re-Loads per active Card on a monthly basis; and (v) a summary report reflecting the sale, activation, purchase and any withdrawal Transactions initiated by Cards associated with the Program.
 
(c)   Bank reserves the right, at its own expense (except as set forth herein below), to inspect, copy and audit any records of Company directly relating to its performance hereunder. Any such audit will be conducted at mutually agreed upon times, upon reasonable prior written notice (no less than ten (10) business days), and in a manner designed to minimize any disruption of Company’s normal business activities; provided, however, that in agreeing to times for the audit, the Company shall be reasonable in scheduling, and shall not delay any audit for more than twenty (20) business days from the date first proposed by Bank. The Parties agree that the audit rights hereunder will be exercised during normal business hours and no more than once in any three (3) month period.
 
3.19   Card Marketing Locations .
 
(a)   Cards may be marketed directly by Bank, by Company, or through third party retailers or sellers approved in writing by Bank. Company shall not engage any third party or retail seller for any Card marketing or sales, without prior Bank approval.
 
(b)   Company shall maintain a complete and accurate list of all Bank-approved locations wherein the Cards will be marketed under this Agreement. Upon Bank’s request, Company shall provide a list of all Card marketing locations to Bank. Company shall further maintain full and complete files including all Company’s due diligence activities and contracts with any third parties in connection with the marketing of the Cards and shall disclose such due diligence information and unredacted copies of any contracts relating to the same to Bank upon Bank’s request.
 
8
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
4.
REPRESENTATIONS AND WARRANTIES OF COMPANY
 
4.1   Representations and Warranties . Company represents and warrants to Bank as follows:
 
(a)   This Agreement is valid, binding and enforceable against Company in accordance with its terms, except as such enforceability may be limited by laws governing creditors’ rights and general principles of equity.
 
(b)   Company is a public corporation duly formed, validly existing and in good standing under the laws of the State of Nevada and is duly qualified and is properly licensed to do business in each jurisdiction in which the nature of Company’s activities makes such authorization or licensure necessary. Neither the execution of this Agreement nor Company’s performance of its obligations hereunder requires any consent, authorization, approval, notice to, license, or other action by or in respect of, any third party or any Regulatory Authority.
 
(c)   Company has the full power and authority to execute and deliver this Agreement and to perform all its obligations under this Agreement. The provisions of this Agreement and the performance by Company of its obligations under this Agreement are not in conflict with Company’s documents of formation or operation, or any other agreement, contract, lease or obligation to which Company is a party or by which it is bound.
 
(d)    Company has not been subject to the following:
 
(i)   Criminal conviction (except minor traffic offenses and other petty offenses) in the United States of America or in any foreign country;
 
(ii)   Federal or state tax lien, or any foreign tax lien;
 
(iii)   Administrative or enforcement proceedings commenced by the Securities and Exchange Commission, any state securities regulatory authority, Federal Trade commission, federal or state bank regulator, or any other state or federal regulatory agency in the United States or in any other country; or
 
(iv)   Restraining order, decree, injunction, or judgment in any proceeding or lawsuit, alleging fraud or deceptive practice on the part of Company.
 
(e)   There is not pending or threatened against Company any litigation or proceeding, judicial, tax or administrative, the outcome of which might materially adversely affect the continuing operations of Company.
 
(f)   Company has delivered to Bank complete and correct copies of the consolidated balance sheets and related statements of income and cash flow of Company’s parent corporation, Payment Data Systems, Inc., and such materials, subject to any limitation stated therein, which have been or which hereafter will be furnished to Bank to induce it to enter into this Agreement, do or will fairly represent the financial condition of the Company. All other information, reports and other papers furnished to Bank will be, at the time the same are furnished, accurate and complete in all material respects and complete insofar as completeness may be necessary to give Bank a true and accurate knowledge of the subject matter. The financial statements are in accordance with the books and records of Parent Company and were prepared in accordance with generally accepted accounting principles (“GAAP”) as in effect in the United States, as consistently applied, and in accordance with all pronouncements of the Financial Accounting Standards Board.
 
4.2   Surety . Company shall procure and provide to the Bank the executed and continuing Surety Agreement of Payment Data Systems, Inc. unconditionally guarantying to Bank Company’s prompt payment of all sums due, and performance of all obligations owed, under this Agreement. The Surety Agreement shall be in form substantially similar to Exhibit B .
 
9
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
5.
COVENANTS OF COMPANY
 
5.1   Covenants . Company covenants and agrees with Bank as follows:
 
(a)   Company is, and will at all times continue to perform its obligations under this Agreement, and is in compliance with all Applicable Laws, the Rules, and any rules, orders and regulations issued by the Regulatory Authorities that relate to the matters and Transactions contemplated by this Agreement. Company will be responsible for all fines and penalties assessed by any Regulatory Authority due to Company’s actions, inactions or omissions. Without limiting the generality of the foregoing and other terms and conditions herein, Company’s obligations under this Agreement, including without limitation, its responsibility for legal compliance, shall in no way be affected, altered and/or waived in the event Bank performs, exercises or fails to exercise, any right, obligation, option, or otherwise, to provide instruction, guidance, or recommendations of any kind, and/or review, any aspect of the Program.
 
(b)   Company will comply with all Network Rules as may be provided by Bank from time to time. Company has received an electronic copy of the applicable Network Rules, as may be amended by the Network.
 
(c)   Company will obtain or will at all times maintain appropriate licenses with respect to any trademarks, copyrights and patents affecting any and all aspects of this Agreement.
 
(d)   Company shall ensure that any Solicitation Material, marketing methods, or other aspects of the Program will not violate any intellectual property rights of any third party.
 
(e)   Company will promptly give written notice to Bank of any material adverse change in the business, properties, assets, operations or condition, financial or otherwise, of Company and any pending, or a threat of litigation involving a sum of $50,000 or more.
 
(f)   As soon as filed with the Securities and Exchange Commission, the Company will provide Bank with the audited balance sheets and related statements of income and cash flow of itself and all notes and schedules thereto as of the end of such period by virtue of posting the reports to www.sec.gov. Company agrees to provide Bank with unaudited balances sheets and related statements of income and related statements of income and cash flow of Parent Company, and all notes and schedules thereto on a more frequent and periodic basis as Bank may require.
 
(g)   Company will timely investigate and resolve all Cardholder reports of “errors” (as defined by 12 CFR 205.11(a) of Regulation E) and will maintain records of the same, including the name and address of the complaining Cardholder, a brief summary of the Cardholder’s complaint, and the date upon which such complaint was received, and a summary of any action taken. Company will further respond to all Cardholder inquiries and complaints, and will promptly resolve the same. All material consumer complaints received by Company, relating to the Card or its use, will be immediately reported to Bank.
 
(h)   Company will not, without Bank’s prior written consent, alter or amend any Solicitation Material, marketing methods, or the terms of any Card Program or Cardholder Agreement.
 
(i)   Company will obtain Bank’s prior written approval before utilizing any third party to market, solicit or service Cardholders or prospective Cardholders in connection with any Program. In connection therewith, and in the event Company seeks to enter into an agreement with any such party prior to Bank’s approval of the same, Company shall include provisions in the agreement with the third party specifically indicating that the third party’s involvement in the program is subject to the Bank’s approval and, in the event Bank declines approval, or rescinds approval after it has previously been granted, that the agreement with the third party will terminate immediately and the third party will no longer be involved in connection with the Program.
 
(j)   At all times, Company’s operations relating to its obligations under this Agreement shall be compliant with the Payment Card Industry Data Security Standards (“PCI-DSS”) as interpreted and applied by Bank in its sole discretion, including the appropriate level within the PCI-DSS covering Company’s operations.
 
10
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
(k)   Company will comply with and perform its obligations under any ancillary agreement or agreements with Bank or any third party provider, including but not limited to any Card Processor, which is now or in the future will be, executed in connection with any Program offered pursuant hereto, including the Agreement for Services.
 
(l)   Company will not, without Bank’s prior written consent, outsource or otherwise subcontract with third parties for the provision of any of its Duties under this Agreement. “Duties” means the obligations Company has agreed to undertake as more fully set forth in this Agreement. Bank shall have the right to conduct Due Diligence on all proposed subcontractors or other third party service providers at its sole discretion prior to granting such written approval. Bank’s review and approval shall not be unreasonably withheld or delayed. However, any such consent of assignment of Duties shall not release Company of its obligations to Bank under this Agreement and Company shall remain fully liable to Bank for any breach of this Agreement caused by an assignee.
 
(m)   Company agrees that any government entity with regulatory or supervisory authority over Bank (collectively the “Auditing Party”), shall have the right to inspect, audit, and examine all of Company’s facilities, records and personnel relating to the Program at any time during normal business hours upon reasonable notice. The Auditing Party shall have the right to make abstracts from Company’s books, accounts, data, reports, papers, and computer records directly pertaining to the subject matter of the Agreement, and Company shall make all such facilities, records, personnel, books, accounts, data, reports, papers, and computer records available to the Auditing Party for the purpose of conducting such inspections and audits. Such audit, inspection or examination shall be during regular business hours of Company, on reasonable notice, and conducted in a manner as to not interfere with Company’s normal business operations. Company shall procure similar audit and inspection rights to the facilities and records of any third party retained by Company to provide any services in connection with this Agreement.
 
(n)   Company will cooperate with Bank in implementing commercially reasonable measures designed to meet the objectives of the security and confidentiality guidelines of the federal banking agencies’ Interagency Guidelines Establishing Standards for Safeguarding Consumer Information and the Interagency Guidelines Establishing Information Security Standards , including, but not limited to, the implementation of appropriate policies, procedures, and other measures designed to protect against unauthorized access to or use of customer information maintained by Company that could result in substantial harm or inconvenience to any Cardholder and the proper disposal of Cardholder information. Company shall further cooperate with Bank in implementing a response program in accordance with the Interagency Guidance on Response Programs for Unauthorized Access to Customer Information and Customer Notice which shall require Company to take commercially reasonable actions to address incidents of unauthorized access to Cardholder or other information, including notification to Bank and Cardholders as soon as possible following any such incident. Company shall ensure that any third party service provider having access to customer information relating to Cardholder be obligated to cooperate in the implementation of similar security measures and response programs as may be directed by Bank.
 
(o)   Company shall, while this Agreement is in effect, prepare and maintain disaster recovery, business resumption, and contingency plans appropriate for the nature and scope of the Program, the activities of Company, and the obligations to be performed by Company hereunder. The plans shall be sufficient to enable Company to promptly resume the performance of its obligations hereunder in the event of a natural disaster, destruction of Company’s facilities or operations, utility or communication failures, or similar interruption in the operations of Company or the operations of a third party which in turn materially affect the operations of Company. Company shall make available to Bank copies of all such disaster recovery, business resumption, and contingency plans and shall make available to Bank copies of any changes thereto. Company shall periodically test such disaster recovery, business resumption, and contingency plans as may be appropriate and prudent in light of the nature and scope of the activities and operations of Company and its obligations hereunder and shall promptly provide Bank with the results of any formal tests of such plans.
 
(p)   Company shall reasonably cooperate with Bank in the implementation of Bank’s Identity Theft Prevention Program (“ITPP”) designed to detect, prevent, and mitigate identity theft in connection with the Program. The ITPP shall be designed to comply with the provisions of 12 CFR 334.90-334.91 and 571.90-571.91 as well as the Interagency Guidelines on Identity Theft Detection, Prevention, and Mitigation set forth at Appendix J to 12 CFR Part 334 and Appendix J to 12 CFR Part 571. To the extent Company is independently obligated to maintain an ITPP, Company shall submit its ITPP to Bank for review.
 
(q)   Company shall obtain Bank’s prior written review and approval of any financial product marketed to Cardholders if the new financial product utilizes Bank’s marks or provides a mechanism for Cardholders to load funds to the Cardholder Accounts.
 
(r)   Company shall promptly (but in any event within thirty (30) days after receiving written notice of the same from Bank) respond to and resolve any Program-related deficiencies (to the extent under the oversight or control of Company), as may be communicated by Bank to Company in connection with Bank’s quality assurance reviews, audits, or other compliance monitoring. Company’s response to such Program-related inquires shall be documented in a quality log or other written tracking tool as Bank may reasonably require, and shall include Company’s written summary of corrective action steps taken to resolve the issue, and the prospective steps to be taken to avoid repeated occurrences of the identified issue. Company’s obligations hereunder shall include the resolution of any Processor-related issues as may be identified by Bank.
 
11
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
6.
DUTIES OF BANK
 
6.1   Certification and Administrative Fees . Bank shall be responsible for any annual or monthly membership fees relating to Bank Membership with any Network.
 
6.2   Memberships in Network . Bank shall use its best efforts to obtain and maintain at its sole expense the required license with each applicable Network, and shall timely pay all normal fees, dues, and assessments associated therewith. Any fees, fines, or charges assessed by any Network as a result of the failure of any aspect of the Program to comply with the Rules shall be the responsibility of Company. Bank shall retain its Membership in Network in good standing and shall abide in all material respects by all the rules and regulations applicable to Bank; provided, however, that Bank shall not be obligated to maintain such Membership. If Bank elects to terminate its membership in any Network, or if a Network elects to terminate Bank’s Membership in spite of Bank’s compliance with the applicable Rules, Bank shall give notice to Company as soon after it provides notice to or receives notice from the Network according to the Rules.
 
6.3   Activity Account . Bank shall open and maintain an Activity Account, for purposes of receiving Cardholder funds and Settlement in connection with a Program. All Load Amounts that have been paid by Cardholders for the Cards, but that have not yet been used by the Cardholder, shall be maintained in the Activity Account in a fiduciary manner in a trust or custodial account associated with the Card Program and the name of such Activity Account shall indicate that the funds are being held for such purpose. With the exception of any gift card, corporate incentive or other anonymous card products, the identities of each of the Cardholders for whose benefit such funds are being held shall be readily identifiable by Bank, either directly or through the Processor.
 
6.4   Card Issuance . Bank shall establish Cardholder Accounts and issue Cards in accordance with this Agreement, and subject to Applicable Law and Network Rules, with the understanding that the Cards are, and shall at all times remain, the property of Bank. Nothing herein shall be interpreted to require Bank to establish a certain number of Cardholder Accounts and Bank shall have the right to terminate marketing and origination of new Cardholder Accounts at its discretion in the event that Bank reasonably determines that further marketing may violate Applicable Law or jeopardize the safety and soundness of Bank.
 
6.5   Cardholder Agreements . Bank shall provide a template for a Cardholder Agreement for the Program.
 
6.6   Notices . Bank shall deliver to Company a copy of all material notices or correspondence that it receives from any Network, or any other third party, relating to this Agreement, within five (5) business days of receipt of such notice or correspondence.
 
6.7   Changes to Rules Adopted by Bank . Bank may adopt new Rules relating to the published policies and procedures of Bank or change existing Rules relating to the policies and procedures of Bank from time to time by giving sixty (60) days’ prior written notice to Company. If such changes require changes to Solicitation Material, Cardholder Agreement, or other material approved by the Bank, Bank will allow Company to exhaust existing inventory thereof or reimburse Company for the cost and destruction of same as well as the cost of preparing revised material.
 
7.  
REPRESENTATIONS AND WARRANTIES OF BANK
 
7.1   Representations and Warranties . Bank represents and warrants to Company as follows:
 
(a)   This Agreement is valid, binding and enforceable against Bank in accordance with its terms, except as such enforceability may be limited by laws governing creditors’ rights and general principles of equity.
 
(b)   Bank is a national bank, validly chartered and in good standing under the laws of the United States, and is duly qualified and is properly licensed to do business in each jurisdiction in which the nature of Bank’s activities makes such authorization or licensure necessary. Neither the execution of this Agreement nor Bank’s performance of its obligations hereunder requires any consent, authorization, approval, notice to, license, or other action by or in respect of, or filing with, any third party or any Regulatory Authority.
 
12
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
(c)   Bank has the full power and authority to execute and deliver this Agreement and to perform all its obligations under this Agreement. The provisions of this Agreement and the performance by Bank of its obligations under this Agreement are not in conflict with Bank’s charter, bylaws or any other agreement, contract, lease or obligation to which Bank is a Party or by which it is bound. There is not pending or threatened against Bank any litigation or proceedings, judicial, tax or administrative, outcome or which might materially adversely affect the continuing operations of Bank.
 
(d)   Neither Bank nor any principal of Bank has not been subject to the following:
 
(i)   Criminal conviction (except minor traffic offenses and other petty offenses) in the United States of America or in any foreign country;
 
(ii)   Federal or state tax lien, or any foreign tax lien;
 
(iii)   Administrative or enforcement proceedings commenced by the Securities and Exchange Commission, any state securities regulatory authority, Federal Trade commission, federal or state bank regulator, or any other state or federal regulatory agency in the United States or in any other country; or
 
(iv)   Restraining order, decree, injunction, or judgment in any proceeding or lawsuit, alleging fraud or deceptive practice on the part of Bank or any principal thereof.
 
(e)   There is not pending or threatened against Bank any litigation or proceeding, judicial, tax or administrative, the outcome of which might materially adversely affect the continuing operations of Company. .
 
8.
PROGRAM FEES AND COMPENSATION
 
8.1   FiCentive Compensation . In consideration of FiCentive’s marketing and distribution of Cards issued by Bank under this Agreement, Bank will pay to TransCard, and TransCard will pay to Bank, those fees and charges provided under the Sponsorship Agreement between TransCard and Bank. The terms of Company’s separate Agreement For Services with TransCard will operate to compensate Company for its services rendered hereunder. Company acknowledges and agrees that Bank’s compliance with the Sponsorship Agreement shall fulfill any and all obligations of Bank to compensate FiCentive for the services provided under this Agreement. Company further acknowledges and agrees that the provisions set forth in the Sponsorship Agreement may be amended by Bank and TransCard from time to time in their sole discretion and without prior approval of Company.
 
8.2   Set-Off Authorization . Company hereby grants and authorizes Bank to exercise a right of set-off against any sums due to TransCard related to this Agreement for any losses or other sums due Bank hereunder, including but not limited to any sums due pursuant to Section 3.9 of this Agreement.
 
9.
TERM OF AGREEMENT
 
9.1   Term and Termination of Agreement Without Cause . The term of this Agreement shall commence from the Effective Date as stated therein, and shall continue through September 14, 2014 (the “Initial Term”), unless terminated earlier as provided below. After the Initial Term, this Agreement shall automatically extend for additional one-year periods (each a “Renewal Term”). Either Party may terminate this Agreement at the end of the Initial Term or at the end of a Renewal Term by providing written notice to the other at least ninety (90) days in advance of the expiration of the Initial Term or such Renewal Term, or as provided below.
 
13
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
9.2   Termination of Agreement or For Cause .
 
(a)   Either Party shall have the right to terminate this Agreement for cause:
 
(i)   In the case of any breach of any duty or obligation under this Agreement (excluding Load Failures), but only if the breach continues for a period of ten (10) days after the breaching Party receives written notice from the other Party specifying the breach. In the case of any breach based on a Load Failure in excess of the Reserve Account, but only if the breach continues for a period of more than two (2) business days after Company receives written notice from Bank specifying the Load Failure. In the event such breaches are not cured during the specified period, then this Agreement may be terminated.
 
(ii)   In the case of a breach of any duty or obligation under this Agreement not involving the payment of money , (so long as such breach is not due to the actions or inaction of the terminating Party) but only if the breach continues for a period of ten (10) days after the breaching Party receives written notice from the non-breaching Party specifying the breach. In the event such breach is not cured during the period, then this Agreement may be terminated.
 
(iii)   Repeated breach of the same provision of the Agreement within any twelve (12) month time shall not entitle the breaching party to additional cure periods. In the event of a subsequent breach of the same provision within twelve (12) months, the non-breaching Party may terminate this Agreement immediately upon written notice.
 
(iv)   Upon termination of either the Agreement For Services or the Sponsorship Agreement unless Bank and Company mutually agree to continue the Program through a new Processor.
 
(b)   Either Party may immediately terminate this Agreement upon written notice to the other in the event of the following:
 
(i)   Discovery that any financial statement, representation, warranty, statement or certificate furnished to it by the other Party in connection with or arising out of this Agreement is materially adverse to the terminating Party and intentionally untrue as of the date made.
 
(ii)   Subject to Applicable Law the commencement by either Party of any proceeding or filing of any petition seeking relief under Title 11 of the United States Code or any other Federal, state or foreign bankruptcy, insolvency, liquidation or similar law; application for or consenting to the appointment of a receiver, trustee, custodian, sequestrator or similar official for such Party or for a substantial part of its property or assets; a general assignment for the benefit of creditors; or taking corporate action for the purpose of effecting any of the foregoing.
 
(iii)   Subject to Applicable Law, the commencement by either Party of an involuntary proceeding or the filing of an involuntary proceeding or the filing of an involuntary petition in a court of competent jurisdiction seeking: relief in respect of the other Party, or of a substantial part of its property or assets under Title 11 of the United States Code or any other Federal, state or foreign bankruptcy, insolvency, receivership or similar law; the appointment of a receiver, trustee, custodian, sequestrator or similar office for the other Party or for a substantial part of its property or assets; or the winding up or liquidation, of the other Party, if such proceeding or petition shall continue un-dismissed for sixty (60) days or an order or decree approving or ordering any of the foregoing shall continue unstayed and in effect for sixty (60) days.
 
(iv)   Upon any change to or enactment of any Applicable Law or Rules which would render any portion of the Program illegal, or otherwise have a material adverse effect upon the Program; provided however that if such change does not materially affect a particular Program, that unaffected Program and this Agreement with respect thereto shall not be terminated.
 
(v)   Upon direction from any Regulatory Authority to cease or materially limit performance of the obligations under this Agreement, or upon the conclusion of Bank’s board of directors that the continued performance by Bank is consistent with safe and sound banking practices.
 
14
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
9.3   Company Purchase Options; Bank Wind-down or Retention .
 
(a)   Company Transfer Option . Company shall have the right, subject to the notice requirements herein, to purchase all of the Cardholder Accounts and direct their transfer to a successor qualified financial institution upon expiration of the applicable term of this Agreement or termination by Company for cause under Section 9.2(a). Written notice of Company’s decision to exercise this option shall be given to Bank at least thirty (30) days prior to termination of this Agreement after expiration of the applicable term under Section 9.1. In the event Company seeks to exercise this option based upon Company’s termination of the Agreement for cause under Section 9.2(a), Company shall provide written notice of its decision to exercise its option to Bank hereunder within ten (10) business days of notifying Bank of termination of the Agreement under such section. Company may only exercise its option set forth herein if Company is in compliance with all of the terms and conditions of this Agreement. In the event Company exercises its option to purchase the Cardholder Accounts, Company shall transfer the Cardholder Accounts within one hundred and eighty (180) days of the termination of the Agreement. Prior to the closing date, Company shall provide Bank with a detailed outline of its intentions in connection with the Cardholder Accounts, including the identity of the successor financial institution, the transition procedures for the transfer, and any other information reasonably requested by Bank. Company shall reimburse Bank for all expenses incurred by Bank in connection with the purchase of the Cardholder Accounts, including, but not limited to, any conversion costs or termination fees payable to any Processor with respect to the Cardholder Accounts, Bank’s reasonable attorneys’ fees incurred in connection with the transfer, and all  other reasonable out-of-pocket costs and expenses incurred by Bank in connection with the transfer of the Cardholder Accounts. Company shall ensure that all aspects of the transfer are accomplished in compliance with Applicable Law. Company shall remain in compliance with all provisions of this Agreement, including the maintenance of the appropriate balances in the Activity Account and the Reserve Account, and the timely payment of all other fees and sums called for under this Agreement through the date of transfer. Provided Company complies with the provisions of this subsection, the purchase price paid by Company to Bank in connection with the purchase of the Cardholder Accounts described herein shall be calculated as the product of 2 basis points (.0002) and the sum of outstanding balances in the Cardholder Accounts as of the date of closing and Bank shall transfer the Cardholder Account balances to the successor financial institution at closing.
 
9.4   Termination Assistance . In the event (i) Company fails to provide timely effective notice of its intent to transfer the Cardholder Accounts as set forth in subsection (a) of this Section 9.3, (ii) Company fails to close its transfer of the Cardholder Accounts within one hundred and eighty (180) days after termination of the Agreement, or (iii) the Agreement is terminated by Bank pursuant to Section 9.2(a) or 9.2(b), Bank may at its sole discretion terminate the Cardholder Agreements, continue the same and retain the benefits thereof, or sell the Cardholder Accounts (and all rights and benefits thereof) to a successor company. Unless Bank elects to continue the Cardholder Agreements or sell the same to a third party, this Agreement shall continue in full force and effect until all Cardholder Agreements are terminated, but in no event exceeding one hundred and eighty (180) days from the termination of this Agreement. During said time, Bank shall be entitled to withhold and pay directly all Program expenses from Program Revenues including the costs of all necessary servicing and processing for the Cards. In such event, Bank shall have no further obligation to accept any new Cardholder Accounts from Company. In the event Bank elects to continue the Cardholder Accounts or sell the same to a third party, Bank shall so notify Company and Company’s rights in connection with the Cardholder Accounts originated under this Agreement shall thereafter be immediately terminated. In such event, however, Company shall remain liable for any obligations owed to Bank under this Agreement. Upon termination of this Agreement, and repayment in full of all obligations of Company owed to Bank, and Bank’s reasonable determination that no additional sums are likely to be owed by Company to Bank in connection with this Agreement, Bank shall return any remaining amount held in the Reserve Account to Company.
 
9.5   Damages Upon Early Termination . The Parties agree that the pricing under this Agreement was determined by mutual agreement based upon certain assumed volumes of processing activity and the length of the Term of this Agreement. The Parties further agree that it would be difficult or impossible to ascertain Bank’s actual damages for breach of this Agreement by Company resulting in a termination of this Agreement before the end of the Term without cause under Section 9.2. The Parties further agree that in the event of such termination, the Bank is entitled to: (i) all fees earned but not paid prior to the date of termination, (ii) any direct costs incurred as a result of the termination, deconversion and/or change-over; and (iii) an amount equal to the monthly minimum amounts set forth in the Prepaid Card Program Agreement multiplied by the number of months then remaining in the Initial Term or Renewal Term. Company agrees this is a reasonable estimation of the actual damages Bank would suffer if Bank did not receive the expected benefits to be derived from this Agreement for the full Term. Company shall pay Bank said sum directly and Company acknowledges and agrees that TransCard shall have no responsibility for Company’s obligations as set forth in this Section 9.4. Each Party acknowledges and agrees, after taking into account the terms of this Agreement and all relevant circumstances at the date hereof, that the liquidated damages payable under this Section 9.4 represents a reasonable and genuine pre-estimate of the damages which would be suffered by Bank in the event of early termination of this Agreement and does not constitute a penalty. The Parties agree that the payments contemplated under this Section 9.4 shall fully satisfy any financial obligations from Company to Bank as contemplated. Nothing in this Agreement shall limit the right of any Party to this Agreement to seek injunctive relief, to the extent available, with respect to breaches of this Agreement.
 
15
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
10.
CONFIDENTIALITY
 
10.1   Confidential Information . The term “Confidential Information” shall mean this Agreement and all proprietary information, data, trade secrets, business information and other information of any kind whatsoever which (a) a Party (“Discloser”) discloses, in writing, orally or visually, to the other Party (“Recipient”) or to which Recipient obtains access in connection with the negotiation and performance of this Agreement, and which (b) relates to (i) the Discloser, (ii) in the case of Company, Bank and its customers and or associates, or (iii) consumers who have made Sensitive Customer Information available to Bank and/or Company. “Sensitive Customer Information” shall include “non-public personal information” as defined in the Gramm-Leach-Bliley Act and implementing regulations; including, without limitation, a consumer customer’s name, address, or telephone number in conjunction with the customer’s social security number, driver’s license number, account number, credit or debit card number, or a personal identification number or password that would permit access to the customer’s account, or any combination of components of customer information that would allow someone to log onto or access a customer’s account, such as a username and password, password and account number, transaction information regarding the Cardholder Account, or any other information provided to Bank or Company by a consumer in connection with the Program.
 
10.2   Sensitive Customer Information . Company acknowledges that Bank has a legal responsibility to its customers to keep Sensitive Customer Information strictly confidential in accordance with Applicable Law. Bank acknowledges that Company has a responsibility to do likewise. In addition to the other requirements set forth in this Section regarding Confidential Information, Sensitive Customer Information shall also be subject to the additional restrictions set forth in this Subsection. The Recipient shall not disclose or use Sensitive Customer Information other than to carry out the purposes for which the Discloser or one of its affiliates disclosed such Sensitive Customer Information to Recipient. Recipient shall not disclose any Sensitive Customer Information other than on a “need to know” basis and then only to: (a) affiliates of Discloser; (b) its employees or officers; (c) affiliates of Recipient provided that such affiliates shall be restricted in use and re-disclosure of the Sensitive Customer Information to the same extent as Recipient; (d) to carefully selected subcontractors provided that such subcontractors shall have entered into a confidentiality agreement no less restrictive than the terms hereof; (e) to independent contractors, agents, and consultants hired or engaged by Recipient, provided that all such persons are subject to a confidentiality agreement which shall be no less restrictive than the provisions of this Section; or (f) pursuant to the exceptions set forth in 15 U.S.C. 6802(e) and accompanying regulations which disclosures are made in the ordinary course of business. The restrictions set forth herein shall apply during the term and after the termination of this Agreement. For the purposes of this Section, Cardholders shall be considered customers of Bank.
 
10.3   Compliance with Privacy Laws . Each Party shall comply with Applicable Law with regard to privacy of Sensitive Customer Information.
 
10.4   Disclosure to Employees and Agents . Each of the Parties, as Recipient, hereby agrees on behalf of itself and its employees, officers, affiliates and subcontractors that Confidential Information will not be disclosed or made available to any person for any reason whatsoever, other than other than on a “need to know basis” and then only to: (a) its employees and officers; (b) subcontractors and other third-Parties specifically permitted under this Agreement, provided that all such persons are subject to a confidentiality agreement which shall be no less restrictive than the provisions of this Section; (c) independent contractors, agents, and consultants hired or engaged by Bank, provided that all such persons are subject to a confidentiality agreement which shall be no less restrictive than the provisions of this Section; and (d) as required by law or as otherwise permitted by this Agreement, either during the term of this Agreement or after the termination of this Agreement. Prior to any disclosure of Confidential Information as required by law, the Recipient shall (i) notify the Discloser of any, actual or threatened legal compulsion of disclosure, and any actual legal obligation of disclosure immediately upon becoming so obligated, and (ii) cooperate with the Discloser's reasonable, lawful efforts to resist, limit or delay disclosure. Nothing in this Section shall require any notice or other action by Bank in connection with request or demands for Confidential Information with request by any Regulatory Authority.
 
10.5   Information Security . Each Party warrants that it has established an information security program which contains appropriate measures designed to (i) ensure the security and confidentiality of Sensitive Customer Information; (ii) protect against any unanticipated threats or hazards to the security or integrity of such information; and (iii) protect against the unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. In the event a Party discovers any unauthorized access to any Sensitive Customer Information, such Party shall take appropriate actions to address such unauthorized access, including but not limited to promptly notifying the other Party of any such incident.
 
10.6   Return/Destruction of Materials . Upon the termination of this Agreement, or at any time upon the request of a Party, the other Party shall return or at the requesting Party’s election, destroy, all Confidential Information, including Customer Information, in the possession of such Party or in the possession of any third party over which such Party has or may exercise control.
 
16
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
10.7   Exceptions . With the exception of the obligations related to Customer Information, the obligations of confidentiality in this Section shall not apply to any information which a Party rightfully has in its possession when disclosed to it by the other Party, information which a Party independently develops, information which is or becomes known to the public other than by breach of this Section or information rightfully received by a Party from a third party without the obligation of confidentiality.
 
10.8   Media Releases . All media releases, public announcements and public disclosures by either Party, or their representatives, employees or agents, relating to this Agreement or the name or logo of Company, Bank, any Bank affiliate or supplier, including, without limitation, promotional or marketing material, but not including any disclosure required by legal, accounting or regulatory requirements beyond the reasonable control of the releasing Party, shall be coordinated with and approved by the other Party in writing prior to the release thereof unless required by law.
 
11.
INSURANCE
 
11.1   Company . Without limiting Company’s liability to Bank or third parties, Company shall maintain comprehensive or commercial general liability insurance, including coverage for products, completed operations, and blanket contractual liability for obligations undertaken by Company under this Agreement. Such comprehensive general liability insurance shall provide for minimum combined bodily injury and property damage coverage limits of $1,000,000 per occurrence or $2,000,000 aggregate and name the Bank as additional insured. In addition, the Company will obtain and maintain in force a comprehensive crime policy including employee dishonesty/fidelity coverage for all Company employees, officers and agents, with fidelity coverage limits of not less than $1,000,000 per occurrence. The policy shall also include Bank and its directors, officers, employees and agents as additional insured with respect to the work or operations done in connection with this Agreement. Coverage will include the processing provided by the Company and/or any third parties Company chooses to maintain, emboss or distribute cards. A copy of such policy or suitable evidence of insurance must be provided to Bank. All policies (providing that such insurance is primary to any liability insurance carried by Bank) must be with insurance carriers that have an A.M. Best rating of “A” or better or otherwise acceptable to Bank. The Certificate will also provide that any such policy may not be terminated or materially modified without the Insurer giving thirty (30) days prior written notice to both the Bank and Company.
 
11.2   Data Security Insurance . Company shall maintain, throughout the term of this Agreement, an appropriate insurance policy or policies providing coverage in the event of a loss of confidential data by Company, including Customer Information. The policy or policies shall have combined single limits of not less than $1,000,000 per occurrence or $2,000,000 in aggregate. The coverage shall name Bank as an additional insured and joint payee. Company shall provide such policies of insurance to Bank for Bank’s review and approval. The insurance policies must also provide that any policy may not be terminated or materially modified without thirty (30) days prior written notice to both Bank and Company.
 
12.
LIMITATION OF LIABILITY
 
12.1   No Special Damages . UNLESS OTHERWISE AGREED, IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE OTHER WHETHER IN CONTRACT, TORT, EQUITY OR OTHERWISE FOR ANY INDIRECT, INCIDENTAL, CONSEQUENTIAL, SPECIAL, PUNITIVE OR EXEMPLARY DAMAGES, INCLUDING, BUT NOT LIMITED TO, LOST PROFITS, EVEN IF SUCH PARTY HAS KNOWLEDGE OF THE POSSIBILITY OF SUCH DAMAGES ARISING FROM OR RELATED TO THIS AGREEMENT.
 
12.2   Disclaimers of Warranties . BANK SPECIFICALLY DISCLAIMS ALL WARRANTIES OF ANY KIND, EXPRESS OR IMPLIED, ARISING OUT OF OR RELATED TO THIS AGREEMENT, INCLUDING WITHOUT LIMITATION, ANY WARRANTY OF MARKETABILITY, FITNESS FOR A PARTICULAR PURPOSE OR NON-INFRINGEMENT, AND IMPLIED WARRANTIES ARISING FROM COURSE OF DEALING OR COURSE OF PERFORMANCE, EACH OF WHICH IS HEREBY EXCLUDED BY AGREEMENT OF THE PARTIES.
 
12.3   Liabilities of Company for Network and Regulatory Claims . Company shall be liable to Bank for any and all liabilities and every loss, claim, demand, and cause of action (including, without limitation, the cost of investigating the claim, the cost of litigation and reasonable attorneys’ fees, whether or not legal proceedings are instituted and whether paid or incurred (“Loss”), as the case may be) by or on behalf of any Cardholder as a result of Company’s failure to comply with the Rules or Applicable Law; provided, however, that the foregoing shall not apply to any Loss resulting from Company’s compliance with any written instructions or guidance given to it by the Bank, or any Bank-specific approvals provided hereunder and Bank shall indemnify and hold Company for any such Loss addressed against Company as a result thereof.
 
17
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
13.
GENERAL PROVISIONS
 
13.1   Indemnification .
 
(a)   Company covenants and agrees to indemnify and hold harmless Bank, its parent, subsidiaries or affiliates, and their respective officers, directors, employees and permitted assigns, as such, against any direct losses or expenses arising from any legal action, claim, demand or proceedings brought against any of them by any third party as a result of any misrepresentation, breach of warranty, Cardholder claim, or failure to fulfill a covenant of this Agreement on the part of Company, breach of any agreement with Processor, any act or omission of Company or its providers, including any Processors, merchants, Program affiliates, or any other person or entity, which violates any by-laws, Rules, or Applicable Law, any claim relating to obligations owed to or by Company or any third party retained by it, or any claim by a Cardholder or prospective Cardholder relating to the Program; provided, that this provision shall not apply if such claim arises out of (i) an act of fraud, embezzlement or criminal activity by Bank, (ii) gross negligence, willful misconduct or bad faith by Bank, (iii) the failure of Bank to comply with, or to perform its obligations under, this Agreement or (iv) Company’s compliance with any written instructions or guidance given to it by Bank or any Bank-specific approvals provided hereunder.
 
(b)   Bank covenants and agrees to indemnify and hold harmless Company and its parent, subsidiaries or affiliates, and their respective officers, directors, employees, and permitted assigns, as such, against any direct, losses or expenses arising from any legal action, claim, demand, or proceedings brought against any of them as a result of any misrepresentation, breach of warranty or failure to fulfill a covenant of this Agreement on the part of Bank, any act or omission of Bank or its providers which violates any law, by-laws or Applicable Law, or any claim relating to obligations owed to or by Bank or any third party retained by it (except to the extent that Company has agreed to fulfill such obligation under this Agreement); provided, that this provision shall not apply if such claim arises out of (i) an act of fraud, embezzlement or criminal activity by Company or its representatives, (ii) gross negligence, willful misconduct or bad faith by Company or its representatives, or (iii) the failure of Company or its representatives to comply with, or to perform its obligations under, this Agreement, or (iv) Company’s failure to comply with any written instructions or guidance given to it by Bank or any Bank-specific approvals provided hereunder.
 
(c)   If any claim or demand is asserted against any Party or Parties (individually or collectively, the “Indemnified Party”) by any person who is not a Party to this Agreement in respect of which the Indemnified Party may be entitled to indemnification under the provisions of subsections (a) or (b) above, written notice of such claim or demand shall promptly be given to any Party or Parties (individually or collectively, the “Indemnifying Party”) from whom indemnification may be sought. The Indemnifying Party shall have the right, by notifying the Indemnified Party within ten (10) days of its receipt of the notice of the claim or demand, to assume the entire control (subject to the right of the Indemnified Party to Participate at the Indemnified Party’s expense and with counsel of the Indemnified Party’s choice) of the defense, compromise or settlement of the matter, including, at the Indemnifying Party’s expense, employment of counsel of the Indemnifying Party’s choice. Any counsel retained by the Indemnifying Party for such purposes shall be reasonably acceptable to the Indemnified Party. The Indemnifying Party shall institute and maintain any such defense diligently and reasonably and shall keep the Indemnified Party fully advised as to the status thereof. If the Indemnifying Party gives notice to any Indemnified Party that the Indemnifying Party will assume control of the defense, compromise or settlement of the mailer the Indemnifying Party will be deemed to have waived all defenses to the claims for indemnification by the Indemnified Party with respect to that matter. The Indemnified Party shall have the right to employ its own counsel if the Indemnified Party so elects to assume such defense, but the fees and expense of such counsel shall be at the Indemnified Party’s expense, unless (i) the employment of such counsel shall have been authorized in writing by the Indemnifying Party; (ii) such Indemnified Party shall have reasonably concluded that the interests of such parties are conflicting such that it would be inappropriate for the same counsel to represent both parties or shall have reasonably concluded that the ability of the parties to prevail in the defense of any claim are improved if separate counsel represents the Indemnified Party (in which case the Indemnifying Party shall not have the right to direct the defense of such action on behalf of the Indemnified Party), and in either of such events such reasonable fees and expenses shall be borne by the Indemnifying Party; and (iii) the Indemnifying Party shall have reasonably concluded that it is necessary to institute separate litigation, whether in the same or another court, in order to defend the claims asserted against it; or (iv) the Indemnifying Party shall have not employed counsel reasonably acceptable to the Indemnified Party to take charge of the defense of such action after electing to assume the defense thereof. Any damages to the assets or business of the Indemnified Party caused by a failure of the Indemnifying Party to defend, compromise or settle a claim or demand in a reasonable and expeditious manner, after the indemnifying Party has given notice that it will assume control of the defense, compromise or settlement of the matter, shall be included in the damages for which the Indemnifying Party shall be obligated to indemnify the Indemnified Party.
 
(d)   The provisions of this Section 13.1 and of Section 13.2 shall survive termination or expiration of this Agreement.
 
18
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
13.2   Disclosure .
 
(a)   Each Party shall promptly notify the other of any action, suit, proceeding, facts and circumstances, and the threat of reasonable prospect of same, which might give rise to any indemnification hereunder or which might materially and adversely affect either Party's ability to perform this Agreement.
 
(b)   Each Party represents and warrants to the other that it has no knowledge of any pending or threatened suit, action, arbitration or other proceedings of a legal, administrative or regulatory nature, or any governmental investigation, against it or any of its affiliates or any officer, director, or employee which has not been previously disclosed in writing and which would materially and adversely affect its financial condition, or its ability to perform this Agreement.
 
13.3   Legal Compliance . Each Party represents and warrants to the other that it is familiar with the requirements of Applicable Law relating to its obligations under this Agreement and agrees that it will comply, in all material respects, with such Applicable Law relating to its activities under this Agreement. Notwithstanding the foregoing, this Section 13.3 shall not alter the direct responsibilities of the parties as provided in this Agreement to warrant compliance in connection with specific aspects of the Program.
 
13.4   Relationship of Parties . Bank and Company agree they are independent contractors to each other in performing their respective obligations hereunder. Nothing in this Agreement or in the working relationship being established and developed hereunder shall be deemed, nor shall it cause, Bank and Company to be treated as partners, joint ventures, or otherwise as joint associates for profit.
 
13.5   No Exclusivity. Nothing in this Agreement shall prohibit Bank or Company from operating any other programs in addition to the Program.
 
13.6   Regulatory Examinations and Financial Information . Company agrees to submit to any examination which may be required by any Regulatory Authority with audit and examination authority over Bank, to the fullest extent of such Regulatory Authority. Company shall also provide to Bank any information, which may be required by any Regulatory Authority in connection with their audit or review of Bank or the Program and shall reasonably cooperate with such Regulatory Authority in connection with any audit or review of Bank. Company shall also secure and contractually protect the right of Bank and any Regulatory Authority to audit the books and records of any Processor or other third party service provider involved in the Program. Company shall furnish Bank, at Company’s expense, with audited financial statements prepared by a certified public accountant. Company shall also provide such other information as Bank, Regulatory Authorities, or the Network may from time to time reasonably request with respect to the financial condition of Company and such other information as Bank may from time to time reasonably request with respect to third Parties contracted with Company. Nothing in this Agreement shall limit the right of any Party to this Agreement to seek injunctive relief, to the extent available, with respect to breaches of this Agreement.
 
13.7   Governing Law . This Agreement shall be governed by the internal laws, and not by the laws regarding conflicts of laws, of the State of Minnesota. Each Party hereby submits to the jurisdiction of the courts of such state, and waives any objection to venue with respect to actions brought in such courts.
 
13.8   Severability . In the event that any part of this Agreement is deemed by a court, Regulatory Authority, or other public or private tribunal of competent jurisdiction to be invalid or unenforceable, such provision shall be deemed to have been omitted from this Agreement unless such invalid or unenforceable provisions are material terms or provision of this Surety Agreement. The remainder of this Agreement shall remain in full force and effect, and shall be modified to any extent necessary to give such force and effect to the remaining provisions, but only to such extent.
 
19
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
13.9   Force Majeure .
 
(a) No Party is liable for failure to perform that Party's obligations if such failure is as a result of Acts of God (including fire, flood, earthquake, storm, hurricane or other natural disaster), war, invasion, act of foreign enemies, hostilities (regardless of whether war is declared), civil war, rebellion, revolution, insurrection, military or usurped power or confiscation, terrorist activities, government sanction, blockage, embargo, labor dispute, strike, lockout or interruption or failure of electricity or telephone service.
 
(b) If either Party asserts Force Majeure as an excuse for failure to perform that Party's obligation, then the nonperforming Party must prove that the Party took commercially reasonable steps to minimize delay or damages caused by foreseeable events, that the Party substantially fulfilled all non-excused obligations, and that the other Party was timely notified of the likelihood or actual occurrence of an event described in subsection (a) of this Section 13.9.
 
13.10   Survival . All representations and warranties herein shall survive any termination or expiration of this Agreement.
 
13.11   Successors and Third Parties . Except as limited by Section 13.12, this Agreement and the rights and obligations hereunder shall bind, and inure to the benefit of the Parties and their successors and permitted assigns.
 
13.12   Assignments . The rights and obligations of Company under this Agreement are personal and may not be assigned either voluntarily or by operation of law, without prior written consent from Bank. Bank may assign this Agreement to any affiliated entity or such other federally-insured financial institution upon reasonable notice to Company.
 
13.13   Notices . All notices, requests and approvals required by this Agreement shall be in writing addressed/directed to the other Party at the address and facsimile set forth below, or at such other address of which the notifying Party hereafter receives notice in conformity with this section. All such notices, requests, and approvals shall be deemed given upon the earlier of receipt of facsimile transmission during the normal business day or actual receipt thereof. All such notices, requests and approvals shall be addressed to the attention of:
 
Bank to: 
University National Bank
 
200 University Avenue West
 
St. Paul, MN  55103
 
Attention:  e-Banking Product Manager
 
Fax No.: 651.259.2206
   
With a copy to: 
Keith A. Gauer, Esq.
 
Davenport, Evans, Hurwitz & Smith, L.L.P.
 
206 West 14 th Street
 
P.O. Box 1030
 
Sioux Falls, SD  57101-1030
 
Fax No.: 605.335.3639
   
Company to:  Payment Data Systems
  12500 San Pedro, Suite 120
  San Antonio, Texas 78216
  Attn: Louis Hoch
   
With a copy to:
Eric A. Pullen
 
Pulman, Cappuccio, Pullen & Benson
 
2161 N.W. Military Highway, Suite 400
 
San Antonio, Texas 78213
 
20
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
13.14   Waivers . Neither Party shall be deemed to have waived any of its rights, power, or remedies hereunder except in writing signed by an authorized agent or representative of the Party to be charged. Either Party may, by an instrument in writing, waive compliance by the other Party with any term or provision of this Agreement on the part of the other Party to be performed or complied with. The waiver by either Party of a breach of any term or provision of this Agreement shall not be construed as a waiver of any subsequent breach.
 
13.15   Entire Agreement; Amendments . This Agreement constitutes the entire Agreement between the Parties and supersedes all prior agreements, understandings, and arrangements, oral or written, between the Parties with respect to the subject matter hereof. This Agreement may not be modified or amended except by an instrument or instruments in writing signed by the Party against whom enforcement of any such modification or amendment is sought.
 
13.16   Counterparts . This Agreement may be executed and delivered by the Parties in counterpart, each of which shall be deemed an original and both of which together shall constitute one and the same instrument.
 
13.17   Disputes .
 
(a)   Cooperation to Resolve Disputes. The Parties shall cooperate and attempt in good faith to resolve any Dispute promptly by negotiating between persons who have authority to settle the Dispute and who are at a higher level of management than the persons with direct responsibility for administration and performance of the provisions or obligations of this Agreement that are the subject of the Dispute.
 
(b)   Arbitration. Any Dispute which cannot otherwise be resolved as provided in paragraph (a) above, shall be resolved by arbitration conducted in accordance with the commercial arbitration rules of the American Arbitration Network, and judgment upon the award rendered by the arbitral tribunal may be entered in any court having jurisdiction thereof. The arbitration tribunal shall consist of a single arbitrator mutually agreed upon by the Parties, or in the absence of such agreement within thirty (30) days from the first referral of the dispute to the American Arbitration Network, designated by the American Arbitration Network. The place of arbitration shall be St. Paul, Minnesota, unless the Parties shall have agreed to another. The arbitral award shall be final and binding. The Parties waive any right to appeal the arbitral award, to the extent a right to appeal may be lawfully waived. Each Party retains the right to seek judicial assistance: (i) to compel arbitration, (ii) to obtain interim measures of protection prior to or pending arbitration, (iii) to seek injunctive relief in the courts of any jurisdiction as may be necessary and appropriate to protect the unauthorized disclosure of its proprietary or confidential information, and (iv) to enforce any decision of the arbitrator, including the final award. In no event shall either Party be entitled to punitive, exemplary or similar damages.
 
(c)   Confidentiality of Proceedings. The arbitration proceedings contemplated by this Section shall be as confidential and private as permitted by law, provided however that Bank is permitted to disclose the proceedings to accountants, legal counsel and professional advisors. To that end, the Parties shall not disclose the existence, content or results of any proceedings conducted in accordance with this Section, and materials submitted in connection with such proceedings shall not be admissible in any other proceeding, provided, however, that this confidentiality provision shall not prevent a petition to vacate or enforce an arbitral award, and shall not bar disclosures required by any laws or regulations.
 
13.18   Communication . Company and Bank may rely in good faith on any document, electronic file or other electronic or telephonic communication of any kind, which appears bona fide, submitted by any appropriate person respecting any matters arising hereunder.
 
13.19   Set-Off and Other Bank Remedies . In the event of any failure by Company to perform any of its obligations hereunder, Bank shall have all rights and remedies available to it at law or in equity except as otherwise provided herein. Without limiting the generality of the foregoing, Company grants to Bank a contractual security interest in, and acknowledges that Bank shall have a contractual and statutory right of set-off against, any and all accounts, funds, monies, and other properties of Company at Bank or which come into possession of Bank for the purpose of satisfying the obligations of Company hereunder. Bank’s right of setoff shall include all sums owed to TransCard in connection with fees relating to Cards issued under this Agreement. Company agrees that none of Company’s deposits at Bank shall be considered “special” deposits unavailable for set-off by Bank unless Bank has specifically so agreed in a separate writing. Company further agrees that the rights and remedies of Bank described herein are in addition to all other rights which Bank may have at law or equity.
 
13.20   Headings . The various captions and section headings in this Agreement are included for convenience only and shall not affect the meaning or interpretation of any provision of this Agreement. References in this Agreement to any Section are to such Section of this Agreement. To the extent possible, each provision of this Agreement shall be interpreted in such a manner as to be effective and valid under applicable law, but if any provision of this Agreement shall be held to be invalid, illegal, or unenforceable, such provision shall be ineffective only to the extent of such invalidity, illegality, or unenforceability, without rendering invalid, illegal, or unenforceable the remainder of such provision or the remaining provisions of this Agreement.
 
21
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
IN WITNESS WHEREOF, this Agreement is executed by the Parties’ authorized officers or representatives and shall be effective as of the date first above-written.
 
FICENTIVE, INC.     UNIVERSITY NATIONAL BANK  
         
By:
   
By:
 
Name:
   
Name:
 
Title:
   
Title:
 
 
22
THE TERMS OF THIS AGREEMENT ARE CONFIDENTIAL.
Rev. August 2011
© 2010 University National Bank, St. Paul, MN
 
 
 
 
LIST OF EXHIBITS
 
Exhibit A   Form of Program Addendum
     
Exhibit B   Form of Surety Agreement
 
Exhibits
 
1
 
 
Surety Agreement

To induce University National Bank , a federally-chartered financial institution, with offices at 200 University Avenue West, St. Paul, Minnesota 55103 ("Bank"), to enter into the Prepaid Card Program Agreement (the “Agreement”) with FiCentive, Inc., a Nevada corporation, whose principal office is located at 12500 San Pedro, Suite 120, San Antonio, TX 78216 (“Company”), the undersigned (each jointly and severally if more than one and referred to as "Surety") agrees as follows:

1.             Undertaking as Surety.   Surety unconditionally guarantees to Bank, and becomes surety for the prompt, full and faithful payment, performance and discharge of each and every term, condition, agreement, undertaking, representation, warranty and provision on the part of Company contained in the Agreement, and any other document executed or delivered by Company to Bank in connection therewith or any modification, amendment or substitution thereof, including, fees, charges and expenses reimbursable by Company to Bank  (collectively the "Obligations");

2.            Continuing Suretyship.   This Surety Agreement shall be a continuing one and shall be binding upon Surety regardless of how long before or after the date hereof any of the Obligations is or was undertaken.
 
3.             Extent of Surety’s Liability. Surety’s liability hereunder shall be limited to the terms of the Obligations. Bank may apply any payment received on account of the Obligations in such order as Bank, in its sole discretion, may elect.
 
4.             Unconditional Liability.   Surety’s liability hereunder is absolute and unconditional and shall not be reduced, diminished, released or affected in any way by reason of:  (a) any failure of Bank to obtain, retain, or preserve, or the lack of enforcement of, any rights against any person, firm or entity (including, without limitation, any Obligor, except that Bank shall use commercially reasonable efforts to attempt to enforce its rights against Company) or in any property (including, without limitation, any deposit securing any of the Obligations); (b) any delay in enforcing or any failure to enforce such rights unless such delay results in the Bank’s failure to comply with any applicable Statute of Limitations; (c) any delay in making demand on any Obligor for performance or payment of any part or all of the Obligations, unless such delay results in the Bank’s failure to comply with any applicable Statute of Limitations; or (d) future changes in conditions, including changes of law or with respect to the execution and delivery of any Obligations between Company and Bank.
 
5.             Waivers.   Except as noted herein, Surety waives all notices whatsoever with respect to this Surety Agreement and the Obligations including, without limitation: notice of the present existence or future incurring of Obligations and the amount, terms and conditions thereof. Surety specifically does not waive any notice of an event of default thereon. To the extent permitted by applicable law, Surety hereby waives the benefit of all laws now or hereafter in effect in any way limiting or restricting the liability of Surety hereunder including: (a) all defenses whatsoever to Surety’s liability hereunder: (b) any right to stay of execution or exemption of property in any action to enforce the liability of Surety hereunder; and (c)  THE RIGHT TO A JURY TRIAL IN ANY ACTION HEREUNDER OR ARISING HEREFROM OR IN CONNECTION HEREWITH and any rights established by statute or otherwise to require Bank to institute suit against Company or to exhaust its rights and remedies first against such Company, Surety being bound to the payment of each and all of the Obligations of  Company to Bank as fully as if such Obligations were directly owing to Bank by Surety.
 
6.             Events of Default.   Upon the occurrence of any of the following events (“Events of Default”), the Obligations shall, at Bank’s sole option, and without the necessity of giving any prior written or other notice to Surety except for the notice of Event of Default, be deemed to be due and payable if the Company and/or Surety have not cured such Event of Default within fifteen (15) days after such written notice. Events of Default shall include: (a) the occurrence of an Event of Default or the breach of any material obligation under the Obligations after the expiration of all applicable grace periods; (b) if Surety becomes insolvent or makes an assignment for the benefit of creditors, or if any petition is filed by or against Surety under any provision of any state or federal law or statute alleging that Surety is insolvent or unable to pay debts as they mature, or under any provision of the United States Bankruptcy Code; (c) the entry of any judgment against Surety which remains unsatisfied for thirty (30) days unless stayed pending appeal or the issuing of any attachment, levy or garnishment against any property of Surety unless execution stayed within thirty (30) days from attachment, levy or garnishment; (d) the dissolution, merger, consolidation or reorganization of Surety, if Surety is not a natural person, without the express prior written consent of Bank; (d) if any information now or hereafter furnished to Bank by Surety or delivered to Bank by any Obligor in connection with any of the Obligations should be materially false or incorrect; or (e) the failure of Surety to promptly furnish to Bank such financial and other information as Bank may reasonably request or require from time to time.
 
Exhibits
 
2
 
 
7.             Bank’s Rights Upon Default.   Upon the occurrence of any Events of Default and the required notice period as set forth in Section 6, Bank may, without the necessity of giving any prior written or other notice to Surety:  (a) exercise all of its rights and remedies under any agreement, instrument, or document issued in connection with or arising out of or relating to any of the Obligations; and (b) initiate any other legal action on this Surety Agreement and/or any of the Obligations.
 
8.             Payment of Costs and Attorneys’ Fees.   Company agrees to pay the Bank’s reasonable attorneys’ fees in connection with any successful litigation to enforce Company’s obligations under this Agreement.
 
9.             Reaffirmation of Surety’s Obligations. Surety agrees that it will promptly execute and deliver to Bank written reaffirmation of Surety’s obligations hereunder, if so requested by Bank from time to time.  Surety’s absolute obligation to make such reaffirmations is not to be construed to infer an absence of liability on Surety’s behalf in any instance in which Surety is not asked to reaffirm (or fails to reaffirm) its obligations notwithstanding any modification of the Company’s Obligations to Bank.
 
10.           Address of Surety.   Warrants that the address set forth below immediately following Surety’s name and signature, is Surety’s current and correct address and principal place of business (if Surety is a corporation, limited liability company, partnership, or other legal entity), and agrees to notify Bank, in the manner set forth below, within three (3) days of any change in Surety’s address.

11.           Notice to Bank by Surety.   Any notice to Bank by Surety pursuant to the provisions of this Surety Agreement shall be sent by certified mail, return receipt requested, addressed as follows:

University National Bank
200 University Avenue West
St. Paul, MN  55103
Attn:  Nichol L. Beckstrand

With a copy to:
Keith A. Gauer
Davenport, Evans, Hurwitz & Smith, LLP
PO Box 1030
206 W. 14 th Street
Sioux Falls, SD 57101-1030

Notice to Surety by Bank.   Any notice to Surety by Bank pursuant to the provisions of this Surety Agreement shall be sent by certified mail, return receipt requested, addressed as follows:

Payment Data Systems
12500 San Pedro, Suite 120
San Antonio, Texas 78216
Attn: Louis Hoch

With a copy to:
Eric A. Pullen
Pulman, Cappuccio, Pullen & Benson
2161 N.W. Military Highway, Suite 400
San Antonio, Texas 78213
 
Exhibits
 
3
 
 
12.           Miscellaneous Provisions.   The term "Surety" as used in this Surety Agreement refers individually and collectively to all persons or entities executing this Surety Agreement as Surety, and all persons or entities executing this Surety Agreement as Surety shall be bound jointly and severally by the terms and provisions of this Surety Agreement. Further, the term "Surety" as used in this Surety Agreement shall have the meaning given to that term in the Restatement of the Law (Third) of Suretyship and Guaranty . All representations, warranties and agreements of Surety made in connection with this Surety Agreement shall bind Surety's personal representatives, heirs, successors and assigns and other legal representatives, and shall inure to the benefit of Bank, its endorsees, successors and assigns forever. If any provision of this Surety Agreement shall for any reason be held to be invalid or unenforceable, such invalidity or unenforceability shall not affect any other provision hereof, but this Surety Agreement shall be construed as if such invalid or unenforceable provision had never been contained herein. Except as set forth herein, the failure of Bank to exercise any right or remedy to which it may be entitled upon or after the occurrence of any Event of Default shall not be deemed to be a waiver of that or any subsequent Event of Default. The rights and remedies of Bank under this Surety Agreement and the Obligations shall be in addition to any other rights and remedies available to Bank at law or in equity, all of which may be exercised singly or concurrently. Surety represents and warrants that under the law of the place of its organization (if not a natural person), and its organizational and other governing documents, it has the power and legal capacity to enter into this Surety Agreement and that all corporate, company, partnership or other action necessary for it to enter into, execute and deliver this Surety Agreement has been taken. Surety further warrants that its making of this Surety Agreement is not in violation of any agreement, understanding, covenant, order, judgment, decree or regulation to which it or any of its property is subject. This Surety Agreement has been delivered to and accepted by Bank in the State of Minnesota. This Surety Agreement shall be governed by the laws of the State of Minnesota. The parties agree to the exclusive jurisdiction of the federal and state courts located in Minnesota in connection with any matter arising hereunder, including the collection and enforcement hereof, except as Bank may otherwise elect. In the event that this Surety Agreement is preceded or followed by any other guaranty or surety agreement(s), all rights granted Bank in such agreement(s) shall be deemed to be cumulative. Surety intends this to be a sealed instrument and to be legally bound hereby.

IN WITNESS WHEREOF, this Surety has duly executed this Surety Agreement on this ____ day of ______, 2011.
 
Surety:
 
  Payment Data Systems, Inc.  
       
 
By:
   
       
  Its:    
       
       
   
Address of Surety:
 
   
12500 San Pedro, Suite 120
 
   
San Antonio, TX 78216
 
 
Exhibits
 
4
EXHIBIT 10.19

Third Amendment to Employment Agreement
 
This Third Amendment (“Third Amendment”) to the Employment Agreement (the "Agreement") dated February 27, 2007 between Payment Data Systems, Inc. ("PDS") and Michael R. Long (“Executive") is entered into this 14th day of January, 2011 and is made part of the Agreement which is hereby amended as follows:

1. Definitions. All capitalized terms used herein and not expressly defined herein shall have the respective meanings given to such terms in the Agreement.

2. Entire Agreement. Except as expressly modified by this Third Amendment, the Agreement shall be and remain in full force and effect in accordance with its terms and shall constitute the legal, valid, binding and enforceable obligations of PDS and Executive.

3. Successors and Assigns. This Third Amendment shall be binding upon and inure to the benefit of the successors and permitted assigns of the parties hereto.

4. Section References. Section titles and references used in this Third Amendment shall be without substantive meaning or content of any kind whatsoever and are not a part of the agreements among the parties hereto evidenced hereby.

5. Now, therefore, in consideration of the mutual covenants set forth herein and for other good and valuable consideration, the adequacy, receipt and sufficiency of which are hereby acknowledged:

The Base Salary as set forth in Schedule 4(a)(i) of Schedule 1 to the Agreement is hereby amended to be $24,000 per annum in year 2011.

This Third Amendment amends the Agreement as set forth herein. All previously existing obligations under the Agreement are hereby reaffirmed in all respects.

In witness thereof, the parties hereto have caused this Third Amendment to the Agreement to be executed on the day and year first above written.
 
 
Payment Data Systems, Inc.     Executive  
         
/s/ Louis A. Hoch
   
/s/ Michael R. Long
 
Name: Louis A. Hoch
   
Name: Michael R. Long
 
Title: President & COO
   
Title
 
EXHIBIT 10.20
Third Amendment to Employment Agreement
 
This Third Amendment (“Third Amendment”) to the Employment Agreement (the "Agreement") dated February 27, 2007 between Payment Data Systems, Inc. ("PDS") and Louis A. Hoch (“Executive") is entered into this 14th day of January, 2011 and is made part of the Agreement which is hereby amended as follows:

1. Definitions. All capitalized terms used herein and not expressly defined herein shall have the respective meanings given to such terms in the Agreement.

2. Entire Agreement. Except as expressly modified by this Third Amendment, the Agreement shall be and remain in full force and effect in accordance with its terms and shall constitute the legal, valid, binding and enforceable obligations of PDS and Executive.

3. Successors and Assigns. This Third Amendment shall be binding upon and inure to the benefit of the successors and permitted assigns of the parties hereto.

4. Section References. Section titles and references used in this Third Amendment shall be without substantive meaning or content of any kind whatsoever and are not a part of the agreements among the parties hereto evidenced hereby.

5. Now, therefore, in consideration of the mutual covenants set forth herein and for other good and valuable consideration, the adequacy, receipt and sufficiency of which are hereby acknowledged:

The Base Salary as set forth in Schedule 4(a)(i) of Schedule 1 to the Agreement is hereby amended to be $24,000 per annum in year 2011.

This Third Amendment amends the Agreement as set forth herein. All previously existing obligations under the Agreement are hereby reaffirmed in all respects.

In witness thereof, the parties hereto have caused this Third Amendment to the Agreement to be executed on the day and year first above written.
 
 
Payment Data Systems, Inc.     Executive  
         
/s/ Michael R. Long    
/s/ Louis A. Hoch
 
Name: Michael R. Long    
Name: Louis A. Hoch
 
Title: CEO & CFO
     
EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
We consent to the incorporation by reference in the Registration Statements (Form SB-2 No. 333-145656) of Payment Data Systems, Inc.; (Form S-8 No. 333-122312) pertaining to the Amended and Restated 1999 Employee Comprehensive Stock Plan of Payment Data Systems, Inc. and the Amended and Restated 1999 Non-Employee Director Plan of Payment Data Systems, Inc.; and (Form S-8 No. 333-30958) pertaining to the Employee Stock Purchase Plan of Payment Data Systems, Inc. of our report dated April 2, 2012, with respect to the consolidated financial statements of Payment Data Systems, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 2011.
 
         
AKIN, DOHERTY, KLEIN & FEUGE, P.C.    
 
 
San Antonio, Texas        
         
April 2, 2012        
EXHIBIT 31.1
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
(18 U.S.C. SECTION 1350)
 
I, Michael R. Long, certify that:
 
1.
I have reviewed this Annual Report on Form 10-K of Payment Data Systems, Inc.;
 
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.
As the registrant’s certifying officer, I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
 
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
 
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
 
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
 
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5.
As the registrant’s certifying officer, I have disclosed, based on my most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
 
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
 
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
 
Date: April 2, 2012
By:
/s/ Michael R. Long
 
   
Michael R. Long
Chairman of the Board, Chief Executive Officer, and Chief Financial Officer
(Principal Executive Officer and Principal Financial and Accounting Officer)
 
EXHIBIT 32.1
 
CERTIFICATION PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(18 U.S.C. SECTION 1350)
 
Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), the undersigned officer of Payment Data Systems, Inc., a Nevada corporation (the “Company”), does hereby certify, to such officer’s knowledge, that:
 
The Annual Report on Form 10-K for the year ended December 31, 2011 (the “Form 10-K”) of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
 
Date: April 2, 2012
By:
/s/ Michael R. Long
 
   
Michael R. Long
Chairman of the Board, Chief Executive Officer, and Chief Financial Officer
(Principal Executive Officer and Principal Financial and Accounting Officer)