Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This Quarterly Report on Form 10-Q (this "Report") contains various forward-looking statements. Such statements can be identified by the use of the forward-looking words "anticipate," "estimate," "project," "likely," "believe," "intend," "expect," or similar words. These statements discuss future expectations, contain projections regarding future developments, operations, or financial conditions, or state other forward-looking information. When considering such forward-looking statements, you should keep in mind the risk factors noted in the section entitled "Risk Factors" below and other cautionary statements throughout this Report and our other filings with the SEC. You should also keep in mind that all forward-looking statements are based on management's existing beliefs about present and future events outside of management's control and on assumptions that may prove to be incorrect. If one or more risks identified in this Report or any other applicable filings materializes, or any other underlying assumptions prove incorrect, our actual results may vary materially from those anticipated, estimated, projected, or intended.
Unless the context requires otherwise, all references to "Ideal," "we," "Ideal Financial Solutions, Inc.," or the "Company" in this Report refer to Ideal Financial Solutions, Inc. and all of its consolidated subsidiaries.
Company Overview
We provide a suite of online, subscription-based software solutions for debt elimination, cash management, bill payment and wealth creation. In addition, these programs come with debt reduction coaching and customer service.
Our principal product offering is our Cashflow Management Tool, which has two components. The first is a debt management and reduction software called iDebtManager. iDebtManager is a web-based application used by customers to organize a debt payment plan. The second is called iBillManager, which interfaces with a third-party, electronic bill-payment system called Metavante (recently acquired by Fidelity), which uses electronic debit transactions to automate all bill payments for customers.
We currently provide Internet-based debt management and wealth building services to over 80,000 customers. We plan to continue to build upon our success, strengths, and reputation as a leading and reliable provider of automated finance management software. With the success in our marketing campaigns, we have been able to see a large increase in revenues and profitability over the last few years, which have allowed us to pay off our interest-bearing debt, expand our management team to further our growth and expand our pursuits to increase stockholder value through greater market penetration, additional services and profitability.
Management believes that we are well positioned in the marketplace as a supplier of subscription-based cash management services in all fifty states. By leveraging the existing scalability of our system, our strategic marketing partners and world-class customer service partners, we believe that we can continue to grow at a strong rate over the long term.
Online subscriptions to our services mainly come from potential customers seeing an offer for our services on the websites of third-party vendors, referred to as lead providers. The websites contain a description of our services, the terms and conditions of our agreement with the customer, the customer's agreement with those terms and conditions by a click on the website and a link to a credit card payment web page.
Since credit card fraud is so prevalent on the Internet, one solution the Company has implemented is to accept payment for their service by eCheck. The acceptance of payment by check is governed and protected by the federal government. Beginning in July of 2010, all of the Company's new business is through eCheck. This may limit expansion of, and even lead to contractions in, our revenue.
General Outlook
We have generated a net loss during the third quarter of 2010 ended September 30, 2010, which is a change from the net income generated in the second quarter of 2010 but contributes to total net loss for the nine months ended September 30, 2010. Revenues of our services have decreased as we have begun the process of migrating our business from credit card sales to the eCheck or Check 21 system. In addition, our accrued liabilities and total expenses for the nine months ended September 30, 2010 have increased due to a fine in connection with excessive charge-back refunds on our VISA account. We are currently negotiating with VISA to resolve the issue and hope to reduce the fine assessed.
We have completed our registration with the SEC under the Securities Exchange Act of 193 and anticipate that our stock will be traded on the OTC Bulletin Board after a broker files the required forms with FINRA. We have also increased our customer service footprint by hiring a consultant with over 25 years experience with the anticipation of building an in-house customer service facility to better serve our customers.
Finally, we are branching our marketing efforts into new areas including providing our services to the clients of companies that specialize in offering loans including payday loan companies, credit unions and mortgage companies.
Results of Operations - Quarters Ended September 30, 2010 and 2009
The following discussions are based on the consolidated balance sheets as September 30, 2010 and statement of operations for the three months ended September 30, 2010 and 2009 and notes thereto.
Revenues and Cost of Revenues
Revenues are achieved through offering subscriptions to our various online applications for automating debt reduction, cash management and wealth building. Revenues from sales of our services for the three months ended September 30, 2010 were $595,364, a decrease of $1,352,164 from $1,947,528 for the three months ended September 30, 2009.
Following the first quarter of 2010, we incurred a high volume of charge-backs on credit card transactions. We determined that this was caused by one particular lead provider who omitted our customer service contact information and telephone number from the terms and conditions of our agreement on their website. Without this customer service telephone number, customers, who normally would have contacted the Company and requested a refund, instead were left with no option other than to contact their bank to request a charge-back to their credit card. Upon identifying this problem, we immediately terminated our relationship with this lead provider. We have also changed our method for receipt of payment from credits cards to eCheck or Check 21 system. Our revenues for the quarter ended September 30, 2010 have decreased as a result of the termination of this marketing partner and change of our method for receiving payments; however, we are seeking to establish relationships with new lead providers and address credit card processing issues and have some promising contacts.
Expenses
Total operating expenses for the three months ended September 30, 2010 were $754,400, a decrease of $962,746 from expenses of $1,717,146 for the three months ended September 30, 2009. The decrease in operating expenses was due to decreases in all categories of operating expenses commensurate with our revenues for the three months ended September 30, 2010 as compared with the three months ended September 30, 2009 with the exception of the $707,500 fine that was included in general and administrative expense and salaries.
Our marketing expenses decreased by $869,194, to $5,244, in the three months ended September 30, 2010, from $874,438 in the three months ended September 30, 2009. This decrease in marketing expenses is a result of ceasing our affiliation with a certain lead provider and relying upon repeat customers, which require no marketing expenditures. Our customer service expenses decreased by $29,018, to $174,345, in the three months ended September 30, 2010 from $203,363 in the three months ended September 30, 2009. The increase in customer service expense is due to a new initiative by the Company to expand and improve our customer service.
Expenses relating to salaries increased by $69,689, to $230,294, in the three months ended September 30, 2010 from $160,605 in the three months ended September 30, 2009 as a result of adding new employees to payroll. Expenses relating to professional fees decreased by $93,782, to $113,314, in the three months ended September 30, 2010 from $207,096 in the three months ended September 30, 2009 due to the expenses related to reporting with the SEC from additional accounting staff, audit and attorney fees. Our general and administrative expenses decreased by $40,441, to $231,203, in the three months ended September 30, 2010 from $271,644 in the three months ended September 30, 2009. The decrease in general and administrative expenses is due to decreases in overall operations.
Our other expenses decreased because interest expense was $0 in the three months ended September 30, 2010 as we have no interest-bearing debt.
For three months ended September 30, 2010, we have reported net loss of $156,559, which represents a change of $388,279 compared to our net income of $231,720 for the three months ended September 30, 2009. The principal drivers of this decrease in net income are: decrease in new customer sales, revenue coming out of deferral and being recognized and a reduction in most expenses, offset by the accrual of a fine.
Results of Operations - Nine Months Ended September 30, 2010 and 2009
The following discussions are based on the consolidated balance sheets as September 30, 2010 and statements of operations for the nine months ended September 30, 2010 and 2009 and notes thereto.
Revenues and Cost of Revenues
Revenues from sales of our services for the nine months ended September 30, 2010 were $5,606,155, an increase of $442,134 from $5,164,021 for nine months ended September 30, 2009. Sales in the first half of 2010 increased year-over-year due to a partnership with a new marketing affiliate who aggressively found new customers.
Following the first quarter of 2010, we incurred a high volume of charge-backs on credit card transactions. We determined that this was caused by one particular lead provider who omitted our customer service contact information and telephone number from the terms and conditions of our agreement on their website. Without this customer service telephone number, customers, who normally would have contacted the Company and requested a refund, instead were left with no option other than to contact their bank to request a charge-back to their credit card. Upon identifying this problem, we immediately terminated our relationship with this lead provider. Our revenues for the nine-months ended September 30, 2010 were not significantly harmed by this termination; however, we experienced a decline in revenue in the three months ended September 30, 2010 and expect to see a decrease for the remainder of 2010 as we seek to establish relationships with new lead providers and address credit card processing issues.
Expenses
Total operating expenses for the nine months ended September 30, 2010 were $5,983,040, an increase of $1,625,098 from $4,357,942 for the nine months ended September 30, 2009. The increase in operating expenses was due to increases in most categories of operating expenses commensurate with our increase in revenues for the nine months ended September 30, 2010 as compared with the nine months ended September 30, 2009 and a fine assessed against the Company.
Our marketing expenses increased by $33,349, to $2,577,464 in the nine months ended September 30, 2010, from $2,544,115 in the nine months ended September 30, 2009. This decrease in marketing expenses is a result of a decrease in new customers, as our marketing expenses largely consist of the fee we pay to referral sources for customer leads. Our customer service expenses decreased by $90,515, to $460,080, in the nine months ended September 30, 2010 from $550,595 in the nine months ended September 30, 2009. The decrease in customer service expense is due to increased scrutiny of the activity and requirements of our customers and from the overall reduction of new customers.
Expenses relating to salaries increased by $337,246, to $721,164, in the nine months ended September 30, 2010 from $383,7918 in the nine months ended September 30, 2009 as a result of adding new employees to payroll. Expenses relating to professional fees increased by $81,576 to $510,271 in the nine months ended September 30, 2010 from $428,695 in the nine months ended September 30, 2009 due to the expenses related to reporting with the SEC from additional accounting staff, audit and attorney fees. Our general and administrative expenses increased by $1,263,442, to $1,714,061, in the nine months ended September 30, 2010 from $450,619 in the nine months ended September 30, 2009. The increase in general and administrative expenses is due to increases in overall operations and the accompanying expenses and the assessment of a fine of $707,500.
Our other expenses decreased because interest expense was $0 in the nine months ended September 30, 2010, as we have no interest-bearing debt.
For nine months ended September 30, 2010, we have reported a net loss of $371,633, which represents a decrease of $749,481,137,7614 compared to our net income of $766,130 for the nine months ended September 30, 2009. Our net loss is largely due to the accrual of a fine assessed to us for excessive credit card refunds of $707,500, which is included in general and administrative expenses.
Liquidity and Capital Resources
Cash Flow
We used $123,039 in cash for operations during the nine months ended September 30, 2010 compared to obtaining $750,834 from operating activities during the nine months ended September 30, 2009.
For the nine months ended September 30, 2010, our primary source of cash has continued to be from operations. We used cash to pay down $124,871 in accounts payable, but used cash to fund a large increase in accrued liabilities of $729,132 for which the majority is an accrual of a probable fine related to excessive refunds on merchant accounts. We reduced accrued salary to the CEO and President by transferring the title of our land to them. Accrued wages were reduced by the value of the land, $70,870. With a decrease in new customers, our deferred revenue has come out of deferment providing $147,665 in cash. Merchant reserves have increased as new online payment systems have been put into place requiring cash of $272,253. We used $18,461 in cash to invest in computer and phone equipment and had no financing activities.
For the nine months ended September 30, 2009, we obtained cash through operations and an increase to deferred revenue of $183,140 and an increase in accounts payable of $73,047 and used it to pay $171,537 in accrued liabilities, $207,685 in cash was used to accommodate increases in merchant reserves.
For the nine months ended September 30, 2009, our primary source of cash was from operations. We freed up cash by paying for services with common stock valued at $79,005 and an increase in accounts payable of $73,047. In 2009, because of our new model for lower cost subscriptions rather than high priced service for a few individuals, we experienced a large increase in revenue and consequently an increase in deferred revenue $183,140. Similarly, merchant reserves increased as revenues increased, which used $207,685 in cash. We also used $102,280 to purchase land, computer and phone equipment. Finally, financing activities included $147,319 of cash to redeem 62,294,467 shares of common stock and place them in treasury, a loan of $24,238 to employees as interest bearing notes and we paid off $279,851 in notes payable.
Capital Expenditures.
We expect capital expenditures during the next 12 months to include upgrades to our software product or the purchase of new software. We will need to fund such expenditures with revenues or through borrowing or by selling equity securities.
Current and Expected Liquidity.
As of September 30, 2010, we had cash and cash equivalents of $187,356 and current assets of $754,979. As of September 30, 2010, we had current liabilities of $1,992,377, which is made up of $199,406 in accounts payable, $1,591,493 in accrued liabilities, $184,248 in deferred revenue and $17,230 in notes payable, creating a working capital deficit of $1,237,398.
Our $1,591,493 in accrued liabilities as of September 30, 2010 is made up of $682,027 in accrued salaries earned by the CEO, COO and President during the period 2004-2007, $83,681 in accrued refunds, $118,285 is accrued payroll and other miscellaneous liabilities and $707,500 in a fine assessed against the Company for excessive credit card refunds. The Company's legal counsel is currently evaluating the fine and is in negotiations to resolve the balance and terms of payment, if any; however, payment has been deemed "probable" and therefore was accrued.
As of December 31, 2009, we had cash and cash equivalents of $328,856 and current assets of $640,700. As of December 31, 2009, we had current liabilities of $1,611,116, which is made up of $328,743 in accounts payable, $933,230 in accrued liabilities, $331,913 in deferred revenue and $17,230 in notes payable, creating a working capital deficit of $970,416.
Our $933,230 in accrued liabilities as of December 31, 2009 is made up of $783,054 in accrued salaries earned by the CEO and President during the period 2004-2007, $62,547 in accrued refunds and $87,629 in accrued payroll and other miscellaneous liabilities. The accrued salary does not bear interest, has no payment schedule or priority and is paid out of profits when management believes operations will not be impacted negatively.
Our cash resources are not sufficient to meet our operating needs for the next 12 months unless we are able to generate positive cash flow from operations. Otherwise, we will be required to seek outside capital funding.
We have relied on cash from operations as the sole source of cash for the past three years. We have used our positive cash flow from the last two years to pay down external debt and begin paying down accrued salaries and other liabilities, while increasing operations and staff and commencing the process of registering with the SEC.
Due to a streamlined business model and corporate structure, our fixed cash requirements are between $200,000 and $250,000 per month; we currently are able to meet these cash requirements through revenues from our current customers, which generally generates $350,000 to $650,000 in cash per month. Even with increased expenses associated with being a reporting company, we expect to be able to experience positive cash flow to cover planned operations (but not extraordinary events) if operations continue at current levels. Because of recent changes in credit card merchanting rules and the Company's recent loss of a significant credit card processing relationship, there is a risk that net cash flow will not continue at current levels during the remainder of 2010, and we may be required to seek additional capital and reduce expenditures.
Due to recent changes in credit card merchanting rules and regulations, certain online activity has become limited. As a result, our total online activity in relation to total sales is limited, which may limit our access to cash for operations. In addition, as previously described, we experienced a result a high volume of chargebacks on credit card transactions in early 2010, which lead to increased minimum merchant reserve levels in the second quarter of 2010, as evidenced by the $272,253 in cash used to finance our merchant reserves. We expect merchant reserve requirements to remain high into the future. We have taken steps to remedy this new limitation by seeking new avenues of electronic payment such as ACH and eCheck options. We believe that these remedies will permit the Company to offset most of the effect of the changes in merchanting rules and increases in reserve requirements in the short term and create an environment for growth long-term.
We also lost our relationship with this same credit card processor as a result of the chargebacks in 2010, and were notified of a related $707,500 fine. We may pursue relationships with other credit card processors and, since our marketing, customer service and other expenses generally decrease proportionately with revenue, we expect to be able to offset much of the reduction in cash receipts with reductions in cash expenses. However, until we can provide credit card processors with assurance that our transactions will not result in significant chargebacks and can enter into additional processing relationships, these credit card processing limits may harm our cash flow during the remainder of 2010.
To the extent we experience a net reduction in cash flow, or are unable to reduce or negotiate extended payment terms for the $707,500 fine, we may be required to raise additional capital. In the event that we need additional capital, because we do not have traditional assets such as equipment, inventory or trade receivables, our access to traditional institutional financing is limited; however, we believe that any effort to raise additional capital would benefit from our absence of significant external debt, guaranties, off-balance sheet financing or similar long term liabilities. To raise additional capital, we would need to issue debt and/or equity securities, including potentially warrants and convertible securities. We do not have any commitments from any party to provide any such capital but do believe we could raise additional capital if needed.
Risk Factors
Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below, and all of the other information set forth in this Report before deciding to invest in shares of our common stock. In addition to historical information, the information in this Report contains forward-looking statements about our future business and performance. Our actual operating results and financial performance may be different from what we expect as of the date of this Report. The risks described in this Report represent the risks that management has identified and determined to be material to our company. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, may also materially harm our business operations and financial condition.
Our accountants have included an explanatory paragraph in our annual audited financial statements regarding our status as a going concern.
Our financial statements included in the Report have been prepared on the assumption that we will continue as a going concern. Our independent registered public accounting firm has stated that it substantially doubts our ability to continue as a going concern in a report dated as of August 16, 2010. This doubt is based on the fact that, as of December 31, 2009, we had a stockholders' deficit of $859,098, and current liabilities exceeded current assets by $970,416. In addition, during the second quarter of 2010, we incurred a $707,500 charge for alleged credit card fines and penalties incurred in excess of the reserves held by a merchant.
Our operating results have fluctuated significantly in the past and will continue to fluctuate in the future, which could cause our stock price to decline.
Our operating results have fluctuated significantly in the past, and we believe that they will continue to fluctuate in the future, due to a number of factors, many of which are beyond our control. Factors that may affect our operating results include the following:
� additions and losses of customers;
� additions or losses of marketing and referral partners, or changes in the number or quality of clients referred by continuing marketing and referral partners;
� our ability to enhance our services and products with new and better functionality;
� costs associated with obtaining new customers, improving our products and expanding our management team and number of advisors;
� new product announcements or introductions or changes in pricing by our competitors;
� technology and intellectual property issues associated with our products; and
� general economic trends, including the level of concern by the general public about debt and debt reduction.
If in future periods our operating results do not meet the expectations of investors, our common stock price may fall.
We may be unable to raise capital needed to pay current liabilities or for operations going forward or may be required to pay a high price for capital. Due to our large working capital deficit of $1,237,398, we may not have enough capital to fund operations.
As of September 30, 2010, our current liabilities exceeded our current assets by $1,237,398. We may need as much as $1 million from operations or financing in order to pay obligations and continue operations. We also expect our general and operating expenses to increase by approximately $150,000 in 2011 as we become subject to the public company reporting requirements, and we expect that amount to increase significantly in late 2011 as we become subject to certain internal control requirements.
If cash generated from operations does not increase as expected, or we experience unexpected increases in expenses, we will likely need to raise additional capital. We may not be able to raise the additional capital needed or may be required to pay a high price for capital. Factors affecting the availability and price of capital may include the following:
� the availability and cost of capital generally;
� our financial results;
� the experience and reputation of our management team;
� market interest, or lack of interest, in our industry and business plan;
� the price and trading volume of, and volatility in, the market for our common stock;
� our ongoing success, or failure, in executing our business plan;
� the amount of our capital needs; and
� the amount of debt, options, warrants and convertible securities we have outstanding.
We may be unable to meet our current or future obligations or to adequately exploit existing or future opportunities if we cannot raise sufficient capital, which in the long run may lead to a contraction of our business and losses.
We are dependent on a concentrated number of referral sources, and a material reduction of new referrals from any of our significant referral sources would harm our financial results. Our relationships with our most significant lead provider in 2009 as terminated in 2010, and a separate relationship that accounted for over 90% of our revenue in the first quarter of 2010 was terminated in the second quarter of 2010.
Historically, a significant portion of our revenues has been referred through a limited number of lead providers. In August 2009, our relationship with a lead provider that had referred to us customers accounting for 83% of our new client revenue during the first eight months of 2009 terminated. In April, 2010, our relationship with a lead provider that had referred to us customers accounting for over 90% of our new client revenue in the first quarter of 2010 was terminated. On average, we lose approximately 20% of our new customers per month and retain only about 20% of new customers longer than five months. As a result, the termination of this relationship has lead to declining growth in the . . .
