10-Q 1 dcti-10q123102.txt DCTI 10Q 123102 Version20 SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2002 ----------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------- -------------- Commission File Number 0-20771 DIGITAL COURIER TECHNOLOGIES, INC. (Exact name of registrant as specified in its charter) Delaware 87-0461856 ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 348 East 6400 South, Suite 220 Salt Lake City, Utah 84107 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (801) 266-5390 ---------------------------------------------------- (Registrant's telephone number, including area code) 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. Yes [X] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: As of February 19, 2003, the Registrant had issued and outstanding 75,000,000 shares of common stock, par value $.0001 per share. 1

2 PART I. FINANCIAL INFORMATION ITEM 1. Condensed Consolidated Financial Statements (unaudited) DIGITAL COURIER TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS ASSETS December 31, June 30, 2002 2002 (unaudited) ------------ ------------ CURRENT ASSETS: Cash $ 6,936 $ 47,492 Restricted cash 2,353,341 10,507,453 Receivable from payment processor 326,383 146,820 Prepaid expenses and other current assets 294,878 366,680 ------------ ------------ Total current assets 2,981,538 11,068,445 ------------ ------------ PROPERTY AND EQUIPMENT: Computer and office equipment 166,362 7,471,563 Furniture, fixtures and leasehold improvements 32,222 391,756 ------------ ------------ 198,584 7,863,319 Less accumulated depreciation and amortization (178,816) (6,921,417) ------------ ------------ Net property and equipment 19,768 941,902 ------------ ------------ TOTAL ASSETS: $ 3,001,306 $ 12,010,347 ============ ============ See accompanying notes to condensed consolidated financial statements. 3

See accompanying notes to condensed consolidated financial statements. 4

See accompanying notes to condensed consolidated financial statements. 5

See accompanying notes to condensed consolidated financial statements. 6

See accompanying notes to condensed consolidated financial statements. 7

During the six months ended December 31, 2002 the Company: o Satisfied an other accrued liability to a related party of $798,570 with a $290,526 related party note payable and 28,948,428 shares of the Company's common stock. o Sold property and equipment in exchange for an $180,000 note receivable. o Satisfied an account payable with a $260,000 note payable. See accompanying notes to condensed consolidated financial statements. 8 DIGITAL COURIER TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1 - INTERIM CONDENSED FINANCIAL STATEMENTS Significant Events During the Period o M2 Transaction During the three months ended December 31, 2002, the Company expanded its relationship with M2 Corporation. The Company sold M2 a license giving M2 certain rights to use its software. In addition, the Company sold essentially all of its data center assets. These transactions are discussed in detail in Note 7 below. As a result of this transaction, all of the Company's processing services have been contracted out to M2. M2 performs the processing services for the Company's customers; the Company charges its customers for such services and pays a fee to M2. o Settlement of Accounts Payable The Company successfully negotiated the settlement of a disputed trade payable. The Company settled a liability of $744,829 with a note payable of $275,000. The promissory note bears simple interest at a rate of 6.00% apr and is to be paid in monthly installments of $15,000 until June 15, 2004 when the entire unpaid principal and interest balance is due. $15,000 was paid by December 31, 2002. This resulted in a gain of $484,556 being recorded during the three months ended December 31, 2002. o Change in Estimate of Chargeback Accrual The Company recorded a gain of $1,298,748 on a change in accounting estimate during the three months ended December 31, 2002. The Company maintains a reserve for unrecoverable merchant chargebacks. Based upon management estimates and analysis, which considered the recent minimal amounts of unrecoverable merchant chargebacks recorded and decreasing processing volumes, the reserve was decreased resulting in the recorded gain. o Loss of Significant Customer As fully discussed in Note 8, during the three months ended December 31, 2002 the Company lost its relationship with its European processing partner and, as a result, significant merchant processing volume. o Increase in Accrual for Legal Settlement The Company recorded expense of $1,361,257 during the three-month period ended December 31, 2002 related to a pending settlement of the Bank of Nevis legal matter. The matter and settlement are fully discussed below under Legal Matters in Note 3 below. 9 Condensed Unaudited Financial Statements The accompanying interim condensed financial statements as of December 31, 2002 and for the three and six months ended December 31, 2002 and 2001 are unaudited. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation have been included. The financial statements are condensed and, therefore, do not include all disclosures normally required by U.S. generally accepted accounting principles. These financial statements should be read in conjunction with the Company's annual financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2002. The results of operations for the three and six months ended December 31, 2002 are not necessarily indicative of the results to be expected for the entire fiscal year ending June 30, 2003. Certain previously reported amounts have been reclassified to conform to the current period presentation. These reclassifications had no effect on the previously reported net loss. Substantial Doubt About the Company's Ability to Continue as a Going Concern During the three months ended December 31, 2002 the Company's operations generated income of $762,339, however operating income was mainly a result of a non-cash adjustment of $1,298,748 to our chargeback accrual due to a change in estimate. Without this adjustment, we would have incurred a significant operating loss. During the six months ended December 31, 2002 the Company's operations generated income of $258,569, however operating income was mainly a result of a non-cash adjustment of $1,298,748 to our chargeback accrual due to a change in estimate. Without this adjustment, we would have incurred a significant operating loss. Since its inception, our business has incurred significant losses, and as of December 31, 2002 had negative working capital of $6,111,341. As a result, there is uncertainty about the Company's ability to continue as a going concern, which was stated in our auditor's report on the Company's financial statements for the 2002 fiscal year. Although management projects improved cash flows from operating activities, there can be no assurance that management's projections will be achieved. Management may also be required to pursue sources of additional funding to meet ongoing operating expenses. There can be no assurance that additional funding will be available or, if available, that it will be available on acceptable terms or in required amounts. Stock Options The Company has established the Second Amended and Restated Incentive Plan (the "Option Plan") for employees and consultants. The company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation. 10

NOTE 2 - NET LOSS PER COMMON SHARE Basic net loss per common share ("Basic EPS") excludes dilution and is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share ("Diluted EPS") reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock. The computation of Diluted EPS does not assume exercise or conversion of securities that would have an anti-dilutive effect on net loss per common share. Options to purchase 4,142,444 and 4,142,444 shares of common stock at weighted average exercise prices of $0.14 and $0.82 per share as of December 31, 2002 and 2001, respectively; warrants to purchase 490,000 and 1,990,000 shares of common stock at weighted average exercise prices of $10.02 and $7.20 per share as of December 31, 2002 and 2001 respectively; 360 shares of Series D preferred stock convertible to 12,000,000 shares of common stock at $0.30 per share at December 31 2002, and 360 shares of Series A preferred stock convertible to 800,000 shares of common stock at $4.50 per share at December 31, 2001 were not included in the computation of Diluted EPS. The inclusion of the options, warrants and preferred stock would have been antidilutive, thereby decreasing net loss per common share. In addition to the options issued, 9,600,398 additional options to purchase shares at weighted average exercise prices of $.06 have been approved but have not been granted because of insufficient authorized capital as discussed in Note 5 below. The inclusion of these options would have been antidilutive, thereby decreasing net loss per common share. 11 NOTE 3 - COMMITMENTS AND CONTINGENCIES Legal Matters On January 17, 2003, Certegy Card Services, Inc., f/k/a Equifax Card Services, Inc. ("Certegy"), filed a lawsuit against the Company as the successor in interest by merger to Access Services, Inc., and other parties named therein in the Circuit Court for the Sixth Judicial Circuit for Pinellas County, Florida. In that lawsuit, Certegy alleges that Access Services engaged in sales and marketing activities that culminated in a credit card processing agreement between Certegy and a third part, Tridico and Tridco, L.L.C. ("TNT"), and that TNT breached that agreement resulting in damages to Certegy. Certegy alleges that it has obtained a judgment against TNT in the amount of $4,424,539.51, which is unsatisfied. Certegy alleges that Access Services, which was acquired by the Company in 1999, is liable for the TNT judgment pursuant to an indemnity covenant in a separate agreement between Certegy and Access Services, and claims money damages for Certegy's losses, interest and attorney fees. The Company intends to vigorously defend the litigation. On July 23, 2002, Evan M. Levine resigned as the Company's interim Chief Executive Officer and a member of its board of directors. Simultaneously with his written notice of resignation, Mr. Levine submitted to the Company a claim in writing for $240,000 in severance payments pursuant to an executive employment agreement Mr. Levine alleges he had with the Company. Mr. Levine asserted that the severance payment was triggered, notwithstanding his voluntary resignation, because a change of control, as defined under the alleged agreement, occurred in July 2002. Mr. Levine also threatened litigation if the amounts he alleged were owed to him were not paid. The Company disputed in writing any claim by Mr. Levine to severance payments under the alleged agreement. On December 12, 2002, the Company, with several other parties, filed a lawsuit against Evan M. Levine in U.S. District in Salt Lake City, Utah. In that action, the Company and its co-plaintiffs sought declaratory judgment for, among other things, that (i) DCTI had no employment agreement with Mr. Levine, (ii) any employment agreement asserted by Mr. Levine was not authorized by the Company or its Board of Directors; (iii) no change of control as defined in the alleged contract had occurred; and (iv) an alleged stock option agreement Levine claimed to have for 3,750,000 shares of common stock was invalid and unenforceable. The Company also asserted a claim for an unspecified amount of money damages against Mr. Levine. The parties entered into a settlement agreement resolving all claims of Mr. Levine against the Company and all claims of the Company against Mr. Levine before Mr. Levine filed an answer. On October 8, 2002, Carib Venture Partners Ltd. a St. Kitts corporation ("Carib") filed suit against the Company in the Eastern Caribbean Supreme Court located in St. Kitts. Carib's statement of claim alleges that the Company has defaulted on a promissory note payable by the Company and in favor of Carib in the face amount of $592,107, of which the outstanding amount allegedly due to Carib is $105,571. The Company intends to vigorously defend this lawsuit. 12 On October 8, 2002, Cyber Consultants, Ltd., a St. Kitts corporation ("Cyber Consultants") filed a lawsuit against the Company in the Eastern Caribbean Supreme Court located in St. Kitts. Cyber Consultants' statement of claim alleges that the Company is in breach of a contract between the Company and Cyber Consultants and seeks an accounting under the contract and damages in an unspecified amount. The Company intends to vigorously defend this lawsuit. On September 23, 2002, Allstate Communications Holdings, Inc. ("Allstate"), of Los Angeles, California, filed suit against DCTI in the California Superior Court in Los Angeles. Allstate's complaint contains three separate claims aggregating to approximately $392,000 plus interest, costs, and punitive damages in unspecified amounts. Allstate's claims are based on theories of breach of contract, conversion, and money had and received, and arise out of alleged transactions between Allstate and DCTI, SecureBank and Cyber Clearing. The Company has answered the complaint and intends to vigorously defend the litigation. On April 22, 2002, Cybernet Ventures, Inc. ("Cybernet") filed a complaint against the Company in Los Angeles County Superior Court alleging that the Company failed to provide certain information in response to requests for information and, as a result, Equifax labeled Cybernet an excessive chargeback merchant and listed it on MasterCard International's Terminated Merchant File, making card-acquiring banks, credit card processors, as well as Visa and MasterCard, reluctant to do business with Cybernet. Cybernet also alleges that in September 2001, Visa fined it for excessive chargebacks, despite an agreement with the Company that it was to get a three-month grace period during which Visa would not impose any fines. Cybernet further alleges that the Company erroneously processed through the MasterCard and Visa systems credit card transactions originated by other Internet merchants not affiliated with Cybernet and that, as a result, MasterCard fined it $1.2 million and St. Kitts Bank placed a hold on its merchant account. Finally, Cybernet alleges that the Company improperly collected certain transaction fees. Cybernet's complaint purports to state claims for fraud, intentional misrepresentation, negligent misrepresentation, conversion, unjust enrichment and interference with economic relations. In July 2002, the Company answered Cybernet's complaint. The Company intends to vigorously defend this action. On April 15, 2002, the Bank of Nevis International Limited ("BONI") filed a claim against the Company and DataBank International Ltd. ("DataBank") in the Eastern Caribbean Supreme Court in the High Court of Justice, Federation of Saint Christopher and Nevis containing various allegations against the Company and DataBank arising from a credit card transaction processing agreement (the "BONI Agreement"). In particular, BONIalleges that DataBank, which the Company acquired in October 1999, and/or the Company breached the BONI Agreement by (1) failing to pay processing fees due under the BONI Agreement; (2) negligently instructing BONI to make refunds to merchants; (3) instructing BONI to pay merchants who were not its customers; (4) failing to ensure that the reserve fund of each merchant was sufficient to cover any loss BONI may suffer; (5) not having proper or effective software to manage credit card transactions; (6) delaying in instructing BONI to make payments; (7) improper bookkeeping; (8) failing to maintain sufficient information for merchant accounts; (9) providing inaccurate instructions to BONI; and (10) failing to provide timely instructions to BONI. The claim also alleges that the Company and DataBank breached an 13 agreement with BONI to be bound by the findings of PricewaterhouseCoopers regarding the amounts owed by each party under the BONI Agreement. Finally, BONI also alleges that DataBank had an obligation to indemnify it against any losses associated with merchant processing. The claim seeks $1.9 million in damages. The Company moved to dismiss, but its motion was denied. During the three months ended December 31, 2002, the Company entered into an interim settlement agreement with BONI that allows the Company to continue its appeal but calls for the payment by the Company of $1,027,000 that the parties admit is not in dispute. On April 8, 2002, Next Generation Ltd., Prospect Creek, Ltd., Oxford Partners, Ltd., and Carib Venture Partners, Ltd. (the "Next Generation plaintiffs") filed a complaint against the Company in the United States District Court for the Northern District of California alleging that the Company failed to register restricted shares of the Company's common stock. The Next Generation plaintiffs received the shares in connection with the Company's acquisition of DataBank in October 1999 and claim that the Company was obligated to periodically register a portion of those restricted shares with the SEC following the DataBank transaction, but failed to do so. The Next Generation plaintiffs' complaint purports to state claims for breach of contract, breach of the implied covenant of good faith and fair dealing, unjust enrichment, negligent misrepresentation, declaratory judgment, negligence and constructive fraud. The Company has filed an answer in response to the Next Generation plaintiffs' complaint. The Company intends to vigorously defend this action. In July 2001, Jim Thompson and Kenneth Nagel, both former owners of shares of SecureBank.com, filed a complaint against the Company, SB.com and Bobbie Downey, the Company's former Secretary and General Counsel, in the Circuit Court of the Sixth Judicial Circuit in and for Pinellas County, State of Florida Civil Division, alleging that the Company failed to register 500,000 shares of the Company's stock pursuant to the parties' June 1, 1999 Registration Rights Agreement. The complaint asserts claims for breach of contract, fraudulent inducement, declaratory judgment and rescission. The Company removed the action to the United States District Court for the Northern District of Florida. The Company also filed a counterclaim for breach of contract against Thompson and Nagel arising from promissory notes they made in favor of the Company and for breach of fiduciary duty against Nagel for conduct he engaged in as a director of the Company. The Company is presently involved in settlement negotiations. In November 2000, Ameropa Ltd. ("Ameropa") filed suit in the California Superior Court in Los Angeles against the Company and Don Marshall, the current Chief Executive Officer and a director of the Company, alleging that Ameropa is the assignee of several persons and entities that owned interests in DataBank. Ameropa claims that Mr. Marshall breached a contract with its assignors to pay them their alleged share of the DataBank purchase price. Ameropa has recently added as a defendant James Egide, a former Chief Executive Officer and Chairman of the Company. On June 13, 2002, the court overruled the Company's demurrer to Ameropa's second cause of action sustained the Company's demurrer to the twelfth 14 cause of action in the Third Amended Complaint. In July 2002, Ameropa filed its Fourth Amended Complaint. The Company answered the complaint and otherwise is defending the Ameropa Litigation. On July 10, 2000, American Credit Card Processing Corp. filed a lawsuit against the Company in the United States District Court for the Southern District of New York. The complaint in that matter includes claims for breach of contract, fraud and negligent representation in connection with a merchant bankcard services agreement. The Company filed and prevailed on a motion to dismiss for lack of jurisdiction. American Credit Card subsequently has re-filed the complaint in the United States District Court for the District of Utah. The Company intends to vigorously defend the claim. The claim for damages is for approximately $422,720. The court in that matter has ordered the Company to mediate the dispute, but no date has been set for the mediation On December 7, 2001, McGlen Micro, Inc. filed suit against the Company and American Credit Card Processing Co. in the California Superior Court in Los Angeles for breach of contract conversion, money had and received, and unfair and deceptive business practices. The complaint seeks money damages of a minimum of $164,323 plus interest arising out of allegedly unauthorized chargebacks. The court has scheduled the matter for trial starting on August 28, 2003. Limited discovery has occurred and there is currently a mediation scheduled for February 20, 2003. On November 8, 2000, NetPro, Ltd. filed a lawsuit against the Company in Circuit Court for Pinellas County, Florida. NetPro's complaint for injunctive relief against DCTI seeks a temporary and permanent injunction enjoining the Company from releasing NetPro's funds to ePayment Solutions, Inc. until an accounting can be done, and then ordering the Company to release the funds directly to NetPro. The amount in controversy is unspecified. Currently, NetPro has granted DCTI an indefinite extension to file an answer to see if the case can be settled. If it is not settled, the Company intends to vigorously defend itself in the matter In addition to the above matters, the Company is and has been the subject of certain legal matters, which it considers incidental to its business activities. It is the opinion of management that the ultimate disposition of these legal matters will not individually or in the aggregate have a material adverse effect on the consolidated financial position, liquidity or results of operations of the Company. These claims, if determined adversely to the Company, could have a material adverse effect on the Company's financial position, liquidity and results of operations. The Company believes that it has adequately provided for all known financial exposures, that are probable and reasonably estimable. 15 NOTE 4 - Under funded Merchant Reserves At December 31, 2002 and June 30, 2002, the Company has withheld $3,095,338 and $10,726,219, respectively, from merchant settlements to cover potential chargebacks and other adjustments that are reflected as merchant reserves in the accompanying consolidated financial statements at December 31, 2002 and June 30, 2002, respectively. The decrease in reserves is a direct result of a decrease in transaction volume. The Company maintains restricted cash balances to fund the reserve liabilities. At December 31, 2002, our merchant reserves accrual was $3,095,338, however our restricted cash set aside for the purpose of funding such reserve was only $2,353,341, therefore the merchant reserve accrual was under funded by $741,997. NOTE 5 - CAPITAL TRANSACTIONS. Preferred Stock The Company is authorized to issue up to 2,500,000 shares of its $0.0001 par value preferred stock. The Company's Board of Directors is authorized, without shareholder approval, to fix the rights, preferences, privileges and restrictions of one or more series of the authorized shares of preferred stock. Common Stock Issuances and Other Transactions In September 2002, the Company issued 28,948,428 shares of its common stock upon the conversion of a debt payable to a stockholder (see Marshall Settlement and Conversion, below). Marshall Settlement and Conversion On October 16, 2001, the Company entered into a Settlement and Release Agreement (the "Settlement Agreement") with Don Marshall, a shareholder of DataBank and a former President and director of the Company. By the Settlement Agreement, Mr. Marshall and the Company settled claims Mr. Marshall had asserted against the Company for breach of a registration rights agreement executed in connection with the DataBank acquisition and for breach of a prior consulting agreement between Mr. Marshall and the Company. As part of that settlement, the Company issued to Mr. Marshall 3,500,000 shares of common stock and agreed to pay Mr. Marshall $800,000 in quarterly installments (the Cash Payment"), beginning with the quarter ending December 31, 2001, based upon a percentage of the Company's earnings before taxes, depreciation and amortization, if any, during each quarter. The Company agreed to make all payments by October 2004 with annual interest at 15% accruing beginning in 2003. To assure payment, the Company also executed a confession of judgment that could be entered upon default under the Settlement Agreement, in the amount of $7,500,000. In February 2002, Mr. Marshall asserted that the Company had defaulted with respect to its obligation to pay the Cash Payment because the Company failed to remit to him the required quarterly payment after due notice and after the expiration of the cure period specified in the Settlement Agreement. In order to resolve that dispute, the Company and Mr. Marshall entered into Amendment No. 1 to Settlement Agreement, dated March 18, 2002, pursuant to which, among other 16 things, (i) Mr. Marshall waived any prior default by the Company with respect to the Cash Payment obligation under the Settlement Agreement, (ii) the Company paid to Mr. Marshall a concession fee of $136,000, of which $36,000 was paid on March 20, 2002 and $100,000 was paid by delivery to Mr. Marshall of 1,428,571 additional shares of the Company's common stock, (iii) the Company and Mr. Marshall agreed to restructure the payment of the Cash Payment so it was payable without interest at the rate of $3,500 on the fifth day and twentieth day of each month (for an aggregate monthly payment of $7,000) commencing with May 5, 2002 and until March 31, 2006, when the balance would be payable in full, (iv) the Company agreed that upon an event of default as defined in the Amendment, including any default in the payment by the Company of the Cash Payment according to the modified schedule, any unpaid balance of the Cash Payment would begin to accrue simple interest at the rate of 1.5% per month until paid in full, and Mr. Marshall would be able to convert all or any portion of the then unpaid balance of the Cash Payment plus any accrued and unpaid interest into the Company's common stock at the lesser of (A) $0.07 per share, or (B) the average closing bid price of the Company's common stock for the 20 trading days immediately preceding the date of such conversion. The Company failed to pay Mr. Marshall as required on May 5, May 20 and June 5, 2002. Mr. Marshall provided written notice as required by the Amendment Agreement on June 19, 2002, and DCTI failed to cure such default with the time allowed. On June 25, 2002, therefore, an Event of Default occurred. On July 8, 2002, Mr. Marshall notified DCTI that he had converted a total of $525,569.52 of the outstanding cash amount under the Amendment Agreement into 29,946,981 shares of DCTI's common stock. The Company subsequently notified Mr. Marshall that it had understated the number of shares of common stock issued and outstanding as of the date of his conversion, and therefore he was allowed to convert only $508,044.91 into 28,948,428 shares of common stock. Certificates representing these shares were issued to Nautilus Management Ltd., a company wholly owned by Mr. Marshall, on September 12, 2002. Since the conversion, the Company has paid a total of $ 10,500 of the Cash Payment to Mr. Marshall $1,429 of which applied to principal and $9,071 paid as interest, leaving an unpaid balance as of the date of this report of $290,526, which amount continues to be convertible into common stock at Mr. Marshall's option, subject to the availability of sufficient authorized and unissued shares of common stock. As a result of his conversion, coupled with his acquisition of certain proxy rights, Mr. Marshall acquired actual ownership or voting control of a total of 37,426,802 shares of the Company's 75,000,000 issued and outstanding shares of common stock, representing 49.9% of the total voting power. NOTE 6 - STOCK-BASED COMPENSATION The Company has elected to continue to apply Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans as they relate to employees and directors. Historically, the Company's stock options have been accounted for using fixed plan accounting. The 17 option grants permit various exercise alternatives, including certain cashless exercise provisions. Through fiscal 1999, the Company's experience indicated that substantially all cashless exercises could have been effected through the use of mature shares and therefore fixed plan accounting was appropriate. Starting with fiscal 2000, and due to the Company's then-recent acquisitions and growth, options were granted to more employees who did not hold mature shares of the Company's common stock, and therefore the Company determined that these options should be accounted for using variable plan accounting. Under variable plan accounting, changes, either increases or decreases, in the market price of the Company's common stock results in a change in the measurement of compensation. Compensation is measured as the difference between the market price and the option exercise price and is amortized to expense over the vesting period. During the three months and six months ended December 31, 2002, the Company did not record any expense associated with these awards as their intrinsic value was zero. During the six months ended December 31, 2002, the Company granted options to purchase 2,000,000 shares to the Company's directors. The grant of these options is specifically conditioned on a future increase in the Company's authorized capital. NOTE 7 - AGREEMENTS WITH M2, INC. On September 30, 2002, the Company entered into an agreement (the "Provider Agreement") with M2, Inc., a Florida corporation ("M2"), pursuant to which the Company engaged M2 to manage the Company's portfolio payment processing and technology business operations on an outsourced basis. Under the Provider Agreement, M2 is responsible for the operation of substantially all of the Company's ongoing business operations, exclusive of administrative, financial and executive functions, which will continue to be located at the Company's Salt Lake City, Utah offices. The term of the Provider Agreement is five years. M2's services under the Provider Agreement are to be subject at all times to the oversight and approval of the Company's Chief Executive Officer, who, in turn, is subject to the oversight of the Company's Board of Directors. In return for its services under the Provider Agreement, the Company is required to pay M2 a monthly fee (the "Monthly Fee") equal to 115% of M2's actual costs and expenses incurred in connection with its performance under the Provider Agreement, provided that the Company shall not be required to pay, in cash, all or any portion of the Monthly Fee if the Company does not have Free Cash Flow, as defined in the Provider Agreement sufficient to make such payments. Free Cash Flow is defined as total cash receipts from the Company's business for a given month, less Operating Outlays. Operating Outlays are defined as ordinary expenses actually paid by the Company plus payables paid, plus expenses accrued in the ordinary course of the Company's business, but excluding (i) any Monthly Fees paid to M2, (ii) any payments of Monthly Fees due to M2 but deferred because of insufficient Free Cash Flow, and interest thereon, (iii) any interest payments relating to any loans entered into by the Company or any of its subsidiaries prior to the date of the Provider Agreement, (iv) any interest payments relating to any payables or accrued expenses incurred by the Company or any of its subsidiaries prior to the beginning of such month, (v) the payment of 18 any liabilities other than payables or accrued expenses incurred in the ordinary course of business, (vi) payments made to any officer or director of the Company or any of its subsidiaries or any of their affiliates for anything other than (a) normal salary in amount equal to that in effect for the month prior to the date hereof and (b) reimbursement of ordinary business expenses in a manner consistent with prior practice, and (vii) payments for the acquisition of capital equipment. If Monthly Fees are not paid because of insufficient Free Cash Flow, the remaining unpaid portion of the Monthly Fee shall be paid by the Company (A) in cash within 30 days, or (B) by delivery of a demand note in the unpaid amount and bearing interest at 8% per annum, which demand note must be paid out of future Free Cash Flow in excess of amounts necessary to pay current Monthly Fees. In addition to Monthly Fees, under the Provider Agreement, M2 is entitled to monthly payments of "Bonus Compensation" equal to 90% of "Adjusted Free Cash Flow" which is equal to Free Cash Flow less Monthly Fees paid to M2 or payments of deferred Monthly Fees. All of the Company's payment obligations to M2 under the Provider Agreement are secured by a grant of a security interest in favor of M2 covering all of the Company's tangible and intangible assets, including its software. Moreover, although the Company has the right to terminate the Provider Agreement at any time, if the Company terminates it without cause, as defined therein, at any time during the initial five year term, the Company thereby would grant to M2 a perpetual, nonexclusive license to sell and sublicense any of the Company's proprietary software products. As additional consideration for the execution of the Provider Agreement, M2 agreed to provide $500,000 of debt financing, which was anticipated to involve the issuance by the Company of debentures to M2, although definitive documentation for such financing was not completed because the parties were unable to agreed to specific terms. During the quarter ended December 31, 2002, and in lieu of debt financing contemplated by the Provider Agreement, the Company and M2 entered into a Software License, Source Code, and Derivative Product Distribution Agreement (the "M2 Software License"). Under M2 Software License, M2 obtained a non-exclusive license to use the Company's proprietary software associated with its credit card processing business in consideration of payment by M2 of $50,000. Also during the quarter ended December 31, 2002, the Company agreed with M2 to sell to M2 essentially all of the fixed assets at the Company's Salt Lake City and Clearwater data center facilities for total consideration of $180,000, with payments to be made to the Company according to an installment payment schedule. During the quarter ended December 31, 2002, M2 paid a total of $10,000 of the purchase price for such assets. The remainder of the purchase price is due to be paid by M2 by April 6, 2003. NOTE 8 - LOSS OF PROCESSING PARTNER AND CUSTOMERS During October 2002, a disagreement arose between the Company's European processing partner and two of the Company's customers. As a result of the disagreement, those customers discontinued card processing through the Company at the end of October 2002. Revenues for the three and six months ended December 31, 2002 have been negatively impacted because these two customers represented approximately 41% of the Company's total revenues from the beginning of fiscal 19 2003 through date processing was discontinued. The Company has put in place an agreement with a new European processing partner and begun the process of migrating its remaining European customers to that platform. There can be no assurance that remaining European customers will successfully be migrated to this new platform. NOTE 9 - RECENT ACCOUNTING PRONOUNCEMENTS In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS No. 145"). This statement eliminates the current requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement. Instead, such gains and losses will be classified as extraordinary items only if they are deemed to be unusual and infrequent, in accordance with the current GAAP criteria for extraordinary classification. In addition, SFAS No. 145 eliminates an inconsistency in lease accounting by requiring that modifications of capital leases that result in reclassification as operating leases be accounted for consistent with sale-leaseback accounting rules. The statement also contains other nonsubstantive corrections to authoritative accounting literature. The changes related to debt extinguishment will be effective for fiscal years beginning after May 15, 2002, and the changes related to lease accounting will be effective for transactions occurring after May 15, 2002. Adoption of this standard will not have any immediate effect on the Company's consolidated financial statements. The Company will apply this guidance prospectively. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities ("SFAS No. 146"), which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The Company will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company's commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized. In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 148 "Accounting for Stock-Based Compensation--Transition and Disclosure--an amendment of FASB Statement No. 123, "which is effective for all fiscal years ending after December 15, 2002. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation under SFAS No. 123 from the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25. SFAS 128 also changes the disclosure requirements of SFAS 123, requiring a more prominent disclosure of the pro-forma effect of the fair value-based method of accounting for stock-based compensation. The adoption of SFAS No. 148 by the Company did not have a material impact on the Company's financial position or future operations. 20 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Information Statements regarding the Company's expectations as to future revenue from its business strategy and certain other statements presented herein, constitute forward-looking information within the meaning of Section 21E of the Securities Exchange Act of 1934. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from expectations. In addition to matters affecting the Company's industry generally, factors which could cause actual results to differ from expectations include, but are not limited to, the risks that are described in the Company's report on Form 10-K for the fiscal year ended June 30, 2002, under the heading "Forward Looking Statements and Certain Risks". Overview During the three months ended December 31, 2002 the Company's operations generated a loss of $536,409 including non-cash expense for depreciation. During the six months ended December 31, 2002 the Company's operations generated a loss of $1,040,179 including non-cash expense for depreciation. Since its inception, our business has incurred significant losses, and as of December 31, 2002 the Company had negative working capital of $5,245,341. As a result, there is substantial uncertainty about the Company's ability to continue as a going concern, which was reflected in the auditor's report on the Company's financial statements for the 2002 fiscal year. During the first six months of the current fiscal year, the Company has significantly reduced some of its costs and operating expenses and will continue to seek ways to more effectively manage its operations. In light of such cost reductions, management projects that there will be sufficient cash flows from operating and financing activities during the next twelve months to provide capital for the Company to sustain its operations; however, there can be no assurance that management's projections will be achieved or that capital from financing through private or commercial credit or through sale of the Company's securities will be available when, and in the amounts required by the Company. If additional required capital is not available when in the amounts required, the Company will have to curtail some operations or seek protections under bankruptcy laws. Critical Accounting Policies Our financial statements are based on the selection and application of significant accounting policies, which require management to make estimates and assumptions. We believe that the following are some of the more critical judgment areas in the application of our accounting policies that currently affect our financial condition and results of operations. 21 Revenue Recognition. Substantially all of our revenues are derived from processing credit card transactions. Our revenue is earned and recognized as each transaction is processed. Goodwill, Intangibles and Other Long-Lived Assets. Property, plant and equipment, intangibles and certain other long-lived assets are depreciated or amortized over their useful lives. Useful lives are based on management's estimates of the period that the assets will generate revenue. Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company's evaluation considers non-financial data such as changes in the operating environment and business strategy, competitive information, market trends and operating performance. The Company recorded write-offs of goodwill of $12,135,383, and $156,123,113 during the years ended June 30, 2002 and June 30, 2001, respectively. In addition, the Company recorded a write-off of prepaid software license of $3,933,447 during the year ended June 30, 2002. Accrual for chargebacks. The Company maintains an accrual for chargebacks that it may incur from the credit card processing volume that goes through its system. Although the Company holds merchant funds in reserve to offset chargebacks, in the event a merchant has insufficient reserves and is unable to meet the chargeback obligation, the chargeback expense is then the Company's liability. Because these chargebacks relate to ongoing revenues, a reserve is maintained. At December 31, 2002 the reserve balance was $575,000 compared to $1,882,195 at June 30, 2002. The reserve is an estimate made by Company's management and is based upon processing volume and unrecoverable chargeback expense experience. DCTI, DCII, Access Services, SB.com, DataBank and CaribCommerce are collectively referred to herein as the "Company". All significant intercompany accounts and transactions have been eliminated in consolidation. Results of Operations Three months ended December 31, 2002 compared with three months ended December 31, 2001. Revenue Revenue for the three months ended December 31, 2002 was $1,957,069 as compared to $4,668,676 for the three months ended December 31, 2002, a decrease of 58%. During the three months ended December 31, 2002, substantially all revenues were derived from payment processing activities, including $53,106 of revenues related to fees earned on the processing of chargebacks. During the three months ended December 31, 2001, substantially all revenues were derived from payment processing activities, including $222,685 of revenues related to fees earned on the processing of chargebacks. The decrease in revenues is primarily due to fewer merchants utilizing the Company's processing services, and specifically the loss of the Company's European processing partner and related customers as discussed in Note 8 to the financial statements. Revenues for the three months 22 ended December 31, 2002 include $50,000 from the sale of a software license to M2 as discussed in Note 7 to the financial statements, which the Company believes will be a non-recurring event. Cost of Revenue Cost of revenue includes amounts paid to banks and processing partners. Cost of revenue for the three months ended December 31, 2002 was $1,411,388 or 72.1% of revenue. For the three months ended December 31, 2001, cost of revenue was $2,958,635 or 63.4% of revenue. The increase of cost of revenue as a percentage of revenue is due to an increase in the percentage of our merchants' transaction dollar volume paid to banks and processors. Operating Expenses Depreciation and amortization expense decreased 90.5% to $221,690 during the three months ended December 31, 2002 from $2,323,146 during the three months ended December 31, 2001. The decrease in depreciation and amortization expense was due to the decrease in amortization of goodwill as a result of the $12,135,383 of goodwill impairment write-down during fiscal 2002. Selling, general and administrative expense decreased 43.5% to $836,876 during the three months ended December 31, 2002 from $1,480,840 during the three months ended December 31, 2001. The decrease in selling, general and administrative expense was primarily due to reductions in work force and paid executive staff during and after fiscal 2002, and the Company's efforts to otherwise reduce operating costs. Research and development expense decreased 80.1% to $23,732 during the three months ended December 31, 2002 from $119,491 during the three months ended December 31, 2001. The decrease in research and development expense was due to the reduction of development staff during fiscal 2002. The Company recorded a gain from a change in accounting estimate of $1,298,748 during the three month period ended December 31, 2002, as a result of adjusting down its reserve for uncollectable chargebacks. This adjustment is based on management assessment of risk of uncollectable chargebacks. The downward adjustment is due primarily to lower processing volumes and improved controls that mitigate potential uncollectable merchant chargebacks. The Company's variable option plan did not create any non-cash compensation adjustment during the three months ended December 31, 2002 or December 31, 2001 because all outstanding options maintained exercise prices greater than the quoted stock price during the three months ended and as of December 31, 2002 and December 31, 2001 respectively. Our income tax benefit is zero because we fully provide for our deferred tax assets as realization of these benefits is not deemed to be more likely than not. 23 Other Income and Expense The Company incurred net other income and expense of ($1,170,907) for the three months ended December 31, 2002. This compares to ($43,105) for the three months ended December 31, 2001. The following items recorded during the three months ended December 31, 2002 account for the net other expense: The Company recorded a gain of $484,556 as a result of settling disputed amounts invoiced by a vendor. These amounts had previously been recorded as operating expense. In addition, Company recorded $1,361,257 additional expense for the pending settlement with Bank of Nevis, as discussed in Note 3 of the financial statements. The Company had previously recorded $531,743 for this matter. Interest and other income and expenses totaled ($12,285) Six months ended December 31, 2002 compared with six months ended December 31, 2001. Revenue Revenue for the six months ended December 31, 2002 was $4,802,050 as compared to $9,311,571 for the six months ended December 31, 2001, a decrease of approximately 48%. During the six months ended December 31, 2002, revenues were primarily derived from payment processing activities, including $134,368 of revenues related to fees earned on the processing of chargebacks. During the six months ended December 31, 2001, revenues were primarily derived from payment processing activities, including $700,578 of revenues related to fees earned on the processing of chargebacks. In addition, $162,000 of revenues were earned under a software distribution agreement. The decrease in revenues is primarily due to fewer merchants utilizing the Company's processing services. This is partially due to the loss of the Company's European processing partner and related customers as discussed in Note 8 to the financial statements. Revenues for the six months ended December 31, 2002 include $50,000 from the sale of a software license to M2 as discussed in Note 7 to the financial statements. Cost of Revenue Cost of revenue for the six months ended December 31, 2002 was $3,620,990 or 75.4% of revenue. For the six months ended December 31, 2001, cost of revenue was $5,954,840 or 64.0% of revenue. The increase of cost of revenue as a percentage of revenue is due to an increase in the percentage of our merchants' transaction dollar volume paid to banks and processors. Operating Expenses Depreciation and amortization expense decreased 90.2% to $460,213 during the six months ended December 31, 2002 from $4,686,781 during the six months ended December 31, 2001. The decrease in depreciation and amortization expense was due to the decrease in amortization of goodwill as a result of the $12,135,383 of goodwill impairment write-down during fiscal 2002. 24 Selling, general and administrative expense decreased 46.7% to $1,645,450 during the six months ended December 31, 2002 from $3,089,465 during the six months ended December 31, 2001. The decrease in selling, general and administrative expense was primarily due to reductions in work force and paid executive staff during and after fiscal 2002, and the Company's efforts to otherwise reduce operating costs. Research and development expense decreased 54.3% to $115,576 during the six months ended December 31, 2002 from $252,882 during the six months ended December 31, 2001. The decrease in research and development expense was due to the reduction of development staff during fiscal 2002. The Company recorded a gain from a change in accounting estimate of $1,298,748 during the six month period ended December 31, 2002, as a result of adjusting down its reserve for uncollectable chargebacks. This adjustment is based on management assessment of risk of uncollectable chargebacks. The downward adjustment is due primarily to lower processing volumes and improved controls that mitigate potential uncollectable merchant chargebacks. The Company's variable option plan did not create any non-cash compensation adjustment during the six months ended December 31, 2002 or December 31, 2001 because all outstanding options maintained exercise prices greater than the quoted stock price during the six months ended and as of December 31, 2002 and December 31, 2001 respectively. Our income tax benefit is zero because we fully provide for our deferred tax assets as realization of these benefits is not deemed to be more likely than not. During six months ended December 31, 2001, the Company incurred fines and added to the reserve for uncollectible chargebacks. No such fines or additions to reserves were incurred or deemed necessary during the six months ended December 31, 2002. Other Income and Expense The Company incurred net other income and expense of ($1,183,721) for the six month period ended December 31, 2002. This compares to ($53,396) for the six month period ended December 31, 2001. For the six month period ended December 31, 2002, the following items account for the net other income: The Company recorded a gain of $484,556 as a result of settling disputed amounts invoiced by a vendor. These amounts had previously been recorded as operating expense. The Company recorded $1,361,257 additional expense for the pending settlement with Bank of Nevis, as discussed in Note 3 of the financial statements. The Company had previously recorded approximately $531,743 for this matter. Interest and other income and expense totaled ($25,099) 25 Liquidity and Capital Resources The Company likely will need to raise additional capital to finance ongoing operations during the next fiscal year, research and development and future plans for expansion. Adequate funds for these and other purposes on terms acceptable to the Company, whether through additional equity financing, commercial or private debt or other sources, may not be available when needed or may result in significant dilution to existing stockholders. Furthermore, the Company's losses and lack of tangible assets to pledge as security for debt financing could prevent the Company from obtaining traditional bank or similar debt financing. Failure to obtain adequate financing when and in the amounts required would have a material adverse effect on the Company and could result in cessation of the Company's business and could force the Company to seek protection under bankruptcy laws. Since its inception, our business has incurred significant losses, and as of December 31, 2002, had an accumulated deficit of $291,535,565. As a result, there is substantial uncertainty about the Company's ability to continue as a going concern, which was stated in our auditor's report on the Company's financial statements for the 2002 fiscal year. The Company expects to incur operating losses for the foreseeable future. We cannot be sure that the Company will generate sufficient revenues to ever achieve or sustain profitability. M2 Agreement On September 30, 2002, the Company entered into an agreement (the "Provider Agreement") with M2, Inc., a Florida corporation ("M2"), pursuant to which the Company engaged M2 to manage the Company's portfolio payment processing and technology business operations on an outsourced basis. Under the Provider Agreement, M2 is responsible for the operation of substantially all of the Company's ongoing business operations, exclusive of administrative, financial and executive functions, which will continue to be located at DCTI's Salt Lake City, Utah offices. The initial term of the Provider Agreement is five years. M2's services under the Provider Agreement are to be subject at all times to the oversight and approval of the Company's Chief Executive Officer, who, in turn, is subject to the oversight of the Company's Board of Directors. In return for its services under the Provider Agreement, the Company is required to pay M2 a monthly fee (the "Monthly Fee") equal to 115% of M2's actual costs and expenses incurred in connection with its performance under the Provider Agreement, provided that the Company shall not be required to pay, in cash, all or any portion of the Monthly Fee if the Company does not have "Free Cash Flow", as defined in the Provider Agreement sufficient to make such payments. Free Cash Flow is defined as total cash receipts from the Company's business for a given month, less Operating Outlays. Operating Outlays are defined as ordinary expenses actually paid by the Company plus payables paid, plus expenses accrued in the ordinary course of the Company's business, but excluding (i) any Monthly Fees paid to M2, (ii) any payments of Monthly Fees due to M2 but deferred because of insufficient Free Cash Flow, and interest thereon, (iii) any interest payments relating to any loans entered into by the Company or any of its subsidiaries prior to the date of the Provider Agreement, (iv) any interest payments relating to any payables or accrued expenses incurred by the Company or any of its subsidiaries prior to the beginning of such month, (v) the payment of any liabilities other than payables or accrued expenses incurred in the ordinary course of business, (vi) payments made to any officer or director of the Company or any of its subsidiaries or any of their affiliates for anything other than (a) normal salary in amount equal to that in effect for the month prior to the date hereof and (b) reimbursement of ordinary business expenses in a manner 26 consistent with prior practice, and (vii) payments for the acquisition of capital equipment. If Monthly Fees are not paid because of insufficient Free Cash Flow, the remaining unpaid portion of the Monthly Fee shall be paid by the Company (A) in cash within 30 days, or (B) by delivery of a demand note for the unpaid amount and bearing interest at 8% per annum, which demand note must be paid out of future Free Cash Flow in excess of amounts necessary to pay current Monthly Fees. In addition to Monthly Fees, under the Provider Agreement, M2 is entitled to monthly payments of "Bonus Compensation" equal to 90% of "Adjusted Free Cash Flow" which is equal to Free Cash Flow less Monthly Fees paid to M2 or payments of deferred Monthly Fees. All of the Company's payment obligations to M2 under the Provider Agreement are secured by a grant of a security interest in favor of M2 covering all of the Company's tangible and intangible assets, including its software and the data centers. Moreover, although the Company has the right to terminate the Provider Agreement at any time, if the Company terminates it without cause, as defined therein, at any time during the initial five year term, the Company thereby would grant to M2 a perpetual, nonexclusive license to sell and sublicense any of the Company's proprietary technologies. As additional consideration for the execution of the Provider Agreement, M2 agreed to provide $500,000 of debt financing, which was anticipated to involve the issuance by the Company of debentures to M2, although definitive documentation for such financing was not completed because the parties were unable to agreed to specific terms. During the quarter ended December 31, 2002, and in lieu of debt financing contemplated by the Provider Agreement, the Company and M2 entered into a Software License, Source Code, and Derivative Product Distribution Agreement (the "M2 Software License"). Under M2 Software License, M2 obtained a non-exclusive license to use the Company's proprietary software associated with its credit card processing business in consideration of payment by M2 of $50,000. Also during the quarter ended December 31, 2002, the Company agreed with M2 to sell to M2 essentially all of the fixed assets at the Company's Salt Lake City and Clearwater data center facilities for total consideration of $180,000, with payments to be made to the Company according to an installment payment schedule. During the quarter ended December 31, 2002, M2 paid a total of $10,000 of the purchase price for such assets. The remainder of the purchase price is due to be paid by M2 by April 6, 2003. The Company believes that the Provider Agreement may affect liquidity positively by (i) increasing sales volume by introducing new payment processing and portfolio business; (ii) reducing expenses by streamlining and outsourcing some management, sales, marketing and technology functions; and (iii) allowing the Company essentially to defer the payment of general operating expenses until Free Cash Flow is sufficient to make payments. There can be no assurance that any of these benefits will materialize. Also, the revenue generated from the licensing transaction and the cash received upon the sale to M2 of the data center assets as described above have provided additional cash to fund the Company's operations. 27 Chargeback Reserves ------------------- At December 31, 2002 and June 30, 2002, the Company had withheld $3,095,338 and $10,726,219, respectively, from merchant settlements to cover potential chargebacks and other adjustments that are reflected as merchant reserves in the accompanying consolidated financial statements at December 31, 2002 and June 30, 2002, respectively. The decrease in reserves is a direct result of a decrease in transaction volume. The Company maintains restricted cash balances to fund the reserve liabilities. At December 31, 2002, our merchant reserves accrual was $3,095,338, however our restricted cash set aside for the purpose of funding such reserve was only $2,353,341, therefore the merchant reserve accrual was under funded by $741,997. Cash Flow Activities -------------------- Operating activities used $14,188 during the six months ended December 31, 2002 compared to providing $227,289 during the six months ended December 31, 2002. The net loss of $925,152 incurred during the six months ended December 31, 2002 included non-cash depreciation of $460,213, a non-cash adjustment to the accrued chargeback estimate of $1,298,748, a non-cash gain on settlement of liabilities of $484,556, and a non-cash loss on the sale of assets of $281,921. The decrease in restricted cash of $8,154,112 was offset, in large part, by a decrease in the merchant reserve liability of $7,630,881. Other changes in current asset and liabilities accounts accounted for the remaining net cash used in operating activities during the period. During the six months ended December 31, 2001, operating activities provided cash of $227,289. The net loss of $5,035,793 was mostly offset by non-cash depreciation and amortization expense of $4,686,781. Additionally, cash provided by a decrease in restricted cash was offset by a decrease in merchant reserve and merchant settlement liabilities. These decreases are consistent with the decrease in revenues. Also, reducing the liability to payment processor offset cash provided by the liquidation of our deposit with payment processor. Other changes in current asset and liabilities accounts accounted for the remaining net cash used in operating activities during the period. During the six months ended December 31, 2002, investing activities provided $10,000 in cash from the payment received on the note receivable from the sale of assets to M2 Corporation. During the six months ended December 31, 2001, investing activities used $11,792 for the purchase of assets. During the six months ended December 31, 2002, $36,368 was paid as principal repayment of capital lease obligations and notes payable. During the six months ended December 31, 2001, $699,290 and $23,601 was paid as principal repayment of notes payable and capital lease obligations, respectively Item 4. Controls and Procedures. Based on their evaluation, as of a date within 90 days of the filing date of this Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 28 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended) are effective. There have been no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. PART II - OTHER INFORMATION Item 1. Legal Proceedings On January 17, 2003, Certegy Card Services, Inc., f/k/a Equifax Card Services, Inc. ("Certegy"), filed a lawsuit against the Company as the successor in interest by merger to Access Services, Inc., and other parties named therein in the Circuit Court for the Sixth Judicial Circuit for Pinellas County, Florida. In that lawsuit, Certegy alleges that Access Services engaged in sales and marketing activities that culminated in a credit card processing agreement between Certegy and a third part, Tridico and Tridco, L.L.C. ("TNT"), and that TNT breached that agreement resulting in damages to Certegy. Certegy alleges that it has obtained a judgment against TNT in the amount of $4,424,539.51, which is unsatisfied. Certegy alleges that Access Services, which was acquired by the Company in 1999, is liable for the TNT judgment pursuant to an indemnity covenant in a separate agreement between Certegy and Access Services, and claims money damages for Certegy's losses, interest and attorney fees. The Company intends to vigorously defend the litigation. On July 23, 2002, Evan M. Levine resigned as the Company's interim Chief Executive Officer and a member of its board of directors. Simultaneously with his written notice of resignation, Mr. Levine submitted to the Company a claim in writing for $240,000 in severance payments pursuant to an executive employment agreement Mr. Levine alleges he had with the Company. Mr. Levine asserted that the severance payment was triggered, notwithstanding his voluntary resignation, because a change of control, as defined under the alleged agreement, occurred in July 2002. Mr. Levine also threatened litigation if the amounts he alleged were owed to him were not paid. The Company disputed in writing any claim by Mr. Levine to severance payments under the alleged agreement. On December 12, 2002, the Company, with several other parties, filed a lawsuit against Evan M. Levine in U.S. District in Salt Lake City, Utah. In that action, the Company and its co-plaintiffs sought declaratory judgment for, among other things, that (i) DCTI had no employment agreement with Mr. Levine, (ii) any employment agreement asserted by Mr. Levine was not authorized by the Company or its Board of Directors; (iii) no change of control as defined in the alleged contract had occurred; and (iv) an alleged stock option agreement Levine claimed to have for 3,750,000 shares of common stock was invalid and unenforceable. The Company also asserted a claim for an unspecified amount of money damages against Mr. Levine. The parties entered into a settlement agreement resolving all claims of Mr. Levine against the Company and all claims of the Company against Mr. Levine before Mr. Levine filed an answer. On October 8, 2002, Carib Venture Partners Ltd. a St. Kitts corporation ("Carib") filed suit against the Company in the Eastern Caribbean Supreme Court located in St. Kitts. Carib's statement of claim alleges that the Company has 29 defaulted on a promissory note payable by the Company and in favor of Carib in the face amount of $592,107, of which the outstanding amount allegedly due to Carib is $105,571. The Company intends to vigorously defend this lawsuit. On October 8, 2002, Cyber Consultants, Ltd., a St. Kitts corporation ("Cyber Consultants") filed a lawsuit against the Company in the Eastern Caribbean Supreme Court located in St. Kitts. Cyber Consultants' statement of claim alleges that the Company is in breach of a contract between the Company and Cyber Consultants and seeks an accounting under the contract and damages in an unspecified amount. The Company intends to vigorously defend this lawsuit. On September 23, 2002, Allstate Communications Holdings, Inc. ("Allstate"), of Los Angeles, California, filed suit against DCTI in the California Superior Court in Los Angeles. Allstate's complaint contains three separate claims aggregating to approximately $392,000 plus interest, costs, and punitive damages in unspecified amounts. Allstate's claims are based on theories of breach of contract, conversion, and money had and received, and arise out of alleged transactions between Allstate and DCTI, SecureBank and Cyber Clearing. The Company has answered the complaint and intends to vigorously defend the litigation. On April 22, 2002, Cybernet Ventures, Inc. ("Cybernet") filed a complaint against the Company in Los Angeles County Superior Court alleging that the Company failed to provide certain information in response to requests for information and, as a result, Equifax labeled Cybernet an excessive chargeback merchant and listed it on MasterCard International's Terminated Merchant File, making card-acquiring banks, credit card processors, as well as Visa and MasterCard, reluctant to do business with Cybernet. Cybernet also alleges that in September 2001, Visa fined it for excessive chargebacks, despite an agreement with the Company that it was to get a three-month grace period during which Visa would not impose any fines. Cybernet further alleges that the Company erroneously processed through the MasterCard and Visa systems credit card transactions originated by other Internet merchants not affiliated with Cybernet and that, as a result, MasterCard fined it $1.2 million and St. Kitts Bank placed a hold on its merchant account. Finally, Cybernet alleges that the Company improperly collected certain transaction fees. Cybernet's complaint purports to state claims for fraud, intentional misrepresentation, negligent misrepresentation, conversion, unjust enrichment and interference with economic relations. In July 2002, the Company answered Cybernet's complaint. The Company intends to vigorously defend this action. On April 15, 2002, the Bank of Nevis International Limited ("BONI") filed a claim against the Company and DataBank International Ltd. ("DataBank") in the Eastern Caribbean Supreme Court in the High Court of Justice, Federation of Saint Christopher and Nevis containing various allegations against the Company and DataBank arising from a credit card transaction processing agreement (the "BONI Agreement"). In particular, BONIalleges that DataBank, which the Company acquired in October 1999, and/or the Company breached the BONI Agreement by (1) failing to pay processing fees due under the BONI Agreement; (2) negligently instructing BONI to make refunds to merchants; (3) instructing BONI to pay merchants who were not its customers; (4) failing to ensure that the reserve fund of each merchant was sufficient to cover any loss BONI may suffer; (5) not 30 having proper or effective software to manage credit card transactions; (6) delaying in instructing BONI to make payments; (7) improper bookkeeping; (8) failing to maintain sufficient information for merchant accounts; (9) providing inaccurate instructions to BONI; and (10) failing to provide timely instructions to BONI. The claim also alleges that the Company and DataBank breached an agreement with BONI to be bound by the findings of PricewaterhouseCoopers regarding the amounts owed by each party under the BONI Agreement. Finally, BONI also alleges that DataBank had an obligation to indemnify it against any losses associated with merchant processing. The claim seeks $1.9 million in damages. The Company moved to dismiss, but its motion was denied. During the three months ended December 31, 2002, the Company entered into an interim settlement agreement with BONI that allows the Company to continue its appeal but calls for the payment by the Company of $1,027,000 that the parties admit is not in dispute. On April 8, 2002, Next Generation Ltd., Prospect Creek, Ltd., Oxford Partners, Ltd., and Carib Venture Partners, Ltd. (the "Next Generation plaintiffs") filed a complaint against the Company in the United States District Court for the Northern District of California alleging that the Company failed to register restricted shares of the Company's common stock. The Next Generation plaintiffs received the shares in connection with the Company's acquisition of DataBank in October 1999 and claim that the Company was obligated to periodically register a portion of those restricted shares with the SEC following the DataBank transaction, but failed to do so. The Next Generation plaintiffs' complaint purports to state claims for breach of contract, breach of the implied covenant of good faith and fair dealing, unjust enrichment, negligent misrepresentation, declaratory judgment, negligence and constructive fraud. The Company has filed an answer in response to the Next Generation plaintiffs' complaint. The Company intends to vigorously defend this action. In July 2001, Jim Thompson and Kenneth Nagel, both former owners of shares of SecureBank.com, filed a complaint against the Company, SB.com and Bobbie Downey, the Company's former Secretary and General Counsel, in the Circuit Court of the Sixth Judicial Circuit in and for Pinellas County, State of Florida Civil Division, alleging that the Company failed to register 500,000 shares of the Company's stock pursuant to the parties' June 1, 1999 Registration Rights Agreement. The complaint asserts claims for breach of contract, fraudulent inducement, declaratory judgment and rescission. The Company removed the action to the United States District Court for the Northern District of Florida. The Company also filed a counterclaim for breach of contract against Thompson and Nagel arising from promissory notes they made in favor of the Company and for breach of fiduciary duty against Nagel for conduct he engaged in as a director of the Company. The Company is presently involved in settlement negotiations. In November 2000, Ameropa Ltd. ("Ameropa") filed suit in the California Superior Court in Los Angeles against the Company and Don Marshall, the current Chief Executive Officer and a director of the Company, alleging that Ameropa is the assignee of several persons and entities that owned interests in DataBank. Ameropa claims that Mr. Marshall breached a contract with its assignors to pay them their alleged share of the DataBank purchase price. Ameropa has recently 31 added as a defendant James Egide, a former Chief Executive Officer and Chairman of the Company. On June 13, 2002, the court overruled the Company's demurrer to Ameropa's second cause of action sustained the Company's demurrer to the twelfth cause of action in the Third Amended Complaint. In July 2002, Ameropa filed its Fourth Amended Complaint. The Company answered the complaint and otherwise is defending the Ameropa Litigation. On July 10, 2000, American Credit Card Processing Corp. filed a lawsuit against the Company in the United States District Court for the Southern District of New York. The complaint in that matter includes claims for breach of contract, fraud and negligent representation in connection with a merchant bankcard services agreement. The Company filed and prevailed on a motion to dismiss for lack of jurisdiction. American Credit Card subsequently has re-filed the complaint in the United States District Court for the District of Utah. The Company intends to vigorously defend the claim. The claim for damages is for approximately $422,720. The court in that matter has ordered the Company to mediate the dispute, but no date has been set for the mediation On December 7, 2001, McGlen Micro, Inc. filed suit against the Company and American Credit Card Processing Co. in the California Superior Court in Los Angeles for breach of contract conversion, money had and received, and unfair and deceptive business practices. The complaint seeks money damages of a minimum of $164,323 plus interest arising out of allegedly unauthorized chargebacks. The court has scheduled the matter for trial starting on August 28, 2003. Limited discovery has occurred and there is currently a mediation scheduled for February 20, 2003. On November 8, 2000, NetPro, Ltd. filed a lawsuit against the Company in Circuit Court for Pinellas County, Florida. NetPro's complaint for injunctive relief against DCTI seeks a temporary and permanent injunction enjoining the Company from releasing NetPro's funds to ePayment Solutions, Inc. until an accounting can be done, and then ordering the Company to release the funds directly to NetPro. The amount in controversy is unspecified. Currently, NetPro has granted DCTI an indefinite extension to file an answer to see if the case can be settled. If it is not settled, the Company intends to vigorously defend itself in the matter In addition to the above matters, the Company is and has been the subject of certain legal matters, which it considers incidental to its business activities. It is the opinion of management that the ultimate disposition of these legal matters will not individually or in the aggregate have a material adverse effect on the consolidated financial position, liquidity or results of operations of the Company. These claims, if determined adversely to the Company, could have a material adverse effect on the Company's financial position, liquidity and results of operations. The Company believes that it has adequately provided for all known financial exposures, that are probable and reasonably estimable. 32 Item 2. Changes in Securities and Use of Proceeds Item 2(c) Equity Securities Issued or Sold by the Registrant without Registration. During the six months ended December 31, 2002, the Company issued the following securities without registration under the Securities Act of 1933, as amended (the "Securities Act"): On June 19, 2002, the holder of a payment obligation convertible into common stock upon a payment default by the Company notified the Company that it was delinquent with respect to two overdue payments, and advised the Company of the applicable cure period. Subsequently, on July 8, 2002, the holder of the convertible payment notified the Company that, because the delinquency referred to in the June 19, 2002 notice had not been cured, a default had occurred under the relevant documents, and therefore such holder had converted, as of that date, $525,569.52 of the outstanding cash amount under the Amendment Agreement into 29,946,981 shares of DCTI's common stock. The Company subsequently notified Mr. Marshall that it had understated the number of shares of common stock issued and outstanding as of the date of his conversion, and therefore he was allowed to convert only $508,044.91 into 28,948,428 shares of common stock. Certificates representing these shares were issued to a company owned by such holder on September 12, 2002. The Company issued such shares without registration under the Securities Act of 1933 (the "Securities Act") in reliance on Section 4(2) of the Securities Act. Such shares of common stock were issued as restricted securities, and the certificates representing such shares was stamped with a standard legend to prevent any resale without registration under the Securities Act or pursuant to an exemption. 33

34 (b) Current Reports on Form 8-K On December 3, 2002, the Company filed an amendment to a Current Report on Form 8-K that originally was filed on July 29, 2002. The amendment to such Current Report reflected that in connection with his conversion, the Company had understated the actual number of issued and outstanding shares of common stock as of July 8, 2002, and the actual number of shares issued and outstanding was not 45,053,019, as reported in the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2002, but was 46,051,572. Thus, the Company was able to issue to Mr. Marshall only 28,948,428 shares, rather than the 29,946,981 shares indicated in the original Current Report. Thus, the percentage of the Company's common stock controlled by Mr. Marshall is approximately 49.9% rather than the 51.1% originally stated in the Current Report. 35 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DIGITAL COURIER TECHNOLOGIES, INC. Date: By /s/ Lynn J. Langford ----------------------------- February 19, 2003 Lynn J. Langford Chief Financial Officer 36 CHIEF EXECUTIVE OFFICER CERTIFICATION I, Don Marshall, Chief Executive Officer of Digital Courier Technologies, Inc., certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Digital Courier Technologies, Inc. (the "Registrant"); 2. Based on my knowledge, this Quarterly 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 Quarterly Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Quarterly 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 Quarterly Report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have: a) designed such disclosure controls and procedures 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 Quarterly Report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the "Evaluation Date"); and c) presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 19, 2003 /s/ Don Marshall --------------------------------- Don Marshall Chief Executive Officer (Principal Executive Officer) 37 CHIEF FINANCIAL OFFICER CERTIFICATION I, Lynn J. Langford, Chief Financial Officer of Digital Courier Technologies, Inc. certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Digital Courier Technologies, Inc. (the "Registrant"); 2. Based on my knowledge, this Quarterly 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 Quarterly Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Quarterly 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 Quarterly Report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have: a) designed such disclosure controls and procedures 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 Quarterly Report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the "Evaluation Date"); and c) presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 19, 2003 /s/ Lynn J. Langford ------------------------------------------------- Lynn J. Langford Chief Financial Officer (Principal Financial and Accounting Officer) 38

DIGITAL COURIER TECHNOLOGIES INC 10-Q