PAYS: What Happens in Vegas
“Las Vegas is the only place I know where money really talks–it says, ‘Goodbye.’”
– FRANK SINATRA
IMPORTANT – Please read this Disclaimer in its entirety before continuing to read our research opinion. The information set forth in this report does not constitute a recommendation to buy or sell any security. This report represents the opinion of the author as of the date of this report. This report contains certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential,” “outlook,” “forecast,” “plan” and other similar terms. All are subject to various factors, any or all of which could cause actual events to differ materially from projected events. This report is based upon information reasonably available to the author and obtained from sources the author believes to be reliable; however, such information and sources cannot be guaranteed as to their accuracy or completeness. The author makes no representation as to the accuracy or completeness of the information set forth in this report and undertakes no duty to update its contents. The author encourages all readers to do their own due diligence.
You should assume that as of the publication date of his reports and research, Marcus Aurelius and possibly any companies affiliated with him and their members, partners, employees, consultants, clients and/or investors (the “Marcus Aurelius Affiliates”) have a short position in the stock (and/or options, swaps, and other derivatives related to the stock) and bonds of Paysign. They therefore stand to realize significant gains in the event that the prices of either equity or debt securities of Paysign decline. Marcus Aurelius and the Marcus Aurelius Affiliates intend to continue transactions in the securities of Paysign for an indefinite period after his first report on a subject company at any time hereafter regardless of initial position and the views stated in Marcus Aurelius’ research. Marcus Aurelius will not update any report or information on this website to reflect such positions or changes in such positions.
Please note that Marcus Aurelius, the author of this report, and the “Marcus Aurelius Affiliates” are not in any way associated with Aurelius Capital Management, LP, a private investment firm based in New York, and any affiliates of or funds managed by the latter company.
You should assume that all persons and entities referenced in lawsuits, government actions, or criminal indictments have denied the allegations referenced herein.
Note: This report references numerous lawsuits and you should assume that Paysign and the referenced defendants or individuals deny all allegations. Some of the referenced lawsuits may also have been settled, dismissed, or otherwise removed.
Summary
We are short Paysign, Inc. (NASDAQ: PAYS) and believe the company bears the markings of yet another stock promotion set to end in failure.
Indeed, evidence reveals that Arthur De Joya, who settled with the SEC in 2015 without admitting guilt for his alleged role in a micro-cap scheme involving sham companies created by a banned Canadian stock promoter, appears to have continued to operate behind the scenes at PAYS. De Joya was PAYS’ CFO from 2007-2015, but we now know he never left the company even though he is currently listed by OTC Markets as one of only 96 prohibited accountants/auditors in the entire country.
PAYS came public via a reverse merger in 2006 and languished for over a decade as a Vegas-area penny stock named 3PEA International, before switching its name to Paysign, Inc. earlier this year and obtaining a NASDAQ listing. Shares have surged from below $1 per share in 2018 to as high as $18 this year amidst hype surrounding the company’s prepaid card offerings. With a current market cap of roughly $450 million, PAYS trades at a monster 13 times trailing twelve-month revenues of $31.8 million and 85 times trailing twelve-month pre-tax income of $5.2 million. At this kind of valuation, we believe investors who have bought into the PAYS promotion have likely overlooked the significant risks we see beneath the surface.
PAYS did not even have an Audit Committee until 2018 because the company had no independent directors, meaning that management was able to operate unfettered without independent oversight for most of its history. All three auditors that have signed off on PAYS financials strike us as highly problematic. Prior to 2008, De Joya’s audit firm (then named De Joya & Company) audited PAYS financials. De Joya’s firm, later named De Joya Griffith, also settled with the SEC in 2015 without admitting guilt for audits allegedly “so deficient that they amounted to no audits at all” and has since withdrawn its Nevada CPA license. Sarna & Company, a tiny firm that had two professional staff members as of 2016, audited ten years of PAYS financials from 2008-2017. Sarna has since withdrawn its registration with the Public Company Accounting Oversight Board (“PCAOB”) and was the subject of a PCAOB inspection report in 2017 which detailed significant audit deficiencies involving revenue recognition of an issuer that we believe was PAYS. In fact, PAYS now features the exact same Squar Milner audit partner as Pareteum (NADAQ: TEUM), the subject of our June 2019 report that has since fallen more than 80% amidst accounting problems and executive departures.
We wonder if PAYS has also swept accounting misdeeds under the rug, especially after learning that a 2015 lawsuit filed by a customer accused PAYS of wrongfully taking $5.8 million worth of the residual/expired card funds that PAYS was not contractually entitled to take. This represents money left on expired cards that the customer says PAYS was required to send back (also commonly known as “breakage”). If PAYS artificially inflated its financials by improperly recognizing profits on this alleged $5.8 million in breakage, we calculate that it would likely have fueled most, if not all, of the company’s reported profits over the previous five-year time period.
Card breakage appears to now, perhaps once again, be having an outsized impact on PAYS’ reported financial results. We calculate that approximately 70% of the pre-tax profits PAYS has reported so far this year has come from breakage. This is problematic because our research suggests breakage revenue is neither scalable or sustainable. Furthermore, in order to justify the current valuation, investors seem to believe that PAYS will be able to take significant market share from seasoned competitors who have robust infrastructure and entrenched operations in pharmaceutical and general-purpose reloadable card markets. Yet while PAYS is promoted as a “fintech” company, it has no patents, a small internal IT team, and has invested a mere $1.9 million in cumulative capital expenditures over the past decade, according to our research. We are therefore skeptical that PAYS will be able to grow anywhere near as rapidly as what investors and analysts currently seem to be anticipating.
PAYS insiders have begun selling millions of dollars of stock in the open market pursuant to 10B5-1 plans. In addition, three senior hires that were featured in PAYS press releases last year appear to have already left the company. As the reality of the business sets in, we believe it’s only a matter of time until PAYS’ stock price begins to reflect the true underlying nature of this company. We therefore see enormous downside potential.
We Believe PAYS Bears the Markings of Yet Another Stock Promotion Set to End in Failure
Arthur De Joya, PAYS’ longtime CFO until October 2015, joined the company in 2007 while he was simultaneously a partner at a public accounting firm named De Joya Griffith LLC. In January 2015, The SEC announced charges against both Arthur De Joya and De Joya Griffith LLC related to an alleged micro-cap fraud involving 20 purported mining companies as part of a scheme orchestrated by a banned Canadian stock promoter named John Briner. The SEC stated that Briner, who was charged by the SEC for a previous alleged pump-and-dump scheme, “recruited clients and associates to become figurehead executives while he secretly controlled the companies from behind the scenes”. De Joya was charged for his alleged role as one of “several gatekeepers that helped Briner perpetrate his scheme” and the SEC stated that De Joya and his firm’s audits of Briner’s sham companies were “so deficient that they amounted to no audits at all, and they ignored red flags that Briner was engaging in fraud”. In the resulting settlement, in which De Joya and De Joya Griffith LLC did not admit to guilt, the SEC prohibited Arthur De Joya from “appearing or practicing before the Commission as an accountant” and De Joya Griffith LLC has since surrendered its Nevada CPA license.
We learned that De Joya has remained at PAYS despite the SEC charges. As demonstrated in this recording (here), when we called Paysign’s corporate phone number and asked to speak to Arthur De Joya, Paysign’s receptionist immediately transferred us to an extension. Although the SEC announced the charges against De Joya in January 2015, PAYS never disclosed them to investors and De Joya remained CFO until October 2015, when PAYS announced his resignation. But De Joya’s own LinkedIn page indicates he is still employed by the company in a “Business Development and Acquisitions” role, which makes us wonder if he is helping lead the M&A efforts the company has been touting. Also, a footnote to an April 2019 Proxy filing made by PAYS listing large shareholders states that De Joya was an “employee or independent contractor of the company” at the time of the filing (below). Two former employees we spoke to also confirmed that De Joya continued to work for PAYS after the SEC charges, with one describing him as working “behind the scenes” in finance and accounting activities. 
We find this highly problematic because De Joya and his firm have collectively been involved in the preparation or audit of nearly a decade of PAYS financial statements. Prior to 2008, De Joya’s audit firm, then named De Joya & Company, audited PAYS financials. De Joya himself is currently named as a “prohibited accountant” by OTC Markets, one of only 96 such prohibited accountants / auditors in the entire country on this list. We note that PAYS didn’t even form an Audit Committee until 2018 because the company had no independent directors, meaning that PAYS management team has been able to operate unfettered by this critical independent oversight function for most of PAYS’ history.
Furthermore, PAYS’ longtime former auditor, Sarna & Company, is a tiny firm described in PCAOB documents as a “sole practitioner” with only two staff members in total. Yet Sarna signed off on ten of PAYS’ audits from 2008-2017. Significant deficiencies with Sarna & Company’s audit of “Issuer A” were detailed in a February 2017 inspection report issued by the PCAOB. We know that “Issuer A” must be PAYS because the report states that Sarna only had a single issuer audit client at the time, who by simple deduction could only be PAYS. The PCAOB’s report states that “the inspection team identified a significant deficiency related to the firm’s testing of revenue recognition” and specifically cites failures that including AS 2301.13, which relates to “Addressing Fraud Risks in the Audit of Financial Statements” (emphasis ours). The PCAOB report also states that “the auditor issued an opinion without satisfying it’s fundamental obligations to obtain reasonable assurance about whether the financial statements were free of material misstatement” and that “this information provides cause for concern regarding the firm’s application of due professional care with respect to auditing revenue recognition”.
Sarna denied the PCAOB’s findings in a response letter that was appended to the report, but we note that the PCAOB also flagged audit issues relating to revenue recognition in a previous inspection report of Sarna in 2014 (which Sarna also denied). In April 2017 Sarna abruptly departed after notifying PAYS that “it would be unable to continue as the Company’s principal independent registered public accounting firm”. Sarna & Company has also since withdrawn its PCAOB registration.
After Sarna left, PAYS retained Squar Milner LLP as its auditor. Diligent readers may remember Squar Milner as the auditor of Pareteum (NASDAQ: TEUM), the subject of our June 2019 report flagging serious irregularities including our concern that the company’s purported $900 million backlog was significantly exaggerated or fictitious. Since our report, TEUM has said its financials can no longer be relied upon, two executive officers have departed, and the stock has fallen more than 80%. PCOAB documents reveal that the exact same Squar audit partner who signed off on TEUM’s audits has now signed off on the last two PAYS audits. We note that the PCAOB’s most recent inspection report of Squar Milner also details audit deficiencies relating to revenue.
Although PAYS did finally establish an Audit Committee in 2018, we are not sanguine about its ability to provide independent oversight. Quinn Williams, who joined PAYS in April 2018 as a purportedly “independent” Director and Audit Committee member, appears to merely be one of PAYS’ lawyers. Williams is a partner and shareholder of Greenberg Traurig, a firm that has defended PAYS in two lawsuits in the last five years and provided an August 21, 2019 opinion letter for PAYS to the SEC “with respect to the legality of the securities being registered”. We are therefore puzzled how an attorney at PAYS’ own law firm, who presumably is bound by attorney client privilege, could be considered independent and sit on the Audit Committee of his own client.
Has PAYS Swept Accounting Misdeeds Under the Rug?
In late 2006, PAYS began providing payment processing services for PSKW’s pharmaceutical copay card programs. Such programs involve pre-paid cards funded by pharmaceutical companies that are issued to consumers to offset the out of pocket costs tied to certain drugs involved in the programs. In 2015, PSKW sued PAYS alleging that PAYS had wrongfully taken $5.8 million worth of the residual/expired funds that had been loaded onto the cards and that PAYS was not contractually entitled to these funds. The lawsuit explains that residual/expired card funds (again known as “breakage”) result from some copay cards expiring before all of the funds loaded on them have been used by a patient. PSKW stated that PAYS was required to remit most of these funds back to PSKW but did not remit said funds.
Source: PSKW, LLC vs 3Pea International, Inc. Docket entry No. 1
(PAYS, who was represented by Greenberg Traurig in this matter, did not admit to wrongdoing and denied the allegations)
Furthermore, the lawsuit alleged that PAYS “has a history of engaging in such conduct” and PSKW stated that it had previously caught PAYS misappropriating residual/expired funds in late 2008 when, according to a declaration made by PSKW’s CEO, “Mr. Newcomer [PAYS CEO] admitted to me that 3PEA was not entitled to the money, and said 3PEA was unable to obtain a much needed loan and was thus experiencing financial difficulties.” According to the lawsuit, that incident was resolved with an updated contract specifically stating that PAYS must pay 95% of the residual/expired funds to PSKW yet PAYS wrongfully began taking the funds again anyways.
Source: PSKW, LLC vs 3Pea International, Inc. Docket entry No. 12
We wonder if PAYS may have been improperly recognizing revenue or earnings on the alleged $5.8 million worth of residual/expired card funds as a means to artificially inflate its prior period financial statements? We note that PAYS reported $5.2 million in total cumulative pre-tax income from 2010-2015. This means that if PAYS was indeed recognizing profits on the residual/expired card funds, it would likely have fueled most, if not all, of the company’s profits over that time period. The answer is unclear because PAYS quickly settled the lawsuit by agreeing to pay $2.5 million to PSKW and took a one-time charge in Q3 2015 as disclosed in an 8-K filing (which misleadingly, in our opinion, characterized the lawsuit as a dispute over “marketing fees”).
We Are Highly Skeptical of PAYS’ Promotional Narratives
Card breakage appears to now, perhaps once again, be having an outsized impact on PAYS’ reported financial results. This is problematic because our research suggests breakage revenue is neither scalable or sustainable. We calculate that approximately $3.5 million of the $5.0 million in pre-tax profit PAYS has reported so far this year, or 70% of profits, is from breakage. By comparison, PAYS doesn’t appear to have recognized any revenue or profit from breakage during either 2016 or 2017. Our calculation of breakage (detailed below), which we assume comes at 100% profit margins, is performed by simply comparing PAYS’ restricted cash balance, which represents funds specifically held for card programs, to the associated liability for customer deposits. In prior periods these balances were roughly equal, but they began to diverge this year presumably as PAYS began recognizing revenue on estimated breakage. We note the just-filed Q3 10-Q added “expiring card balances” as a source of revenue (page 10) for the first time ever.
Source: Non-GAAP internal inferences and calculations using as reported PAYS’ restricted cash, customer deposits, and pre-tax profits.
The breakage appears to be a product of PAYS’ re-entry into the pharmaceutical copay business which began generating revenue again this year. But our research, including conversations with four experienced industry participants, suggests that PAYS’ keeping the breakage is not customary in the industry. Two of the industry participants stated that copay service providers such as PAYS do not typically get any breakage, two others said they were familiar with some industry contracts having breakage provisions but that it is uncommon. One of the industry veterans explained that, as the copay industry has evolved and grown, pharmaceutical companies have become increasingly aware of breakage and typically aren’t interested in sharing these funds with the 3rd party service providers. We’re informed that some competitors even have processes where excess card funds are swept back to the pharma companies on a regular basis. Therefore, if PAYS has favorable existing contracts allowing it to keep these balances for itself, we view these as more of a “one off” and unlikely to recur or scale. We calculate that PAYS’ implied breakage, actually declined 13% sequentially from $1.5 million in Q2 2019 to $1.3 million in Q3 2019 after having increased rapidly earlier this year (above). This may be indicative of our broader belief that, even if PAYS is able gather additional copay card contracts, especially ones of larger size, they are unlikely to be anywhere near as profitable as investors may currently be extrapolating.
Furthermore, in order to justify the current valuation, investors seem to believe that PAYS will be able to take significant market share from seasoned competitors. For example, one sell side analyst estimated earlier this year that PAYS pharma business will grow from $7 million this year to $176 million in annual revenues by 2024. But our research suggests that PAYS lacks the infrastructure and capabilities to compete with established operators such as TrialCard and ConnectiveRX, who have invested to build out a robust variety of offerings such as hub services and advanced analytics that go far beyond transaction processing and that have become integral to pharmaceutical copay programs. While PAYS is promoted to investors as a “fintech”, the company admitted in a September 2019 8-K filing that “We erroneously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018 that we have patents, which we do not” (emphasis ours). We found only five PAYS employees on Linkedin that appear to be working in an IT capacity and PAYS has invested only approximately $1.9 million in cumulative capital expenditures over the last decade, according to our calculations from SEC filings. We believe this dynamic explains why PAYS conceded on a February 2019 conference call that “instead of going out and establishing individual relationship with the manufacturers, we are doing it through others that provide pharmaceutical services”. In other words, we believe PAYS provides an increasingly commoditized service in the form of a payment vehicle (debit card) that is being bundled into a more comprehensive offering provided by other companies to the pharmaceutical manufacturers. Yes, PAYS can probably grow revenues this way, but we are skeptical these contracts will prove to be anywhere near as large, numerous, or valuable as many investors currently seem to expect.
We are also highly skeptical of the narratives surrounding PAYS planned rollout of a new general-purpose reloadable card called the “Paysign Premier Card”. PAYS intends to market this card to its existing plasma cardholder base of more than two million individuals as a prepaid card linked to a deposit account at one of PAYS’ bank partners. Bulls point to PAYS bringing on Dan Henry as its Chairman in 2017, who was the former CEO of Netspend, as reason for optimism. But PAYS ended Q3 2019 with only $29.6 million in existing customer deposits and the vast majority of its plasma cardholders (as explained below) have limited disposable income and therefore can’t possibly load massive amounts of money onto new PAYS cards even if they wanted to, in our opinion. We also don’t believe PAYS has a “secret sauce” that could allow it to have success attracting large amounts of customers outside of plasma and note that customer reviews we’ve read concerning PAYS mobile app have been quite poor. This is a competitive landscape dominated by larger companies, such as Green Dot (NYSE: GDOT), which has spent over $235 million in capital expenditures over the last five years and has approximately 1,100 employees, according to our analysis of SEC filings.
After languishing as a penny stock for a decade, some of the hype appears to be a product of PAYS hiring certain new vice presidents, executives, and directors with good resumes who have been awarded lots of stock. But we found that three hires PAYS touted in press releases during 2018 appear to have already left the company including Dana Barciz (Chief Marketing Officer), Mark Jacobs (Sales Director), and Dennis DiVenuta (Executive Vice President Strategy and Corporate Development). Notably, certain PAYS insiders have already begun to sell their stock in the open market pursuant to 10B5-1 plans. Since PAYS lowered revenue guidance on September 9th 2019, CEO Mark Newcomer has sold 200,000 shares (for $2.2 Million), Dan Henry has already sold 150,000 shares (for $1.5 million), CTO Daniel Spence sold 120,000 shares (for $1.34 Million), and Quinn Williams sold 15,000 shares (for $164k).
Most of PAYS’ revenues currently come from processing pre-paid cards for the plasma donation industry, whereby blood donors receive cards loaded with funds as compensation. PAYS says it has 33% market share and earns various fees driven largely by the amount of total funds loaded onto the cards. For reference, one sell side analyst projected this year that PAYS’ plasma revenue, which was then roughly $27 million over the past 12 months, will grow at roughly 20% per year over the next three years. But even some bulls assign only around $5 per share to this business, a valuation that seems excessive to us, but illustrates exactly how much promotional “blue sky” appears to be embedded in PAYS’ current stock price. We note that PAYS’ plasma business is not without regulatory risk, with media reports increasingly scrutinizing the high fees being harvested from plasma cards at the expense of unsuspecting donors, who tend to be impoverished individuals (see example here). While these fees are good for PAYS’ shareholders at present, we believe they may prove to be unsustainable over time, especially if political or regulatory winds begin to change.
We therefore see significant downside potential.
All investors are encouraged to conduct their own due diligence into these factors.