TPNL 3pea International, Inc.

Item 2. Management’s discussion and analysis of financial condition and results of operations.

Disclosure Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q includes forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (“Forward Looking Statements”). All statements other than statements of historical fact included in this report are Forward Looking Statements. In the normal course of our business, we, in an effort to help keep our shareholders and the public informed about our operations, may from time-to-time issue certain statements, either in writing or orally, that contains or may contain Forward-Looking Statements. Although we believe that the expectations reflected in such Forward-Looking Statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Generally, these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of such plans or strategies, past and possible future, of acquisitions and projected or anticipated benefits from acquisitions made by or to be made by us, or projections involving anticipated revenues, earnings, levels of capital expenditures or other aspects of operating results. All phases of our operations are subject to a number of uncertainties, risks and other influences, many of which are outside of our control and any one of which, or a combination of which, could materially affect the results of our proposed operations and whether Forward Looking Statements made by us ultimately prove to be accurate. Such important factors (“Important Factors”) and other factors could cause actual results to differ materially from our expectations are disclosed in this report, including those factors discussed in “Item 1A. Risk Factors.” All prior and subsequent written and oral Forward Looking Statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the Important Factors described below that could cause actual results to differ materially from our expectations as set forth in any Forward Looking Statement made by or on behalf of us.

Overview

3PEA International, Inc. is a vertically integrated provider of innovative prepaid card programs and processing services for corporate, consumer and government applications. Our payment solutions are utilized by our corporate customers as a means to increase customer loyalty, reduce administration costs and streamline operations. Public sector organizations can utilize the solutions to disburse public benefits or for internal payments. We market our prepaid debit card solutions under our PaySign brand. As we are a payment processor and debit card program manager, we derive our revenue from all stages of the debit card lifecycle. We provide a card processing platform consisting of proprietary systems and innovative software applications based on the unique needs of our programs. We have extended our processing business capabilities through our proprietary PaySign platform. Through the PaySign platform, we provide a variety of services including transaction processing, cardholder enrollment, value loading, cardholder account management, reporting, and customer service.

The PaySign platform was built on modern cross-platform architecture and designed to be highly flexible, scalable and customizable. The platform has allowed 3PEA to significantly expand its operational capabilities by facilitating our entry into new markets within the payments space through its flexibility and ease of customization. The PaySign platform delivers cost benefits and revenue building opportunities to our partners.

We have developed prepaid card programs for corporate and incentive rewards including, but not limited to healthcare reimbursement payments, pharmaceutical co-pay assistance, donor compensation and automobile dealership incentives. We are expanding our product offering to include additional corporate incentive products, payroll cards, general purpose re-loadable cards, travel cards, and expense reimbursement cards. Our cards are offered to end users through our relationships with bank issuers.

We are a vertically integrated payment processor and debit card program manager offering innovative payment solutions to corporations, government agencies, universities and other organizations. Our payment solutions are utilized by our customers as a means to increase customer loyalty, reduce administration costs and streamline operations. We market our prepaid debit card solutions under our PaySign brand. As we are a payment processor and debit card program manager, we derive our revenue from all stages of the debit card lifecycle. These revenues can include fees from program set-up; customization and development; data processing and report generation; card production and fulfillment; transaction fees derived from card usage; inactivity fees; card replacement fees and program administration fees. We provide an in-house customer service center which includes live bi-lingual phone operators staffed 24/7, for incoming calls. We also provide in house Interactive Voice Response (IVR), SMS alerts and two-way SMS messaging platforms.

The Company divides prepaid cards into two general categories: corporate and consumer reloadable and non-reloadable cards.

Reloadable Cards: These types of cards are generally incentive, payroll or considered general purpose reloadable (“GPR”) cards. Payroll cards are issued to an employee by an employer to receive the direct deposit of their payroll. GPR cards can also be issued to a consumer at a retail location or mailed to a consumer after completing an on-line application. GPR cards can be reloaded multiple times with a consumer’s payroll, government benefit, a federal or state tax refund or through cash reload networks located at retail locations. Reloadable cards are generally open loop cards as described below.

Non-Reloadable Cards: These are generally one-time use cards that are only active until the funds initially loaded to the card are spent. These types of cards are gift or incentive cards. These cards may be open loop or closed loop. Normally these types of cards are used for purchase of goods or services at retail locations and cannot be used to receive cash.

These prepaid cards may be open loop, closed loop or semi-closed loop. Open loop cards can be used to receive cash at ATM locations or purchase goods or services by PIN or signature at retail locations. These cards can be used virtually anywhere that the network brand (Visa, MasterCard, Discover, etc.) is accepted. Closed loop cards can only be used at a specific merchant. Semi-closed loop cards can be used at several merchants such as a shopping mall.

The prepaid card market is one of the fastest growing segments of the payments industry in the U.S. This market has experienced significant growth in recent years due to consumers and merchants embracing improved technology, greater convenience, more product choices and greater flexibility. Prepaid cards have also proven to be an attractive alternative to traditional bank accounts for certain segments of the population, particularly those without, or who could not qualify for, a checking or savings account.

We have developed prepaid card programs for healthcare reimbursement payments, corporate and incentive rewards and expense reimbursement cards. We plan to expand our product offering to include payroll cards, general purpose re-loadable cards and travel cards. Our cards are offered to end users through our relationships with bank issuers.

Our products and services are aimed at capitalizing on the growing demand for stored value and reloadable ATM/prepaid card financial products in a variety of market niches. Our proprietary platform is scalable and customizable, delivering cost benefits and revenue building opportunities to partners. We manage all aspects of the debit card lifecycle, from managing the card design and approval processes with banking partners and card associations, to production, packaging, distribution, and personalization. We also oversee inventory and security controls, renewals, lost and stolen card management and replacement.

As part of our platform expansion development process, we evaluate current and emerging technologies for applicability to our existing and future software platform. To this end, we engage with various hardware and software vendors in evaluation of various infrastructure components. Where appropriate, we use third-party technology components in the development of our software applications and service offerings. Third-party software may be used for highly specialized business functions, which we may not be able to develop internally within time and budget constraints. Our principal target markets for processing services include prepaid card issuers, retail and private-label issuers, small third-party processors and small and mid-size financial institutions in the United States and in emerging international markets.

The Company is devoting more extensive resources to sales and marketing activities as we have added essential personnel to our marketing and sales department. We sell our products directly to customers in the U.S. but may work with a small number of resellers and third parties in international markets to identify, sell and support targeted opportunities.

In order to expand into new markets, we will need to invest additional funds in technology improvements, sales and marketing expenses and regulatory compliance costs. We are considering raising capital to enable us to diversify into new market verticals. If we do not raise new capital, we believe that we will still be able to expand into new markets using internally generated funds, but our expansion will not be as rapid.

Key Performance Indicators and Non-GAAP Measures

Management reviews key performance indicators including revenue, gross profits, growth in card programs and cardholder participation. In addition, we consider certain non-GAAP (or "adjusted") measures to be useful to management and investors evaluating our operating performance for the periods presented, and provide a tool for evaluating our ongoing operations, liquidity and management of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment and investment in new card programs. These adjusted metrics are consistent with how management views our business and are used to make financial, operating and planning decisions. These metrics, however, are not measures of financial performance under GAAP and should not be considered a substitute for revenue, operating income, net income, earnings per share (basic and diluted) or net cash from operating activities as determined in accordance with GAAP. We consider the following non-GAAP measures, which may not be comparable to similarly titled measures reported by other companies, to be key performance indicators:

Results of Operations

Three Months ended March 31, 2018 and 2017

Revenues for the three months ended March 31, 2018 were $4,676,320 an increase of $1,475,425 compared to the same period in the prior year, when revenues were $3,200,895. The increase in revenue was primarily due to an increase in the number of new corporate incentive prepaid card products and growth within our existing corporate incentive prepaid card products. As of March 31, 2018, we managed 217 card programs with over 1,700,000 participating cardholders.

Revenue from our card programs is typically impacted by seasonality normally seen in the first quarter. However, we expect our revenues will continue to trend upward during the remaining part of 2018 with the continued growth in both card programs and cardholder base.

Cost of revenues (excluding depreciation and amortization) for the three months ended March 31, 2018 were $2,433,210, an increase of $599,661 compared to the same period in the prior year, when cost of revenues were $1,833,549. Cost of revenues constituted approximately 52% and 57% of total revenues in 2018 and 2017, respectively. Cost of revenues is comprised of transaction processing fees, data connectivity and data center expenses, customer service, network fees, card production costs, and program management expenses, application integration setup and sales expense.

Gross profit for the three months ended March 31, 2018 was $2,243,110, an increase of $875,764 compared to the same period in the prior year, when gross profit was $1,367,346. Our overall gross profit percentage approximated 48% and 43% during the first quarters of 2018 and 2017 which is consistent with our overall expectations.

Selling, general and administrative expenses for the three months ended March 31, 2018 were $1,579,019, an increase of $764,742 compared to the same period in the prior year, when selling, general and administrative expenses were $814,277.  The increase in selling, general and administrative expenses was primarily due to the expansion of our compliance, technology, customer service, operations, and sales and marketing departments.

Depreciation and amortization for the three months ended March 31, 2018 were $246,038, an increase of $30,771 compared to the same period prior year of $215,267. Overall increase in depreciation and amortization was primarily a result of an increase in amortization expense related to additional capitalized platform costs.

In the three months ended March 31, 2018, we recorded operating income of $418,053, as compared to operating income of $337,802 in the same period in the prior year, a change of $80,251 compared to the prior period.

Other (expense) income for the three months ended March 31, 2018 was $(7,400) a decrease in net other income (expense) of $(27,496) compared to the same period in the prior year when other income (expense) was $20,096.

Net income before noncontrolling interest for the three months ended March 31, 2018 was $410,653, an increase of $55,755 compared to the same period in the prior year of $357,898. The increase in our net income before noncontrolling interest is attributable to the aforementioned factors.

Net loss attributable to the noncontrolling interest for the three months ended March 31, 2018 was $1,895, a decrease of $12,601 compared to the same period in the prior year of $14,496. The decrease in net loss attributable to noncontrolling interest is primarily due to a decrease in expenses related to our European subsidiary.

Net income attributable to 3Pea International, Inc. for the three months ended March 31, 2018 was $412,548, an increase of $43,154 compared to the same period in the prior year, when we recorded net income of $369,394. The increase in our net income is attributable to the aforementioned factors.

Comparison of three months ended March 31, 2018 and 2017

During the three months ended March 31, 2018 and 2017, we financed our operations primarily through internally generated funds.

Operating activities provided $1,682,723 of cash in the three months ended March 31, 2018, as compared to $1,470,011 of cash provided by the same period in the prior year. Excluding the change in restricted cash, net cash used by operating activities was $(225,389). In 2018, $1,908,112 of cash was provided by change in customer card funding, which affected our restricted cash for the same amount. Major non-cash items that affected our cash flow from operations in the three months ended March 31, 2018 were non-cash charges of $246,038 for depreciation and amortization, and stock-based compensation of $137,401. Our operating assets and liabilities, excluding customer card funding, used $1,019,481 of cash, most of which resulted from a decrease in accounts payable of $(607,123), and by an increase in prepaid expenses and other assets of $414,181. Major non-cash items that affected our cash flow from operations in the three months ended March 31, 2017 were non-cash charges of $215,267 for depreciation and amortization, and stock-based compensation of $52,001.  Our operating assets and liabilities in the three months ended March 31, 2017, excluding customer card funding, used $(424,445) of cash, most of which resulted from a decrease in legal settlements payable of $(254,900) and decrease in accounts payable of $(114,558).

Investing activities used $(352,533) of cash in 2018, as compared to $(244,099) of cash used in 2017, most of which related to the enhancement of the processing platform used in our business.

Financing activities used $0 of cash in the three months ended March 31, 2018 as compared to $(152,060) of cash used in the three months ended March 31, 2017. In the three months ended March 31, 2017 cash used in financing activities consisted entirely of payments on notes payables totaling $152,060.

Sources of Financing

We believe that our available cash on hand, excluding restricted cash, at March 31, 2018 of $2,170,391, combined with revenues and operating earnings anticipated for the remainder of 2018 will be sufficient to sustain our operations for the next twelve months.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Critical Accounting Estimates

Our significant accounting policies are described in Note 1 of Notes to Financial Statements. At this time, we are not required to make any material estimates and assumptions that affect the reported amounts and related disclosures of assets, liabilities, revenue, and expenses.

Any estimates we make will be based on our experience and our interpretation of economic, political, regulatory, and other factors that affect our business prospects. Actual results may differ significantly from our estimates.