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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2004 Commission file number 000-25959 Private Business, Inc.  Tennessee
    
    62-1453841(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)9020 Overlook Blvd., Brentwood, Tennessee
    
    37027(Address of principal executive offices)
    
    (Zip Code)
 (615) 221-8400
(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 [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).     Yes [ ]       No [x] Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practical date. Class
    
    Outstanding as of October 31, 2004Common Stock, no par value
    
    14,382,520 shares
 1




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PRIVATE BUSINESS, INC. Form 10-Q For Quarter Ended September 30, 2004 INDEX  
 Page No.Part I  Financial InformationItem 1 
    
    Financial StatementsUnaudited Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003
    
    
    3Unaudited Consolidated Statements of Income for the three months ended September 30, 2004 and 2003
    
    
    4Unaudited Consolidated Statements of Income for the nine months ended September 30, 2004 and 2003
    
    
    5Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003
    
    
    6Notes to Unaudited Consolidated Financial Statements
    
    
    7-12Item 2 
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13-25Item 3 
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4 
    
    Controls and Procedures
    
    
    25Part II  Other InformationItem 1 
    
    Legal Proceedings
    
    
    26Item 6 
    
    Exhibits and Reports on Form 8-K
    
    
    27Signatures
    
    
    28EX-10.4  EMPLOYMENT AGREEMENTEX-10.5  INCENTIVE STOCK OPTION AGREEMENTEX-10.6  EMPLOYMENT AGREEMENTEX-31.1  SECTION 302 CERTIFICATION OF THE CEOEX-31.2  SECTION 302 CERTIFICATION OF THE CFOEX-32.1  SECTION 906 CERTIFICATION OF THE CEOEX-32.2  SECTION 906 CERTIFICATION OF THE CFO
  2




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Part 1 Financial Information 
 Item 1.     Financial Statements PRIVATE BUSINESS, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS  UNAUDITED
 September 30,
    
    December 31,(in thousands, except share data)
    
    2004
    
    2003ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    2,318
    
    
    $
    1,586Accounts receivable  trade, net of allowance for doubtful accounts of $388 and $358, respectively
    
    
    4,617
    
    
    
    4,575Accounts receivable  other
    
    
    89
    
    
    
    371Deferred tax assets
    
    
    366
    
    
    
    859Prepaid and other current assets
    
    
    1,224
    
    
    
    1,620Total current assets
    
    
    8,614
    
    
    
    9,011PROPERTY AND EQUIPMENT, NET
    
    
    2,683
    
    
    
    3,698OTHER ASSETS:Software development costs, net
    
    
    1,232
    
    
    
    1,267Deferred tax assets
    
    
    2,859
    
    
    
    2,980Intangible and other assets, net
    
    
    9,188
    
    
    
    10,129Total other assets
    
    
    13,279
    
    
    
    14,376Total assets
    
    $
    24,576
    
    
    $
    27,085LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)CURRENT LIABILITIES:Accounts payable
    
    $
    1,655
    
    
    $
    1,741Accrued liabilities
    
    
    2,169
    
    
    
    3,786Other short term borrowings
    
    
    
    
    
    
    388Dividends payable
    
    
    
    
    
    
    735Deferred revenue
    
    
    557
    
    
    
    557Current portion of long-term debt and capital lease obligations
    
    
    1,667
    
    
    
    3,849Total current liabilities
    
    
    6,048
    
    
    
    11,056REVOLVING LINE OF CREDIT
    
    
    3,250
    
    
    
    950OTHER NONCURRENT LIABILITIES
    
    
    97
    
    
    
    170LONG-TERM DEBT, net of current portion
    
    
    2,083
    
    
    
    19,277Total liabilities
    
    
    11,478
    
    
    
    31,453COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY (DEFICIT):Common stock, no par value; 33,333,333 shares authorized; shares issued and outstanding, 14,369,637 and 14,063,487, respectively
    
    
    
    
    
    
    Series A Preferred Stock, nonconvertible, no par value; 20,000,000 shares authorized, 20,000 shares issued and outstanding
at September 30, 2004
    
    
    6,209
    
    
    
    Series B Preferred Stock, convertible, no par value; 20,000,000 shares authorized, 40,031 shares issued and outstanding
    
    
    114
    
    
    
    114Additional paid-in capital
    
    
    3,706
    
    
    
    (7,326
    )Retained earnings
    
    
    3,069
    
    
    
    2,844Total stockholders equity (deficit)
    
    
    13,098
    
    
    
    (4,368
    )Total liabilities and stockholders equity (deficit)
    
    $
    24,576
    
    
    $
    27,085
 The accompanying notes are an integral part of these consolidated financial statements. 3




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PRIVATE BUSINESS, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF INCOME  UNAUDITED For the Three Months Ended September 30, 2004 and 2003
 (in thousands, except per share data)
    
    2004
    
    2003REVENUES:Participation fees
    
    $
    6,394
    
    
    $
    7,063Software license
    
    
    50
    
    
    
    62Retail planning services
    
    
    2,272
    
    
    
    2,244Maintenance and other
    
    
    1,282
    
    
    
    1,337Total revenues
    
    
    9,998
    
    
    
    10,706OPERATING EXPENSES:General and administrative
    
    
    3,804
    
    
    
    4,355Selling and marketing
    
    
    4,638
    
    
    
    4,137Research and development
    
    
    58
    
    
    
    102Amortization
    
    
    263
    
    
    
    431Other operating expense, net
    
    
    19
    
    
    
    21Total operating expenses
    
    
    8,782
    
    
    
    9,046OPERATING INCOME
    
    
    1,216
    
    
    
    1,660INTEREST EXPENSE, NET
    
    
    (93
    )
    
    
    (385
    )OTHER INCOME
    
    
    
    
    
    
    INCOME BEFORE INCOME TAXES
    
    
    1,123
    
    
    
    1,275Income tax provision (benefit)
    
    
    (531
    )
    
    
    497NET INCOME
    
    
    1,654
    
    
    
    778Preferred stock dividends
    
    
    540
    
    
    
    40NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
    
    $
    1,114
    
    
    $
    738EARNINGS PER SHARE:Basic
    
    $
    0.08
    
    
    $
    0.05Diluted
    
    $
    0.07
    
    
    $
    0.05WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:Basic
    
    
    14,303
    
    
    
    14,106Diluted
    
    
    14,795
    
    
    
    14,210
 The accompanying notes are an integral part of these consolidated financial statements. 4




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PRIVATE BUSINESS, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF INCOME  UNAUDITED For the Nine Months Ended September 2004 and 2003
 (in thousands, except per share data)
    
    2004
    
    2003REVENUES:Participation fees
    
    $
    19,231
    
    
    $
    21,272Software license
    
    
    164
    
    
    
    213Retail planning services
    
    
    6,735
    
    
    
    6,886Maintenance and other
    
    
    3,866
    
    
    
    4,578Total revenues
    
    
    29,996
    
    
    
    32,949OPERATING EXPENSES:General and administrative
    
    
    11,696
    
    
    
    14,823Selling and marketing
    
    
    13,714
    
    
    
    13,309Research and development
    
    
    293
    
    
    
    304Amortization
    
    
    879
    
    
    
    1,280Other operating expense, net
    
    
    2,006
    
    
    
    94Total operating expenses
    
    
    28,588
    
    
    
    29,810OPERATING INCOME
    
    
    1,408
    
    
    
    3,139INTEREST EXPENSE, NET
    
    
    (382
    )
    
    
    (1,136
    )OTHER INCOME
    
    
    266
    
    
    
    INCOME BEFORE INCOME TAXES
    
    
    1,292
    
    
    
    2,003Income tax provision (benefit)
    
    
    (462
    )
    
    
    781NET INCOME
    
    
    1,754
    
    
    
    1,222Preferred stock dividends
    
    
    1,523
    
    
    
    120NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
    
    $
    231
    
    
    $
    1,102EARNINGS PER SHARE:Basic
    
    $
    0.02
    
    
    $
    0.08Diluted
    
    $
    0.01
    
    
    $
    0.08WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:Basic
    
    
    14,193
    
    
    
    14,086Diluted
    
    
    14,675
    
    
    
    14,131
 The accompanying notes are an integral part of these consolidated financial statements. 5




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PRIVATE BUSINESS, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS  UNAUDITED For the Nine Months Ended September 30, 2004 and 2003
 (in thousands)
    
    2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    1,754
    
    
    $
    1,222Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    2,285
    
    
    
    3,375Deferred taxes
    
    
    614
    
    
    
    612Write-off of debt issuance costs
    
    
    780
    
    
    
    Gain on sale of Bank Insurance division
    
    
    
    
    
    
    (427
    )Changes in assets and liabilities:Accounts receivable, net
    
    
    240
    
    
    
    1,648Prepaid and other current assets
    
    
    396
    
    
    
    759Other assets
    
    
    17
    
    
    
    (288
    )Accounts payable
    
    
    (86
    )
    
    
    (167
    )Accrued liabilities
    
    
    (1,617
    )
    
    
    (1,046
    )Deferred revenue
    
    
    
    
    
    
    16Other noncurrent liabilities
    
    
    
    
    
    
    (428
    )Net cash provided by operating activities
    
    
    4,383
    
    
    
    5,276CASH FLOWS FROM INVESTING ACTIVITIES:Additions to property and equipment
    
    
    (315
    )
    
    
    (89
    )Software development costs
    
    
    (569
    )
    
    
    (555
    )Payments received on notes receivable
    
    
    29
    
    
    
    14Proceeds from sale of Bank Insurance division
    
    
    
    
    
    
    325Net cash used in investing activities
    
    
    (855
    )
    
    
    (305
    )CASH FLOWS FROM FINANCING ACTIVITIES:Repayments on long-term debt
    
    
    (1,250
    )
    
    
    (4,014
    )Repayments on capitalized lease obligations
    
    
    (201
    )
    
    
    (301
    )Repayments of other short-term borrowings
    
    
    (414
    )
    
    
    (454
    )Extinguishment of long-term debt facility with Fleet
    
    
    (23,875
    )
    
    
    Proceeds from revolving line of credit, net
    
    
    750
    
    
    
    Proceeds from exercise of employee stock options
    
    
    321
    
    
    
    Stock issued through employee stock purchase plan
    
    
    23
    
    
    
    47Net proceeds from sale of Series A preferred shares and common stock warrant
    
    
    16,894
    
    
    
    Proceeds from new debt facility with Bank of America, net of issuance cost of $286
    
    
    7,214
    
    
    
    Payments of declared preferred dividends
    
    
    (2,258
    )
    
    
    Net cash used in financing activities
    
    
    (2,796
    )
    
    
    (4,722
    )NET CHANGE IN CASH AND CASH EQUIVALENTS
    
    
    732
    
    
    
    249CASH AND CASH EQUIVALENTS at beginning of year
    
    
    1,586
    
    
    
    1,146CASH AND CASH EQUIVALENTS at end of period
    
    $
    2,318
    
    
    $
    1,395SUPPLEMENTAL CASH FLOW INFORMATION:Cash payments for income taxes during period
    
    $
    260
    
    
    $
    207Cash payments of interest during period
    
    $
    379
    
    
    $
    1,147NON-CASH INVESTING ACTIVITIES:Note receivable for sale of Bank Insurance division
    
    $
    
    
    
    $
    175NON-CASH FINANCING ACTIVITIES:Notes payable for certain insurance and software support contracts
    
    $
    
    
    
    $
    865
 The accompanying notes are an integral part of these consolidated financial statements. 6




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PRIVATE BUSINESS, INC. 
 Notes to Consolidated Financial Statements  Unaudited  A.
    
    Basis of Presentation The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial reporting and in accordance with Rule 10-01
of Regulation S-X. In the opinion of management, the unaudited interim financial statements
contained in this report reflect all adjustments, consisting of only normal
recurring accruals, which are necessary for a fair presentation of the
financial position, and the results of operations for the interim periods
presented. The results of operations for any interim period are not necessarily
indicative of results for the full year. These consolidated financial statements, footnote disclosures and other
information should be read in conjunction with the consolidated financial
statements and notes thereto included in our Annual Report on Form 10-K for the
year ended December 31, 2003.  B.
    
    Summary of Significant Accounting Policies Principles of Consolidation The accompanying financial statements include the accounts of Private
Business, Inc. and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation. Our significant accounting policies include revenue recognition and
software development costs. Please refer to our Annual Report on Form 10-K for
the year ended December 31, 2003 for a more detailed description of these
accounting policies. Stock-Based Compensation The Company has elected to account for its stock-based compensation plans
under the intrinsic value-based method of accounting prescribed by Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,
and does not utilize the fair value method. 7




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The following table illustrates the effect on net income (loss) available
to common shareholders and earnings (loss) per share if the fair value based
method had been applied to all outstanding and unvested awards for the three
and nine month periods ended September 30, 2004 and 2003, respectively. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(in thousands, except per share data)
    
    2004
    
    2003
    
    2004
    
    2003Net income available to common shareholders, as reported
    
    $
    1,114
    
    
    $
    738
    
    
    $
    231
    
    
    $
    1,102Add: Stock-based employee compensation expense included in
reported net income (loss), net of related tax effects
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net
of related tax effects
    
    
    77
    
    
    
    73
    
    
    
    253
    
    
    
    556Pro forma net income (loss)
    
    $
    1,037
    
    
    $
    665
    
    
    $
    (22
    )
    
    $
    546Earnings (loss) per share:Basicas reported
    
    $
    0.08
    
    
    $
    0.05
    
    
    $
    0.02
    
    
    $
    0.08Basicpro forma
    
    $
    0.07
    
    
    $
    0.05
    
    
    $
    (0.00
    )
    
    $
    0.04Dilutedas reported
    
    $
    0.07
    
    
    $
    0.05
    
    
    $
    0.01
    
    
    $
    0.08Dilutedpro forma
    
    $
    0.07
    
    
    $
    0.05
    
    
    $
    (0.00
    )
    
    $
    0.04
  C.
    
    Income Taxes During September 2004, the Company recorded a $972,000 tax benefit
relating to an income tax contingent liability for which the statute of
limitations expired in September 2004. This resulted in an overall tax benefit
for the third quarter of 2004 totaling $531,000.  D.
    
    Reclassifications Certain prior year amounts have been reclassified to conform with current
year presentation.  E.
    
    Capital Event On January 20, 2004, the Company completed the sale of 20,000 shares of
Series A non-convertible preferred stock and a warrant to purchase 16,000,000
shares of our common stock ($1.25 per share exercise price) for a total of $20
million (the Lightyear Transaction) to Lightyear Fund, L.P. (together with
its affiliates, Lightyear). The Series A preferred shares carry a cash
dividend rate of 10% per annum of an amount equal to the liquidation
preference, payable quarterly in arrears, when and as declared by the Board of
Directors. The Series A preferred stock has a liquidation preference superior
to the common stock and to the extent required by the terms of the Series B
preferred stock, in parity with the currently outstanding Series B preferred
stock. The liquidation preference is equal to the original $20 million
purchase price, plus all accrued but unpaid dividends. In addition, the
Securityholders agreement between the Company and Lightyear PBI Holdings, LLC,
executed in conjunction with the sale of the preferred stock and warrant,
entitles Lightyear to an additional equity purchase right. The equity purchase
right allows Lightyear, so long as Lightyear continues to hold any shares of
Series A Preferred Stock, all or any portion of its rights under the warrant or
any shares of common stock issued pursuant to an exercise of the warrant, the
right to purchase its pro rata portion of all or any part of any new securities
which the Company may, from time to time, propose to sell or issue. However,
in the case of new security issuances resulting from the exercise of employee
stock options which have an 8




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exercise price less than $1.25 per share, Lightyear must still pay $1.25 per
share under this equity purchase right. To the extent that new security
issuances resulting from the exercise of employee stock options occur which
have an exercise price in excess of $1.25 per share, then Lightyear will be
required, if it chooses to exercise their equity purchase right, to pay the
same price per share as the employee stock options being exercised. The net proceeds from the Lightyear Transaction are shown below (in thousands): Cash Received from Lightyear
    
    $
    20,000Less:Broker fees
    
    
    1,255Legal and accounting fees
    
    
    383Transaction structuring fees
    
    
    1,200Other
    
    
    268Net Proceeds Received
    
    $
    16,894
 The net proceeds above were allocated among the preferred stock, the
common stock warrant and the additional common stock equity right based upon
the estimated fair values of each instrument, resulting in
$6.2 million allocated to the preferred shares and $10.7 million allocated to
the common stock warrant and additional common stock equity right. The
estimated fair value of the preferred stock was determined based on valuing the
expected preferred stock dividend stream using expected yields ranging from
20.2% to 30.2%. These yield ranges were derived by comparison to other similar
preferred issuances at companies with similar equity ratings. The estimated
fair value of the common stock warrant and additional common stock equity right
were determined by using the Black-Scholes model. The assumptions used in this
valuation for the warrant included the exercise price of $1.25, the expected
life of the warrant of ten years, an interest rate of 4.41% and volatility
factors of between 51.9% and 64.3% based on selected comparable companies. The
assumptions used in this valuation for the additional common stock equity right
included exercise prices ranging from $1.25 to $42.64, expected lives between
two and seven years, an interest rate of 4.0% and a volatility factor of 75%. Simultaneous with the closing of the Lightyear Transaction, the Company
entered into a new credit facility (the Bank of America Credit Facility).
The Bank of America Credit Facility is an $11.0 million facility that includes
a term loan in the amount of $5.0 million and a revolving line of credit of up
to $6.0 million. The revolving line of credit includes a $1.0 million letter of
credit sub-limit. The Bank of America Credit Facility expires on January 19, 2007. The
revolving credit commitment reduces by $1.0 million on each of the first two
anniversary dates of the credit facility. The term loan is repayable in twelve equal quarterly installments of
$416,667, along with interest at the applicable margin. Interest is also due on
the outstanding revolving line of credit quarterly at the applicable margin.
The interest rates of the term loan and revolving loan are based on a pricing
grid using the Companys Funded Debt to EBITDA Ratio, as follows (The Company
has the option of choosing the Libor or Base Rate): Funded Debt to EBITDA
    
    Libor Margin
    
    Base Rate MarginLess than or equal to 1.0
    
    
    2.25
    %
    
    
    0Greater than 1.0 but less than or equal to 1.25
    
    
    2.50
    %
    
    
    0Greater than 1.25 but less than or equal to 1.50
    
    
    2.75
    %
    
    
    0
 The Bank of America Credit Facility includes certain restrictive financial
covenants relating to minimum net worth, maximum annual capital expenditures,
funded debt to EBITDA ratio and fixed charge coverage ratio. The Bank of America Credit Facility prohibits the Company from declaring
and paying any cash dividends on any class of stock except for the Series A and
Series B preferred shares outstanding, provided that no default, 9




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as defined in the Bank of America Credit Facility, exists as of the date
of the dividend payment and such dividend payment will not cause a default. The total net proceeds of both the Lightyear Transaction and the Bank of
America Credit Facility were used to extinguish the Companys 1998 credit
facility. As a result of the 1998 credit facility extinguishment, the Company
recorded a charge of $780,000 to write-off the unamortized portion of debt
issuance costs as of January 20, 2004. Also, the Lightyear Transaction required
that the Company obtain directors and officers tail insurance coverage for
periods prior to January 20, 2004. The premium for the tail directors and
officers liability insurance coverage totaled approximately $900,000. The
Company expensed the entire premium in January 2004. Therefore, first quarter
2004 other operating expense includes two unusual expense items totaling
approximately $1.7 million.  F.
    
    Sale of Bank Insurance Business On June 30, 2003, the Company entered into an agreement to sell certain
operating assets of its Bank Insurance business for cash of $325,000 and a note
receivable for $175,000. The note is secured by all assets of the business
sold, is due in equal quarterly installments of principal and interest through
June 2006 and bears interest at 3%. The result of this transaction is a gain
on sale of approximately $427,000, which is included in maintenance and other
revenues in the accompanying 2003 statement of operations.  G.
    
    Stock Option Grants On May 30, 2003, the Companys Board of Directors approved grants of
incentive stock options totaling 745,700 shares to certain employees of the
Company. All of the grants have an exercise price equal to the market value of
a share of stock as of the date of grant. As such, no compensation expense was
recorded in accordance with Accounting Principles Board Opinion No. 25.  H.
    
    Net Income (Loss) Per Share Basic earnings (loss) per share is computed by dividing net income (loss)
available to common shareholders by the weighted average number of common
shares outstanding during the period. Diluted earnings (loss) per share is
computed by dividing net income (loss) available to common shareholders by the
weighted average number of common and common equivalent shares outstanding
during the period, which includes the additional dilution related to exercise
of stock options and warrant as computed under the treasury stock method and
the conversion of the preferred stock under the if-converted method. 10




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The following table represents information necessary to calculate earnings
per share for the three and nine month periods ended September 30, 2004 and
2003: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Net income available to common shareholders
    
    $
    1,114
    
    
    $
    738
    
    
    $
    231
    
    
    $
    1,102Weighted average common shares outstandingPlus additional shares from common stock equivalent shares:
    
    
    14,303
    
    
    
    14,106
    
    
    
    14,193
    
    
    
    14,086Options and convertible preferred stock
    
    
    492
    
    
    
    104
    
    
    
    482
    
    
    
    45Diluted weighted average common shares outstanding
    
    
    14,795
    
    
    
    14,210
    
    
    
    14,675
    
    
    
    14,131
 For the nine months ended September 30, 2004 and 2003, approximately 17.1
million and 2.1 million employee stock options, warrant and the Series B
preferred shares were excluded from diluted earnings per share calculations, as
their effects were anti-dilutive.  I.
    
    Bank Covenants The Companys Bank of America Credit Facility is secured by a pledge of
all Company assets and imposes financial covenants and requirements and
contains limitations on the Companys ability to sell material assets, redeem
capital stock and pay dividends, among other actions. As of September 30, 2004,
the Company was in compliance with all such covenants.  J.
    
    Comprehensive Income Comprehensive income (loss) for the three and nine months ended September
30, 2004 and 2003 was comprised solely of net income (loss).  K.
    
    Legal Proceedings The Company is subject to various legal proceedings, tax matters and other
claims which arise in the ordinary course of business. In the opinion of
management, the amount of any ultimate liability with respect to these actions
will not materially affect the financial position or results of operations of
the Company.  L.
    
    Segment Information The Company accounts for segment reporting under SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information.No corporate overhead
costs or interest have been allocated to income (loss) before taxes of the
retail inventory forecasting segment, but are included in the accounts
receivable financing segment costs. Additionally, $1.5 million of goodwill
associated with the Towne merger has been allocated to the retail inventory
forecasting segment and is therefore included in the segments total assets. 11




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##### Table of Contents



The following tables summarize the financial information concerning the
Companys reportable segments for the three and nine months ended September 30,
2004 and 2003. Three Months Ended
    
    Three Months EndedSeptember 30, 2004
    
    September 30, 2003Accounts
    
    Retail
    
    
    
    
    
    Accounts
    
    RetailReceivable
    
    Inventory
    
    
    
    
    
    Receivable
    
    Inventory(in thousands)
    
    Financing
    
    Forecasting
    
    Total
    
    Financing
    
    Forecasting
    
    TotalRevenues
    
    $
    7,726
    
    
    $
    2,272
    
    
    $
    9,998
    
    
    $
    8,462
    
    
    $
    2,244
    
    
    $
    10,706Income before taxes
    
    $
    661
    
    
    $
    462
    
    
    $
    1,123
    
    
    $
    866
    
    
    $
    409
    
    
    $
    1,275Assets
    
    $
    20,334
    
    
    $
    4,242
    
    
    $
    24,576
    
    
    $
    24,133
    
    
    $
    4,599
    
    
    $
    28,732Total expenditures for
additions to long-lived
assets:
    
    $
    313
    
    
    $
    117
    
    
    $
    430
    
    
    $
    151
    
    
    $
    2
    
    
    $
    153
 Nine Months Ended
    
    Nine Months EndedSeptember 30, 2004
    
    September 30, 2003Accounts
    
    Retail
    
    
    
    
    
    Accounts
    
    RetailReceivable
    
    Inventory
    
    
    
    
    
    Receivable
    
    Inventory(in thousands)
    
    Financing
    
    Forecasting
    
    Total
    
    Financing
    
    Forecasting
    
    TotalRevenues
    
    $
    23,263
    
    
    $
    6,733
    
    
    $
    29,996
    
    
    $
    26,063
    
    
    $
    6,886
    
    
    $
    32,949Income (loss) before taxes
    
    $
    178
    
    
    $
    1,114
    
    
    $
    1,292
    
    
    $
    1,159
    
    
    $
    844
    
    
    $
    2,003Assets
    
    $
    20,334
    
    
    $
    4,242
    
    
    $
    24,576
    
    
    $
    24,133
    
    
    $
    4,599
    
    
    $
    28,732Total expenditures for
additions to long-lived
assets:
    
    $
    757
    
    
    $
    127
    
    
    $
    884
    
    
    $
    642
    
    
    $
    2
    
    
    $
    644
  M.
    
    New Accounting Pronouncements In 2003, the FASB issued FASB Interpretation No. (FIN) 46(R),
Consolidation of Variable Interest Entities, to expand upon and strengthen
existing accounting guidance that addresses when a company should include in
its financial statements the assets, liabilities and activities of another
entity. Until now, a company generally has included another entity in its
consolidated financial statements only if it controlled the entity through
voting interests. FIN 46(R) changes that guidance by requiring a variable
interest entity, as defined, to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entitys
activities or is entitled to receive a majority of the entitys residual
returns or both. FIN 46(R) also requires disclosure about variable interest
entities that the company is not required to consolidate but in which it has a
significant variable interest. The consolidation requirements of FIN 46(R)
applied to variable interest entities in the first fiscal year or interim
period ending after March 15, 2004. Certain of the disclosure requirements
apply in all financial statements issued after January 31, 2003, regardless of
when the variable interest entity was established. The Company has adopted the
provisions of FIN 46(R) effective March 31, 2004, which did not have any impact
on the Companys consolidated results of operations and financial position. 12




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##### Table of Contents



PRIVATE BUSINESS, INC. 
  Item 2.
    Managements Discussion and Analysis of Financial Condition and Results of Operations Three and Nine Months Ended September 30, 2004 and 2003
 Note Regarding Forward Looking Information This interim report contains several forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995 including,
without limitation, statements containing the words may, would, could,
will, expect, anticipate, believe, intend, plan, and estimate and
words of similar importance. Such statements include statements concerning our
operations, prospects, strategies and financial condition, including our future
economic performance, intent, plans and objectives, and the likelihood of
success in developing and expanding our business. These statements are based
upon a number of assumptions and estimates which are subject to significant
uncertainties, many of which are beyond our control. Actual results may differ
materially from those expressed or implied by such forward-looking statements.
The Company assumes no obligation to update this information. Factors that
could cause actual results to differ materially are discussed in our filings
with the Securities and Exchange Commission, including those identified in the
Risk Factors section and elsewhere in this Quarterly Report on Form 10-Q and
in our Annual Report on Form 10-K for the year ended December 31, 2003, and
include, among other factors, the timely development and market acceptance of
products and technologies and competitive market conditions. Overview We are a leading provider of solutions that enable community banks to
manage accounts receivable financing provided to their small business
customers. Our solution is called Business Manager, and is based on software,
marketing, and online electronic transaction processing services. One element
of Business Manager is our proprietary software, which enables our network of
client banks to purchase accounts receivable from their small business
customers. The banks then process, bill and track those receivables on an
ongoing basis. As a major component of our program, we work with client banks
to design, implement and manage the sale of Business Manager accounts
receivable financing services to their small business customers. We also give
our client banks the option of outsourcing to us their application hosting and
transaction processing through secure Internet connections, allowing them to
receive accounts receivable information and make funding decisions
electronically. On January 20, 2004, we completed a capital restructuring event consisting
of the sale of 20,000 shares of our Series A preferred stock and a warrant to
purchase up to 16 million shares of our common stock at a price of $1.25 per
share to Lightyear Fund, L.P. for a total purchase price of $20 million, as
well as the execution of a new long-term credit facility with Bank of America
that allows for total borrowings of up to $11 million. The completion of this
Capital Event was a significant milestone in our Companys history as it
improved our capitalization and financial position. While we continue to market new products as part of our overall strategy,
our primary focus in 2004 is to lay the groundwork for our core receivables
financing business to a growth business. We believe that the market for this
product is strong, particularly given the indications that an economic recovery
is underway. The receivables financing market is strongly influenced by the
United States economy, and as the U.S. economy has experienced two years of
economic decline, our core business revenues have been negatively impacted. We
believe that, with an improving and growing economy and initiatives underway,
we can return our core receivables financing business to a growth mode. The Company remains focused on improving its sales function. In addition
to expanding our sales force and increasing training, we hired a new Chief
Sales Officer in August, 2004. 13




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##### Table of Contents



We believe that successful execution of the sales force initiatives will
eventually result in growth of the core business. These initiatives, however,
will take a considerable amount of time and effort to implement and we can
provide no assurances that these initiatives can be successfully implemented.
We believe these initiatives will not impact our financial results until late
2004 or beyond. Critical Accounting Policies Managements Discussion and Analysis of Financial Condition and Results of
Operations are based upon the Companys consolidated financial statements. The
preparation of these consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the dates of the financial statements, and the reported amounts
of revenues and expenses during the reporting periods. On an on-going basis,
management evaluates its critical accounting policies and estimates. A critical accounting policy is one that is both important to the
understanding of the financial condition and results of operations of the
Company and requires managements most difficult, subjective or complex
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain. Management believes the following
accounting policies fit this definition: Revenue Recognition.We generate revenue from four main sources:  
    
    participation fees earned on client bank purchases of small business accounts receivable.
    
    software license fees from new client banks.
    
    retail planning services.
    
    maintenance fees and other revenues, comprised primarily of fees
received for insurance brokerage services, paper-based form sales,
software maintenance, medical, and processing services. There are two types of participation fees. The first type is earned upon
the client banks initial purchase of a small business accounts receivable
during the first 30 days in our program. The second type is an ongoing
participation fee earned from subsequent period purchases. Both types of fees
are based on a percentage of the receivables that a client bank purchases from
its small business customers during each month. The second type of fee is a
smaller percentage of the ongoing receivables purchased. Participation fees are
recognized as earned, which is based upon the transaction dates of bank
purchases from its small business customers. Software license fees for Business Manager consist of two components: the
license fee and customer training and support fee. These are one-time fees that
we receive upon the initial licensing of our Business Manager program to a
community bank. Our license agreements are executed with terms ranging from
three to five years, and are renewable for subsequent terms. Some agreements
contain performance or deferred payment terms that must be met in order for us
to receive payment and recognize revenue. We recognize revenues from the
license fee once we have met the terms of the customer agreement. The customer
training and support fee are recognized ratably over the twelve-month service
period subsequent to the activation of the license agreement. Revenue
recognition rules for up front fees are complex and do require interpretation
and judgment on the part of management. Management has consistently followed
the same revenue recognition practices for this type of revenue during all
years presented. We believe that this practice most accurately portrays the
economic reality of the transactions. Retail planning services revenue is generated from fees charged primarily
for providing inventory merchandising and forecasting information for specialty
retail stores and ancillary services related to these 14




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##### Table of Contents



products. RMSA uses proprietary software to process sales and inventory
transactions and provide the merchandising forecasting information. We
recognize revenues as the transactions occur and merchandising and forecasting
services are performed. Maintenance fees and other revenues include several ancillary products and
services we provide to client banks. Annual software maintenance fees are
generated from our client banks starting on the first anniversary date of the
Business Manager license agreement and annually thereafter. These revenues are
recognized ratably over a twelve-month period beginning on the first
anniversary date of the agreement. Additionally, since 1995, we have brokered,
through our Private Business Insurance subsidiary, credit and fraud insurance
products from a national insurance company. We earn fees based on a percentage
of the premium that is paid to the insurance company. These commission revenues
are recognized at the time receivable fundings covered by credit and fraud
insurance policies are purchased by our bank customers. We also provide a
standard set of forms that client banks may purchase and use in the normal
course of administering the Business Manager program. Revenues related to these
forms are recognized in the period that they are shipped to the client bank. We
also have some industry-focused applications for the medical and dental
markets. Monthly transaction processing fees include charges for electronic
processing, statement rendering and mailing, settling payments, recording
account changes and new accounts, leasing and selling point of sale terminals,
telephone and software support services, rental fees and collecting debts. Software Development Costs.Software development costs incurred in the
research and development of new software products and enhancements to existing
software products to be sold or marketed are expensed as incurred until
technological feasibility has been established. After such time, any additional
costs are capitalized in accordance with Statement of Financial Accounting
Standards (SFAS) No. 86, Accounting for the Costs of Computer Software to Be
Sold, Leased, or Otherwise Marketed.Also, the Company capitalizes the cost of
internally used software when application development begins in accordance with
AICPA SOP No. 98-1, Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use. This is generally defined as the point when research
and development has been completed, the project feasibility established, and
management has approved a development plan. Many of the costs capitalized for
internally used software are related to upgrades or enhancements of existing
systems. These costs are only capitalized if the development costs will result
in specific additional functionality of the existing system, and are
capitalized at the point that application development begins. Capitalized
software development costs are amortized on a straight-line basis over their
useful lives, generally three years. The key assumptions and estimates that
must be made relative to this accounting policy center around determining when
technological feasibility has been achieved and whether the project being
undertaken is one that will be marketable or enhance the marketability of an
existing product for externally marketed software and whether the project will
result in additional functionality for internal use software projects.
Management consults monthly with all project managers to ensure that the scope
and expected results of each project are understood in order to make a judgment
on whether it meets the requirements outlined in the authoritative accounting
literature. 15




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##### Table of Contents



Results of Operations The following table sets forth, for the periods indicated, the percentage
relationships of the identified consolidated statements of operations items to
total revenue. Third Quarter
    
    Year to Date2004
    
    2003
    
    2004
    
    2003Revenues:Participation fees
    
    
    64.0
    %
    
    
    66.0
    %
    
    
    64.1
    %
    
    
    64.6
    %Software license
    
    
    0.5
    %
    
    
    0.6
    %
    
    
    0.5
    %
    
    
    0.6
    %Retail planning services
    
    
    22.7
    %
    
    
    21.0
    %
    
    
    22.5
    %
    
    
    20.9
    %Maintenance and other
    
    
    12.8
    %
    
    
    12.4
    %
    
    
    12.9
    %
    
    
    13.9
    %100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Operating Expenses:General and administrative
    
    
    38.0
    %
    
    
    40.7
    %
    
    
    39.0
    %
    
    
    45.0
    %Selling and marketing
    
    
    46.4
    %
    
    
    38.6
    %
    
    
    45.7
    %
    
    
    40.4
    %Research and development
    
    
    0.6
    %
    
    
    1.0
    %
    
    
    1.0
    %
    
    
    0.9
    %Amortization
    
    
    2.6
    %
    
    
    4.0
    %
    
    
    2.9
    %
    
    
    3.9
    %Other operating expense, net
    
    
    0.2
    %
    
    
    0.2
    %
    
    
    6.7
    %
    
    
    0.3
    %87.8
    %
    
    
    84.5
    %
    
    
    95.3
    %
    
    
    90.5
    %Operating Income
    
    
    12.2
    %
    
    
    15.5
    %
    
    
    4.7
    %
    
    
    9.5
    %Interest expense, net
    
    
    0.9
    %
    
    
    3.6
    %
    
    
    1.3
    %
    
    
    3.4
    %Other income
    
    
    0.0
    %
    
    
    0.0
    
    
    
    (0.9
    )%
    
    
    0.0
    %Income Before Income Taxes
    
    
    11.3
    %
    
    
    11.9
    %
    
    
    4.3
    %
    
    
    6.1
    %Income Tax Provision (Benefit)
    
    
    (5.3
    )%
    
    
    4.6
    %
    
    
    (1.5
    )%
    
    
    2.4
    %Net Income
    
    
    16.6
    %
    
    
    7.3
    %
    
    
    5.8
    %
    
    
    3.7
    %Preferred Stock Dividends
    
    
    5.4
    %
    
    
    0.4
    %
    
    
    5.1
    %
    
    
    0.4
    %Net Income Available to Common Shareholders
    
    
    11.2
    %
    
    
    6.9
    %
    
    
    0.7
    %
    
    
    3.3
    %
 Participation fees.Participation fees decreased 9.5% and 9.6% to $6.4
million and $19.2 million for the third quarter and first nine months of 2004
compared to $7.1 million and $21.3 million for the comparable periods of 2003.
The decreases were primarily due to a reduction in the total funding through
our BusinessManager program to $1.04 billion and $3.02 billion for the third
quarter and first nine months of 2004, compared to $1.15 billion and $3.43
billion for the comparable periods of 2003. The decrease in funding is due
primarily to fewer merchants funding through our BusinessManager program. As a
percentage of total revenues, participation fees accounted for 64.0% and 64.1%
for the third quarter and nine month period ended September 30, 2004 compared
to 66.0% and 64.6% for the comparable periods of 2003. (NOTE: The first quarter
10Q disclosed total BusinessManager funding of $909 million and $1.1 million
for the first quarter of 2004 and 2003, respectively. These funding numbers
were incorrect. The correct funding numbers for the first quarters of 2004 and
2003 were $957 million and $1.12 million, respectively). Software license. Software license fees decreased 19.4% and 23.0% to
$50,000 and $164,000 for the third quarter and first nine months of 2004,
compared to $62,000 and $213,000 for the comparable periods of 2003. The
decrease was due to fewer software license agreements being sold. This is the
result of fewer bank salesmen in the first half of 2004 compared to 2003.
Software license fees accounted for 0.5% of total revenues for the third
quarter and nine months ended September 30, 2004 compared to 0.6% for the
comparable periods in 2003. 16




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##### Table of Contents



Retail planning services. Retail planning services revenues increased 1.2%
to $2.3 million during the third quarter and declined 2.2% to $6.7 million for
the nine months ended September 30, 2004 as compared to $2.2 and $6.9 million
for the comparable periods of 2003. The quarter to quarter increase for the
third quarter is due to an increase in the number of forecast plans produced in
the third quarter of 2004 as compared to the same quarter in the prior year.
The year over year decline is due primarily to lower point of sale system
support and billing services provided by RMSA to its customers. As a percentage
of total revenues, retail planning services accounted for 22.7% and 22.5% for
the third quarter and first nine months of 2004 compared to 21.0% and 20.9% in
the comparable periods of 2003. Maintenance and other. Maintenance and other fees decreased 4.1% and 15.6%
to $1.3 and $3.9 million for the third quarter and nine months ended September
30, 2004 compared to $1.3 and $4.6 million for the comparable periods for 2003.
Maintenance and other fees consist primarily of software maintenance fees,
credit and fraud risk insurance commissions earned from the sale of policies to
our BusinessManager banks, commissions earned through our referrals of certain
merchants to alternative financing companies and account verification services
performed for some of our BusinessManager banks. The decrease between years is
primarily attributable to a gain from a customer dispute settlement of $250,000
recognized in the quarter ended March 31, 2003, the gain on sale of the Bank
Insurance division totaling $427,000 recognized in the quarter ended June 30,
2003, as well as, decreases in our insurance revenues. Our insurance revenues
decreased 14.2% and 8.9% to $637,000 and $2.0 million for the third quarter and
first nine months of 2004 compared to $743,000 and $2.2 million for the
comparable periods in 2003. The decline in insurance revenues is due to the
lower funding levels through the BusinessManager program as discussed above.
Maintenance and other fees accounted for 12.8% and 12.9% of total revenues for
the third quarter and nine month period ended
September 30, 2004 compared to 12.4% and 13.9% for the comparable periods in
2003. Total revenues. Total revenues for the third quarter and first nine months
of 2004 decreased 6.6% and 9.0% to $10.0 and $30.0 million compared to $10.7
and $32.9 million for the comparable periods of 2003. General and administrative. General and administrative expenses decreased
12.7% and 21.1% to $3.8
and $11.7 million for the third quarter and nine month period ended September
30, 2004 compared to $4.4 and $14.8 million for the comparable periods in 2003.
The decrease is primarily due to reductions in salary and benefits expense of
approximately $1.2 million as a result of reduced headcount, as well as,
reduced depreciation expense of approximately $773,000 due to continued lower
capital spending. General and administrative expenses include the cost of our
executive, finance, human resources, information and support services,
administrative functions and general operations. As a percentage of total
revenue, general and administrative expenses decreased 6.6% and 13.3% to 38.0%
and 39.0% for the third quarter and nine month period ended September 30, 2004
compared to 40.7% and 45.0% for the same periods in the prior year. Selling and marketing. Selling and marketing expenses increased 12.1% and
3.0% to $4.6 and $13.7 million for the third quarter and nine month period
ended September 30, 2004 compared to $4.1 and $13.3 million for the comparable
periods of 2003. Selling and marketing expenses include the cost of wages and
commissions paid to our dedicated business development and bank sales force,
travel costs of our sales force, recruiting for new sales and marketing
personnel and marketing fees associated with direct and telemarketing programs.
Although selling and marketing expenses in total remained unchanged quarter to
quarter and year to year, there were several significant fluctuations within
this category. Recruiting expenses increased by approximately $290,000 for the
nine months ended September 30, 2004 as compared to the same period in 2003.
This is due to the extensive sales force hiring initiative discussed elsewhere
in this document. Also contributing to the increase between periods was a
$156,000 increase in marketing expense. During the third quarter of 2004, the
Company completed a project to rebrand the Company with a new logo and sales
and marketing materials. As a percentage of total revenue, selling and
marketing expenses increased 20.2% and 13.1% to 46.4% and 45.7% for the third
quarter and nine month period of 2004 compared to 38.6% and 40.4% for the
comparable periods in 2003. 17




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##### Table of Contents



Research and development. Research and development expenses decreased
43.1% and 3.6% to $58,000
and $293,000 for the third quarter and nine month period ended September 30,
2004 compared to $102,000
and $304,000 for the year earlier periods. These costs include the
non-capitalizable direct costs associated with developing new versions of our
products and other projects that have not yet reached technological
feasibility. The decrease in costs for the first nine months of 2004 was
primarily due to increased capitalization activity as a result of extensive
work on several new projects that began capitalization late in the first
quarter of 2004. As a percentage of total revenues, research and development
expenses decreased to 0.6% for the third quarter and increased to 1.0% for the
first nine months of 2004 compared to 1.0% and 0.9% for the same periods in the
prior year. Amortization. Amortization expenses decreased 39.0% and 31.3% to $263,000
and $879,000 for the first nine months of 2004 compared to $431,000 and $1.3
million for the comparable periods in 2003. These expenses include the cost of
amortizing intangible assets including trademarks, software development costs
and debt issuance costs (2003 only). The decrease is due to reductions in
amortization expense for deferred debt issuance costs. This is a result of the
write-off of $780,000 of deferred debt issuance costs related to the Companys
1998 credit facility that was extinguished as part of the Capital Event
described elsewhere in this document. Other operating expenses, net. Other operating expenses for the three
months ended September 30, 2004 were flat as compared to the same period in
2003. For the nine months ended September 30, 2004 other operating expenses
increased $1.9 million to $2.0 million compared to $94,000 for the same period
of 2003. As previously disclosed, for the first quarter of 2004, two unusual
charges occurred totaling approximately $1.7 million related to the January
2004 Capital Event. Other operating expenses include property tax and other
miscellaneous costs associated with providing support and services to our
client banks. Operating income.As a result of the above factors, our operating income
totaled $1.2 million and $1.4 million for the three and nine month periods
ended September 30, 2004, compared to operating income of $1.7 and $3.1 million
for the third quarter and nine months of 2003. As a percentage of total
revenue, operating income was 11.8% and 4.6% for the third quarter and nine
months of 2004 compared to 15.5% and 9.5% for the same periods in 2003. Interest expense, net. Interest expense, net decreased 75.8% and 66.1% to
$93,000 and $382,000 for the third quarter and nine months ended September 30,
2004 compared to $385,000 and $1.1 million for the comparable periods in 2003.
The decrease was primarily due to the reduction of our debt balances in 2004 as
a result of the capital event discussed elsewhere in this document. For the
nine months ended September 30, 2004, interest expense includes approximately
$67,000 of debt issuance cost amortization. Other income.During the nine months ended September 30, 2004, the Company
received proceeds totaling $266,000 relating to notes receivable from former
officers of one of the Companys subsidiaries. These notes had previously been
written-off as uncollectible, therefore their collection resulted in this gain. Income tax provision (benefit).The income tax benefit was approximately
$531,000 and $462,000 for the third quarter and nine months ended September 30,
2004 compared to a provision of $497,000 and $781,000 for the same periods in
2003. During September of 2004, the Company recorded a tax benefit of $972,000
relating to an income tax contingent liability for which the statute of
limitations expired in September 2004. As a result, the effective tax rate for
the quarter ended September 30, 2004 was (47.2%). The Company expects its
effective tax rate to be approximately 39.0% in all future periods. As a
percentage of income before taxes, the income tax rate was approximately 39.0%
for all of 2003. 18




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##### Table of Contents



Liquidity and Capital Resources Our primary sources of capital have historically been cash provided by
operations, short-term and long-term debt, and investment from stockholders. During the first nine months
of 2004 our operating activities provided cash of approximately $4.4 million.
We used approximately $855,000 in our investing activities, consisting of
capital expenditures of $315,000 and $569,000 of software development costs.
We currently estimate that total capital expenditures for 2004 will be
approximately $600,000 (excluding expenditures for software development costs). Cash used in financing activities totaled $2.8 million for the first nine
months of 2004, which is (i) the sum of the net proceeds received from the
Capital Event closing, proceeds of $750,000 from a draw against our line of
credit and $321,000 of proceeds received from employee stock option exercises;
minus (ii) the sum of repayments of long-term debt subsequent to the Capital
Event totaling $1.2 million, dividend payments of $2.3 million, capital lease
payments of $201,000 and repayments against short-term borrowings of $414,000. The Company was the borrower under a credit agreement dated August 7, 1998
between the Company as borrower, Fleet National Bank as administrative agent
and a syndicate of other lenders (the 1998 Credit Facility). This 1998 Credit
Facility was secured by a pledge of all of our assets and contained financial
and non-financial covenants and contained negative covenants, which, among
other things, contained limitations on our ability to sell material assets,
redeem capital stock and pay cash dividends. The 1998 Credit Facility was paid
in full on January 20, 2004 using the net proceeds received from the Lightyear
transaction and the net proceeds from the Bank of America Credit Facility. As
such, the Fleet covenants expired at the time of refinancing. The Company entered into the Bank of America Credit Facility on January
19, 2004. The credit facility is secured by a pledge of all of the Companys
assets and contains financial and non-financial covenants. The new credit
agreement includes a term loan in the amount of $5.0 million and a revolving
line of credit of up to $6.0 million for a total facility of up to $11.0
million. The revolving line of credit includes a $1.0 million letter of credit
sub-limit. As of September 30, 2004, $7.0 million was outstanding under the
Bank of America Credit Facility. The Bank of America Credit Facility expires on January 19, 2007. The
revolving credit commitment reduces by $1.0 million on each of the first two
anniversary dates. The term loan is repayable in twelve equal quarterly installments of
$416,667, along with interest at the applicable margin. Interest is also due on
the revolving loan quarterly at the applicable margin. The interest rates of
the term loan and revolving loan are based on a pricing grid using the
Companys Funded Debt to Earnings before Interest, Taxes, Depreciation and
Amortization (EBITDA) Ratio, as follows (The Company has the option of
choosing Libor or Base Rate): Funded Debt to EBITDA
    
    Libor Margin
    
    Base Rate MarginLess than or equal to 1.0
    
    
    2.25
    %
    
    
    0Greater than 1.0 but less than or equal to 1.25
    
    
    2.50
    %
    
    
    0Greater than 1.25 but less than or equal to 1.50
    
    
    2.75
    %
    
    
    0
 As of September 30, 2004, the rates, calculated as Libor + 2.25%, ranged
from 3.87% to 4.75%. The credit agreement includes certain restrictive financial covenants,
measured quarterly, relating to net worth, maximum annual capital expenditures,
funded debt to EBITDA ratio and fixed charge coverage ratio, as defined in the
credit agreement. The credit agreement also contains certain non-financial
covenants, including but not limited to a prohibition on declaring and paying
any cash dividends on any class of stock, except for the Series A and Series B
preferred shares outstanding, provided, that no default, as defined in the
credit agreement, exists as of the date of payment and such payment will not
cause a default. As of September 30, 2004, the Company was, and expects to be
throughout 2004, in compliance with the credit agreement covenants. 19




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As of September 30, 2004, we had working capital of approximately $2.6
million compared to a working capital deficit of approximately $2.0 million as
of December 31, 2003. The change in working capital resulted primarily from an
increase in cash and decreases in accounts payable, accrued liabilities, other
short-term borrowings, dividends payable and the current portion of long-term
debt. We believe that our line of credit availability along with future
operating cash flows will be sufficient to meet our working capital and capital
expenditure requirements for the next twelve months. We may, in the future, acquire businesses or products complementary to our
business, although we cannot be certain that any such acquisitions will be
made. The need for cash to finance additional working capital or to make
acquisitions may cause us to seek additional equity or debt financing. We
cannot be certain that such financing will be available, or that our need for
higher levels of working capital will not have a material adverse effect on our
business, financial condition or results of operations. New Accounting Pronouncements In 2003, the FASB issued FASB Interpretation No. (FIN) 46(R),
Consolidation of Variable Interest Entities, to expand upon and strengthen
existing accounting guidance that addresses when a company should include in
its financial statements the assets, liabilities and activities of another
entity. Until now, a company generally has included another entity in its
consolidated financial statements only if it controlled the entity through
voting interests. FIN 46(R) changes that guidance by requiring a variable
interest entity, as defined, to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entitys
activities or is entitled to receive a majority of the entitys residual
returns or both. FIN 46(R) also requires disclosure about variable interest
entities that the company is not required to consolidate but in which it has a
significant variable interest. The consolidation requirements of FIN 46(R)
apply to variable interest entities in the first fiscal year or interim period
ending after March 15, 2004. Certain of the disclosure requirements apply in
all financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. The Company has adopted the
provisions of FIN 46(R) effective March 31, 2004 which did not have any impact
on the Companys consolidated results of operations and financial position. Inflation We do not believe that inflation has had a material effect on our results
of operation. There can be no assurance, however, that our business will not be
affected by inflation in the future. Risk Factors This section summarizes certain risks, among others, that should be
considered by stockholders and prospective investors in the Company. Many of
these risks are discussed in other sections of this report. If any of the
following risks actually occur, our business, financial condition or results of
operations could be materially adversely affected. In such case, the trading
price of our common stock could decline, and you may lose all or part of your
investment. Primary Dependence on One Product. We currently derive a significant
portion of our revenues from receivables financing; the majority of which flows
through Business Manager. Approximately 1% of our consolidated revenues derived
from license fees from new agreements with client banks and approximately 65%
derive from participation fees based on accounts receivables purchased by our
bank clients from small businesses. We expect to continue to derive significant
revenues from this product and related services. If total revenues derived from
Business Manager decline, our other products or services may not be sufficient
to replace that lost revenue, so any events that adversely impact Business
Manager could adversely impact our business. We cannot be certain that we will
be able to continue to successfully market and sell Business Manager to both
banks and their small business customers or that problems will not develop with
Business Manager that could materially impact our business. 20




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Potential Inability to Grow Our Business. Other than the initial contract
fee and a small annual support fee, we do not generate any income from banks
contracting to utilize Business Manager unless small businesses finance their
accounts receivable through our client banks. If we and our client banks cannot
retain existing clients and convince potential small business customers of the
benefits of Business Manager, such businesses will not continue to use or
initiate use of our products and services. Since small business customers of
our client banks are the foundation of our business, their unwillingness to use
Business Manager or to increase the volume of receivables purchased through
Business Manager could have a material adverse effect on our business,
operating results and financial condition. Dependence on Banking Industry for Clients. Business Manager is used
almost exclusively by banks, primarily community banks. Due to our dependence
upon the banking industry, any events that adversely impact the industry in
general and community banks in particular, such as changed or expanded bank
regulations, could adversely affect the Company and its operations. The banking
industry is subject to supervision by several federal and/or state governmental
regulatory agencies. Regulation of banks, especially with respect to receivable
services such as Business Manager, can indirectly affect our business. The use
of Business Manager by banks is currently in compliance with or is not subject
to banking regulations. These regulatory agencies, however, could change or
impose new regulations on banks, including modifying the banks ability to
offer products and services similar to ours to their small business customers.
These new regulations, if any, could prevent or lessen the use of our services
by banks. Lightyear Owns a Majority of the Companys Stock and Therefore Effectively
Controls the Companys Management and Policies. The Lightyear Fund, L.P., an
affiliate of Lightyear Capital (the Lightyear Fund), through its holdings of
Company Series A Preferred Stock, and warrants convertible into common stock,
beneficially owns, in the aggregate, approximately 53% of the Companys common
stock. As a result of the Lightyear Funds investment in the Company, the
Company has agreed to use its best efforts to cause four Lightyear Fund
nominees to serve on the Companys Board of Directors, which would be composed
of seven directors. Currently, Lightyear has identified three nominees that are
currently serving on the Companys Board and one vacancy remains. In addition,
the Company is required to obtain the approval of holders of the Series A
Preferred Stock prior to taking certain actions. The holders of the Series A
Preferred Stock have certain pre-emptive rights to participate in future equity
financings. In view of its large percentage of ownership and its rights as the
holders of the Series A Preferred Stock, the Lightyear Fund effectively
controls the Companys management and policies, such as the appointment of new
management and the approval of any other action requiring the approval of the
stockholders, including any amendments to the Companys certificate of
incorporation, a sale of all or substantially all of the Companys assets or a
merger. In addition, the Lightyear fund has registration rights with respect to
the shares of the Company common stock that it beneficially owns. These rights
generally became exercisable after July 18, 2004. Any decision by the Lightyear
Fund to exercise such registration rights and to sell a significant amount of
its shares in the public market could have an adverse effect on the price of
the Companys common stock. The Holders of Our Series A and B Preferred Stock Have a Liquidation
Preference Over the Holders of Our Common Stock.Lightyear holds 20,000 shares
of Series A preferred stock, and the Company has issued and outstanding 40,031
shares of Series B preferred stock. The Series A preferred shares carry a
cumulative cash dividend rate of 10% of an amount equal to the liquidation
preference, and the Series B preferred shares carry a cumulative cash dividend
rate of $1.0009 per share, each payable quarterly in arrears, when and as
declared by the Board of Directors. The Series A preferred stock has a
liquidation preference superior to the common stock and, to the extent required
by the terms of the Series B preferred stock, in parity with the currently
outstanding Series B preferred stock. Upon any liquidation, dissolution or
winding up of the Company (including, with respect to the Series A only, a
change in control, sale of all or substantially of all the Companys assets or
a merger in which the Company is not the survivor), the Series A liquidation
preference provides that Lightyear will be entitled to receive an amount equal
to its initial investment of $20 million, plus all accrued but unpaid
dividends, and holders of the Series B preferred stock will be entitled to
receive the 21




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greater of either the amount that the Series B holder would be entitled to
receive if it converted its Series B preferred stock into common stock before
the liquidation or $50.0425 per share of Series B preferred stock, plus
declared but unpaid dividends. Accordingly, in such an event there may not be
sufficient assets to make distributions to the holders of the Companys common
stock. Potential Inability to Successfully Market our Products and Services to
New Client Banks or to Retain Current Client Banks. Our success depends to a
large degree on our ability to convince prospective client banks to utilize
Business Manager and offer it to small businesses. Failure to maintain market
acceptance, retain clients or successfully expand our offered services could
adversely affect our business, operating results and financial condition. We
have spent, and will continue to spend, considerable resources educating
potential customers about our products and services. However, even with these
educational efforts, we may not be able to maintain market acceptance and
client retention. In addition, as we continue to offer new products and expand
our services, existing and potential client banks or their small business
customers may be unwilling to accept the new products or services. Potential Inability to Attract, Hire, or Retain Enough Qualified Sales and
Marketing Personnel. If we are unable to implement our growth plans and
strategies, our business, operating results and financial condition could be
adversely affected. An important part of our sales strategy is to attract, hire
and retain qualified sales and marketing personnel in order to maintain our
marketing capabilities in our current markets and expand the number of markets
we serve. Since competition for experienced sales and marketing personnel is
intense, we cannot be certain that we will be able to attract and retain enough
qualified sales and marketing personnel or that those we do hire will be able
to generate new business at the rate we currently expect. If the Company is
unable to hire and retain enough qualified sales and marketing personnel or
those we hire are not as productive as we expect, the Company may not be able
to implement its sales plans. Potential Inability to Manage Growth of Business. Our business has the
potential to grow in size and complexity. If our management is unable to manage
growth effectively, our business, operating results and financial condition
could be adversely affected. Any new sustained growth would be expected to
place a significant strain on our management systems and operational resources.
We anticipate that new sustained growth, if any, will require us to recruit,
hire and retain new managerial, finance, sales, marketing and support
personnel. We cannot be certain that we will be successful in recruiting,
hiring or retaining such personnel. Our ability to compete effectively and to
manage our future growth, if any, will depend on our ability to maintain and
improve operational, financial, and management information systems on a timely
basis and to expand, train, motivate and manage our work force. If we begin to
grow, we cannot be certain that our personnel, systems, procedures, and
controls will be adequate to support our operations. Also, one element of our
growth strategy is to actively evaluate and pursue strategic alliances with
businesses that are complementary to the Companys business. We cannot be
certain that we will be able to integrate fully any such alliances with our
existing operations or otherwise implement our growth strategy. Intended Expansion of Offered Products and Services May Lower Our Overall
Profit Margin and New Products may not be Successful. Part of our business
strategy is to expand our offering of products and services. We believe that we
can provide these services profitably, but such services may generate a lower
profit margin than our current products and services. As a result, by offering
additional products and services, we may lower our overall profit margin.
Although gross revenues would possibly increase, the lowering of our profit
margin may be viewed negatively by the stock market, possibly resulting in a
reduction in our stock price. As stated elsewhere in this filing, we are engaged in introducing several
new products to our customer base. Although our research leads us to believe
that markets and customers exist for this expansion, there can be no assurances
that the introduction and sales of these new products will be sufficient for us
to recover our investment in costs. 22




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Our Products and Services May Not be as Successful in a Slower Economy. If
the United States economy
further weakens or enters into a recession or depression, our client banks
and their small business customers may view the services and benefits provided
by Business Manager differently and may be reluctant to use the products and
services we provide. In addition, in an economic recession or depression, the
customers of small businesses may reduce their purchases of goods and services,
thus reducing accounts receivable eligible for our solution. This development
could have a material adverse effect on our business, operating results and
financial condition. Potential Inability to Compete in the Financial Services Market. The
market for small business financial services is competitive, rapidly evolving,
fragmented and highly sensitive to new product introductions and marketing
efforts by industry participants. Fluctuations in interest rates and increased
competition for services similar to Business Manager could lower our market
share and negatively impact our business and stock price. The Company faces
primary competition from a number of companies that offer to banks products
similar to Business Manager. However, we believe that we are the largest of the
companies offering these services in terms of revenues and number of client
banks under contract. We also compete with banks that use their internal information technology
departments to develop proprietary systems or purchase software from third
parties to offer similar services to small businesses. In addition, we compete
with traditional sources of financial services to small businesses such as
lines of credit, amortizing loans and factoring. Many banks and other
traditional providers of financing are much larger and more established than
Private Business, have significantly greater resources, generate more revenues
and have greater name recognition. We cannot be certain our competitors will
not develop products and services comparable or superior to those that we have
developed or adapt more quickly to new technologies, evolving industry trends
or changing small business requirements. Most providers of traditional sources
of financing have already established relationships with small businesses may
be able to leverage these relationships to discourage these customers from
purchasing the Business Manager solution or persuade them to replace our
products with their products. We expect that competition will increase as other established and emerging
companies enter the accounts receivable financing market, as new products and
technologies are introduced and as new competitors enter the market. In
addition, as we develop new services, we may begin competing with companies
with whom we have not previously competed. Increased competition may result in
price reductions, lower profit margins and loss of our market share, any of
which could have a material adverse effect on our business, operating results
and financial condition. Dependence on Key Employees. Our future performance will also largely
depend on the efforts and abilities of our executive officers, as well as our
key employees and our ability to retain them. The loss of any of our executive
officers or key employees could have a material adverse effect on our business,
operating results and financial condition. Our Charter, Bylaws and Tennessee Law Contain Provisions that Could
Discourage a Takeover. Our charter, bylaws and Tennessee law contain provisions
that could make it more difficult for a third party to obtain control of the
Company. For example, our charter provides for a staggered board of directors,
restricts the ability of stockholders to call a special meeting and prohibits
stockholder action by written consent. Our bylaws allow the board to expand its
size and fill any vacancies without stockholder approval. In addition, the
Tennessee Business Corporation Act contains provisions such as the Tennessee
Business Combination Act and the Tennessee Greenmail Act, which impose
restrictions on stockholder actions. Potential Inability to Adequately Protect Our Proprietary Technology. Our
success and ability to compete are dependent largely upon our proprietary
technology. Third party claims against our proprietary technology could
negatively affect our business. We cannot be certain that we have taken
adequate steps to deter misappropriation or independent third-party development
of our technology. In addition, we cannot be certain that third parties will
not assert infringement claims in the future or, if infringement claims are
asserted, that 23




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such claims will be resolved in our favor. Although we are not currently
subject to any dispute either protecting our proprietary technology or
asserting a third party claim against our proprietary technology, any
infringement claims resolved against us could have a material adverse effect on
the Companys business, operating results and financial condition. Failure of Our Network Infrastructure and Equipment Would Have a Material
Effect on Our Business. Failure of our network infrastructure and equipment,
upon which our business is greatly dependent, as well as the occurrence of
significant human error, a natural disaster or other unanticipated problems
could halt our services, damage network equipment and result in substantial
expense to repair or replace damaged equipment. In addition, the failure of our
telecommunications providers to supply the necessary services could also
interrupt our business, in particular, the application hosting and transaction
processing services we offer to our client banks via secure Internet
connections. The inability to supply these services to our customers could
negatively affect our business, operating results and financial condition and
may also harm our reputation. Private Business Relies on the Technological Infrastructure of its Client
Banks and Their Individual Customers. The success of the products and services
offered by Private Business depends, to a degree, on the technological
infrastructure and equipment of its client banks and their small business
customers. Private Business provides application hosting and transaction
processing services to its client banks that require some level of integration
with the client banks technological infrastructure. In addition, management
services and access to information related to the Private Business products are
offered to each client bank and their customers through the Private Business
portal at BusinessManager.com. Proper technical integration between Private
Business and its client banks, as well as continued accessibility of the
BusinessManager.com portal is critical to the successful provision of services
by Private Business. A failure of a client banks infrastructure or the
inability to access BusinessManager.com for any reason could negatively affect
the business, financial condition and results of Private Businesss operations. Private Businesss Revenues Declined in 2003 and 2004 and May Continue to
Decline. Private Businesss revenues declined in the first nine months of 2004
and all of 2003 as compared the comparable prior periods. There is no assurance
that revenues will grow in the future. This could cause the financial results
of the company to suffer and have a negative effect on the price of Private
Business common stock. Private Business May Not be Able to Use the Tax Benefit from its
Operating Loss Carryforwards. At December 31, 2003, Private Business Inc. had
available federal net operating losses, or NOLs, of approximately $40.5 million
that will expire beginning in 2011 if not used. The majority of these NOLs
were acquired in connection with the Companys merger with Towne Services, Inc.
The amount of these NOLs available to Private Business in any given year will
be limited by Section 382 of the Internal Revenue Code. This limitation could
be material and only permit Private Business to realize a small portion of the
potential tax benefit of the available NOLs. Private Business estimates it will
be able to realize approximately $7.0 million of these NOLs, which has been
recorded as a $2.7 million deferred tax asset at September 30, 2004. To the
extent that Private Business is not permitted to use these NOLs in future
years, some NOLs will not be realized before they expire. Increased Fraud Committed by Small Businesses and Increased Uncollectible
Accounts of Small Businesses May Adversely Affect our Business. Small business
customers from time to time fraudulently submit artificial receivables to our
client banks using our products and services. In addition, customers from time
to time keep cash payments that are mistakenly remitted to the small business
when those payments should actually be remitted directly to the client bank.
Our client banks are also susceptible to uncollectible accounts from small
business customers. Many of the banks purchase insurance through us to insure
against these risks. If the number and amount of fraudulent or bad debt claims
increase, our client banks may decide to reduce or terminate their use of our
products and services, reducing our ability to attract and retain revenue
producing client banks. Further, our insurance carrier providing coverage for
the insurance products may increase rates or cancel coverage, reducing our
ability to produce that revenue and reducing our margins on that business. 24




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Errors and Omissions by our Employees at the Private Business Service
Center and any Problems with Systems or Software may Expose Private Business to Claims and Loss of
Business. Private Business currently conducts processing services for certain
client banks and may do so for future client banks. Acting as processor for
client banks may expose Private Business to claims about the quality of those
services. Private Business employees may make errors, or technical or other
events beyond our control may occur. These errors or events may cause banks to
reduce their participation in the program or leave the program entirely,
negatively affecting our revenue. Access to Capital for Growth and New Product Introduction or Acquisitions.
A significant part of our growth plans rest on the development of new products
or the formation of certain strategic alliances. The execution of these plans
may require that we have access to additional capital. Market conditions at the
time we need this capital may preclude access to new capital of any kind. Any
of these developments could significantly hinder our ability to add new
products or services. 
  Item 3.
    Quantitative and Qualitative Disclosures About Market Risk The Company is subject to market risk from exposure to changes in interest
rates based on our financing and cash management activities. Our exposure
relates primarily to our long-term debt obligations that expire in 2007. In the
event that interest rates associated with these debt obligations were to
increase 100 basis points, the annual impact on future cash flows would be
approximately $70,000. 
  Item 4.
    Controls and Procedures In an effort to ensure that the information the Company must disclose in
its filings with the Securities and Exchange Commission is recorded, processed,
summarized, and reported on a timely basis, the Companys principal executive
officer and principal financial officer have evaluated the effectiveness of the
Companys disclosure controls and procedures, as defined in Exchange Act Rules
13a-15(e) and 15d-15(e), as of
September 30, 2004. Based on such evaluation, such officers have concluded
that, as of September 30, 2004, the Companys disclosure controls and
procedures were effective in timely alerting them to information relating to
the Company required to be disclosed in the Companys periodic reports filed
with the SEC. There has been no change in the Companys internal control over
financial reporting during the quarter ended September 30, 2004 that has
materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting. 25




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PART II  Other Information 
  Item 1.
    Legal Proceedings The Company is subject to various legal proceedings, tax matters and other
claims which arise in the ordinary course of business. In the opinion of
management, the amount of any ultimate liability with respect to these actions
will not materially affect the financial position or results of operations of
the Company. 26




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Item 6.
    Exhibits and Reports on Form 8-K (a)       Exhibits 3.1
    
    
    
    Amended and Restated Charter of the Company (incorporated by reference to
Exhibit 3.1 to the Companys Registration Statement on No. 333-75013 Form
S-1).3.1.1
    
    
    
    Charter Amendment Dated August 9, 2001 (incorporated by reference to Exhibit
3.3 of the Companys Quarterly Report on Form 10-Q for the quarter ended
September 30, 2001).3.1.2
    
    
    
    Charter Amendment Dated January 16, 2004 (incorporated by reference to
Exhibit B of the Companys Definitive Proxy Statement on Schedule 14A filed
on December 29, 2003).3.2
    
    
    
    Amended and Restated By-laws of the Company (incorporated by reference to
Exhibit 3.2 to the Companys Registration Statement on No. 333-75013 Form
S-1).3.2.1
    
    
    
    Bylaw Amendment Dated January 20, 2004 (incorporated by reference to Exhibit
3.2.1 to the Companys Annual Report on Form 10-K for the year ended
December 31, 2003).10.1
    
    
    
    Amended and Restated Securities Purchase Agreement dated December 24, 2003,
between the Company and Lightyear PBI Holdings, LLC (incorporated by
reference to Exhibit A of the Companys Definitive Proxy Statement on
Schedule 14A filed on December 29, 2003).10.2
    
    
    
    Warrant Agreement dated January 20, 2004, by and among the company and
Lightyear PBI Holdings, LLC (incorporated by reference to Exhibit D of the
Companys Definitive Proxy Statement on Schedule 14A filed on December 29,
2003).10.3
    
    
    
    Securityholders Agreement dated January 20, 2004, by and among the company
Lightyear PBI Holdings, LLC (incorporated by reference to Exhibit D of the
Companys Definitive Proxy Statement on Schedule 14A filed on December 29,
2003).10.4
    
    
    
    Employment agreement with Henry M. Baroco dated July 1, 2004.10.5
    
    
    
    Incentive Stock Option agreement with Henry M. Baroco dated August 4, 2004.10.6
    
    
    
    Employment agreement with Arthur J. Kimicata dated August 18, 2004.31.1
    
    
    
    Certificate of CEO pursuant to 18 U.S.C. Section 1350, adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    Certificate of CFO pursuant to 18
U.S.C. Section 1350, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    Certificate of CEO pursuant to to
18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    
    Certificate of CFO pursuant to 18 U.S.C. Section 1350, adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 (b)       Reports on Form 8-K  1.
    
    A current report on Form 8-K was filed on August 25, 2004 to announce
the appointment of Arthur J. Kimicata as the Companys new Chief Sales
Officer. 27




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Signatures Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Private Business, Inc.
        (Registrant)Date: November 9, 2004
    By:
    /s/ Henry M. BarocoHenry M. BarocoChief Executive Officer Date: November 9, 2004
    By:
    /s/ Gerard M. Hayden, Jr.Gerard M. Hayden, Jr.Chief Financial Officer 28