Item 1.   Financial Statements

 

US DATAWORKS, INC.

UNAUDITED CONDENSED BALANCE SHEETS

 

		September 30,				March 31, 2010
		2010				(See Note)
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	308,418			$	444,542
Accounts receivable, trade			577,519				1,059,825
Prepaid expenses and other current assets			108,466				307,653
Total current assets			994,403				1,812,020
Property and equipment, net			182,520				169,796
Goodwill			4,020,698				4,020,698
Other assets			80,472				90,835
Total assets		$	5,278,093			$	6,093,349
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long term debt		$	569,444			$	350,972
Accounts payable			267,488				235,077
Accrued interest – related party			30,161				30,162
Accrued expenses			67,603				246,558
Deferred revenue (as restated)			1,022,531				781,330
Total current liabilities (as restated)			1,957,227				1,644,099
Long term liabilities:
Notes payable			236,112				638,889
Note payable – related party, net of unamortized discount of $477,209 and $543,736 respectively			2,615,036				2,548,509
Total long term liabilities			2,851,148				3,187,398
Total liabilities (as restated)			4,808,375				4,831,497
Commitments and Contingencies
Stockholders’ Equity:
Convertible Series B preferred stock, $0.0001 par value 700,000 shares authorized, 109,933 shares issued and outstanding $3.75 liquidation preference, dividends of $396,652 and $376,312 in arrears as of September 30, 2010 and March 31, 2010, respectively			11				11
Common stock, $0.0001 par value 90,000,000 shares authorized, 33,189,383 and 33,103,951 shares issued and outstanding as of September 30, 2010 and March 31, 2010, respectively			3,319				3,310
Additional paid-in-capital			66,524,594				66,369,315
Accumulated deficit (as restated)			(66,058,206	)			(65,110,784	)
Total stockholders’ equity (as restated)			469,718				1,261,852
Total liabilities and stockholders’ equity		$	5,278,093			$	6,093,349

 

Note: The balance sheet at March 31, 2010, as restated in the Company’s Annual Report on Form 10-K/A (Amendment No. 2), has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

The accompanying notes are an integral part of these unaudited condensed financial statements.

 

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US DATAWORKS, INC.

UNAUDITED CONDENSED STATEMENTS OF OPERATIONS

 

		For the Three Months Ended September 30,								For the Six Months Ended September 30,
		2010				2009				2010				2009
Revenues:
Software transactional and subscription revenue		$	586,765			$	518,725			$	1,085,982			$	1,039,968
Software maintenance revenues			140,866				208,488				285,188				420,859
Professional services revenues			977,267				1,359,976				1,700,066				2,634,823
Total revenues			1,704,898				2,087,189				3,071,236				4,095,650
Cost of revenues			586,266				670,318				1,192,523				1,346,689
Gross profit			1,118,632				1,416,871				1,878,713				2,748,961
Operating expenses:
Research and development			252,766				217,254				495,273				430,191
Sales and marketing			210,865				237,290				482,652				499,590
General and administrative			797,685				793,496				1,542,548				1,365,137
Depreciation and amortization			46,322				39,018				76,119				82,664
Total operating expense			1,307,638				1,287,058				2,596,592				2,377,582
(Loss)/Income from operations			(189,006	)			129,813				(717,879	)			371,379
Other expense:
Financing expense – related party			(5,181	)			(55,518	)			(10,362	)			(165,119	)
Interest expense			43,093				(134,066	)			25,397				(266,675	)
Interest expense – related party			(123,172	)			(94,979	)			(244,576	)			(118,248	)
Total other expense			(85,260	)			(284,563	)			(229,541	)			(550,042	)
Net loss		$	(274,266	)		$	(154,750	)		$	(947,420	)		$	(178,663	)
Basic and diluted loss per share		$	(0.01	)		$	0.00			$	(0.03	)		$	(0.01	)
Basic and diluted weighted-average shares outstanding			33,188,907				32,849,330				33,167,132				32,815,014

The accompanying notes are an integral part of these unaudited condensed financial statements.

 

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US DATAWORKS, INC.

 

UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS

 

For the Six Months Ended September 30,

		2010				2009
Cash flows from operating activities:
Net loss		$	(947,420	)		$	(178,663	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization of property and equipment			76,120				82,664
Amortization of note discount on note payable – related party			66,527				93,063
Amortization of deferred financing costs – related party			10,363				162,248
Stock based compensation			89,286				118,503
Changes in operating assets and liabilities:
Accounts receivable			482,306				(125,645	)
Prepaid expenses and other current assets			199,187				(190,916	)
Accounts payable			32,410				(63,756	)
Accrued expenses			(112,955	)			(68,144	)
Accrued interest – related party			¾				(14,679	)
Deferred revenue			241,201				62,033
Net cash provided (used) by operating activities			137,025				(123,293	)
Cash flows from investing activities:
Purchase of property and equipment			(88,844	)			¾
Net cash used by investing activities			(88,844	)			¾
Cash flows from financing activities:
Payments on note payables			(184,305	)			(17,638	)
Repayments of note payable – related party			¾				(111,105	)
Net cash used by financing activities			(184,305	)			(128,743	)
Net decrease  in cash and cash equivalents			(136,124	)			(252,036	)
Cash and cash equivalents, beginning of period			444,542				403,863
Cash and cash equivalents, end of period		$	308,418			$	151,827
Supplemental disclosures of cash flow information:
Interest paid		$	229,541			$	285,226
Federal income taxes paid			¾				¾

 

The accompanying notes are an integral part of these unaudited condensed financial statements. 

 

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US DATAWORKS, INC.

 

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

1.	Organization and Business

 

General

 

US Dataworks, Inc., a Nevada corporation, (the “Company”), develops, markets, and supports payment processing software for multiple market segments. Its customer base includes some of the largest financial institutions as well as credit card companies, government institutions, banker’s banks and high-volume merchants in the United States. The Company was formerly known as Sonicport, Inc.

 

2.	Summary of Significant Accounting Policies

 

Interim Financial Statements

 

The accompanying interim unaudited condensed financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  The financial statements reflect all adjustments that are, in the opinion of management, necessary to fairly present such information.  All such adjustments are of a normal recurring nature.  Although the Company believes that the disclosures are adequate to make the information presented not misleading, certain information and footnote disclosures, including a description of significant accounting policies normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”), have been condensed or omitted pursuant to such rules and regulations.

 

These financial statements should be read in connection with the audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K/A (Amendment No. 2) for the fiscal year ended March 31, 2010 filed with the Commission on February 22, 2011.  As discussed in Note 8, the financial statements for the year ended March 31, 2010 and the quarters ended June 30, 2010 and September 30, 2010 have been restated.  The results of operations for interim periods are not necessarily indicative of the results for any subsequent quarter or the fiscal year ending March 31, 2011.

 

Revenue Recognition

The Company recognizes revenues associated with its software products in accordance with the provisions of the Financial Accounting Standard Board (“FASB”) Accounting Standards Codification (“ASC”) Topic No. 985 – 605, “Software Revenue Recognition”.

 

The Company licenses its software on a transactional or a subscription fee basis. In these arrangements, the customer is charged a fee based upon the number of items processed by the software and the Company recognizes revenue as these transactions occur. The transaction fee also includes the provision of standard maintenance and support services as well as product upgrades should such upgrades become available.  If professional services that are essential to the functionality of the software are provided in connection with the installation of the software licensed, revenue is recognized when these services have been provided on a percentage of completion basis.

 

 In certain instances, we license our software products under non-exclusive, non-transferable license agreements that involve services essential to the functionality of the software.  License revenue is recognized when services have been provided on the percentage of completion basis.

 

For license agreements that include a separately identifiable fee for contracted maintenance services, such maintenance revenues are recognized on a straight-line basis over the life of the maintenance agreement noted in the agreement, but following any installation period of the software.

 

In certain instances, the Company enters into arrangements that include multiple elements, where fees are allocated to the various elements based on vendor specific objective evidence of fair value.

 

 

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Goodwill

The goodwill recorded on the Company’s books is from the acquisition of US Dataworks, Inc. in fiscal year 2001 which remains the Company’s single reporting unit. FASB ASC Topic No. 350, “Intangibles – Goodwill and Other Intangibles”), requires goodwill for each reporting unit of an entity be tested for impairment by comparing the fair value of each reporting unit with its carrying value. Fair value is determined using a combination of the discounted cash flow, market multiple and market capitalization valuation approaches. Significant estimates used in the methodologies include estimates of future cash flows, future short-term and long-term growth rates, weighted average cost of capital and estimates of market multiples for each reportable unit. On an ongoing basis, absent any impairment indicators, the Company performs impairment tests annually during the fourth quarter.

FASB ASC Topic No. 350 requires goodwill to be tested annually and between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of the reportable unit below its carrying amount. The Company did not record an impairment of goodwill for either the quarter ended September 30, 2010 or the year ended March 31, 2010.

Goodwill is classified as Level 3 within the fair value hierarchy.

 

Convertible Debt Financing – Derivative Liabilities

The Company reviews the terms of its convertible debt and equity instruments issued to determine whether there are embedded derivative instruments, including embedded conversion options, that are required to be bifurcated and accounted for separately as a derivative financial instrument.  In circumstances where the convertible instrument contains more than one embedded derivative instrument, including the conversion option, that is required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument.  Also, in connection with the sale of convertible debt and equity instruments, the Company may issue freestanding options or warrants that may, depending on their terms, be accounted for as derivative instrument liabilities, rather than as equity. As of September 30, 2010 and March 31, 2010, the Company did not have any derivative instrument liabilities.

Stock Options

 

The Company follows the guidance cited in ASC Topic No. 718, “Compensation – Stock Compensation”, to account for its stock options. ASC Topic No. 718 requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, based on estimated fair values. Stock-based compensation expense recognized under ASC Topic No. 718, which consists of stock-based compensation expense related to employee and director stock options and restricted stock issuances, for the six months ended September 30, 2010 was $72,638 and $101,403 for the six months ended September 30, 2009, which consists of stock-based compensation expense related to employee and director stock options and restricted stock issuances.

ASC Topic No. 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s statement of operations. Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Compensation expense recognized for all employee stock options awards granted is recognized over their respective vesting periods unless the vesting period is graded. As stock-based compensation expense recognized in the Statement of Operations for the six months ended September 30, 2010 and September 30, 2009 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures as explained below.

 

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Upon adoption of ASC Topic No. 718, the Company continued to use the Black-Scholes option valuation model, which requires management to make certain assumptions for estimating the fair value of employee stock options granted at the date of the grant. In determining the compensation cost of the options granted, as specified by ASC Topic No. 718, the fair value of each option grant has been estimated on the date of grant using the Black-Scholes pricing model. The weighted average assumptions used in the calculations for the options granted in the six months ended September 30, 2009 included a risk-free interest rate of .9%, expected life of options granted  is ten years, expected volatility is 208%, expected dividend yield of zero, and expected forfeiture rate of 30%. There were 25,000 options granted during the six months ended September 30, 2010.  There were 800,000 options granted during the six months ended September 30, 2009. The weighted average assumptions used in the calculations for the options granted in the six months ended September 30, 2010 included a risk-free interest rate of 2.35%, expected life of options granted  is ten years, expected volatility is 117%, expected dividend yield of zero, and expected forfeiture rate of 30%.

As of September 30, 2010, there was approximately $19,212 of total unrecognized compensation cost related to non-vested share-based compensation arrangements, which is expected to be recognized over a period of two years.

Income and Loss per Share

The Company calculates income and loss per share in accordance with FASB ASC Topic No. 260 – 10, “Earnings Per Share”. Basic loss per share is computed by dividing the net loss by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common stock equivalents had been issued and if the additional common shares were dilutive.

The following potential common stock equivalents have been excluded from the computation of diluted net loss per share for the periods presented because the effect would have been anti-dilutive (options and warrants typically convert on a one-for-one basis, see conversion details of the preferred stock stated below for the common stock shares issuable upon conversion). The weighted-average common stock equivalents as of September 30, 2010 and 2009 are as follows:

		September 30,
		2010				2009
Options outstanding under the Company’s stock option plans			6,571,832				7,745,720
Options outstanding outside the Company’s stock option plans			580,000				1,160,000
Warrants outstanding in conjunction with private placements			7,539,364				2,888,201
Warrants outstanding as a financing cost for notes payable
and convertible notes payable			3,599,976				2,888,201
Warrants outstanding for services rendered and litigation settlement			200,000				200,000
Convertible Series B preferred stock outstanding (a)			109,933				109,933

(a)

The Series B preferred stock is convertible into shares of common stock at a conversion ratio of one share of Series B preferred stock for one share of common stock.

 

Estimates

 

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

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Concentrations of Credit Risk

 

The Company sells its products throughout the United States and extends credit to its customers. It also performs ongoing credit evaluations of such customers. The Company does not obtain collateral to secure its accounts receivable. The Company evaluates its accounts receivable on a regular basis for collectability and provides for an allowance for potential credit losses as deemed necessary.

 

Three of our customers accounted for 61%, 10% and 9% of our net revenues for the six months ended September 30, 2010. Two of our customers accounted for 59% and 12% of our net revenues for the six months ended September 30, 2009.

 

At September 30, 2010, amounts due from four of our customers accounted for 38%, 19%, 13% and 10% of accounts receivable. At September 30, 2009, amounts due from five of our customers accounted for 36%, 12%, 12%, 12% and 10% of accounts receivable.

 

Recent Accounting Pronouncements

 

There have been no additional accounting pronouncements or changes in accounting pronouncements during the six months ended September 30, 2010, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010, that are material, or potentially material, to the Company’s financial statements.

 

Income Taxes

 

Deferred income taxes are provided on a liability method whereby deferred tax assets and liabilities are established for the difference between the financial reporting and income tax basis of assets and liabilities as well as operating loss and tax credit carryforwards.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. At September 30, 2010 and March 31, 2010, a valuation allowance has been established to fully offset deferred tax assets.

 

The Company has computed the tax provision for the six months ended September 30, 2010 in accordance with the provisions of ASC 740-Income Taxes and ASC 270-Interim Reporting.  The Company has estimated that its effective tax rate for US purposes will be 0% for 2010, and consequently, recorded zero income tax benefit for the six months ended September 30, 2010.

 

At September 30, 2010, the Company had approximately $28 million of net operating loss carryforwards for U.S. purposes.  These loss carryforwards will expire from 2020 through 2030 if not utilized.

 

The Company records expense and penalties related to unrecognized tax benefits as income tax expense, and there is no liability accrued for the payment of interest and penalties as of September 30, 2010 and March 31, 2010, respectively. The Company recognized no benefits for uncertain positions during the six months ended September 30, 2010, and there are no unrecognized tax positions that may be recognized in the next twelve months as a result of a lapse of statute of limitations and settlement of ongoing audits.

 

3.	Property and Equipment

 

Property and equipment as of September 30, 2010 and March 31, 2010 consisted of the following:

		September 30,
		2010				March 31, 2010
Furniture and fixtures		$	99,535			$	99,535
Office and telephone equipment			182,275				182,275
Computer equipment			808,037				747,631
Computer software			1,299,536				1,271,098
Leasehold improvements			64,733				64,733
			2,454,116				2,365,272
Less accumulated depreciation and amortization			(2,271,596	)			(2,195,476	)
Total		$	182,520			$	169,796

 

 

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Depreciation and amortization expense for the three months ended September 30, 2010 and 2009 was $46,322 and $39,018, respectively.  Depreciation and amortization for the six months ended September 30, 2010 and 2009 was $76,119 and $82,663, respectively.

 

4.	Bank Credit Line and Long-Term Debt

 

At September 30, 2010 and March 31, 2010, the Company’s bank credit line and long-term debt consisted of the following:

 

		September 30,				March 31,
		2010				2010
Bank credit line		$	-			$	-
Bank term loan			805,556				972,222
Notes payable –related party			3,092,245				3,092,245
Notes payable –equipment			¾				17,639
Unamortized debt discount			(477,209	)			(543,736	)
Total secured notes payable and bank debt			3,420,592				3,538,370
Total long-term debt			3,420,592				3,538,370
Less: Current portion of long-term debt			569,444				350,972
Bank credit line and long-term debt, net of current portion			2,851,148				3,187,398

Revolving Bank Credit Line and Term Loan

On February 9, 2010, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank (“SVB”) and related agreements and documents providing for a senior credit facility comprised of a revolving line of credit and a term loan (the “Credit Facility”). Pursuant to the Loan Agreement, the Company has granted SVB a security interest in all of its assets, whether now owned or hereafter acquired, including but not limited to, all accounts receivable, copyrights, trademarks, licenses, equipment and all proceeds from such collateral. The initial maximum availability under the revolving line of credit (the “Revolver”) was $250,000 and increased to $1,000,000 on July 1, 2010. The maturity date of the Revolver was February 8, 2011. The Revolver accrued interest at an annual rate equal to the higher of (i) 1.25% above SVB’s prime rate or (ii) 5.25% and is payable monthly. No principal payments are due on the Revolver until its maturity date. Subject to the commitment limits described above, the Company could borrow up to eighty percent (80%) of its eligible accounts receivable subject to a number of exceptions. The Company will use the proceeds from the Revolver for general corporate purposes. As of September 30, 2010, the Company had zero borrowings on the revolving line of credit. The amount originally borrowed under the term loan (the “Term Loan”) was $1,000,000 and the amount outstanding was $805,556 at September 30, 2010 and $972,222 at March 31, 2010. The maturity date of the Term Loan was February 9, 2013. The Term Loan accrued interest at the fixed annual rate of 6.50% and is payable monthly. Principal payments on the Term Loan were scheduled to be made in thirty six equal monthly installments. If an event of default occurs and is continuing, the interest rates on the Revolver and the Term Loan will increase by 5.00% on an annualized basis.

The Credit Facility required that the Company comply with financial covenants for an adjusted quick ratio and a fixed charge coverage ratio, as defined. As of September 30, 2010, the Company was not in compliance with its financial covenants and certain other covenants under the Loan Agreement.  The Company entered into a series of forbearance agreements with SVB addressing such non-compliance.  Further, SVB has recently waived the events of default arising out of such non-compliance in connection with entering into an amended and restated loan agreement with the Company (See “Note 8-Subsequent Events”).

 

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Notes Payable – Related Parties

Through a series of negotiated agreements, the Company has executed and delivered, and is currently indebted under, (i) a promissory note (the “Nicholson Refinance Note”) payable to John L. Nicholson, an outside director of the Company, and (ii) a promissory note (the “Ramey Refinance Note”) payable to Charles E. Ramey, the Chairman and CEO of the Company.  The original proceeds from the Nicholson Refinance Note and the Ramey Refinance Note (collectively, the “Refinance Notes”) were used to refinance certain debt of the Company and for other corporate purposes.

The terms of the Nicholson Refinance Note are as follows:

·

Current principal balance is $2,295,000.

·

The maturity date is January 1, 2014.

·

Annual interest rate is twelve percent (12%) but will reduce down to ten percent (10%) if the principal balance is reduced below $1,905,000.

·

Interest is payable monthly.

·

No principal payments required until the maturity date.

The terms of the Ramey Refinance Note are as follows:

·

Current principal balance is $792,245.

·

The maturity date is January 1, 2014.

·

Annual interest rate is ten percent (10%).

·

Interest is payable monthly.

·

No principal payments required until the maturity date.

The Refinance Notes are expressly subject to the terms and provisions of the Amended and Restated Subordination Agreement among SVB, Messrs. Nicholson and Ramey, and the Company that was entered into as of October 27, 2010 in connection with closing the New Credit Facility (the “Subordination Agreement”).  The Subordination Agreement provides, among other things, that no payments on the Refinance Notes other than regular scheduled non-default interest payments are permitted without the consent of SVB unless and until the New Credit Facility is paid in full and terminated.

The Refinance Notes were originally issued pursuant to a Note Purchase Agreement between the Company and Messrs. Nicholson and Ramey dated August 13, 2008 that remain in effect.  The Refinance Notes are secured by a Security Agreement, dated August 13, 2008, by and between the Company and Messrs. Nicholson and Ramey, pursuant to which the Company granted Messrs. Nicholson and Ramey a security interest in all its personal property, whether now owned or hereafter acquired, including but not limited to, all accounts receivable, copyrights, trademarks, licenses, equipment and all proceeds as from such collateral.  Pursuant to the Subordination Agreement, this security interest will remain junior to SVB’s security interest under the New Credit Facility as long as such facility remains in place.

       Note Payable Equipment

 In August 2007, the Company entered into a note payable with an equipment vendor to purchase new telephone equipment for $105,835. The note bears a 10.68% per annum interest rate, is secured by the equipment and was due in 36 equal monthly installments of $3,418. As of March 31, 2010, the outstanding balance on this note payable was $17,639, and has been paid in full in FY2011.

 

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Payment Table

Future minimum payments under our loan agreements affected for the subsequent modifications of our loan agreement with SVB and notes payable at September 30, 2010 were as follows:

 

Fiscal Year Ended
March 31,		Amount
2011		$	486,111
2012			166,667
2013			152,778
2014			3,092,245
		$	3,897,801

 

Expiration of Private Placement Liability

 

During the quarter ended September 30, 2010, the Company recorded a non-cash event when it released a $66,000 accrual due to the expiration of a liability that arose in connection with a prior private placement of securities.

 

5.	Commitments and Contingencies