UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington D.C., 20549

 

  

FORM 10-Q

 

 

(Mark One)

 

x	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended December 31, 2012
¨	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934
	For the transition period                        to

 

Commission file number: 001-15835

 

US Dataworks, Inc.

(Exact name of registrant as specified in its charter)

 

Nevada	84-1290152
(State or other jurisdiction of	(I.R.S. employer identification number)
incorporation or organization)

 

One Sugar Creek Center Boulevard
5th Floor
Sugar Land, Texas	77478
(Address of principal executive offices)	(Zip Code)

 

Registrant’s telephone number: (281) 504-8000

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x   No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

	Large accelerated filer	¨	Accelerated filer	¨
	Non-accelerated filer	¨	Smaller reporting company	x
	(Do not check if smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES ¨ NO x

 

Number of shares of the issuer’s common stock outstanding as of February 14, 2013: 33,615,439.

 

 

US DATAWORKS, INC.

 

TABLE OF CONTENTS

 

FORM 10-Q

 

QUARTERLY PERIOD ENDED DECEMBER 31, 2012

 

			Page
PART I - FINANCIAL INFORMATION			4
Item 1.	Financial Statements		4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		21
Item 4.	Controls and Procedures		21
PART II - OTHER INFORMATION.			21
Item 1.	Legal Proceedings		21
Item 1A.	Risk Factors		21
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		21
Item 3.	Defaults Upon Senior Securities		21
Item 4.	Mine Safety Disclosures		22
Item 5.	Other Information		22
Item 6.	Exhibits		22

 

 

NOTE REGARDING FORWARD LOOKING STATEMENTS AND CERTAIN TERMS

 

When used in this Report, the words “expects,” “anticipates,” “believes,” “plans,” “will” and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include, but are not limited to, statements regarding our critical accounting policies, our operating expenses, our strategic opportunities, adequacy of capital resources, our potential professional services contracts and the related benefits, demand for software and professional services, demand for our solutions, expectations regarding net losses, expectations regarding cash flow and sources of revenue, statements regarding our growth and profitability, investments in marketing and promotion, fluctuations in our operating results, our need for future financing, effects of accounting standards on our financial statements, our investment in strategic partnerships, development of our customer base and our infrastructure, our dependence on our strategic partners, our dependence on personnel, our employee relations, our disclosure controls and procedures, our ability to respond to rapid technological change, expansion of our technologies and products, benefits of our products, our competitive position, statements regarding future acquisitions or investments, our legal proceedings, and our dividend policy.  Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, those discussed herein, as well as risks related to our ability to develop and timely introduce products that address market demand, the impact of alternative technological advances and competitive products, market fluctuations, our ability to obtain future financing, and the risks referred to in “Part II - Item 1A. Risk Factors.” These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

All references to “US Dataworks,” the “Company,” “we,” “us,” or “our” means US Dataworks, Inc.

 

MICRworks™, Clearingworks®, Returnworks™, Remitworks™, ClearPayments™, ClearDeposits™, ClearReturns™, ClearInsights™ and PayItFast™ are trademarks of US Dataworks. Other trademarks referenced herein are the property of their respective owners.

 

 

PART I - FINANCIAL INFORMATION

 

Item 1.                Financial Statements

 

US DATAWORKS, INC.

UNAUDITED CONDENSED BALANCE SHEETS

 

		December 31, 2012				March 31, 2012
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	57,527			$	81,985
Accounts receivable, trade, net of allowance for doubtful accounts at December 31, 2012 and March 31, 2012 of $10,500 and $0, respectively			698,638				437,662
Prepaid expenses and other current assets			173,208				200,636
Total current assets			929,373				720,283
Property and equipment, net			152,060				184,387
Goodwill			4,020,698				4,020,698
Other assets			29,751				42,354
Total assets		$	5,131,882			$	4,967,722
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long term debt, net of unamortized discount at December 31, 2012 and March 31, 2012 of $3,264 and $0, respectively		$	346,095			$	244,667
Current portion of long term debt – related party, net of unamortized discount at December 31, 2012 and March 31, 2012 of $812 and $0, respectively			24,188				—
Accounts payable			435,895				426,895
Accrued expenses			324,436				138,033
Accrued interest – related parties			525,737				383,592
Deferred revenue			483,185				424,191
Derivative instruments			10,701				—
Total current liabilities			2,150,237				1,617,378
Long term liabilities:
Notes payable, net of unamortized discount at December 31, 2012 and March 31, 2012 of $3,371 and $2,557, respectively			103,231				109,078
Notes payable – related parties, net of unamortized discount  at December 31, 2012 and March 31, 2012 of  $156,862 and $267,689, respectively			2,960,383				2,849,556
Total long term liabilities			3,063,614				2,958,634
Total liabilities			5,213,851				4,576,012
Commitments and contingencies
Stockholders’ equity (deficit):
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 $489,878 and $458,802 in arrears as of December 31, 2012 and March 31, 2012, respectively			11				11
Common stock, $0.0001 par value, 90,000,000 shares authorized,  33,583,606 and 33,485,835 shares issued and outstanding as of December 31, 2012 and March 31, 2012, respectively			3,358				3,348
Additional paid-in-capital			66,928,668				66,593,160
Accumulated deficit			(67,014,006	)			(66,204,809	)
Total stockholders’ equity (deficit)			(81,969	)			391,710
Total liabilities and stockholders’ equity (deficit)		$	5,131,882			$	4,967,722

 

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

 

 

US DATAWORKS, INC.

UNAUDITED CONDENSED STATEMENTS OF OPERATIONS

 

		For the Three Months Ended December 31,								For the Nine Months Ended December 31,
		2012				2011				2012				2011
Revenues:
Software transactional and subscription		$	616,144			$	688,341			$	1,899,838			$	2,056,567
Software licensing			8,587				29,483				18,161				127,953
Software maintenance			164,210				213,203				506,172				518,837
Professional services			984,100				856,323				2,261,272				2,266,838
Software resale			37,686				36,027				46,617				112,716
Total revenues			1,810,727				1,823,377				4,732,060				5,082,911
Cost of revenues			510,465				548,574				1,532,635				1,652,211
Gross profit			1,300,262				1,274,803				3,199,425				3,430,700
Operating expenses:
Research and development			196,187				172,280				636,651				631,887
Sales and marketing			283,926				303,401				787,449				992,258
General and administrative			877,020				542,002				2,031,007				1,738,340
Depreciation and amortization			13,745				19,586				47,479				67,064
Total operating expenses			1,370,878				1,037,269				3,502,586				3,429,549
Income (loss) from operations			(70,616	)			237,534				(303,161	)			1,151
Other expense:
Interest expense			(32,630	)			(28,378	)			(76,170	)			(71,913	)
Interest expense – related parties			(142,077	)			(125,438	)			(432,565	)			(374,566	)
Unrealized gain on fair value of derivative instruments			14,458				—				2,699				—
Total other expense			(160,249	)			(153,816	)			(506,036	)			(446,479	)
Net income (loss)		$	(230,865	)		$	83,718			$	(809,197	)		$	(445,328	)
Basic earnings (loss) per share		$	(0.01	)		$	0.00			$	(0.02	)		$	(0.01	)
Diluted earnings (loss) per share		$	(0.01	)		$	0.00			$	(0.02	)		$	(0.01	)
Basic weighted-average shares outstanding			33,583,606				33,425,606				33,550,662				33,397,300
Diluted weighted-average shares outstanding			33,583,606				33,430,151				33,550,662				33,397,300

 

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

 

 

US DATAWORKS, INC.

UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS

 

For the Nine Months Ended December 31,

 

		2012				2011
Cash flows from operating activities:
Net loss from operating activities		$	(809,197	)		$	(445,328	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization of property and equipment			47,479				67,064
Bad debt expense			15,581				—
Amortization of discount on notes payable			5,854				2,792
Amortization of discount on notes payable – related parties			111,670				106,006
Amortization of deferred financing costs – related parties			12,603				17,513
Stock based compensation			337,330				27,199
Unrealized loss on gain value of derivative instruments			(2,699	)			—
Changes in operating assets and liabilities:
Accounts receivable			(276,557	)			311,154
Prepaid expenses and other current assets			27,428				190,714
Accounts payable			9,000				(172,301	)
Accrued expenses			186,403				135,095
Accrued interest – related parties			142,145				238,664
Deferred revenue			58,994				(142,272	)
Net cash (used in) provided by operating activities			(133,966	)			336,300
Cash flows from investing activities:
Purchase of property and equipment			(15,152	)			(23,015	)
Net cash used in investing activities			(15,152	)			(23,015	)
Cash flows from financing activities:
Payments on note payable to bank			—				(808,562	)
Payments on secured line of credit			(1,751,383	)			—
Proceeds from secured line of credit			1,507,331				445,902
Payments on factoring facility			(1,960,051	)			—
Proceeds from factoring facility			2,206,238				—
Proceeds from issuance of notes payables and detachable stock warrants			125,000				125,000
Payments on equipment loan payable			(2,475	)			(2,476	)
Net cash provided by (used in) financing activities			124,660				(240,136	)
Net decrease in cash and cash equivalents			(24,458	)			73,149
Cash and cash equivalents, beginning of period			81,985				44,096
Cash and cash equivalents, end of period		$	57,527			$	117,245
Supplemental disclosures of cash flow information:
Interest paid		$	243,447			$	44,036
Income taxes paid			—				—
Supplemental disclosures of non-cash financing activities:
In conjunction with the extension of certain existing notes payable and the issuance of new notes payable, the Company issued additional common stock warrants and modified the existing notes to add a common stock conversion feature. As a result, the following balance sheet accounts were affected as follows:
Increased derivative warrant instruments		$	13,400			$	—
Increased note discount on notes payable			11,588				—
Decreased additional paid-in-capital			(1,812	)			—

  

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

 

 

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 on-premise customers and cloud-computing service customers within 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 conjunction with the audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2012.  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, 2013.

 

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 985–605, Software Revenue Recognition.

 

The Company licenses its software on a transaction or 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 the percentage of completion basis. The Company also charges an onboarding fee for implementation services when a customer chooses its cloud based service. The revenue from the onboarding fee and the associated costs are deferred and recognized over the first year of the new contract. The Company measures its percentage of completion by the percentage of labor hours incurred to-date to estimated total labor hours for each contract.

 

In certain instances, the Company licenses its software products under non-exclusive, non-transferable license agreements that involve services essential to the functionality of the software in which case 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 established in the agreement, commencing upon completion of the 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.

  

Cash and Cash Equivalents

 

For the purpose of the statements of cash flows, the Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.

 

The Company maintains cash deposits with a major bank that, from time to time, may exceed federally insured limits; however, the Company has not experienced any losses on deposits.

 

  

Accounts Receivable and Allowance for Doubtful Accounts

 

The Company’s receivables are recorded when revenue is earned and claims against third parties will be settled in cash.  The carrying value of the Company’s receivables represents their estimated net realizable value.   The Company extends credit to customers and other parties in the normal course of business.  The Company regularly reviews outstanding receivables and provides for estimated losses through an allowance for doubtful accounts.  In evaluating the level of established reserves, the Company makes judgments regarding its customers’ ability to make required payments, economic events, and other factors.  As the financial condition of these parties change, circumstances develop or additional information becomes available, adjustments to the allowance for doubtful accounts may be required.  Provisions for bad debts and recoveries of accounts previously charged off are adjusted to the allowance account.

 

Property and Equipment

 

Property and equipment are recorded at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over estimated useful lives as follows:

 

Furniture and fixtures	5 years
Telephone equipment	5 to 10 years
Computer equipment	5 years
Computer software	5 years
Leasehold improvements	Shorter of lease period or useful life of asset

 

Maintenance and minor replacements are charged to expense as incurred. Gains and losses on disposals are included in the results of operations.

 

Impairment of Long-Lived Assets

 

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future net cash flows expected to be generated by the assets. If the assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair value of the assets.

 

Goodwill

 

The goodwill recorded on the Company’s books is from the acquisition of US Dataworks, Inc. in fiscal year 2002 which remains the Company’s single reporting unit. ASC Topic 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.

 

ASC Topic 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 December 31, 2012 or the year ended March 31, 2012.

 

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

 

Stock Options

 

The Company follows the guidance cited in ASC Topic 718, Compensation – Stock Compensation, to account for its stock options. ASC Topic 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 718, which consists of stock-based compensation expense related to employee, consultant and director stock options and stock issuances, for the nine months ended December 31, 2012 and December 31, 2011 were $337,330 and $27,199, respectively.

 

ASC Topic 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 nine months ended December 31, 2012 and December 31, 2011 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.

 

 

Upon adoption of ASC Topic 718, the Company continues 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.  There were 2,400,000 stock options (400,000 consultant options and 2,000,000 employee options) granted during the nine months ended December 31, 2012 and 50,000 employee stock options granted during the nine months ended December 31, 2011. There were 2,000,000 employee options granted during the quarter to the Chief Executive Officer of the Company that were immediately vested with an exercise price of $0.14 per share. The associated expense charged during the quarter ended December 31, 2012 was $268,295.

  

As of December 31, 2012, there was approximately $48,801 of total unrecognized compensation cost related to non-vested share-based compensation arrangements, which is expected to be recognized over a period of one year.

 

Derivative Instruments

 

The Company accounts for warrant derivative instruments under the provisions of ASC Topic 815 – 40, Derivatives and Hedging - Contracts in Entity’s Own Stock. The requirements of this ASC Topic can affect the accounting for warrants and many convertible instruments with provisions that protect holders from a decline in the stock price (or “down-round” provisions). For example, warrants or convertible instruments with such provisions cannot be recorded in equity. Downward provisions reduce the exercise price of a warrant or convertible instrument if a company either issues equity shares for a price that is lower than the exercise price of those instruments or issues new warrants or convertible instruments that have a lower exercise price. The Company evaluated whether warrants contained provisions that protect holders from declines in the Company’s stock price or otherwise could result in modification of the exercise price and/or shares to be issued under the respective warrant or preferred stock agreements based on a variable that is not an input to the fair   value of a “fixed-for-fixed” option as defined under ASC Topic 815 – 40.

 

In accordance with ASC Topic 815 – 40, the Company recognized the financial instruments that contain these down round provisions as liabilities at their respective fair values on each reporting date. ASC Topic 815 – 40 also requires that such instruments be measured at fair value at each reporting period. See Footnote 5 – Derivative Instruments for disclosure regarding amount of derivative instrument presented on the balance sheet.

 

Income and Loss per Share

 

The Company calculates income and loss per share in accordance with ASC Topic 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.

 

For the nine months ended December 31, 2012, 13,238,615 potential common stock equivalents have been excluded from the computation of diluted earnings per share because the effect would have been anti-dilutive.  For the nine months ended December 31, 2011, 15,369,508 potential common stock equivalents have been excluded from the computation of diluted earnings per share because the effect would have been anti-dilutive.  Options and warrants typically convert on a one-for-one basis – see below for details of the conversion of the preferred stock into shares of common stock. The weighted-average common stock equivalents that were excluded from the computation of diluted loss per share for the nine months ended December 31, 2012 and December 31, 2011 are as follows:

 

		For the Nine Months
		Ended December 31,
		2012				2011
Options outstanding:
Under the Company’s stock option plan			8,976,669				6,303,632
Outside the Company’s stock option plan			—				580,000
Warrants outstanding:
In conjunction with private placements			31,596				4,709,301
For services rendered and settlement			—				200,000
As consideration for note extensions			4,120,417				3,466,642
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 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 disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The most significant estimates relate to the measurement of progress of completion on contracts, determination of allowance for doubtful accounts, share based compensation, fair value of derivative instrument, and fair value of goodwill impairment assessment. Actual results could differ from those estimates.

 

 

Concentrations of Credit Risk

 

The Company sells its products and services 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.

 

One of our customers accounted for 67% and 58% of the total net revenues for the nine months ended December 31, 2012 and December 31, 2011, respectively.

 

At December 31, 2012, amounts due from three of the Company’s customers accounted for 44%, 29% and 12%, respectively, of accounts receivable. At December 31, 2011, amounts due from two of the Company’s customers accounted for 61%, and 12%, respectively, of accounts receivable.

 

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.

 

The Company recorded a net loss of $809,197 for the nine months ended December 31, 2012 and has computed the tax provision for the nine months ended December 31, 2012 in accordance with the provisions of ASC Topic 740, Income Taxes and ASC Topic 270, Interim Reporting.  The Company has estimated that its overall effective tax rate for US purposes to be 0% for the nine months ended December 31, 2012. Consequently, the Company recorded zero income tax expense or benefit for the period ended December 31, 2012. The Company’s income tax benefit on the loss before taxes was offset by an increase in the valuation allowance. At December 31, 2012 and March 31, 2012, a valuation allowance has been maintained to fully offset net deferred tax assets until it is evident that the deferred tax assets will be utilized in the future.

 

At December 31, 2012, the Company had approximately $30.1 million of net operating loss carryforwards for U.S. purposes.  These loss carryforwards will expire beginning in 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 December 31, 2012 and March 31, 2012, respectively.  The Company recognized no tax benefits or liabilities for uncertain positions during the nine months ended December 31, 2012.

 

 

3.	Property and Equipment

 

 Property and equipment at December 31, 2012 and March 31, 2012 consisted of the following:

 

		December 31, 2012				March 31, 2012
Furniture and fixtures		$	102,631			$	102,631
Office and telephone equipment			198,781				198,781
Computer equipment			861,183				855,564
Computer software			1,377,793				1,368,260
Leasehold improvements			64,732				64,732
			2,605,120				2,589,968
Less: accumulated depreciation and amortization			(2,453,060	)			(2,405,581	)
Total		$	152,060			$	184,387

 

Depreciation and amortization expense for the three months ended December 31, 2012 and December 31, 2011 was $13,745 and $19,586, respectively. Depreciation and amortization expense for the nine months ended December 31, 2012 and December 31, 2011 was $47,479 and $67,064, respectively.

 

4.	Bank Credit Line and Long-Term Debt

 

At December 31, 2012 and March 31, 2012, the Company’s bank credit line and long-term debt consisted of the following:

 

		December 31, 2012				March 31, 2012
Secured line of credit		$	—			$	243,923
Factoring facility			246,059				—
Notes payable			200,000				100,000
Notes payable – related parties			3,142,245				3,117,245
Notes payable – equipment			9,902				12,379
Unamortized debt discount			(164,309	)			(270,246	)
Total secured notes payable and bank debt			3,433,897				3,203,301
Less: Current portion of long-term debt			(370,283	)			(244,667	)
Long-term debt, net of current portion		$	3,063,614			$	2,958,634

 

A/R Line of Credit and Term Loan

 

Effective as of October 27, 2010, the Company entered into an Amended and Restated Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank (“SVB”) providing for a senior credit facility (the “Credit Facility”) comprised of an asset-based accounts receivable line of credit (the “A/R Line of Credit”) and a term loan (The “Term Loan”). The Loan Agreement amended and restated a previous loan agreement with SVB in its entirety. As of February 8, 2011, May 9, 2011, June 7, 2011, July 7, 2011, September 12, 2011, November 1, 2011, March 15, 2012 and June 28, 2012, the Company entered into certain amendments to the Loan Agreement.

 

The Term Loan, which was fully repaid in March 2012, accrued interest at the fixed annual rate of 7.00% prior thereto.

 

The A/R Line of Credit accrued interest by applying a variable finance charge and a collateral handling fee to the A/R Line of Credit balance. For the quarters ended June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012 and June 30, 2012 the effective rates were 10.31%, 10.82%, 10.82%, 10.82%, and 10.82%, respectively.

 

Pursuant to the June 28, 2012 amendment, the maturity date of the Loan Agreement was extended to September 26, 2012. On August 17, 2012, the A/R Line of Credit was paid in full and the Loan Agreement was terminated

 

Factoring Facility

 

On July 13, 2012, the Company and Porter Capital Corporation (“PCC”) entered into a certain Recourse Receivables Purchase & Security Agreement pursuant to which PCC has agreed to purchase from the Company certain of its accounts receivable from time to time (the “Factoring Agreement”).  The Factoring Agreement provides, among other things, that (i) the line of credit will be $1,000,000 measured as the unpaid face amount of all purchased receivables at any given time; (ii) the initial term of the facility will be one year with automatic one-year renewals unless the Company elects in advance not to renew; (iii) the advance rate under the facility will be 85% of the face amount of purchased receivables (the “Advance Amount”), with the remaining 15% being held in reserve until the purchased receivable is paid in full, (iv) interest will accrue on the Advance Amount until the purchased receivable is paid in full at an annual rate equal to (a) the greater of prime rate or 5%, plus (b) 1.75%; (v) additional service fees will accrue on the full face amount of each purchased receivable until such purchased receivable is paid in full at a rate of 0.90% for each 30 days, or 0.03% per day; and (v) the Company will owe a minimum term fee in an amount, if any, by which the sum of the interest paid plus the service fee paid plus the origination/renewal fee paid during the initial or any renewal term is less than $36,000. The obligations owed under the Factoring Agreement are secured by a perfected first priority security interest in all of the assets of the Company. In connection with entering into this factoring facility, the Company paid an origination fee of $7,500 when it first accessed the facility, which occurred on August 17, 2012. The Company will also be required to pay a renewal fee of $7,500 each year that it renews the facility. At December 31, 2012, the amount advanced under the facility was $246,059 and the amount held in reserve until each purchased receivable is paid was $43,573.  The combined amount of $289,632 is included in accounts receivable, trade on the Company's Balance Sheet. At December 31, 2012, the amount available for advance under the facility was $347,655.

 

 

Notes Payable

 

In August 2011, the Company completed a private placement in which investors received in the aggregate $125,000 in one-year notes (the “One-Year Notes”) and three-year warrants to purchase a total of 58,138 shares of the Company’s common stock at an exercise price of $0.43 per share (the “Three Year Warrants”). Included in the One-Year Notes is $25,000 held by a related party. The One-Year Notes accrue interest at a rate of 12% per annum payable monthly in arrears.  No principal payments are required to be made on the Notes until the maturity date, which was August 1, 2012. The One-Year Notes are secured by a second lien on all of the assets of the Company which is junior only to the first lien that secures the Company’s factoring facility with PCC. The Three Year Warrants were valued at $7,111, which represents the original issue discount to the One-Year- Notes.

 

In June 2012, the Company and the holders of the One-Year Notes and the Three-Year Warrants agreed to certain amendments to the One-Year Notes and the Three-Year Warrants. Specifically, the One-Year Notes were amended to (i) extend the maturity date of the notes out to August 1, 2013 and (ii) add a right to convert the notes into shares of the Company’s common stock at a conversion price of $0.43 per share, with such conversion price being subject to reduction in the event of certain dilutive equity issuances by the Company. The Three-Year Warrants were amended to (i) double the number of shares of the Company’s common stock into which the warrants are exercisable, (ii) extend the expiration date of the warrants to August 1, 2017 and (iii) add a provision that the exercise price of the warrants will be subject to reduction in the event of certain dilutive equity issuances by the Company. The unamortized discount on the One-Year-Notes was $4,076 at December 31, 2012.

 

In August 2012, the Company completed two closings of a private placement in which investors received in the aggregate $125,000 of 12% Senior Subordinated Convertible Notes due August 1, 2014 (the “Two-Year Notes”) and five-year warrants to purchase a total of 58,137 shares of the Company’s common stock at an exercise price of $0.43 per share, with such exercise price being subject to reduction in the event of certain dilutive equity issuances by the Company (the “Five Year Warrants”). Included in the Two-Year Notes is $25,000 held by a related party. Holders of the Two Year Notes have the right to convert the notes into shares of the Company’s common stock at a conversion price of $0.43 per share, with such conversion price being subject to reduction in the event of certain dilutive equity issuances by the Company. The Two-Year Notes accrue interest at a rate of 12% per annum payable monthly in arrears.  No principal payments are required to be made on the Two-Year Notes until the maturity date, which is August 1, 2014.  The Two-Year Notes are secured by a second lien on all of the assets of the Company, which is junior to the first lien that secures the Company’s factoring facility with PCC, pari passu with the One-Year Notes and senior to all other Company debt, including the affiliate debt. The Five Year Warrants were valued at $4,912, which represents the original issue discount to the Two-Year Notes. The unamortized discount on the Two-Year-Notes was $4,214 at December 31, 2012.

 

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 Refinance Notes are as follows:

 

Refinance Notes
Nicholson				Ramey				Total
$	2,295,000			$	797,245			$	3,092,245

 

The maturity date on the Refinance Notes is January 1, 2014. Interest on the Refinance Notes is payable monthly and no principal payments are required until maturity.  The annual interest rate for the Nicholson Refinance Note is 12% but reduces to 10% if the principal balance drops below $1,905,000.  The annual interest rate for the Ramey Refinance Note is 10%. As of December 31, 2012, the Company had $525,737 in accrued but unpaid interest on the Refinance Notes. On July 11, 2012, the Company and the holders of the Refinance Notes entered into a letter agreement pursuant to which such holders agreed to (i) waive the default under their notes that has occurred and will continue to occur as a result of the Company’s failure to remain current on the interest owed on these notes and (ii) agreed not to take any action against the Company for such defaults.  These agreements expire on June 30, 2013.

 

 

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 agreements with PCC and the holders of the One-Year Notes and the Two-Year Notes, this security interest will be junior to PCC’s security interest under the Factoring Agreement as long as that agreement is in place and junior to the security interest of the holders of the One-Year Notes and the Two-Year Notes until those notes are paid in full.

 

The $25,000 of One-Year Notes held by a related party is reported on the balance sheet at December 31, 2012 net of unamortized debt discount of $812 in current portion of long term debt – related party and at March 31, 2012 net of unamortized debt discount of $0 in notes payable – related parties.

 

The $25,000 of the Two-Year Notes held by a related party is reported on the balance sheet at December 31, 2012 net of unamortized debt discount of $843 in notes payable – related parties.

 

Note Payable – Equipment

 

In December 2010, the Company entered into a capital lease agreement with CIT Technology Financing Services, Inc. to lease new telephone equipment for $16,505. The lease has a $1 purchase option at the end of 60 equal monthly installments of $379.  As of December 31, 2012, the outstanding balance on this capital lease was $9,902.

 

Payment Table

 

Future minimum payments under our loan agreements and notes payable at December 31, 2012 were as follows:

 

Fiscal Year Ended March 31,		Amount
2013		$	246,884
2014			3,220,546
2015			128,301
2016			2,475
2017			—
		$	3,598,206

 

5.	Derivative Instruments

 

In June 2012, the Company modified the One-Year Notes and the Three-Year Warrants. After the modification, the One-Year Notes are convertible into shares of the Company’s common stock at any time at the option of the holder at the conversion price of $0.43 per share. If the Company, at any time or from time to time while any of the One-Year Notes are outstanding, issues (1) any common stock or common stock equivalent at a price per share that is less than the conversion price or (2) any common stock equivalents that entitle the holder thereof to acquire shares of common stock at a price per share that is less than the conversion price, then in each case, except for certain excluded issuances, the applicable conversion price shall be adjusted to equal to that lower issuance price. Both the One-Year Notes and the Three-Year Warrants, as amended, contain the same price protection. The Company determined the embedded conversion feature for the One-Year Notes and the Three-Year Warrants to be a derivative liability in accordance with ASC Topic 815, Derivatives and Hedging and estimated the fair value of the derivative using Lattice Model with Monte Carlo simulation as of June 28, 2012. Such estimates are revalued at each balance sheet date, with changes in value recorded as unrealized gains or losses in non-operating income (expense) in the Company’s statements of operations.

 

In August 2012, the Company issued the Two-Year Notes and the Five Year Warrants. The Two-Year Notes are convertible into shares of the Company’s common stock at any time at the option of the holder at the conversion price of $0.43 per share. If the Company, at any time or from time to time while any of the Two-Year Notes are outstanding, issues (1) any common stock or common stock equivalent at a price per share that is less than the conversion price or (2) any common stock equivalents that entitle the holder thereof to acquire shares of common stock at a price per share that is less than the conversion price, then in each case, except for certain excluded issuances, the applicable conversion price shall be adjusted to equal to that lower issuance price. Both the Two-Year Notes and the Five Year Warrants contain the same price protection. The Company determined the embedded conversion feature for the Two-Year Notes and the Five Year Warrants to be a derivative liability in accordance with ASC Topic 815, Derivatives and Hedging and estimated the fair value of the derivative using Lattice Model with Monte Carlo simulation as of August 7, 2012. Such estimates are revalued at each balance sheet date, with changes in value recorded as unrealized gains or losses in non-operating income (expense) in the Company’s statements of operations.

 

 

During the nine months ended December 31, 2012, the fair value of the derivative instruments liability decreased by $2,699. This was recorded as unrealized gain on fair value of derivative instruments in the accompanying statements of operations.

 

Activity for derivative instruments liability during the nine months ended December 31, 2012 was as follows:

 

		March 31, 2012				Activity During Fiscal Year				Decrease in Fair Value of Derivative liability				December 31, 2012
Derivative instruments		$	—			$	13,400			$	(2,699	)		$	10,701

 

The following is a summary of the assumptions used in the Lattice valuation model as of the initial valuations of the derivative instruments issued during the nine months ended December 31, 2012 and as of December 31, 2012:

 

		Initial Valuations – December 31, 2012				December 31, 2012
Common stock issuable upon exercise of warrants and conversion of notes			755,809				755,809
Market value of common stock on measurement date		$	0.12 - 0.15			$	0.14
Projected		$	0.12 - 0.43			$	0.12 - 0.43
Offering price range (1)		$	0.12 - 0.35			$	0.12 - 0.35
Risk free interest rate (2)			0.27% - 0.71	%			0.11% - 0.72	%
Warrant and convertibles lives in years			1.00 – 5.00				.85 – 4.91
Expected volatility (3)			39% - 49	%			39	%
Expected dividend yields (4)			None				None

 

	(1)	Represents the estimated offering price range in future offerings as determined by management
	(2)	The risk-free interest rate was determined by management using 1, 3 or 5 year Treasury Bill as of the respective measurement date.
	(3)	The volatility factor was estimated by management using the historical volatilities of comparable companies in the industry.
	(4)	Management determined the dividend yield to be 0% based upon its expectation that it will not pay dividends for the foreseeable future.

 

6.	Fair Value Measurement

 

As defined in ASC Topic 820 – 10, Fair Value Measurement and Disclosures, fair value is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 – 10 requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements. The statement requires fair value measurements be classified and disclosed in one of the following categories:

 

Level 1:

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. The Company considers active markets as those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 

Level 2:

Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. Substantially all of these inputs are observable in the marketplace throughout the term of the derivative instruments, can be derived from observable data, or supported by observable levels at which transactions are executed in the marketplace.

 

Level 3:

Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e. supported by little or no market activity). The Company’s valuation models are primarily industry standard models.  Level 3 instruments include derivative warrant instruments.  US Dataworks does not have sufficient corroborating evidence to support classifying these assets and liabilities as Level 1 or Level 2.

 

As required by ASC Topic 820 – 10, financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels. The estimated fair value of the derivative warrant instruments was calculated using the Lattice model (see Note 5 – Derivative Instruments).

 

 

Fair Value on a Recurring Basis

 

The following table sets forth, by level within the fair value hierarchy, the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2012:

 

		Fair Value Measurements at December 31, 2012
		Quoted prices in active markets for identical assets (Level 1)				Significant other observable inputs (Level 2)				Significant unobservable inputs (Level 3)				Total carrying value as of December 31, 2012
Derivative instruments		$	—			$	—			$	10,701			$	10,701
Total		$	—			$	—			$	10,701			$	10,701

 

Fair Value on a Non-Recurring Basis

 

Certain nonfinancial assets and liabilities are measured at fair value on a nonrecurring basis in accordance with ASC 820 – 10.  This includes items such as nonfinancial assets and liabilities initially measured at fair value in a business combination and nonfinancial long-lived asset groups measured at fair value for an impairment assessment.  In general, nonfinancial assets including goodwill and property and equipment are measured at fair value when there is an indication of impairment and are recorded at fair value only when any impairment is recognized.  

 

7.	Commitments and Contingencies

 

Leases

 

The Company leases an office in Sugar Land, Texas under an operating lease agreement that expires on January 31, 2018. Rent expense for the nine months ended December 31, 2012 and December 31, 2011 was $293,911 and $289,258, respectively. This lease was amended on June 2, 2011 to, among other things, extend the term through January 31, 2018 and provide for total rent abatements of approximately $188,000 and a refurbishment allowance of approximately $282,000. As of December 31, 2012, the Company has used approximately $215,262 of the refurbishment allowance. The Company expenses rent on a straight line basis over the lease term at $31,196 per month.

 

Future minimum lease payments under operating leases at December 31, 2012 were as follows:

 

Fiscal Year Ended March 31,		Amount
2013		$	93,950
2014			378,932
2015			397,722
2016			416,512
2017			433,736
Thereafter			367,971
		$	2,088,823

  

8.	Stockholders’ Equity

 

Preferred Stock

 

The Company has 10,000,000 authorized shares of $0.0001 par value preferred stock. The preferred stock may be issued in series, from time to time, with such designations, rights, preferences, and limitations as the Board of Directors may determine by resolution.

 

Convertible Series B Preferred Stock

 

The Company has 700,000 shares authorized, 109,933 shares issued and outstanding, of $0.0001 par value convertible Series B preferred stock. The Series B preferred stock has a liquidation preference of $3.75 per share and carries a 10% cumulative dividend payable each March 1 and September 1, as and when declared by the Board of Directors. Each share of Series B preferred stock is convertible into one share of common stock, resulting in an effective conversion price of $3.75 per share. The Company has the right to redeem the Series B preferred stock at any time after issuance at a redemption price of $4.15 per share, plus any accrued but unpaid dividends.

 

At December 31, 2012 and March 31, 2012, there were accumulated, undeclared dividends in arrears of $489,878 and $458,802, respectively.

 

 

Stock Options

 

In August 2000, the Company’s Board of Directors approved the 2000 Stock Option Plan , which has since been amended and/or amended and restated multiple times (the “2000 Plan”).  As of December 31, 2012, the maximum aggregate number of shares which may be granted under the 2000 Plan was 10,000,000. Under the 2000 Plan, the exercise price must not be less than the fair market value on the date of grant of the option. The options vest in varying increments over varying periods and expire 10 years from the date of grant. In the case of incentive stock options granted to any 10% owners of the Company, the exercise price must not be less than 100% of the fair market value on the date of grant. During the nine months ended December 31, 2012, the Company granted 2,400,000 stock options under the 2000 Plan. There were 2,000,000 employee options granted during the quarter to the Chief Executive Officer of the Company that were immediately vested with an exercise price of $0.14 per share. The associated expense charged during the quarter ended December 31, 2012 was $268,295.

 

The following table summarizes certain information relative to stock options:

 

		2000 Stock Option Plan
		Shares				Weighted-Average Exercise Price
Outstanding, March 31, 2012			6,691,169			$	0.59
Granted			2,400,000			$	0.14
Forfeited/canceled			(114,500	)		$	0.69
Outstanding, December 31, 2012			8,976,669			$	0.47
Exercisable, December 31, 2012			8,014,501			$	0.51

 

The weighted-average remaining lives of the unvested options granted under the 2000 Plan at December 31, 2012 were 5.7 years.

 

Common Stock Grants

 

During the three months ended December 31, 2012, the Company granted 31,833 shares of common stock (at $0.15 per share based on the closing price of the common stock on the grant date) to its outside directors pursuant to the Company’s Outside Director Compensation Plan. The Company expensed $4,775 related to these grants during the three months ended December 31, 2012. These grants were made under the 2000 Plan.

 

Warrants

 

All warrants outstanding as of December 31, 2012 have an exercise price of $0.43. During the quarter ended December 31, 2012, 4,851,163 warrants issued in connection with a private placement with an exercise price of $0.43 expired. The warrants outstanding as of December 31, 2012 expire as of the following dates:

 

Expiration Date		Amount
June 26, 2014			1,854,141
February 9, 2015			1,612,501
April 1, 2015			537,499
August 1, 2017			174,413
			4,178,554

 

9.

Liquidity

 

The Company has a history of experiencing negative cash flow from operations and continues to operate under liquidity constraints. Over the years, the Company has put a number of debt financings in place to address this ongoing situation. As of December 31, 2012, the Company had approximately $3.1 million of affiliate debt coming due January 1, 2014, $125,000 of debt coming due on August 1, 2013 and $125,000 of debt coming due on August 1, 2014. The Company also has a factoring agreement pursuant to which the Company borrows on certain outstanding accounts receivables from time to time. As of December 31, 2012, the Company had $525,737 in accrued but unpaid interest on the affiliate debt. Although the Company has had the right to pay the affiliate debt interest since March 2012, the affiliate debt holders have been willing to defer a portion of the affiliate debt interest in order to accommodate the Company’s liquidity constraints. The affiliate debt holders have agreed to (i) waive the defaults arising from the Company’s inability to keep current on the affiliate debt interest payments through June 30, 2013 and (ii) agreed not to take any action against the Company to collect this growing past due interest payment through June 30, 2013. However, there can be no assurance that the Company will be current on these payments or enter into a similar agreement beyond such date.

 

 

With respect to the $3.1 million in principal payments due to the affiliate debt holders on January 1, 2014 and any unpaid interest thereon as of such date as well as the $125,000 of debt coming due on August 1, 2013, the Company will have to come to an agreement with the holders of such debt to restructure the payment terms thereof or obtain other adequate sources of debt or equity funding to retire this debt when it comes due.

 

The Company will need to increase revenues from transaction and subscription based software license contracts and professional services agreements and software licenses to achieve and sustain profitability.

 

The Company has taken a number of steps to address and improve its liquidity.  These steps include additional rent abatements in fiscal year 2013 in connection with the negotiation of a renewal of the Company’s office lease and deferring interest payments on the affiliate debt, as needed.  The Company’s management believes the processes put in place will fund its operations through March 31, 2013, and for a reasonable period of time thereafter.  If the Company’s liquidity does not improve in a meaningful way, the Company will be forced to take additional steps to address the issue, primarily being restructuring the related party debt and raising additional equity and/or debt capital.  However, there can be no assurance that the Company would be successful in attempting to raise such capital.

 

Item 2.                       Management’s Discussion and Analysis of Financial Condition and Results of Operations.

  

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2012.

 

Critical Accounting Policies

 

The following discussion and analysis of our unaudited condensed financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate these estimates, including those related to revenue recognition and concentration of credit risk. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

We believe that of the significant accounting policies used in the preparation of our unaudited condensed financial statements (see Note 2 to the Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2012), the following are critical accounting policies, which may involve a higher degree of judgment, complexity and estimates.

 

Revenue Recognition

 

We recognize revenues associated with our software products in accordance with the provisions of the Financial Accounting Standard Board (“FASB”) Accounting Standards Codification (“ASC”) ASC Topic 985–605, Software Revenue Recognition.

 

We license 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.  We also charge an onboarding fee for implementation services when a customer chooses our cloud based service. The revenue from the onboarding fee and the associated costs are deferred and recognized over the first year of the new contract. 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.

 

To apply the percentage of completion revenue recognition method, we must have the ability to estimate contract revenue, costs, and the extent of progress toward completion. Percentage of completion revenues is generally stated in the contract and costs are generally based on estimated labor hours for each contract. Estimating progress toward completion is determined as a ratio of hours incurred to total hours of the project and revisions to those estimates are made at times as work progresses. In determining reasonableness of progress toward completion we consider various other assumptions that are reasonable under the circumstances, such as achieving certain milestones stated in the contract at a certain level of quality. Actual hours incurred and total estimated hours for a contract may differ from original estimates based on the results of the various assumptions or conditions. Contingent revenue is excluded from the percentage of completion calculations until the future contingencies have been met.

 

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 in which case 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 established in the agreement, but following any installation period of the software. In certain instances, we enter into arrangements that include multiple elements, where fees are allocated to the various elements based on vendor specific objective evidence of fair value.

 

 

Goodwill

 

The goodwill recorded on the Company’s books is from the acquisition of US Dataworks, Inc. in fiscal year 2002 which remains the Company’s single reporting unit. 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.

  

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 December 31, 2012 or the year ended March 31, 2012. At the most recent testing date of March 31, 2012, the Company had significant excess fair value over its carrying value of goodwill.

 

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

 

Concentrations of Credit Risk

 

We sell our products throughout the United States and extend credit to our customers. We also perform ongoing credit evaluations of such customers. We do not obtain collateral to secure our accounts receivable. We evaluate our accounts receivable on a regular basis for collectability and provide for an allowance for potential credit losses as deemed necessary. Historically we have not experienced significant credit losses.

 

One of our customers accounted for 67% and 58% of the total net revenues for the nine months ended December 31, 2012 and December 31, 2011, respectively.

 

At December 31, 2012, amounts due from three of our customers accounted for 44%, 29% and 12%, respectively, of accounts receivable. At December 31, 2011, amounts due from two of our customers accounted for 61% and 12%, respectively, of accounts receivable.

 

Results of Operations

 

The results of operations reflected in this discussion include our operations for the three and nine months ended December 31, 2012 and December 31, 2011.

 

Revenue

 

We generate revenues from (i) licensing and supporting software with fees due on a transactional or subscription basis, (ii) licensing software with fees due on the grant of the license and delivery of the software recognizing revenue as percentage of completion over the term of professional services associated with the license, (iii) providing maintenance, enhancement and support for previously licensed products, (iv) providing professional services and (v) reselling third party software in connection with our software.

 

		For the Three Months Ended December 31,												For the Nine Months Ended December 31,
		2012				2011				Change				2012				2011				Change
Software transactions and subscription		$	616,144			$	688,341				-10.5	%		$	1,899,838			$	2,056,567				-7.6	%
Software licensing			8,587				29,483				-70.9	%			18,161				127,953				-85.8	%
Software maintenance			164,210				213,203				-23.0	%			506,172				518,837				-2.4	%
Professional services			984,100				856,323				14.9	%			2,261,272				2,266,838				-0.2	%
Software resale			37,686				36,027				4.6	%			46,617				112,716				-58.6	%
Total revenue		$	1,810,727			$	1,823,377				-0.7	%		$	4,732,060			$	5,082,911				-6.9	%

 

Total revenue decreased by 6.9% for the nine months ended December 31, 2012 as compared to the nine months ended December 31, 2011. For the nine months ended December 31, 2012 as compared to the nine months ended December 31 2011, recurring revenue as a percentage of total revenue decreased 3.3% and non-recurring revenue as a percentage of total revenue decreased 3.6%. Total revenue decreased by 0.7% for the three months ended December 31 2012 as compared to the three months ended December 31, 2011. For the three months ended December 31, 2012 as compared to the three months ended December 31, 2011, recurring revenue as a percentage of total revenue decreased 6.7% and non-recurring revenue as a percentage of total revenue increased 6.0%. Recurring revenue consists of software transaction and subscription revenue and software maintenance revenue, while non-recurring revenue consist of software licensing revenue, professional services revenue and software resale revenue.

 

 

Software transactional and subscription revenue decreased 10.5% for the three months ended December 31, 2012 as compared to the three months ended December 31, 2011. While we have had a net gain of customers in the current year period as compared to prior year period, there were fewer transactions processed in the current year period as our newer customers are in the ramp up stage. Software transactional and subscription revenue decreased 7.6% for the nine months ended December 31, 2012 as compared to the nine months ended December 31, 2011 due to the loss of a customer for a nine month period, while our newer customers are in the ramp up stage.   

 

Software license revenue is recognized ratably over the period that related services are rendered.  Software license revenue decreased 70.9% for the three months ended December 31, 2012 as compared to the three months ended December 31, 2011, due to a nonrecurring Clearingworks product license upgrade where more work was performed in the prior year period. Software license revenue decreased 20.2% for the nine months ended December 31, 2012, as compared to the nine months ended December 31, 2011, due to a nonrecurring Clearingworks product license implementation that was completed in June 2011.

 

Software maintenance revenue decreased 23.0% for the three months ended December 31, 2012 as compared to the three months ended December 31, 2011 due to a loss of a customer and a reclass of revenue that was formerly maintenance to subscription revenue as a result of an amendment to a customer contract. Software maintenance revenue decreased 6.2% for the nine months ended December 31, 2012 as compared to the nine months ended December 31, 2011 due to a loss of a customer partially offset by the addition of a Clearingworks product at an existing customer.

 

Professional services revenue increased by 14.9% for the three months ended December 31, 2012 as compared to the three months ended December 31, 2011 due to the difference in timing of each period’s professional services engagements from a large customer. Professional services revenue decreased by 0.2% for the nine months ended December 31, 2012 as compared to the nine months ended December 31, 2011 due to the timing of professional services engagements from a large customer.

 

Software resale revenues increased 4.6% for the three months ended December 31, 2012 as compared to the three months ended December 31, 2011 related to sale of hardware that was part of a professional services engagement that occurred in the current year period. Software resale revenues decreased 58.6% for the nine months ended December 31, 2012 as compared to the nine months ended December 31, 2011 related to sale of hardware that was part of a professional services engagement that occurred in the prior year period.

 

Cost of Revenues

 

Cost of revenues includes personnel costs associated with our software, maintenance, support, training and installation services of our on premise and cloud-computing offerings.  Cost of revenues also includes the cost of other third party software resold in connection with our software. Cost of revenues for the three months ended December 31, 2012 decreased by $38,109, or 6.9%, to $510,465 as compared to $548,574 for the three months ended December 31, 2011. The decrease was due to lower data center costs and costs with our outsourced sales and marketing firm.

 

Cost of revenues for the nine months ended December 31, 2012 decreased by $119,576, or 7.2%, to $1,532,635 as compared to $1,652,211 for the nine months ended December 31, 2011. This decrease was due to a $105,000 decrease in outside services related to remote deposit capture payment project in the prior year.

 

Operating Expenses

 

Total operating expenses for the three months ended December 31, 2012 increased by $333,609, or 32.3%, to $1,370,878 as compared to $1,037,269 for the three months ended December 31, 2011. Total operating expenses for the nine months ended December 31, 2012 increased by $73,037, or 2.1%, to $3,502,586 as compared to $3,429,549 for the nine months ended December 31, 2011.

 

Research and development expenses for the three months ended December 31, 2012 increased by $23,907, or 13.9%, as compared to the three months ended December 31, 2011. Research and development expenses for the nine months ended December 31, 2012 increased by $4,764 or 0.8%, as compared to the nine months ended December 31, 2011. The increases were due to the research and development employees working on various consulting projects.

 

Sales and marketing expenses for the three months ended December 31, 2012, as compared to the three months ended December 31, 2011, decreased by $19,475, or 6.4%. The decrease is due to a decrease of $67,933 in sales and marketing outside services relating to expenses incurred from outside sales engagement during the three months ended December 31, 2011 which was terminated during the third quarter of fiscal year 2012, partially offset by an increase of $16,108 in personnel expenses incurred during the three months ended December 31, 2012 after bringing the sales and marketing functions in-house and $32,350 for trade shows. Sales and marketing expenses for the nine months ended December 31, 2012, as compared to the nine months ended December 31, 2011, decreased by $204,809, or 20.6%. The decrease is due to a decrease of $369,355 in sales and marketing outside services relating to expenses incurred from outside sales engagement during the nine months ended December 31, 2011 which was terminated during the third quarter of fiscal year 2012, partially offset by an increase of $110,127 in personnel expenses, $27,183 in commissions expense and $27,982 in other sales related expenses incurred during the nine months ended December 31, 2012 after bringing the sales and marketing functions in-house.

 

 

General and administrative expenses for the three months ended December 31, 2012 increased by $335,018, or 61.8%, as compared to the three months ended December 31, 2011. The increase is due to an increase of $279,479 in stock based compensation relating to granting of options, $35,958 of payroll expense and $13,825 in outside services and professional expense, partially offset by a decrease of $5,755 for all other expense. General and administrative expenses for the nine months ended December 31, 2012 increased by $292,667, or 16.8%, as compared to the nine months ended December 31, 2011. The increase is due to an increase of $310,131 in stock based compensation relating to granting of options partially offset by a decrease of $17,465 in all other general and administrative expense. There were 2,000,000 employee options granted during the quarter to the Chief Executive Officer of the Company that were immediately vested with an exercise price of $0.14 per share. The associated expense charged during the quarter ended December 31, 2012 was $268,295.

 

Depreciation and amortization expenses for the three months ended December 31, 2012 decreased by $5,841, or 29.8%, as compared to the three months ended December 31, 2011. Depreciation and amortization expenses for the nine months ended December 31, 2012 decreased by $19,585, or 29.2%, as compared to the nine months ended December 31, 2011. These decreases are primarily due to property and equipment items attaining a fully depreciated state during the current fiscal.

 

Other Expenses

 

Other expenses include interest expense, financing costs and unrealized gain on derivative instruments. Other expenses for the three months ended December 31, 2012 increased by $6,433, or 4.2%, to $160,249 as compared to $153,816 for the three months ended December 31, 2011. The increase is due to unrealized gain on derivative instruments of $14,458 and increased interest expense of $20,891 from the interest charges incurred on the deferred interest balance on the notes payable – related parties. Other expenses for the nine months ended December 31, 2012 increased by $59,587, or 13.3%, to $506,036 as compared to $446,479 for the nine months ended December 31, 2011. The increase is due to increased interest expense of $62,257 from the interest incurred on the deferred interest balance on the notes payable – related parties.

 

Net Loss

 

Net loss for the three months ended December 31, 2012 increased by $314,584 to a net loss of $230,865 compared to net income of $83,718 for the three months ended December 31, 2011. Net loss for the nine months ended December 31, 2012 increased by $363,869 to a net loss of $809,197 compared to a net loss of $445,328 for the three months ended December 31, 2011. For details related to these losses, see the preceding discussions related to revenues, cost of revenues, operating expenses and other income sections above.

 

Liquidity and Capital Resources

 

We have a history of experiencing negative cash flow from operations and continue to operate under liquidity constraints. Over the years, we have put a number of debt financings in place to address this ongoing situation. As of December 31, 2012, we have approximately $3.1 million of affiliate debt coming due January 1, 2014, $125,000 of debt coming due on August 1, 2013 and $125,000 of debt coming due on August 1, 2014. We also have a factoring agreement pursuant to which we borrow on certain outstanding accounts receivable from time to time. As of December 31, 2012, we had $525,737 in accrued but unpaid interest on the affiliate debt. Although we have had the right to pay the affiliate debt interest since March 2012, the affiliate debt holders have been willing to defer a portion of the affiliate debt interest in order to accommodate our liquidity constraints. The affiliate debt holders have agreed to (i) waive the defaults arising from our inability to keep current on the affiliate debt interest payments through June 30, 2013 and (ii) agreed not to take any action against us to collect this growing past due interest payment through June 30, 2013. However, there can be no assurance that we will be current on these payments or enter into a similar agreement beyond such date. With respect to the $3.1 million in principal payments due to the affiliate debt holders on January 1, 2014 and any unpaid interest thereon as of such date as well as the $125,000 of debt coming due on August 1, 2013, we will have to come to an agreement with the holders of such debt to restructure the payment terms thereof or obtain other adequate sources of debt or equity funding to retire this debt when it comes due.

 

We will need to increase revenues from transaction and subscription based software license contracts and professional services agreements and software licenses to achieve and sustain profitability.

 

We have taken a number of steps to address and improve our liquidity.  These steps include additional rent abatements in fiscal 2013 in connection with the negotiation of a renewal of our office lease and deferring interest payments on the affiliate debt, as needed.  Management believes the processes put in place will fund its operations through March 31, 2013, and for a reasonable period of time thereafter.  If our liquidity does not improve in a meaningful way, we will be forced to take additional steps to address the issue, primarily being restructuring the related party debt and raising additional equity and/or debt capital.  However, there can be no assurance that we would be successful in attempting to raise such capital.

 

 

Cash and cash equivalents at December 31, 2012 were $57,527 as compared to $81,985 at March 31, 2012.  

 

Cash used by operating activities for the nine months ended December 31, 2012 was $133,966, which consisted of a net loss of $809,197 offset by changes in working capital of $147,413 and by noncash expenses of $527,817. Cash provided by operating activities for the nine months ended December 31, 2011 was $336,300, which consisted of a net loss of $445,326 offset by changes in working capital of $561,054 and by noncash expense of $220,574.

 

Cash used by investing activities for the nine months ended December 31, 2012 and December 31, 2011 was $15,152 and $23,015, respectively, representing minimal capital expenditures during the period.

 

Cash provided by financing activities for the nine months ended December 31, 2012 was $124,660, resulting from increased borrowing, net of payments, from the secured line of credit and factoring facility of $2,135 and $125,000 in proceeds from the issuance of notes payable and detachable stock warrants. For the nine months ended December 31, 2011, cash used in financing activities was $240,136, resulting from decreased borrowings, net of payments of $365,136, from the Company’s secured line of credit and note payable to bank and $125,000 in proceeds from the issuance of notes payable and detachable stock warrants.

 

Item 3.                     Quantitative and Qualitative Disclosures about Market Risk

 

Not applicable.

 

Item 4.                     Controls and Procedures

 

Disclosure controls and procedures. We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, or the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.  In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, have concluded that, as of that date, our disclosure controls were effective at the reasonable assurance level.

 

Changes in internal control over financial reporting.  There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with management’s evaluation during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1.                Legal Proceedings  

 

From time to time, we may become involved in various legal and other proceedings that are incidental to the conduct of our business. We are currently not involved in any such legal proceedings. 

 

Item 1A.             Risk Factors

 

There have been no material changes in our risk factors disclosed in our Annual Report on Form 10-K for the year ended March 31, 2012 filed with the SEC on July 13, 2012 under “Item 1A. Risk Factors.”

 

Item 2.                Unregistered Sales of Equity Securities and Use of Proceeds

 

None

 

Item 3.                Defaults Upon Senior Securities

 

None

 

 

Item 4.               Mine Safety Disclosures

 

Not applicable.

  

Item 5.               Other Information

 

None. 

 

Item 6.               Exhibits

 

Listed below are the exhibits required by Item 601 of Regulation S-K.

 

Exhibit Number		Description of Document
31.1*		Section 302 Certification of Chief Executive Officer.
31.2*		Section 302 Certification of Chief Financial Officer.
32.1*		Section 906 Certification of Chief Executive Officer.
32.2*		Section 906 Certification of Chief Financial Officer.
101*		Interactive Data File

 

*Filed herewith

 

 

SIGNATURE

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated:  February 14, 2013

	US DATAWORKS, INC.
	By:	/s/ Charles E. Ramey
		Charles E. Ramey
		Chief Executive Officer
		(Duly Authorized Officer)

 

	By:	/s/ Randall J. Frapart
		Randall J. Frapart
		Chief Financial Officer
		(Principal Financial Officer)

 

 

EXHIBIT INDEX

 

Exhibit Number		Description of Document
31.1*		Section 302 Certification of Chief Executive Officer.
31.2*		Section 302 Certification of Chief Financial Officer.
32.1*		Section 906 Certification of Chief Executive Officer.
32.2*		Section 906 Certification of Chief Financial Officer.
101*		Interactive Data File

 

*Filed herewith