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EX-10.1 - EXHIBIT 10_2 - LML PAYMENT SYSTEMS INCexh10_2.htm
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EX-32.1 - EXHIBIT 32_1 - LML PAYMENT SYSTEMS INCexh32_1.htm
EX-31.1 - EXHIBIT 31_1 - LML PAYMENT SYSTEMS INCexh31_1.htm
EX-10.1 - EXHIBIT 10_1 - LML PAYMENT SYSTEMS INCexh10_1.htm


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


Form 10-Q


[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2011

OR

[]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from ________ to ________

Commission File Number: 000-13959

Logo
 

LML PAYMENT SYSTEMS INC.
(Exact name of registrant as specified in its charter)

Yukon Territory
 
###-##-####
(State or other jurisdiction of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
   

1680-1140 West Pender Street
Vancouver, British Columbia
Canada  V6E 4G1
(Address of principal executive offices) (Zip Code)

Registrant's Telephone Number, Including Area Code: (604) 689-4440

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 (§ 232.405) of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [  ]   No [X] (not applicable to registrant)

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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large Accelerated Filed
[  ]
Accelerated Filer
[  ]
Non-Accelerated Filer
[   ]
 
Smaller Reporting Company
[X]
       
(Do not check if a 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]

The number of shares of the registrant's Common Stock outstanding as of August 3, 2011 was 28,233,434.





 
 

 

LML PAYMENT SYSTEMS INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2011

INDEX


   
Page Number
     
PART I.
 FINANCIAL INFORMATION
 
     
Item 1.
Consolidated Financial Statements (unaudited)
1
 
Consolidated Statements of Financial Position (unaudited) at June 30, 2011, March 31, 2011 and April 1, 2010
1
 
Consolidated Statements of Earnings and Comprehensive Income (unaudited) for the Three Months Ended June 30, 2011 and 2010
2
 
Consolidated Statements of Shareholders' Equity (unaudited) at June 30, 2011 and 2010
3
 
Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended June 30, 2011 and 2010
4
 
Notes to Consolidated Financial Statements (unaudited)
5
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
35
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
48
     
Item 4.
Controls and Procedures
48
     
PART II.
 OTHER INFORMATION
49
     
Item 1.
Legal Proceedings
49
     
Item 1A.
Risk Factors
50
     
Item 6.
Exhibits
50
     
 
SIGNATURE PAGE
51
     


In this Quarterly Report on Form 10-Q, unless otherwise indicated, all dollar amounts are expressed in United States Dollars.


 
 

 

  PART I.
FINANCIAL INFORMATION
  ITEM 1.  
CONSOLIDATED FINANCIAL STATEMENTS

LML PAYMENT SYSTEMS INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(In U.S. Dollars, except as noted below)
(Unaudited)

   
As at June 30,
   
As at March 31,
   
As at April 1,
 
   
2011
   
2011
   
2010
 
ASSETS
 
               
(Note 18)
 
Current assets
                 
Cash and cash equivalents (Note 5)
  $ 22,726,293     $ 26,917,491     $ 5,069,763  
Funds held for merchants (Note 5)
    8,357,070       7,164,420       5,804,752  
Restricted cash (Note 4(b))
    175,000       175,000       175,000  
Accounts receivable, less allowance of $28,295 ($28,152; $31,463)
    1,993,388       1,103,529       799,584  
Corporate taxes receivable
    160,866       101,162       1,072,930  
Prepaid expenses
    244,987       266,066       416,507  
Total current assets
    33,657,604       35,727,668       13,338,536  
                         
Property and equipment, net  (Notes 6 and 9)
    151,304       163,222       219,580  
Patents (Note 7)
    246,022       287,877       455,304  
Restricted cash (Note 4(b))
    263,504       262,644       255,247  
Deferred tax assets (Note 13)
    899,233       1,189,747       3,687,333  
Goodwill
    17,874,202       17,874,202       17,874,202  
Other intangible assets (Note 8)
    4,091,400       4,215,187       4,710,337  
Other assets
    21,086       21,041       20,641  
                         
Total assets
  $ 57,204,355     $ 59,741,588     $ 40,561,180  
                         
LIABILITIES
                       
Current liabilities
                       
Accounts payable
  $ 706,372     $ 702,820     $ 836,274  
Accrued liabilities
    1,250,509       1,390,847       1,040,443  
Corporate taxes payable
    459,237       4,796,157       -  
Funds due to merchants (Note 5)
    8,357,070       7,164,420       5,804,752  
Current portion of obligations under finance lease (Note 9)
    2,460       2,460       11,195  
Current portion of deferred revenue
    1,423,410       1,420,228       1,325,983  
Total current liabilities
    12,199,058       15,476,932       9,018,647  
                         
Obligations under finance lease (Note 9)
    7,380       7,380       9,840  
                         
Deferred revenue
    627,875       935,979       2,155,162  
                         
Total liabilities
    12,834,313       16,420,291       11,183,649  
                         
COMMITMENTS AND CONTINGENCIES (Note 14)
                       
                         
SHAREHOLDERS’ EQUITY
                       
                         
Capital stock (Note 10)
                       
Class A, preferred stock, $1.00 CDN par value, 150,000,000 shares authorized, issuable in series, none issued or outstanding
    -       -       -  
Class B, preferred stock, $1.00 CDN par value, 150,000,000 shares authorized, issuable in series, none issued or outstanding
    -       -       -  
Common shares, no par value, 100,000,000 shares authorized, 28,233,434 issued and outstanding (28,127,184 ; 27,241,408)
    53,883,659       53,557,276       50,152,385  
                         
Contributed surplus (Note 10)
    8,834,435       8,819,006       7,987,727  
Warrants (Note 10)
    113,662       113,662       649,500  
Deficit
    (18,870,631 )     (19,563,201 )     (29,562,166 )
Accumulated other comprehensive income
    408,917       394,554       150,085  
Total shareholders’ equity
    44,370,042       43,321,297       29,377,531  
                         
Total liabilities and shareholders’ equity
  $ 57,204,355     $ 59,741,588     $ 40,561,180  


Approved by the Board and authorized for issuance on August 10, 2011
 

/s/ Patrick  H. Gaines
 
/s/ Greg A. MacRae
Board of Directors
 
Board of Directors
 
 

See accompanying notes to the unaudited consolidated financial statements.


 
 
-1-

 

LML PAYMENT SYSTEMS INC.

CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME
(In U.S. Dollars, except share data)
(Unaudited)


   
Three Months Ended
 
   
June 30
 
   
2011
   
2010
 
         
(Note 18)
 
             
REVENUE
  $ 5,976,324     $ 5,130,919  
COST OF REVENUE
    3,321,826       2,605,782  
GROSS PROFIT
    2,654,498       2,525,137  
                 
OPERATING EXPENSES
               
General and administrative
    889,146       1,057,917  
Sales and marketing
    210,223       108,336  
Product development and enhancement
    247,195       127,048  
Amortization of intangible assets (Notes 7 and 8)
    165,645       165,645  
INCOME BEFORE OTHER INCOME AND INCOME TAXES
    1,142,289       1,066,191  
                 
Foreign exchange gain
    31,650       67,902  
Interest income
    17,177       6,119  
 INCOME BEFORE INCOME TAXES
    1,191,116       1,140,212  
                 
 Income tax expense (recovery) (Note 13)
               
Current
    208,032       (341,218 )
Deferred
    290,514       940,325  
      498,546       599,107  
                 
NET INCOME
    692,570       541,105  
                 
OTHER COMPREHENSIVE INCOME
               
Unrealized foreign exchange gain (loss) on translation of foreign operations
    14,363       (91,936 )
                 
TOTAL COMPREHENSIVE INCOME
  $ 706,933     $ 449,169  
                 
EARNINGS PER SHARE, basic and diluted
  $ 0.02     $ 0.02  
                 
WEIGHTED AVERAGE SHARES OUTSTANDING
               
Basic
    28,149,725       27,251,984  
Diluted
    28,987,253       27,496,401  


















See accompanying notes to the unaudited consolidated financial statements.


 
 
-2-

 

LML PAYMENT SYSTEMS INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In U.S. Dollars)
(Unaudited)


                           
Accumulated
             
                           
Other
             
   
Common
         
Contributed
         
Comprehensive
             
   
Shares
   
Amount
   
Surplus
   
Warrants
   
Income (Loss)
   
Deficit
   
Total
 
Balance as at April 1, 2010
    27,241,408     $ 50,152,385     $ 7,987,727     $ 649,500     $ 150,085     $ ( 29,562,166 )   $ 29,377,531  
                                                         
Net income
    -       -       -             -       541,105       541,105  
Change in cumulative translation adjustment
    -       -       -             (91,936 )     -       (91,936 )
Previous capital consolidation adjustment (Note 10(e))
    10,576       -       -             -       -       -  
Reallocation of contributed surplus on exercise of options
    -       19,948       (19,948 )           -       -       -  
Share-based payments (Note 10(c))
    -       -       130,515             -       -       130,515  
Balance as at June 30, 2010
    27,251,984     $ 50,172,333     $ 8,098,294     $ 649,500     $ 58,149     $ (29,021,061 )   $ 29,957,215  
                                                         
                                   
Accumulated
                 
                                   
Other
                 
   
Common
           
Contributed
           
Comprehensive
                 
   
Shares
   
Amount
   
Surplus
   
Warrants
   
Income (Loss)
   
Deficit
   
Total
 
Balance as at April 1, 2011
    28,127,184     $ 53,557,276     $ 8,819,006     $ 113,662     $ 394,554     $ (19,563,201 )   $ 43,321,297  
                                                         
Net income
                                  692,570       692,570  
Change in cumulative translation adjustment
                            14,363       -       14,363  
Exercise of stock options
    106,250       205,375                         -       205,375  
Reallocation of contributed surplus on exercise of options
          121,008       (121,008 )                 -       -  
Share-based payments (Note 10(c))
                136,437                   -       136,437  
Balance as at June 30, 2011
    28,233,434     $ 53,883,659     $ 8,834,435     $ 113,662     $ 408,917     $ (18,870,631 )   $ 44,370,042  
                                                         
































See accompanying notes to the unaudited consolidated financial statements.


 
 
-3-

 


LML PAYMENT SYSTEMS INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS
(In U.S. Dollars)
(Unaudited)


   
Three Months Ended
 
   
June 30
 
   
2011
   
2010
 
         
(Note 18)
 
Operating Activities:
           
Net income
  $ 692,570     $ 541,105  
Adjustments to reconcile net income to net cash (used in) provided by operating activities
               
Amortization of property and equipment
    34,240       37,529  
Amortization of intangible assets
    165,645       165,645  
Share-based payments
    136,437       130,514  
Deferred income taxes
    290,514       940,325  
Foreign exchange gain
    (3,703 )     -  
                 
Changes in non-cash operating working capital
               
Accounts receivable
    (884,868 )     (56,055 )
Corporate taxes receivable
    (59,169 )     (344,293 )
Prepaid expenses
    21,507       12,065  
Accounts payable and accrued liabilities
    (138,024 )     232,863  
Corporate taxes payable
    (4,336,920 )     -  
Deferred revenue
    (305,947 )     (266,943 )
Net cash (used in) provided by operating activities
    (4,387,718 )     1,392,755  
                 
Investing Activities:
               
Acquisition of property and equipment
    (21,242 )     (3,420 )
Net cash used in investing activities
    (21,242 )     (3,420 )
                 
Financing Activities:
               
Principal payments on finance leases
    -       (4,318 )
Proceeds from exercise of stock options
    205,375       -  
Net cash provided by (used in) financing activities
    205,375       (4,318 )
                 
Effects of foreign exchange rate changes on cash and cash equivalents
    12,387       (64,386 )
                 
(DECREASE) INCREASE  IN CASH AND CASH EQUIVALENTS
    (4,191,198 )     1,320,631  
                 
Cash and cash equivalents, beginning of period
    26,917,491       5,069,763  
                 
Cash and cash equivalents, end of period
  $ 22,726,293     $ 6,390,394  
                 
Supplemental disclosure of cash flow information
               
Interest paid
  $ -     $ -  
Taxes paid
  $ 4,599,921     $ -  













See accompanying notes to the unaudited consolidated financial statements.


 
 
-4-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
1.
NATURE OF OPERATIONS

LML Payment Systems Inc. (a Yukon Territory corporation) and its subsidiaries (the "Corporation"), see Note 2, is a financial payment processor providing electronic payment, risk management, and authentication services primarily to businesses and organizations who use the Internet to receive or send payments.  Its corporate office address is 1140 West Pender Street, Suite 1680, Vancouver, British Columbia, Canada.  The Corporation links merchants selling products or services to customers wanting to buy them and financial institutions who allow the transfer of payments to occur.  The Corporation has partnership arrangements and certified connections to financial institutions, payment processors and other payment service providers in order to enable its customers to safely and reliably conduct e-Commerce.  The Corporation provides its electronic payment, authentication and risk management services to over 10,000 businesses and organizations in Canada and the United States of America (“U.S.”).  The Corporation also provides check processing solutions including primary and secondary check collection including electronic check re-presentment (RCK) to retailers in the U.S.

The Corporation also provides licenses to its intellectual property. The Corporation’s intellectual property estate, owned by subsidiary LML Patent Corp., includes U.S. Patent No. 6,354,491, No. 6,283,366, No. 6,164,528, No. 5,484,988, and No. RE40,220, all of which describe electronic check processing methods.

The Corporation is incorporated under the Yukon Business Corporations Act and qualifies as a foreign private issuer in the U.S. for purposes of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Although as a foreign private issuer the Corporation is no longer required to do so, the Corporation currently voluntarily continues to file on domestic forms, including annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, with the Securities and Exchange Commission (“SEC”) instead of filing the reporting forms available to foreign private issuers.


 
2.
BASIS OF PRESENTATION

The Accounting Standards Board of the Canadian Institute of Chartered Accountants (“CICA”) announced that Canadian generally accepted accounting principles (“GAAP”) for publicly accountable enterprises have been replaced with International Financial Reporting Standards (“IFRS”), as published by the International Accounting Standards Board (“IASB”), for fiscal years beginning on or after January 1, 2011.

The unaudited interim consolidated financial statements, including comparatives, are the Corporation’s first financial statements under IFRS and have been prepared in accordance with IAS 34 “Interim Financial Reporting” and IFRS 1 “First Time Adoption of International Financial Reporting Standards”.  The Corporation’s first annual consolidated financial statements under IFRS will be presented for the year ending March 31, 2012.  The accounting policies adopted in these interim financial statements are consistent with the accounting policies the Corporation expects to adopt in its first annual consolidated financial statements under IFRS for the year ending March 31, 2012, and are based on IFRS as issued by the IASB that the Corporation expects to be applicable at that time.

The Corporation’s date of transition to IFRS and its opening statement of financial position are as at April 1, 2010.

These interim consolidated financial statements do not include all disclosures required by IFRS for annual consolidated financial statements and accordingly, should be read in conjunction with the Corporation’s audited consolidated financial statements for the year ended March 31, 2011 presented under Canadian GAAP and in conjunction with the IFRS transition disclosures in Note 18 to these interim consolidated financial statements.

The consolidated financial statements are presented in United States Dollars, except when otherwise indicated.

The results for the three months ended June 30, 2011 may not be indicative of the results that may be expected for the full year or any other period.


 
 
-5-

 


LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

 
2.
BASIS OF PRESENTATION (Continued)


These consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries as set out below. All significant inter-company balances and transactions have been eliminated on consolidation.

CANADA
 
UNITED STATES
Legacy Promotions Inc.
 
LHTW Properties Inc.
Beanstream Internet Commerce Inc. (“Beanstream”)
 
LML Corp.
0858669 B.C. Ltd.
 
LML Patent Corp.
   
LML Payment Systems Corp.
   
Beanstream Internet Commerce Corp.
     


 
3.
SIGNIFICANT ACCOUNTING POLICIES

 
(a)
Use of Estimates and Measurement Uncertainty

The preparation of financial statements in conformity with IFRS requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant areas requiring the use of management estimates relate to, among others, the allowance for doubtful accounts, determination of impairment of assets, determination of share-based payments, useful lives for depreciation and amortization and recoverability of deferred income taxes.  Actual results could differ from those estimates.

 
(b)
Cash and Cash Equivalents
 
Cash and cash equivalents include cash on hand and all highly liquid debt instruments purchased with a maturity of three months or less at the date of purchase.

 
(c)
Accounts Receivable
 
Accounts receivable are stated net of allowances for uncollectible accounts.  Management develops the estimate of the allowance based on the Corporation’s experience with specific customers, its understanding of their current economic circumstances and its own judgment as to the likelihood of their ultimate payment.  Management also considers the Corporation’s collection experience with the balance of its receivables portfolio and makes estimates regarding collectability based on trends in aging.

 
(d)
Property and Equipment
 
Property and equipment are recorded at cost less accumulated depreciation. The straight-line method is used to depreciate assets over their estimated useful lives as follows:

Computer equipment
3 – 5 years
Computer software
3 – 5 years
Furniture and fixtures
3 years
Leasehold improvements
Lesser of the term of the lease or the useful life of the leasehold improvement
Office equipment
5 years
Website & trademarks
5 years


 
 
-6-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

 
3.
SIGNIFICANT ACCOUNTING POLICIES (Continued)


 
(e)
Leases
 
Leases are classified as either finance or operating leases.  A lease that transfers substantially all of the risks and rewards incidental to the ownership of property is classified as a finance lease.  All other leases are accounted for as operating leases wherein rental payments are expensed on a straight-line basis.  At the inception of a finance lease, an asset and an obligation are recorded at an amount equal to the lesser of the present value of the future minimum lease payments and the property’s fair value at the beginning of such lease.  Amortization of the equipment under a finance lease is on the same basis as similar property and equipment.
 
 
(f)
Research and Development Costs

The Corporation incurs costs to research and develop its proprietary software products to be sold, licensed or otherwise marketed.  Costs incurred in the research phase are expensed as incurred.  Costs incurred in the development phase are expensed as incurred unless a project meets the criteria for deferral and amortization, in which case the development costs are deferred and amortized over the estimated useful life of the software product developed.  Amortization commences when development of the software is complete and the product is available for sale to customers.  During the interim period ended June 30, 2011 and the fiscal years ended March 31, 2011 and 2010, the Corporation did not defer any development costs.
 
 
(g)
Patents
 
Patent costs are amortized using the straight-line method over the estimated useful life of 15 years.

 
(h)
Goodwill
 
Goodwill represents the future economic benefits arising from a business combination that are not individually identified and separately recognized. Goodwill is stated after separate recognition of identifiable intangible assets. It is calculated as the excess of the sum of a) fair value of consideration transferred, b) the recognized amount of any non-controlling interest in the acquiree and c) acquisition-date fair value of any existing equity interest in the acquiree, over the acquisition-date fair values of identifiable net assets. If the fair values of identifiable net assets exceed the sum calculated above, the excess amount (i.e. gain on a bargain purchase) is recognized in profit or loss immediately. Goodwill is carried at cost less accumulated impairment losses. Refer to note 3(j) for a description of impairment testing procedures.
 
 
 
(i)
Other Intangible Assets
 
Other intangible assets relate to the acquisition of partner relationships, merchant contracts, existing technology and trade names.  The partner relationships and merchant contracts are amortized over ten years on a straight-line basis.  The existing technology is amortized over five years on a straight-line basis.  Trade names are considered indefinite-life intangible assets and as such are not amortized. Trade names are tested for impairment at least annually or more frequently if an event or circumstance occurs that more likely than not reduces the fair value of the asset below its carrying amount.

 
 
(j)
Impairment testing of goodwill, other intangible assets and property, plant and equipment

For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are largely independent cash inflows (cash-generating units). As a result, some assets are tested individually for impairment and some are tested together with other assets. Goodwill is allocated to those cash-generating units that are expected to benefit from synergies of the related business combination and represent the lowest level within the Corporation at which management monitors goodwill.

Cash-generating units to which goodwill has been allocated are tested for impairment at least annually. All other individual assets or cash-generating units are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

 
 
 
-7-

 


 
LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


 
3.
SIGNIFICANT ACCOUNTING POLICIES (continued)

An impairment loss is recognized for the amount by which the asset's or cash-generating unit's carrying amount exceeds its recoverable amount, which is the higher of fair value less costs to sell and value-in-use. To determine the value-in-use, management estimates expected future cash flows from each cash-generating unit and determines a suitable interest rate in order to calculate the present value of those cash flows. The data used for impairment testing procedures are directly linked to the Corporation's latest approved budget, adjusted as necessary to exclude the effects of future reorganizations and asset enhancements. Discount factors are determined individually for each cash-generating unit and reflect their respective risk profiles as assessed by management.

Impairment losses for cash-generating units reduce first the carrying amount of any goodwill allocated to that cash-generating unit. Any remaining impairment loss is charged pro rata to the other assets in the cash-generating unit. With the exception of goodwill, all assets are subsequently reassessed for indications that an impairment loss previously recognized may no longer exist. An impairment charge is reversed if the cash-generating unit’s recoverable amount exceeds its carrying amount.

 
(k)
Revenue Recognition
 
The Corporation’s revenue is derived from three separate lines of business:  (i) transaction payment processing; (ii) intellectual property licensing and (iii) check processing.
 
Revenue from the Corporation’s transaction payment processing (“TPP”) segment is derived from transaction fees, monthly gateway fees and one-time set-up fees paid by merchants.  Transaction fees are recognized in the period in which the transaction occurs.  Gateway fees are monthly subscription fees charged to the merchant customers for the use of its payment gateway and are recognized in the period in which the service is provided.  Set-up fees represent one-time charges for initiating the processing services.  Although these fees are generally paid at the commencement of the agreement, they are recognized ratably over the estimated average life of the merchant relationship, which is determined through a series of analyses of active and deactivated merchants.
 
Our Intellectual Property Licensing (“IPL”) segment revenues are derived from licensing fees paid to us by licensees of our intellectual property.  In some instances, licensees pay licensing fees on a running royalty basis and in other instances, particularly those instances that involve enforcement or litigation efforts on our behalf, licensees typically pay royalties on a fully paid-up non-recurring basis. Within the IPL segment, revenue arrangements typically include the following elements:
 
·  
Licenses – licenses are issued for the use of existing patents;
·  
Release from litigation – the Corporation releases the licensees from any claims or causes of action for patent infringement as of the effective date of the underlying agreement;
·  
Covenant-not-to-sue provision – the Corporation agrees to a covenant-not-to-sue provision for infringement of any patents for a specified period commencing on the effective date of the underlying agreement.

As the above elements are fully delivered as of the effective date of each underlying agreement, revenue related to these elements is recognized at that time, assuming (i) the amount of revenue can be measured reliably, (ii) it is probable that the economic benefits associated with the transaction will flow to the entity, (iii) the stage of completion of the transaction at the end of the reporting period can be measured reliably and (iv) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.
 


 
 
-8-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


 
3.
SIGNIFICANT ACCOUNTING POLICIES (continued)

On rare occasions, the Corporation will enter into intellectual property licensing and settlement agreements comprising multiple elements that are not fully delivered on the effective date of the respective agreement.  In these instances, the significant factors, inputs, assumptions and methods used to determine the estimated selling price of each element present in the arrangement include:
 
·  
Royalty rates from existing licenses;
 
·  
Actual usage, including transaction volumes, by the existing licensees; and
 
·  
Expected usage by the customer.
 
Total arrangement consideration is then allocated to each of the deliverables using the relative selling price method and revenue is recognized separately for each element as the applicable criteria in IAS 18 are met.
 
Revenue from the Corporation’s check processing (“CP”) segment consists primarily of transaction charges from primary and secondary check collection business, including electronic check re-presentment. Fees associated with the primary and secondary check collection business, including electronic check re-presentment, are contingent on successful recovery and, accordingly, revenue is recognized as cash is received.
 
 
(l)
Income Taxes
 
Tax expense recognized in profit or loss comprises the sum of deferred tax and current tax not recognized in other comprehensive income or directly in equity.
 
Current income tax assets and/or liabilities comprise those obligations to, or claims from, fiscal authorities relating to the current or prior reporting periods, that are unpaid at the reporting date. Current tax is payable on taxable profit, which differs from profit or loss in the financial statements. Calculation of current tax is based on tax rates and tax laws that have been enacted or substantively enacted by the end of the reporting period.

Deferred income taxes are calculated using the liability method on temporary differences between the carrying amounts of assets and liabilities and their tax bases. However, deferred tax is not provided on the initial recognition of goodwill or on the initial recognition of an asset or liability unless the related transaction is a business combination or affects tax or accounting profit. Deferred tax on temporary differences associated with investments in subsidiaries and joint ventures is not provided if reversal of these temporary differences can be controlled by the Corporation and it is probable that reversal will not occur in the foreseeable future.
 
Deferred tax assets and liabilities are calculated, without discounting, at tax rates that are expected to apply to their respective period of realization, provided they are enacted or substantively enacted by the end of the reporting period. Deferred tax liabilities are always provided for in full.
 
Deferred tax assets are recognized to the extent that it is probable that they will be able to be utilized against future taxable income.
 
Deferred tax assets and liabilities are offset only when the Corporation has a right and intention to set off current tax assets and liabilities from the same taxation authority.
 
Changes in deferred tax assets or liabilities are recognized as a component of tax income or expense in profit or loss, except where they relate to items that are recognized in other comprehensive income or directly in equity, in which case the related deferred tax is also recognized in other comprehensive income or equity, respectively.


 
 
-9-

 


LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


 
3.
SIGNIFICANT ACCOUNTING POLICIES (continued)

 
 
(m)
Earnings Per Common Share
 
Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period.

Diluted earnings per share is computed similar to basic earnings per share, except that the weighted average shares outstanding are increased to include additional shares for the assumed exercise of stock options and warrants at the beginning of the reporting period, if dilutive.  The number of additional shares is calculated assuming that outstanding stock options and warrants were exercised and the proceeds from such exercises were used to repurchase common shares at the average market price during the reporting period.  Stock options and warrants are dilutive when the market price of the common shares for the average of the period exceeds the exercise price of the options and warrants and the Corporation has generated positive income from operations during the period.

 
(n)
Share-Based Payment Plans
 
The Corporation has three share-based payment plans, described more fully in Note 10(c). The Corporation recognizes compensation expense for stock options awarded based on the fair value of the options at the grant date using the Black-Scholes option pricing method.  The Corporation recognizes share-based payments expense over the requisite service period during which an employee is required to provide service in exchange for the equity instrument award, which generally is the vesting period with the offsetting credit to contributed surplus.  Upon the exercise of an equity instrument award, any amounts originally credited to contributed surplus are credited to capital stock.  The impact of forfeitures that may occur prior to vesting is also estimated and considered in the amount of expense recognized.  Forfeiture estimates are revised, if necessary, in subsequent periods when actual forfeitures differ from those estimates.

Any consideration paid on the exercise of equity awards or purchase of equity is credited to share capital.
 
 
(o)
Foreign currency translation
 
Except as described below, the Corporation’s functional and reporting currency is the U.S. dollar.  Monetary assets and liabilities denominated in foreign currencies are translated using the exchange rate prevailing at the balance sheet date and non-monetary assets and liabilities are translated at exchange rates prevailing at the historical transaction date.  Average rates for the period are used to translate the Corporation’s revenue and expenses. Gains and losses arising on settlement of foreign currency denominated transactions or balances are included in the determination of income.

The functional currency of the Corporation’s Canadian Beanstream subsidiary is the Canadian dollar.    Beanstream’s assets and liabilities are translated into U.S. dollars at rates of exchange in effect at the balance sheet date.  Average rates for the period are used to translate Beanstream’s revenues and expenses.  Gains and losses arising on the translation of Beanstream’s financial statements are reported as a cumulative translation adjustment which is a component of accumulated other comprehensive income.

 
(p)
Financial Instruments
 
All financial instruments are classified into one of five categories: fair value through profit and loss, held-to-maturity investments, loans and receivables, available-for-sale financial assets or other financial liabilities. All financial instruments are measured in the balance sheet at fair value except for loans and receivables, held-to-maturity investments and other financial liabilities which are measured at amortized cost using the effective interest method. Subsequent measurement and changes in fair value will depend on their initial classification, as follows: fair value through profit and loss financial instruments is measured at fair value and changes in fair value are recognized in net income. Available-for-sale financial instruments are measured at fair value with changes in fair value recorded in other comprehensive income until the instrument is derecognized or impaired.


 
 
-10-

 


 
LML PAYMENT SYSTEMS INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

4.
FINANCIAL INSTRUMENTS

 
(a)
The Corporation classifies its cash and cash equivalents, funds held for merchants, restricted cash and accounts receivable as loans and receivables measured at amortized cost using the effective interest rate method. Accounts payable, certain accrued liabilities and funds due to merchants are classified as other financial liabilities measured at amortized cost using the effective interest rate method.

The carrying value of the Corporation’s financial assets and liabilities is considered to be a reasonable approximation of fair value due to their immediate or short term maturity or their ability for liquidation at comparable amounts.

Carrying value and fair value of financial assets and liabilities as at June 30, 3011, March 31, 2011 and April 1, 2010 are summarized as follows:

   
June 30, 2011
 
March 31, 2011
 
April 1, 2010
 
   
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
                         
Loans and receivables
 
$ 33,515,255
 
$ 33,515,255
 
$ 35,623,084
 
$ 35,623,084
 
$ 12,104,346
 
$12,104,346
Other financial liabilities
 
10,313,951
 
10,313,951
 
9,258,087
 
9,258,087
 
7,681,469
 
7,681,469


 
(b)
Restricted cash

Under the terms of the processing agreement with one of the Corporation’s processing banks, the Corporation pledged a deposit of $175,000 (March 31, 2011 and April 1, 2010 - $175,000) against charge back losses.  Non-current restricted cash represents funds held by a third party processor as security for the Corporation’s merchant accounts.

 
(c)
Market Risk

Currency Risk

The Corporation’s functional currency is the U.S. dollar except for the Corporation’s Canadian Beanstream subsidiary whose functional currency is the Canadian dollar.  Movements in the foreign currency exchange rate between the Canadian and U.S. dollar will give rise to gains and losses to the Corporation due to the existence of cash balances and other monetary assets and liabilities denominated in a currency other than the functional currency of each entity within the consolidated group. Significant losses may occur due to significant balances of cash and cash equivalents and short-term investments held in Canadian dollars (U.S. dollars for Beanstream) that may be affected negatively by an increase in the value of the U.S. dollar as compared to the Canadian dollar (Canadian dollar as compared to the U.S. dollar for Beanstream). The Corporation has not hedged its exposure to foreign currency fluctuations.

As at June 30, 2011, March 31, 2011 and April 1, 2010, the Corporation is exposed to currency risk through its cash and cash equivalents, restricted cash, funds held for merchants, accounts receivable, accounts payable, accrued liabilities, and funds due to merchants denominated in Canadian dollars (U.S. dollars for Beanstream).

Based on the foreign currency exposure as at June 30, 2011, March 31, 2011 and April 1, 2010 and assuming all other variables remain constant, a 10% depreciation or appreciation of the Canadian dollar against the U.S. dollar would result in an increase/decrease of $281,335, $453,920 and $243,571 respectively, in the Corporation’s foreign currency loss/gain.


 
 
-11-

 


 
LML PAYMENT SYSTEMS INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

 
4.
FINANCIAL INSTRUMENTS (continued)

As at June 30, 2011, March 31, 2011 and April 1, 2010, the Corporation’s Canadian Beanstream subsidiary was exposed to currency risk on the translation of its financial instruments to U.S. dollars.  Beanstream’s financial instruments are translated into U.S. dollars at rates of exchange in effect at the balance sheet date.   Gains and losses arising on the translation of Beanstream’s financial instruments are reported as a cumulative translation adjustment which is a component of accumulated other comprehensive income. Based on the foreign currency exposure as at June 30, 2011, March 31, 2011 and April 1, 2010 and assuming all other variables remain constant, a 10% depreciation or appreciation of the Canadian dollar against the U.S. dollar would result in an increase/decrease of $38,946, $6,461 and $18,922, respectively, in the Corporation’s other comprehensive income.

Interest Rate Risk

Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Corporation’s exposure to interest rate risk is limited as its cash and payment processing accounts earn minimal interest.

Other Price Risk

Other price risk is the risk that the future value or cash flows of a financial instrument will fluctuate because of changes in market prices. Exposure to price risk is low as the Corporation’s cash management policy is to invest excess cash in high grade/low risk investments over short periods of time.
 
 
(d)
Credit Risk

Credit risk is the risk of a financial loss if a customer or counter party to a financial instrument fails to meet its contractual obligations. Any credit risk exposure on cash balances is considered negligible as the Corporation places funds or deposits only with major established banks in the countries in which it has payment processing services. The credit risk arises primarily from the Corporation’s trade receivables from customers.

On a regular basis, the Corporation reviews the collectability of its trade accounts receivable and establishes an allowance for doubtful accounts based on its best estimates of any potentially uncollectible accounts. As at June 30, 2011, the balance of the Corporation’s allowance for doubtful accounts was $28,295 (March 31, 2011 - $28,152; April 1, 2010 - $31,463).  The Corporation has good credit history with its customers and the amounts due from them are received as expected.

Pursuant to their respective terms, gross accounts receivable are aged as follows at June 30, 2011:

0-30 days
$1,650,408
31-60 days
1,758
61-90 days
219,251
Over 90 days due
150,266
 
$2,021,683

 
Concentration of credit risk

Financial instruments that potentially subject the Corporation and its subsidiaries to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable.

Cash and cash equivalents are invested in major financial institutions in the U.S. and Canada. Such deposits may be in excess of insured limits and are not insured in other jurisdictions. Management believes that the financial institutions that hold the Corporation’s investments are financially sound and, accordingly, relatively minimal credit risk exists with respect to these investments.


 
 
-12-

 


LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 
 
4.
FINANCIAL INSTRUMENTS (continued)


The accounts receivable of the Corporation and its subsidiaries are derived from sales to customers located primarily in the U.S. and Canada. The Corporation performs ongoing credit evaluations of its customers. The Corporation generally does not require collateral.

An allowance for doubtful accounts is determined with respect to those amounts that the Corporation has determined to be doubtful of collection.  At June 30, 2011, three customers accounted for 26%, 12% and 11% of the Corporation’s accounts receivable balance (March 31, 2011 – 19%, 10% and 13%; April 1, 2010 – 25%, 19% and 2%).

 
(e)
Liquidity Risk

Liquidity risk is the risk that the Corporation will not be able to meet its financial obligations as they become due. The Corporation continuously monitors actual and forecasted cash flows to ensure, as far as possible, there is sufficient working capital to satisfy its operating requirements.

 
   
June 30, 2011
 
   
Total
   
Less than 1 year
   
1-3 years
   
4-5 years
   
After 5 years
 
Contractual Obligations, at June 30, 2011
                             
Accounts payable and accrued liabilities
  $ 1,956,881     $ 1,956,881     $ -     $ -     $ -  
Funds due to merchants
    8,357,070       8,357,070       -       -       -  
Capital lease obligations
    9,840       2,460       4,920       2,460       -  
Total
  $ 10,323,791     $ 10,316,411     $ 4,920     $ 2,460     $ -  
                                         

   
March 31, 2011
 
   
Total
   
Less than 1 year
   
1-3 years
   
4-5 years
   
After 5 years
 
Contractual Obligations, at March 31, 2011
                             
Accounts payable and accrued liabilities
  $ 2,093,667     $ 2,093,667     $ -     $ -     $ -  
Funds due to merchants
    7,164,420       7,164,420       -       -       -  
Capital lease obligations
    9,840       2,460       4,920       2,460       -  
Total
  $ 9,267,927     $ 9,260,547     $ 4,920     $ 2,460     $ -  
                                         

   
April 1, 2010
 
   
Total
   
Less than 1 year
   
1-3 years
   
4-5 years
   
After 5 years
 
Contractual Obligations, at April 1, 2010
                             
Accounts payable and accrued liabilities
  $ 1,876,717     $ 1,876,717     $ -     $ -     $ -  
Funds due to merchants
    5,804,752       5,804,752       -       -       -  
Capital lease obligations
    21,035       11,195       4,920       4,920       -  
Total
  $ 7,702,504     $ 7,692,664     $ 4,920     $ 4,920     $ -  
                                         



 
 
-13-

 


LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


5.
CASH AND CASH EQUIVALENTS AND FUNDS HELD FOR/DUE TO MERCHANTS

Cash and cash equivalents

At June 30, 2011, the Corporation held $22,726,293 (March 31, 2011 - $26,917,491; April 1, 2010: $5,069,763) in cash and cash equivalents.  Included in this balance is $1 million in cash and cash equivalents used as continuing collateral security with the Corporation’s primary financial institution which is available for use by the Corporation.

Funds held for/due to merchants

At June 30, 2011, the Corporation was holding funds due to merchants in the amount of $8,357,070 (March 31, 2011 - $7,164,420; April 1, 2010 – $5,804,752).    The funds held for/due to merchants are comprised of the following:

·  
funds held in reserves calculated by applying contractually determined percentages of the gross transaction volume for a hold-back period of up to six months;
·  
funds from transaction payment processing which may be held for up to approximately fifteen days, the actual number of days depends on the contractual terms with each merchant; and
·  
funds from payroll/pre-authorized debit services provided on behalf of merchants, which may be held for up to approximately two days.

 

6.
PROPERTY AND EQUIPMENT
 
   
June 30, 2011
 
                   
   
Cost
   
Accumulated Amortization and Depreciation
   
Net Book Value
 
                   
Computer equipment
  $ 139,102     $ 87,197     $ 51,905  
Computer software
    148,580       87,365       61,215  
Furniture and fixtures
    5,623       4,180       1,443  
Leasehold  improvements
    2,969       2,376       593  
Office equipment
    142,593       106,445       36,148  
Total cost
  $ 438,867     $ 287,563     $ 151,304  



   
March 31, 2011
 
                   
   
Cost
   
Accumulated Amortization and Depreciation
   
Net Book Value
 
                   
Computer equipment
  $ 130,472     $ 74,432     $ 56,040  
Computer software
    136,334       76,132       60,202  
Furniture and fixtures
    4,560       3,420       1,140  
Leasehold  improvements
    2,954       2,186       768  
Office equipment
    143,395       98,323       45,072  
Total cost
  $ 417,715     $ 254,493     $ 163,222  



 
 
-14-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


 
6.
PROPERTY AND EQUIPMENT (continued)


   
April 1, 2010
 
                   
   
Cost
   
Accumulated Amortization and Depreciation
   
Net Book Value
 
                   
Computer equipment
  $ 156,662     $ 95,075     $ 61,587  
Computer software
    207,004       117,829       89,175  
Furniture and fixtures
    4,560       2,509       2,051  
Leasehold  improvements
    2,820       1,551       1,269  
Office equipment
    155,072       89,689       65,383  
Website & trademarks
    1,932       1,817       115  
Total cost
  $ 528,050     $ 308,470     $ 219,580  

Depreciation expense on property and equipment totaled $34,240 and $37,529 for the three months ended June 30, 2011 and June 30, 2010, respectively.  Property and equipment includes $12,300, $12,300 and $29,770 of assets that are financed under finance leases as at June 30, 2011, March 31, 2011 and April 1, 2010, respectively.  Accumulated amortization on these assets totals $3,075, $2,460 and $1,849 as at June 30, 2011, March 31, 2011 and April 1, 2010, respectively.  Amortization of assets under finance lease is included in depreciation expense and totaled $615 for the three months ended June 30, 2011 and June 30, 2010, respectively.

 
 
7.
PATENTS

   
June 30, 2011
   
March 31, 2011
   
April 1, 2010
 
                   
Cost
  $ 2,045,715     $ 2,045,715     $ 2,045,715  
Less: accumulated amortization
    (1,799,693 )     (1,757,838 )     (1,590,411 )
Net book value
  $ 246,022     $ 287,877     $ 455,304  

Amortization expense totaled $41,855 for the three months ended June 30, 2011 and June 30, 2010, respectively.

Estimated aggregate amortization expense for each of the five succeeding fiscal years is as follows:

Years ending March 31
   
     
2012
 
$124,095
2013
 
$121,927
2014
 
$            -
2015
 
$            -
2016
 
$            -



 
 
-15-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 

8.
OTHER INTANGIBLE ASSETS

The components of other intangible assets are as follows:

   
June 30, 2011
 
   
Gross
   
Accumulated Amortization
   
Net
 
Amortizable intangible assets:
                 
Partner relationships
  $ 928,000     $ 371,200     $ 556,800  
Merchant contracts
    2,963,500       1,185,400       1,778,100  
Existing technology
    530,000       424,000       106,000  
Unamortized intangible assets:
                       
Trade names
    1,650,500       -       1,650,500  
    $ 6,072,000     $ 1,980,600     $ 4,091,400  


   
March 31, 2011
 
   
Gross
   
Accumulated Amortization
   
Net
 
Amortizable intangible assets:
                 
Partner relationships
  $ 928,000     $ 348,000     $ 580,000  
Merchant contracts
    2,963,500       1,111,313       1,852,187  
Existing technology
    530,000       397,500       132,500  
Unamortized intangible assets:
                       
Trade names
    1,650,500       -       1,650,500  
    $ 6,072,000     $ 1,856,813     $ 4,215,187  


   
April 1, 2010
 
   
Gross
   
Accumulated Amortization
   
Net
 
Amortizable intangible assets:
                 
Partner relationships
  $ 928,000     $ 255,200     $ 672,800  
Merchant contracts
    2,963,500       814,963       2,148,537  
Existing technology
    530,000       291,500       238,500  
Unamortized intangible assets:
                       
Trade names
    1,650,500       -       1,650,500  
    $ 6,072,000     $ 1,361,663     $ 4,710,337  


Amortization expense for other intangible assets totaled $123,790 for the three months ended June 30, 2011 and June 30, 2010 respectively.


9.
OBLIGATIONS UNDER FINANCE LEASE

In March 2010, the Corporation entered into a lease agreement with Ikon Financial Services to finance an equipment purchase of $11,269. Lease payments are due monthly under the lease term of sixty (60) months. Title to the equipment will transfer to the Corporation at the expiration of the lease. Accordingly, these amounts have been recorded as a finance lease.


 
 
-16-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


9.
OBLIGATIONS UNDER FINANCE LEASE (continued)


In September 2009, the Corporation entered into a lease agreement with Dell Financial Services Canada to finance an equipment purchase of $17,470.  Lease payments were due monthly under the lease term of twelve (12) months. Title to the equipment transferred to the Corporation at the expiration of the lease. Accordingly, these amounts have been recorded as a finance lease.

Future minimum payments due
 
June 30, 2011
   
March 31, 2011
   
April 1, 2010
 
                   
2011
  $ -     $ -     $ 12,226  
2012
    2,460       2,460       2,460  
2013
    2,460       2,460       2,460  
2014
    2,460       2,460       2,460  
2015
    2,460       2,460       2,460  
Less amount representing interest
    -       -       (1,031 )
Net principal balance
    9,840       9,840       21,035  
                         
Less current portion
    (2,460 )     (2,460 )     (11,195 )
    $ 7,380     $ 7,380     $ 9,840  

The lease is collateralized by the equipment under finance lease.


10.
SHARE CAPITAL

 
(a)
Shares issued and outstanding
 
 
Shares issued and outstanding
 
Number of Shares
   
Amount
 
             
Balance, April 1, 2010
    27,241,408     $ 50,152,385  
                 
Previous capital consolidation adjustment (Note 10(e))
    10,576       -  
Exercise of stock options (Note 10(c))
    545,200       1,126,648  
Exercise of warrants (Note 10(d))
    330,000       1,122,000  
Reallocation of contributed surplus on exercise of options
    -       620,405  
Reallocation of contributed surplus on exercise of warrants (Note 10(d))
    -       535,838  
                 
Balance, March 31, 2011
    28,127,184     $ 53,557,276  
                 
Exercise of stock options (Note 10(c))
    106,250       205,375  
Reallocation of contributed surplus on exercise of options
    -       121,008  
                 
Balance, June 30, 2011
    28,233,434     $ 53,883,659  





 
 
-17-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

10.
SHARE CAPITAL (continued)

 
(b)
Weighted average common shares outstanding

Dilutive securities included in the determination of the weighted average number of common shares outstanding for the purposes of computing diluted earnings per common share included 3,196,550 (June 30, 2010 – 375,000) shares issuable pursuant to outstanding stock option awards and resulted in an additional 837,528 (June 30, 2010 - 244,418) common shares being included in the computation of diluted earnings per share.

 
(c)
Stock Options

The Corporation maintains three stock option plans; the 1996 Stock Option Plan (the “1996 Plan”), the 1998 Stock Incentive Plan (the “1998 Plan”) and the 2009 Stock Incentive Plan (the “2009 Plan”).  The 10-year term of the 1998 Plan expired on July 28, 2008 and, accordingly, the 4,825,217 shares that had remained available for grant pursuant to additional stock options or other equity awards may no longer be granted under that plan (although, outstanding awards under the 1998 Plan are not affected by the expiration of the term and will continue to be governed by the provisions of the plan). At March 31, 2011, 362,000 common shares were reserved for issuance pursuant to the 1996 Plan and 5,262,500 common shares were reserved for issuance pursuant to the 2009 Plan.  These amounts reflect the limit of shares collectively that may be issued pursuant to stock options and/or other equity awards that are granted pursuant to the 1996 Plan and the 2009 Plan, respectively, less the number of shares subject to stock options and/or other equity awards that have been granted and are still outstanding and the number of shares subject to stock options and/or other equity awards that have been granted and exercised.

All director, officer and employee stock options or equity awards are granted under either the 1996 Plan or the 2009 Plan.  The exercise price of stock options granted under the 1996 Plan and the 2009 Plan is equivalent to the closing price of the Corporation’s shares as quoted on the NADSAQ Stock Market on the date the stock option is granted. Stock options granted to independent directors vest one year from the date of grant and are exercisable for a period of five years in accordance with the compensation plan adopted for the Corporation’s independent directors during the fiscal year ended March 31, 2005.  Stock options granted to executive officers have varying vesting schedules, which range from immediate vesting of all of the stock options granted to vesting over a five-year period, and are exercisable for periods ranging from five to ten years.  Stock options granted to employees normally vest over a three-year period and are exercisable for a period of five years from the date of grant.  Generally, stock options granted to employees are forfeited 30 days after leaving the employment of the Corporation.

Stock option activity for the periods ended June 30, 2011, March 31, 2011 and April 1, 2010:

   
June 30, 2011
   
March 31, 2011
   
April 1, 2010
 
   
Total # of Shares
   
Weighted average exercise price
   
Total # of Shares
   
Weighted average exercise price
   
Total # of Shares
   
Weighted average exercise price
 
Stock options outstanding, beginning of period
    4,487,300     $ 2.59       3,640,000     $ 3.11       3,640,000     $ 3.11  
Granted
    -       -       1,745,000       1.62       -       -  
Expired
    (100,000 )     3.43       (275,000 )     4.31       -       -  
Forfeited
    (93,750 )     1.62       (77,500 )     2.80       -       -  
Exercised
    (106,250 )     1.93       (545,200 )     2.07       -       -  
Stock options outstanding, end of period
    4,187,300       2.61       4,487,300       2.59       3,640,000       3.11  

 
 
 
-18-

 

 
LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

10.
SHARE CAPITAL (continued)


There were no stock options granted during the three months ended June 30, 2011.  The stock options granted during the fiscal year ended March 31, 2011 have a grant date fair value of $1.04 per stock option.

The fair value for each stock option granted was estimated at the date of grant using a Black-Scholes Option Pricing Model with the following assumptions:

 
June 30, 2011
 
March 31, 2011
 
April 1, 2010
           
Risk-free interest rate
-
 
2.79%
 
-
Expected volatility
-
 
88.09%
 
-
Expected life of stock option (in years)
-
 
4
 
-
Expected forfeiture rate
-
 
0%
 
-
Dividend yield
-
 
-
 
-

The total fair value of share-based payments is amortized over the vesting of issued stock options and resulted in share-based payments of $136,437 for the three months ended June 30, 2011 and $130,514 for the three months ended June 30, 2010.

The following table summarizes information about the stock options outstanding:

     
Options outstanding
   
Options exercisable
 
Range ($)
   
Total # of Shares
   
Weighted average exercise price
   
Weighted average contract life remaining (years)
   
Total # of Shares
   
Weighted average exercise price
   
Weighted average contract life remaining (years)
 
                                       
  0.65       229,800     $ 0.65       3.13       136,050     $ 0.65       3.13  
  1.62       1,370,500       1.62       4.14       376,750       1.62       4.14  
  2.95       32,500       2.95       0.27       32,500       2.95       0.27  
  3.00-3.90       2,554,500       3.31       4.70       2,314,500       3.34       4.49  
          4,187,300       2.61       4.40       2,859,800       2.98       4.33  


 
(d)
Warrants

In March 2008, the Corporation completed a private placement of common stock. The private placement consisted of 4,000,000 common shares at a purchase price of $1.80 per common share, from which the Corporation realized $7,200,000. The Corporation paid a financial advisor a 6.5% fee in cash as well as warrants to acquire 400,000 shares of the Corporation’s common stock. The warrants are exercisable at $3.40 per share for a period of five years from March 26, 2008.

The fair value of the private placement warrants was calculated as $1.62 per share, based on the Black-Scholes Option Pricing Model with the following assumptions:

·  
Risk-free interest rate of 3.825%;
·  
Expected volatility of 57.5%;
·  
Expected life of the warrants of 4 years; and
·  
No dividend yields.


 
 
-19-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

10.
SHARE CAPITAL (continued)


The total fair value of the warrants was $649,500.  During the fiscal year ended March 31, 2011, 330,000 warrants were exercised resulting in the issuance of 330,000 shares of the Corporation’s common stock. The fair value of $535,838 attributable to these exercised warrants was allocated to common share value. As of June 30, 2011, 70,000 warrants remain outstanding with a value of $113,662.

 
(e)
Capital adjustment

Due to fractional rounding resulting from ongoing exchanges processed for previous capital consolidations of the shares in the capital of the Corporation and its corporate predecessors, the recorded total of issued and outstanding shares in the capital of the Corporation (“Common Shares”) as of dates in April and May 2003 was 10,576 Common Shares less than should have been recorded on the share register of the Corporation at that time.

As a result, during the quarter ended June 30, 2010, the Corporation’s board of directors ratified the issuance of the following numbers of Common Shares on the following dates in respect of shareholders in the following predecessor corporations of the Corporation who had not, by that time, exchanged their shares in such predecessor corporations for Common Shares:

Predecessor Corporation
 
Date of Issuance
 
Number of
Common Shares
         
Solid Gold Capital Corp.
 
May 13, 2003
 
79
Ruskin Developments Ltd.
 
May 13, 2003
 
208
Leisureways Marketing Ltd.
 
May 13, 2003
 
225
Santa Sarita Mining Company Limited
 
April 7, 2003
 
10,064


11.
EMPLOYEE BENEFIT PLAN

The Corporation has a defined contribution 401(k) plan (the "Plan") for eligible employees. The Plan requires that the Corporation match 50% of eligible employees’ contributions, up to 6% of their compensation. The Corporation recorded matching contribution expenses for the three months ended June 30, 2011 and 2010 of $1,126 and $1,344, respectively.


12.
RELATED PARTY TRANSACTIONS

Compensation of key management personnel for the three month periods ended June 30, 2011 and 2010 are as follows:

   
Three month period ended
 
   
June 30, 2011
   
June 30, 2010
 
             
Short-term employee benefits
  $ 157,105     $ 147,928  
Share-based payments
    70,695       55,773  
Total
  $ 227,800     $ 203,701  

The amounts disclosed in the table are the amounts recognized as an expense during the reporting period related to key management personnel.

 
 
-20-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

13.
INCOME TAXES

At June 30, 2011, the Corporation has Canadian non-capital loss carry-forwards for income tax purposes of approximately $547,108 and U.S. federal net operating loss carry-forwards of $1,960,002.  Due to Canadian and U.S. tax "change of ownership" rules, the loss carry-forwards are restricted in their use.   These losses expire as follows:

Canadian non-capital loss-carry-forwards:
 
U.S. federal net operating loss carry-forwards:
             
2031
 
$547,108
 
2017 to 2032
 
$1,960,002

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Corporation’s deferred tax assets as of June 30, 2011, March 31, 2011 and April 1, 2010 are as follows:


   
June 30, 2011
   
March 31, 2011
   
April 1, 2010
 
Deferred tax assets:
                 
Excess of tax value over the net book value for capital assets
  $ 658,158     $ 663,663     $ 708,083  
Canadian non-capital loss carry-forwards
    142,248       335,821       858,167  
U.S. federal net operating loss carry-forwards
    8,116       -       2,028,665  
U.S. alternative minimum tax carry-forwards
    -       92,419       92,418  
Other
    90,711       97,844       -  
Total deferred tax assets
  $ 899,233     $ 1,189,747     $ 3,687,333  

A portion of potential income tax benefits related to deferred tax assets have not been recognized in the consolidated financial statements as their realization is not probable due to the Corporation’s history of losses. These unrecognized deferred tax assets are as follows:

   
June 30, 2011
   
March 31, 2011
   
April 1, 2010
 
Unrecognized deferred tax assets:
                 
U.S. federal net operating loss carry-forwards
  $ 717,084     $ 717,050     $ 811,965  

The Corporation’s Canadian Beanstream entity suffered a loss in the prior year and has no deferred tax liabilities, therefore IAS 12 requires disclosure of the supporting evidence for the realization of the entity’s deferred tax assets. The entity’s loss in the prior year was the result of implementing a tax planning strategy to shift income from that entity to LML Payment Systems Inc. (the “Parent Corporation”) to utilize the Parent Corporation’s Canadian loss carryforwards. The Canadian Beanstream entity would otherwise have been profitable in the prior year and is expected to be profitable in future years.

The reconciliation of income tax attributable to operations computed at the statutory tax rates to income tax expense (recovery), using an approximate 26% statutory tax rate at June 30, 2011 and an approximate 29% statutory tax rate at June 30, 2010, is as follows:

   
June 30, 2011
   
June 30, 2010
 
             
Income taxes at statutory rates
  $ 301,661     $ 275,547  
Share-based payments and other permanent differences
    83,321       361,128  
Effect of U.S. tax rates
    118,014       -  
Effect of foreign exchange translation of foreign currency denominated deferred income tax assets
    2,369       2,372  
Effect of change in tax rates and other
    (6,819 )     (39,940 )
    $ 498,546     $ 599,107  



 
 
-21-

 


LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

13.
INCOME TAXES (continued)

During the Corporation’s assessment of the realizability of its deferred tax assets, the Corporation considered all available positive and negative evidence including its past operating results, the existence of cumulative losses and its forecast of future taxable income. In determining future taxable income, the Corporation is responsible for assumptions utilized including the amount of pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates it uses to manage the underlying businesses.


14.
COMMITMENTS AND CONTINGENCIES

 
(a)
On November 19, 2008, a subsidiary of the Corporation filed a patent infringement lawsuit in the U.S. district court for the Eastern District of Texas against multiple financial institutions operating in the United States (the “2008 Litigation”).  In the suit, the subsidiary of the Corporation alleges that the defendants infringe U.S. Patent No. RE40,220 (the “40,220 Patent”) and is seeking damages and injunctive and other relief for the alleged infringement of this patent.

During the three months ended June 30, 2011 the subsidiary of the Corporation entered into a Settlement and License Agreement (the “Settlement Agreement”) with The Northern Trust Company and Northern Trust Corporation (collectively, “Northern Trust”).  The Settlement Agreement provided Northern Trust with a fully paid-up license to certain of the subsidiary of the Corporation’s patents for electronic check conversion transactions including “ARC”, “WEB”, “POP”, “TEL” and “BOC”.  In connection with the Settlement Agreement, the subsidiary of the Corporation received compensation totaling $1,250,000 for releases, licenses, covenants and all other rights granted under the Settlement Agreement and, pursuant to the Settlement Agreement, the lawsuit against Northern Trust was dismissed.  Pursuant to a retention agreement with its legal firm, the subsidiary of the Corporation paid approximately $610,400 in legal fees for the firm’s services in connection with the Settlement Agreement.

The Settlement Agreement contained a number of elements for which revenue has been recognized in these consolidated financial statements, which does not differ materially from the application required under the FASB issued authoritative guidance on revenue arrangements with multiple deliverables.  Total consideration received under the Settlement Agreement has been allocated to each of the following deliverables using the relative selling price method:

·  
Licenses – the Corporation has issued a license for the use of existing patents. This revenue has been recognized in the respective period.
·  
Release from litigation – the Corporation has agreed to release Northern Trust from any claims or causes of action for patent infringement as of the effective date of the Settlement Agreement.  This revenue has been recognized in the respective period.
·  
Covenant-not-to-sue provision – the Corporation has agreed to a covenant-not-to-sue provision for infringement of any existing patents as of the effective date of the Settlement Agreement. This revenue has been recognized in the respective period.


 
 
-22-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

14.
COMMITMENTS AND CONTINGENCIES (continued)

Given the number and size of the defendants in the 2008 Litigation, during the three months ended December 31, 2010, the subsidiary of the Corporation filed a motion to separate the defendants in the 2008 Litigation into groups for the purpose of holding separate trials so that each trial can be conducted in a feasible and judicious manner.  In January 2011, the Court in the 2008 Litigation issued a trial order that: (i) defendants Citibank, HSBC Bank USA N.A. and PayPal be grouped together for a trial to begin on March 8, 2011 (the “Phase I trial”); (ii) defendants JPMorgan, Wells Fargo and Wachovia be grouped together for a trial to begin on October 4, 2011 (the “Phase II trial”) and (iii) defendants Capital One, Northern Trust and Deutsche Bank be grouped together for another  trial also to begin on October 4, 2011 (the “Phase III trial”).  In addition, to enable the Court and the parties to the Phase I trial to better focus on the issues pertinent to the Phase I trial, the Court also ordered that pre-trial proceedings be stayed until further notice as to all defendants in the Phase II and Phase III trials. As a result of the settlements reached with each of HSBC North American Holdings Inc., Citigroup Inc. and PayPal Inc., during the fourth quarter of fiscal 2011, the Phase I trial was rendered moot and did not take place.  As a result of the settlement reached with Northern Trust during the first quarter of fiscal 2012, Northern Trust is no longer a defendant in the Phase III trial.  On May 23, 2011, the temporary stay order with respect to the Phase II and Phase III trials was lifted and they remain set to commence on October 4, 2011.

 
(b)
On May 13, 2010, four of the defendants in the 2008 Litigation submitted a request for inter-partes reexamination to the United States Patent and Trademark Office (“USPTO”) regarding the 40,220 Patent.  Generally, an inter-partes reexamination is a USPTO administrative proceeding requested by a third party (the “Third Party Requester”) to challenge the validity of patents that have already issued.  On July 29, 2010, the USPTO posted a non-final office action on its public Patent Application Information Retrieval (“PAIR”) website ordering an inter-partes reexamination proceeding with respect to the 40,220 Patent pursuant to which 16 of the 40,220 Patent’s 100 claims became subject to reexamination and were rejected.  All 16 of the patent claims that were rejected and are now subject to re-examination are claims that LML Patent Corp. has asserted and is seeking to enforce in the 2008 Litigation.  During the three months ended December 31, 2010, LML Patent Corp. filed a response to this non-final office action with the USPTO, following which the Third Party Requester filed a response to LML Patent Corp.’s response with the USPTO.  The Examiner issued a non-final “Action Closing Prosecution” on March 14, 2011 pursuant to which 16 of the 40,220 Patent’s 100 claims continue to be subject to reexamination.  Subsequent to the fiscal year ended March 31, 2011, on April 14, 2011, LML Patent Corp. filed a response to the non-final Action Closing Prosecution. On May 16, 2011, the Third Party Requester filed comments in response to LML Patent Corp.’s response to the non-final Action Closing Prosecution.  LML Patent Corp. anticipates a “Right of Appeal Notice,” which is a final but appealable office action, will be issued by the USPTO with respect to the 16 rejected claims.  LML Patent Corp. also anticipates that it may appeal the decision to the Patent Office Board of Appeals and Interferences (“Board”) and then to the Court of Appeals for the Federal Circuit ("Federal Circuit") or seek other remedies such as amending certain aspects of the rejected claims.  The ultimate outcome of the reexamination proceeding (including any appeals that may be made) is indeterminable at this time (see Note 15).

 
(c)
During the three months ended June 30, 2011, LML Patent Corp. filed a separate ex-parte re-examination request with the USPTO.  As part of this request, LML Patent Corp. also requested cancelation of certain claims, amendments to certain claims and the addition of new claims.  LML Patent Corp. anticipates a response from the USPTO in due course.  The likelihood that this request will be granted in whole or in part cannot be determined at this time.

 
(d)
During the three months ended June 30, 2011, Beanstream received a document from Canada Revenue Agency (“CRA”) proposing to deny certain expenses deducted by Beanstream on its 2007 income tax return in relation to the sale of Beanstream to the Corporation in 2007 and the tax treatment of the sale with respect to the former shareholders of Beanstream.  These deductions resulted in a reduction of taxes of approximately $300,000.  The Corporation, with its tax counsel, has responded to CRA and believes it is more likely than not that the deductions are supportable, however, the ultimate outcome of this matter is indeterminable at this time.


 
 
-23-

 


LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

14.
COMMITMENTS AND CONTINGENCIES (continued)
 
 
 
(e)
The Corporation is a party to additional ordinary litigation incidental to its business, none of which is expected to have a material adverse effect on results of operations, financial position or liquidity of the Corporation.
 
 
(f)
Operating lease obligations

Future minimum lease payments for obligations under operating leases, including premises for the next five years and thereafter are as follows:

2012
  $ 302,618  
2013
    302,999  
2014
    203,329  
2015
    -  
2016 and thereafter
    -  
    $ 808,946  

The Corporation’s rent expense totaled $105,008 for the three months ended June 30, 2011 and $89,207 for the three months ended June 30, 2010.
 
 
(g)
Purchase obligations

Future minimum payments under all other contractual purchase obligations for the next five years and thereafter are as follows:

2012
  $ 69,911  
2013
    -  
2014
    -  
2015
    -  
2016 and thereafter
    -  
    $ 69,911  

15.
SUBSEQUENT EVENT

On August 8, 2011 the USPTO’s website indicated that a “Right of Appeal Notice” had been mailed with respect to the inter-parte reexamination proceeding initiated on May 13, 2010 by four of the defendants in the 2008 Litigation.  The Corporation has 30 days to commence an appeal of this final but appealable office action.  The Corporation anticipates that it will file an appeal with the Patent Office Board of Appeals and Interferences (“Board”) in due course.  The ultimate outcome of the reexamination proceeding (including any appeals that may be made) is indeterminable at this time.


16.
CAPITAL MANAGEMENT DISCLOSURES

The Corporation’s objectives when managing capital are to safeguard its ability to support its normal operating requirements on an ongoing basis, so that it can continue to provide returns for shareholders and benefits for other stakeholders, and to provide an adequate return to shareholders by pricing products and services commensurately with the level of risk.

The capital structure of the Corporation consists of obligations under a finance lease and shareholders’ equity. The Corporation manages its capital structure and makes adjustments to it in light of economic conditions. The Corporation, upon approval from its Board of Directors, will balance its overall capital structure through new share issues or by undertaking other activities as deemed appropriate under the specific circumstances.



 
 
-24-

 


LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


16.
CAPITAL MANAGEMENT DISCLOSURES (continued)


The Corporation is not subject to any externally imposed capital requirements.  The Corporation’s overall strategy with respect to capital risk management remains unchanged from the year ended March 31, 2011.


17.
INDUSTRY AND GEOGRAPHIC SEGMENTS

Based upon the way financial information is provided to the Corporation’s Chief Executive Officer for use in evaluating allocation of resources and assessing performance of the business, the Corporation reports its operations in three distinct operating segments, described as follows:

TPP operations involve financial payment processing, authentication and risk management services provided by Beanstream.  The services are accessible via the Internet and are offered in an application service provider (ASP) model.

IPL operations involve licensing an intellectual property estate, which includes five U.S. patents describing electronic check processing methods.

CP operations involve primary and secondary check collection including electronic check re-presentment (RCK).

Within these segments, performance is measured based on revenue, factoring in interest income and expenses and amortization and depreciation as well as income before income taxes from each segment. There are no transactions between segments. The Corporation does not generally allocate corporate or centralized marketing and general and administrative expenses to its business unit segments because these activities are managed separately from the business units.


 
 
-25-

 

LML PAYMENT SYSTEMS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


17.
INDUSTRY AND GEOGRAPHIC SEGMENTS (continued)
 
Financial information for each reportable segment for the three months ended June 30, 2011and 2010 is as follows:
 
Three Months Ended
 
TPP
   
IPL
   
CP
   
Reconciling
 
Consolidated
 
June 30, 2011
 
Canada
   
U.S.
   
U.S.
   
Items
 
Total
 
                             
Total revenue
  $ 3,685,852     $ 1,681,548     $ 608,924     $ -   $ 5,976,324  
Revenue: major customers
    528,359       1,250,000       374,178       -     2,152,537  
Cost of revenue
    2,219,626       683,248       392,741       10,916 1   3,306,531 5
General and administrative
    228,946       11,279       99,734       538,626 2   878,585 5
Sales and marketing
    197,619       -       4,354       3,639