UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington D.C., 20549

 

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FORM 10-Q

 

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(Mark One)

 

S	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended December 31, 2011
£	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT 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 incorporation or organization)	(I.R.S. employer identification number)

 

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 o

 

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 o

 

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	S
	(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 o   NO x

 

Number of shares of the issuer’s common stock outstanding as of February 14, 2012: 33,485,835.

 

 

 

US DATAWORKS, INC.

 

TABLE OF CONTENTS

 

FORM 10-Q

 

QUARTERLY PERIOD ENDED DECEMBER 31, 2011

 

 

				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			15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		19
Item 4.	Controls and Procedures		19
PART II - OTHER INFORMATION.				19
Item 1.	Legal Proceedings		19
Item 1A.	Risk Factors			19
Item 2.	Unregistered Sales of Equity Securitites and Use of Proceeds			19
Item 3.	Defaults Upon Senior Securities			19
Item 4.	[Removed and Reserved]			20
Item 5.	Other Information			20
Item 6.	Exhibits			21

 

 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, benefits of our relationship with an MSP, 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™, and ClearInsights™ 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

 

ASSETS		December 31, 2011				March 31, 2011
		(Unaudited)
Current assets:
Cash and cash equivalents		$	117,245			$	44,096
Accounts receivable, trade			708,425				1,019,579
Prepaid expenses and other current assets			196,834				387,548
Total current assets			1,022,504				1,451,223
Property and equipment, net			196,451				240,500
Goodwill			4,020,698				4,020,698
Other assets			52,596				70,109
Total assets		$	5,292,249			$	5,782,530
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long term debt, net of unamortized discount at December 31, 2011 and  March 31, 2011 of $4,319 and 0, respectively		$	574,466			$	663,667
Accounts payable			410,003				582,304
Accrued expenses			214,652				79,557
Accrued interest – related parties			325,963				87,299
Deferred revenue			546,068				688,340
Total current liabilities			2,071,152				2,101,167
Long term liabilities:
Notes payable			9,903				165,157
Notes payable – related parties, net of unamortized discount  at December 31, 2011 and  March 31, 2011 of  $303,296 and $409,302, respectively			2,788,949				2,682,943
Total long term liabilities			2,798,852				2,848,100
Total liabilities			4,870,004				4,949,267
Commitments and contingencies
Stockholders’ equity:
Convertible Series B preferred stock, $0.0001 par value, 700,000 shares authorized, 109,933 shares issued and outstanding, $3.75 liquidation preference, dividends of $448,519 and $417,444 in arrears as of December 31, 2011 and March 31, 2011, respectively			11				11
Common stock, $0.0001 par value, 90,000,000 shares authorized,  33,426,148 and 33,318,842 shares issued and outstanding as of December 31, 2011 and March 31, 2011, respectively			3,342				3,331
Additional paid-in-capital			66,582,787				66,548,488
Accumulated deficit			(66,163,895	)			(65,718,567	)
Total stockholders’ equity			422,245				833,263
Total liabilities and stockholders’ equity		$	5,292,249			$	5,782,530

 

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,
		2011				2010				2011				2010
Revenues:
Software transactional and subscription revenues		$	688,341			$	552,233			$	2,056,567			$	1,638,216
Software licensing revenues			29,483				106,864				127,953				106,864
Software maintenance revenues			213,203				140,662				518,837				425,849
Professional services revenues			856,323				1,294,564				2,266,838				2,994,630
Software resale revenues			36,027				52,839				112,716				52,839
Total revenues			1,823,377				2,147,162				5,082,911				5,218,398
Cost of revenues			548,574				699,333				1,652,211				1,891,856
Gross profit			1,274,803				1,447,829				3,430,700				3,326,542
Operating expenses:
Research and development			172,280				209,954				631,887				705,227
Sales and marketing			303,401				222,186				992,258				704,837
General and administrative			542,002				624,465				1,738,340				2,167,016
Depreciation and amortization			19,586				23,350				67,064				99,469
Total operating expense			1,037,269				1,079,955				3,429,549				3,676,549
Income (loss) from operations			237,534				367,874				1,151				(350,007	)
Other expense:
Interest expense			(28,378	)			(20,734	)			(71,913	)			(5,699	)
Interest expense – related party			(125,438	)			(123,616	)			(374,566	)			(368,193	)
Total other expense			(153,816	)			(144,350	)			(446,479	)			(373,892	)
Net income (loss)		$	83,718			$	223,524			$	(445,328	)		$	(723,899	)
Basic earnings (loss) per share		$	0.00			$	0.01			$	(0.01	)		$	(0.02	)
Diluted earnings (loss) per share		$	0.00			$	0.01			$	(0.01	)		$	(0.02	)
Basic weighted-average shares outstanding			33,425,606				33,267,580				33,397,300				33,188,350
Diluted weighted-average shares outstanding			33,430,151				33,282,261				33,397,300				33,188,350

 

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

 

 

US DATAWORKS, INC.

 

UNAUDITED CONDENSED STATEMENTS OF CASH FLOW

 

For the Nine Months Ended December 31,

 

		2011				2010
Cash flows from operating activities:
Net loss		$	(445,328	)		$	(723,899	)
Adjustments to reconcile net loss to net cash provided (used) by operating activities:
Depreciation and amortization of property and equipment			67,064				99,469
Amortization of note discount on notes payable			2,792				—
Amortization of note discount on notes payable – related parties			106,006				100,633
Amortization of deferred financing costs – related parties			17,513				15,545
Stock based compensation			27,199				102,082
Changes in operating assets and liabilities:
Accounts receivable			311,154				127,377
Prepaid expenses and other current assets			190,714				18,116
Accounts payable			(172,301	)			72,657
Accrued expenses			135,095				(95,591	)
Accrued interest – related party			238,664				(1	)
Deferred revenue			(142,272	)			282,106
Net cash provided (used) by operating activities			336,300				(1,506	)
Cash flows from investing activities:
Purchase of property and equipment			(23,015	)			(170,350	)
Net cash used by investing activities			(23,015	)			(170,350	)
Cash flows from financing activities:
Payments on notes payable to bank			(808,562	)			(1,262,278	)
Proceeds from line of credit			445,902				1,029,819
Proceeds from issuance of notes payable and detachable stock warrants			125,000				—
Payment on equipment loan payable			(2,476	)			—
Net cash used by financing activities			(240,136	)			(232,459	)
Net increase (decrease) in cash and cash equivalents			73,149				(404,315	)
Cash and cash equivalents, beginning of period			44,096				444,542
Cash and cash equivalents, end of period		$	117,245			$	40,227
Supplemental disclosures of cash flow information:
Interest paid		$	44,036			$	373,891
Income taxes paid			—				—

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, 2011.  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, 2012.

 

Revenue Recognition

 

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

 

The Company licenses its software on a 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 a percentage of completion basis.

 

In certain instances, we license our software products under non-exclusive, non-transferable license agreements that involve services essential to the functionality of the software.  License revenue is recognized when services have been provided on the percentage of completion basis. For license agreements that include a separately identifiable fee for contracted maintenance services, such maintenance revenues are recognized on a straight-line basis over the life of the maintenance agreement, 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 No. 350, Intangibles – Goodwill and Other Intangibles, requires goodwill for each reporting unit of an entity be tested for impairment by comparing the fair value of each reporting unit with its carrying value. Fair value is determined using a combination of the discounted cash flow, market multiple and market capitalization valuation approaches. Significant estimates used in the methodologies include estimates of future cash flows, future short-term and long-term growth rates, weighted average cost of capital and estimates of market multiples for each reportable unit. On an ongoing basis, absent any impairment indicators, the Company performs impairment tests annually during the fourth quarter.

 

FASB ASC Topic No. 350 requires goodwill to be tested annually and between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of the reportable unit below its carrying amount. The Company did not record an impairment of goodwill for either the quarter ended December 31, 2011 or the year ended March 31, 2011.

 

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

 

Stock Options

 

The Company follows the guidance cited in ASC Topic No. 718, Compensation – Stock Compensation, to account for its stock options. ASC Topic No. 718 requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, based on estimated fair values. Stock-based compensation expense recognized under ASC Topic No. 718, which consists of stock-based compensation expense related to employee and director stock options and restricted and unrestricted stock issuances, for the nine months ended December 31, 2011 and December 31, 2010 were $27,199 and $102,082, respectively.

 

ASC Topic No. 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s statement of operations. Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Compensation expense recognized for all employee stock options awards granted is recognized over their respective vesting periods unless the vesting period is graded. As stock-based compensation expense recognized in the Statement of Operations for the nine months ended December 31, 2011 and December 31, 2010 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.

 

 

Upon adoption of ASC Topic No. 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 50,000 and 56,000 employee stock options granted during the nine months ended December 31, 2011 and December 31, 2010, respectively.

 

As of December 31, 2011, there was approximately $6,058 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.

 

Income and Loss per Share

 

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

 

For the three months ended December 31, 2011, 4,545 potential common stock equivalents have been included in the computation of diluted earnings per share and 15,364,963 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. For the three months ended December 31, 2010, 14,681 potential common stock equivalents have been included in the computation of diluted earnings per share and 18,492,771 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, 2010, 18,507,452 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 three and nine months ended December 31, 2011 and December 31, 2010 are as follows:

 

		For the Three Months								For the Nine Months
		Ended December 31,								ended December 31,
		2011				2010				2011				2010
Options outstanding:
Under the Company’s stock option plan			6,299,087				6,596,832				6,303,632				6,611,513
Outside the Company’s stock option plans			580,000				580,000				580,000				580,000
Warrants outstanding:
In conjunction with private placements			4,709,301				7,539,364				4,709,301				7,539,364
For services rendered and litigation settlement			200,000				200,000				200,000				200,000
As consideration for note extensions			3,466,642				3,466,642				3,466,642				3,466,642
Convertible Series B preferred stock outstanding (a)			109,933				109,933				109,933				109,933

 

 

(a)

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

 

Estimates

 

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

 

Concentrations of Credit Risk

 

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

 

Two of the Company’s customers accounted for 58% and 9%, respectively, of the total net revenues for the nine months ended December 31, 2011. Three of the Company’s customers accounted for 64%, 10% and 9%, respectively, of the total net revenues for the nine months ended December 31, 2010.

 

 

At December 31, 2011, amounts due from three of the Company’s customers accounted for 61%, 12% and 9%, respectively, of accounts receivable. At December 31, 2010, amounts due from three of the Company’s customers accounted for 48%, 12%, and 10%, 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 $445,328 for the nine months ended December 31, 2011 and has computed the tax provision for the nine months ended December 31, 2011 in accordance with the provisions of ASC Topic No. 740, Income Taxes and ASC Topic No. 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, 2011. Consequently, the Company recorded zero income tax expense or benefit for the period ended December 31, 2011. The Company’s income tax benefit on the loss before taxes was offset by an increase in the valuation allowance. At December 31, 2011 and March 31, 2011, 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, 2011, the Company had approximately $30.8 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, 2011 and March 31, 2011, respectively.  The Company recognized no tax benefits or liabilities for uncertain positions during the nine months ended December 31, 2011.

 

Subsequent Events

 

The Company has evaluated subsequent events from the balance sheet date through the date the financials were issued, and has determined there are no events that would require disclosure herein.

 

Recently Issued Accounting Pronouncements

 

Fair Value Measurements: In August 2009, the FASB issued ASU No. 2009-05, Measuring Liabilities at Fair Value   (“ASU 2009-05”). ASU 2009-05 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value of such liability using one or more of the techniques prescribed by the update. ASU 2009-05 is effective for the first reporting period beginning after issuance. There was no change to our financial statements due to the implementation of this guidance.

 

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements   (“ASU 2010-06”). Reporting entities will have to provide information about movements of assets among Levels 1 and 2; and a reconciliation of purchases, sales, issuance, and settlements of activity valued with a Level 3 method, of the three-tier fair value hierarchy established by ASC 820. The ASU 2010-06 also clarifies the existing guidance to require fair value measurement disclosures for each class of assets and liabilities. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009 for Level 1 and 2 disclosure requirements and after December 15, 2010 for Level 3 disclosure requirements. The implementation of this guidance did not have a material effect to the financial statements.

 

Revenue Recognition: In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605)—Multiple Deliverable Revenue Arrangements   (“ASU 2009-13”). ASU 2009-13 eliminates the residual method of allocation and requires the relative selling price method when allocating deliverables of a multiple-deliverable revenue arrangement. The determination of the selling price for each deliverable requires the use of a hierarchy designed to maximize the use of available objective evidence, including VSOE, third party evidence of selling price (“TPE”), or estimated selling price (“ESP”).

 

In October 2009, the FASB also issued ASU No. 2009-14, Software (Topic 985)—Certain Revenue Arrangements That Include Software Elements   (“ASU 2009-14”). ASU 2009-14 excludes tangible products containing software and non-software components that function together to deliver the product’s essential functionality from the scope of ASC 605-985,   Software-Revenue Recognition.

 

ASU 2009-13 and ASU 2009-14 are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and must be adopted in the same period using the same transition method. If adoption is elected in a period other than the beginning of a fiscal year, the amendments in these standards must be applied retrospectively to the beginning of the fiscal year. Full retrospective application of these amendments to prior fiscal years is optional. Early adoption of these standards may be elected. The implementation of this guidance did not have a material effect to the financial statements.

 

 

In September 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This ASU is intended to simplify how entities, both public and nonpublic, test goodwill for impairment. ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles – Goodwill and Other. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal year beginning after December 15, 2011 with early adoption permitted.

 

 

3.      Property and Equipment

 

Property and equipment at December 31, 2011 and March 31, 2011 consisted of the following:

 

		December 31, 2011				March 31, 2011
Furniture and fixtures		$	102,631			$	99,535
Office and telephone equipment			199,074				198,781
Computer equipment			856,089				854,126
Computer software			1,361,259				1,343,596
Leasehold improvements			64,733				64,733
			2,583,786				2,560,771
Less: accumulated depreciation and amortization			(2,387,335	)			(2,320,271	)
Total		$	196,451			$	240,500

 

Depreciation and amortization expense for the three months ended December 31, 2011 and December 31, 2010 was $19,586 and $23,350, respectively. Depreciation and amortization expense for the nine months ended December 31, 2011 and December 31, 2010 was $67,064 and $99,469, respectively.

 

 

4.      Bank Credit Line and Long-Term Debt

 

At December 31, 2011 and March 31, 2011, the Company’s bank credit line and long-term debt consisted of the following:

 

		December 31, 2011				March 31, 2011
Bank credit line		$	403,504			$	493,699
Bank term loan			46,980				319,444
Notes payable			125,000				—
Notes payable –related parties			3,092,245				3,092,245
Notes payable –equipment			13,204				15,681
Unamortized debt discount			(307,615	)			(409,302	)
Total secured notes payable and bank debt			3,373,318				3,511,767
Less: Current portion of long-term debt			(574,466	)			(663,667	)
Long-term debt, net of current portion		$	2,798,852			$	2,848,100

 

 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 (“Term Loan”).  The Loan Agreement amended and restated a previous loan agreement with SVB in its entirety. On February 8, 2011, May 9, 2011, June 7, 2011, July 7, 2011, September 12, 2011, and November 1, 2011 the Company entered into certain amendments to the Loan Agreement.

 

The Term Loan accrues interest at the fixed annual rate of 7.00% and is payable monthly.  Principal payments on the Term Loan are being made in equal monthly installments of $13,889.  Pursuant to the July 7, 2011 amendment, the Company is required to make additional principal payments as follows: $36,667 in July 2011, $30,000 by August 1, 2011 and, beginning in August 2011, additional principal payments equal to 3% of daily collections. Although the Term Loan has a maturity date of February 1, 2013, with the payment of the additional principal payments noted above, the Term Loan is expected to be fully repaid by February 2012.

 

 

The maximum availability under the A/R Line of Credit is $1,000,000. Subject to certain commitment limits, through June 30, 2011, the Company could borrow up to eighty percent (80%) of its eligible accounts receivable.  Pursuant to the July 7, 2011 amendment, SVB increased the borrowing availability up to eighty-five percent (85%) of its eligible accounts receivables.  Also, pursuant to the July 7, 2011 amendment, the maturity date of the A/R Line of Credit was extended to June 28, 2012.  The finance charges and handling fees that applied to the A/R Line of Credit through June 30, 2011 consisted of (i) a finance charge of 1.25% above SVB’s prime rate and (ii) a collateral handling fee of either 0.10% per month or 0.25% per month depending on whether the Company’s adjusted quick ratio was above or below 1.30 (for the quarter ended June 30, 2011, the higher collateral handling fee applied). These charges apply to the full face amount of the financed receivables.  The effective rate of these charges during the quarter ended June 30, 2011 was 10.31%.  Pursuant to the July 7, 2011 amendment, (i) the finance charge applicable to the A/R Line of Credit was increased to 2.20% above SVB’s prime rate but will reduce back to 1.25% above SVB’s prime rate if the Company’s adjusted quick ratio exceeds 1.00 and (ii) the adjusted quick ratio trigger to reduce the collateral handling fee was reduced to 1.00. The effective interest rate of these changes for the quarter ended September 30, 2011 and for the quarter ended December 31, 2011 was 10.82%.

 

Through July 31, 2011, the Loan Agreement imposed one financial covenant that required the Company to meet certain minimum EBITDA requirements (where “EBITDA” is defined to include an add-back for equity-based compensation expense) for a trailing three-month period.  Beginning in August 2011, the EBITDA covenant was replaced with a minimum liquidity ratio covenant that requires the Company to maintain a liquidity ratio of at least 1.20 at all times but measured at the end of each month. Beginning in September 2011, the Loan Agreement imposed an additional covenant requiring the Company to maintain a fixed charge coverage ratio (excluding the mandatory $36,667 July 2011 principal payment, the mandatory $30,000 August 2011 principal payment and the mandatory principal payments of 3% of daily collections) of at least 1.30 at all times but tested at the end of each month based on a trailing three-month total.  The Company failed to comply with the EBITDA covenant for the three months ended June 30, 2011. On August 12, 2011 the Company received a waiver from SVB for the violation. The Company failed to comply with the EBITDA covenant for the three months ended July 31, 2011. On September 12, 2011 the Company received a conditional waiver from SVB which was subsequently met.  The Company failed to comply with the fixed charge coverage ratio covenant originally imposed for the three months ended September 30, 2011. Pursuant to the November 1, 2011 amendment the Company received a waiver from SVB for the violation and SVB agreed to move the initial compliance period for the covenant to the three months ended November 30, 2011.  At December 31, 2011, the Company was in compliance with the financial covenants. All financial covenants will be eliminated when the Term Loan is paid in full.

 

The July 7, 2011 amendment also (i) provides that no payments in respect of any subordinated debt can be made without the prior written consent of SVB until the Term Loan is paid in full, (ii) eliminates all early termination fees and (iii) imposes certain additional reporting requirements. 

 

The indebtedness owed under the Credit Facility is fully secured by a perfected first priority security interest in favor of SVB in all of the Company’s assets, including its cash, accounts receivable, inventory, equipment, intellectual property rights and contract rights.

 

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 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 is August 1, 2012.  The One-Year Notes rank junior to the SVB bank debt but senior to all other Company debt, including the affiliate debt.  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 securing the SVB bank debt. The warrants were valued at $7,111, which represents the original issue discount to the One-Year Notes. The unamortized discount on the One-Year-Notes was $4,319 at December 31, 2011.

 

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 (subject to certain conditions as discussed below) 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, 2011, we had $325,963 in accrued but unpaid interest on the Refinance Notes.

 

Pursuant to the July 7, 2011 amendment to the Loan Agreement, all payments on the Refinance Notes (including regular scheduled interest payments) are prohibited unless consented to in writing to by SVB until the Refinanced Term Loan is paid in full.

 

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 SVB and the holders of the One-Year Notes, this security interest will remain junior to SVB’s security interest under the Credit Facility as long as such facility remains in place and will be junior to the security interest of the holders of the One-Year Notes until those notes are paid in full.

 

 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, 2011, the outstanding balance on this capital lease was $13,204.

 

Payment Table

 

Future minimum payments under our loan agreements and notes payable at December 31, 2011 were as follows:

 

Fiscal Year Ended March 31,		Amount
2012		$	451,310
2013			128,301
2014			3,095,546
2015			3,301
2016			2,475
		$	3,680,933

 

5.    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, 2011 and 2010 was $289,258 and $291,971, respectively. This lease was amended on June 2, 2011 by extending the term through January 31, 2018.  The amended lease provides for total rent abatements of approximately $188,000 and a refurbishment allowance of approximately $282,000. 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, 2011 were as follows:

 

Fiscal Year Ended March 31,		Amount
2012		$	93,950
2013			281,850
2014			378,932
2015			397,722
2016			416,512
Thereafter			801,707
		$	2,370,673

 

 

6.    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, 2011, and March 31, 2011, there were accumulated, undeclared dividends in arrears of $448,519 and $417,444, respectively.

 

Stock Options

 

In August 1999, the Company implemented its 1999 Stock Option Plan (the “1999 Plan”). In August 2000, the Company’s Board of Directors approved the 2000 Stock Option Plan (the “2000 Plan”), which amends and restates the 1999 Plan.  As of June 30, 2011, 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. Such incentive stock options vest in varying increments and expire five years from the date of vesting. During the nine months ended December 31, 2011, the Company granted 50,000 stock options.

 

The following table summarizes certain information relative to stock options:

 

		2000 Stock Option Plan								Outside of Plan
		Shares				Weighted-   Average Exercise Price				Shares				Weighted- Average Exercise Price
Outstanding, March 31, 2011			6,445,132			$	0.67				580,000			$	1.02
Granted			50,000			$	0.10				—				—
Forfeited/canceled			(191,500	)		$	1.41				—				—
Outstanding, December 31, 2011			6,303,632			$	0.96				580,000			$	1.02
Exercisable, December 31, 2011			6,249,631			$	0.65				580,000			$	1.02

 

The weighted-average remaining lives of the options granted under the 2000 Stock Option Plan and outside the 2000 Stock Option Plan at December 31, 2011 were 4.31 years and 1.82 years, respectively.

 

Common Stock Grants

 

During the three months ended December 31, 2011, the Company granted 24,663 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 $17,847 related to these grants during the nine months ended December 31, 2011. These grants were made under the 2000 Plan.

 

7.     Fair Value Measurements

 

On April 1, 2008, the Company adopted “Fair Value Measurements” in accordance with ASC Topic No. 820 - 10, “Fair Value Measurements and Disclosures”. ASC Topic No. 820 - 10, among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. ASC Topic No. 820 – 10 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.  As a basis for considering such assumptions, ASC Topic No. 820 – 10 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

 

Level 1.

Observable inputs such as quoted prices in active markets for identical assets or liabilities;

 

Level 2.

Inputs, other than quoted prices included within Level 1, that are observable either directly or indirectly; and

  

Level 3.

Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

 

 

Certain nonfinancial assets and liabilities are measured at fair value on a nonrecurring basis in accordance with applicable U.S. GAAP.  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.  

 

8.    Liquidity

 

Due to the Company’s prior history of experiencing negative cash flow from operations and the debt financing that it put in place to fund this historical negative cash flow, as of December 31, 2011, the Company has approximately $3.1 million of affiliate debt coming due January 1, 2014, $125,000 of debt coming due on August 1, 2012 and another $46,980 of bank debt payable in various installments that the Company expects to fully repay by February 2012.  The Company also has an A/R Line of Credit with SVB that was renewed through June 28, 2012. In addition, under certain circumstances, the Company is required to defer interest payments on our affiliate debt.  However, this deferred interest will be payable when the conditions allowing the Company to make such payments are met.  As of December 31, 2011, the Company had $325,963 in such accrued but unpaid interest on this debt.  The Company expects the condition prohibiting it from making interest payments on the affiliate debt will be lifted within the next few weeks.  At that time the Company will resume making monthly interest payments on the affiliate debt of approximately $33,000. The Company has tentatively reached an agreement with affiliate debt holders to restructure the pay down of the deferred interest amount which will enable the Company to do so using its operating cash flow. However, if the Company does not restructure payment of the deferred interest amount, its viability as a going concern will be in jeopardy and will depend on the Company’s ability to quickly obtain debt or equity funding to make the deferred interest amount.

 

The Company plans to be able to fund its operations and build enough cash to pay off these obligations as they come due, except for the payment of the accumulating accrued but unpaid interest on the affiliate debt, as explained above. If the Company is unable to fund its operations and build enough cash to pay off these obligations, the Company will have to either come to an agreement with holders of the affiliate debt to restructure the payment terms of this debt or obtain adequate sources of debt or equity funding to retire all of this affiliate debt. If that is not the case, the Company’s viability as a going concern will be in jeopardy and will depend on its ability to obtain adequate sources of debt or equity funding to refinance this debt and to fund the continuation of its business operations and to ultimately achieve adequate profitability and cash flows to sustain its operations. In addition, 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.

 

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, 2011.

 

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 on-going 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, 2011), the following are critical accounting policies, which may involve a higher degree of judgment, complexity and estimates.

 

Revenue Recognition

 

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

 

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

 

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

 

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

 

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

 

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, 2011 or the year ended March 31, 2011. At the most recent testing date of March 31, 2011, 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

 

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

 

Two of our customers accounted for 58% and 9%, respectively, of Company’s net revenues for the nine months ended December 31, 2011. Three of our customers accounted for 64%, 10% and 9%, respectively, of the Company’s net revenues for the nine months ended December 31, 2010.

 

At December 31, 2011, amounts due from three of our customers accounted for 61%, 12% and 9%, respectively, of accounts receivable. At December 31, 2010, amounts due from three of our customers accounted for 48%, 12% and 10%, 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, 2011 and December 31, 2010.

 

 

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,
		2011				2010				Change				2011				2010				Change
Software transactional and
subscription revenues		$	688,341			$	552,233				25	%		$	2,056,567			$	1,638,216				26	%
Software licensing revenues			29,483				106,864				-72	%			127,953				106,864				20	%
Software maintenance revenues			213,203				140,662				52	%			518,837				425,849				22	%
Professional services revenues			856,323				1,294,564				-34	%			2,266,838				2,994,630				-24	%
Software resale revenues			36,027				52,839				-32	%			112,716				52,839				113	%
Total revenue		$	1,823,377			$	2,147,162				-15	%		$	5,082,911			$	5,218,398				-3	%

 

Total revenue decreased by 15% and 3% for the three and nine months ended December 31, 2011, respectively, as compared to the prior year periods. Software transactional and subscription revenue increased by 25% and 26% for the three and nine months ended December 31, 2011, respectively, as compared to the prior year periods due to increased transactions under management from a significant customer and from the addition of new customers.  

 

License revenue is recognized ratably over the period that related services are rendered. License revenue decreased by 72% for the three months ended December 31, 2011, as compared to the prior year period in relation to a Clearingworks product license upgrade being recognized as a percentage of completion of the associated professional fees. This installation was completed in May 2011. License revenue increased by 20% for the nine months ended December 31, 2011, as compared to the prior year period, due to the continuation of existing license agreements in addition to the sale of a new license agreement recognized as a percentage of completion of the associated professional fees. This installation was completed in May 2011.

 

Professional services revenue decreased by 32% and 24% for the three and nine months ended December 31, 2011, as compared to the prior year periods due to a decrease in consulting revenue from a large customer as we were between the end of one consulting engagement and the start of a follow-on consulting engagement, partially offset by the professional services earned from upgrades by two of our customers.  

 

Software resale revenues decreased 32% for the three months ended December 31, 2011, as compared to the prior period, due to a nonrecurring revenue amount billed in December 2010. The 113% increase in software resale revenues for the nine months ended December 31, 2011 as compared to the prior year period, related to sale of hardware as part of a professional services engagement.

 

Cost of Revenues

 

Cost of revenues includes personnel costs associated with our software, maintenance, support, training and installation services of our on premise and on-demand 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, 2011 decreased by $150,759, or 22%, to $548,574 as compared to $699,333 for the prior year period.  This decrease was due to a $50,803 decrease in personnel cost and a $116,702 decrease in outside consulting fees associated with management’s cost reduction actions. Cost of revenues for the nine months ended December 31, 2011 decreased by $239,645, or 13%, to $1,652,211 as compared to $1,891,856 for the prior year period. The nine month decrease was primarily due to a decrease of $152,918 in personnel costs and a decrease of $249,060 in outside consulting fees associated with management’s cost reduction actions, partially offset by an increase of $136,769 in hardware and software resale expenses.

  

  

Operating Expenses

 

Total operating expenses for the three months ended December 31, 2011 decreased by $42,686, or 4%, to $1,037,269 as compared to $1,079,955 for the prior year period. Total operating expenses for the nine months ended December 31, 2011 decreased by $247,000, or 7%, to $3,429,549 as compared to $3,676,549 for the prior year period.

 

General and administrative expenses for the three and nine months ended December 31, 2011, as compared to the prior year periods, decreased by $82,463 and $428,677, or 13% and 20%, respectively. The decrease for the three months ended December 31, 2011 was due to a $28,381 decrease in bad debt expense, a $12,249 decrease in administrative outside services, a $24,000 decrease in directors’ fees, and a $28,893 decrease in other computer office equipment. The decrease for the nine months ended December 31, 2011 was due to a $125,246 decrease in legal expenses, a $135,338 decrease in outside serves fees, a $99,259 decrease in administration salaries and benefits, and $74,884 decrease in stock based compensation.   

 

Research and development expenses for the three and nine months ended December 31, 2011 decreased by $37,674 and $73,340, or 18% and 10%, respectively, as compared to the prior year periods. The decrease for the three and nine months ended December 31, 2011 was due to the allocation of workforce to various consulting projects.

 

Sales and marketing expenses for the three and nine months ended December 31, 2011, as compared to the prior year periods, increased by $81,215 and $287,420, or 37% and 41%, respectively. The increase in sales and marketing expense of $78,144 for the three months ended December 31, 2011 was primarily due to a severance charge incurred in connection with an employee resignation. The increase for the nine months ended December 31, 2011 was due to an increase of $265,551 in expenses relating to the engagement of Full Quota in May 2011 for inside sales services, which was terminated in the third quarter of 2011.

 

Depreciation and amortization expenses for the three and nine months ended December 31, 2011 decreased by $3,764 and $32,405, or 15% and 33%, respectively, as compared to the prior year periods. These decreases are primarily due to a number of our property and equipment items attaining a fully depreciated state during the current fiscal.

 

Other Expenses

 

Other expenses, including interest expense and financing costs, for the three months ended December 31, 2011 increased by $9,466, or 7%, to $153,816 as compared to $144,350 for the prior year period. The increase for the three months ended December 31, 2011 was due to an increase of $3,750 in interest expense related to the One-Year Notes. Other expenses, including interest expense and financing costs, for the nine months ended December 31, 2011 increased by $72,586, or 19%, to $446,478 as compared to $373,892 for the prior year period. The increase for the nine months ended December 31, 2011 was primarily due a $60,000 accrual reversal for which the obligation expired and an increase in interest expense of $4,847 related to the One-Year Notes.

 

Net Income (Loss)

 

Net income for the three months ended December 31, 2011 decreased by $139,806 to $83,718 compared to $223,524 for the prior year period. Net loss for the nine months ended December 31, 2011 improved by $278,571 to $445,328 compared to $723,899 for the prior year period. 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

 

Due to our prior history of experiencing negative cash flow from operations and the debt financing that we put in place to fund this historical negative cash flow, as of December 31, 2011, we had approximately $3.1 million of affiliate debt coming due January 1, 2014, $125,000 of debt coming due on August 1, 2012 and another $46,980 of bank debt payable in various installments that the Company expects to fully repay by February 2012.  The balance of such bank debt as of February 14, 2012 is $2,465. We also have an A/R Line of Credit with SVB that was renewed through June 28, 2012. In addition, under certain circumstances, we are required to defer interest payments on our affiliate debt.  However, this deferred interest will be payable when the conditions allowing us to make such payments are met.  As of December 31, 2011, we had $325,963 in such accrued but unpaid interest on this debt.  We expect the condition prohibiting us from making interest payments on the affiliate debt will be lifted within the next few weeks.  At that time we will resume making monthly interest payments on the affiliate debt of approximately $33,000. We have tentatively reached an agreement with affiliate debt holders to restructure the pay down of the deferred interest amounts which will enable us to do so using our operating cash flow. However, if we do not restructure payment of the deferred interest amount, our viability as a going concern will be in jeopardy and will depend on our ability to quickly obtain debt or equity funding to make the deferred interest amount.

 

We plan to be able to fund our operations and build enough cash to pay off these obligations as they come due, except for the payment of the accumulating accrued but unpaid interest on the affiliate debt, as explained above. If we are unable to fund its operations and build enough cash to pay off these obligations, we will have to either come to an agreement with holders of the affiliate debt to restructure the payment terms of this debt or obtain other adequate sources of debt or equity funding to retire all of this affiliate debt. If that is not the case, our viability as a going concern will be in jeopardy and will depend on our ability to obtain adequate sources of debt or equity funding to refinance this debt and to fund the continuation of its business operations and to ultimately achieve adequate profitability and cash flows to sustain its operations. In addition, 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.

 

 

Cash and cash equivalents at December 31, 2011 increased by $73,149 to $117,245, as compared to $44,096 at March 31, 2011.  Cash provided by operating activities for the nine months ended December 31, 2011 was $336,300 as compared to cash used by operating activities of $1,506 for the nine months ended December 31, 2010.  Cash used by investing activities for the nine months ended December 31, 2011 was $23,015 as compared to $170,350 for the prior year period.  Cash used by financing activities for the nine months ended December 31, 2011 was $240,136 as compared to $232,459 for the prior year period.

 

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 was no change 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. 

 

 

Item1A.

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, 2011 filed with the SEC on July 13, 2011 under “Item 1A. Risk Factors.”

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3.

Defaults Upon Senior Securities

 

During the quarter ended December 31, 2011, the Company was in default under its Loan Agreement with SVB as a result of failing to comply with the fixed charge coverage ratio covenant for the three months ended September 30, 2011. The Company has since received a waiver from SVB for this covenant violation.

 

 

Item 4

Removed and Reserved

 

 

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
	10.1		Separation and Release Agreement dated December 29, 2011 between Mario H. Villarreal and US Dataworks, Inc. (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on December 30, 2011).
	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, 2012

	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
	10.1		Separation and Release Agreement dated December 29, 2011 between Mario H. Villarreal and US Dataworks, Inc. (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on December 30, 2011).
	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