. . . . . . . . . .
The Accompanying Notes are an Integral Part
of These Consolidated Financial Statements.
The Accompanying Notes are an Integral Part
of These Consolidated Financial Statements.
The Accompanying Notes are an Integral Part
of These Consolidated Financial Statements.
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
[1] Description of Business
Cover-All Technologies
Inc., through its wholly-owned subsidiary, Cover-All Systems, Inc. (collectively, the “Company”), licenses and maintains
its software products for the property/casualty insurance industry throughout the United States and Puerto Rico. The subsidiary
also provides professional consulting services to its customers interested in customizing their software.
[2] Basis of Presentation
The consolidated
balance sheet as of December 31, 2013 has been derived from audited financial statements, and the unaudited interim financial statements
have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).
Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted
accounting principles (“U.S. GAAP”) have been condensed or omitted pursuant to those rules and regulations, although
the Company believes that the disclosures made are adequate to make the information not misleading. It is suggested that these
consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included
in the Company’s latest shareholders’ annual report on Form 10-K filed with the SEC on March 28, 2014 for the fiscal
year ended December 31, 2013 (“Form 10-K”).
Amortization of
capitalized software development costs in the amount of $1,181,000 and $2,273,000, as previously reflected in the Consolidated
Statement of Operations for the three and six months ended June 30, 2013, respectively, have been reclassified from Cost of Revenues
– Licenses to Operating Expenses – Amortization of Capitalized Software to conform to the current period presentation.
This reclassification had no effect on the previously reported Net Income for the three and six month periods ended June 30, 2013.
The Company’s
policy is to periodically review the estimated useful lives and value of its capitalized software costs. During the quarter ended
March 31, 2014, this review indicated that the revised estimated life (5 years) for capitalized software differed from the useful
lives (3 years) that had been previously used for amortization purposes in the Company’s financial statements. This revision
in the estimated life is based upon the period over which the asset is expected to contribute directly or indirectly to the future
cash flows of the Company. As a result, the Company revised the estimated useful lives of capitalized software, effective January
1, 2014. The effect of this change in estimate was to decrease amortization expense, increase operating income, and increase net
income by $291,000 and $582,000 for the three and six month periods ended June 30, 2014, respectively.
In the opinion of
management, all adjustments (which include normal and recurring nature adjustments) necessary to present a fair statement of the
Company’s financial position as of June 30, 2014, and results of operations for the three and six month periods ended June
30, 2014 and 2013 and the cash flows for the six month periods ended June 30, 2014 and 2013, as applicable, have been made.
The results of operations
for the three and six month periods ended June 30, 2014 and 2013 are not necessarily indicative of the operating results for the
full fiscal year or any future periods.
[3] Capitalized Software
Development Costs
Costs for the conceptual
formulation and design of new software products are expensed as incurred until technological feasibility has been established.
Once technological feasibility has been established, we capitalize costs to produce the finished software products. Capitalization
ceases when the product is available for general release to customers. Costs associated with product enhancements that extend the
original product’s life or significantly improve the original product’s marketability are also capitalized once technological
feasibility has been established. Amortization is calculated on a product-by-product basis using the straight-line method over
the remaining economic life of the product. The Company incurred capitalized software development costs of approximately $0 and
$0, respectively, in the three and six months ended June 30, 2014 compared to approximately
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
$646,000 and $1,430,000,
respectively, in the same periods in 2013. Amortization of capitalized software development costs was approximately $373,000 and
$745,000, respectively, in the three and six months ended June 30, 2014 compared to approximately $1,181,000 and $2,273,000, respectively,
in the same periods in 2013.
[4] Earnings Per Share
The following is
a reconciliation of the numerators and denominators of the basic and diluted earnings per share (“EPS”) computations:
|
|
For the three months ended
June 30, 2014
|
|
|
Income
(Numerator)
|
|
Shares
(Denominator)
|
|
Per Share
Amount
|
Basic EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income Available to Common Stockholders
|
|
$
|
327,789
|
|
|
|
26,638,477
|
|
|
$
|
0.01
|
|
Effect of Dilutive Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Options and Restricted Stock
|
|
|
––
|
|
|
|
273
|
|
|
|
––
|
|
Diluted EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income Available to Common Stockholders
Plus Assumed Exercises
|
|
$
|
327,789
|
|
|
|
26,638,750
|
|
|
$
|
0.01
|
|
|
|
For the three months ended
June 30, 2013
|
|
|
Income
(Numerator)
|
|
Shares
(Denominator)
|
|
Per Share
Amount
|
Basic EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income Available to Common Stockholders
|
|
$
|
(1,148,999
|
)
|
|
|
26,081,985
|
|
|
$
|
(0.04
|
)
|
Effect of Dilutive Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Options and Restricted Stock
|
|
|
––
|
|
|
|
––
|
|
|
|
––
|
|
Diluted EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income Available to Common Stockholders
Plus Assumed Exercises
|
|
$
|
(1,148,999
|
)
|
|
|
26,081,985
|
|
|
$
|
(0.04
|
)
|
|
|
For the six months ended
June 30, 2014
|
|
|
Income
(Numerator)
|
|
Shares
(Denominator)
|
|
Per Share
Amount
|
Basic EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income Available to Common Stockholders
|
|
$
|
761,638
|
|
|
|
26,590,825
|
|
|
$
|
0.03
|
|
Effect of Dilutive Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Options and Restricted Stock
|
|
|
––
|
|
|
|
2,630
|
|
|
|
––
|
|
Diluted EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income Available to Common Stockholders
Plus Assumed Exercises
|
|
$
|
761,638
|
|
|
|
26,593,455
|
|
|
$
|
0.03
|
|
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
|
|
For the six months ended
June 30, 2013
|
|
|
Income
(Numerator)
|
|
Shares
(Denominator)
|
|
Per Share
Amount
|
Basic EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income Available to Common Stockholders
|
|
$
|
(443,673
|
)
|
|
|
26,026,092
|
|
|
$
|
(0.02
|
)
|
Effect of Dilutive Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Options and Restricted Stock
|
|
|
––
|
|
|
|
––
|
|
|
|
––
|
|
Diluted EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income Available to Common Stockholders
Plus Assumed Exercises
|
|
$
|
(443,673
|
)
|
|
|
26,026,092
|
|
|
$
|
(0.02
|
)
|
[5]
Stock-Based Compensation and Stock Purchase Plans
Stock Options
In the three and
six months ended June 30, 2014, we recognized approximately $101,770 and $172,116, respectively, of stock-based compensation expense
in our consolidated financial statements.
In June 2005, we
adopted the 2005 Stock Incentive Plan (as amended, the “2005 Plan”). Options and stock awards for the purchase of up
to 5,000,000 shares may be granted by the Board of Directors to our employees and consultants at an exercise or grant price determined
by the Board of Directors on the date of grant. Options may be granted as incentive or nonqualified stock options with a term of
not more than ten years. The 2005 Plan allows the Board of Directors to grant restricted or unrestricted stock awards or awards
denominated in stock equivalent units, securities or debentures convertible into common stock, or any combination of the foregoing,
and may be paid in common stock or other securities, in cash, or in a combination of common stock or other securities and cash.
At June 30, 2014, an aggregate of 1,593,684 shares were available for grant under the 2005 Plan.
The Company uses
the Black-Scholes-Merton option pricing model (“Black-Scholes”) to measure fair value of the share-based awards. The
Black-Scholes model requires us to make significant judgments regarding the assumptions used within the model, the most significant
of which are the expected stock price volatility, the expected life of the option award, the risk-free interest rate of return
and dividends during the expected term.
- Expected volatilities are based
on historical volatility of the Company’s stock during the preceding periods.
- The Company uses historical data
to estimate the expected life of option awards. The expected term of options granted represents the period of time that options
granted are expected to be outstanding.
- The risk-free interest rate for
periods within the contractual life of the option is based on the U.S. Treasury yields for an equivalent term at the time of grant.
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
- The Company does not anticipate issuance
of dividends during the expected term.
|
2014
|
2013
|
|
|
|
Expected volatility
|
41%-50%
|
41%-50%
|
Weighted-average volatility
|
41%
|
41%
|
Expected dividends
|
0%
|
0%
|
Expected term (in years)
|
3-5
|
3-5
|
Risk-free interest rate
|
0.46%
|
3%
|
As of June 30, 2014,
there was approximately $236,041 of total unrecognized compensation cost related to non-vested share-based compensation arrangements
previously granted by the Company. That cost is expected to be recognized over a weighted-average period of 0.5 years.
A summary of the
changes in our outstanding common stock options for all outstanding plans for the six months ended June 30, 2014 is as follows:
|
Shares
|
Exercise
Price
Per Share
|
Weighted-Average
Remaining
Contractual Life
|
Weighted-Average
Exercise Price
|
Balance, January 1, 2014
|
1,787,500
|
$ 1.00 – 1.67
|
2.2 years
|
$ 1.48
|
Exercised
|
(450,000)
|
1.04
|
—
|
1.04
|
Cancelled
|
(270,000)
|
1.55
– 1.63
|
—
|
1.62
|
Balance, June 30, 2014
|
1,067,500
|
$ 1.50 – 1.67
|
2.5 years
|
$ 1.62
|
Of the stock options
outstanding, an aggregate of 555,500 are currently exercisable.
The Black-Scholes
option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the
expected stock price volatility. Because our employee stock options have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s
opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our employee stock options.
Warrants
As of June 30, 2014,
there were 1,442,000 warrants outstanding. A summary of the changes in outstanding warrants is as follows:
|
Outstanding
and Exercisable
Warrants
|
Exercise
Price
Per Warrant
|
Weighted-Average
Remaining
Contractual Life
|
Weighted-Average
Exercise Price
|
Balance, January 1, 2014
|
1,442,000
|
$ 1.48
|
3.7
|
$ 1.48
|
Balance, June 30, 2014
|
1,442,000
|
$ 1.48
|
3.2
|
$ 1.48
|
Time-Based Restricted Stock
Units
A summary of the changes
in our time-based restricted stock units, or RSUs, for the six months ended June 30, 2014 is as follows:
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
|
|
Shares
|
|
Weighted-Average Grant
Date Fair Value Per Share
|
Balance, January 1, 2014
|
|
|
|
169,309
|
|
|
$
|
1.65
|
|
Granted
|
|
|
|
123,218
|
|
|
|
1.39
|
|
Cancelled
|
|
|
|
—
|
|
|
|
—
|
|
Vested
|
|
|
|
(91,250
|
)
|
|
|
1.65
|
|
Balance, June 30, 2014
|
|
|
|
201,277
|
|
|
$
|
1.49
|
|
We follow Financial
Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 718,
Accounting for Stock
Options and Other Stock-Based Compensation
. Among other items, ASC 718 requires companies to record compensation expense for
share-based awards issued to employees and directors in exchange for services provided. The amount of the compensation expense
is based on the estimated fair value of the awards on their grant dates and is recognized over the required service periods. Our
share-based awards include stock options and restricted stock awards. For restricted stock awards, the calculation of compensation
expense under ASC 718 is based on the intrinsic value of the grant.
[6] Income Taxes
The deferred tax
asset from tax net operating loss carryforwards of approximately $4,673,000 represents approximately $11,800,000 of net operating
loss carryforwards which are subject to expiration beginning in 2023. During the six months ended June 30, 2014, the deferred tax
asset valuation allowance was decreased for the assumed utilization of prior period net operating loss carryforwards utilized to
offset taxable income for the current period, subject to federal alternative minimum tax limitations. In assessing the realizability
of deferred tax assets, management considers, within each taxing jurisdiction, whether it is more likely than not that some portion
or all of the deferred tax assets will not be realized. The Company considers the scheduled reversal of deferred tax liabilities,
projected future taxable income, and tax planning strategies in making this assessment. Factors that may affect the Company’s
ability to achieve sufficient forecasted taxable income in future periods may include, but are not limited to, the following: increased
competition; a decline in sales or margins; a loss of market share; and a decrease in demand for professional services. Based upon
the levels of historical taxable income and projections for future taxable income over the years in which the deferred tax assets
are deductible, at June 30, 2014, management believes that it is more likely than not that the Company will realize the benefits,
net of the established valuation allowance, of these deferred tax assets in the future.
The Tax Reform Act
of 1986 enacted a complex set of rules which limits a company’s ability to utilize net operating loss carryforwards and tax
credit carryforwards in periods following an ownership change. These rules define an ownership change as a greater than 50 percent
point change in stock ownership within a defined testing period which is generally a three-year period. As a result of stock which
may be issued by us from time to time, and the conversion of outstanding warrants, or the result of other changes in ownership
of our outstanding stock, the Company may experience an ownership change and consequently our utilization of net operating loss
carryforwards could be significantly limited.
[7] Recently Issued Accounting
Standards
From time to time,
new accounting pronouncements are issued by the FASB or other standard setting bodies that are adopted by the Company as of the
specified effective date. Unless otherwise discussed, the Company believes that the impact of recently issued standards that are
not yet effective will not have a material impact on its financial position or consolidated results of operations upon adoption.
In July 2013, the
FASB issued an accounting standard update, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward,
a Similar Tax Loss, or Tax Credit Carryforward Exists.” This
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
standard requires
netting of unrecognized tax benefits against a deferred tax asset for a loss or other carryforward that would apply in settlement
of the uncertain tax positions. This standard is effective prospectively for annual and interim periods beginning December 16,
2013. The adoption of this guidance did not have a significant effect on the consolidated financial statements.
In May 2014, the
FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU is the result of a joint project by the FASB
and the International Accounting Standards Board (“IASB”) to clarify the principles for recognizing revenue and to
develop a common revenue standard for GAAP and International Financial Reporting Standards (“IFRS”) that would: remove
inconsistencies and weaknesses; provide a more robust framework for addressing revenue issues; improve comparability of revenue
recognition practices across entities, jurisdictions, industries, and capital markets; improve disclosure requirements and resulting
financial statements; and simplify the presentation of financial statements. The core principle of the new guidance is that an
entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the
consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU is effective for annual
reporting periods beginning after December 15, 2016. Early adoption is not permitted. We are currently evaluating the effect that
the updated standard will have on our consolidated financial statements and related disclosures.
We believe there
is no additional new accounting guidance adopted, but not yet effective, that is relevant to the readers of our financial statements.
However, there are numerous new proposals under development which may have a significant impact on the Company’s financial
reporting, if and when enacted.
[8] Long-Term Debt
On September 11,
2012, the Company entered into a Loan and Security Agreement (“Loan Agreement”) between and among Imperium Commercial
Finance Master Fund, LP, a Delaware limited partnership (“Imperium”), as lender, Cover-All Systems, Inc., a wholly-owned
subsidiary of the Company (the “Subsidiary”), as borrower, and the Company, as a guarantor. The Loan Agreement provides
for a three-year term loan to the Subsidiary of $2,000,000, evidenced by a Term Note in favor of Imperium, and a three-year revolving
credit line to the Subsidiary of up to $250,000, evidenced by a Revolving Credit Note in favor of Imperium (together with the Term
Note, the “Imperium Notes”). The amount available to be borrowed under the revolving credit line may not exceed 80%
of Eligible Accounts (as defined in the Loan Agreement). All amounts borrowed under the term loan and the revolving credit line
are secured by a security interest in all of the assets of the Subsidiary and guaranteed by the Company, which guarantee is secured
by a pledge by the Company of all of the outstanding shares of capital stock of the Subsidiary. As of June 30, 2014, no balance
was outstanding under the Revolving Credit Line. As of June 30, 2014 the Long-Term Debt balance consists of the following:
Principal Balance Outstanding
|
|
$
|
2,000,000
|
|
Discount
|
|
|
(262,035
|
)
|
Long-Term Debt
|
|
$
|
1,737,965
|
|
Interest on the
outstanding principal balance under the Imperium Notes accrues at a fixed rate equal to 8% per annum and is payable monthly. The
$2,000,000 principal balance and any remaining interest under the Imperium Notes will be immediately due and payable on the earliest
of (1) September 10, 2015, or (2) the date Imperium’s obligation to advance funds under the revolving credit line is terminated
following an event of default pursuant to the terms and conditions of the Loan Agreement. Payments and prepayments received by
Imperium will be applied against principal and interest as provided for in the Loan Agreement.
The Loan Agreement
contains customary representations, warranties, affirmative and negative covenants, and events of default. If an event of default
occurs and is continuing, Imperium has certain rights and remedies under the Loan Agreement. Additionally, the Loan Agreement requires
the Company to maintain minimum
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
revenues and earnings
before interest, taxes, depreciation and amortization (“EBITDA”), tested annually, commencing with the twelve months
ending September 30, 2013.
In connection with
the Loan Agreement, the Company issued to Imperium a five-year warrant (the “Stock Purchase Warrant”) to purchase 1,400,000
shares of the Company’s common stock at an exercise price of $1.48 per share. The Stock Purchase Warrant is not exercisable
until the earliest of (i) the date when Current Market Value (as defined therein) exceeds the exercise price multiplied by two,
(ii) the date of a Change of Control (as defined therein), and (iii) the third anniversary of the date of issuance of the Stock
Purchase Warrant. The Stock Purchase Warrant provides for adjustments to the exercise price and the number of shares issuable upon
exercise in certain events to protect against dilution and for cashless exercise. The Stock Purchase Warrant also required the
Company to file a registration statement with the SEC with respect to the shares issuable upon exercise of the Stock Purchase Warrant
within 45 days of the date of issuance of the Stock Purchase Warrant, and that the Company use its best efforts to obtain the effectiveness
of such registration statement within 90 days (subject to extension to 120 days) of the date of issuance of the Stock Purchase
Warrant. The Company filed the Registration Statement and it was effective in the required time frame. If the Company failed to
comply with its obligations to file the registration statement and obtain its effectiveness within the specified periods, and in
certain other events, the Company would have been required to pay Imperium, for each month such failure continued, the amount of
$22,500. The Stock Purchase Warrant also provided for piggyback registration rights. The proceeds from the $2,000,000 Imperium
Note were allocated using the relative fair value method, to both the notes payable balance and warrants issued.
The Company also
issued five-year warrants (the “Monarch Warrants”) to purchase 42,000 shares, in the aggregate, of the Company’s
common stock at an exercise price of $1.48 per share, to Monarch Capital Group, LLC (“Monarch”), which acted as the
Company’s financial adviser in connection with the loan transaction, and an officer of Monarch. The Monarch Warrants are
not exercisable until the earliest of (i) the date when the Current Exercise Price (as defined therein) exceeds the exercise price
multiplied by two, (ii) the date of a Change of Control transaction (as defined therein), and (iii) the third anniversary of the
date of issuance. The Monarch Warrants provide for adjustment to the exercise price and the number of shares issuable upon exercise
in certain events to protect against dilution and for cashless exercise. The Monarch Warrants also provided for piggyback registration
rights. On April 10, 2013, the Company amended and restated the terms of the Imperium Warrant and each of the Finder’s Warrants
to provide that the aggregate number of shares issuable on exercise of the Imperium Warrant and the Finder’s Warrants shall
not exceed 19.9% of the Company’s issued and outstanding shares of common stock at the date of original issuance (i.e., 5,171,145
shares of common stock based on 25,857,730 shares of common stock issued and outstanding at September 11, 2012) without first obtaining
the approval of the Company’s stockholders.
In connection with
the Imperium Loan Agreement financing, the Company incurred deferred financing costs of approximately $92,000, which will be amortized
over the life of the loan (or earlier if the loan becomes due or is repaid before its fixed maturity).
[9] Commitments and Contingencies
Sales and Use Tax Audit
The New York State
Department of Taxation and Finance (the “Department”) conducted an examination of the Company for state sales and use
tax for audit periods March 1, 2009 through February 28, 2013. In February 2014, the Company received a Statement of Proposed Audit
Change from the Department. The Change asserts proposed Sales and Use Tax due in the amount of approximately $191,600 together
with interest of approximately $46,400. Interest will continue to accrue on the proposed outstanding balances until the date of
payment. On March 11, 2014, the Company paid the Department an aggregate of approximately $238,000 in satisfaction in full of all
amounts owed in connection with such examination.
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
Item 2:
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
.
Certain of the
matters discussed in this report, including, without limitation, matters discussed under this Item 2, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” may constitute forward-looking statements (as
such term is defined in the Private Securities Litigation Reform Act) and are subject to the occurrence of certain risks, uncertainties
and contingencies which may not occur in the time frames anticipated or otherwise, and, as a result, could cause actual results
to differ materially from such statements. In addition to other factors and matters discussed elsewhere in this Quarterly Report
on Form 10-Q and in our other filings with the Securities and Exchange Commission (“SEC”) over the last 12 months,
including our Annual Report on Form 10-K filed with the SEC on March 28, 2014, these risks, uncertainties and contingencies include,
but are not limited to, risks associated with increased competition, customer decisions, the successful completion of continuing
development of new products, the successful negotiation, execution and implementation of anticipated new software contracts, the
successful addition of personnel in the marketing and technical areas and our ability to complete development and sell and license
our products at prices which result in sufficient revenues to realize profits, and other business factors beyond our control.
Overview
We are a supplier
of software products for the property and casualty insurance industry, supplying a wide range of professional services that support
product customization, conversion from existing systems and data integration with other software or reporting agencies. We also
offer on-going support services including incorporating recent insurance rate and rule changes in our solutions. These support
services also include analyzing the changes, developments, quality assurance, documentation and distribution of insurance rate
and rule changes.
We earn revenue
from software contract licenses, fees for servicing the product, which we call support services, and professional services. Total
revenue for the three months ended June 30, 2014 increased to approximately $5,001,000 from approximately $4,004,000 for the three
months ended June 30, 2013, mainly due to an increase in support and professional services revenues for the three months ended
June 30, 2014. Total revenue for the six months ended June 30, 2014 decreased to approximately $10,209,000 from approximately $10,889,000
for the six months ended June 30, 2013, mainly due to a decrease in license revenue.
The following is
an overview of the key components of our revenue and other important financial data for the three and six months ended June 30,
2014:
Software Licenses.
Our license revenue in the three and six months ended June 30, 2014 of approximately $227,000 and $1,034,000, respectively,
was from new and existing customers who chose to renew, add onto or extend their use of our software. For the three and six months
ended June 30, 2013, we generated approximately $697,000 and $4,320,000, respectively, in license revenue. Our new software license
revenue is affected by the strength of general economic and business conditions and the competitive position of our software products.
New software license sales are characterized by long sales cycles and intense competition. Timing of new software license sales
can substantially affect our quarterly results.
Support Services.
Support services revenue was approximately $2,121,000 and $4,251,000, respectively, in the three and six months ended June
30, 2014 compared to approximately $1,981,000 and $4,004,000, respectively, in the same periods in 2013. Support services revenue
is influenced primarily by the following factors: the renewal rate from our existing customer base; the amount of new maintenance
associated with new license sales; and annual price increases.
Professional
Services.
Professional services revenue was approximately $2,653,000 and $4,924,000, respectively, in the three and six months
ended June 30, 2014 compared to approximately $1,326,000 and $2,565,000, respectively, in the same periods of 2013, due to an increase
in demand for customizations and implementations of Cover-All Policy in the three and six months ended June 30, 2014.
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
Income (Loss)
before Income Taxes.
Income (loss) before income taxes was approximately $332,000 and $769,000, respectively, in the three
and six months ended June 30, 2014 compared to approximately $(1,145,000) and $(436,000), respectively, in the same periods of
2013, primarily due to an increase in support and professional services revenue and our continuing and ongoing effort to maintain
our expenses in line with our revenues for the six months ended June 30, 2014.
Net Income (Loss).
Net income (loss) for the three and six months ended June 30, 2014 was approximately $328,000 and $762,000, respectively, compared
to approximately $(1,149,000) and $(444,000), respectively, in the same periods of 2013. This was mainly a result of an increase
in support and professional services revenue in the three months ended June 30, 2014.
EBITDA
. Earnings
before interest, taxes, depreciation and amortization (“EBITDA”), a non-GAAP metric, was approximately $872,000 and
$1,880,000, respectively, for the three and six months ended June 30, 2014 compared to approximately $217,000 and $2,214,000,
respectively, for the three and six months ended June 30, 2013.
Cash Flow.
We
generated approximately $1,705,000 in positive cash flow from operations in the first six months of 2014 and ended the period with
approximately $3,489,000 in cash and cash equivalents and approximately $1,398,000 in accounts receivable.
We continue to face
competition for growth in 2014 mainly in the marketing and selling of our products and services to new customers, caused by a number
of factors, including long sales cycles and general economic and business conditions. In addition, there are risks related to customers’
acceptance and implementation delays, which could affect the timing and amount of license revenue we are able to recognize. However,
given the positive response to our new software from existing customers and the introduction of additional software capabilities,
we are expanding our sales and marketing efforts to both new and existing customers. Consequently, we are incurring additional
sales and marketing expense in advance of generating the corresponding revenue.
As we shift over
time from software development to deployment, from a financial perspective, the non-cash charges for amortization of developed
software will increasingly impact our bottom line. Therefore, in order to provide more visibility to investors, we have decided
to also report EBITDA to show what we believe is the Company’s earnings power without the impact of, among other items, amortization.
In the first six months of 2014, the non-cash charge for amortization of capitalized software decreased to $745,000 from $2,273,000
in the same period in 2013, and we expect this amount to be approximately $1,500,000, or $0.06 per share, in 2014, depending on
our sales success. Therefore, we believe that EBITDA will be a useful measure of the true earnings power of the Company while we
complete the development and deployment cycle. As such, we expect to increasingly focus on EBITDA to evaluate our progress.
USE OF NON-GAAP
FINANCIAL MEASURES
In evaluating our
business, we consider and use EBITDA as a supplemental measure of our operating performance. The Company defines EBITDA as earnings
before interest, taxes, depreciation and amortization. The Company presents EBITDA because it believes it is frequently used by
securities analysts, investors and other interested parties as a measure of financial performance.
The term EBITDA
is not defined under U.S. generally accepted accounting principles, or U.S. GAAP, and is not a measure of operating income, operating
performance or liquidity presented in accordance with U.S. GAAP. EBITDA has limitations as an analytical tool, and when assessing
the Company’s operating performance, investors should not consider EBITDA in isolation, or as a substitute for net income
(loss) or other consolidated income statement data prepared in accordance with U.S. GAAP. Among other things, EBITDA does not reflect
the Company’s actual cash expenditures. Other companies may calculate similar measures differently than we do, limiting their
usefulness as comparative tools. We compensate for these limitations by relying on our U.S. GAAP results and using EBITDA only
supplementally.
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
The following is
an unaudited reconciliation of U.S. GAAP net income to EBITDA for the three and six months ended June 30, 2014 and 2013:
|
|
Three months ended June 30,
|
|
Six months ended June 30,
|
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
Net Income (Loss)
|
|
$
|
327,789
|
|
|
$
|
(1,148,999
|
)
|
|
$
|
761,638
|
|
|
$
|
(443,673
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Income (Expense), Net
|
|
|
95,270
|
|
|
|
90,912
|
|
|
|
188,942
|
|
|
|
183,423
|
|
Income Tax Expense
|
|
|
3,920
|
|
|
|
3,505
|
|
|
|
7,608
|
|
|
|
8,171
|
|
Depreciation
|
|
|
49,429
|
|
|
|
66,398
|
|
|
|
131,258
|
|
|
|
128,236
|
|
Amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of Capitalized Software
|
|
|
372,638
|
|
|
|
1,181,017
|
|
|
|
745,276
|
|
|
|
2,273,124
|
|
Amortization of Customer Lists/Relationships
|
|
|
15,167
|
|
|
|
17,408
|
|
|
|
30,334
|
|
|
|
50,908
|
|
Amortization of Deferred Financing Costs
|
|
|
7,810
|
|
|
|
6,947
|
|
|
|
15,395
|
|
|
|
13,693
|
|
Total Amortization
|
|
|
395,615
|
|
|
|
1,205,372
|
|
|
|
791,005
|
|
|
|
2,337,725
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBITDA
|
|
$
|
872,023
|
|
|
$
|
217,188
|
|
|
$
|
1,880,451
|
|
|
$
|
2,213,882
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBITDA per Common Share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.03
|
|
|
$
|
0.01
|
|
|
$
|
0.07
|
|
|
$
|
0.09
|
|
Diluted
|
|
$
|
0.03
|
|
|
$
|
0.01
|
|
|
$
|
0.07
|
|
|
$
|
0.09
|
|
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
Results of Operations
The following table
sets forth, for the periods indicated, certain items from the consolidated statements of operations expressed as a percentage of
total revenues:
|
|
Three Months
Ended June 30,
|
|
Six Months
Ended June 30,
|
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
License
|
|
|
4.5
|
%
|
|
|
17.4
|
%
|
|
|
10.1
|
%
|
|
|
39.7
|
%
|
Support Services
|
|
|
42.4
|
|
|
|
49.5
|
|
|
|
41.6
|
|
|
|
36.8
|
|
Professional Services
|
|
|
53.1
|
|
|
|
33.1
|
|
|
|
48.3
|
|
|
|
23.5
|
|
Total Revenues
|
|
|
100.0
|
|
|
|
100.0
|
|
|
|
100.0
|
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
License
|
|
|
––
|
|
|
|
(7.7
|
)
|
|
|
––
|
|
|
|
0.4
|
|
Support Services
|
|
|
29.3
|
|
|
|
40.9
|
|
|
|
30.9
|
|
|
|
39.6
|
|
Professional Services
|
|
|
24.2
|
|
|
|
19.1
|
|
|
|
22.7
|
|
|
|
13.3
|
|
Total Cost of Revenues
|
|
|
53.5
|
|
|
|
52.3
|
|
|
|
53.6
|
|
|
|
53.3
|
|
Direct Margin
|
|
|
46.5
|
|
|
|
47.7
|
|
|
|
46.4
|
|
|
|
46.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales and Marketing
|
|
|
10.9
|
|
|
|
13.1
|
|
|
|
10.0
|
|
|
|
10.8
|
|
General and Administrative
|
|
|
15.1
|
|
|
|
12.2
|
|
|
|
14.6
|
|
|
|
9.8
|
|
Amortization of Capitalized Software
|
|
|
7.5
|
|
|
|
29.4
|
|
|
|
7.3
|
|
|
|
20.9
|
|
Research and Development
|
|
|
4.5
|
|
|
|
19.4
|
|
|
|
5.1
|
|
|
|
7.6
|
|
Total Operating Expenses
|
|
|
38.0
|
|
|
|
74.1
|
|
|
|
37.0
|
|
|
|
49.1
|
|
Operating (Loss) Income
|
|
|
8.5
|
|
|
|
(26.4
|
)
|
|
|
9.4
|
|
|
|
(2.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Expense (Income):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense (Income)
|
|
|
1.9
|
|
|
|
2.3
|
|
|
|
1.9
|
|
|
|
1.7
|
|
Other Income
|
|
|
––
|
|
|
|
(0.1
|
)
|
|
|
––
|
|
|
|
(0.1
|
)
|
Total Other Expense (Income)
|
|
|
1.9
|
|
|
|
2.2
|
|
|
|
1.9
|
|
|
|
1.6
|
|
Income (Loss) Before Income Taxes
|
|
|
6.6
|
|
|
|
(28.6
|
)
|
|
|
7.5
|
|
|
|
(4.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income Taxes
|
|
|
––
|
|
|
|
0.1
|
|
|
|
––
|
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Income (Loss)
|
|
|
6.6
|
%
|
|
|
(28.7
|
)%
|
|
|
7.5
|
%
|
|
|
(4.1
|
)%
|
Three and Six Months Ended June
30, 2014 Compared to Three and Six Months Ended June 30, 2013
Total revenues for
the three months ended June 30, 2014 were approximately $5,001,000 compared to approximately $4,004,000 for the same period in
2013. License fees were approximately $227,000 for the three months ended June 30, 2014 compared to approximately $697,000 in the
same period in 2013 as a result of fewer sales to new and existing customers in 2014. For the three months ended June 30, 2014,
support services revenues were approximately $2,121,000 compared to approximately $1,981,000 in the same period of the prior year
primarily due to the annual renewals from existing customers and new customer contracts signed in 2013. Professional services revenue
contributed approximately $2,653,000 in the three months ended June 30, 2014 compared to approximately $1,326,000 in the second
quarter of 2013, as a result of an increase in demand for new software capabilities and customizations from our current customer
base and implementation of Cover-All Policy for our new customers.
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
For the six months
ended June 30, 2014, total revenues were approximately $10,209,000 compared to approximately $10,889,000 in the same period of
the prior year as a result of an increase in support and professional services revenue offset by a decrease in license sales for
the six months ended June 30, 2014.
Cost of sales was
approximately $2,674,000 and $5,471,000, respectively, for the three and six months ended June 30, 2014 compared to approximately
$2,092,000 and $5,807,000, respectively, for the same periods in 2013 due to an increase in personnel-related costs in the six
months ended June 30, 2014. In the second quarter of 2013, we reversed the bonus accrual of $310,000 we had accrued in the first
quarter of 2013. We are expanding our delivery bandwidth while maintaining our costs in line with our revenues through improved
productivity and new technology in order to meet our increasing demand. Non-cash capitalized software amortization was approximately
$373,000 and 745,000, respectively, for the three and six months ended June 30, 2014 as compared to approximately $1,181,000
and $2,273,000, respectively, for the same periods in 2013. We capitalized approximately $0 and $0, respectively, of software development
costs in the three and six months ended June 30, 2014 as compared to approximately $646,000 and $1,430,000, respectively, in the
same periods in 2013.
The direct margin
during the three and six month periods ended June 30, 2014 was 46.5% and 46.4%, respectively, compared to 47.7% and 46.7%, respectively,
in the same periods in 2013. Support services margin increased in the three and six months ended June 30, 2014 compared to the
same periods in 2013 primarily due to several cost saving initiatives. Professional services direct margin increased for the three
and six months ended June 30, 2014, compared to the same periods in 2013, primarily due to use of offshore resources to provide
customizations to new and existing customers.
We expect our quarterly
gross margin to vary in percentage terms in future periods as we experience changes in the mix between higher gross margin license
revenues and lower gross margin services revenues.
Amortization of
capitalized software was approximately $373,000 and $745,000, respectively, for the three and six months ended June 30, 2014, as
compared to approximately $1,181,000 and $2,273,000, respectively, in the same periods of 2013. The Company revised the estimated
useful life of its capitalized software, effective January 1, 2014, from three years to five years.
Research and development
expenses decreased to approximately $228,000 and $524,000, respectively, for the three and six months ended June 30, 2014 as compared
to approximately $775,000 and $826,000, respectively, for the same periods in 2013, primarily as a result of work on fewer new
products and capabilities. We are continuing our ongoing efforts to enhance the functionality of our products and solutions and
believe that investments in research and development are critical to our remaining competitive in the marketplace.
Sales and marketing
expenses were approximately $543,000 and $1,022,000, respectively, for the three and six months ended June 30, 2014 was compared
to approximately $526,000 and $1,174,000, respectively, in the same periods of 2013. This increase in the second quarter of 2014
was primarily due to an increase in our marketing and sales staff, resulting in an increase in personnel-related costs and in expenditures
related to advertising and promotion.
General and administrative
expenses increased to approximately $756,000 and $1,489,000, respectively, in the three and six months ended June 30, 2014 as compared
to approximately $489,000 and $1,066,000, respectively, in the same periods in 2013. This increase in 2014 was mainly due to reclassing
of all facilities costs to general and administrative expenses in 2014.
Liquidity and Capital Resources
Sources of Liquidity
We have funded our
operations primarily from cash flow from operations and from debt facilities. Cash from operations results primarily from net income
from the income statement plus non-cash expenses (depreciation and amortization) and is adjusted for changes in working capital
from the balance sheet.
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
Our largest source
of operating cash flows is cash collections from our customers following the purchase or renewal of software licenses, product
support agreements and other related services. Payments from customers for software licenses are generally received at the beginning
of the contract term. Payments from customers for support services and ASP services are generally received in advance on a quarterly
basis. Payments for professional services are generally received 30 days after the services are performed.
On September 11,
2012, we entered into a $2,250,000 credit facility with Imperium Commercial Finance Master Fund, LP, an affiliate of Imperium Partners
(the “Loan Agreement”). The $2,250,000 credit facility, which will support our product/services expansion and growth
initiatives, consists of a $2,000,000 three-year term loan, bearing interest at a fixed rate of 8% per annum, and a $250,000 revolving
credit facility, also bearing interest at a fixed rate of 8% per annum. Imperium also received five-year warrants to purchase 1,400,000
shares of our common stock, with an exercise price of $1.48 per share.
In connection with
the Imperium Loan Agreement financing, we incurred deferred financing costs of $92,283, which will be amortized over the life of
the loan (or earlier if the loan becomes due or is repaid before its fixed maturity).
At June 30, 2014,
we had cash and cash equivalents of approximately $3,489,000 compared to cash and cash equivalents of approximately $1,849,000
at December 31, 2013. The increase in cash and cash equivalents is primarily attributable to the increase in support and professional
services revenue in the six months ended June 30, 2014.
Cash Flows
Our ability to generate
cash has depended on a number of different factors, primarily our ability to continue to secure and retain existing customers and
generate new license sales and related product support agreements. In order to attract new customers and maintain or grow existing
revenue streams, we utilize our existing sources of capital to invest in sales and marketing, technology infrastructure and research
and development.
Our ability to continue
to control expenses, maintain existing revenue streams and anticipate new revenue will impact the amounts and certainty of cash
flows. We intend to maintain our expenses in line with existing revenue streams from maintenance support, ASP services and professional
services and to invest in our products consistent with our sales efforts.
Balance sheet items
that should be considered in assessing our liquidity include cash and cash equivalents, accounts receivable, prepaid expenses,
accounts payable and accrued liabilities. Statement of operations items that should be considered in assessing our liquidity include
revenues, cost of revenues (net of depreciation and amortization), operating expenses (net of depreciation and amortization) and
other expenses. Statement of cash flows items that should be considered in assessing our liquidity include net cash flows from
operating activities, net cash flows from investing activities and net cash flows from financing activities.
At June 30, 2014,
we had working capital of approximately $2,040,000 compared to working capital of approximately $(19,000) at December 31, 2013.
For the six months ended June 30, 2014, net cash provided from operating activities totaled approximately $1,705,000 compared to
approximately $2,446,000 for the six months ended June 30, 2013 due to a decrease in license revenue for the six months ended June
30, 2014. In 2014, cash flow from operating activities represented the Company’s principal source of cash and results primarily
from net income (loss), less non-cash expense and changes in working capital.
For the six months
ended June 30, 2014, net cash used for investing activities was approximately $8,000 compared to approximately $1,449,000 for the
six months ended June 30, 2013. The Company expects capital expenditures and capital software expenditures to continue to be funded
by cash generated from operations. For the six months ended June 30, 2014, net cash used for financing activities was approximately
$57,000 compared to approximately $63,000 for the six months ended June 30, 2013. The cash used for financing activities in 2014
consisted of the principal payments on our capital lease.
COVER-ALL TECHNOLOGIES INC.
AND SUBSIDIARY
Funding Requirements
Our primary uses
of cash are for operating expenses, including personnel-related expenditures, facilities and technology costs, and for interest
only payments under our Loan Agreement.
We may need additional
funding for any large capital expenditures and for continued product development. We lease computer equipment for terms of three
years in order to have the latest available technology to serve our customers and develop new products.
Interest on the
outstanding principal balance under the Imperium Notes accrues at a fixed rate equal to 8% per annum and is payable monthly, in
arrears. The outstanding principal and any remaining interest under the Imperium Notes will be immediately due and payable to Imperium
on the earlier of (1) September 10, 2015 and (2) the date Imperium’s obligation to advance funds under the revolving credit
line is terminated following an event of default pursuant to the terms and conditions of the Loan Agreement. Payments and prepayments
received by Imperium will be applied against principal and interest as provided for in the Loan Agreement.
On December 16,
2011, we announced that our board of directors authorized a share buyback plan of up to 1,000,000 shares of the Company’s
common stock, in accordance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
The Imperium Loan Agreement prohibits buybacks of our common stock.
On December 30,
2011, the Company completed the acquisition of the PipelineClaims assets (excluding working capital) of Ho’ike Services,
Inc. dba BlueWave Technology (“BlueWave”), a provider of enterprise claims management software to the property and
casualty insurance industry based in Honolulu, Hawaii. The aggregate purchase price for the acquisition, in addition to the assumption
by the Company of certain assumed liabilities, consisted of the following: (i) $1,100,000 in cash on the closing date, (x) $635,821
of which (net of adjustments for certain prepayments to BlueWave and other prorations) was paid in cash to BlueWave, and (y) $400,000
of which was deposited into an escrow account to be held and distributed by an escrow agent pursuant to the terms of an escrow
agreement to secure possible future indemnification claims and certain other post-closing matters in favor of the Company; and
(ii) up to an aggregate of $750,000 in an earnout, which earnout will be based upon the performance of the acquired business in
the five years following the closing. More particularly, for each of the five years following the closing, BlueWave will be entitled
to receive an amount equal to ten percent (10%) of the PipelineClaims Free Cash Flow (as such term is defined in the purchase agreement)
but in no event will the Company be required to pay to BlueWave in excess of $750,000 in the aggregate for the 5-year period. For
each of the first two years following the closing of the BlueWave transaction, BlueWave was not entitled to receive any earnout
payment. In December 2012, we received a disbursement from the escrow account of $250,000 as a result of a contractual provision
entitling us to such amount if PipelineClaims was not licensed by Island Insurance by December 31, 2012.
We prepare monthly
cash flow projections on a rolling twelve-month basis based on a detailed review of anticipated receipts and revenue from licenses,
support services and professional services. We also perform a detailed review of our disbursements, including fixed costs, variable
costs, legal costs, payroll costs and other specific payments, on a rolling twelve-month basis.
We believe that
our current cash balances and anticipated cash flows from operations will be sufficient to meet our normal operating needs for
at least the next twelve months. These projections include anticipated sales of new licenses, the exact timing of which cannot
be predicted with absolute certainty and can be influenced by factors outside the Company’s control. Our ability to fund
our working capital needs and address planned capital expenditures will depend on our ability to generate cash in the future. We
anticipate generating future working capital through sales to new customers and continued sales and services to our existing customers.
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Our future liquidity
and capital resource requirements will depend on many factors, including, but not limited to, the following trends and uncertainties
we face:
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Our ability to generate cash is subject to general economic, financial, competitive and other factors
beyond our control.
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Our need to invest resources in product development in order to continue to enhance our current
product, develop new products, attract and retain customers and keep pace with competitive product introductions and technological
developments.
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We experience competition in our industry and continuing technological changes.
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Insurance companies typically are slow in making decisions and have numerous bureaucratic and institutional
obstacles, which can make our efforts to attain new customers difficult.
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We compete with a number of larger companies who have greater resources than those of ours.
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We compete on the basis of insurance knowledge, products, services, price, technological advances
and system functionality and performance.
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Our operations continue to depend upon the continuing business of our existing customers and our
ability to attract new customers.
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A decline in software spending in the insurance industry could result in a decrease in our revenue.
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Material risks to
cash flow from operations include delayed or reduced cash payments accompanying sales of new licenses or a decline in our services
business. There can be no assurance that changes in our plans or other events affecting our operations will not result in materially
accelerated or unexpected expenditures.
We do not expect
for there to be a need for a change in the mix or relative cost of our sources of capital.
The New York State
Department of Taxation and Finance (the “Department”) conducted an examination of the Company for state sales and use
tax for audit periods March 1, 2009 through February 28, 2013. In February 2014, the Company received a Statement of Proposed Audit
Change from the Department. The Change asserts proposed Sales and Use Tax due in the amount of approximately $191,600 together
with interest of approximately $46,400. Interest will continue to accrue on the proposed outstanding balances until the date of
payment. On March 11, 2014, the Company paid the Department an aggregate of approximately $238,000 in satisfaction in full of all
amounts owed in connection with such examination.
Net Operating
Loss Carryforwards
The deferred tax
asset from tax net operating loss carryforwards of approximately $4,673,000 represents approximately $11,800,000 of net operating
loss carryforwards which are subject to expiration beginning in 2028. During the six months ended June 30, 2014, the deferred tax
asset valuation allowance was decreased for the assumed utilization of prior period net operating loss carryforwards utilized to
offset taxable income for the current period, subject to federal alternative minimum tax limitations. In assessing the realizability
of deferred tax assets, management considers, within each taxing jurisdiction, whether it is more likely than not that some portion
or all of the deferred tax assets will not be realized. The Company considers the scheduled reversal of deferred tax liabilities,
projected future taxable income, and tax planning strategies in making this assessment. Factors that may affect the Company’s
ability to achieve sufficient forecasted taxable income in future periods may include, but are not limited to, the following: increased
competition, a decline in sales or margins, a loss of market share, and a decrease in demand for professional services. Based upon
the levels of historical taxable income and projections for future taxable income over the years in which the deferred tax assets
are deductible, at June 30, 2014, management believes that it is more likely than not that the Company will realize the benefits,
net of the established valuation allowance, of these deferred tax assets in the future.
The Tax Reform Act
of 1986 enacted a complex set of rules which limits a company’s ability to utilize net operating loss carryforwards and tax
credit carryforwards in periods following an ownership change. These rules define an ownership change as a greater than 50 percent
point change in stock ownership within a defined testing period which is generally a three-year period. As a result of stock which
may be issued by us from time to time, and the conversion of outstanding warrants, or the result of other changes in ownership
of our outstanding stock, the
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Company may experience an ownership
change and consequently our utilization of net operating loss carryforwards could be significantly limited.
Off-Balance Sheet Transactions
We do not maintain
any off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that
are reasonably likely to have a material current or future effect on our condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies
and Estimates
The SEC has issued
cautionary advice to elicit more precise disclosure in this Item 2, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations,” about accounting policies that management believes are most critical in portraying
our financial results and in requiring management’s most difficult subjective or complex judgments.
The preparation
of financial documents in conformity with accounting principles generally accepted in the United States of America requires management
to make judgments and estimates. On an on-going basis, we evaluate our estimates, the most significant of which include establishing
allowances for doubtful accounts, a valuation allowance for our deferred tax assets and determining the recoverability of our long-lived
assets. The basis for our estimates are historical experience and various assumptions that are believed to be reasonable under
the circumstances, given the available information at the time of the estimate, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results
may differ from the amounts estimated and recorded in our financial statements.
We believe the following
critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial
statements:
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Valuation of Capitalized Software
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Valuation of Allowance for Doubtful Accounts Receivable
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Revenue Recognition
Revenue recognition
rules are very complex, and certain judgments affect the application of our revenue policy. The amount and timing of our revenues
is difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary
significantly from quarter to quarter. In addition to determining our results of operations for a given period, our revenue recognition
determines the timing of certain expenses, such as commissions, royalties and other variable expenses.
Our revenues are
recognized in accordance with FASB ASC 986-605, “Software Revenue Recognition,” as amended. Revenue from the sale of
software licenses is predominately related to the sale of standardized software and is recognized when these software modules are
delivered and accepted by the customer, the license term has begun, the fee is fixed or determinable, and collectability is probable.
Revenue from support services is recognized ratably over the life of the contract. Revenue from professional consulting services
is recognized when the service is provided.
Amounts invoiced
to our customers in excess of recognizable revenues are recorded as deferred revenues. The timing and amounts invoiced to customers
can vary significantly depending on specific contract terms and can therefore have a significant impact on deferred revenues in
any given period.
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Our revenues are
derived from the licensing of our software products, professional services, and support services. We recognize revenue when persuasive
evidence of an arrangement exists, we have delivered the product or performed the service, the fee is fixed or determinable, and
collection is probable.
License Revenue
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We recognize our license revenue upon delivery, provided that collection is determined to be probable and no significant obligations
remain.
Services and Support
Revenue
. Our services and support revenue is composed of professional services (such as consulting services and training) and
support services (maintenance, support and ASP services). Our professional services revenue is recognized when the services are
performed. Our support services are recognized ratably over the term of the arrangement.
Valuation of Capitalized
Software
Costs for the conceptual
formulation and design of new software products are expensed as incurred until technological feasibility has been established.
Once technological feasibility is established, we capitalize costs to produce the finished software products. Capitalization ceases
when the product is available for general release to customers. Costs associated with product enhancements that extend the original
product’s life or significantly improve the original product’s marketability are also capitalized once technological
feasibility for that particular enhancement has been established. Amortization is calculated on a product-by-product basis as the
greater of the amount computed using (a) the ratio that current gross revenues for a product bear to the total of current and anticipated
future gross revenues for that product or (b) the straight-line method over the remaining economic life of the product. At each
balance sheet date, the unamortized capitalized costs of each computer software product is compared to the net realizable value
of that product. If an amount of unamortized capitalized costs of a computer software product is found to exceed the net realizable
value of that asset, such amount will be written off. The net realizable value is the estimated future gross revenues from that
product reduced by the estimated future costs of completing and deploying of that product, including the costs of performing maintenance
and customer support required to satisfy our responsibility set forth at the time of sale.
Valuation of Allowance
for Doubtful Accounts Receivable
Management’s
estimate of the allowance for doubtful accounts is based on historical information, historical loss levels, and an analysis of
the collectability of individual accounts. We routinely assess the financial strength of our customers and, based upon factors
concerning credit risk, establish an allowance for uncollectible accounts. Management believes that accounts receivable credit
risk exposure beyond such allowance is limited.
Deferred Income
Taxes
Deferred income
taxes are determined based on the estimated future tax effects of differences between the financial statement and tax bases of
assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes
to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions
in which we operate, estimates of future taxable income and available tax planning strategies. If tax regulations, operating results
or the ability to implement tax planning and strategies vary, adjustments to the carrying value of deferred tax assets and liabilities
may be required. We estimate our income tax valuation allowance by assessing which deferred tax assets are more-likely-than-not
to be recovered in the future. The valuation allowance is based on our estimates of taxable income in each jurisdiction in which
we operate and the period over which the deferred tax assets will be recoverable. If it appears that we will not generate such
taxable income, we may need to increase the valuation allowance against the related deferred tax asset in a future period.
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