SideChannel, Inc. - Quarter Report: 2014 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Commission File No. 000-28745

Cloud Medical Doctor Software Corporation

(Name of small business issuer as specified in its charter)

(formerly National Scientific Corporation)

1291 Galleria Drive, Suite 200

Henderson, NV 89014

(Address of principal executive offices) (Zip Code)

(702) 818-9011

Registrant’s telephone number, including area code

Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: Yes [x] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [x] No [ ]

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b–2 of the Exchange Act). Yes [ ] No [x]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

CLOUD MEDICAL DOCTOR SOFTWARE CORPORATION

INDEX TO FORM 10-Q FILING

FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2014 AND 2013

TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

The accompanying interim consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q.  Therefore, they do not include all information and footnotes necessary for a complete presentation of financial position, results of operations, cash flows, and stockholders' equity in conformity with generally accepted accounting principles.  Except as disclosed herein, there has been no material change in the information disclosed in the notes to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended September 30, 2013.  In the opinion of management, all adjustments considered necessary for a fair presentation of the results of operations and financial position have been included and all such adjustments are of a normal recurring nature.  Operating results for the nine months ended June 30, 2014 are not necessarily indicative of the results that can be expected for the year ending September 30, 2014.

CLOUD MEDICAL DOCTOR SOFTWARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2014 AND 2013

(Unaudited)

NOTE 1- DESCRIPTION OF BUSINESS

Cloud Medical Doctor Software Corporation (the “Company”) was incorporated in Texas on June 22, 1953 as American Mortgage Company. On May 16, 1996, the Company changed its name to National Scientific Corporation. On April 3, 2012, the Company changed its name to Cloud Medical Doctor Software Corporation. 

In the year ended September 30, 2011, Cloud-MD introduced the Cloud-MD Office, a “Cloud Based”, 5010 ready and ICD-10 compliant, fully integrated and interoperable suite of medical software and services, designed by experienced healthcare analysts and programmers for healthcare providers, that produces “Actionable Information” to help Independent Physician Practices, New Care Delivery Models (ACO), Healthcare Systems and Billing Services optimize a wide range of business processes resulting in Increased Profits, Higher Quality, Greater Efficiency, Noticeable Cost Reductions and Better Patient Care. Current software product offerings include Practice Management, Electronic Medical Records, Revenue Management, Patient Financial Solutions, Medical and Pharmaceutical Supply Management, Claims Management and PHI Exchange.

In the year ended September 30, 2012, Cloud-MD launched Cloud-MD Billing Services which provides management of medical claims from posting physician charges and payments into our medical billing software. The software uses a continuous insurance claim follow-up system to track and research all rejected or denied medical claims; a Comprehensive Reporting module that includes monthly financial statements sent to our clients so they can see how their practice is performing and a variety of detailed reports giving our clients the necessary information and tools used to assist in the increased production which leads to more profit; and patient account inquiries and support to assist patients with their billing and insurance questions.

On November 21, 2012, the Company purchased from CipherSmith, LLC a complete source code, intellectual property rights, all computer software or algorithm licensed or sold under CipherSmith, and appropriate copy rights, patents, mask works, trademarks, service marks, internet domain names or world wide web URS. Since 2012 the Company has tested the software application and created a commercial product for distribution of its encryption technology. The Company is presently, developing more applications for consumer usage in the future.

NOTE 2 – BASIS OF PRESENTATION OF INTERIM CONSOLIDATED FINANCIAL STATEMENTS

The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America.  The accompanying interim unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information in accordance with the instructions to Form 10-Q and Article 8 of Regulation S-X. In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

Operating results for the nine months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending September 30, 2014. Notes to the unaudited interim consolidated financial statements that would substantially duplicate the disclosures contained in the audited consolidated financial statements for the year ended September 30, 2013 have been omitted; this report should be read in conjunction with the audited consolidated financial statements and the footnotes thereto for the fiscal year ended September 30, 2013 included within the Company’s Form 10-K as filed with the Securities and Exchange Commission.

Segment reporting change

With the placement into service of the Company’s encryption technology, the Company began a segment reporting structure to match the new operating structure and how the Company’s management views the business and allocates resources, beginning in the quarter ended June 30, 2014. Reclassifications of prior period financial information have been made to conform to the current period presentation. This change does not impact previously reported condensed consolidated financial statements of the Company. See Note 12 for additional information on our segment reporting change.

NOTE 3 - GOING CONCERN

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. However, the Company has recurring losses from operations and an accumulated deficit at June 30, 2014 of $27,858,918 and needs additional cash to maintain its operations.

These factors raise doubt about the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. The Company’s continued existence is dependent upon management’s ability to develop profitable operations, continued contributions from the Company’s executive officers to finance its operations and the ability to obtain additional funding sources to explore potential strategic relationships and to provide capital and other resources for the further development and marketing of the Company’s products and business.

NOTE 4 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are as follows:

Use of Estimates and Assumptions

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities known to exist as of the date the consolidated financial statements are published, and (iii) the reported amount of net revenues and expenses recognized during the periods presented. Adjustments made with respect to the use of estimates often relate to improved information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of consolidated financial statements; accordingly, actual results could differ from these estimates. The Company’s most significant estimates relate to the valuation of its proprietary technology and its valuation of its common stock.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.  At June 30, 2014, cash and cash equivalents include cash on hand and cash in the bank and the FDIC insures these deposits up to $250,000.

Impairment of Long-Lived Assets

Long-lived assets are evaluated for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Each impairment test is based on a comparison of the undiscounted future cash flows to the recorded value of the asset. If impairment is indicated, the asset is written down to its estimated fair value. The acquired software technologies are reviewed annually for impairment.

Fair Value of Financial Instruments

The Company's financial instruments consist primarily of cash, accounts payable and accrued expenses, and debt. The carrying amounts of such financial instruments approximate their respective estimated fair value due to the short-term maturities and approximate market interest rates of these instruments.  

Fair value is focused on an exit price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Within the measurement of fair value, the use of market-based information is prioritized over entity specific information and a three-level hierarchy for fair value measurements is used based on the nature of inputs used in the valuation of an asset or liability as of the measurement date.  

The three-level hierarchy for fair value measurements is defined as follows:

The following table summarizes fair value measurements by level at June 30, 2014 and September 30, 2013 for assets measured at fair value on a recurring basis:

Accounts Receivable and Allowance for Uncollectible Accounts

Substantially all of the Company’s accounts receivable balance is related to trade receivables. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in its existing accounts receivable. The Company will maintain allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments for services. Accounts with known financial issues are first reviewed and specific estimates are recorded. The remaining accounts receivable balances are then grouped in categories by the number of days the balance is past due, and the estimated loss is calculated as a percentage of the total category based upon past history. Account balances are charged against the allowance when it is probable the receivable will not be recovered. As of June 30, 2014 and 2013, the Company had no valuation allowance for the Company’s accounts receivable.

Income Taxes

The Company utilizes the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carry-forwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that the value of such assets will be realized.

The Company uses the two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not, that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount, which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating the Company's tax positions and tax benefits, which may require periodic adjustments. At June 30, 2014, the Company did not record any liabilities for uncertain tax positions.

Revenue Recognition

Medical Licensing Agreement

License revenue consists principally of revenue earned under software license agreements. The Company sells its software to a medical practitioner for direct payment or through a third party leasing company for direct payment to the Company. The third party lease agreement is a non-recourse debt and the Company is not responsible for the default of the medical practitioner. License revenue is generally recognized when a signed contract or other persuasive evidence of an arrangement exists, the software has been electronically delivered, the license fee is fixed or is measured on a paid user basis; and collection of the resulting receivable is probable. When contracts contain multiple elements wherein Vendor-Specific Objective Evidence (“VSOE”) exists for all undelivered elements, we account for the delivered elements in accordance with the “Residual Method.”

VSOE of fair value for maintenance and support is established by a stated renewal rate, if substantive, included in the license arrangement or rates charged in stand-alone sales of maintenance and support. Revenue from subscription license agreements, which include software, rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription period.

Provided all other revenue criteria are met, the upfront, minimum, non-refundable license fees from customers are generally recognized upon delivery and on-going royalty fees are generally recognized upon reports of new licenses issued. If there is significant uncertainty about the project completion or receipt of payment for professional services, revenue is deferred until the uncertainty is sufficiently resolved. VSOE of fair value of services is based upon stand-alone sales of those services.

Subscription revenue is generated from bandwidth and information storage. In the first year and each year thereafter, the software is purchased and installed the purchaser will pay an annual fee of $1,200, $1,500, $1,800, and $2,400, respectively. Subscription revenue is recognized ratably over the term of the agreement.

Transaction revenue is generated from the following services and recognized when a transaction occurs:

The Company had not received any transaction revenues in the three and nine months ended June 30, 2014.

CipherLoc Licensing Agreement

License revenue also consists of revenue earned under a CipherLoc License Agreement. License revenue is generally recognized when a signed contract or other persuasive evidence of an arrangement exists, the software has been electronically delivered, the license fee is fixed or is measured on a paid user basis; and collection of the resulting receivable is probable. When contracts contain multiple elements wherein Vendor-Specific Objective Evidence (“VSOE”) exists for all undelivered elements, we account for the delivered elements in accordance with the “Residual Method.”

VSOE of fair value for maintenance and support is established by a stated renewal rate, if substantive, included in the license arrangement or rates charged in stand-alone sales of maintenance and support. Revenue from subscription license agreements, which include software, rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription period.

Provided all other revenue criteria are met, the upfront, minimum, non-refundable license fees from customers are generally recognized upon delivery and on-going royalty fees are generally recognized upon reports of new licenses issued. If there is significant uncertainty about the project completion or receipt of payment for professional services, revenue is deferred until the uncertainty is sufficiently resolved. VSOE of fair value of services is based upon stand-alone sales of those services.

Cost of License and Subscription Revenues

Cost of license revenue is primarily comprised of the license-based royalties to third parties and production and distribution costs for initial product licenses. No costs were incurred for license-based royalties during the nine months ended June 30, 2014 and 2013.

Cost of subscription revenue is primarily comprised of the costs associated with the customer support personnel that provide maintenance, enhancement and support services to customers. No costs were incurred for customer support during the nine months ended June 30, 2014 and 2013.

The amortization of acquired technology for products acquired through business combinations are considered as the cost of revenues. The acquired software technologies are amortized over their useful lives of 5 years

Deferred Revenue

Deferred revenue result from fees billed to customers for which revenue has not yet been recognized or for which the conditions of the arrangement have been modified. The Company recognizes revenue to provide up-front capitalization to Cloud-MD for each provider added to the solution set. The Company also recognizes annual subscription fees for virtual servers and subscription and small usage fees and those revenues are based on a 48-month lease, Cloud-MD would amortize the revenue over the life of the agreement of 48 months. In addition, it features incremental monthly revenue, for the duration of the lease (48 months) based on fees assessed for transactions such as eligibility claims processing, etc.

The Company has deferred revenue of $0 as of June 30, 2014.

Sales Commissions

The Company pays commissions, including sales bonuses, to the direct sales force related to revenue transactions under sales compensation plans which are established annually. The commission payments are typically paid in full in the month or quarter following execution of the customer contracts. The Company paid commissions of $0 and $10,000 for the three months ended June 30, 2014 and 2013, respectively, and $35,650 and $50,260 for the nine months ended June 30, 2014 and 2013, respectively.

Research and Development and Software Development Costs

Capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on our product development process, technological feasibility is established upon the completion of a working model. To date, costs incurred by us from the completion of the working model to the point at which the product is ready for general release have been insignificant. Accordingly, we have charged all such costs to research and development expense in the period incurred. The Company recorded research and development costs of $0 and $58,044 for the three months ended June 30, 2014 and 2013, respectively, and $20,000 and $153,044 for the nine months ended June 30, 2014 and 2013, respectively.

Share-Based Compensation

The Company measures the cost of services received in exchange for an award of an equity instrument based on the grant-date fair value of the award.  Compensation cost is recognized over the vesting or requisite service period.

Basic and Diluted Net Income (Loss) per Common Share

Basic income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the reporting period. The weighted average number of shares is calculated by taking the number of shares outstanding and weighting them by the amount of time that they were outstanding.  Diluted earnings per share reflects the potential dilution that could occur if stock options, warrants, and other commitments to issue common stock were exercised or equity awards vest resulting in the issuance of common stock that could share in the earnings of the Company.

The Company has 4,000,000 preferred shares that can be converted subject to the limitation of the Company’s authorized shares at 1 preferred share for 150 common shares. The conversion can only take place with the approval of the Board of Directors. At June 30, 2014, the preferred shares could be converted into 600,000,000 of common shares resulting in dilution of common shareholders. The preferred shares are anti-dilutive since the losses the Company has incurred for the periods ended June 30, 2014 and 2013.

Diluted loss per share is the same as basic loss per share during periods where net losses are incurred since the inclusion of the potential common stock equivalents would be anti-dilutive as a result of the net loss.  

Concentration of Credit Risk

All of the Company’s cash and cash equivalents are maintained in regional and national financial institutions. The Company has exposure to credit risk to the extent that its cash and cash equivalents exceed amounts covered by the U.S. federal deposit insurance; however, the Company has not experienced any losses in such accounts. In management’s opinion, the capitalization and operating history of the financial institutions are such that the likelihood of material loss is remote. Presently the bank accounts held by Chase bank exceeds the $250,000 FDIC insurance by $608,201.

Subsequent Events

The Company has evaluated all transactions occurring between June 30, 2014and the date of issuance of the consolidated financial statements for subsequent event disclosure consideration.

Recent Accounting Pronouncements

No accounting standards or interpretations issued recently are expected to a have a material impact on the Company’s financial position, operations or cash flows.

NOTE 5 – SOFTWARE

The following is a detail of software at June 30, 2014 and September 30, 2013:

The Company’s software was placed into service starting in the second quarter of fiscal year ended September 30, 2012. The amortization expense was $61,155 and $61,155 for the three months ended June 30, 2014 and 2013, respectively. The Company recognized a $0 and $10,000 for impairment of software acquired from Doctors Network of America (“DNA”) operating in Flowood, Mississippi during the nine months ended June 30, 2014 and the year ended September 30, 2013, respectively. The Company is currently in litigation with the sellers of DNA relating to the collection of certain medical billings owed to the Company. As a result of the litigation, the Company deemed the assets to be impaired.

Source Code License

In October 2013, the Company through a purchase agreement with Antree Systems Limited has purchased a complete source code, intellectual property rights, all computer software, patents, or formulas, algorithm licensed or sold under a project known as Compass Rose and appropriate copyrights, patents, mask works, trademarks, service marks, internet domain names and world wide web uniform resource locators (“URLs”) from Antree Systems Limited. The Company issued 200,000 shares of its common stock as consideration for the purchase. The fair value of the consideration and the assets acquired is based on the fair value of the common stock issued in exchange for the software. The total fair value, based on the market price on the date of grant, was $6,000. The Company evaluated this acquisition and determined that it did not meet the definition of a significant business acquisition.

Encryption Software Code

On November 21, 2012, the Company purchased from CipherSmith, LLC a complete source code, intellectual property rights, all computer software or algorithm licensed or sold under CipherSmith, and appropriate copy rights, patents, mask works, trademarks, service marks, internet domain names or world wide web URS. The Company issued 500,004 shares of its common stock as payment for the acquisition. The fair value of the consideration and the assets acquired is based on the aggregate fair value of the common stock issued in exchange for the software. The total fair value of the shares of common stock issued on the date of grant was $15,800.

Doctors Network of America

On June 22, 2012, the Company entered into an acquisition agreement that closed on March 16, 2013. The Company agreed to acquire DNA in Flowood, Mississippi from Krooss Medical Management Systems, LLC (“Krooss”) for 500,000 shares of common stock. As of September 30, 2012, 200,000 shares of common stock were issued as a deposit, which was valued at $4,000 based on the market value on the date of grant. At the closing of the transaction on March 16, 2013, the Company issued an additional 300,000 shares of common stock which were valued at $6,000 based on the market value on the date of grant.

Subsequent to the transaction closing on March 16, 2013, the sellers refused to pay for medical billing process transaction fees in accordance with their contracts in the amount of approximately $200,000. The Company and the sellers are currently in litigation over the disputed transaction fees of $200,000.

NOTE 6- DISCONTINUED OPERATIONS

The Company’s former Board of Directors believed that it was in the best interest of the Company to discontinue the former business operation of the GPS operational device business. In 2011, this business was transferred to National Scientific, LLC, a company owned by the Company’s prior CEO, by prior management in which the Company’s former CEO was to pay $100,000 plus 2% of revenues for that technology. The former officer never paid the specific consideration for this transaction. Accordingly, the Company reclassified the assets, liabilities and operations related to its GPS operational device business as discontinued operations.  Consequently, the accompanying consolidated financial statements reflect the assets, liabilities and operations of the GPS operational device business as net assets of discontinued operations, net liabilities of discontinued operations and results from discontinued operations.

On March 16, 2013, the Company closed the acquisition with the final payment for DNA. Subsequent to the transaction closing, the sellers refused to pay the transaction fees for medical billing contracts that were processed. The Company filed a lawsuit against the sellers for Breach of Contract among other things in June of 2013. During that time, the Company believes the sellers began contacting all billing contract holders and interfered with the acquisition of all the assets from the transaction. Consequently, the accompanying consolidated financial statements reflect the assets, liabilities and operations of DNA as net assets of discontinued operations, net liabilities of discontinued operations and results from discontinued operations.

Details of the classifications for net assets, liabilities and operations are shown below.

NOTE 7 – LINES OF CREDIT

In November 2013, the Company entered into a revolving line of credit with Mutual of Omaha in the amount of $65,000 at a 4.00% interest rate per annum which renews annually. As of June 30, 2014, the Company had borrowed $62,612 against the line of credit.

The Company has a revolving line of credit with Chase Bank with a balance as of June 30, 2014 in the amount of $0 and a borrowing limit of $50,000. The line of credit with Chase Bank has an interest rate of 4.25% per annum and renews annually.

Interest expense for these lines of credit was $1,657 from $15 for the three months ended June 30, 2014 and 2013, respectively, and $2,171 and $211 for the nine months ended June 30, 2014 and 2013, respectively.

NOTE 8 – DEBT MITIGATION PROGRAM

The Company determined that the statute of limitations for certain of the Company’s creditors to enforce collection of any amounts they might be owed has now elapsed. Based on the determinations and findings, during nine months ended June 30, 2014 and 2013, the Company recognized a gain on the write-off of liabilities in the amount of $0 and $58,984 from third party liabilities, respectively, which was recorded in income from discontinued operations, and additional paid-in capital of $59,704 and $0 for related party liabilities, respectively. The Company will continue to conduct this analysis going forward and write-off obligations when such obligations are no longer enforceable based on applicable law.

The following liabilities, through the opinion of legal counsel, were determined by the Company as unenforceable.

(1)   All amounts that were owed to related parties in prior years were recorded to paid-in capital.

NOTE 9 – COMMITMENTS AND CONTINGENCIES

Rent expense for the three and nine months ended June 30, 2014 and 2013 was $0 for both periods.

The Company entered into an agreement to purchase the assets of DNA in June 2012 and after due diligence by both parties the transaction closed on March 16, 2013. Subsequent to the transaction closing on March 16, 2013, the sellers refused to pay for medical billing process transaction fees in accordance with their contracts of approximately $200,000. In June 2013, the Company sued the sellers in federal court for breach of contract among other causes of action of unpaid medical billing transaction fees of approximately $200,000. The Company believes it will be successful in its litigation. However, if the Company is successful, the collectability of the judgment is highly questionable.

On July 5, 2013, the Company filed a complaint against Krooss Medical Management Systems, LLC, William F. Krooss and Marie W. Krooss in the United States District Court, District of Nevada Case No. 2013-CV-01187-ABG-VCF for the collection of $200,000 of unpaid medical billing fees that were seriously delinquent. After many attempts by the Company to begin collections, the Defendants refused to pay the outstanding balances, however expected the Company to continue to bill for them. The Complaint includes causes of action Breach of the PTAPA, Breach of Billing and Collections Contracts, Negligence, Breach of the Duty of Good Faith and Fair Dealing, Tortious Interference with Business Relations, Fraud, among other causes of action.

On August 13, 2013, Krooss Medical Management Systems et al filed a Complaint in Chancery Court of Rankin County, Mississippi Case No. 13-1372 as a strategy to keep the collection matter in Mississippi Chancery Court.

Case No. 13-1372 was remanded to the United States District Court, Southern District of Mississippi Jackson Division Case No. 3:13CV507-HTW-LRA.

This litigation is a collection matter of unpaid fees by the Defendants and the Company vehemently denies the allegations (Breach of the Permanent Transfer Asset Purchase Agreement (“PTAPA”), Rescission of the PTAPA, Breach of Billing and Collections Contracts, Negligence, Quantum Meruit, Restitution, and Estoppel, Breach of the Duty of Good Faith and Fair Dealing, Tortious Interference with Business Relations, among other causes of action) filed in Mississippi Chancery Court related to this collection matter. The Company does not expect the cost to litigate this matter to adversely affect the Company’s operations. However, the Company has reduced operations in DNA-Cloud in Mississippi as the sellers have interfered with the billing contracts purchased which is one of the causes of action in Complaint, among others. Many of the contracts have been terminated due to the interference by the sellers, and DNA-Cloud has not been able to expand the business because of the reputation of the sellers in Jackson, Mississippi and the surrounding area.

The Company has issued shares to new investors since January 2, 2011, that have an anti-reverse common stock split clause if the Company reverse splits the common stock. The reverse split of common stock is determined by management but must be approved by Financial Industry Regulation Authority (“FINRA”). The current investors holding anti-reverse split stock will have the right to hold the same number of shares of common stock as status quo after the reverse split. The anti-reverse split common stock protection is only for stock subject to reverse split and once the Company declares a reverse split and it is completed, the anti-reverse split protection will be terminate and shareholders that received anti-reverse split stock will be held with regular stockholders as the Company proceeds forward. In accordance with the anti-reverse split provision, no further shares will be issued to the anti-reverse split shareholders once the reverse split is approved and completed. The Company has issued 90,029,843 anti-reverse split shares and these holders will hold the same number of shares after the reverse split has been completed.

As discussed in Note 8, the Company has written off $59,704 and $58,984 in accounts payable, accrued liabilities and notes payable based on the opinion of legal counsel for the nine months ended June 30, 2014 and 2013. However, the related creditors could make a claim in the future in regards to these liabilities.

In June 2014, the Company entered into an investor relations agreement and market awareness consulting agreement with BCMG Entertainment, Inc. (“BCMG”) for $450,000. The Company has paid BCMG $75,000 as of June 30, 2014. The Company will continue to pays $25,000 per month based on performance until the contract is satisfied.

NOTE 10– RELATED PARTY TRANSACTIONS

The Company repaid $8,299 and $25,591 of the advances from the Company’s CEO in the nine months ended June 30, 2014 and 2013, respectively. The advances from the CEO are due on demand and do not accrue interest. As of June 30, 2014 and September 30, 2013, there were no amounts owed to the CEO for advances, respectively.

NOTE 11 - EQUITY

As of June 30, 2014, the Company was authorized to issue 650,000,000 common shares and 4,000,000 preferred shares at a par value of $0.01.  

Nine months ended June 30, 2014

Stock Issued for Cash

During the nine months ended June 30, 2014, the Company issued 35,000 shares of common stock for $15,000 in net cash proceeds as follows:

Stock Issued in Connection with Software Licensing and Subscription Agreements

During the nine months ended June 30, 2014, the Company issued 220,000 shares of common stock valued at $5,700 based on the market price on the date of grant, to customers, in regards to the purchase of software from the Company in accordance with the Software Licensing and Subscription Agreements. The fair values of the shares issued were recorded as a reduction of software revenue recognized during the three months ended June 30, 2014.

Stock Issued for Assets Acquisition

In October 2013, the Company through a purchase agreement with Antree Systems Limited has purchased a complete source code, intellectual property rights, all computer software, patents, or formulas, algorithm licensed or sold under a project known as Compass Rose and appropriate copyrights, patents, mask works, trademarks, service marks, internet domain names and world wide web uniform resource locators (“URLs”) from Antree Systems Limited. The Company issued 200,000 shares of its common stock as consideration for the purchase. The fair value of the consideration and the assets acquired is based on the fair value of the common stock issued in exchange for the software. The total fair value, based on the market price on the date of grant, was $6,000. The Company evaluated this acquisition and determined that it did not meet the definition of a significant business acquisition.

In November 2013, the Company issued 180,000 shares of common stock as replacement shares for the 160,000 shares of common stock issued to Antree Systems Limited and 20,000 shares of common stock to Kimberly Ilicerl. The Company intends to cancel the original shares issued because the shares were lost during delivery to the shareholders.

Stock Issued for Services

During the nine months ended June 30, 2014, the Company issued 65,207,506 shares of common stock as compensation. The fair values of the shares were a total of $1,446,069 and were recorded at the market price on the date of grant. The issuances of stock were as follows:

In June 2014, the Company entered into a consulting agreement with Gawk, Inc. This agreement requires the issuance of 3,000,000 common shares and Gawk has agreed to assist the Company in seeking addition purchasers of CipherLoc Encryption Technology within the entertainment industry. The Company has valued the shares on the date of grant and recorded a stock payable in the amount of $177,300.

Nine months ended June 30, 2013

Stock Issued for Cash

During the nine months ended June 30, 2013, the Company issued 197,500 shares of common stock for $141,000 in net cash proceeds as follows:

Stock Issued in Connection with Software Licensing and Subscription Agreements

During the nine months ended June 30, 2013, the Company issued 400,000 shares of common stock valued at $12,313 based on the market price on the date of grant, to customers, in regards to the purchase of software from the Company in accordance with the Software Licensing and Subscription Agreements. The fair values of the shares issued were recorded as a reduction of software revenue recognized during the nine months ended June 30, 2013.

Stock Issued for Services

During the nine months ended June 30, 2013, the Company issued 945,500 shares of common stock as compensation. The fair values of the shares were a total of $31,829 and were recorded at the market price on the date of grant. The issuances of stock were as follows:

Stock Issued for Assets Acquisition

During the nine months ended June 30, 2013, the Company issued 400,000 shares of common stock for the acquisition of CipherSmith software. Those shares were valued at $13,000 based on the market price on the dates of grant.

Preferred Stock

The Company has authorized 4,000,000 shares of preferred stock, at $0.01 par value and 4,000,000 are issued and outstanding as of September 30, 2013. Each share of the Preferred Stock has 150 votes on all matters presented to be voted by the holders of our common stock. All 4,000,000 shares of preferred stock have been granted to our CEO & CFO on November 30, 2010 and issued on April 11, 2012 which was valued at the trading price of the common stock of $0.0095 and recorded as an expense of $38,000.

On December 17, 2013, the Company amended its Articles of Incorporation that gave the right to the holders of Preferred A shares to convert 1 share of Convertible Preferred A shares to 150 Common Shares of the Company. The holders of the Preferred A shares can convert the shares upon proper notice and approval of the Board of Directors. Presently, the holders of the Preferred A shares have not sent notice to the Board of Directors.

NOTE 12 – SEGMENT INFORMATION

Cloud Medical Doctors Software Corporation has two reporting segments and corporate overhead:

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performances based on profit or loss from operations before income taxes, not including nonrecurring gains and losses and foreign exchange gains and losses. The reportable segments are strategic business units that offer different technology and marketing strategies. Most of the businesses were developed internally and management remains the same. To date, the Company’s operations are principally in the United States.

Consolidated revenues from external customers, operating loss, and identifiable assets were as follows:

NOTE 13 – SUBSEQUENT EVENTS

On July 11, 2014 the Company issued 35,000 common shares for compensation. The stock was issued as compensation for work performed on our Cypher Loc Encryption Technology. The shares were valued at $2,450 based on the market price on the date of grant.

In this Quarterly Report on Form 10-Q, “Company,” “our company,” “us,” and “our” refer to Cloud Medical Doctor Software Corporation and its subsidiaries, unless the context requires otherwise.

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

Management’s Discussion and Analysis contains various “forward looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, regarding future events or the future financial performance of the Company that involve risks and uncertainties. Certain statements included in this Form 10-Q, including, without limitation, statements related to anticipated cash flow sources and uses, and words including but not limited to “anticipates”, “believes”, “plans”, “expects”, “future” and similar statements or expressions, identify forward looking statements. Any forward-looking statements herein are subject to certain risks and uncertainties in the Company’s business, including but not limited to, reliance on key customers and competition in its markets, market demand, delayed payments of accounts receivables, technological developments, maintenance of relationships with key suppliers, difficulties of hiring or retaining key personnel and any changes in current accounting rules, all of which may be beyond the control of the Company. Management will elect additional changes to revenue recognition to comply with the most conservative SEC recognition on a forward going accrual basis as the model is replicated with other similar markets (i.e. SBDC). The Company’s actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth therein.

Forward-looking statements involve risks, uncertainties and other factors, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements. Factors and risks that could affect our results and achievements and cause them to materially differ from those contained in the forward-looking statements include those identified in the section titled “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended September 30, 2013, as well as other factors that we are currently unable to identify or quantify, but that may exist in the future.

In addition, the foregoing factors may affect generally our business, results of operations and financial position. Forward-looking statements speak only as of the date the statement was made. We do not undertake and specifically decline any obligation to update any forward-looking statements.

Our Business

Cloud Medical Doctor Software Corporation (the “Company”) was incorporated in Texas on June 22, 1953 as American Mortgage Company. On May 16, 1996, the Company changed its name to National Scientific Corporation. On April 3, 2012, the Company changed its name to Cloud Medical Doctor Software Corporation. 

In the year ended September 30, 2011, Cloud-MD introduced the Cloud-MD Office, a “Cloud Based”, 5010 ready and ICD-10 compliant, fully integrated and interoperable suite of medical software and services, designed by experienced healthcare analysts and programmers for healthcare providers, that produces “Actionable Information” to help Independent Physician Practices, New Care Delivery Models (ACO), Healthcare Systems and Billing Services optimize a wide range of business processes resulting in Increased Profits, Higher Quality, Greater Efficiency, Noticeable Cost Reductions and Better Patient Care. Current software product offerings include Practice Management, Electronic Medical Records, Revenue Management, Patient Financial Solutions, Medical and Pharmaceutical Supply Management, Claims Management and PHI Exchange.

In the year ended September 30, 2012, Cloud-MD launched Cloud-MD Billing Services which provides management of medical claims from posting physician charges and payments into our medical billing software. The software uses a continuous insurance claim follow-up system to track and research all rejected or denied medical claims; a Comprehensive Reporting module that includes monthly financial statements sent to our clients so they can see how their practice is performing and a variety of detailed reports giving our clients the necessary information and tools used to assist in the increased production which leads to more profit; and patient account inquiries and support to assist patients with their billing and insurance questions.

On November 21, 2012, the Company purchased from CipherSmith, LLC a complete source code, intellectual property rights, all computer software or algorithm licensed or sold under CipherSmith, and appropriate copy rights, patents, mask works, trademarks, service marks, internet domain names or world wide web URS. CipherLoc is an entirely new approach to the problem of encryption and it consists of both a Polymorphic Cipher Engine (software) and a Polymorphic Hardware Engine. The Polymorphic Cipher Engine and the Polymorphic Hardware Engine platforms are designed to work together, but, are actually mutually exclusive of each other and can be used separately in a multitude of divergent ways. The Company currently is selling this encryption technology to commercial users that are in need of Polymorphic encryption technology to protect their members.

Strategy

Our strategy is to establish leadership in the evolving software services and products. We have already established a cloud based application in our two revenues segments and we intend to commit more sales staff to develop a sustainable financial performance. To be successful we must implement and focus our priority on our sales team by developing a large sales base to sell our cloud based medical billing software and allow our technical experts to meet with commercial buyers of our encryption technology. The new focus will provide a strong foundation for our long-term growth.

Our Operating Segments

Cloud Medical Doctors Software Corporation has two reporting segments and corporate overhead:

The Future for Cloud-MD™

Our business strategy includes the acquisition of successful billing companies in strategic markets, the acquisition or licensing of useful emerging technologies and the direct sale to physicians of Cloud-MD™ Office software licenses.

On the Medical Software and Billing Services side of the equation, Cloud-MD™ has already begun the sale of software licenses and the acquisition of billing companies with the purchase of Doctors Network of America, LLC and is currently in final negotiations with two others billing companies in Texas and we are currently in talks with another medical software company to acquire their software assets and customer base.

Our model is effective because we offer:

As we move forward building on our current platforms and strengths and gaining significant momentum in acquisitions, capabilities and revenue streams, it is important for Cloud-MD™ to augment its portfolio of capabilities with solutions that complement those offerings currently available. With the addition of a pending acquisition, we will add another dimension to our Cloud-MD™ Office and Billing Services offering that will offer a secure mechanism for providers to exchange patient PHI without the need to have all of the providers on a common EMR platform, but will integrate with our EMR in a manner that offers prospective large clients such as hospitals, ACO’s, etc. the functionality of an Electronic Health Interchange without the huge costs and overhead. In addition, we have recently developed enhanced capabilities within our Cloud-MD™ Office product offering that will offer superior solutions to hospitalists, nursing home practitioners and providers of home health services.

The Company is currently negotiating a front end software interface that will enhance our software capabilities.

The Future for CipherLoc™

Our CipherLoc™ Polymorphic Cipher Engine is a ground-breaking; state-of-the-art Polymorphic Key Progression Algorithm (PKPA) based digital encryption solution that has wide-spread applicability throughout the commercial computer, communications and broadcasting industries as well as significant applicability in the government arena. The CipherLoc Polymorphic Hardware Engine has a current patent and is fully developed and ready for use.

CipherLoc is different from the historical Digital Cyber Security Solutions as it incorporates polymorphism which is the ability to change an encryption to another method of encryption or key on the fly. Polymorphic ciphers are more commonly known as “mutating” ciphers.

Polymorphic ciphers are an idea based on the information content in a message rather than the difficulty of the key. Using advanced set theory and information theory, this encryption method does not rely exclusively on large keys and complicated permutation/obscuring techniques. This makes the algorithm faster and requires less memory than other encryptions. A polymorphic cipher solves both asset intrusion and electronic attack problems.

Our business strategy includes the sales of our encryption technology for commercial use to credit card companies, investment companies, retailers, among others. We have internally tested our demonstration model with success and we have used this demonstration software to show potential buyers of its powerful security encryption technology. The digital cipher and encryption market offers seemingly endless opportunity. The Company is presently discussing licensing agreements with several large corporations that are in need of this software to protect their customers, passwords, websites and other devices that require data security.

Strategic Alliances

The Company entered into a consulting agreement with Hemp, Inc. The agreement requires Hemp to provide introductions, products, financing contacts, and other significant business opportunities to the Company. The principles of Hemp, Inc. have had a long term relationship with the CEO of Gawk, Inc. (“Gawk”) which facilitated in our first sale of our CipherLoc Encryption Technology.

Presently the entertainment industry has one of the highest pirated assets and is in need for advance encryption technology to protect those assets. Accordingly, the Company has entered into consulting agreements to facilitate introductions with entertainment industry participants.

The Company entered into a consulting agreement with Gawk. This agreement was to help facilitate introductions by Gawk to the Company from their list of contacts in the entertainment industry. Through our relationship with Gawk, Inc. and its CEO we believe they will be instrumental in future introductions for the sale of our CipherLoc Encryption Technology.

The Company entered into an investor relations and consulting agreement with BCMG Entertainment, Inc. (“BCMG”). The agreement provides for BCMG to introduce the Company to participants in the entertainment industry. BCMG also has experience in market awareness which the Company can benefit from through this alliance.

On July 22, 2014 the Company entered into a consulting service agreement with Vindonnus Group/Alerce Global LLC. This agreement will provide marketing and sales strategies for the sale of CipherLoc our encryption technology. As compensation for the consulting services and sales, the consultant will receive 1,000,000 warrants exercised price of $1.00 with a three year live for each $10,000,000 in annualized sales directly attributed to Consultants efforts and subject to the terms and condition of the Agreement. This Agreement will help increase our sales and marketing of our CipherLoc Encryption Technology.

SIGNIFICANT ACCOUNTING POLICIES

The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are as follows:

Use of Estimates and Assumptions

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities known to exist as of the date the consolidated financial statements are published, and (iii) the reported amount of net revenues and expenses recognized during the periods presented. Adjustments made with respect to the use of estimates often relate to improved information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of consolidated financial statements; accordingly, actual results could differ from these estimates. The Company’s most significant estimates relate to the valuation of its proprietary technology and its valuation of its common stock.

Share-Based Compensation

The Company measures the cost of services received in exchange for an award of an equity instrument based on the grant-date fair value of the award.  Compensation cost is recognized over the vesting or requisite service period.

Basic and Diluted Net Income (Loss) per Common Share

Basic income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the reporting period. The weighted average number of shares is calculated by taking the number of shares outstanding and weighting them by the amount of time that they were outstanding.  Diluted earnings per share reflects the potential dilution that could occur if stock options, warrants, and other commitments to issue common stock were exercised or equity awards vest resulting in the issuance of common stock that could share in the earnings of the Company. The Company has 4,000,000 preferred shares that can be converted subject to the limitation of the Company’s authorized shares at 1 preferred share for 150 common shares. The conversion can only take place with the approval of the Board of Directors. At June 30, 2014, the preferred shares could be converted into 600,000,000 of common shares resulting in dilution of common shareholders. The preferred shares are anti-dilutive since the losses the Company has incurred for the periods ended June 30, 2014 and 2013.

Diluted loss per share is the same as basic loss per share during periods where net losses are incurred since the inclusion of the potential common stock equivalents would be anti-dilutive as a result of the net loss.

Revenue Recognition

Medical Licensing Agreement

License revenue consists principally of revenue earned under software license agreements. The Company sells its software to a medical practitioner for direct payment or through a third party leasing company for direct payment to the Company. The third party lease agreement is a non-recourse debt and the Company is not responsible for the default of the medical practitioner. License revenue is generally recognized when a signed contract or other persuasive evidence of an arrangement exists, the software has been electronically delivered, the license fee is fixed or is measured on a paid user basis; and collection of the resulting receivable is probable. When contracts contain multiple elements wherein Vendor-Specific Objective Evidence (“VSOE”) exists for all undelivered elements, we account for the delivered elements in accordance with the “Residual Method.”

VSOE of fair value for maintenance and support is established by a stated renewal rate, if substantive, included in the license arrangement or rates charged in stand-alone sales of maintenance and support. Revenue from subscription license agreements, which include software, rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription period.

Provided all other revenue criteria are met, the upfront, minimum, non-refundable license fees from customers are generally recognized upon delivery and on-going royalty fees are generally recognized upon reports of new licenses issued. If there is significant uncertainty about the project completion or receipt of payment for professional services, revenue is deferred until the uncertainty is sufficiently resolved. VSOE of fair value of services is based upon stand-alone sales of those services.

Subscription revenue is generated from bandwidth and information storage. In the first year and each year thereafter, the software is purchased and installed the purchaser will pay an annual fee of $1,200, $1,500, $1,800, and $2,400, respectively. Subscription revenue is recognized ratably over the term of the agreement.

Transaction revenue is generated from the following services and recognized when a transaction occurs:

The Company had not received any transaction revenues in the three and nine months ended June 30, 2014.

CipherLoc Licensing Agreement

License revenue consists also of revenue earned under CipherLoc License Agreement. License revenue is generally recognized when a signed contract or other persuasive evidence of an arrangement exists, the software has been electronically delivered, the license fee is fixed or is measured on a paid user basis; and collection of the resulting receivable is probable. When contracts contain multiple elements wherein Vendor-Specific Objective Evidence (“VSOE”) exists for all undelivered elements, we account for the delivered elements in accordance with the “Residual Method.”

VSOE of fair value for maintenance and support is established by a stated renewal rate, if substantive, included in the license arrangement or rates charged in stand-alone sales of maintenance and support. Revenue from subscription license agreements, which include software, rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription period.

Provided all other revenue criteria are met, the upfront, minimum, non-refundable license fees from customers are generally recognized upon delivery and on-going royalty fees are generally recognized upon reports of new licenses issued. If there is significant uncertainty about the project completion or receipt of payment for professional services, revenue is deferred until the uncertainty is sufficiently resolved. VSOE of fair value of services is based upon stand-alone sales of those services.

Financial results and trends

Results of Operations for the Three Months Ended June 30, 2014 and 2013

Revenue increased to $1,126,725 from $137,941 for the three months ended June 30, 2014 and 2013, respectively. Our revenues increased as a result of higher sales activity during the three months ended June 30, 2014 compared to the three months ended June 30, 2013. The higher sales activity is due to the Company’s focus on CipherLoc Encryption Technology.

Cost of revenue was $61,155 for the three months ended June 30, 2014 and 2013, respectively. Our cost of revenue was related to the amortization of the software costs placed into service.

Selling, general and administrative expenses increased to $1,079,306 from $202,005 for the three months ended June 30, 2014 and 2013, respectively. The increase in our selling, general and administrative expenses are related to the contract services of $920,900, and investor relations of $75,000 in the three months ended June 30, 2014 compared to contract services of $0, and investor relations of $0 in the three months ended June 30, 2013.

Research and development costs decreased to $0 from $58,044 for the three months ended June 30, 2014 and 2013, respectively. Our research and development costs decrease is related to decreased salary costs for programmers to update software required to be in compliance with the updates and modifications to the Affordable Care Act.

Interest expense increased to $1,656 from $15 for the three months ended June 30, 2014 and 2013, respectively. Our interest expense increased as a result of the increase in outstanding borrowings on our lines of credits.

We recorded loss from discontinued operations of $5,376 and to income of $1,138 for the three months ended June 30, 2014 and 2013, respectively. The Company is currently engaged in the medical billing operations.  Until October 1, 2009, the Company’s sole sources of revenues were from GPS operational device business.  The Company discontinued its GPS operational device business in February 2010 (See “Note 6 - Discontinued Operations” to the accompanying Consolidated Financial Statements).   

Results of Operations for the Nine Months Ended June 30, 2014 and 2013

Revenue increased to $1,349,400 from $461,512 for the nine months ended June 30, 2014 and 2013, respectively. Our revenues increased as a result of higher sales activity during the nine months ended June 30, 2014 compared to the nine months ended June 30, 2013. The higher sales activity is due to the Company’s focus on CipherLoc Encryption Technology.

Cost of revenue increased to $183,465 from $182,315 for the nine months ended June 30, 2014 and 2013, respectively. Our cost of revenue increased during the nine months ended due to the additional amortization of the software costs placed into service.

Selling, general and administrative expenses increased to $2,447,524 from $537,830 for the nine months ended June 30, 2014 and 2013, respectively. The increase in our selling, general and administrative expenses are related to the salaries and bonuses of management of $1,133,583, contract services of $920,900, accounting fees of $126,852, investor relations of $75,000, and legal costs of $44,635 in the nine months ended June 30, 2014 compared to $290,150 of salaries and bonuses of management, contract services of $0, accounting fees of $59,000, investor relations of $0 and legal costs of $2,800 in the nine months ended June 30, 2013.

Research and development costs decreased to $20,000 from $153,044 for the nine months ended June 30, 2014 and 2013, respectively. Our research and development costs decrease is related to decreased salary costs for programmers to update software required to be in compliance with the updates and modifications to the Affordable Care Act.

Interest expense increased to $2,171 from $211 for the nine months ended June 30, 2014 and 2013, respectively. Our interest expense increased as a result of the increase in outstanding borrowings on our lines of credits.

We recorded a loss from discontinued operations of $12,893 and to income of $60,084 for the nine months ended June 30, 2014 and 2013, respectively. The Company is currently engaged in the medical billing operations. Until October 1, 2009, the Company’s sole sources of revenues were from GPS operational device business.  The Company discontinued its GPS operational device business in February 2010 (See “Note 6 - Discontinued Operations” to the accompanying Consolidated financial statements).   

Liquidity and Capital Resources

We expect to incur substantial expenses and generate significant operating losses as we continue to grow our operations, as well as incur expenses related to operating as a public company and compliance with regulatory requirements. At June 30, 2014, the Company had cash of $828,156.

We have an accumulated deficit at June 30, 2014 of $27,858,918 and need additional cash flows to maintain our operations. We depend on the continued contributions of our executive officers to finance our operations and need to obtain additional funding sources to explore potential strategic relationships and to provide capital and other resources for the further development and marketing of our products and business. We expect our cash needs for the next 12 months to be $850,000 to fund our operations. The ability of the Company to continue its operations is dependent on the successful execution of management’s plans, which include expectations of raising debt or equity based capital until such time that funds from operations are sufficient to fund working capital requirements. The Company may need to incur additional liabilities with related parties to sustain the Company’s existence. There is no assurance that such funding, if required will be available to us or, if available, will be available upon terms favorable to us.

Sources of Cash

The Company has a revolving line of credit with Chase Bank with a balance as of June 30, 2014 in the amount of $0 and a borrowing limit of $50,000. We have previously received advances from our Chief Executive Officer which we have used to help fund our operations.

In November 2013, the Company entered into a revolving line of credit with Mutual of Omaha for a line of credit at 4.00% interest rate which renews annually. The outstanding balance as of June 30, 2014 is $62,612.

We believe that our existing cash and investment balances, our available revolving credit facility, our ability to issue new debt instruments, and cash generated from operations will be sufficient to meet our working capital and capital expenditure requirements. Our strategy emphasizes organic growth through internal innovation and will be complemented by acquisitions that fit strategically and meet specific internal profitability hurdles.

Uses of Cash

Our revolving lines of credit renew annually and we make significant principle payments to those lines to assure that they remain a line of credit.

We have a commitment of payment based upon performance from BCMG for an investor relations agreement and market awareness consulting agreement in the amount of $450,000. We have paid BCMG $75,000 as of June 30, 2014. We will continue to pays $25,000 per month based on performance until the contract is satisfied.

Cash Flow

The following table summarizes, for the periods indicated, selected items in our Condensed Consolidated Statements of Cash Flows:

Operating Activities

Cash flows from operating activities. Our cash provided by (used in) operating activities were $752,098 and ($40,043) for the nine months ended June 30, 2014 and 2013, respectively. The increase in cash provided by operations was primarily attributable to the increase of revenue generated by our Cypher Loc segment.

Investing Activities

Cash flows from investing activities. Our cash used in investing operating activities were $0 and $10,147 for the nine months ended June 30, 2014 and 2013, respectively. The decrease in cash used in investing activities was primarily attributable to the purchase of intangible assets for $11,000 and the sale of assets of $1,353 in June 30, 2013 with no such activities in the nine months ended June 30, 2014.

Financing Activities

Cash flows from financing activities. Cash provided by financing activities was $67,816 and $98,646 for the nine months ended June 30, 2014 and 2013, respectively. We received cash from the sale of our common stock of $15,000 and $141,000 for the nine months ended June 30, 2014 and 2013, respectively. During the nine months ended June 30, 2014, we received $103,529 from our lines of credit, repaid our lines of credit of $50,713. We also received $8,299 in advances from our officer, and repaid $8,299 to our officer. During the nine months ended June 30, 2013, we received $5,664 from our Chase line of credit, repaid the Chase line of credit of $22,427, and repaid our advances from our officer of $25,591.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements including arrangements that would affect the liquidity, capital resources, market risk support and credit risk support or other benefits.

WHERE YOU CAN FIND MORE INFORMATION

You are advised to read this Quarterly Report on Form 10-Q in conjunction with other reports and documents that we file from time to time with the SEC. In particular, please read our Quarterly Reports on Form 10-Q, Annual Report on Form 10-K, and Current Reports on Form 8-K that we file from time to time. You may obtain copies of these reports directly from us or from the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E. Washington, D.C. 20549, and you may obtain information about obtaining access to the Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains information for electronic filers at its website http://www.sec.gov.

ITEM 3.         QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not hold any derivative instruments and do not engage in any hedging activities.

ITEM 4.          CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

The SEC defines the term “disclosure controls and procedures” to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. “Disclosure controls and procedures” include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management. Our management (with the participation of our Chief Executive Officer and Chief Financial Officer) has conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act). Based on such evaluation, our Chief Executive Officer and our interim Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this report.

PART II

OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are currently not involved in any litigation that we believe could have a material adverse effect on our financial condition or results of operations. There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of the executive officers of our company or any of our subsidiaries, threatened against or affecting our company, our common stock, any of our subsidiaries or of our company’s or our company’s subsidiaries’ officers or directors in their capacities as such, in which an adverse decision is expected to not have a material adverse effect.

On July 5, 2013, the Company filed a complaint against Krooss Medical Management Systems, LLC, William F. Krooss and Marie W. Krooss in the United States District Court, District of Nevada Case No. 2013-CV-01187-ABG-VCF for the collection of $200,000 of unpaid medical billing fees that were seriously delinquent. After many attempts by the Company to begin collections, the Defendants refused to pay the outstanding balances, however expected the Company to continue to bill for them. The Complaint includes causes of action Breach of the PTAPA, Breach of Billing and Collections Contracts, Negligence, Breach of the Duty of Good Faith and Fair Dealing, Tortious Interference with Business Relations, Fraud, among other causes of action.

On August 13, 2013, Krooss Medical Management Systems et al filed a Complaint in Chancery Court of Rankin County, Mississippi Case No. 13-1372 as a strategy to keep the collection matter in Mississippi Chancery Court.

Case No. 13-1372 was remanded to the United States District Court, Southern District of Mississippi Jackson Division Case No. 3:13CV507-HTW-LRA.

This litigation is a collection matter of unpaid fees by the Defendants and the Company vehemently denies the allegations (Breach of the Permanent Transfer Asset Purchase Agreement (“PTAPA”), Rescission of the PTAPA, Breach of Billing and Collections Contracts, Negligence, Quantum Meruit, Restitution, and Estoppel, Breach of the Duty of Good Faith and Fair Dealing, Tortious Interference with Business Relations, among other causes of action) filed in Mississippi Chancery Court related to this collection matter. The Company does not expect the cost to litigate this matter to adversely affect the Company’s operations. However, the Company has reduced operations in DNA-Cloud in Mississippi as the sellers have interfered with the billing contracts purchased which is one of the causes of action in Complaint, among others. Many of the contracts have been terminated due to the interference by the sellers, and DNA-Cloud has not been able to expand the business because of the reputation of the sellers in Jackson, Mississippi and the surrounding area.

ITEM 1A - RISK FACTORS

There were no material changes from the risk factors previously disclosed in Part II, Item 1A, “Risk Factors” in our  Annual Report on Form 10-K for the year ended September 30, 2013 during our nine months ended June 30, 2014.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS SECURITIES

Period from July 1, 2014 to August 3, 2014

None

Nine months ended June 30, 2014

Stock Issued for Cash

During the nine months ended June 30, 2014, the Company issued 35,000 shares of common stock for $15,000 in net cash proceeds as follows:

Stock Issued in Connection with Software Licensing and Subscription Agreements

During the nine months ended June 30, 2014, the Company issued 220,000 shares of common stock valued at $5,700 based on the market price on the date of grant, to customers, in regards to the purchase of software from the Company in accordance with the Software Licensing and Subscription Agreements. The fair values of the shares issued were recorded as a reduction of software revenue recognized during the three months ended June 30, 2014.

Stock Issued for Assets Acquisition

In October 2013, the Company through a purchase agreement with Antree Systems Limited has purchased a complete source code, intellectual property rights, all computer software, patents, or formulas, algorithm licensed or sold under a project known as Compass Rose and appropriate copyrights, patents, mask works, trademarks, service marks, internet domain names and world wide web uniform resource locators (“URLs”) from Antree Systems Limited. The Company issued 200,000 shares of its common stock as consideration for the purchase. The fair value of the consideration and the assets acquired is based on the fair value of the common stock issued in exchange for the software. The total fair value, based on the market price on the date of grant, was $6,000. The Company evaluated this acquisition and determined that it did not meet the definition of a significant business acquisition.

In November 2013, the Company issued 180,000 shares of common stock as replacement shares for the 160,000 shares of common stock issued to Antree Systems Limited and 20,000 shares of common stock to Kimberly Ilicerl. The Company intends to cancel the original shares issued because the shares were lost during delivery to Antree Systems.

Stock Issued for Services

During the nine months ended June 30, 2014, the Company issued 65,207,506 shares of common stock as compensation. The fair values of the shares were a total of $1,432,869 and were recorded at the market price on the date of grant. The issuances of stock were as follows:

Nine months ended June 30, 2013

Stock Issued for Cash

During the nine months ended June 30, 2013, the Company issued 197,500 shares of common stock for $141,000 in net cash proceeds as follows:

Stock Issued in Connection with Software Licensing and Subscription Agreements

During the nine months ended June 30, 2013, the Company issued 400,000 shares of common stock valued at $12,313 based on the market price on the date of grant, to customers, in regards to the purchase of software from the Company in accordance with the Software Licensing and Subscription Agreements. The fair values of the shares issued were recorded as a reduction of software revenue recognized during the nine months ended June 30, 2013.

Stock Issued for Services

During the nine months ended June 30, 2013, the Company issued 945,500 shares of common stock as compensation. The fair values of the shares were a total of $31,829 and were recorded at the market price on the date of grant. The issuances of stock were as follows:

Stock Issued for Assets Acquisition

During the nine months ended June 30, 2013, the Company issued 400,000 shares of common stock for the acquisition of CipherSmith software. Those shares were valued at $13,000 based on the market price on the dates of grant.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

There were no defaults upon senior securities during the nine months ended June 30, 2014.

ITEM 4. MINING SAFETY DISCLOSURES 

N/A

ITEM 5.  OTHER INFORMATION

There is no information with respect to which information is not otherwise called for by this form.

ITEM 6.  EXHIBITS

Exhibits

____________

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.