Usio, Inc. - Quarter Report: 2022 September (Form 10-Q)

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

USIO, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

See the accompanying notes to the condensed interim consolidated financial statements.

USIO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

See the accompanying notes to the condensed interim consolidated financial statements.

USIO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

See accompanying notes to the condensed interim consolidated financial statements.

USIO, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

(UNAUDITED)

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

USIO, INC.

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1. Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements of Usio, Inc. and its subsidiaries (the “Company”) have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles have been omitted pursuant to such rules and regulations. In the opinion of management, the accompanying interim condensed consolidated financial statements reflect all adjustments of a normal recurring nature considered necessary to present fairly the Company's financial position, results of operations and cash flows for such periods. The accompanying unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2021, as filed with the Securities and Exchange Commission on March 17, 2022. Results of operations for interim periods are not necessarily indicative of results that may be expected for any other interim periods or the full fiscal year. References in this quarterly report to "the quarter" or the "third quarter" mean the three month period ended September 30, 2022 or 2021 , as the case may be.

Use of Estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Revenue Recognition: Revenue consists primarily of fees generated through the electronic processing of payment transactions and related services. Revenue is recognized during the period in which the transactions are processed or when the related services are performed. The Company complies with ASC 606-10 and reports revenues at gross as a principal versus net as an agent. Although some of the Company's processing agreements vary with respect to specific credit risks, the Company has determined that for each agreement it is acting in the principal role. Revenues derived from electronic processing of credit, debit, and prepaid card transactions that are authorized and captured through third-party networks are reported as gross of amounts paid to sponsor banks as well as interchange and assessments paid to credit card associations. Merchants processing credit, debit, prepaid card, and ACH transactions may be charged for these services at a bundled rate based on a percentage of the dollar amount of each transaction and, in some instances, additional fees are charged for each transaction. Certain merchant customers may also be charged miscellaneous fees, including fees for chargebacks or returns, monthly minimums, and other miscellaneous services. Certain card distributors remit payment of fees earned 45 days after the end of the processing period. Prepaid card distributors have payment terms of 30 days following the end of the month. Sales taxes billed are reported directly as a liability to the taxing authority and are not included in revenue.  Our wholly-owned subsidiary, Usio Output Solutions, Inc., or Output Solutions, provides bill preparation, presentment and mailing services. Revenue from Output Solutions is recognized when the related services are performed for printing and delivered to the United States Postal Service, or USPS, for postage.

The following table presents the Company's revenues by source:

Deferred Revenues: The Company records deferred revenues as a liability when it receives payments in advance of transferring control of promised goods or services to a customer. The advance consideration received from a customer is deferred until the Company provides the customer that product or service. The deferred revenues totaled $0 and $17,647 at September 30, 2022 and December 31, 2021, respectively.

Cash and Cash Equivalents: Cash and cash equivalents includes cash and other money market instruments. The Company considers all highly liquid investments with an original maturity of 90 days or less to be cash equivalents.

Settlement Processing Assets and Obligations: Settlement processing assets and obligations represent intermediary balances arising in our settlement process for merchants.

Customer Deposits: The Company holds customer deposits primarily for postage expenses to ensure the Company is not out of pocket for amounts billed daily by the USPS. These customer deposits are carried on the Company's balance sheet with a corresponding liability.

Merchant Reserves: The Company has merchant reserve requirements associated with Automated Clearing House, or ACH, transactions. The merchant reserve assets are carried on the Company's balance sheet with a corresponding liability. Merchant Reserves are set for each merchant and funds are collected and held as collateral to minimize contingent liabilities associated with any losses that may occur. While this cash is not restricted in its use, the Company believes that designating this cash to collateralize Merchant Reserves strengthens its standing with the Company's member sponsors and is in accordance with the guidelines set by the card networks.

Prepaid Card Load Assets: The Company maintains pre-funding accounts for its customers to facilitate prepaid card loads as initiated by the customer. These prepaid card load assets are carried on the Company's balance sheet with a corresponding liability.

The reconciliation of cash and cash equivalents to cash, cash equivalents, prepaid card load assets, customer deposits and merchant reserves is as follows for each period presented:

Allowance for Estimated Losses: The Company maintains an allowance for estimated doubtful accounts receivable resulting from the inability or failure of the Company’s customers to make required payments. The Company determines the allowance for estimated doubtful accounts receivable losses based on an account-by-account review, taking into consideration such factors as the age of the outstanding balance, historical pattern of collections, and financial condition of the customer. During the nine months ended September 30, 2022 and the year ended  December 31, 2021, losses incurred by the Company due to bad debts were within its expectations. If the financial conditions of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make contractual payments, additional losses may be incurred in future periods. Estimates for doubtful account losses are variable based on the volume of transactions processed and could increase or decrease accordingly. The allowance for estimated doubtful accounts was $319,000 at September 30, 2022 and December 31, 2021.

Inventory: Inventory is stated at the lower of cost or net realizable value. At September 30, 2022 and December 31, 2021, inventory consisted primarily of printing and paper supplies used for Output Solutions.

Accounting for Internal Use Software: The Company capitalizes the costs associated with software being developed or obtained for internal use when both the preliminary project stage is completed, and it is probable that computer software being developed will be completed and placed-in service. Capitalized costs include only (i) external direct costs of materials and services consumed in developing or obtaining internal-use software, (ii) payroll and other related costs for employees who are directly associated with and who devote time to the internal-use software project, and (iii) interest costs incurred, when material, while developing internal-use software. The Company ceases capitalization of such costs no later than the point at which the project is substantially complete and ready for its intended purpose. During the nine months ended September 30, 2022 and September 30, 2021, the Company capitalized $438,128 and $561,177, respectively.

Valuation of Long-Lived and Intangible Assets: The Company assesses the impairment of long-lived and intangible assets at least annually, and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important, which could trigger an impairment review, include the following: significant under performance relative to historical or projected future cash flows; significant changes in the manner of use of the assets or the strategy of the overall business; and significant negative industry trends. When management determines that the carrying value of long-lived and intangible assets may not be recoverable, impairment is measured as the excess of the assets’ carrying value over the estimated fair value. No impairment losses were recorded in 2021 or during the nine months ended September 30, 2022. Management is not aware of any impairment changes that may currently be required; however, the Company cannot predict the occurrence of events that might adversely affect the reported values in the future.

Reserve for Processing Losses: If, due to insolvency or bankruptcy of one of the Company’s merchant customers, or for any other reason, the Company is not able to collect amounts from its credit card, ACH or prepaid customers that have been properly "charged back" by the customer, or if a prepaid cardholder incurs a negative balance, the Company must bear the credit risk for the full amount of the transaction. The Company may require cash deposits and other types of collateral from certain merchants to minimize any such risks. In addition, the Company utilizes multiple systems and procedures to manage merchant risk. ACH, prepaid and credit card merchant processing loss reserves are primarily determined by performing a historical analysis of the Company’s loss experience, considering other factors that could affect that experience in the future, such as the types of transactions processed and nature of the merchant relationship with its consumers and the Company’s relationship with the Company’s prepaid card holders. This reserve amount is subject to the risk that actual losses may be greater than the Company’s estimates. The Company has not incurred any significant processing losses to date. Estimates for processing losses are variable based on the volume of transactions processed and could increase or decrease accordingly. At September 30, 2022 and December 31, 2021, the Company’s reserve for processing losses was $722,494 and $623,494 respectively.

Legal Proceedings: The Company may be involved in legal matters arising in the ordinary course of business from time to time. While the Company believes that such matters are currently not material, there can be no assurance that matters arising in the ordinary course of business for which the Company is or could become involved in litigation will not have a material adverse effect on its business, financial condition or results of operations.

New Accounting Pronouncements: In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326), to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date.  To achieve this objective, the amendments in Topic 326 replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.  Topic 326 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years for smaller reporting companies. The Company does not expect the adoption of the amendments in ASU 2016-13 to have a significant effect on its financial position and the results of its operations when such amendment is adopted.

Accounting standards that have been issued or proposed by the FASB, the SEC or other standard setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

Note 2. Leases

The Company leases facilities and office equipment under various operating leases, which generally are expected to be renewed or replaced by other leases. For each of the three months ended September 30, 2022 and 2021, operating lease expenses totaled $152,401 and $117,689, respectively.

Note 3. Accrued Expenses

Accrued expenses consisted of the following balances:

Note 4. Equipment Loan

On March 20, 2021, the Company entered into a debt arrangement to finance $165,996 for the purchase of an Output Solutions sorter. The loan is for a period of 36 months with a maturity date of March 20, 2024 and annual interest of 3.95%. Monthly principal and interest payments are required in the amount of $4,902. Payments for the three and nine months ended September 30, 2022 were $13,762 and $40,872, respectively.

Note 5. Stockholders' Equity

Stock Warrants: On August 21, 2018, the Company issued University FanCards, LLC a warrant to purchase 150,000 shares of the Company's common stock which were subject to the following vesting schedule: (i) 30,000 warrants vested upon the date on which the first financial transaction was processed, which occurred on October 5, 2018; and (ii) 120,000 warrants vested annually over 4 years in 30,000 warrant increments beginning on July 31, 2019 and ending on July 31, 2022. The exercise price for the initial 30,000 warrants was $1.80 per share. The exercise price for the remaining 120,000 warrants was the lesser of $2.00 per share or one hundred and twenty percent (120%) of the market price of the Company's common stock on the vesting date of the warrant. At the time of issuance, the warrants were valued using the Black-Scholes option pricing model. Assumptions used were as follows: (i) the fair value of the underlying stock was $0.94 for the 30,000 warrants and $0.90 for the 120,000 warrants; (ii) the risk-free interest rate is 2.77%; (iii) the contractual life is 5 years; (iv) the dividend yield is 0%; and (v) the volatility is 64.6%. The fair value of the warrants was $135,764 which will be amortized over the life of the warrants as a reduction of revenues. The reduction of revenues recorded for the nine months ended September 30, 2022 and 2021 was $20,965 and $26,955 respectively.

On August 12, 2020, the Company issued 27,051 shares of our common stock to University FanCards, LLC in a cashless exercise at $3.46 per share in exchange for 60,000 warrants exercised by FanCards, LLC.

On February 5, 2021, the Company issued 19,795 shares of our common stock to University FanCards, LLC in a cashless exercise at $5.88 per share in exchange for 30,000 warrants exercised by FanCards, LLC.

On September 1, 2021, the Company issued 19,950 shares of our common stock to University FanCards, LLC in a cashless exercise at $5.97 per share in exchange for 30,000 warrants exercised by FanCards, LLC.

On December 15, 2020, the Company issued warrants to purchase 945,599 shares of the Company's common stock with an exercise price of $4.23 per share to Information Management Solutions, LLC. The Management Solutions' warrants vest annually over 3 years in three equal tranches beginning on December 15, 2021 and become fully vested on December 15, 2023. At the time of issuance, these warrants were valued using the Black-Scholes option pricing model. Assumptions used were as follows: (i) the fair value of the underlying stock was $0.58; (ii) the risk-free interest rate is 0.09%; (iii) the contractual life is 5 years; (iv) the dividend yield of 0%; and (v) the volatility is 59.9%. The fair value of the warrants amounted to $552,283 and will be recorded as an increase in the customer list asset and have a term of five years from time of vest.

Note 6. Net (Loss) Per Share

Basic (loss) per share (EPS) was computed by dividing net (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted EPS differs from basic EPS due to the assumed conversion of potentially dilutive awards and options that were outstanding during the period. The following is a reconciliation of the numerators and the denominators of the basic and diluted per share computations for net (loss) for the three and nine months ended September 30, 2022 and September 30, 2021.

The awards and options to purchase shares of common stock that were outstanding at September 30, 2022 and September 30, 2021 that were not included in the computation of diluted earnings per share because the effect would have been anti-dilutive, are as follows:

Note 7. Income Taxes

Deferred tax assets and liabilities are recorded based on the difference between financial reporting and tax basis of assets and liabilities and are measured by the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Deferred tax assets are computed with the presumption that they will be realizable in future periods when taxable income is generated. Predicting the ability to realize these assets in future periods requires judgment by management. U.S. generally accepted accounting principles prescribe a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return. Income tax benefits that meet the “more likely than not” recognition threshold are recognized.

The Company has recognized a net deferred tax asset of approximately $1.5 million and has recorded a valuation allowance of approximately $5.2 million against the other deferred tax assets. The Company reviews the assessment of the deferred tax asset and valuation allowance on an annual basis or more often when events indicate that a change to the valuation allowance may be warranted.

At  December 31, 2021, the Company had available net operating loss carryforwards of approximately $29.5 million. Net operating loss carryforwards prior to 2017 are available to offset taxable income of future periods and expire 20 years after the loss was generated. 

Net operating loss carryforwards totaling $10.7 million expired in 2021. The schedule below outlines when the Company's pre-2017 net operating losses were generated and the year they  may expire.

Effective for tax years ending in 2018, net operating losses can be carried forward to future years indefinitely. Net operating losses generated in 2018 and later total $9,413,692. The below table outlines our net operating losses generated in 2018 and after.

Management is not aware of any tax positions that would have a significant impact on the Company’s financial position.

Note 8. Related Party Transactions

Louis Hoch

During the nine months ended September 30, 2022 and the year ended December 31, 2021, the Company purchased a total of $22,478 and $4,009, respectively, of corporate imprinted sportswear and caps from Angry Pug Sportswear. Louis Hoch, the Company’s Chairman of the Board, President, and Chief Executive Officer, is a 50% owner of Angry Pug Sportswear.

Directors and Officers

On  January 6, 2022, the Company repurchased 11,361 shares for $47,930 in a private transaction at the closing price on  January 6, 2022 of $4.21 per share from Tom Jewell, the Company's Chief Financial Officer, to cover his share of taxes in the vesting of stock compensation issued via a 3-year RSU.

On January 6, 2021, the Company repurchased 11,860 shares of common stock at a closing price of $3.25 per share from Tom Jewell, the Company's Chief Financial Officer to cover his share of taxes in the vesting of stock compensation issued via a 3-year RSU.

The Company granted 319,900 shares of restricted common stock with a 10-year vesting period and 141,900 restricted stock units (RSUs) with a 3-year vesting period to employees and Directors as a performance bonus on  November 18, 2021 at an issue price of $6.39 per share. Executive officers and Directors included in the 10-year restricted stock grant were Louis Hoch (100,000 shares), Tom Jewell (50,000 shares), Greg Carter (30,000 shares) and Houston Frost (25,000 shares). Executive officers and Directors included in the RSU grant were Louis Hoch (30,000 shares), Tom Jewell (21,000 shares), Greg Carter (9,000 shares) Houston Frost (6,000 shares), Blaise Bender (12,000 RSUs), Brad Rollins (12,000 RSUs) and Ernesto Beyer (12,000 RSUs).

On April 1, 2021, the Company granted 1,444,000 shares of restricted common stock with a 10-year vesting period and 103,000 restricted stock units (RSUs) with a 3-year vesting period to employees and Directors as a performance bonus at an issue price of $1.08 per share. Executive officers and Directors included in the grants were Louis Hoch (300,000 shares), Tom Jewell (200,000 shares), Blaise Bender (10,000 RSUs) and Brad Rollins (30,000 RSUs).

Note 9. COVID-19

The ongoing COVID-19 pandemic has had a notable impact on general economic conditions, including but not limited to the temporary closures of many businesses, “shelter in place” and other governmental regulations, reduced consumer spending due to both job losses and other effects attributable to the COVID-19 pandemic. There remain many uncertainties as a result of the pandemic.  As a result of the spread of COVID-19, economic uncertainties could continue to impact our operations. Any potential incremental financial impact is unknown at this time.

During 2020 and 2021, the government issued several rounds of COVID-19 relief and stimulus payments and other programs to stimulate economic activity and facilitate an economic recovery.  

In  April and  May of 2020, the Company's business was adversely affected as doctor's offices, dental offices, veterinarian offices and non-bank consumer lending accounts were ordered closed in connection with curbing the spread of the pandemic.   As these doctors, dental and veterinarian offices re-opened, these businesses quickly recovered and returned to levels higher than pre-COVID.   Consumer lending merchants were adversely affected by COVID relief payments made during the pandemic and a pause placed on past due amounts owed.   The level of activity for consumer lending merchants continues to recover to pre-COVID levels.  The Company recorded an increase in revenues in its prepaid business line, as it was able to work in conjunction with major cities across the U.S. to use its prepaid debit cards to facilitate the transfer of money via its debit cards from city foundations to the local residents in need of financial assistance.  The efforts have included the disbursement of funds to encourage vaccinations. 

Since 2020, the Company has experienced some difficulty in recruiting and retaining certain categories of employees due to limited labor availability.  The Company continues to monitor labor availability and is taking necessary steps to retain employees and recruit employees to fill open positions.

Due to the COVID-19 pandemic and global economic challenges, supply chain issues have resulted in a reduced supply, and growing demand of paper and paper products utilized in our Output Solutions line of business. Sourcing inventory remains a key challenge to execute jobs and projects with existing and new customers. While these efforts have been successful thus far, if the Company cannot continue to acquire sufficient inventory stock, the successful completion, margins, and growth of Output Solutions  may be impacted.

The impacts and recovery from the COVID-19 pandemic are still a work in process.  To date, the Company has not been adversely impacted in the magnitude that other payment processors were, as our customer base had limited exposure to retail facing businesses.   Within that framework, the Company will continue to monitor the overall impact on its operations and take necessary steps to ensure the safety of its employees and the well-being of its customers.

Note 10. Subsequent Events

Following the close of the quarter ended  September 30, 2022 the Company has bought 135,578 incremental shares of stock on the open-market as part of its stock buyback program in the amount of $232,611. 

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

FORWARD-LOOKING STATEMENTS DISCLAIMER

This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. If used in this report, the words "anticipate," "believe," "estimate," "intend," and other words or phrases of similar import are intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described in our annual report on Form 10-K and other reports we file with the Securities and Exchange Commission. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made. We do not intend to update any of the forward-looking statements after the date of this report to conform these statements to actual results or to changes in our expectations, except as required by law.

This discussion and analysis should be read in conjunction with the unaudited interim condensed consolidated financial statements and the notes thereto included in this report, and our annual report on Form 10-K for the fiscal year ended December 31, 2021, filed on March 17, 2022, including the audited consolidated financial statements and the notes contained therein.

Name Change

Effective on June 26, 2019, we changed our corporate name from Payment Data Systems, Inc. to Usio, Inc.

Overview

We provide integrated payment processing services to merchants and businesses, including all types of Automated Clearing House, or ACH, processing, credit, prepaid card and debit card-based processing services and statement preparation, presentment and mailing services.

In addition, we offer customizable prepaid cards which companies use for expense management, incentives, refunds, claims and disbursements, as well as unique forms of compensation such as per diem payments, government disbursements, and similar payments. We also offer prepaid cards to consumers for use as a tool to stay on budget, manage allowances and share money with family and friends. Our UsioCard platform supports Apple Pay®, Samsung Pay™ and Google Pay™. Our PIN-less debit product allows merchants to debit and credit accounts in real-time. In our over 20-year history, we have created a loyal customer base that relies on us for our convenient, secure, innovative and adaptive services and technology, and we have built long-standing and valuable relationships with premier banking institutions such as Fifth-Third Bank, Sunrise Bank, and Wells Fargo Bank.

Our strategy is to drive growth through a leveraged, one to many, distribution model in the software development marketplace. Following the completion of the Singular Payments acquisition, we launched our payment facilitation, PayFac, platform called "PayFac-in-a-Box" in late 2018 targeting partnership opportunities with app and software developers in bill-centric verticals, such as legal, healthcare, property management, utilities and insurance. The PayFac-in-a-Box platform 'integration layer' offers a simple integration experience for technology companies who are looking to monetize payments within an existing base of downstream clients. The added value of offering our integration partners access to credit card, debit card, ACH and prepaid card issuance capabilities through a single vendor partner relationship in face-to-face, mobile and virtual payment acceptance environments provides a true single channel commerce experience through an application programming interface, API.

With the acquisition of the assets of Information Management Solutions, LLC, or IMS, in December 2020, we now offer additional services relating to electronic bill presentment, document composition, document decomposition and printing and mailing services serving hundreds of customers representing a wide range of industry verticals, including utilities and financial institutions through our wholly-owned subsidiary, Usio Output Solutions, Inc., or Output Solutions.  This product offering provides an outsourced solution for document design, print and electronic delivery to potential customers and entities looking to reduce postage costs and increase efficiencies.

Summary of Results

We believe that our success will continue to depend in large part on our ability to (a) grow revenues, (b) manage our operating expenses, (c) add quality customers to our client base, (d) meet evolving customer requirements, (e) adapt to technological changes in an emerging market, and (f) assimilate current and future acquisitions of companies and customer portfolios. We will continue to invest in our sales force and technology platforms to drive revenue growth. In particular, we are focused on growing our ACH merchants, adding new software integrators, growing our electronic bill presentment, document composition, document decomposition, printing and mailing services business while providing incremental services to existing merchants. In addition to our near-term growth opportunities, we are focused on leveraging and optimizing the infrastructure of the organization allowing expansion of our payment processing and mail and printing capabilities without significantly increasing our operating costs.

We believe that the number of credit card transactions processed, ACH transaction counts, prepaid card volumes and total card volumes are the most critical measures to gauge the state of our business. During the third quarter of 2022, the number of credit card transactions processed by us increased by 41% versus the third quarter of 2021.  The volume of credit card dollars processed during the third quarter of 2022 increased by 7% compared to the same time period in 2021. Both the number of credit card transactions and dollars processed by us during the three months ended September 30, 2022 were the highest in our history.  The continued growth in credit card metrics was primarily attributable to our PayFac strategy to drive increased penetration across multiple industries including healthcare and legal. 

ACH (eCheck) transaction counts during the third quarter of 2022 decreased by 4% compared to the third quarter of 2021. Returned check transactions processed during the third quarter of 2022 increased by 72% compared to the third quarter of 2021.  Electronic check dollars processed during the third quarter of 2022 decreased by 36% compared to the third quarter of 2021. The decreases in eCheck transactions and electronic check dollar volumes processed were primarily attributable to significantly higher cryptocurrency activity levels in the prior year period versus the current year period. Increases in returned check transactions were primarily attributable to the continued recovery of the consumer lending market following its decline due to COVID-19.

Prepaid card load volumes processed during the third quarter of 2022 decreased by 41% compared to the third quarter of 2021. Prepaid card transaction counts processed during the third quarter of 2022 increased by 5% compared to the third quarter of 2021. Prepaid card purchase volume during the third quarter of 2022 decreased by 26% compared to the third quarter of 2021. This decrease occurred primarily due to the continued wind down of government assistance programs including organizations such as New York City Economic Development Corporation, City of Houston, Harris County, TX, Open Society International (City of Baltimore), and Greater Washington Community Foundation (Washington DC) with their vaccine incentive and cash disbursement programs.  We continue to support numerous guaranteed income programs including the Arlington Community Foundation, E.A.T (Equity and Transformation) Chicago, and Hudson UP, the City of Denver's Basic Income Project.

Total dollar volumes processed across all business lines in the third quarter of 2022 were $2.4 billion compared to $2.7 billion processed in the third quarter of 2021 primarily as a result of the decrease in cryptocurrency activity and the winding down of COVID-19 government assistance programs.

Critical Accounting Policies

Our management’s discussion and analysis of our financial condition and results of operations is based upon our interim condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to the reported amounts of revenues and expenses, bad debt, investments, intangible assets, income taxes, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions or conditions. We consider the accounting policies described in Note 1 to the Notes to the Interim Condensed Consolidated Financial Statements to be critical because the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change or because the impact of the estimates and assumptions on financial condition or operating performance is material.

For a summary of Critical Accounting Policies, please refer to the Notes to Interim Condensed Consolidated Financial Statements, Note 1, Basis of Presentation.

Key Business Metric - Non-GAAP Financial Measures

This filing includes non-GAAP financial measures, EBITDA and adjusted EBITDA, as defined in Regulation G of the Securities and Exchange Act of 1934, as amended. The Company reports its financial results in compliance with GAAP, but believes that also discussing non-GAAP financial measures provides investors with financial measures it uses in the management of its business. The Company defines EBITDA as operating income (loss), before interest, taxes, depreciation and amortization of intangibles. The Company defines adjusted EBITDA as EBITDA, as defined above, plus non-cash stock option costs and certain non-recurring items, such as costs related to acquisitions. These measures may not be comparable to similarly titled measures reported by other companies. Management uses EBITDA and adjusted EBITDA as indicators of the Company's operating performance and ability to fund acquisitions, capital expenditures and other investments and, in the absence of refinancing options, to repay debt obligations.

Management believes EBITDA and adjusted EBITDA are helpful to investors in evaluating the Company's operating performance because non-cash costs and other items that management believes are not indicative of its results of operations are excluded. EBITDA and adjusted EBITDA are supplemental non-GAAP measures, which have limitations as an analytical tool. Non-GAAP financial measures should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. Non-GAAP financial measures do not reflect a comprehensive system of accounting, may differ from GAAP measures with the same names, and may differ from non-GAAP financial measures with the same or similar names that are used by other companies. 

We reported an adjusted EBITDA loss of  $0.5 million for the quarter ended September 30, 2022, as compared to an adjusted EBITDA of $1.2 for the same period in the prior year. The increase in adjusted EBITDA loss in the current quarter was attributable to increases in SG&A combined with reduced profit margins.

We reported an adjusted EBITDA loss of  $1.4 million for the nine months ended September 30, 2022, as compared to an adjusted EBITDA of $2.7 million for the same period in the prior year. The increase in adjusted EBITDA loss in the current year was attributable to increases in SG&A combined with reduced profit margins.

The following table is a reconciliation of Net Income to EBITDA for the three and nine months ended September 30, 2022 and 2021.

Results of Operations

Revenues

Our revenues are principally derived from providing integrated electronic payment services to merchants and businesses, including credit and debit card-based processing services and transaction processing via the Automated Clearing House, or ACH, network and the program management and processing of prepaid debit cards. With the acquisition of the assets of IMS in December 2020, we now offer additional services relating to electronic bill presentment, document composition, document decomposition and printing and mailing services through our wholly-owned Output Solutions subsidiary.

Revenues for the quarter ended September 30, 2022 increased by 4% to $16.4 million, as compared to $15.8 million for the quarter ended September 30, 2021 due to continued traction and growth in our PayFac and Output Solutions lines of business, despite declines in both our Prepaid, and ACH and complimentary services business sectors. These declines were a result of  our ACH business achieving a record 2021 quarter when cryptocurrency activity was substantially higher as compared with the same period in 2022, along with the wind down of COVID-19 relief programs which were at their peak in the third and fourth quarter of 2021.

Revenues for the nine months ended September 30, 2022 increased by 14% to $50.7 million, as compared to $44.5 million for the nine months ended September 30, 2021 primarily as a result of continued growth in our prepaid card services category, and strong performance from our wholly-owned Output Solutions subsidiary.

Cost of Services

Cost of services includes the cost of personnel dedicated to the creation and maintenance of connections to third-party payment processors and the fees paid to such third-party providers for electronic payment processing services. Through our contractual relationships with our payment processors and sponsoring banks, we process ACH and debit, credit or prepaid card transactions on behalf of our customers and their consumers. We pay volume-based fees for debit, credit, ACH and prepaid transactions initiated through these processors or sponsoring banks, and pay fees for other transactions such as returns, notices of change to bank accounts and file transmission. Cost of service fees also include fees paid to referral agents and partners.

Cost of services increased by $1.5 million, or 13%, to $13.3 million for the quarter ended September 30, 2022, as compared to $11.8 million for the same period in the prior year. 

Cost of services increased by $7.4 million, or 22%, to $40.8 million for the nine months ended September 30, 2022, as compared to $33.4 million for the same period in the prior year. 

Increases in cost of services in both the three and nine months ended September 30, 2022 as compared to the same periods a year ago were due to proportionally greater revenue growth in lower margin business lines.

Gross Profit

Gross profit is the net profit existing after the cost of services.

Gross profits decreased by 22% to $3.1 million for the quarter ended September 30, 2022, as compared to $4.0 million for the same period in the prior year. Similarly, the gross margin percentage was 19.1% for the quarter ended September 30, 2022 as compared to 25.5% in the prior year period. The decrease in gross profits and margin percentage in the quarter ended September 30, 2022, as compared to the same period during the prior year, was primarily attributable to increased revenue contribution from business lines with lower profit margins, as well as decreased ACH and complementary service revenues, a higher margin business.

Gross profits decreased by 11% to $9.9 million for the nine months ended September 30, 2022, as compared to $11.1 million for the same period in the prior year. Similarly, the gross margin percentage was 19.5% for the nine months ended September 30, 2022 as compared to 24.9% in the prior year period. The decrease in gross profits and margin percentage in the nine months ended September 30, 2022, as compared to the prior year was primarily attributable to increased revenue contribution from business lines with lower profit margins.

Stock-based Compensation

Stock-based compensation expenses were $0.5 million for the quarter ended September 30, 2022 as compared to $0.3 million for the quarter ended September 30, 2021, an increase of 50.2% due to incremental stock compensation from new hires, along with the Company's 10-year and 3-year stock vesting for performance compensation entered into on November 18, 2021. 

Stock-based compensation expenses were $1.5 million for the nine months ended September 30, 2022 as compared to $1.0 million for the nine months ended September 30, 2021, an increase of 55.8% due to incremental stock compensation from new hires, along with the Company's 10-year and 3-year stock vesting for performance compensation entered into on November 18, 2021. 

Other Selling, General and Administrative Expenses

Other selling, general and administrative expenses (other SG&A) were $3.7 million for the quarter ended September 30, 2022 as compared to $2.8 million in the prior year, a 29% increase. The increase in other SG&A for the quarter ended September 30, 2022 reflects continued investments in our ACH, PayFac, Prepaid and Output Solutions business lines, a substantial portion of which represents an investment in strengthening our infrastructure to support our current growth. These investments include preparation for increased service requirements for growing card holders in our prepaid line of business, security and IT infrastructure, as well as staffing and employee retention. 

Other selling, general and administrative expenses (other SG&A) were $11.3 million for the nine months ended September 30, 2022 as compared to $8.3 million in the prior year, a 36% increase. The increase in other SG&A for the nine months ended September 30, 2022 reflects continued investments in our ACH, PayFac, Prepaid and Output Solutions business lines, a substantial portion of which represents an investment in strengthening our infrastructure to support our current growth. These investments include preparation for increased service requirements for growing card holders in our prepaid line of business, security and IT infrastructure, as well as staffing and employee retention.

Depreciation and Amortization 

Depreciation and amortization expense consist of the reduction in value of our tangible and intangible assets over their useful life. These assets include property, plant, and equipment, along with intangible assets acquired through acquisition, or developed as internal use software.

Depreciation and amortization totaled $0.6 million and $0.6 million for the quarters ended September 30, 2022 and September 30, 2021, respectively. Depreciation and amortization expense was flat in the quarter due to the completed amortization of intangible assets in the third quarter, reducing overall depreciation and amortization expenses to the same levels they were in the same period a year ago. 

Depreciation and amortization totaled $2.2 million and $1.9 million for the nine months ended September 30, 2022 and September 30, 2021, respectively. This change was due primarily to the overall increase in intangible assets being amortized versus the same period a year ago. 

Other Income (Expense)

Other income and expense, net was $1,785 for the quarter ended September 30, 2022 compared to $287 for the quarter ended September 30, 2021. Lower interest-bearing merchant reserves and lower interest rates drove the lower interest income as well as interest expense associated with our equipment loan.

Other income and expense, net was $1,231 for the nine months ended September 30, 2022 compared to $3,439 for the nine months ended September 30, 2021. Lower interest-bearing merchant reserves and lower interest rates drove the lower interest income as well as interest expense associated with our equipment loan.

Net Income (Loss)

We reported a net loss of $1.8 million for the quarter ended September 30, 2022, as compared to a net income of $0.1 million for the same period in the prior year. The increase in net loss in the current quarter was attributable to increases in SG&A combined with reduced profit margins.

We reported a net loss of $5.3 million for the nine months ended September 30, 2022, as compared to a net loss of $0.4 million for the same period in the prior year. The increase in net loss in the current quarter was attributable to increases in SG&A combined with reduced profit margins.

We may incur future operating losses. To maintain, grow and sustain profitability, we must, among other things, continue to incrementally grow and maintain our customer base, sell our ACH, credit card, prepaid product offerings and output solutions offerings to existing and new customers, implement successful marketing strategies, maintain and upgrade our technology and transaction-processing systems, provide superior customer service, respond to competitive developments, attract, retain and motivate personnel, and respond to unforeseen industry developments among other factors.

Liquidity and Capital Resources

Our primary sources of liquidity are available cash and cash equivalents and cash flows provided by operations. As of September 30, 2022, we had cash and cash equivalents of  $4.6 million. For the nine months ended September 30, 2022, cash used in operations was $22.8 million. We expect available cash and cash equivalents and internally generated funds to be sufficient to support working capital needs, capital expenditures (including acquisitions), and our debt service obligations. In addition, we may also receive proceeds, if an opportunity presents itself,  from the sale of assets and/or the sale of debt or equity securities, although we may not be able to complete such a sale or any such financing on terms acceptable to us, if at all. We believe we have sufficient liquidity to operate for at least the next 12 months from the date of filing this report.

We reported a net loss of $1.8 million for the quarter ended September 30, 2022. At September 30, 2022, we had an accumulated deficit of $70.7 million. Additionally, we had working capital of $5.6 million and $8.8 million at September 30, 2022 and December 31, 2021, respectively.

Cash Flows

Net cash used by operating activities, including merchant reserve funds, prepaid card load assets, customer deposits and net operating lease assets for the nine months ended September 30, 2022 was $22.8 million, as compared to net cash provided by operating activities of $8.7 million for the nine months ended September 30, 2021. Excluding merchant reserves, prepaid card load assets, customer deposits and lease right of use assets and liabilities, our cash used by operating activities was $1.1 million and cash provided by operating activities was $2.0 for the nine months ended September 30, 2022 and September 30, 2021, respectively. We continue to invest resources and infrastructure in our business to achieve scale across all business lines.

Net cash used by investing activities was $642,764 and $999,493 for the nine months ended September 30, 2022 and September 30, 2021, respectively. The primary drivers of our investing activities were capital expenditures associated with capitalized software development costs and other capital investments associated with growing our business lines and associated employee counts. The decrease in cash used by investing activities was primarily attributable to the reduced amount of fixed asset purchases relative to the same period a year ago.

Net cash used by financing activities for the nine months ended September 30, 2022 was $935,513 and net cash used by financing activities for the nine months ended September 30, 2021 was $58,800, respectively. The increase in cash used by financing activities was due to the Company's stock buyback program, and increased quantity of treasury stock purchased in 2022. The 2021 cash used by financing activities included the net proceeds from our equipment loan offset by treasury stock transactions. 

Material Trends and Uncertainties

Please refer to Note 9 of our financial statements included in this report that describe certain risks in connection with the Covid-19 pandemic.

Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

As a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item.

Item 4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

Our management evaluated, with the participation of our Chief Executive and Chief Financial Officers, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report on Form 10-Q. Based on that evaluation, our Chief Executive and Chief Financial Officers concluded that our disclosure controls and procedures as of September 30, 2022 were effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive and Chief Financial Officers, 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 evaluation of disclosure controls and procedures included an evaluation of certain components of our internal control over financial reporting. Management’s assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance that the control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system's objectives will be met.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

KDHM, LLC

On September 1, 2021, KDHM, LLC sued PDS Acquisition Corp, now known as Usio Output Solutions, Inc., claiming a breach of the asset purchase agreement executed by the parties on December 14, 2020. The lawsuit alleges that due to a mistake, accident, or inadvertence, certain customer deposits in the amount of $317,000 were improperly transferred to us.

We believe that plaintiff's claims in the lawsuit have no merit and contradict the express terms of the asset purchase agreement. As a result of this post sale dispute, we discovered that KDHM, LLC, and its principals, made certain misrepresentations and breached the terms of the asset purchase agreement. 

On September 28, 2021, we filed an answer generally denying plaintiff’s allegations. On October 5, 2021, we filed a counterclaim and third-party petition. Therein, we allege that neither KDHM nor its principals disclosed that KDHM was not accounting for the customer deposits in accordance with Generally Accepted Accounting Principles.  Yet, KDHM, and third-party defendants its principals Henry Minten and Thomas Dowe, affirmatively represented and warranted in section 3.1(e) of the agreement that “[t]Annual Financial Statements and the Interim Financial Statements have been prepared from the books and records of Seller in accordance with GAAP applied on a consistent basis.” 

We also discovered that KDHM by and through its principals failed to disclose that $305,000 in additional customer deposits existed and these deposits were not conveyed to us as required by the agreement.  KDHM, Minten and Dowe provided us with fraudulent and misleading profit and loss statements that did not disclose these additional customer deposits.  KDHM and the defendants do not dispute that these additional customer deposits exist and that they were purchased by Usio.  However, despite a written representation that these funds would be returned, KDHM and its principal have held these funds hostage.  Section 2.1(b)(x) of the agreement provides that the purchased assets includes “All of Seller’s deposits from its customer, including without limitation, those customer deposits listed on Schedule 2.1(b)(xi) of the Disclosure Schedules.”  Finally, we discovered that KDHM did not provide us with all customer lists, which are identified as purchased asset under the agreement.  We demanded the missing customer lists, but they have yet to be provided to us per the agreement.

In our counterclaims and third-party petition, we assert causes of action for fraud, breach of contract and conversion.  At this time, the parties have not engaged in any written discovery or depositions and no trial date has been set.

We consider the risk of loss as remote related to this lawsuit.

Aside from the proceedings described above, we may be involved in legal matters arising in the ordinary course of business from time to time. While we believe that such matters are currently not material, there can be no assurance that matters arising in the ordinary course of business for which we are or could become involved in litigation will not have a material adverse effect on our business, financial condition or results of operations.

Item 1A. RISK FACTORS.

There have been no material changes from risk factors previously disclosed in our annual report on Form 10-K for the fiscal year ended December 31, 2021, as filed with the Securities and Exchange Commission on March 17, 2022.

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

Recent Sales of Unregistered Securities

We did not issue unregistered securities during the quarter ended September 30, 2022.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

On November 2, 2016, we announced that our Board of Directors authorized the repurchase of up to $1 million of our common shares from time to time on the open market, in block transactions, or in privately negotiated transactions. On January 9, 2018, the Board of Directors added an additional $2 million to the buyback plan. The program began on November 16, 2016 and ended on September 29, 2019. At September 29, 2019 when the program ended, $1,374,049 was available under the repurchase plan. On November 7, 2019, the Board of Directors approved the renewal of the share buy-back program. The Board approved a limit of $1,420,000 which was rolled over from the prior buy-back program with a three-year duration. On May 13, 2022, the Board of Directors authorized a renewal of the buy-back program, with a limit up to $4 million of the Company's common stock with a three year duration. The new buyback program terminates on the earliest of May 15, 2025, the date the funds are exhausted, or the date the Board of Directors, at its sole discretion, terminates or suspends the program. The program is used for the purchase of stock from employees and directors, and for open-market purchases through a broker. During the three months ended September 30, 2022, we made the following stock repurchases:

Item 3. Defaults Upon Senior Securities.

None.

Item 4. MINE SAFETY DISCLOSURES.

Not applicable.

Item 5. OTHER INFORMATION.

None.

Item 6. Exhibits.

Copies of above exhibits not contained herein are available to any stockholder, upon written request to: Chief Financial Officer, Usio, Inc., 3611 Paesanos Parkway, Suite 300, San Antonio, TX 78231.

SIGNATURES

Pursuant to the requirements 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.