Notes
to Interim Unaudited Consolidated Financial Statements
For
the Period Ended June 30, 2016
The
accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States for interim financial statements. Accordingly, such interim financial statements
do not include all the information and footnotes required by accounting principles generally accepted in the United States for
complete annual financial statements. The information furnished reflects all adjustments, consisting only of normal recurring
items which are, in the opinion of management, necessary in order to make the financial statements not misleading. The balance
sheet as of December 31, 2015 has been derived from the Company’s annual financial statements that were audited by an independent
registered public accounting firm, but does not include all of the information and footnotes required for complete annual financial
statements. The consolidated financial statements included in this Quarterly Report on Form 10-Q 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 fiscal year ended December 31, 2015.
2.
|
RELATED
PARTY TRANSACTIONS
|
A
party is considered to be related to the Company if the party directly or indirectly or through one or more intermediaries controls,
is controlled by, or is under common control with the Company. Related parties also include principal owners of the Company, its
management, members of the immediate families of principal owners of the Company and its management and other parties with which
the Company may deal if one party controls or can significantly influence the management or operating policies of the other to
an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. A party which
can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest
in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties
might be prevented from fully pursuing its own separate interests is also a related party.
The
accounts payable due to a related party at December 31, 2015 was comprised of $6,000 of director fees which were paid in January
2016.
Inventories
are stated at the lower of cost or market using the first-in, first-out method. Cost includes materials, labor and manufacturing
overhead related to the purchase and production of inventories. The Company regularly reviews inventory quantities on hand, future
purchase commitments with its suppliers, and the estimated utility of its inventory. If the review indicates a reduction in utility
below carrying value, inventory is reduced to a new cost basis through a charge to cost of goods sold. Allowance for slow moving
items decreased $15,383 due to the sale of an aerostat launcher. Inventory consists of the following at June 30, 2016 and December
31, 2015:
|
|
|
June 30,
2016
|
|
|
December 31,
2015
|
|
|
Raw materials inventory
|
|
$
|
23,173
|
|
|
$
|
26,358
|
|
|
Work in process inventory
|
|
|
26,745
|
|
|
|
3,817
|
|
|
Finished goods inventory
|
|
|
100,409
|
|
|
|
107,209
|
|
|
Less valuation allowance
|
|
|
(3,206
|
)
|
|
|
(18,589
|
)
|
|
Total
|
|
$
|
147,121
|
|
|
$
|
118,795
|
|
4.
|
PROPERTY
AND EQUIPMENT
|
Property
and equipment is recorded at cost when acquired. Depreciation is provided principally on the straight-line method over
the estimated useful lives of the related assets, which is 3-7 years for equipment, furniture and fixtures, hardware and software
and leasehold improvements. During the six months ended June 30, 2016, the Company invested $5,142 in shop machinery
and equipment, $3,719 in computers and electronics and $1,922 in office furniture and fixtures. Depreciation expense was $16,572
and $5,160 for the six months ended June 30, 2016 and 2015, respectively. Property and equipment consists of the following at
June 30, 2016 and December 31, 2015:
|
|
|
June 30,
2016
|
|
|
December 31,
2015
|
|
|
Shop machinery and equipment
|
|
$
|
86,031
|
|
|
$
|
80,889
|
|
|
Computers and electronics
|
|
|
32,630
|
|
|
|
28,911
|
|
|
Office furniture and fixtures
|
|
|
35,899
|
|
|
|
33,977
|
|
|
Leasehold improvements
|
|
|
19,514
|
|
|
|
19,514
|
|
|
|
|
|
174,074
|
|
|
|
163,291
|
|
|
Less - accumulated depreciation
|
|
|
(43,567
|
)
|
|
|
(26,995
|
)
|
|
|
|
$
|
130,507
|
|
|
$
|
136,296
|
|
On
July 20, 2015, the Company entered into an asset purchase agreement to acquire exclusive commercial software licenses for the
“GUST” (Georgia Tech UAV Simulation Tool) autopilot system from Adaptive Flight, Inc. (“AFI”). Through
the purchase of the assets of privately held AFI, the Company assumed the transferable licenses from the Georgia Tech Research
Corporation, which included flight simulation tools and fault tolerant flight control algorithms. In addition, the Company acquired
AFI’s dedicated flight computer and additional related hardware and airframes. The Company paid $100,000 in immediately
available funds and $100,000 to be held in escrow. In addition, the Company issued 150,000 shares of unregistered common stock
valued at $8.40 per share on the date of agreement, to be held in escrow.
The
Company had a milestone of twelve months from July 20, 2015 to complete a technology Integration Plan, the non-completion of which
may result in the return of the purchased assets and termination of the Company’s obligations to release the escrow cash
and shares. Additional milestones include exclusive, no-cost and perpetual licenses to all contributing intellectual property
included or related to the purchased assets. As such time as all milestones are met, one-half of the escrow shares will be released
to AFI. Upon termination of the Escrow Agreement, anticipated to be twelve months from the closing of the asset purchase, if all
milestones have been met, the remaining escrowed shares will be released to AFI, but if all milestones have not been met, the
escrowed cash and escrowed shares will be released to the Company and the purchased assets will be returned to AFI. According
to the terms of the Escrow Agreement, if the escrow share value is less than $1,400,000, the Company must issue an additional
number of unregistered shares, not to exceed 50,000 shares. At December 31, 2015, the value of the 150,000 shares was $3.23 per
share, or $484,500. The Company recorded $161,500 as an additional liability and expense at December 31, 2015 for the cost of
50,000 shares at $3.23 per share.
On
June 3, 2016, the Integration Plan was deemed to be completed. At June 3, 2016, the value of the 150,000 shares was $3.01 per
share, or $451,150. The additional liability was reduced to $150,500 for the cost of 50,000 shares at $3.01 per share. The Company
recorded the $11,000 reduction in the additional liability through the statement of operations at June 3, 2016. The Company began
amortizing the $1,460,000 of purchased assets over a sixty month period on June 3, 2016 in the amount of $24,333 per month. Total
amortization expense for the six months ended June 30, 2016 is $24,333. The Company and AFI instructed the Escrow Agent to disburse
the cash and 150,000 shares of stock. The Company issued an additional 50,000 shares valued at $150,500 as described above.
The
asset acquisition did not qualify as a business combination under ASC 805-10 and has been accounted for as a regular asset purchase.
On
October 29, 2015, a 1:40 reverse split of the Company stock occurred and the effect has been applied retroactively for disclosure
purposes.
The
Company issued a total of 1,785,968 shares of common stock during the six months ended June 30, 2016, as described below:
The
Company issued 2,500 shares of common stock pursuant to conversions of an aggregate of 1,000 shares of Series A preferred stock.
The
Company issued 183,468 shares of common stock pursuant to conversions of an aggregate of 73,387 shares of Series C preferred stock.
The
Company issued 50,000 shares of common stock pursuant to conversions of an aggregate of 2,000,000 shares of Series D preferred
stock.
The
Company issued 50,000 shares of common stock pursuant to conversions of an aggregate of 1,999,998 shares of Series F preferred
stock.
The
Company issued 50,000 shares of common stock pursuant to conversions of an aggregate of 2,000,000 shares of Series G preferred
stock.
The
Company issued 50,000 shares of restricted common stock to AFI, as discussed above in Note 5, after all milestones had been met
as a requirement of the terms of the Escrow Agreement because the value of the escrowed shares fell below $1,400,000 and triggered
a ‘make whole’ provision.
The
Company issued 100,000 shares of restricted common stock with monthly vesting provisions to a newly-appointed director, Lt. Gen.
Michael T. Flynn, for 24 months of services. Lt. Gen. Flynn can earn a pro rata portion of the shares, calculated based on the
twenty four-month vesting schedule. The Company recognized a total of $24,250 expense for the pro rata portion of shares earned
by Lt. Gen. Flynn during the six months ended June 30, 2016.
The
Company issued 150,000 shares of restricted common stock with monthly vesting provisions to Strategic Advisory Board members,
Dr. Philip Frost and Steven Rubin, for 12 month’s services. The advisors can earn a pro rata portion of the shares, calculated
based on the twelve-month vesting period, in the event the service agreements are terminated prior to the expiration date as described
in the agreements. The Company recognized a total of $75,000 expense for the pro rata portion of shares earned by the two members
during the six months ended June 30, 2016.
The Company issued 1,150,000 shares of restricted common stock outside of the
2015 Equity Plan to Jay Nussbaum, Felicia Hess, Daniyel Erdberg, Kendall Carpenter, and Kevin Hess pursuant to Restricted Stock
Agreements. The shares will vest upon consummation of a significant equity and/or debt financing at least equal to the November
2015 financing which raised $3,725,000 provided that the holder remains engaged by the Company through the vesting date. Stock
based compensation of $1,115,500 was recognized during the six months ended June 30, 2016 based on management’s estimate
that the shares will be fully vested by October 2016.
On
June 1, 2015, the Company issued 50,000 shares of restricted common stock with monthly vesting provisions to the Chairman of the
Board for twenty-four months services pursuant to a Director Agreement. The Chairman can earn a pro rata portion of the shares,
calculated on a twenty-four month vesting period, in the event the Chairman relinquishes his position and Board seat prior to
the expiration date of the Director Agreement. The Company recognized a total of $135,000 expense for the portion of such shares
earned by the Chairman during the six months ended June 30, 2016.
On
September 4, 2015, the Company issued 450,000 shares of restricted common stock to four management employees and one director
pursuant to stock award agreements. The shares will vest upon consummation of a $4,000,000 equity or debt financing provided that
the holder remains engaged by the Company through the vesting date. Stock based compensation of $604,440 was recognized during
the six months ended June 30, 2016 based on management’s estimate that the shares would be fully vested by February 4, 2016,
when the Board deemed vesting occurred with the issuance of $4,000,000 in common stock on November 20, 2015.
On
October 29, 2015, a 1:40 reverse split of the Company stock occurred and the effect has been applied retroactively for disclosure
purposes.
All
of the preferred stock of the Company is convertible into common shares. The Series A and Series C stock conversion ratio is 1
to 2.5 common shares. The Series B, B-1, D, E, F and G stock conversion ratio is 1 to 0.025 common shares. All preferred stock
has voting rights equal to the number of shares it would have on an ‘as if converted’ basis subject to any ownership
limitations governing such preferred shares. All preferred stock is entitled to dividends rights equal to the number of shares
it would have on an ‘as if converted’ basis. None of the preferred stock is redeemable, participating nor callable.
The
Company analyzed the embedded conversion option for derivative accounting consideration under ASC 815-15 “Derivatives and
Hedging” and determined that the conversion option should be classified as equity.
During
the six months ended June 30, 2016, one investor who held Series A preferred stock converted a total of 1,000 shares of Series
A preferred stock for an aggregate of 2,500 shares of restricted common stock in accordance with their conversion rights which
includes a blocker with respect to individual ownership percentages. During the same period, two investors who held Series C preferred
stock converted a total of 73,387 shares of Series C for an aggregate of 183,468 shares of restricted common stock, one investor
who held Series D preferred stock converted a total of 2,000,000 shares of Series D for an aggregate of 50,000 shares of restricted
common stock, one investor who held Series F preferred stock converted a total of 1,999,998 shares of Series F for an aggregate
of 50,000 shares of restricted common stock, and two investors who held Series G preferred stock converted a total of 2,000,000
shares of Series G for an aggregate of 50,000 shares of restricted common stock, all in accordance with their conversion rights
which includes a blocker with respect to individual ownership percentages.
8.
|
EMPLOYEE
STOCK OPTIONS
|
On
October 29, 2015, a 1:40 reverse split of the Company stock occurred and the effect has been applied retroactively for disclosure
purposes.
On
April 27, 2016, the Company issued 50,000 options from the 2015 Equity Plan to two employees for services provided. These options
immediately vested and were granted with an exercise price of $2.91 and expiration date of April 27, 2019.
The
Company used the Black-Scholes option pricing model to estimate the fair value on the date of grant of the 50,000 options granted
during the six months ended June 30, 2016.
The
following table summarizes the assumptions used to estimate the fair value of the 50,000 stock options granted during the six
month ended June 30, 2016 on the date of grant.
|
|
|
2016
|
|
|
|
|
|
Expected
dividend yield
|
|
|
0
|
%
|
|
Expected
volatility
|
|
|
108
|
%
|
|
Risk-free
interest rate
|
|
|
0.99
|
%
|
|
Expected
life of options
|
|
|
3
years
|
|
Under
the Black-Scholes option pricing model, the fair value of the 50,000 options granted during the six months ended June 30, 2016
is estimated at $95,649 on the date of grant. During the six months ended June 30, 2016, $95,649 compensation expense was recognized
on these 50,000 options.
During
2015, the Company granted 842,500 common stock options to employees and a director for service provided. Of those 842,500 options,
250,000 options immediately vested and were granted with an exercise price of $6.00 and expiration date of May 18, 2018. Another
105,000 options immediately vested and were granted with an exercise price of $5.00 and expiration date of December 10, 2018.
Another 250,000 options vest over two years or upon the up-listing of the Company’s common stock and were granted with an
exercise price of $6.00 and expiration date of June 1, 2018. These 250,000 options were surrendered and cancelled on September
4, 2015. A director received two option awards. The first was for 75,000 shares vesting over two years and was granted with an
exercise price of $10.00 and expiration date of June 1, 2018. The second was for 125,000 shares with vesting tied to performance
and was granted with an exercise price of $10.00 and expiration date of June 1, 2018. These two director option awards were surrendered
and cancelled on September 4, 2015.
Stock based compensation was reversed for costs previously
recognized on the total 450,000 surrendered and cancelled unvested options. Another option award for 37,500 shares vesting over
three years was granted with an exercise price of $10.80 and expiration date of May 4, 2019.
The
Company used the Black-Scholes option pricing model to estimate the fair value on the date of grant of the 37,500 stock-based
awards that continue to vest during the six months ended June 30, 2016.
The
following table summarizes the assumptions used to estimate the fair value of the 37,500 stock options granted during 2015 on
the date of grant:
|
|
|
2015
|
|
|
|
|
|
|
|
|
Expected dividend yield
|
|
|
0
|
%
|
|
Expected volatility
|
|
|
129
|
%
|
|
Risk-free interest rate
|
|
|
0.79 – 1.05
|
%
|
|
Expected life of options
|
|
|
2.43 – 3.43 years
|
|
Under
the Black-Scholes option price model, fair value of the 37,500 options granted during 2015 is estimated at $293,954 on the date
of grant. During the six months ended June 30, 2016, $80,226 compensation expense was recognized on these 37,500 options.
The
following table represents stock option activity as of and for the period ended June 30, 2016:
|
|
|
Number of Options
|
|
|
Weighted
Average
Exercise Price per
Share
|
|
|
Weighted
Average
Contractual Life in Years
|
|
|
Aggregate
Intrinsic
Value
|
|
|
Outstanding – December 31, 2015
|
|
|
392,500
|
|
|
$
|
6.19
|
|
|
$
|
2.62
|
|
|
|
|
|
|
Exercisable – December 31, 2015
|
|
|
355,000
|
|
|
$
|
5.70
|
|
|
$
|
2.55
|
|
|
$
|
0
|
|
|
Granted
|
|
|
50,000
|
|
|
$
|
2.91
|
|
|
|
|
|
|
|
|
|
|
Exercised or Vested
|
|
|
–
|
|
|
$
|
0.00
|
|
|
|
|
|
|
|
|
|
|
Cancelled or Expired
|
|
|
–
|
|
|
$
|
0.00
|
|
|
|
|
|
|
|
|
|
|
Outstanding – June 30, 2016
|
|
|
442,500
|
|
|
$
|
5.82
|
|
|
|
2.20
|
|
|
|
|
|
|
Exercisable – June 30, 2016
|
|
|
417,500
|
|
|
$
|
5.52
|
|
|
|
2.17
|
|
|
$
|
9,500
|
|
On
October 29, 2015, a 1:40 reverse split of the Company stock occurred and the effect has been applied retroactively for disclosure
purposes.
On
April 27, 2016, under the 2015 Equity Plan, the Company issued warrants to purchase 60,000 shares of the Company's common stock
to four consultants for services provided. These warrants immediately vested and were granted with an exercise price of $2.91
and expiration date of April 27, 2019.
The
Company used the Black-Scholes warrant pricing model to estimate the fair value on the vesting date of the 60,000 warrants granted
during the six months ended June 30, 2016.
The
following table summarizes the assumptions used to estimate the fair value of the 60,000 warrants granted during the six month
ended June 30, 2016 on the date of vesting.
|
|
|
2016
|
|
|
|
|
|
|
|
Expected dividend yield
|
|
|
0
|
%
|
|
Expected volatility
|
|
|
108
|
%
|
|
Risk-free interest rate
|
|
|
0.99
|
%
|
|
Expected life of warrants
|
|
|
3.0 years
|
|
Under
the Black-Scholes warrant pricing model, fair value of the 60,000 warrants granted during the six months ended June 30, 2016 is
estimated at $114,779 on the date of vesting. During the six months ended June 30, 2016, $114,779 compensation expense was recognized
on these 60,000 warrants.
For
the year 2015, 52,500 common stock purchase warrants were granted to two consultants and a vendor for service provided. One consultant
was granted 25,000 warrants with exercise price of $10.00, vesting over two years and the expiration date is June 16, 2018. The
other consultant was granted 12,500 warrants with exercise price of $10.00, vesting over one year and the expiration date is June
25, 2018. These same two consultants and the vendor each received 5,000 warrants with an exercise price of $5.00, immediately
vested and an expiration date of December 10, 2018.
The
Company used the Black-Scholes warrant pricing model to estimate the fair value on the re-measurement dates of the 30,000 warrants
that continue to vest during the six months ended June 30, 2016.
The
following table summarizes the assumptions used to estimate the fair value of the 30,000 warrants granted during 2015 as of re-measurement
dates:
|
|
|
2016
|
|
|
|
|
|
|
|
Expected dividend yield
|
|
|
0
|
%
|
|
Expected volatility
|
|
|
108
|
%
|
|
Risk-free interest rate
|
|
|
0.73
|
%
|
|
Expected life of warrants
|
|
|
1.95 – 1.99 years
|
|
Under
the Black-Scholes warrant pricing model, fair value of the 30,000 warrants granted during 2015 is estimated at $27,303 as of re-measurement
dates. During the six months ended June 30, 2016, $4,995 compensation expense was recognized on these 30,000 warrants.
The
following table represents warrant activity as of and for the period ended June 30, 2016:
|
|
|
Number of Warrants
|
|
|
Weighted Average Exercise Price per
Share
|
|
|
Weighted
Average
Contractual Life in Years
|
|
|
Aggregate
Intrinsic Value
|
|
|
Outstanding – December 31, 2015
|
|
|
134,209
|
|
|
$
|
23.87
|
|
|
|
3.66
|
|
|
|
|
|
|
Exercisable – December 31, 2015
|
|
|
104,209
|
|
|
$
|
27.87
|
|
|
|
4.01
|
|
|
$
|
0
|
|
|
Granted
|
|
|
60,000
|
|
|
$
|
2.91
|
|
|
|
|
|
|
|
|
|
|
Forfeited or Expired
|
|
|
(80
|
)
|
|
$
|
404.49
|
|
|
|
|
|
|
|
|
|
|
Outstanding – June 30, 2016
|
|
|
194,129
|
|
|
$
|
17.24
|
|
|
|
3.06
|
|
|
|
|
|
|
Exercisable – June 30, 2016
|
|
|
181,629
|
|
|
$
|
17.73
|
|
|
|
3.14
|
|
|
$
|
11,400
|
|
10.
|
OKLAHOMA
TECHNOLOGY COMMERCIALIZATION CENTER
|
At
the time of the April 30, 2014 merger between MacroSolve, Inc. (“MacroSolve”) and the Company, MacroSolve had a $110,000
balance on its refundable award from the State of Oklahoma Technology Business Finance Program. The Company has not made any reductions
in the award, so the Company is in default. The parties are discussing a release from the debt that is unrelated to the current
operations.
11.
|
COMMITMENTS
AND CONTINGENCIES
|
As
the Company previously reported in its Quarterly Report on Form 10-Q for the quarter ended March 31, 2016, on January 30, 2012,
MacroSolve filed suit against Newegg Inc. (“Newegg”) in the United States District Court for the Eastern District
of Texas alleging infringement of one or more claims of United States Patent #7,822,816 (the “‘816 Patent”).
On March 7, 2014, the United States Patent and Trademark Office (“USPTO”) sent MacroSolve an office action related
to an
ex parte
reexamination of the ‘816 Patent, which rejected all the claims in the ‘816 patent (the “USPTO
Office Action”). As a result of the USPTO Office Action, on March 31, 2014, MacroSolve dismissed its patent enforcement
case against Newegg with prejudice. On April 6, 2015, the court denied a motion by Newegg for recovery of its legal fees of approximately
$400,000 from MacroSolve. On April 24, 2015, Newegg filed a Notice of Appeal with the United States Court of Appeals for the Federal
Circuit, which issued an opinion on February 9, 2016, affirming the district court’s denial of Newegg’s motion to
recover its legal fees. On May 9, 2016, Newegg filed a Petition for a Writ of Certiorari with the United States Supreme Court.
On June 13, 2016, the United States Supreme Court issued an order denying that petition. Consequently, MacroSolve prevailed in
the matter..
On
May 16, 2016, Banco Popular North America (“Banco”) filed a lawsuit in Duval County, Florida in the Circuit Court
of the Fourth Judicial Circuit against Aerial Products Corporation d/b/a Southern Balloon Works (“Aerial Products”),
Kevin M. Hess, LTAS, and the Company to collect on a delinquent Small Business Administration loan that Banco made in 2007 to
Aerial Products with Mr. Hess as the personal guarantor. LTAS and the Company filed an Answer on June 30, 2016. It is our position
that neither LTAS nor the Company are continuations of Aerial Products, and LTAS and the Company have denied all allegations made
by Banco and will vigorously defend that position. The Company has not recorded any contingent liability expense because the incurrence
of loss is considered remote. Settlement discussions between Mr. Hess and Banco are ongoing.
On July 28, 2016, the Company
issued 5,000 options from the 2015 Equity Plan to one employee as an employment bonus. These options were immediately vested and
were granted with an exercise price of $3.77 and the expiration date of July 28, 2019.