Notes to Unaudited Condensed Consolidated Financial
Statements
For the Three and Nine Months Ended September 30, 2016 and
2015
NOTE 1 – DESCRIPTION OF THE BUSINESS
Brekford
Corp. (BFDI), headquartered in Hanover, Maryland, is a leading
public safety technology service provider of fully integrated
traffic safety solutions, parking enforcement citation management,
and mobile technology equipment for public safety vehicle services
to state and local municipalities, the U.S. Military and various
federal public safety agencies throughout the United States and
Mexico. Brekford’s combination of upfitting services,
cutting edge technology, and automated traffic safety enforcement
(“ATSE”) services offers a unique 360º solution
for law enforcement agencies and municipalities. Our core values of
integrity, accountability, respect, and teamwork drive our
employees to achieve excellence and deliver industry leading
technology and services, thereby enabling a superior level of
safety solutions to our clients. Brekford has one wholly
owned subsidiary, Municipal Recovery Agency, LLC, a Maryland
limited liability company, formed in 2012 for the purpose of
providing collection systems and services for unpaid citations and
parking fines.
As used
in these notes, the terms “Brekford”, “the
Company”, “we”, “our”, and
“us” refer to Brekford Corp. and, unless the context
clearly indicates otherwise, its consolidated
subsidiary.
NOTE 2 – LIQUIDITY
For the
nine months ended September 30, 2016, the Company incurred a net
loss of $803,998 and provided $426,780 of cash for operations.
Additionally, at September 30, 2016 the Company had cash available
of $593,806, a working capital surplus of $531,713
and availability under the established credit facility (see
Note 4) of $2,163,187.
On July
12, 2016 (the “Closing Date”), the Company entered into
a loan and security agreement (the “Loan Agreement”)
with Fundamental Funding LLC (the
“Lender”). The primary purpose of the new
Loan Agreement is to pay off the prior loan with the lender, and
provide additional working capital. The Loan Agreement provides for
a multi-draw loan to the Company for (i) the Company’s
accounts receivable, the lesser of (y) $2,500,000 or (z) 85%
of the Company’s eligible accounts and (ii) the
Company’s inventory advances, the lesser of (y) $500,000 or
(z) 50% of the eligible inventory (the “Revolving
Loans”). The maximum amount available to the Company under
the Loan Agreement for the Revolving Loans is $3,500,000 (the
“Credit Limit”). In addition, the Lender agreed to
provide the Company with an accommodation loan in an amount not to
exceed $500,000, which shall be repaid in thirty-six (36) equal
monthly installments of principal and interest (the
“Accommodation Loan” and together with the Revolving
Loans, the “Loans”). Management believes
that the Company’s current level of cash combined with cash
that it expects to generate in its operations during the next
twelve months including anticipated new customer contracts and
funds available from the credit facility (see Note 14) will be
sufficient to sustain the Company’s business initiatives
through at least September 30, 2017, but there can be no assurance
that these measures will be successful or adequate. In the
event that the Company’s cash reserves, cash flow from
operations and funds available under the Credit Facility (see Note
14) are not sufficient to fund the Company’s future
operations, it may need to obtain additional capital.
There
can be no assurance, however, that such financing will be available
or, if it is available, that we will be able to structure such
financing on terms acceptable to us and that it will be sufficient
to fund our cash requirements until we can reach a level of
sustained profitable operations and positive cash flows. If we are
unable to obtain the financing necessary to support our operations,
we may be unable to continue as a going concern. We currently have
no firm commitments for any additional capital. Further, if we
issue additional equity or debt securities, stockholders may
experience additional dilution or the new equity securities may
have rights, preferences or privileges senior to those of existing
holders of our shares of common stock.
NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING
POLICES
Principles of Consolidation and Basis of Presentation
The
Company’s consolidated financial statements include the
accounts of Brekford and its wholly owned subsidiary, Municipal
Recovery Agency, LLC. Intercompany transactions and balances are
eliminated in consolidation.
Use of Estimates
The
preparation of financial statements in conformity with U.S.
generally accepted accounting principles (“GAAP”)
requires us 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 amount of revenues and expenses during
the reporting period. In the accompanying unaudited condensed
consolidated financial statements, estimates are used for, but not
limited to, stock-based compensation, allowance for doubtful
accounts, sales returns, allowance for inventory obsolescence, fair
value of long-lived assets, deferred taxes and valuation allowance,
and the depreciable lives of fixed assets. Actual results could
differ from those estimates.
Concentration of Credit Risk
The
Company maintains cash accounts with major financial
institutions. From time to time, amounts deposited may exceed
the FDIC insured limits.
Accounts Receivable
Accounts
receivable are carried at estimated net realizable value. The
Company has a policy of reserving for uncollectable accounts based
on its best estimate of the amount of probable credit losses in its
existing accounts receivable. The Company calculates the allowance
based on a specific analysis of past due balances. Past due status
for a particular customer is based on how recently payments have
been received from that customer. Historically, the Company’s
actual collection experience has not differed significantly from
its estimates, due primarily to credit and collections practices
and the financial strength of its customers.
Inventory
Inventory
principally consists of hardware and third party packaged software
that is modified to conform to customer specifications and held
temporarily until the completion of a contract. Inventory is valued
at the lower of cost or market value. The cost is determined by the
first-in, first-out (“FIFO”) method, while market value
is determined by replacement cost for raw materials and parts and
net realizable value for work-in- process.
Property and Equipment
Property
and equipment is stated at cost. Depreciation of furniture,
vehicles, computer equipment and software and phone equipment is
calculated using the straight-line method over the estimated useful
lives (two to ten years), and leasehold improvements are amortized
on a straight-line basis over the shorter of their estimated useful
lives or the lease term (which is three to five
years).
Management
reviews property and equipment for impairment whenever events or
changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of the long-lived
asset is measured by a comparison of the carrying amount of the
asset to future undiscounted net cash flows expected to be
generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount
by which the carrying amount of the assets exceeds the estimated
fair value of the assets.
Revenue Recognition
The
Company recognizes revenue relating to its vehicle upfitting
solutions when all of the following criteria have been
satisfied: (i) persuasive evidence of an arrangement
exists; (ii) delivery or installation has been completed; (iii) the
customer accepts and verifies receipt; and (iv) collectability is
reasonably assured. The Company considers delivery to
its customers to have occurred at the time at which products are
delivered and/or installation work is completed and the customer
acknowledges its acceptance of the work.
The
Company provides its customers with a warranty against defects in
the installation of its vehicle upfitting solutions for one year
from the date of installation. Warranty claims
were insignificant for the three months and nine months
ended September 30, 2016 and September 30, 2015. The
Company also performs warranty repair services on behalf of the
manufacturers of the equipment it sells. The Company also offers
separately priced extended warranty and product maintenance
contracts to its customers on the equipment sold by the Company.
Revenues from extended warranty services are apportioned over the
period of the extended warranty service contracts and the warranty
costs are expensed as incurred. Revenue from extended warranties
amounted to $25,054 and $86,594 for the three and nine months ended
September 30, 2016, respectively, compared to $39,166 and $211,100
respectively, for the same periods in 2015.
For
automated traffic safety enforcement revenue, the Company
recognizes the revenue when the required collection efforts are
completed and the respective municipality is billed depending on
the terms of the respective contract. The Company records revenue
related to automated traffic violations for the Company’s
share of the violation amount.
Share-Based Compensation
The
Company complies with the provisions of Financial Accounting
Standards Board (“FASB”) Accounting Standards
Codification (“ASC”) Topic 718,
Compensation
-
Stock Compensation
, in measuring and
disclosing stock based compensation cost. The measurement objective
in ASC Paragraph 718-10-30-6 requires public companies to measure
the cost of employee services received in exchange for an award of
equity instruments based on the grant date fair value of the award.
The cost is recognized in expense over the period in which an
employee is required to provide service in exchange for the award
(the vesting period). Performance-based awards are expensed ratably
from the date that the likelihood of meeting the performance
measures is probable through the end of the vesting
period.
Treasury Stock
The
Company accounts for treasury stock using the cost method. As of
September 30, 2016, 10,600 shares of our common stock were held in
treasury at an aggregate cost of $5,890.
Income Taxes
The
Company uses the liability method to account for income taxes.
Income tax expense includes income taxes currently payable and
deferred taxes arising from temporary differences between financial
reporting and income tax bases of assets and liabilities. Deferred
income taxes are measured using the enacted tax rates and laws that
are expected to be in effect when the differences are expected to
reverse. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized.
Income tax expense, if any, consists of the taxes payable for the
current period. Valuation
allowances are established when
the realization of deferred tax assets are not considered more
likely than not. Due to the Company’s continued losses, 100%
valuation allowance has been established on all deferred tax
assets.
The
Company files income tax returns with the U.S. Internal Revenue
Service and with the revenue services of various states. The
Company’s policy is to recognize interest related to
unrecognized tax benefits as income tax expense. The Company
believes that it has appropriate support for the income tax
positions it takes and expects to take on its tax returns, and that
its accruals for tax liabilities are adequate for all open years
based on an assessment of many factors including past experience
and interpretations of tax law applied to the facts of each
matter.
Earnings (loss) per Share
Basic
earnings (loss) per share is calculated by dividing net income
(loss) available to common stockholders by the weighted-average
number of common shares outstanding and does not include the effect
of any potentially dilutive common stock
equivalents. Diluted earnings (loss) per share is
calculated by dividing net income (loss) by the weighted-average
number of shares outstanding, adjusted for the effect of any
potentially dilutive common stock equivalents. There is
no dilutive effect on the loss per share during loss
periods. See Note 13 for the calculation of basic and diluted
earnings (loss) per share.
Fair Value of Financial Instruments
The
carrying amounts reported in the balance sheets for cash, accounts
receivable, accounts payable and accrued expenses approximate their
fair values based on the short-term maturity of these instruments.
The carrying amount of the Company’s promissory note
obligations approximate fair value, as the terms of these notes are
consistent with terms available in the market for instruments with
similar risk.
We
account for our derivative financial instruments, consisting solely
of certain stock purchase warrants that contain non-standard
anti-dilutions provisions and/or cash settlement features, and
certain conversion options embedded in our convertible instruments,
at fair value using Level 3 inputs, which are discussed in Note 14
to these condensed consolidated financial statements. We determine
the fair value of these derivative liabilities using the
Black-Scholes option-pricing model when appropriate, and in certain
circumstances using binomial lattice models or other accepted
valuation practices.
When
determining the fair value of our financial assets and liabilities
using the Black-Scholes option-pricing model, we are required to
use various estimates and unobservable inputs, including, among
other things, contractual terms of the instruments, expected
volatility of our stock price, expected dividends, and the
risk-free interest rate. Changes in any of the assumptions related
to the unobservable inputs identified above may change the fair
value of the instrument. Increases in expected term, anticipated
volatility and expected dividends generally result in increases in
fair value, while decreases in the unobservable inputs generally
result in decreases in fair value.
Foreign Currency Transactions
The
Company has certain revenue and expense transactions with a
functional currency in Mexican pesos and the Company's reporting
currency is the U.S. dollar. Assets and liabilities are translated
from the functional currency to the reporting currency at the
exchange rate in effect at the balance sheet date and equity at the
historical exchange rates. Revenue and expenses are translated at
rates in effect at the time of the transactions. Resulting
translation gains and losses are accumulated in a separate
component of stockholders' equity - other comprehensive income
(loss). Realized foreign currency transaction gains and losses are
credited or charged directly to operations.
Segment Reporting
FASB
ASC Topic 280,
Segment
Reporting
, requires that an enterprise report selected
information about operating segments in its financial reports
issued to its stockholders. Based on its current analysis,
management has determined that the Company has only one operating
segment, which is Traffic Safety Solutions. The chief operating
decision-makers use combined results to make operating and
strategic decisions, and, therefore, the Company believes its
entire operation is covered under a single segment.
Recent Accounting Pronouncements
In May
2014 the FASB issued ASU 2014-09, Revenue from contracts with
Customers (Topic 606) (May 2014). The topic of Revenue Recognition
had become broad with several other regulatory agencies issuing
standards, which lacked cohesion. The new guidance established a
“comprehensive framework” and “reduces the number
of requirements to which an entity must consider in recognizing
revenue” and yet provides improved disclosures to assist
stakeholders reviewing financial statements. The amendments in this
Update are effective for annual reporting periods beginning after
December 15, 2017. Early adoption is permitted for annual reporting
periods beginning after December 31, 2016. The Company will adopt
the methodologies prescribed by this ASU by the date required.
Adoption of the ASU is not expected to have a significant effect on
the Company’s consolidated financial statements.
The
FASB has issued ASU No. 2014-15, Presentation of Financial
Statements-Going Concern (Subtopic 205-40): Disclosure of
Uncertainties about an Entity’s Ability to Continue as a
Going Concern. ASU 2014-15 is intended to define management’s
responsibility to evaluate whether there is substantial doubt about
an organization’s ability to continue as a going concern and
to provide related footnote disclosures. Under Generally Accepted
Accounting Principles (GAAP), financial statements are prepared
under the presumption that the reporting organization will continue
to operate as a going concern, except in limited circumstances.
Financial reporting under this presumption is commonly referred to
as the going concern basis of accounting. The going concern basis
of accounting is critical to financial reporting because it
established the fundamental basis for measuring and classifying
assets and liabilities. Currently, GAAP lacks guidance about
management’s responsibility to evaluate whether there is
substantial doubt the organization’s ability to continue as a
going concern or to provide footnote disclosures. The ASU provides
guidance to an organization’s management, with principles and
definition that are intended to reduce diversity in the timing and
content of disclosures that are commonly provided by organizations
today in the financial statement footnotes. The amendments in this
update are effective for the annual period ending after December
31, 2016, and for annual periods and interim periods thereafter.
Early application is permitted. The Company will adopt the
methodologies prescribed by this ASU by the date required. Adoption
of the ASU is not expected to have a significant effect on the
Company’s consolidated financial statements.
In
April 2015, the FASB issued ASU No. 2015-03,
“Interest-Imputation of Interest (Subtopic 835-30):
Simplifying the Presentation of the Debt Issuance Cost.” To
simplify the presentation of the debt issuance costs, the
amendments in this ASU require that debt issuance costs related to
a recognized debt liability be presented in the balance sheet as a
direct deduction from the carrying amount of that debt liability,
consistent with debt discounts. The recognition and measurement
guidance for debt issuance costs are not affected by the amendments
in this ASU. The amendments in this ASU are effective for financial
statements issued for fiscal years beginning after December 15,
2015 and interim periods within those years. By adopting this
standard, we have reclassified certain of our assets and
liabilities.
In
February 2016, FASB issued ASU-2016-02, "Leases (Topic 842)." The
guidance requires that a lessee recognize in the statement of
financial position a liability to make lease payments (the lease
liability) and a right of use asset representing its right to use
the underlying asset for the lease term. For finance leases: the
right-of-use asset and a lease liability will be initially measured
at the present value of the lease payments, in the statement of
financial position; interest on the lease liability will be
recognized separately from amortization of the right-of-use asset
in the statement of comprehensive income; and repayments of the
principal portion of the lease liability will be classified within
financing activities and payments of interest on the lease
liability and variable lease payments within operating activities
in the statement of cash flows. For operating leases: the
right-of-use asset and a lease liability will be initially measured
at the present value of the lease payments, in the statement of
financial position; a single lease cost will be recognized,
calculated so that the cost of the lease is allocated over the
lease term on a generally straight-line basis; and all cash
payments will be classified within operating activities in the
statement of cash flows. Under Topic 842 the accounting applied by
a lessor is largely unchanged from that applied under previous
GAAP. The amendments in Topic 842 are effective for the Company
beginning January 1, 2019, including interim periods within that
fiscal year. We are currently evaluating the impact of adopting the
new guidance of the consolidated financial statements.
In
January 2016, the Financial Accounting Standards Board ("FASB"),
issued Accounting Standards Update ("ASU") 2016-01, "Financial
Instruments-Overall (Subtopic 825-10): Recognition and Measurement
of Financial Assets and Financial Liabilities," which amends the
guidance in U.S. generally accepted accounting principles on the
classification and measurement of financial instruments. Changes to
the current guidance primarily affect the accounting for equity
investments, financial liabilities under the fair value option, and
the presentation and disclosure requirements for financial
instruments. In addition, the ASU clarifies guidance related to the
valuation allowance assessment when recognizing deferred tax assets
resulting from unrealized losses on available-for-sale debt
securities. The new standard is effective for fiscal years and
interim periods beginning after December 15, 2017, and is to be
adopted by means of a cumulative-effect adjustment to the balance
sheet at the beginning of the first reporting period in which the
guidance is effective. Early adoption is not permitted except for
the provision to record fair value changes for financial
liabilities under the fair value option resulting from
instrument-specific credit risk in other comprehensive income. The
Company is currently evaluating the impact of adopting this
standard.
In
November 2015, the FASB issued ASU 2015-17, "Income Taxes (Topic
740): Balance Sheet Classification of Deferred Taxes," which
simplifies the presentation of deferred income taxes by requiring
that deferred tax liabilities and assets be classified as
noncurrent in a classified statement of financial position. This
ASU is effective for financial statements issued for annual periods
beginning after December 16, 2016, and interim periods within those
annual periods. The adoption of this standard will not have any
impact on the Company's financial position, results of operations
and disclosures.
NOTE 4 – LINE OF CREDIT AND OTHER NOTES PAYABLE
On July
12, 2016 (the “Closing Date”), the Company entered into
a loan and security agreement (the “Loan Agreement”)
with Fundamental Funding LLC (the
“Lender”). The Loan Agreement provides for a
multi-draw loan to the Company for (i) the Company’s accounts
receivable, the lesser of (y) $2,500,000 or (z) 85% of the
Company’s eligible accounts and (ii) the Company’s
inventory advances, the lesser of (y) $500,000 or (z) 50% of the
eligible inventory (the “Revolving Loans”). The maximum
amount available to the Company under the Loan Agreement for the
Revolving Loans is $3,500,000 (the “Credit Limit”). In
addition, the Lender agreed to provide the Company with an
accommodation loan in an amount not to exceed $500,000, which shall
be repaid in thirty-six (36) equal monthly installments of
principal and interest (the “Accommodation Loan” and
together with the Revolving Loans, the
“Loans”).
On the
Closing Date, the Lender advanced the Company an amount equal to
$533,670. The amounts advanced under the Loan Agreement
are due and payable on the three (3) year anniversary of the
Closing Date (the “Maturity Date”), and thereafter, the
Maturity Date shall automatically be extended for successive
periods of one year unless the Company shall give lender written
notice of termination not less than ninety (90) days prior to the
end of such term or renewal term, as applicable. Lender may
terminate the Loan Agreement at any time in its sole discretion by
giving the Company ninety (90) days prior written notice, provided
that upon an Event of Default (as defined in the Loan Agreement),
Lender may terminate the Loan Agreement without notice to the
Company, effective immediately. Upon termination by the Lender, the
Company shall be required to pay certain termination fees based on
a percentage of the Credit Limit as set forth in the Loan
Agreement.
The
outstanding principal balance under the Note for the Revolving
Loans shall bear interest at a rate per annum equal to the
“prime rate” published from time to time in
the
Wall Street
Journal
(the “Prime Rate”), plus 1.75% per
annum, accruing daily and payable monthly. The outstanding
principal balance under the Accommodation Loan shall bear interest
at a rate per annum equal to the Prime Rate in effect from time to
time, plus 12.75% per annum, accruing daily and payable
monthly. Notwithstanding any other provision
in the Loan Agreement, interest on Loans shall be calculated on the
higher of: (i) the actual average monthly balance of all Loans from
the prior month, or (ii) $1,350,000. In addition the Company will
be subject to certain monthly or annual fees on the Loans as set
forth in the Loan Agreement.
The
remaining portion of Credit Limit may be advanced to the Company
upon written notice provided to the Lender during the period
beginning from the Closing Date through the Maturity Date provided
no default has occurred under the Loan Agreement. The Company may
prepay any portion of the Accommodation Loan, in whole or in part,
to Lender on or prior to the Maturity Date.
Initial
borrowings under the Loan Agreement were subject to, among other
things, the substantially concurrent repayment by the Company of
all amounts due and owing under the Company’s credit
facility, dated May 24, 2014, with Rosenthal & Rosenthal, Inc.
and the satisfaction and termination of such borrowing and all
liens thereunder (collectively, the “Rosenthal
Loan”). All amounts owed under the Rosenthal Loan,
which was approximately an aggregate of $2,253,617, was satisfied
and terminated by the Company on the Closing Date.
In
addition, on the Closing Date, the Company entered into a
subordination agreement with each of C.B. Brechin and Scott
Rutherford, the Company’s chief executive officer and chief
strategy officer, respectively, as well as with the Investor
described in Note 6 pursuant to which each of the parties agreed to
subordinate all present and future indebtedness held by each of
them to the obligations of the Lender.
On the
Closing Date, as part of the Loan Agreement and to secure the
payment and performance of all of the obligations owed to Lender
under the Loan Agreement when due, the Company granted to Lender a
security interest in all right, title and interest to all assets of
the Borrower, whether now owned or hereafter arising or acquired
and wherever located.
The
Loan Agreement contains customary affirmative and negative
covenants for loan agreements of its type, including but not
limited to, limiting the Company’s ability to pay dividends
or make any distributions, incur additional indebtedness, grant
additional liens, engage in any other lime of business, make
investments, merge, consolidate or sell all or substantially all of
its assets and enter into transactions with related
parties. The Loan Agreement also contains certain
financial covenants, including, but not limited to, a debt service
coverage ratio.
The
Loan Agreement includes customary events of default, including but
not limited to, failure to pay principal, interest or fees when
due, failure to comply with covenants, default under certain other
indebtedness, certain insolvency or bankruptcy events, the
occurrence of certain material judgments the institution of any
proceeding by a government agency or a change of control of the
Company.
All
borrowings under the Loan Agreement are due upon a default under
the terms of the Loan Agreement. The Company’s obligations
under the Loan Agreement are guaranteed by C.B. Brechin, the
Company’s chief executive officer pursuant to the terms of a
surety agreement.
At
September 30, 2016, the Company had $836,813 in outstanding
indebtedness under the Revolving Facility and $500,000 in
outstanding indebtedness under the Term Loan, and the Company could
have borrowed up to an additional $2,163,187 under the Revolving
Facility. As of September 30, 2016, we were out of compliance
with one of the financial covenants contained in the Credit
Facility as a result of the loss recorded for the nine months ended
September 30, 2016. We reported this non-compliance to
Fundamental, and requested a waiver for the nine months ended
September 30, 2016.
The
Company financed certain vehicles and equipment under finance
agreements. The agreements mature at various dates through December
2017. The agreements require various monthly payments of principal
and interest until maturity. At September 30, 2016 and December 31,
2015, financed assets of $26,539 and $47,732, respectively, net of
accumulated amortization of $115,377 and $98,184, respectively,
were included in property and equipment on the balance sheets. The
weighted average interest rate was 3.75% at September 30, 2016 and
December 31, 2015.
NOTE 5 – CONVERTIBLE NOTES PAYABLE –
STOCKHOLDERS
Brekford financed the repurchase of shares of its common stock and
warrants from the proceeds of convertible promissory notes that
were issued by Brekford on November 9, 2009 in favor
of a
lender group that included two of its directors, Messrs. C.B.
Brechin and Scott Rutherford, in the principal amounts of $250,000
each (each, a “Promissory Note” and together, the
“Promissory Notes”). Each Promissory Note bears
interest at the rate of 12% per annum and at the time of issuance
was to be convertible into shares of Brekford common stock, at the
option of the holder, at an original conversion price of $.07 per
share. At the time of issuance, Brekford agreed to pay the unpaid
principal balance of the Promissory Notes and all accrued but
unpaid interest on the date that was the earlier of (i) two years
from the issuance date or (ii) 10 business days after the date on
which Brekford closes an equity financing that generates gross
proceeds in the aggregate amount of not less than
$5,000,000.
On
April 1, 2010, Brekford and each member of the lender group
executed a First Amendment to each Promissory Note, which amended
the respective Promissory Note as follows:
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Revise
the conversion price in the provision that allows the holder of the
Promissory Note to elect to convert any outstanding and unpaid
principal portion of the Promissory Note and any accrued but unpaid
interest into shares of the common stock at a price of fourteen
cents ($0.14) per share, and
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Each
Promissory Note’s maturity date was extended to the earlier
of (i) four years from the issuance date or (ii) 10 business days
after the date on which Brekford closes an equity financing that
generates gross proceeds in the aggregate amount of not less than
$5,000,000.
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On
November 8, 2013, Brekford and each member of the lender group
agreed to extend the maturity dates of the Promissory Notes to the
earlier of (i) November 9, 2014 or (ii) 10 business days after the
date on which Brekford closes an equity financing that generates
gross proceeds in the aggregate amount of not less than
$5,000,000.
On November 9, 2015, the maturity dates of the Promissory Notes
were extended to the earlier of (i) November 9, 2016 or
(ii) 10 business days from the date on which Brekford closes
an equity financing that generates gross proceeds in the aggregate
amount of not less than $5,000,000.
On November 4, 2016, the maturity dates of the Promissory Notes
were extended to the earlier of (i) November 9, 2017 or
(ii) 10 business days from the date on which Brekford closes
an equity financing that generates gross proceeds in the aggregate
amount of not less than $5,000,000. Mr. Brechin and Mr. Rutherford
have indicated that they will not exercise their right of repayment
prior to September 30, 2017.
The Company anticipates the maturity date of the Promissory Notes
will continue to be extended for the foreseeable future; thus, they
are classified as long-term liabilities. As of September 30, 2016
and December 31, 2015, the amounts outstanding under the Promissory
Notes totaled $500,000.
NOTE 6 – CONVERTIBLE PROMISSORY NOTES PAYABLE -
INVESTOR
On March 17, 2015, the Company entered into a note and warrant
purchase agreement (the “Agreement”) with an accredited
investor (the “Investor”) pursuant to which the
Investor purchased an aggregate principal amount of $715,000 of a
6% convertible promissory note issued by the Company for an
aggregate purchase price of $650,000 (the “Investor
Note”). The Investor Note bears interest at a rate of 6% per
annum and the principal amount is due on March 17, 2017. Any
interest that accrues under the Investor Note is payable either
upon maturity or upon any principal being converted on any
voluntary conversion date (as to that principal amount then being
converted). The Investor Note is convertible at the option of the
Investor at any time into shares of Common Stock at a conversion
price equal to the lesser of (i) $0.25 per share and (ii) 70% of
the average of the lowest three volume weighted average prices for
the twelve (12) trading days prior to such conversion (the
“Conversion Price”). In no event can the Conversion
Price be less than $0.10; provided, however, that if on or after
the date of the Agreement the Company sells any Common Stock or
Common Stock Equivalents (as defined in the Agreement) at an
effective price per share that is less than $0.10 per share, then
the Conversion Price shall be equal to the par value of the Common
Stock then in effect. In connection with the Agreement, the
Investor received a warrant to purchase 780,000 shares of Common
Stock (the “Warrant”). The Warrant is exercisable for a
period of five years from the date of issuance at an exercise price
of $0.50 per share, subject to adjustment (the “Exercise
Price”).
On October 23, 2015, the Investor converted $25,000 of principal
and $904 of accrued interest due under the Investor Note into
169,530 shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $19,869.
On December 2, 2015, the Investor converted $50,000 of principal
and $2,129 of accrued interest due under the Investor Note into
349,155 shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $35,160.
On February 26, 2016 the Investor converted $50,000 of principal
and $2,844 of accrued interest due under the Investor Note into
476,500 shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $49,525.
On March 31, 2016 the Investor converted $50,000 of principal and
$3,123 of accrued interest due under the Investor Note into 510,310
shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $72,947.
On May 31, 2016 the Investor converted $50,000 of principal and
$3,625 of accrued interest due under the Investor Note into 605,928
shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $38,923.
On July 1, 2016 the Investor converted $50,000 of principal and
$3,880 of accrued interest due under the Investor Note into 699,733
shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $40,875.
On July 27, 2016 the Investor converted $50,000 of principal and
$4,093 of accrued interest due under the Investor Note into 758,670
shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $45,024.
On August 31, 2016 the Investor converted $50,000 of principal and
$4,381 of accrued interest due under the Investor Note into 776,869
shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $44,618.
The
following table provides information relating to the Investor Note
at September 30, 2016:
|
|
|
Convertible
promissory note payable
|
$
340,000
|
$
640,000
|
Original issuance
discount, net of amortization of the $57,896 and $29,820 as of
September 30, 2016 and December 31, 2015
|
(7,104
)
|
(35,180
)
|
Beneficial
conversion feature, net of amortization of $496,948 and $255,960 as
of September 30, 2016 and December 31, 2015
|
(60,973
)
|
(301,960
)
|
Warrant feature,
net of amortization of the $82,015 and $42,243 as of September 30,
2016 and December 31, 2015
|
(10,063
)
|
(49,835
)
|
Original issuance
cost, net of amortization of $40,433 and $20,744 as of September
30, 2016 and December 31, 2015
|
(12,066
)
|
(31,756
)
|
Convertible
promissory note payable, net
|
$
249,794
|
$
221,269
|
We evaluated the financing transactions in accordance with ASC
Topic 470, Debt with Conversion and Other Options, and
determined that the conversion feature of the Investor Note was
afforded the exemption for conventional convertible instruments due
to its fixed conversion rate. The Investor Note has an explicit
limit on the number of shares issuable so it did meet the
conditions set forth in current accounting standards for equity
classification. The debt was issued with non-detachable conversion
options that are beneficial to the investors at inception, because
the conversion option has an effective strike price that is less
than the market price of the underlying stock at the commitment
date. The accounting for the beneficial conversion feature requires
that the beneficial conversion feature be recognized by allocating
the intrinsic value of the conversion option to additional
paid-in-capital, resulting in a discount on the convertible notes,
which will be amortized and recognized as interest
expense.
Accordingly, a portion of the proceeds was allocated to the Warrant
based on its relative fair value, which totaled $92,079 using the
Black Scholes option-pricing model. Further, the Company attributed
a beneficial conversion feature of $557,921 to the shares of
Common Stock issuable under the Investor Note based upon the
difference between the effective Conversion Price and the closing
price of the Common Stock on the date on which the Investor Note
was issued. The assumptions used in the Black-Scholes model are as
follows: (i) dividend yield of 0%;
(ii) expected volatility of 80.5%, (iii) weighted
average risk-free interest rate of 1.56%, (iv) expected
life of five years, and (v) estimated fair value of the Common
Stock of $0.26 per share. The expected term of the Warrant
represents the estimated period of time until exercise and is based
on historical experience of similar awards giving consideration to
the contractual terms. The Company recorded amortization of the
beneficial conversion feature and warrant feature of the Investor
Note in other expense in the amount of $240,988 and $39,773 during
the nine months ended September 30, 2016 and $255,960 and $42,243,
during the year ended December 31, 2015 which also includes the
unamortized beneficial conversion feature and warrant feature
attributable to the $375,000 principal converted to
equity.
The Company recorded an original issue discount of $65,000 to be
amortized over the term of the Agreement as interest expense. The
Company recognized $28,076 and $29,820 of interest expense as a
result of the amortization during the nine months ended September
30, 2016 and the year ended December 31, 2015 respectively, which
also includes the unamortized original issue discount attributable
to the $375,000 principal converted to equity.
NOTE 7 – WARRANT DERIVATIVE LIABILITY
On
March 17, 2015, in conjunction with the issuance of the Investor
Note (see Note 6), the Company issued the Warrant, which permits
the Investor to purchase 840,000 shares of Common Stock, including
60,000 related to the financing costs, with an exercise price of
$0.50 per share and a life of five years.
The
Exercise Price is subject to anti-dilution adjustments that allow
for its reduction in the event the Company subsequently issues
equity securities, including shares of Common Stock or any security
convertible or exchangeable for shares of Common Stock, for no
consideration or for consideration less than $0.50 a share. The
Company accounted for the conversion option of the Warrant in
accordance with ASC Topic 815. Accordingly, the conversion option
is not considered to be solely indexed to the Company’s own
stock and, as such, is recorded as a liability. The derivative
liability associated with the Warrant has been measured at fair
value at March 17, 2015 and September 30, 2016 using the Black
Scholes option-pricing model. The assumptions used in the
Black-Scholes model are as follows: (i) dividend yield of
0%; (ii) expected volatility of 81.67% -80.50%;
(iii) weighted average risk-free interest rate of 1.14% -
1.56% (iv) expected life of five years; and (v) estimated fair
value of the Common Stock of $0.10-$0.26 per share.
At
September 30, 2016, the outstanding fair value of the derivative
liability was $18,228.
NOTE 8 – LEASES
Capital Leases
At
September 30, 2016 and December 31, 2015, no capital lease was
included in property and equipment on the consolidated balance
sheets.
Operating Leases
The
Company rents office space under separate non-cancelable
operating leases. Rent expense under our main headquarters lease,
expiring on April 30, 2020 amounted to $128,432 and $
126,486
for the nine
months ended September 30, 2016 and 2015,
respectively.
The
Company also leases approximately 2,500 square feet of office space
from a related party under a non-cancelable operating lease
expiring on June 30, 2017. Rent expense under this lease amounted
to $36,900 for the nine months ended September 30, 2016 and 2015,
respectively.
NOTE 9 – MAJOR CUSTOMERS AND VENDORS
Major Customers
The Company has several contracts with government agencies, of
which net revenue from one major customer during the nine months
ended September 30, 2016 represented 14% of the total net revenue
for the period. Accounts receivable due from three customers at
September 30, 2016 amounted to 43% of total accounts
receivable.
For the period ended September 30, 2015, the Company has several
contracts with government agencies, of which net revenue from one
major customer represented 23% of the total net revenue for the
period. Accounts receivable due from three customers at September
30, 2015 amounted to 60% of total accounts receivable.
Accounts
receivable due from these customers at December 31, 2015 amounted
to 53% of total accounts receivable at that date.
Major Vendors
The
Company purchased substantially all hardware products that it
resold during the periods presented from two major
distributors. Revenues from hardware products amounted to 51%
and 47% of total revenues for the nine months ended September 30,
2016 and 2015, respectively. As of September 30, 2016 and
2015, accounts payable due to these distributors amounted to 62%
and 43% of total accounts payable, respectively.
Accounts
payable due to these distributors at December 31, 2015, amounted to
72% of total accounts payable at that date.
NOTE 10 - STOCKHOLDERS’ EQUITY
Warrants
The
assumptions used to value warrant grants during the nine months
ended September 30, 2016, which consisted solely of the Warrant,
were as follows:
|
Nine months
ended
September 30,
2016
|
Expected life (in
years)
|
5.00
|
Volatility
|
81.67
%
|
Risk free interest
rate
|
1.14
%
|
Expected Dividend
Rate
|
0
|
Summary
of the warrant activity for
the nine
months ended September 30, 2016 is as follows
:
|
|
Weighted
Average
Exercise
Price
|
Weighted
Average
Remaining
Contractual Life
(Years)
|
Aggregate
Intrinsic
Value
|
Outstanding at
January 1, 2016
|
840,000
|
$
0.50
|
4.21
|
$
0.00
|
Granted
|
—
|
—
|
—
|
0.00
|
Forfeited or
expired
|
—
|
—
|
—
|
0.00
|
Exercised
|
—
|
—
|
—
|
—
|
Outstanding at
September 30, 2016
|
840,000
|
0.50
|
3.46
|
0.00
|
Exercisable at
September 30, 2016
|
840,000
|
0.50
|
3.46
|
0.00
|
The
weighted average remaining contractual life of warrants outstanding
as of September 30, 2016 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
0.50
|
840,000
|
840,000
|
3.46
|
|
|
|
|
|
840,000
|
840,000
|
3.46
|
NOTE 11 – SHARE-BASED COMPENSATION
The
Company has issued shares of restricted common stock and warrants
to purchase shares of common stock and has granted non-qualified
stock options to certain employees and non-employees. On April 25,
2008, the Company’s stockholders approved the 2008 Stock
Incentive Plan (the “2008 Incentive
Plan”).
Stock Options
Option grants during the nine months ended September 30, 2016 were
primarily made to non-employee directors who elected to receive
options for their Board service. The options had a grant date fair
value of $0.07 per share and will vest and become exercisable with
respect to option shares over a three year period commencing from
the date of grant at a rate of 33.33% per year.
The
Company recorded $3,515 and $10,988 and $4,360 and $8,100 in stock
option compensation expense for the three and nine months ended
September 30, 2016 and 2015, respectively, related to the stock
option grants.
Summary
of the option activity for nine months ended September 30, 2016 is
as follows: